Adam Smith, the Scottish wine critic.
LONDON — In 1690, the UK imposed a 25% import tax on all goods coming from France to Britain. France responded likewise. For the next 200 years, until about 1860, British people who wanted to drink French wine paid 25% more per bottle than anyone else. Trade between the two countries almost vanished (except for brandy, which for some reason was exempt).

The intent of the tax was to boost domestic makers of wool, silk, and linen, and to protect British merchants selling salted fish and cattle. It was a blanket tax, and it covered wine as well.

The Scottish economist Adam Smith wrote about the tariffs in Wealth of Nations, his keystone analysis of capitalism. He noticed that there was one specific group of British businessmen who benefited more than the others from the tariffs — smugglers:

"Those mutual restraints have put an end to almost all fair commerce between the two nations, and smugglers are now the principal importers, either of British goods into France, or of French goods into Great Britain."

Last week, we learned that President Trump wants to start a trade war with the rest of the world by imposing a 20% import tax on goods entering the country.

This is familiar territory.

There is a trade war brewing between Britain and the EU, too. Europe is implicitly threatening to tax British imports after it leaves the EU in order to show EU countries that Brexit comes with negative consequences. Prime Minister Theresa May's government has hinted that it may lower corporation tax in response.

Until very recently, most people felt this debate was settled in favour of free trade. Almost no one who is serious about economics argues in favour of protectionism, trade wars, or restrictions on international free trade.

So perhaps it is worth going back to basics.

Why doesn't Scotland make its own wine?

The Upper Largo vineyard in Scotland.
The Branch
When Smith wrote about trade between Britain and France in 1776, he suggested that if the tariffs were effective then Scotland ought to be making its own wine. The tariffs made French wine expensive. You can grow grapes in Scotland. So surely Scotland's domestic vineyards would have an advantage. Obviously, they did not, Smith wrote, 241 years ago:


Scotland is cold and rainy, and France is warm and dry. It makes more sense for France to specialise in wine based on its natural advantages, and for the Scots to let that wine into their country as cheaply as possible.

Specialisation is the key to free trade.

There is a reason you don't make your own shoes

Try making them yourself.
superde1uxe / Flickr, CC
There is a reason free trade exists: It's a lot easier than the alternative.

Before capitalism, there wasn't much trade. People lived in rural villages and made a living on small farms. They grew their own food, made their own clothes, and built their own houses. There is nothing wrong with this, but it is laborious.

Try making your own shoes, for instance.

Obviously, it is a lot easier for people to take some extra wheat to the local market and trade it for shoes than it is to make your own shoes from scratch. Unsurprisingly, some people stopped bothering to grow their own food and began to specialise exclusively in making shoes for sale or barter. Specialisation and trade have gone hand in hand ever since.

That principle remains the basis of free trade today: It's more efficient to specialise in one trade and buy everything else you need than it is to make everything yourself. The principle is the same for individuals, families, villages, cities and nations. Trade has been conducted this way for about 7,000 years. Even Karl Marx recognised that exchange needed to be based on differing specialisation: "From each according to his ability, to each according to his need."

OK, so the French are good at wine and the Scots shouldn't try to compete because their climate is lousy.

Not all industries are like wine.

What about something like steel, which is not dependent on the local environment? Anyone can make steel. China makes really cheap steel. How do you keep steel jobs from being outsourced to China?

A trade war sounds like an easy, cost-free solution to a country's jobs problem: Place a tariff on foreign goods. The government gets a new stream of income from import taxes. Foreign goods become more expensive. Domestic ones cheaper, comparatively. As a result, money stays at home where it saves jobs instead of leaking out of the country to foreign suppliers.

In the short-term, that may indeed happen. That's is why "economic nationalism" is so popular right now.

The problem is that the short-term doesn't last very long. Pretty soon you're living in the long term, where things get harder.

Tariffs give all your enemies an instant advantage

Workers hold placards and banners at the Tata Steel plant in Port Talbot, South Wales, April 1, 2016.
REUTERS/Ben Birchall/Pool
Steel is a good example because both the US and the UK steel industries have suffered from competition from cheaper Chinese steel imports. Factories have closed and jobs have been lost due to Chinese steel "dumping." Tata's Port Talbot plant in Britain was losing a £1 million ($1.3 million) a day at one point because it could not compete with steel from China.

Let's assume that the UK government had followed Trump's plan and propped up Port Talbot by taxing foreign steel at 20%. What would happen next?

In the short-term it would be good news for the workers of Port Talbot, they would all keep their jobs.

But it would be bad news for everyone else in Britain.

Other companies in other countries don't care about the origin of their steel. Those companies would immediately source their steel more cheaply, probably from the Chinese. So suddenly every single company on the planet that buys steel would have a cost advantage over every British company buying British steel. That would instantly hurt British companies who trade globally.

