In a recent Defining Ideas article, “Why Trade Should Be Free,” I made the case for free trade. Although my way of stating it is slightly original, the case for free trade is one that many economists, including Adam Smith, have made. Free trade causes people in the free trade country to produce the goods and services for which they are the least-cost producer and to import goods and services for which people in other countries are the least-cost producers. The case for free trade is no more complicated than the case for hiring someone to mow your lawn. The conclusion that free trade is good for a country’s government to adopt does not depend on other countries adopting free trade. Even if other countries’ governments impose tariffs, we are better off, on average (there could be some losers), if our government refrains from restricting trade.
Are there any exceptions to the case for free trade? There’s one main one. Adam Smith himself laid out this exception in The Wealth of Nations: restricting trade when the traded item is crucial for national security. But the case for restricting trade even in such cases is not airtight and, indeed, other ways to assure a supply of such items may be better than restrictions on trade. One such way is by stockpiling the crucial items and that may well involve more trade, not less. Whatever the measures taken to assure availability of crucial inputs to defense, we, unfortunately, depend on government officials with information and competence, two characteristics that are typically in short supply in government.
Here's how Adam Smith put it in The Wealth of Nations:
If any particular manufacture was necessary, indeed, for the defence of the society, it might not always be prudent to depend upon our neighbours for the supply; and if such manufacture could not otherwise be supported at home, it might not be unreasonable that all the other branches of industry should be taxed in order to support it. The bounties upon the exportation of British-made sail-cloth and British-made gun-powder may, perhaps, both be vindicated upon this principle.
Steel: The Margin Matters
One good we often think of as crucial for national defense is steel. Ships, tanks, submarines, aircraft, and much ammunition all require steel. It’s certainly true that if the US government imposed tariffs or import quotas on steel, the domestic price of steel would rise and that would lead to more domestic production. But even without any protection of steel from imports, we in the United States would still have substantial production of steel.
In a discussion of industrial policy in 1983, the late Brookings Institution economist Charles Schultze, who had been the chairman of the Council of Economic Advisers under President Jimmy Carter, put it well, writing:
The national defense/essential industry argument is usually presented in an all-or-nothing mode, as though, in the absence of import protection, the affected industry would disappear. In fact, what is almost always at stake is a much less dramatic change in the industry’s fortunes, of a magnitude that is irrelevant to national defense. Whether, for example, the domestic steel industry meets 80 percent of the nation’s peacetime needs, as it does now, or only 60 percent is of no significance to the nation’s security.
(Charles L. Schultze, “Industrial Policy: A Dissent,” The Brookings Review, Fall 1983, Volume 2, Number 1)
More recently, in 2018, Jon Murphy, then a graduate student and now an economics professor at Nicholls State University, wrote that “only about 3 percent of US steel shipments go to servicing US defense.” Moreover, most of the finished steel that we use is produced in the United States. In 2023, finished steel imports were about 21 percent of US consumption. It is true that low import penetration is, in part, due to the tariffs that the US government has imposed over the years. Nevertheless, most of our finished steel imports come from countries whose governments are outright allies or are friendly to the United States. In 2023, the main producers of our steel imports, Canada, Mexico, and Brazil, accounted for 69 percent of overall imports. Canada accounted for 31.7 percent of imports, Mexico for 19.3 percent, and Brazil for 18.2 percent. Depending on those three countries for imports—especially Canada and Mexico—is relatively safe.
Where the rubber meets the war
The story of rubber is and has been a very different story from that of steel.
Because of our climate, the United States has never been a producer of rubber. This mattered during World War II. In a December 2023 paper titled “The US Rubber Famine during World War II,” Alexander J. Field, an economic historian at Santa Clara University, tells the story of US dependence on rubber imports during the war. After the Japanese government invaded Singapore, it took control, writes Field, of “almost all Southeast Asian sources of natural rubber.” Field notes that this “deprived the United States of 97 percent of its supply of the one strategic material in which it had effectively no domestic sourcing” (italics added).
The good news is that various US officials saw this coming before the US government officially entered the war. Field notes the three strategies to deal with the loss of imports: (1) domestic stockpiling of rubber before US entry into the war; (2) subsidizing “domestic production of alternative plant-based sources of latex”; and (3) developing a synthetic rubber capability.
The bad news, according to Field, is that the chief US official who controlled US policy, Jesse Jones, slowed the pursuit of the first and third strategies.
The main promising strategy was the first one: to stockpile rubber. The US government adopted that strategy but, because of Jones’s decisions, did so conservatively.
Field writes:
Although the stockpile quadrupled between its low level in 1939 and its peak in April 1942, it remained far too low given the needs of the country and its allies. As Federal Loan Administrator, Jones controlled the RFC [Reconstruction Finance Corporation, a New Deal agency], which had responsibility for building this stock, particularly following the formation of its Rubber Reserve subsidiary in June 1940, when it assumed sole responsibility. Both before and after, Jones slow-walked buying from the international cartel because he doubted a large reserve was necessary, and if it was, he wanted to wait until prices were lower.
