“We’re like the piggy bank that everybody’s robbing,” President Donald Trump said at a Saturday news conference at the G7 summit in Canada. “And that ends.”
The president, who perceives that the U.S. is being treated unfairly by its trading partners, had imposed tariffs on steel and aluminum imports from Canada, Mexico, and the European Union, along with a threat of further penalties. After a press conference in which Canadian Prime Minister Justin Trudeau reiterated that his country plans to retaliate against the new tariffs, Trump said that when it comes to a potential trade battle, “We win that war a thousand times out of a thousand.”
Trump’s tariffs puzzle many economists; they are unlikely to effectively address China’s oversupply of steel or to lower U.S. trade deficits. But the decision is consistent with his rhetoric on the campaign trail, when he invoked Ronald Reagan’s example. “President Reagan deployed similar trade measures when motorcycle and semiconductor imports threatened U.S. industry,” Trump said in a June 2016 campaign speech in Pennsylvania. “I remember. His tariff on Japanese motorcycles was 45 percent, and his tariff to shield America’s semiconductor industry was 100 percent, and that had a big impact, folks. A big impact.”
Reagan did impose tariffs on Japanese motorcycles, electronics, and other products. But while these penalties could be seen by some as a precursor to Trump’s recent decisions, there are some critical differences. Reagan’s actions were more targeted, and he also promoted some free-trade policies alongside them, including proposing a North American common market. Perhaps more important is the fact that, according to a recent study, it wasn’t really the tariffs, but another policy altogether, that helped U.S. businesses compete in a global economy: Reagan’s change to the tax code in 1981, establishing the federal Research and Experimentation Tax Credit to subsidize innovation.
Businesses can claim the tax credit if they are working to develop new, improved, or technologically advanced products or trade processes. Created as a temporary incentive for two years, the credit was extended repeatedly by Congress until it became permanent in 2015. (The credit was briefly in jeopardy during the tax-bill negotiations last year, but the final version preserved its benefits.) Most U.S. states, too, now offer tax incentives for research and development.
In the 1980s, this stimulus induced companies to innovate and catch up to their foreign competitors, according to the economists who co-authored the recent study: Ufuk Akcigit of the University of Chicago, Sina T. Ates of the Federal Reserve Board of Governors, and Giammario Impullitti of the University of Nottingham. They describe how, in the second half of the 1970s, U.S. manufacturing productivity was lagging behind that of other advanced economies, and technological competition from Japan, Germany, and France was increasing. While U.S. residents filed 70 percent of patent applications in the United States in 1975, that share had fallen to closer to 60 percent by 1981.
Then, as now, “there was concern that the U.S. was losing leadership,” Akcigit told me. It could have just isolated itself from the world economy. “But instead, the U.S. decided to subsidize its industries quite strongly.” International competition, according to Akcigit and his colleagues, has two playing fields: a company’s home market and its foreign markets. In open economies, companies first have to push hard to improve their productivity and quality of goods, or they will be vulnerable to foreign competitors encroaching on their turf. Second, large businesses can gain share in foreign markets.
In the absence of tariffs, research and development subsidies will encourage companies to make long-term investments to improve their competitive position at home and abroad, the researchers find. After the creation of the federal and state R&D tax credits, U.S. businesses began to catch up to their foreign counterparts; the intensity of their research spending increased, and, after continuing to fall for a few more years, their share of patent applications rebounded by the mid-1990s to above 60 percent.
Akcigit and his co-authors find that economies benefit more in the long run by subsidizing innovation than by stifling trade. Having recently visited Germany, Akcigit cited the rivalry between BMW and Tesla as an example of international competition pressuring companies to develop new products. BMW felt the pressure on the market when Tesla came along, he said. “Now they are pushing hard for electric cars. The consumers are benefiting from it: The price of electric cars will come down.”
Why, though, do businesses need subsidies? The research-and-development tax credit has been controversial at times, with some economists arguing that businesses would have made the investments anyway. But R&D spending has an uncertain payoff, Akcigit argues, and new products and business processes benefit all of society, not just the company that creates them. His research shows that subsidies induce businesses to invest more in long-term innovation than they would have otherwise.
In this analysis, Reagan’s tax credit looks like a smart move. Then, there’s the separate issue of his tariffs, including the 49.4 percent import duty on Japanese motorcycles, imposed in 1983 to benefit Harley-Davidson, which was struggling at the time. Harley revived its business and returned to profitability by 1986, but it’s not clear that the tariffs were responsible. A study conducted for Japan’s Research Institute of Economy, Trade and Industry, by Taiju Kitano and Hiroshi Ohashi of the University of Tokyo, credited Harley’s internal improvements, including reducing the share of motorcycles it produced with defective parts from around 50 percent to 2 percent.
“For years we tried to figure out why the Japanese were beating us so badly,” Vaughn L. Beals, Harley’s former CEO, told The New York Times. “First we thought it was their culture. Then we thought it was automation. Then we thought it was dumping. Finally we realized the problem was us, not them.” (Among the EU’s current targets for duties on U.S. imports are Harley motorcycles. Harley said the retaliation would have a “significant impact” on its sales.)
Akcigit, Ates, and Impullitti find that protectionism can lead to short-run gains for an economy—say, over 10 to 15 years—as businesses temporarily reap higher profits. This only works, though, if a country can impose tariffs without retaliation. That’s an unlikely scenario, as evidenced by the fierce response to Trump’s import duties. If countries retaliate, the researchers find, global competition diminishes, and everyone suffers because of slower technological progress.
Over a longer period, whether countries retaliate or not, consumers in the country that imposes the tariffs become much worse off. If countries do not retaliate, companies have less fear of foreign competitors entering their home market. If countries do retaliate, companies have fewer opportunities to expand overseas. Either way, businesses in the home market have less motivation to come up with new ideas. “You are shielding them from international competition,” Akcigit said, “so they become lazier.”
This is the opposite of the argument from the White House. “We may have a little bit of short-term pain, but we’re certainly going to have long-term success,” White House press secretary Sarah Huckabee Sanders told reporters in April.
Akcigit said policymakers face one important question: How much do you care about the future? If an administration could impose tariffs unilaterally, at least during a single election cycle, “they will just see the benefits of it as a politician,” he said. “But as a citizen of the country, in the long run, the society will be hurt by this.”