In a 1987 address to the US nation, Republican President Ronald Reagan discussed the question of tariffs. His message was clear.
You see, at first, when someone says, ‘Let’s impose tariffs on foreign imports,’ it looks like they’re doing the patriotic thing by protecting American products and jobs. And sometimes for a short while it works – but only for a short time. What eventually occurs is:
First, homegrown industries start relying on government protection in the form of high tariffs. They stop competing and stop making the innovative management and technological changes they need to succeed in world markets.
And then, while all this is going on, something even worse occurs: high tariffs inevitably lead to retaliation by foreign countries and the triggering of fierce trade wars. The result is more and more tariffs, higher and higher trade barriers, and less and less competition. So, soon, because of the prices made artificially high by tariffs that subsidise inefficiency and poor management, people stop buying.
Then the worst happens: markets shrink and collapse; businesses and industries shut down; and millions of people lose their jobs.
The memory of all this occurring back in the thirties made me determined when I came to Washington to spare the American people the protectionist legislation that destroys prosperity.
Now, it hasn’t always been easy. There are those in this Congress, just as there were back in the ’30s, who want to go for the quick political advantage, who will risk America’s prosperity for the sake of a short-term appeal to some special interest group, who forget that more than five million American jobs are directly tied to the foreign export business and additional millions are tied to imports.
For those of us who lived through the Great Depression, the memory of the suffering it caused is deep and searing. And today, many economic analysts and historians argue that high tariff legislation, passed back in that period called the Smoot-Hawley Tariff, greatly deepened the Depression and prevented economic recovery.
He returned to the topic of tariffs in November 1988, when he reflected on the benefits of free and fair trade and the dangers of protectionism.
Here in America, as we reflect on the many things we have to be grateful for, we should take a moment to recognize that one of the key factors behind our nation’s great prosperity is the open trade policy that allows the American people to freely exchange goods and services with free people around the world. The freedom to trade is not a new issue for America.
In 1776 our Founding Fathers signed the Declaration of Independence, charging the British with a number of offenses, among them, and I quote, ‘cutting off our trade with all parts of the world’.
And that same year, a Scottish economist named Adam Smith launched another revolution with a book entitled ‘The Wealth of Nations’, which exposed for all time the folly of protectionism. Over the past 200 years, not only has the argument against tariffs and trade barriers won nearly universal agreement among economists but it has also proven itself in the real world, where we have seen free-trading nations prosper while protectionist countries fall behind.
America’s most recent experiment with protectionism was a disaster for the working men and women of this country. When Congress passed the Smoot-Hawley tariff in 1930, we were told that it would protect America from foreign competition and save jobs in this country – the same line we hear today. The actual result was the Great Depression, the worst economic catastrophe in our history; one out of four Americans were thrown out of work. Two years later, when I cast my first ballot for President, I voted for Franklin Delano Roosevelt, who opposed protectionism and called for the repeal of that disastrous tariff.
Ever since that time, the American people have stayed true to our heritage by rejecting the siren song of protectionism. In recent years, the trade deficit led some misguided politicians to call for protectionism, warning that otherwise we would lose jobs. But they were wrong again. In fact, the United States not only didn’t lose jobs, we created more jobs than all the countries of Western Europe, Canada, and Japan combined. The record is clear that when America’s total trade has increased, American jobs have also increased. And when our total trade has declined, so have the number of jobs.
Part of the difficulty in accepting the good news about trade is in our words. We too often talk about trade while using the vocabulary of war. In war, for one side to win, the other must lose. But commerce is not warfare. Trade is an economic alliance that benefits both countries. There are no losers, only winners. And trade helps strengthen the free world.
Yet today protectionism is being used by some American politicians as a cheap form of nationalism, a fig leaf for those unwilling to maintain America’s military strength and who lack the resolve to stand up to real enemies – countries that would use violence against us or our allies. Our peaceful trading partners are not our enemies; they are our allies.
We should beware of the demagogs who are ready to declare a trade war against our friends – weakening our economy, our national security, and the entire free world – all while cynically waving the American flag. The expansion of the international economy is not a foreign invasion; it is an American triumph, one we worked hard to achieve, and something central to our vision of a peaceful and prosperous world of freedom.
