FIGHTING TARIFFS WITH TARIFFS.

Maybe it’s just trying to make up to our first prime minister for booting him off the $ 10 bill in favour of civil- rights heroine Viola Desmond, but the Bank of Canada this week published a research study that says Sir John A. Macdonald’s National Policy tariffs of 1879 actually increased Canadian welfare — albeit by a tiny 0.13 to 0.20 per cent of GDP. This runs contrary to most previous studies of the Macdonald tariff, as well as to standard international trade theory, which holds that small, open economies like ours only hurt themselves by imposing tariffs, no matter what their trading partners do.

The study comes at an interesting time politically. Macdonald brought in his tariffs only after an aggressive Republican administration rejected his efforts to restore the free- trade Reciprocity Treaty of 1854– 66 and hiked U. S. manufacturing tariffs sharply ( you might even say big-ly, yuge-ly) to an average of 37 per cent. Remind you of anyone? To have a Bank of Canada study even imply that fighting tariffs with tariffs might be the way to go is, to say the least, interesting. Mind you, I’m guessing the people who least enjoyed reading the study’s conclusions are higher- ups at the bank, who understand that the bank doesn’t, and doesn’t want to, set Canadian trade policy.

So why would the Bank of Canada study the National Policy? It has a very active, very good research department that studies lots of things, many having no connection with monetary policy. But if you’re running a central bank, you want a good research department and if you want a good research department, you’ve got to cut your researchers slack. All “overnight rate and nothing else” makes a researcher a dull boy or girl.

The National Policy paper was written by the bank’s Patrick D. Alexander and Ian Keay of Queen’s University, who is one of Canada’s best economic historians. How do they conclude that, in the face of U. S. tariffs, Canadian tariffs actually helped, if only a bit?

For tiny countries with no ability at all to influence the world price of a good, tariffs only hurt. Putting a tariff on imported goods raises government revenue, which might seem helpful, but it causes twin economic distortions: Consumers consume less of the imported good, which reduces their wellbeing, and domestic producers supply a greater share of whatever consumption continues. Domestic producers love that, but the big picture is that resources move from higher- to lower- return activities, which is wasteful. With unobjectionable assumptions about demand and supply, it’s easy to show that the hit to consumers and the waste from producing things that really should be imported add up to more than the tariff revenue — even assuming the government would use the money wisely.

On the other hand, if countries are big enough to affect the prices of their exports and imports, then theory says the “optimal tariff ” may be greater than zero. With 19th- century, not 21st- century transportation costs, maybe small countries, like objects in a car’s rear-view mirror, were actually bigger than they appear in hindsight. If your tariff forces your trading partner to lower his selling price, that’s a gain to your country that might well offset both the consumer hit and the resource waste that the tariff does still produce.

So the effect of the Macdonald tariff depends on how economically “big” or “small” Canada was in the various markets for the goods it was buying in 1879. Unfortunately, as the study’s authors will be the first to admit, we don’t have all the data needed to assess that. But, patching data together from various sources and eras, they come up with their best guesstimate, which is that we weren’t entirely small — thus leading to the result that the tariff did have a slight positive effect.

By contrast, unilateral free trade would have produced a small negative effect: a reduction of welfare of half to three- quarters of a per cent of GDP. World free trade — everybody dropping their tariffs to zero — would have been best of all: a gain in Canadian welfare equal to almost a full per cent of GDP.

However irresistible, the temptation to draw parallels with today’s situation is unwise. Almost everything about the North American economies is different. But if you were to ignore good sense and insist on trying to draw guidance from the past, the lesson to Prime Minister Justin Trudeau might not actually be “Fight back, like Macdonald did!” On the contrary, the cost to Canada of sticking with unilateral free trade would have been minor. The Canadian Intellectual Establishment is always thrilled when our country holds fast to its principles on human rights, international relations, climate change and so on, even when the cost of doing so makes us look Boy Scout-ish.

So why not a little Boy Scout- ism on global free trade, too?

EVEN IF MACDONALD’S TARIFFS PAID OFF, UNILATERAL FREE TRADE WOULD STILL HAVE BEEN BETTER.