One of Britain's main industries is car manufacturing. The Brits make 1.7 million cars per year, mostly for export to the EU. All those cars would become more expensive, either because the car companies would be using comparatively expensive British steel or because they would be buying foreign steel with a 20% tax markup. Remember, the tariff hasn't actually brought down the cost of British steel, it has merely made foreign steel more expensive for British people. Outside the UK, foreign steel would still be cheaper than British steel. So the government's attempt to make foreign steel feel more expensive has the exact opposite effect on the global market, to the disadvantage of British steel buyers.

Carmakers in Germany, India and China — who all make a lot of cars — would love that to happen. It would give them a 20% head start over Britain.

The Soviet Union had good trade barriers too

The cost of protecting British steel would quickly seep back into the UK economy. Anything that contained steel — any product, any toy, any component — would cost the British more than it cost the Germans or the Chinese. British companies, saddled with the expense of buying either British steel above global market prices or foreign steel with a 20% tariff, would lose business to foreign competitors able to make the same goods cheaper. Their revenues would suffer, and their profits would decline. They might put their prices up to compensate — but that would make them even more uncompetitive, and spur internal inflation. And when prices creep up, workers get poorer in real terms.

That's when long-term stagnation hits.

Britain might carry on for years with full employment in the steel business. But the investment capital you need to keep every other business going, innovating, renewing, and creating more jobs, would all evaporate. Capital isn't stupid. It would notice the declining returns and go elsewhere — probably to the companies in countries who hadn't erected a steel tariff barrier.

Britain would find itself falling behind other countries, in much the same way as the Soviet Union fell behind during the Cold War. (If communism was successful at one thing, it was good at restricting imports from competitive countries.)

By the end of a decade, Britain would be stuck making steel no one wants to buy. Smaller, more marginal UK companies would go out of business, unable to shoulder the extra cost of steel. Those jobs are lost. The economy would coalesce around only the biggest, most profitable companies that can withstand the hit. That's OK, as long as you are comfortable with your national economy being run by only gigantic mega-corporations.

"The Tree" in Bergen, Norway, has 14 storeys and is the tallest wooden building in the world.
Lastly, everyone in Britain would be incentivised to create products using any other substance than steel. There would be a boom in the aluminium and plastics business. Wood and bricks might make a comeback in the construction industry. There would be fewer skyscrapers.

Again, this is fine ... as long as you are comfortable distorting your entire economy — even the skylines of your cities — to save one type of business.

This is what trade barriers do. They might boost your domestic industry in the short term but they distort everything else in the long term.

America is Britain's biggest single trading partner. £100 billion ($130 billion) of goods are shipped to the US from the UK every year. Trump's 20% tax might reduce that trade, and shift some of that business from the UK to America. But assuming the UK responds in kind it would hurt America, too. The US exports £61 billion ($80 billion) in goods to the UK annually. The American jobs created by that £61 billion in trade would all be in jeopardy, along with the jobs dependent on trade with every other country on the planet.

How you create jobs when China is destroying them

There are negatives to free trade, of course.

China's government subsidises its industries, and many of its products are so cheap they drive Western companies bankrupt. That costs us jobs.

It is tempting to simply block China from trade. But by doing so you set in motion the cycle just described, and most of the damage is inflicted on your own workers, years later. The Chinese have plenty of other people to sell steel to. India (pop. 1 billion) for instance. The Chinese would love it if the UK and the US hobbled themselves with a protectionist steel tariff.

The solution is for countries to behave like the guy in the village who stops growing wheat in order to make shoes: When countries can't compete in the steel business they ought to get out of steel and get into any business that can exploit China's supply of cheap steel. If Chinese taxpayers want to subsidise British industries that need steel, then we should quietly rejoice and import that steel like crazy! Cheap steel is good, as the car workers of Sunderland (Nissan) and Swindon (Honda) will tell you. Yes, we might lose some jobs in Port Talbot. But we will gain many, many more everywhere else.

Getty Images
This is why, eventually, Britain and France lowered their tariffs Adam Smith was complaining about to around 5% by the 1800s.

When Britain joined the EU in 1973, all those tariffs went away, cut to 0%. One of the monumental achievements of the EU was to persuade 28 different countries to remove all trade barriers with each other. It created a democratic, prosperous, Western counterweight to US economic power. (It also kept the peace for 60 years on a continent that had seen two world wars in the previous 50.) Now, 44% of British trade is conducted tax-free with Europe. That's £240 billion ($312 billion) of business per year. That's a lot of UK jobs.

As for the Scottish wine industry, despite Adam Smith's warning from 241 years ago, there are still people trying to make wine in Scotland today.

It is " undrinkable," according to The Scotsman.

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