An externality is a cost of economic activity that is not easily ascertainable, or accounted for, and that therefore is not usually covered by the prices of goods. Externalities are costs that are suffered, but not paid for. Because the market has a hard time recognizing them properly, they are considered a sort of market failure; and the perfection of markets involves accurate accounting for externalities, and for their inclusion among the factors of production, and thus of the prices of goods and services. Perfect markets internalize all costs.
Many externalities are costs imposed on commons: goods held in common by the whole commonwealth – by everybody, and by nobody in particular. Precisely because they are difficult to account for, externalities are not usually controlled costs. The commons they injure are then subject to unbridled exploitation.
Imports have obvious benefits, or no one would want to pay for them. They also impose externalities.
Those externalities include the costs associated with the displacement of domestic workers, industries, plant and equipment, and – most of all – knowledge and skill encoded in the bodies and minds of domestic workers, entrepreneurs, managers, engineers, and so forth. It is the latter that makes of a nation a people that can invent, establish, and innovate on the basis of the profound knowledge of a business or trade or process that enables its continued maintenance.
The more a nation depends upon foreigners to manufacture its goods and provide its services, the fewer competent men will be around to keep things running smoothly. In time of war, dependence upon foreign goods is a terrible vulnerability. National independence, and national security, are common national goods.
Another externality of imported goods is not even much suffered domestically. When manufacturing is outsourced from America to China, the manufacture must proceed according to Chinese environmental and labor regulations, which are of course much looser than in America. The human population of the globe does not benefit from that tradeoff. The more business of that sort that goes to China, the worse for the global environment – especially the environment of China. The more business of that sort that goes to China, the worse is the global population of workers treated.
Optimal tariffs internalize the externalities of imported goods. The optimal tariff imposes a cost on importers more or less equivalent to what they would have paid, had they manufactured their products locally. Thus the optimal tariff has the effect of ensuring that each country is equipped with the trained, skilled, intelligent minds and hands that will be needed in every industry and occupation in order to keep the country running smoothly, and to enable it to respond quickly and effectively to crises.
The overall effect of a global system of optimal tariffs would be to distribute, diversify and thus stabilize the global supply chain for everything. Every country would be more or less competent at everything a country needs to be competent to do in order to survive. One result should be an increase in geopolitical stability, at the margin.
Access to a national market is a valuable economic good. To the extent that it is being sold for less than the market will bear, a cost is being imposed upon the commonwealth of the nation. That cost is almost impossible to ascertain, but it is certain. The likelihood is that it is roughly equivalent to the price differential between foreign and domestic goods. The optimal tariff is determined by raising tariff rates until sovereign revenues from tariffs stop increasing. At that point, the tariff will be such as to make the prices of foreign and domestic goods equivalent, so that consumers will be just as likely to want domestic goods as foreign. Imports will level off at that quantity of supply; so then will sovereign revenues from tariffs.
The optimal tariff thus has the effect of enclosing the national commons, and so preventing its destruction, by pricing the externalities imposed upon it by imported goods.