As of today, the Trump administration has announced a series of “reciprocal tariffs”. The tariffs range from a low of 10% on Colombia, to a high of 46% on Vietnam. What the Trump administration means by “reciprocal tariffs” and how it calculates reciprocal tariffs can be found here . If until now you have thought there was any kind of reasonable economic logic or rationale behind the Trump administration’s policies, now is the time to abandon that view. Not since the rise of voodoo economics, has there been less of a theoretical rationale for a policy. And indeed, by comparison, the idea that one might balance a budget by decreasing marginal tax rates and closing tax loopholes, is at least one based on a modicum of reasoning. But the Trump administration’s calculation of reciprocal tariffs is one that has no basis in any kind of economic theory.
Firstly, let’s be clear about how nearly every economist defines a tariff and what we generally mean by a “reciprocal tariff”. As most of us understand, a tariff is a tax on an import. If a good is worth $100, a 10% tariff means that the importer pays a tax of $10. If your trading partner has a tariff of 10% on your goods, then a “reciprocal tariff” by most definitions is an equivalent tax of 10%. This tax will not necessarily raise the price of the good by 10% unless the price elasticity of demand is effectively 0 (consumers make no reductions in the purchases of the good when the price goes up). If the good is one that consumers can easily find substitutes for, consumers will respond by buying proportionately less of the good (price elasticity is greater than 1). Thus a 10% tariff will generally lead to less than a 10% price increase and some amount of reduction in how much consumers buy. Most economists (not all, including myself) are generally anti-tariffs, but I think there are some good arguments for some kinds of tariffs some of the time, mostly for developing countries that have a reasonable chance of starting an industry that they could be competitive in. There is also an argument to be had that “tit for tat” in international economic policy, or even the threat of tit for tat makes good sense as a tool of international economic statecraft. But notably, that is not what the Trump administration is doing. What the Trump administration is doing, as I discuss below, is computing a tariff rate that they calculate would be necessary to eliminate trade deficits with all trading partners.
Now, with that basic concept of a tariff under our belt, let’s also take note that the US has both benefited and paid costs for its international position as the hegemonic power. We benefit by having the dollar be the international currency most often used in international payments. Consequently, we can run huge trade deficits and large fiscal deficits and still have the rest of the world buy our financial assets. On the other hand, being the world’s strongest military power comes at a cost in higher levels of defense spending and our commitment to a global liberal order has meant that we chose trade openness over maintaining the US industrial base. One can argue with the wisdom and desirability of these policies (as I would in fact do) but the argument that the rest of the world has taken us for chumps, simply flies in the face of actual history and the structure of the international regime we have lived in since the end of WWII. Yet Trump’s policies are premised on the idea that the rest of the world has taken advantage of us, used us and abused us, and that we should no longer take it. The politics of resentment may indeed play well with some constituencies-at least until the bills come due. Some US workers may get higher wage jobs. But we are all going to be paying higher prices. There are good arguments that the Liberal Economic Order does not in fact benefit all, but there are also good arguments that what replaces it might be worse.
With that said, let us now turn to some brief analysis of the Trump administration’s “reciprocal tariff rates”. The Trump administration defines a reciprocal tariff as follows:
Reciprocal tariffs are calculated as the tariff rate necessary to balance bilateral trade deficits between the U.S. and each of our trading partners.
As noted above, that is not the definition of a “reciprocal tariff.”
A point that is implicit in the Trump administration’s argument is that the failure of trade deficits to balance is primarily a consequence of protectionist policies by other countries.
While models of international trade generally assume that trade will balance itself over time, the United States has run persistent current account deficits for five decades, indicating that the core premise of most trade models is incorrect.
The failure of trade deficits to balance has many causes, with tariff and non-tariff economic fundamentals as major contributors. Regulatory barriers to American products, environmental reviews, differences in consumption tax rates, compliance hurdles and costs, currency manipulation and undervaluation all serve to deter American goods and keep trade balances distorted.
Firstly, models of international trade that assume trade will balance over time do not assume that trade will balance under the current mosaic structure of world trading rules and practices. They assume trade will balance (globally) under very specific and restrictive conditions none of which apply in the real world. To assume, as the Trump administration does, that most of the trade imbalance is due to protectionist practices by other countries is therefore erroneous. In addition, the US practices many of these same kinds of distorting policies. In principle, these distortions were supposed to have been eliminated, or at least held in check by the World Trade Organization and other trade treaties and organizations, but they have not. There is no evidence, or at least none that the Trump administration has presented that supports the view that wide and persistent US current account deficits over the last 50 years are a consequence of protectionist policies on the part of the rest of the world-especially when the US has engaged in significantly more protectionist policies than most people realize.
Then, the Trump administration asserts:
While individually computing the trade deficit effects of tens of thousands of tariff, regulatory, tax and other policies in each country is complex, if not impossible, their combined effects can be proxied by computing the tariff level consistent with driving bilateral trade deficits to zero. If trade deficits are persistent because of tariff and non-tariff policies and fundamentals, then the tariff rate consistent with offsetting these policies and fundamentals is reciprocal and fair.
A tariff rate that is intended to drive trade deficits to zero can only have the effect of chasing its own tail. The extent and steepness of the tariffs will raise prices to American consumers of foreign goods, and stimulate inflation as well on domestically produced goods. It will not improve the competitiveness of American goods. Furthermore, other countries will retaliate so in order to find a tariff rate that eliminates trade imbalances it will be necessary to consistently raise tariffs faster than the rest of the world.
Citizen Rat 