After the Second World War, America led the way to dismantle trade barriers and create a world trading system that set the stage for decades of unparalleled economic growth. And in one week, when important multilateral trade talks are held in Montreal, we will be in the forefront of efforts to improve this system. We want to open more markets for our products, to see to it that all nations play by the rules, and to seek improvement in such areas as dispute resolution and agriculture. We also want to bring the benefits of free trade to new areas, including services, investment, and the protection of intellectual property. Our negotiators will be working hard for all of us.
Yes, back in 1776, our Founding Fathers believed that free trade was worth fighting for. And we can celebrate their victory because today trade is at the core of the alliance that secure the peace and guarantee our freedom; it is the source of our prosperity and the path to an even brighter future for America.
The questions below address whether these radio addresses by President Reagan are relevant in today’s context of the imposition of tariffs by President Trump.
Videos of Radio Addresses
Articles and postings
Questions
- Summarise Ronald Reagan’s arguments.
- How would Donald Trump reply to these arguments?
- Can tariffs ever be justified on efficiency grounds?
- Can tariffs be justified as a bargaining ploy? Can they be used as a means of achieving freer and fairer trade?
- Find out why the Smoot-Hawley Tariff Act was introduced in 1930 and what were its consequences.
- How does the World Trade Organization seek to promote freer and fairer trade? How does it resolve trade disputes?
International wholesale gas prices have soared in recent months. This followed a cold winter in 2021/22 across Europe, the bounceback in demand as economies opened up after COVID and, more recently, pressure on supplies since the Russian invasion of Ukraine and the resulting restricted gas supplies from Russia. The price of gas traded on the UK wholesale market is shown in Chart 1 (click here for a PowerPoint). Analysts are forecasting that the wholesale price of gas will continue to rise for some time. The higher price of gas has had a knock-on effect on wholesale electricity prices, as gas-fired power stations are a major source of electricity generation and electricity prices.
In the UK, domestic fuel prices were capped by the regulator, Ofgem. The cap reflected wholesale prices and was designed to allow electricity suppliers to make reasonable but not excessive profits. The cap was adjusted every six months, but this was been reduced to three months to reflect the rapidly changing situation. Prices are capped for both gas and electricity for both the standing charge and the rate per kilowatt hour (kWh). This is illustrated in Chart 2 (click here for a PowerPoint).
The effects of the cap were then projected in terms of a total annual bill for a typical household consuming 12 000 kWh of gas and 2900 kWh of electricity. Chart 3 shows the typical fuel bill for the last four price caps and, prior to the mini-Budget of 23 September, the projected price caps for the first and second quarters of 2023 based on forecasts at the time of wholesale prices (click here for a PowerPoint). As you can see, wholesale gas and electricity prices account for an increasing proportion of the total bill. The remaining elements in cost consist of profits (1.9% assumed), VAT (5%), operating costs, grid connection costs and green levies (around £153). The chart shows that, without government support for prices, the price cap would have risen by 80.6% in October 2022 and was projected to rise by a further 51% in January 2023 and by another 23% in March 2023. If this were to have been the case, then prices would have risen by 481% between the summer of 2021 and March 2023.
This was leading to dire warnings of extreme fuel poverty, with huge consequences for people’s health and welfare, which would put extra demands on an already stretched health service. Many small businesses would not be able to survive the extra fuel costs, which would lead to bankruptcies and increased unemployment.
Future wholesale gas prices
Energy market analysts expect wholesale gas prices to remain high throughout 2023, with little likelihood that gas supplies from Russia will increase. Some European countries, such as Germany, have been buying large amounts of gas to fill storage facilities before winter and before prices rise further. This has added to demand.
The UK, however, has only limited storage facilities. Although it is not an importer of gas from Russia and so, in one sense, storage facilities are less important at the current time, wholesale gas prices reflect international demand and supply and thus gas prices in the UK will be directly affected by an overall global shortage of supply.
