Trump’s Tariff Bomb: The Pointlessness of the Ongoing Debate
On my annual teaching sojourn in Geneva, I had the opportunity to watch the European (French, specifically) reaction to Trump’s tariff speech. Watching with closed captioning (I can read French fine, my ear sucks) was especially illuminating, because it allowed me to focus on the body language and vocal pitch of the various commentators. Both clearly betrayed extreme anxiety, not to say hysteria.
I guess that hysteria is warranted, because what Trump has done is indeed unprecedented and likely to have seismic effects, intended and unintended. And these effects will be global in scope, and indeed, impact Europe more than anywhere, even more than the US and perhaps even China.
I am an economist, and I obviously understand the conventional argument against trade protection. Much of the criticism of what Trump has done adopts the economist’s conventional framing. But it should be blindingly obvious that the administration’s policy is based on a totally different vision. A vision that finds the conventional approach far too blindered and narrow-minded. And it has a point.
Therefore, the question is: which vision is correct? The conventional wisdom, or Trump’s heretical alternative?
Much of the criticism has focused on the issue of the “reciprocity” of the tariffs, and specifically the formula that the administration used to calculate tariff rates by country. The critics say that the tariffs the formula generates are far larger than the tariffs that the target countries impose on US goods, so that Trump’s claim of reciprocity is a lie.
Viewed narrowly, these criticisms are correct. But in his speech, and elsewhere, Trump alluded to a nexus of non-tariff policies that are either nakedly or implicitly protectionist to justify the rates he is demanding. These policies include “currency manipulation,” among other things.
In essence, what the administration is doing is using bilateral trade deficits as a proxy to measure the total impact on the US of this nexus of policies (going beyond tariffs) of each trading partner. Yes, this is obviously a crude proxy. Bilateral deficits are driven by many factors other than asymmetric protectionist measures, such as comparative advantage, but such measures do also matter.
The formula thus results in false positives–charging tariffs that are based on trade deficits driven by non-protectionist factors. But it is clearly focused on avoiding false negatives–i.e., not punishing those whose surpluses with the US are driven by the nexus of protectionist policies.
Put simply, the tariffs are a bludgeon, and if the skulls of some innocents are smashed, Trump gives no Fs as long as the skulls of the targets (yeah, I’m looking at you, China) are well and truly pulverized.
Given the parameters used in it, specifically the elasticity of US import demand with respect to prices, and the fraction of tariffs passed through, the formula spits out a tariff level for each country that would cut the trade deficit in half. There’s a lot of snarking about these two parameters (remember all large calculations are wrong!) but it’s likely that they were chosen largely to achieve this objective.
Two observations that are well outside the conventional framing that is dominating the criticism.
First, I do have doubts that tariffs, even as punitive as those being implemented, will affect the overall US trade balance. In a one period world, there are no trade deficits: the value of imports must equal the value of exports. However, with multiple periods and capital markets, trade deficits can exist, and they are the mirror of capital flows.
In essence, foreigners are willing to sell a greater value of goods to the US than the value of goods they receive in return only under the expectation that they will receive a greater value of goods on net in the future, and where the net is zero in present value terms. The US pays for the surplus of goods imported today with IOUs.
One implication of this is that trade deficits are largely driven by US budget deficits. The deficits generate IOUs, much of which are taken up by foreigners in exchange for the goods they sell us today.
Meaning that the efforts of DOGE will be more material in reducing trade deficits than the tariffs will be.
Second, the conventional framing implicitly assumes we are in a “first best” world. That is, economies are currently efficient, and operating with no distortions. Edenic, in other words. Introducing a distortion like tariffs into Eden creates a fallen world.
But, of course, we are decidedly not in a first best world. Indeed, the entire rationale for the tariffs is that we are in a very, very fallen world in which foreign nations–again, I’m looking at you, China–implement a vast complex of distortionary policies. With respect to China these include, inter alia, capital controls, currency management, financial repression (a big one), restrictions on foreign investment, widespread subsides (e.g., shipbuilding as laid out in an earlier post) and a plethora of regulatory policies that favor domestic firms over round eyed devils.
In such a world, it is categorically incorrect to conclude that an aggressive tariff policy is bad, based on the effects of tariffs in a first best world, which is not the world we are in.
