Appendix A — On the Incidence of Protective Duties

It is sometimes asserted, as one of the advantages of tariff duties, that they fall on the producers of imported goods, and are thus paid by foreigners. This assertion contains a scintilla of truth. An import duty on a commodity of which the production is a closely controlled foreign monopoly may in some cases fall in part or in whole upon the foreign producer. For instance, let us say that a foreign corporation has a monopoly in the production of a certain article. Within the limits of cost on the one hand and the highest rate at which any can be sold on the other, the price of such article can be fixed by the producers, who will naturally fix it at the point they conclude will give the largest aggregate profits. If we impose an import duty on such an article they may prefer to reduce to some extent their profit on what they sell to this country rather than have the sale diminished by the addition of the duty to the price. In such case the duty will to that extent fall upon them.*

Or, again, let us suppose a Canadian farmer so situated that the only market in which he can conveniently sell his wheat is on the American side. Wheat being a commodity of which our home production not merely supplies home demands, but leaves a surplus for export, the duty on wheat does not add to price, and the Canadian farmer so exceptionally situated that he must send wheat to this side although there is no general demand for Canadian wheat, cannot get back in enhanced price the duty he must pay.

Such cases, too unimportant to be considered in any estimates of national revenue, are only the rare exceptions to the general rule that the ability to tax ends with the territorial limits of the taxing power. And it is well for mankind that this is so. If it were possible for the government of one country, by any system of taxation, to compel the people of other countries to pay its expenses, the world would soon be taxed into barbarism.

But the possibility of exceptional cases in which import duties may in part or in whole fall on foreign producers, instead of domestic consumers, has in it, even for those who would gladly tax "foreigners," no shadow of a recommendation for protection. For it will be noticed that the few and exceptional cases in which an import duty falls on foreign producers, are cases in which it can afford no encouragement to home producers. An import duty can only fall on foreign producers when its payment does not add to price; while the only possible way in which an import duty can encourage home producers is by adding to price.

*In certain cases where an import duty, levied in one country on the produce of another, has the effect of reducing price in the exporting country at the expense of rent, it may, in some part, fall upon foreign landowners. John Stuart Mill (chap. iii, Book V, Political Economy) further maintains that taxes on imports fall in part, not on the foreign producer of whom we buy, but on the foreign consumer to whom we sell — since they increase the cost of products we export. But this is only to say that the injury which we do ourselves by protection must in some part fall upon those with whom we trade. And even if import duties do, in such ways, somewhat increase the cost to foreigners of what they get from us, and thus, in some degree, compel them to share our loss, yet they also handicap us when we come into competition with them. Thus, assuming that our tariff upon imports may at times, to some slight extent, have increased the price which English consumers have had to pay for our cotton, wheat, or oil, the increased cost of production in the United States has certainly operated far more strongly to give English producers an advantage over American producers in markets in which they compete, and to enable England to take the lion's share of the ocean-borne commerce of the world. The minute tracing of the actions and reactions of taxation upon international trade is, however, more a matter of theoretical nicety than of practical interest, since the general conclusion will be that stated in the text: while we cannot injure ourselves without injuring others, the taxing power of a government is substantially restricted to its territorial limit. The clearest exception to this is in the case of export duties on articles of which the country levying the export duty has a monopoly, as Brazil has of indiarubber and Cuba of the Havana tobacco.

Appendix B — On Adam Smith's Two Capitals Fallacy

The proposition that restrictions on foreign trade are beneficial because home trade is more profitable than foreign trade is fortified by the authority of Adam Smith. In Book II, chapter v of The Wealth of Nations, occurs this passage:

The capital which is employed in purchasing in one part of the country in order to sell in another the produce of the industry of that country, generally replaces by every such operation two distinct capitals that had both been employed in the agriculture or manufactures of that country, and thereby enables them to continue that employment .... The capital which sends Scotch manufactures to London, and brings back English corn and manufactures to Edinburgh, necessarily replaces by every such operation two British capitals which had both been employed in the agriculture or manufactures of Great Britain .

