President Trump loves tariffs. “They are the greatest!” he tweeted recently. The sentiment would be familiar to most Latin American leaders from the middle of the 20th century. At the time, Latin America was engaged in a massive attempt to develop local industries, so following the ideas of the Argentinian economist Raúl Prebisch, the region embraced tariffs enthusiastically. The reasoning was simple. During that period, Latin America was connected to the world economy mostly as a provider of primary goods—commodities that were not only very sensitive to foreign markets, and thus had an inherent built-in boom and bust cycle, but whose price declined relative to those of manufacturing goods over the long term. In other words, as time went on it would take, say, far more coffee exports than its equivalent in cars to achieve the same amount of development leaving the region permanently behind the rich parts of the world.
The obvious solution was to transform the Latin American economies from ones that concentrated mostly on primary goods to those that supplied manufactured products or what policymakers called Import Substitution Industrialization (ISI). The problem was that one could not simply will these into existence because even if they had enough capital—as generously provided by the state—these investments could plainly not compete with the more established industries in the rich world. They lacked both the know-how and the supply chains that would permit these potential manufacturing centers to be profitable. Putting up the capital without further regulation would basically guarantee lots of losses for taxpayers. So tariffs it was. These guaranteed protection for the nascent industries as taxes imposed on imports meant that someone buying x at the store would see a local product’s price as cheaper than an import. At that point, it did not matter what a person chose to buy; either they would contribute to national industries directly by buying a locally made product, or indirectly by paying more for a foreign good, so long as that tax was then reinvested back into local manufacturing. In effect, the government policy was for its citizens to pay more for the privilege of buying products made in the country.
And it worked. Sort of. National industries were indeed started and lots of jobs were created. Economies in the large Latin American economies—Mexico, Argentina, Brazil—soared, sustaining growth of over 8% of GDP for a decade or so. The problem is that import substitution industrialization cannot be permanent for two reasons. First, new manufacturing centers cannot be limited to the home market—doing that would mean an eventual saturation which in turn would lead to diminishing returns and stagnation. Second, protecting home industries indefinitely would result in no need to innovate or improve efficiency as markets would be more or less guaranteed. Consequently, this would mean that consumers would be forced to pay more for inferior products in perpetuity. Thus, while tariffs might have been an option as a way to incentivize local industry, as a development strategy, they would have to be pulled back gradually. Otherwise, they would collapse under their own weight, which is exactly what happened. During the 1980s, most of the economic growth that had been gained during the previous decades evaporated as the economic model broke down leading to massive unemployment and economic turmoil.
This experience provides several lessons for the Trump administration. First, Latin Americans had clear development goals and they still failed. It is not clear what this President is trying to do. It is certainly not an attempt to create new industries and it is difficult to tell what he expects other countries to do in order for him to relent as he often contradicts himself on the matter. Setting up tariffs for an extended period of time is bad enough, doing so without concrete objectives is far worse because taxes on imports will be more likely to remain without achieving any of its intended aims.
Second, it is not that Latin American leaders did not know that Import Substitution Industrialization was not meant to be permanent and they must pull back tariffs and subsidies gradually, it is that doing so was always politically unpalatable and each administration left it to subsequent administrations. After all, it was easy for Latin American leaders to tell themselves they were protecting Latin American workers, as their jobs were visible (as were their votes), while higher costs on consumers were not so much. And if patriotic delusions were not enough, industries could lobby; workers could strike; those receiving subsidies could mobilize. It was simpler to leave it to the next President to deal with. So lesson number two is that once the economy is distorted, it will not be so easy to simply pull back. Take just one product in the US as an example: sneakers. Currently, there is roughly a 20% tariff on all athletic shoes imported into the country. This particular tax was first instituted during the Great Depression and has remained in various forms since then in part because companies like the Boston based New Balance Athletics lobby to retain them. Despite Americans paying more, however, the shoe manufacturing business in the United States is hardly booming; the vast majority of shoes bought in America come from abroad. Meanwhile, providing direct subsidies—as the Trump administration is reportedly considering, to the tune of $12 billion—is even worse because once instituted they are the most difficult to pull back, especially if they benefit politically sensitive areas like the Midwest. Just look at corn ethanol subsidies going strong after 40 years.
Third, tariffs encourage smuggling and the creation of other black markets. In the 1980s, there was no clearer sign of the failure of Mexican economic policy than taking a stroll along the dozens of mercados de fayuca—markets of smuggled American goods—in Mexico City and other major cities in the country. As of right now, that is not likely in the United States, but if Trump goes ahead and puts a tariff on all imported Chinese goods as he has threatened, its probability will be much higher. China is a manufacturing powerhouse and it is implausible that all of those goods could be produced more cheaply in the United States, thus creating the economic incentive to smuggle them. This already happens with things like tobacco across state lines—expanding it to other types of goods across international borders would not be all that difficult for organized crime.
The Latin American experience is clear then. Given that the Trump administration is not trying to substitute imports, it is unlikely to see any type of growth—only the unintended consequences. These will cost Americans as taxpayers and as consumers, the exact opposite of what the President should be trying to accomplish.