Are Trump’s tariffs what economists call a second best policy? That is, a policy that is welfare improving because it offsets pre-existing distortions? I don’t know: the world is very complex, and tracing through all the effects is a daunting task.
But what I do know is that this is the question that must be addressed, but which virtually everyone is ignoring. Meaning that the hysteria is utterly pointless, and the current debate is totally off-point. And it will be until the we’re-not-in-the-first-best-world nettle is grasped.
The misdirection of the hysteria is even more pronounced due to a widespread failure to determine whether the tariffs are a tactic, or a strategy based on a conviction that tariffs are good per se. Knowing Mr. Art of the Deal, it is highly likely that the tariff bomb is a tactic, and specifically a negotiating tactic in which Trump exchanges concessions on the punitive rates for foreign reductions in their protectionist measures.
If that’s the case, and the tactic works, ironically the end state would be closer to the classical liberal economic outcome that the critics assert Trump is destroying. That is, when all is said and done there will be less protectionism in all forms, tariff and non-tariff.
The imposition of tariffs on pretty much everyone (including islands inhabited mainly by penguins!) has important implications for the negotiation game.
One implication is that this is a divide an conquer strategy. Although the rest of the world’s collective interest would be to cooperate to counter the US strategy, collective action problems abound. Indeed, there is a prisoner’s dilemma in play here. Countries realize that they can get a better deal if they bend the knee early. Hence the rapid actions by Vietnam, Cambodia, and Israel. They may be the first, but no doubt the last. Indeed, there is likely an unraveling dynamic here: who wants to be the last to genuflect?
Or consider our “friends” in Europe. They are now confronted by the ugly reality that US tariffs on China will result in a redirection of goods to Europe that will hit European industries hard. So Europe may be sorely tempted to raise unilaterally its tariffs on Chinese goods–which would suit Trump just fine, since the tariff policy, and as is the case with almost all other Trump foreign policies, is all about China, China, China, and specifically weakening China. And even if Europe doesn’t unilaterally respond to a surge in Chinese goods by raising protective barriers, it may well agree to do so as part of a deal with Trump to reduce the tariffs they pay in the US. (Even though European consumers would benefit from this influx of Chinese goods, the political economy of protectionism favors producers-concentrated interests-over consumers-a diffuse interest).
The confusion over whether this is actually a negotiating tactic, or whether Trump is in fact a true believer that tariffs are great policy is actually necessary for it to be an effective negotiating tactic. Game theory long ago demonstrated that a reputation for doing seemingly irrational things requires that there be a positive probability that someone is in fact irrational. So the uncertainty over whether Trump is truly crazy is a necessary condition for him to implement a crazy-like-a-fox negotiating strategy. Even if he is really just bluffing, he has to credibly signal that he’s not, and he does that by proclaiming his love for tariffs.
In sum, the cramped vision of those melting down and freaking out over Trump’s démarche precludes a serious analysis of it. Econ 101 says–tariffs are bad economic drugs, M’kay. Agreed!–in an otherwise first best world. But since we are clearly not in that world, and that Trump has identified (inarticulately, as is his wont) ways in which the world is fallen, it is not necessarily the case that the extraordinary measures that he has put forward are bad. Especially if he is using them to extract concessions that eliminate or at least mitigate the policies that currently distort world trade, production, and consumption.
That is, contrary to the critics, one cannot conclude that the tariff bomb is destructive a priori, based on Econ 101. One must grapple with the much more daunting challenge of evaluating its effect in a decidedly fallen world.
Alas, there seems to be little ability or inclination to do so. Instead we are likely to be be bombarded with a continual stream of hysterical rants rooted in textbooks not reality, and amplified by the pre-existing hatred of all things Trump among the soi disant elites.
Trump haters will use Econ 101 and not look at the broader strategy. They can’t get out of their box.
Comment by Jeff Carter (@pointsnfigures1) — April 6, 2025 @ 8:46 am
Yes, this is obviously a
crude proxywild-assed guess.FTFY
Comment by dcardno — April 6, 2025 @ 11:26 am
So, we’re to consider that Trump is actually secretly a globalist and free-trade champion? And this tariff action is part of a strategy to lower trade barriers globally?
Trump has NEVER given an indication or hint that he believes in reducing trade barriers, the exact opposite in fact. He has made his beliefs crystal clear – that he believes that the US historically prospered under protectionist policies. He enacted tariffs during his first term, he criticized Biden for everything EXCEPT his additional tariffs. Nothing he has ever said in his life could be construed as suggesting he is anything but a protectionist.