What would have been the response to the projected rise in gas prices? Eventually demand would fall as substitute fuels are used for electricity generation. But demand is highly inelastic. People cannot readily switch to alternative sources of heating. Most central heating is gas fired. People may reduce consumption of energy by turning down their heating or turning it off altogether, but such reductions are likely to be a much smaller percentage than the rise in price. Thus, despite some use of other fuels and despite people cutting their energy usage, people would still end up spending much more on energy.
Over the longer term, new sources of supply of gas, including liquified natural gas (LNG), may increase supply. And switching to green energy sources for electricity generation, may bring the price of electricity back down and lead to some substitution been gas and electricity in the home and businesses. Also improved home insulation and the installation of heat pumps and solar panels in homes, especially in new builds, may reduce the demand for gas. But these changes take time. Chart 4 illustrates the situation (click here for a PowerPoint).
Both demand and supply are relatively inelastic. The initial demand and supply curves are D1 and S1. Equilibrium price is P1 (point a). There is now a fall in supply. Supply shifts to S2. With an inelastic demand, there is a large rise in price to P2 (point b).
Over two or three years, there is a modest fall in demand (as described above) to D2 and a modest rise in supply to S3. Price falls back somewhat to P3 (point c). Over a longer period of time, these shifts would be greater and the price would fall further.
Possible policy responses
What could the government do to alleviate the problem? Consensus was that the new Conservative Prime Minister, Liz Truss, and her Chancellor, Kwasi Kwarteng, would have to take radical measures if many households were to avoid severe hardship and debt. One proposal was to reduce VAT on domestic energy from 5% to zero and to cut green levies. Although this would help, it would make only a relatively small dent in people’s rising bills.
Another proposal was to give people cash payments to help with their bills. The more generous and widespread these payments, the more costly they would be.
One solution here would be to impose larger windfall taxes on oil and gas producers (as opposed to retailers). Their profits have soared as oil and gas prices have soared. Such a move is generally resisted by those on the right of politics, arguing that it could discourage investment in energy production. Those on the centre and left of politics argue that the profits are the result of global factors and not because of wise business decisions by the energy producers. A windfall tax would only take away these excess profits.
The EU has agreed a tax on fossil fuel companies’ surplus profits made either this year or next. It is also introducing a levy on the excess revenues that other low-cost power producers make from higher electricity prices.
Another proposal was to freeze retail energy prices at the current or some other level. This would make it impossible for energy suppliers to cover their costs and so they would have to be subsidised. This again would be very expensive and would require substantially increased borrowing at a time when interest rates are rising, or increased taxation at a time when people’s finances are already squeezed by higher inflation. An alternative would be to cap the price North Sea producers receive. As around half of the UK’s gas consumption is from the North Sea, this would help considerably if it could be achieved, but it might be difficult to do so given that the gas is sold onto international markets.
One proposal that was gaining support from energy producers and suppliers is for the government to set up a ‘deficit fund’. Energy suppliers (retailers) would freeze energy prices for two years and take out state-backed loans from banks. These would then be paid back over time by prices being capped sufficiently high to cover costs (which, hopefully, by then would be lower) plus repayments.
Another policy response would be to decouple electricity prices from the wholesale price of gas. This is being urgently considered in the EU, and Ofgem is also consulting on such a measure. This could make wholesale electricity prices reflect the costs of the different means of generation, including wind, solar and nuclear, and would see a fall in wholesale electricity prices. At the moment, generators using these methods are making large profits.
The government’s response
On September 23, the government held a mini-Budget. One of its key elements was a capping of the unit price of energy for both households and firms. The government called this the Energy Price Guarantee. For example, those households on a variable dual-fuel, direct-debit tariff would pay no more than 34.0p/kWh for electricity and 10.3p/kWh for gas. Standing charges are capped at 46p per day for electricity and 28p per day for gas. These rates will apply for 2 years from 1/10/22 and should give an average annual household bill of £2500.
Although the government has widely referred to the ‘£2500 cap’, it is the unit price that is capped, not the annual bill. It is still the case that the more you consume, the more you will pay. As you can see from Chart 3, the average £2500 still represents an average increase per annum of just over £500 per household and is almost double the cap of £1277 a year ago. It will thus still put considerable strain on many household finances.
