Market Forces, Not Tariffs, Drive Industrial Success

Oren Cass, in an Atlantic article, argues for higher tariffs, claiming that free trade generates negative externalities by undervaluing the nation’s “industrial base.” He posits that individual actors, focused on cost savings through imports, overlook the collective benefits of domestic production. Cass believes tariffs counteract these harms by promoting domestic industry.

However, this argument overlooks the sophisticated mechanisms of a free market. Market signals, including prices, wages, and investment decisions, already incorporate the value of domestic production. Firms like John Deere, driven by profit, optimize their resource allocation, including factory capacity and workforce, based on these signals. Their objective is profit maximization, not bolstering the “industrial base,” yet their actions contribute to it nonetheless. Market signals, amplified through financial markets, offer firms critical feedback, enabling them to adjust their production strategies dynamically. Share prices and lending decisions provide powerful incentives for efficiency and course correction. This decentralized system, driven by individual incentives, is far more effective than centralized planning in allocating resources effectively.

Cass’s critique of financial markets as being “too large” reveals a fundamental misunderstanding of their role. Financial markets channel savings into specific investment projects deemed most promising, effectively directing resources away from less productive ventures. This dynamic optimization of resource allocation within the industrial base, rather than mere expansion, is essential for economic growth. Cass treats the industrial base as a monolithic entity, failing to recognize the intricate interplay of complementary and substitute capital goods, and the constant evolution of optimal capital structures.

The notion that manufacturing inherently holds greater value than services, such as finance, is another fallacy. Financial markets are crucial for allocating capital to the most productive segments of manufacturing. Curtailing financial activity would starve manufacturing of essential investment, akin to limiting transportation services – both are crucial supporting functions. A robust industrial base requires a sophisticated and well-functioning financial market to support its growth and development. Cass’s simultaneous arguments for a larger industrial base and smaller financial markets are inherently contradictory.

Cass’s argument also misconstrues the impact of imports on domestic industries. Increased imports do not directly diminish the physical capacity of domestic plants. Rather, they lower the capital value of those plants if they continue producing the same goods. This incentivizes producers to repurpose those resources towards more profitable ventures, contributing to overall economic efficiency. The assumption that resources released from import-competing industries are either consumed or redeployed less productively is baseless. Protectionism, by hindering this reallocation, actually reduces the overall productivity and economic value of the industrial base.

Contrary to Cass’s assertions, American industrial capacity is at a historical peak, significantly exceeding levels predating China’s entry into the WTO. This robust performance undermines the claim that free trade undervalues the industrial base. Furthermore, Cass conflates national security concerns with economic arguments for protectionism. While national security considerations are valid, they should be analyzed separately from economic arguments for clarity and to prevent rent-seeking behavior disguised as national security concerns. A nuanced approach recognizes the distinct nature of these arguments, avoiding the common protectionist tactic of blending them to justify trade restrictions.

In conclusion, Cass’s argument for tariffs based on the alleged negative externalities of free trade is flawed. It overlooks the market’s inherent mechanisms for valuing domestic production, misrepresents the role of financial markets, and misunderstands the dynamic reallocation of resources prompted by import competition. Empirical evidence further contradicts his claims, demonstrating the continued strength of American industrial capacity under free trade. While national security considerations can warrant specific trade interventions, they should not be conflated with economic justifications for protectionism, which are demonstrably weak in this case.