AEI Doug Irwin: The ‘consumer-cost-of-protection argument’ should be augmented by the ‘businesses are consumers too argument’ In a short 27-page pamphlet published by AEI in 1996 titled Three Simple Principles of Free Trade Policy, Dartmouth economist Douglas A. Irwin explained why he thinks there is a problem with pushing the “consumer cost of protection” argument too much. Not that the argument is wrong, but that it has failed in the political arena, partly because jobs are viewed as being much more important than consumer welfare in the political debate on trade. As Professor Irwin writes “If the question comes down to saving a few hundred jobs in some industry or saving consumers a few hundred dollars in income, the policy of import protection will win every time.” And of course,
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In a short 27-page pamphlet published by AEI in 1996 titled Three Simple Principles of Free Trade Policy, Dartmouth economist Douglas A. Irwin explained why he thinks there is a problem with pushing the “consumer cost of protection” argument too much. Not that the argument is wrong, but that it has failed in the political arena, partly because jobs are viewed as being much more important than consumer welfare in the political debate on trade. As Professor Irwin writes “If the question comes down to saving a few hundred jobs in some industry or saving consumers a few hundred dollars in income, the policy of import protection will win every time.” And of course, there is the political economy reality that domestic producers are always much better organized, more concentrated, better connected politically and with much greater rent-seeking resources at their disposal than the disorganized, dispersed, politically unconnected, underfunded consumers. In the section of the pamphlet titled “Businesses Are Consumers Too” Professor Irwin makes his case that the “customer-cost-of-protection argument” should be augmented by the “businesses are consumers too argument” to have a greater chance of combatting trade protection with a more politically potent message. Here’s Doug Irwin (emphasis mine):
I believe that this simple augmentation can go a long way in leveling the playing field between those who want some form of trade protection and those who do not. Business firms are, in fact, bigger consumers of imported products than are U.S. households. The U.S. Department of Commerce publishes data on US imports by end-use classification, wherein they attempt to determine what the imports are actually used for. The table above shows that distribution for 2017.
Industrial materials and capital goods are, for the most part, not sold directly to households but to business firms as an input into their production process. The table above indicates that nearly 60% of U.S. imports are intermediate components of raw materials that are inputs to production, not final consumer goods. How does recognition of this fact affect our thinking about trade policy and alter the political debate over the desirability of intervention?
One can go down the list of past trade policy interventions and see that many of the commodities at issue constitute intermediate goods. Any trade intervention that raises the price of an intermediate good will at some point adversely affect most households as final consumers. But the immediate adverse effect is on other downstream user industries and, necessarily, employment in those industries. Thus, a clear link can be established between import protection and job losses in other industries. If one can augment the statement that protection will cost consumers more with the message that it will reduce employment in related industries, one has a more politically more potent argument.
For example, the United States has maintained tight quotas on sugar imports, which have pushed the U.S. price of sugar up to two and sometimes three times the world price. While U.S. consumers pay more for a bag of sugar at the grocery store as a result, the real effect has been on sugar-using industries. Food manufacturers who produce sugar-intensive products have to pay a higher price for this input than do their foreign rivals, and as a result, they are less competitive against imported and domestic substitutes. Brach’s Candy Company, for example, announced in 1990 that because of the high price of sugar in the United States it would close a factory in Chicago that employed 3,000 workers and would expand production in Canada. The United States has only 11,000 sugar farmers but more than 7,000 jobs in the sugar refining industry have been lost as imports have been squeezed out.
By viewing imports not as final consumer goods but as inputs to U.S. production, policymakers can more clearly recognize that the issue is not so much one of “saving” jobs but of “trading off” jobs between sectors. This brings home forcefully the most important lesson in all of economics – there is no such thing as a free lunch. Every action involves a trade-off of some sort. Higher domestic steel prices help employment in the steel industry but harm employment in steel-using industries. Higher domestic semiconductor prices help employment in the semiconductor industry but harm employment in semiconductor-using industries. As John Stuart Mill wrote in 1848 in the context of import protection, “The alternative is not between employing our own workers and foreigners, but between employing one class or another of our own workers.”
The “businesses are consumers too” is just one of the three excellent principles that Professor Irwin highlights in his essay, the other two are: a) a tax on imports is a tax on exports and b) trade imbalances reflect capital flows. There is a lot of sound economic thinking on trade and trade policy in the 27 pages of Irwin’s easy-to-read, non-technical pamphlet — maybe it should be required reading for Trump’s trade team?
A few years ago, George Mason economist and uber-blogger Don Boudreaux extended Irwin’s “businesses are consumers” argument by pointing out that “Almost All Imports Are Inputs,” here’s Don:
Nearly all imports that are not raw materials are appropriately classified as intermediate components. Thus, the percentage of American imports that together comprise the category “intermediate components or raw materials” is far larger than 60%. Indeed, it’s likely well over 95%. Nearly all American imports – even of goods formally classified as consumer goods are inputs into the production of producers in America.
Consider, for example, a truckload of individually packaged bed linen imported into America from China. And to make matters simpler that no American-supplied cotton or other inputs, at any stage of production, went into making these packages of bed linen. Suppose, reasonably, that these packages of bed linen will be offered for sale to final consumers in Walmart stores throughout the United States.
These packages of bed linen are classified as consumer goods. They are, therefore, not among the 60% of American imports that are conventionally classified as intermediate components. Yet I submit that this conventional classification is mistaken. These packages of bed linen, when unloaded on an American dock, are not sold directly to final consumers. They have already been purchased by Wal-Mart. These packages of bed linen are intermediate goods; they are inputs into Wal-Mart’s production process.
So when Wal-Mart imports packaged bed linen, it does not buy these goods as consumer goods; it buys them as intermediate goods – goods that are used by Wal-Mart as inputs into producing the final consumer service that we might call “shopping convenience.” Only by supplying this latter service – shopping convenience – does Wal-Mart earn profits. From Wal-Mart’s perspective, imports from China of packaged bed linen are inputs used to produce its own output no less so than are Wal-Mart’s delivery trucks, warehouses, cash registers, advertising, and corporate stationery.
MP: It’s an excellent point and helps us understand that tariffs like the recent ones imposed on imported washing machines will not only harm U.S. consumers, but will also harm the U.S. retailers like Best Buy, Lowe’s, J.C. Penney, Sears, and Home Depot that sell Samsung and LG washers by raising the prices of inputs for those stores.