The tariff policy announced by President Trump could be the most consequential action of his presidency. The new tariffs will have disastrous economic and political consequences and undo the many good policy ideas that the Administration has enacted or advocated. They are a political dream come true for Bernie Sanders and the Chinese Communist Party. At a moment when the feckless Democrats are unable to find a path to a viable future, and when China’s economic growth and international influence are in steep decline, these tariffs will help to revive the Democratic Party and push other countries into the arms of China.
The immediate economic consequences of the new tariffs – all of which follow from non-controversial economic reasoning – will be recession, inflation, export collapse, and rising interest rates. Republicans in Congress need to understand how disastrous will be the result of permitting the President to usurp their Article I authority under the phony argument of a national emergency. Congressional action to stop the tariffs must be swift and decisive because their negative consequences will begin to be felt immediately and acutely.
Let’s begin with some simple facts. The tariff rates set by the President would result in a tariff-to-import ratio of roughly 27%, according to JP Morgan’s estimates, which is the highest in over a century. Empirical evidence shows that the consequences for the economy would be catastrophic declines in output and employment and a large rise in the price level. The notion that those consequences would be mitigated by the construction of new factories to restore American manufacturing is a form of absurd magical thinking. Instead, the predictable economic and political consequences of the tariffs will reduce investment. Who would invest in a factory (based on a long-term calculation of its profitability) based on policies that will be so immediately disastrous that they cannot possibly survive the next election?
How will exporters (like farmers) fare? The Lerner Symmetry Theorem in economics reveals as a matter of simple math that a tariff has the same effect as a tax on exports. That is why exporters usually have opposed tariffs throughout history. Because tariffs reduce the trade deficit, as a matter of simple arithmetic that also implies that they reduce capital inflows into the US (arithmetically, the current account deficit must equal the capital account surplus). Interest rates must rise because that is part and parcel of arriving at a new lower level of capital inflows necessitated by the tariffs. That’s right, not only will farmers and other exporters be harmed by higher tariffs; we also will see major declines in foreign investment into America, which is the opposite of what President Trump has predicted.
Some will read all this and say: “But this is a strategic ploy to restore free trade. We need to impose these tariffs as a matter of principle, to stop the unfair trade practices of other countries that the President described in his Rose Garden speech. And the President assured us that the tariffs only go part of the way toward addressing those unfair trade practices (demonstrating his kindness). Furthermore, as the President said, if countries reduce their trade barriers, the new tariffs will be reduced.” All of those statements are demonstrably false.
Are the new tariffs “reciprocal” or “kind,” as the President has characterized them? First, note that a minimum tariff of 10% has been imposed on countries irrespective of their policy stance or any other facts. That simple fact reveals that the purpose of the tariffs is to reduce trade, not to be reciprocal.
For many countries, the tariff rates set by the President are much higher than 10%. He claims that this reflects their own tariffs and other non-tariff barriers to U.S. exports. To be specific, the Administration is claiming that the tariff rate of 46% on Viet Nam is set at roughly half of the tariff-equivalent trade barriers the Administration’s economists calculate that Viet Nam imposes on the U.S. The fact that it is “half” is supposed to indicate the “kindness” of the new tariff policy.
But the calculations are fatuous, and laughably absurd to anyone with a simple understanding of the arithmetic of trade and capital flows. The Administration economists assume that the only reason for a country to have a trade deficit with the U.S. is an unfair trade practice by the country (which could include quotas, value-added-tax exemptions, or currency manipulation). It is possible – even likely – that for many countries, most of the explanation for their trade surpluses with the U.S. is some or all of those practices, and the President was right to point to examples of some of those in his remarks.
However, it is simply wrong to assume that U.S. trade deficits can only occur, or largely do occur, because of unfair trade practices. By making that false assumption, President Trump’s economic team has dramatically exaggerated the extent of unfair trade practices by other countries.
According to the simple arithmetic of international trade and capital flows, the current account (or trade deficit, which is closely related to it) must be equal to the capital account surplus. In other words, if you import from a country more than you export to that country, that difference must reflect an equal and opposite amount of investment by that country into the U.S. (that is, foreigners make financial investments in lieu of demanding immediate payment in the form of U.S. exports). For that reason, economists recognize that the trade deficit reflects not only influences on import and export demand (such as trade barriers) but also influences on foreign demand for investment in the U.S. and U.S. savings behavior.
The notion that U.S. trade deficits result from foreign interest in investing in the U.S. and U.S. savings behavior are not just hypothetical possibilities, they are the dominant explanation offered by economic research that has sought to explain the high and persistent levels of U.S. trade deficits in recent years. That’s right, contrary to the Trump Administration’s assumption that U.S. trade deficits only reflect unfair practices by our trading partners, the empirical economics literature finds that the deficits primarily reflect U.S. savings decisions and foreigners’ desire to invest in the U.S. To be specific, the high government deficit spending is a form of U.S. dis-saving that makes us more needy of foreign capital inflows. Furthermore, because the U.S. enjoys robust capital markets, skillful financial intermediaries, and reliable contract enforcement, the U.S. is a desirable place for foreigners to invest.
Because neither the 10% minimum tariff nor the higher tariff rates set by President Trump mainly reflect trade barriers set by other countries, generally it will not be possible for other countries to achieve significant reductions in the new U.S. tariffs by eliminating whatever barriers they have imposed on U.S. exports.
Congress urgently needs to reclaim its authority to set sensible trade policy. It could do so by setting tariffs that truly respond to unfair trading practices. For example, a border adjustment tax to counter the effect of VAT subsidies is an idea that economic theory has supported for decades. A reciprocal approach grounded in real evidence of unfair trading practices would not only be fair, it would encourage countries to dismantle trade barriers and thereby increase world trade and the prosperity it brings. The President has also been right to argue that there are legitimate strategic U.S. interests that need to be taken into account by trade policy. It makes sense to use tariffs alongside other tools to reduce China’s global influence and ensure U.S. access to critical resources and productive capabilities. But the President’s specific new tariff ideas will produce the opposite effects, strengthening China, encouraging trade wars, crippling the U.S. economy, and advancing the position of his domestic political opponents. Congressional Republicans need to save the President, and the U.S., from his misguided tariff initiative.