For businesses, prices will be capped for 6 months from 1 October at 21.1p per kWh for electricity and 7.5p per KWh for gas – considerably lower than for domestic consumers.
The government will pay subsidies to the retail energy companies to allow them to make sufficient, but not excess, profit. These subsidies are estimated to cost around £150 billion. This will be funded by borrowing, not by tax increases, with the government ruling out a windfall tax on North Sea oil and gas extracting companies. Indeed, the mini-Budget contained a number of tax reductions, including scrapping the 45% top rate of income tax, cutting the basic rate of income tax from 20% to 19% and scrapping the planned rise in corporation tax from 19% to 25%.
Articles
Data
Questions
- Why are the demand and supply of gas relatively inelastic with respect to price?
- Why are the long-run elasticities of demand and supply of gas likely to be greater than the short-run elasticities?
- Find out how wholesale electricity prices are determined. Is there a case for reforming the system and, if so, how?
- Identify ways in which people could be protected from rising energy bills.
- Assess these different methods in terms of (a) targeting help to those most in need; (b) economic efficiency.
In a recently published book, Scroogenomics, Joel Waldfogel, Professor of Business and Public Policy at the University of Pennsylvania, examines the economics of giving presents and considers whether we would be better off being Scrooges. This book brings to a general audience some of Professor Waldfogel’s work on giving. In a 1993 paper, he argued that holiday gift-giving involves a deadweight welfare loss. “I find that holiday gift-giving destroys between 10 per cent and a third of the value of gifts.” (See The Deadweight Welfare Loss of Christmas. Note: you should be able to access this from a UK university site if you are logged on.)
The core of his argument is that many gifts we give are not really what the person receiving it would have chosen. If you give someone a gift costing £10 for which the person would not have paid more than £6, then that is £4 wasted – a deadweight loss of £4.
So should we all be Scrooges and stop giving? Think of all money that would be saved and which could be spent on things that were more wanted. But wait a minute. What about the pleasure (i.e. utility) of giving? And what about the pure pleasure of receiving a gift, irrespective of the gift itself? Should these be added in to arrive at the total utility? Then there is the pleasure (or hassle) of shopping for the gift. Shouldn’t this be taken into account too? In other words, to establish deadweight loss, we need to take into account all the pleasures and displeasures of the process of giving and receiving.
Finally there is the question of whether better research on the part of the giver into the tastes of the receiver would enable them to choose more wanted gifts. Or should we simply give cash or gift tokens: at least these can be used by the recipient for whatever they choose?
Interview with Joel Waldfogel Princeton University Press, on YouTube
See also the following articles:
It’s not just Scrooge who wants Christmas abolished Financial Times, Tim Harford (20/11/09)
Stop blaming Grandma for cruddy Christmas presents Seattle Times, Joel Waldfogel (20/11/09)
It may not be the thought that counts Washington Post (22/11/09)
Economics of gift vouchers BBC News Magazine, Ruth Alexander (17/12/07)
The high cost of ugly, useless Christmas gifts Globe and Mail (Canada), Erin Anderssen (13/11/09)
Author’s argument that unappreciated gifts drag down economy isn’t Scroogish, it’s foolish Mlive.com, Nancy Crawley (8/11/09)
Give gold, not myrrh The Economist (21/12/09)
Questions
- What factors would need to be taken into account in attempting to measure the true deadweight loss of giving? Would this involve inter-personal comparisons of utility and, if so, what problems might arise from this?
- Examine whether it is better to give cash or gift tokens rather than a physical gift?
- Consider whether charitable donations would be the best form of gift to a friend or relative?
- One practice used in many families is the ‘secret Santa’. This is where everyone in the family secretly draws the name of another family member at random. They then buy a gift for this person and put the gift under the tree (or in a box). Thus each person gives just one gift and receives one gift and nobody knows who has given them their gift. Normally a maximum value of the gift is determined in advance. Consider the advantages and disadvantages of such as system. Is it a more efficient way of giving?
- What are the macroeconomic arguments for giving presents at Christmas time or at other festivals?