Nah, I’m not joining Craig to drink this kool-aid.
Trump is following some economic quackery because he doesn’t even understand Econ 101 – he believes that tariffs allow him to “tax other countries”. You said the same thing yourself before the election, Prof, that Trump was clueless when it came to tariffs, only that he was slightly less clueless than the Dems.
The cost of this folly is already immense – in terms of savings wiped out – but the long term damage is going to be even worse as business investment in the US, both domestically and FDI, will take a massive hit. Cancelling the tariffs in a few weeks will not undo this damage to investment. This is a disastrous policy for the US and – to a lesser extent the rest of the world – at least for those countries who manage to avoid “retaliatory” tariffs. A stupid description -I don’t see how shooting yourself in the face in response to aggression is any sort of retaliation.
Comment by derriz — April 6, 2025 @ 1:27 pm
I ask myself what people would be saying if Trump had not done this and if instead his economic policy had been merely to play more rounds of golf.
The answer is that there would have been hysterical rants about the evil of Golfonomics and how it threatens the wellbeing of everyone on earth.
Comment by dearieme — April 6, 2025 @ 2:22 pm
this got a chuckle out of me: “There’s a lot of snarking about these two parameters (remember all large calculations are wrong!) but it’s likely that they were chosen largely to achieve this objective.” So they reverse-engineered the model input parameters in order to get the result they wanted. That’s good science here folks, even for an economist.
And, at the risk of stating something obvious, we are getting when the prof thinks we are getting “bombarded with a continual stream of hysterical rants rooted in textbooks not reality.”, a reasonable person would argue the ranting has something to do with the biggest indirect tax rise in U.S. modern history PLUS a brutal market sell-off. You know, pretty real things.
Comment by [email protected] — April 6, 2025 @ 2:35 pm
Given: it’s all about China, but Europe will likely be hit the most. Question: where is the *uncertainty* whether Trump is truly crazy supposed to come from?
I think it’s been obvious that the tariffs are a negotiating tactic and not a strategy at least since those penguins have been spotted rowing on an ice slab in the direction of DC.
But I’m not sure we should disregard the actual effects of Trump’s actions and focus on the academic question of whether the end result will be freer trade any more than we should disregard the actual effects of bolshevik actions and focus on whether the end result will be true communism.
Because on the way to true communism there are bound to be some temporary difficulties.
Comment by Ivan — April 6, 2025 @ 3:03 pm
Hmm, yet the mood music coming from retard HQ has definitely changed over the weekend. To extend their tough medicine theme, it’s like a heart surgeon telling a patient they’ll be fine after some radical surgery, even though the patient is seeing their early life flashing before their eyes, and they can hear the surgeon’s colleagues saying “sir, maybe you should use the defibrillator?”
Comment by David Mercer — April 7, 2025 @ 1:10 am
On a related note, I went to a Robert Kaplan talk over le weekend. Very interesting, although slightly rambling for one so accomplished (possibly a consequence of him being somewhat intimidated by his surroundings). He made several interesting points about the relationship between China and the US, including how trade had effectively kept them at bay militarily, his view being that tariffs could seriously undermine this status quo.
Afterwards it did occur to me that the US may have made a major mistake in imposing such swingeing tariffs on its other major trading partners in that neck of the woods (Vietnam etc), potentially pushing them more into Beijing’s orbit.
I also got an answer as to why the US is so interested militarily in this region, although on reflection this doesn’t really stack up. Hegemonic power & history? Unsurprisingly the Chinese aren’t buying that.
Comment by David Mercer — April 7, 2025 @ 1:26 am
“Both clearly betrayed extreme anxiety, not to say hysteria.”
Yeah, this is the kind of wishful thinking that led Putin to think that he could use the threat of gas markets to bully Europe into not supporting Ukraine. Like the Prof, Putin imagined that the Euro-weenies would run around with their hair on fire for a while, before pooping their pants and giving in to whatever demands the big bad leader made. Unlike Putin, the Prof and Trump now have ample evidence that when pushed hard enough, this is not what Europe does. So, enjoy your trade war. We will happily hoover up the investment and economic opportunity that the US has decided to price itself out of (not saying that this will fully compensate the loss of the US market, but I think we are not going to suffer as much as the US will).
