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Fallacious arguments for low levels of tariff protection

The argument that Nicholas Gruen has propounded, and which John Quiggin seems to have supported, that low levels of tariff protection are justified by the existence of market power in export markets, is just wrong.

I think they have in mind a simple two good model where the Lerner symmetry condition implies that it doesn’t matter whether you levy an export tax on goods in not perfectly elastic supply or instead levy equivalent tariffs on imports. In this simple two good model it doesn’t matter which traded good you tax in order, for example, to exploit the optimal tariff argument. The argument here suggests that restricting output in export markets will raise price sufficiently to increase a nation’s advantage. Specifically levying a tariff on imports in a two good world will drag resources away from the export sector, reducing output there and potentially advantaging the economy from an optimal tariff viewpoint.

But in a model that even broadly captures the features of the Australian economy this argument breaks down completely. For example if you have market power only in wool exports and you put an import tariff on car imports, then in general, that tariff will draw resources away from all sectors, not just the wool sector. Lerner symmetry disintegrates and doesn’t help design policy.

And given the vastly different production technologies in play here in the Australiuan economy a tariff on car imports may not draw any resources at all from the wool sector – instead it will draw resources away from industries with no exporting market power at all. In this case the economy will be worse off with any non-zero tariff on car imports since the tariff will be distortionary.

In general you can’t draw any conclusion about a case for low level tariffs without paying attention to the nature of complementarities and substitutabilities in the use of inputs in the economy as a whole. To suggest there is some general argument for low tariffs is an erroneous conclusion.

And to present the rejection of this fallacious argument as a kneejerk rejection of any argument against free trade is unfair. The optimal tariff type of argument can only ever be a very specialised argument that will only ever work in the most restricted circumstances. The difficulty with such fallacious arguments is that they create the impression – on the basis of an inapplicable 2*2 trade model – that there is a general argument for low levels of tariff protection in any economy with some market power in exporting. Since this would apply to almost any economy it suggests a general case against free trade.

There is no such general case and, in particular given the lack of input substitutability between the car industry and those industries where Australia does have market power, there is no specific argument for low levels of import tariff protection in this particular setting.

There is a well-known argument that cutting low tariffs to still lower levels will confer almost no national advantage in terms of output gains. This argument is correct but it has nothing to do with the fallacious argument that optimal tariff arguments on the basis of claimed monopoly power in exporting creates a general case for low level tariff protection of industries such as the car industry.

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