David Chan Smith argues that tariff regimes during the eighteenth century encouraged modern history’s first offshore markets to reroute goods through jurisdictions that faced lower tariff rates. This historical “entrepôt trade” could outstrip the legal trade of some goods and carries lessons for contemporary revisions to international trade.
Imagine stepping into a future world of permanently high tariffs and governmental controls on American trade. According to supporters, these policies would create economic incentives to bring manufacturing back to the United States and restore the prosperous days of the 1950s. Opponents have argued differently and looked further back in time to draw comparisons with the 1930 Smoot-Hawley Act, whose tariffs incited a trade war that accelerated the economic collapse of the Great Depression. Which is it? There might be a third, even more interesting possibility.
Recent research on the effects of the first round of Trump tariffs from 2019 reveals significant evasion. Chinese manufacturers redirected goods through third-party countries for importation into the U.S. at more favorable tariff rates in what is called entrepôt trade. Goldman Sachs has estimated that $30-50 billion worth of Chinese trade was redirected through “bystander” or “connector” countries in this way. Possibly a further $80 billion in goods was underreported or mislabeled. So, what does a landscape of trade taxes and unintended consequences hold in store? Turn back the clock, and you’ll find that today’s tariff avoidance and evasion tactics have deep historical roots. Extensive trade regulations have long incentivized businesses to game the system and shift commerce to the offshore shadows with surprising results.
Back in time to bigger tariffs
For good reason the new protectionism has been dubbed “neomercantilism,” an echo of the economic orthodoxy of eighteenth-century Europe. At that time, high tariffs on key goods such as sugar, tobacco, wine and tea reflected a zero-sum, beggar-thy-neighbor approach to commerce and the belief in the importance of a favorable balance of trade. “Tariffs” was a beautiful word because extensive duties on trade served several functions. They provided a critical source of revenue for the emerging European nation states and were also sometimes used to protect established or emerging industries. A confusing, and occasionally corrupt, system of financial incentives to exporters, including drawbacks and bounties, combined with extensive regulation about the conditions under which trade might be conducted, sought to control the colonial circulation of goods in favor of European home countries. American readers may remember back to their history classes that these regulations were one of the things that made the Thirteen Colonies particularly cranky.
The consequences of tariffs now seem predictable: the summoning of a vast illicit economy conducted through entrepôt trade, flags of convenience, and even foreign corporations. This wasn’t just a business for dodgy smugglers. Professional merchants and wholesalers were extensive participants. Testifying before the British Parliament in 1784, Richard Twining (of the same tea company operating today), explained that many tea dealers “openly” bought and sold illicit tea. And the volumes were substantial in highly dutiable commodities, sometimes more than the lawful trade. When Parliament lowered the tea duties in 1785 the legally imported volume more than doubled the following year.
My research is reconstructing this clandestine economy as it functioned through dozens of key entrepôts. Though formally under the dominion of countries like Britain, France and the Netherlands, these jurisdictions held liberties and exemptions from their central governments by reason of ancient custom or recent charters. They were often semi-autonomous islands, like the Channel Islands, or sometimes favored trading ports such as Dunkirk. Their services were many: warehousing, facilitation (false papers, in particular), protection from customs officers, and so forth. These entrepôts enabled traders from many different countries, sometimes at war, to come together to discover arbitrage opportunities through smuggling or tariff avoidance schemes.
The birth of the global offshore
The literature on “the offshore,” a term that emerged during the late 1960s (“offshoring” as a verb became popular in the 1980s), mostly describes the network of modern havens that facilitate tax avoidance and evasion on capital.
Identifying when this world originated is a subject of continuing debate. But when we expand the focus beyond just capital to include the movement of commodities for the purposes of avoidance, the offshore world looks co-original with the development of networks of global capitalism in the early modern period. A small literature has begun to develop on modern trade entrepôts, specialist zones for relabeling the origins of merchandise, as mechanisms of tariff avoidance.