The capital employed in purchasing foreign goods for home consumption, when this purchase is made with the produce of domestic industry, replaces, too, by every such operation, two distinct capitals: but one of them only is employed in supporting domestic industry. The capital which sends British goods to Portugal, and brings back Portuguese goods to Great Britain replaces by every such operation only one British capital. The other is a Portuguese one. Though the returns, therefore, of the foreign trade of consumption should be as quick as those of the home trade, the capital employed in it will give but one-half the encouragement to the industry or productive labor of the country.

This astonishing proposition, of which Adam Smith never seemed to see the significance, is one of the inconsistencies into which he was led by his abandonment of the solid ground from which labor is regarded as the prime factor in production, for that from which capital is so regarded — a confusion of thought which has ever since befogged political economy. This passage is quoted approvingly by protectionist writers, and made by them the basis of assertions even more absurd, if that be possible.* Yet the fallacy ought to be seen at a glance. It is of the same nature as the Irishman's division, "Two for you two, and two for me, too," and depends upon the introduction of a term "British," which includes in its meaning two of the terms previously used, "English" and "Scotch." If we substitute for the terms used by Adam Smith other terms of the same relation we may obtain, with equal validity, such propositions as this: If Episcopalians trade with Presbyterians, two profits are made by Protestants; whereas when Presbyterians trade with Catholics only one profit goes to Protestants. Therefore, trade between Protestants is twice as profitable as trade between Protestants and Catholics.

In Adam Smith's illustration there are two quantities of British goods, one in Edinburgh and one in London. In the domestic trade which he supposes, these two quantities of British goods are exchanged; but if the Scotch goods be sent to Portugal instead of to England and Portuguese goods brought back, only one quantity of British goods is exchanged. There will be only one-half the replacement in Great Britain, but there has been only one-half the displacement. The Edinburgh goods which have been sent away have been replaced with Portuguese goods; but the London goods have not been replaced with anything, because they are still there. In the one case twice the amount of British capital is employed as in the other, and consequently double returns show equal profitableness.

This is just such a proposition as that an innkeeper who only permits his guests to stay with him one day can, with equal facilities, furnish twelve times as much entertainment to man and beast as can the innkeeper who permits each guest to stay with him twelve days.

The arguments by which it is attempted to prove that it is no hardship to a people to be forced to pay higher prices to home producers for goods they can more cheaply obtain by importation are of no better consistency. The real cost of commodities, it is declared, is not to be measured by their price but by the labor needed to produce them, and hence as it is put, though higher wages, interest, taxes, etc., may make it impossible to produce certain things for as low a price in one country as in another, their real cost is no greater, if no greater amount of labor is needed for their production, and thus a nation loses nothing by shutting out the cheaper foreign products.

The fallacy is in the assumption that equal amounts of labor always produce equal results. A first-class portrait painter may be able to do whitewashing with no more labor than a professional whitewasher, but it would nevertheless be a loss to him to take time in which he might earn the wages of a portrait painter in order to do whitewashing that he might get done for the wages of a whitewasher. Nor would his loss be the less real if he chose to average his income so as to credit himself with as much for whitewashing as for portrait painting. In the same way, it is not the amount of labor required to produce a thing here or there which determines whether it can be more profitably obtained by home production or by importation, but the relation between what the same labor could produce in that and in other employments. This is shown by price. Though as between different times and places the prices of things do not accurately indicate the relative quantity and quality of labor necessary to obtain them, they do in the same time and place. If at any given time and place, a certain commodity cannot be produced for as low a price as it can be imported for, this is not necessarily proof that it would take more labor to produce it in the given place, but it is proof that labor there and then can be more profitably employed. And when industry is diverted from more profitable to less profitable occupations, though the capital and labor so transferred may be compensated by duties or bounties, there must be a loss to the people as a whole.

*In the next paragraph Adam Smith goes on to carry the proposition to an unconscious reductio ad absurdum. He says: "A capital therefore employed in the home trade will sometimes make twelve operations, or be sent out and returned twelve times, before a capital employed in the foreign trade of consumption has made one. If the capitals are equal, therefore, the one will give four-and-twenty times more encouragement and support to the industry of the country than the other."