Thinking Through Trump Tariffs
Now that the election is over, we can discuss and analyze things again without every piece of analysis needing to be pro or contra or seen in some political light.
One thing we know is that the Trump Administration will push tariffs. So, I thought it’d be useful to think through what’s likely to happen and what it might mean, at least in my opinion.
I am an economics professor and I too think tariffs are a bad idea, but that’s no longer helpful. They are coming and I hope this helps you and me think through the most likely effects for us all.
Professor Ball analyzing tariffs in his Economics Research Lab. (Actually this is a Photo by National Cancer Institute on Unsplash .)
Tariffs as Negotiation vs Economic Policy
In my view, Trump is definitely using tariffs and the threat of tariffs as negotiating tools. I think he was already publicly starting negotiations with US politicians, businesses, foreign countries, and so on. He said as much many times.
So, I’d like to think of tariffs for negotiation purposes as tariffs for “non-economic” reasons, although his negotiations are also focused on economics as much as national security.
With tariffs for negotiating, he might threaten, say, 100% or 200% tariffs on a good, company, or sector to push a country or a specific company to do something. Again, he’s said as much when he explained that he’ll call companies looking to move production from the US to another country and explain that if they do so, their goods will have 200% tariffs on them when they try to send them back into the USA.
That’s very different from an economic policy of 20% tariffs across the board which is what he says he’ll do and it looks like he’ll have the political support to accomplish. I’ll focus my analysis instead on the 20% tariffs.
The Best Case: Short Term Boom and Little Price Effect
I think it’s fair to say that Trump and Team’s real goal is to grow the US economy. They want to use tariffs to defend American businesses and to encourage re-shoring of American businesses. In both cases, the real economic policy goal seems to be to cause American businesses to grow and also to hire people.
If that’s your goal and you want to use tariffs as your policy tools to achieve it, then what would be the best way to do it?
First, let’s assume they aim for 20% tariffs across the board as an end goal.
Second, I think the best approach would be to announce them now and phase them in. For simplicity, suppose they could credibly lock them in to go up by 5% every 2 or so years, so they are at 20% within 10 years.
In that case, you might get the benefits today and few of the costs. That means companies would start immediately to seek domestic suppliers to replace their foreign ones but have plenty of time to do so. That would automatically increase demand for US-produced goods and potentially cause a boom in domestic production.
This would also, I think, slowly raise the price of these inputs for businesses, which is one of the costs of tariffs. So, this announce and phase-in policy would potentially maximize the initial benefits and minimize the initial costs.
Domestic businesses love tariffs on their outputs since this makes their (foreign) competitors’ products more expensive and hence favors the domestic business. And they hate tariffs on their inputs because it raises their costs either directly, if imported, or indirectly when people re-shore and drive those input prices up.
Announcing and phasing in the tariffs might maximize the benefits to outputs and minimize - or at least slow - the costs on the input side.
To the extent the tariffs hit the output side more and any re-shoring does happen, this will indeed increase US domestic production and increase demand for US labor. To the extent the tariffs hit the input side more, it will decrease US domestic production and decrease demand for US labor. In both cases, it eventually raises the price of goods and services.
The only case I can think of where it wouldn’t raise prices is if the re-shoring and positive production effects were so huge that it dwarfs the higher input cost issue. This is unlikely in my opinion, but we have to be honest that it is a theoretical possibility1.
The Longer-Term Problems with Tariffs
I have long thought that we economists and commentators often underestimate the potential short-run benefits from some policies, especially certain collectivist policies like tariffs or industrial policies. When we talk about the problems with, say, tariffs, we are really talking about the long-run effects or imagining them being bluntly implemented all at once, over night.
I have watched many countries over the years engage in policies that economists rightly criticized but that instead led to seeming gains immediately. The problems we warn about usually show up, just later than we imagine. As a matter of fact, I have a series of academic articles arguing for exactly these results for populist governments (see Ball, Freytag, Kautz (2019) and a soon-to-be public new paper with theoretical model and updated empirics).