Indeed, one consequence of the early modern tariff system was the emergence of the first global offshore market based on the flow of goods. By bringing this side of the offshore world, long dormant during a period of trade liberalization, back into focus, tariffs are a reminder of the influence of self-organizing networks of tax avoidance and jurisdictional arbitrage. These networks created a “countergeography” for the movement of goods and capital against the preferences of imperial administrators and their official policies. These transgressional, self-organizing networks were highly dynamic: entrepôts might rise and fall, trade flows were quickly rerouted as central government authorities became alert to illicit importation schemes, information was passed about new arbitrage opportunities. Similarly today, groups of specialists work to find paths to “sidestep” high-tariff regimes. We can only expect these types of “tax minimization strategies” to become more lucrative should the global tariff level rise.
The consequences of offshore tariff evasion
Entrepôts were tightly integrated with the legal trade and involved traders who were highly capitalized. Sure, there were smugglers who skirted customs and took unannounced cargoes directly onto moonlit beaches. But merchants also loaded goods in entrepôts where they were legal, and then undervalued or omitted them from declarations at mainland ports. In fact, a high tariff regime creates a cheating problem for “fair traders.” They are in danger of being undersold by those who don’t play by the rules and so are incentivized to join evasion schemes depending on the level and consequences of enforcement.
Nor should we necessarily expect foreign governments to prevent evasion. Historically, many of these entrepôts had central as well as local government support. They were embedded in institutional strategies of growth. Some jurisdictions, like Dunkirk, functioned as a means to penetrate the tariff walls of other nations. Others presented themselves as marts for large regional areas. St. Eustatius, with full knowledge of the Dutch government, was a free port for traders of many nations throughout the Caribbean and Americas. As a source of arms for Americans in rebellion, this proved a cause of its downfall in 1781 when the British invaded in response. Tariff evasion can also be a state-supported game.
The illicit trade supported by these entrepôts demanded an increasingly aggressive response from central governments in Europe and stimulated the growth of policing. Thousands of customs officers roamed European coasts and terrestrial borders, prosecuting for penalties that became ever more severe over the decades. By the later eighteenth and early-nineteenth century, one of the classical liberal complaints about high tariffs was the policing power spun up by central governments to enforce them. As J.R. McCullough wrote in 1834 as the free trade movement gathered force in Britain, the coasts swarmed with “cordons of troops.”
In closing: some tariff advice from Adam Smith
Adam Smith lived in this high-tariff world and he excoriated its shortcomings in his 1776 opus The Wealth of Nations. Smith knew what he was talking about: he came from a family of customs officers, and was appointed as a customs commissioner in Scotland in 1778.
Although celebrated as a source of free market ideas, the Wealth of Nations is also (and explicitly) a manual for good tax policy. Smith approved of trade regulation in some instances: the Navigation Acts were acceptable because their goal was national security. Tariffs should be few and calibrated, and guided by rational calculation. Their level ought to be set in response to the level of evasion. At what point was there enough arbitrage opportunity to incentivize widespread evasion? Guided by these principles, Smith believed, governments could transform tariffs to “an instrument of revenue” from one of “monopoly.”
Hence the need to consider the calibration and purposefulness of tariffs and to assess how they are gathered. Recent proposals have urged the need to rethink origin-specific tariffs and instead target specific sectors or transition to ownership-based duties where tariffs are determined by whether the exporter of the goods is a national or foreign company. During the eighteenth century, governments frequently sought to transfer trade duties to the more easily administered excise tax. This was a politically unpopular move then and now.
But Smith’s allusion to monopoly speaks to a final point for those who might live in a world of neomercantilism. Parts of The Wealth of Nations focused on the capture or shaping of trade regulation to serve business interests through the establishment of monopolies. Smith highlighted how tariffs force an intersection between economic interests and political power. Today, more than ever, there is a need to pay attention to corporate political activity. Recent work by Veljko Fotak et al., for example, has explored the political economy of tariff exemptions and their relationship to political connections and campaign contributions.
Smith is remembered as a firm critic of monopoly, but we should also consider him an astute analyst of smuggling and other forms of tariff evasion. His own beliefs, and the evidence of his times, should be taken seriously: the dynamism of offshore networks remains a countervailing force against trade restrictions.
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