Field points out that by 1944, the United States had almost run out of rubber and would have if the war had continued into 1946 rather than ending in 1945.
Field also notes that Jones, who had a lot of say over the development of synthetic rubber, was in over his head. Field writes, “For all his success in the private sector and then as a government banker, Jones lacked the experience to design, let alone evaluate, the merits or size of a proposed synthetic rubber industry.”
Field writes:
In February 1941, driven by doubts about the need for a subsidized synthetic rubber program, Jones completely cancelled it, defending his action on the grounds that he did not want to waste government money on “expensive plants,” except in an “extraordinary emergency,” which in his judgment did not then exist.
The whole story of Jones’s missteps, despite the advice he was getting from other government officials, is fascinating.
Notice, in light of the fact that this is an essay on whether national security would justify tariffs, that in this case of extreme dependency tariffs would have done little good. Even if the government had restricted imports so much that the price of natural rubber doubled or tripled, the amount of domestic production of natural rubber would have been zero and the amount of domestic production of synthetic rubber would have likely been small. Stockpiling would have been the way to go. So, score one for stockpiling and zero for tariffs.
Would private stockpiling work?
During World War II, while government stockpiling would have worked, it wasn’t done adequately. That raises the question: could private stockpiling work?
The answer is yes under certain conditions. Consider a case in which there is no domestic production. When stockpilers are free to set their prices, and they anticipate a reduction in access due to a war, they will also anticipate higher prices. That gives them an incentive to stockpile before the war because if the war happens, they can sell some or all of their stocks at high prices. The higher the probability the stockpilers put on war and reduced access, the more they will stockpile.
Would the amount of stockpiling be optimal in such a situation? Yes, because the stockpilers would have an incentive to get good information and to be right.
To say it would be optimal is not to say that with hindsight, we wouldn’t have wanted even a bigger stock. But, by definition, no one in the present has hindsight about events that haven’t happened.
So, one can make an argument for no government stockpile and for letting participants in the market act independent of government.
But for the market to work well, the government would have to refrain from imposing price controls. Unfortunately, during large wars, governments, including ours, tend to impose price controls on crucial items.
Why does this matter? It removes the incentive for private actors to build stocks. They know that when the war comes that makes the stocked item more valuable, they will not be able to collect on this value.
The paradox of price controls
It appears, therefore, that we are stuck with a second-best solution: having the government stockpile crucial war materiel.
But there is one source of the crucial items on which the US government would not be able to impose price controls: imports. If the imports are, as in the case of rubber during World War II, controlled by a foreign power, then, as they say in New Jersey, fuhgeddaboudit. But what if the imports are from allied countries? Then, paradoxically, the fact that the US government can’t impose price controls is a blessing, not a curse. It means that those producers in other countries would have an incentive to build stocks in anticipation of a war and to sell to the US government. (I should give credit where credit is due. I first became aware of this argument when defense economist Benjamin Zycher made it in “Defense,” in David R. Henderson, ed., The Concise Encyclopedia of Economics.)
What if the US government, anticipating a war, imposed tariffs on imports of crucial items from friendly countries? Then it would get fewer such items, not more. This would hurt, not help, the war effort.
The argument so far
Now that we’re past the detour on stockpiling, where are we in examining the case for tariffs on items that are crucial for the war effort?
First, if the item is produced by friendly countries, as is true for steel, there’s not a good case for tariffs on imports. Second, if the item is produced or controlled by hostile countries but is not produced in the United States, as was true for rubber during World War II, there is not a case for tariffs but there is a case for government stockpiling. What if the item is produced only in countries whose governments are expected to be hostile, and we have substantial ability to produce domestically? Under those assumptions, there could be a case for tariffs.
The big problem: government incentives
One issue that Adam Smith did not address in the context of free trade or protectionism for crucial war materiel is the issue of whether British government officials had good incentives to respond appropriately. In many other discussions in The Wealth of Nations, he questioned whether governments had good incentives. Not the least of these was his superb reasoning that led him to conclude that it was in Britain’s interest to let the thirteen colonies go without a fight. In that same section of his book, Smith also argued, correctly, that the British government would not take such a reasonable course. Smith understood perverse government incentives.
So should we. While one can make a theoretical case that a government that makes good decisions should, in rare circumstances, protect domestic production of crucial war materiel from foreign competition, the record of governments does not suggest optimism about whether governments will choose the right measures or the right goods to protect.
Is this a slam-dunk argument against any tariffs for items that are crucial for national defense? No. But the argument for such tariffs, given the incentives of government officials, is weak.