“what the administration is doing is using bilateral trade deficits as a proxy to measure the total impact on the US of this nexus of policies”
The Administration appears to have disregarded the value of the services exported by the US to those countries. Thus making this argument patently false.
“So Europe may be sorely tempted to raise unilaterally its tariffs on Chinese goods–which would suit Trump just fine”
Literally something we have already been doing for years, and will continue to do if the Chinese start dumping goods on our markets. Why does Trump suddenly get credit for this? Also, what kind of cognitive dissonance is in that whole paragraph: Europe has such low tariffs that we’re at risk of being flooded by Chinese goods, but our tariffs on the USA (which are lower than on China) are so high as to prevent fair market access for US goods? Well – which is it?!
“and if the skulls of some innocents are smashed, Trump gives no Fs as long as the skulls of the targets … are well and truly pulverized”
These aren’t bombs. There is no rule of law, economics or physics that stops the US from exempting the UK and Australia (with whom the US has a trade surplus and who have been exemplary allies), just as the US exempted Russia and Belarus. Why isolate yourselves from partners who are already doing what these tariffs claim to be trying to achieve, and who support US ideals and goals? How on Earth can you claim that this action serves your country’s best interest?
Comment by HibernoFrog — April 7, 2025 @ 7:43 am
Seriously, Craig, the “Trump is playing 4D chess” analysis is not very credible, as noted by derriz above. Because the Trump administration is pretty leaky, we know how the sausage was made. There was a debate among his advisers about which of Trump’s contradictory policies and objective should be emphasized–universal tariffs? reciprocal tariffs? raise revenue? protect American jobs? lower bilateral trade deficits? leverage over fentanyl?–and then Trump kinda sorta sided with the reciprocal gang. They had to come up with a formula that would incorporate tariff and non-tariff barriers and were too badly staffed to perform an actual country-by-country analysis before the arbitrary “Liberation Day” deadline. So, like a group of students on a project where they ran out of time, they cooked up the bizarre formula that has almost nothing to do with protectionist policies but fixates on bilateral trade balance and foreign country openness (so punishing the likes of non-protectionist Switzerland and Singapore). It seems likely that they cooked this up via a naive chain of thought prompt to ChatGPT or Grok: https://www.theverge.com/news/642620/trump-tariffs-formula-ai-chatgpt-gemini-claude-grok
Comment by SRP — April 7, 2025 @ 5:09 pm
As for the second-best analysis of these tariffs as a long-run policy, I must also request that you come on. The tariff formula generated, which is a bad DEI version of trade policy (“disparate impact proves discrimination”) that doesn’t even measure the disparate impact very well, is unlikely to be third- or fourth-best, much less second-best. As over half of U.S. imports, per the BEA, are inputs to U.S. production and not consumer goods, the broad-based clobbering of imported capital equipment, components, and materials will harm globally competitive U.S. manufacturers. Any global manufacturing exporter with a high foreign share of total sales must now seriously consider moving manufacturing out of the U.S., both to compete on costs and avoid retaliatory tariffs and other protectionist measures.
Geopolitically, we are driving the ASEAN nations toward China, not exactly the sort of China containment policy that makes sense. We are taking some of the heat off Xi to play nice with his neighbors and now must hope that he will overplay his hand.
Comment by SRP — April 7, 2025 @ 5:18 pm
I get the political angle but in the end ECON 101 wins. These tariffs, poorly thought, poorly staffed and economically dumb is going hurt us a lot. If anyone thinks protectionism works consider how poor it’s made Argentina and North Korea.
I’m much in favor of what I think are Trump’s goals—reduce scope and cost of government, manage and enforce the borders, reform programs—.but he and his team are grossly incompetent at the basic “blocking and tackling” of government. There’s ways to effect change, throwing around furniture and making stupid statements only to be crawled back the next day ain’t it.
Comment by The Pilot — April 7, 2025 @ 7:14 pm
“a bad DEI version of trade policy (“disparate impact proves discrimination”)”
OUCH! That might be the most biting comment I’ve yet seen about this debacle. Nicely put!
Comment by HibernoFrog — April 8, 2025 @ 3:30 am
https://modernity.news/2025/04/07/heres-schumer-in-2005-saying-big-tariffs-on-china-needed/
Comment by dearieme — April 8, 2025 @ 10:59 am