My argument today is in this vein: gain today, pain tomorrow. We can see the possible short-term gain: some boost to domestic businesses. Let’s now explore the problems with tariffs.
The Traditional Economic Argument Against Tariffs: Efficiency
The fundamental, traditional economic criticism against tariffs is that they lead to inefficiencies. That is wholly unconvincing for most people, but it’s the heart of the economist’s critique nonetheless.
Economic growth and human flourishing is based on ever more efficient production of the things we value. A hundred years ago, a much greater percentage of our population was employed in farming yet produced a fraction of what we produce today. (This is the case for non-GMO and other food production too.) Today a tiny fraction works in farming and yet we produce giant surpluses. That gain in efficiency - producing more with the same or fewer inputs - means those people are freed to engage in other activities. This leads to growth in other industries.
This is true with everything. As we get better at doing something, we generally need fewer people doing it while we still get more of it. That means, immediately, there’s a benefit of getting more for less which is why the prices generally decline for the goods which are being more efficiently produced.
We normally think of efficiency as coming from technological innovations, and that’s true, but economists define innovation as anything allowing fewer inputs for the same or more outputs. Thus, it also comes from buying the same inputs more cheaply from foreign sources, assuming the quality is the same. That too decreases the cost of the inputs per output and is therefore also considered innovation and lowers the price of those goods.
Improved efficiency leads to lower costs per good over time and allows more people and, specifically, people with lower incomes to afford more goods. They can buy more of something that’s getting cheaper or they can buy the same amount and save the gains or spend those savings elsewhere. It’s their choice and when people have more resources to spend and are better able to spend them how they see fit, economists call that an improvements in the well-being of those people.
This is why economists are always hyper focused on efficiency and so against anything makes things less efficient. More efficiency will lead to economic growth and increasing human well-being, or flourishing, over time. Less efficiency will lead to the opposite.
Tariffs force businesses and people to switch to less efficient goods and processes. While there can be some initial economic gains from this, over time, it always means less efficiency and hence less of all the good things I mentioned above.
Political Economy Problems with Tariffs
The other long-term problem with tariffs is that it creates political factions and interest groups, pitting one group of Americans against other Americans, and also opens the door for all sorts of interest groups (both foreign and domestic) and potential for corruption (both foreign and domestic) that will influence both our American politics and our economy2.
Once tariffs are in place, some businesses will be harmed more than others. The businesses that import specialized parts or special resources, for example, will be harmed for sure because those things all become more expensive, making that business less competitive in open markets. The immediate reaction by the business is to ask for some sort of further government protection. Either they’ll lobby for a subsidy or a tariff exemption or some other tariff or legal restriction on their competition. Any politician running for office can court their vote/support by promising to provide just such benefits. Now you have created another government-business interest group that will only feed on itself, growing and worsening over time.
Each country has an incentive to lobby for special exemptions from tariffs for their products if they help US businesses sell into their countries in exchange. Which US businesses? Well, which ones do you think? They’ll start with the big businesses who have money to lobby politicians in that country for exactly this policy and those are also the larger businesses who have enough money to lobby in Washington D.C. too.
Now, this is actually something that Trump wants. He is openly and publicly using tariffs to negotiate with foreign countries and to seek reciprocal fair trade agreements. Again, I think he can succeed with that in the short run. Ex ante (i.e., before it starts) those political factions and lobby groups I’m talking about don’t all exist yet, at least in theory. So I actually think he can do this relatively fairly and evenly during his term. The problems set in and grow roots over time.
Of course, some of those interest groups are already there and we can see them even today. Where did Trump need votes, for example? Michigan and places with traditional auto industries. It’s no surprise he’s publicly discussed how he threatened auto companies not to build in Mexico. That got him what? Union support. So already we see those interest groups forming. Just think through the groups he catered to and you’ll find others3.
We could continue with industries favored by Democrats like EVs and other “green tech”. Do you think they’ll be able to get favored treatment and exemptions today? No. But, after the new tariff scheme is built, they can agree to support Democrats next time in exchange for favorable tariff treatment or subsidies to offset Trump tariffs, etc.
Essentially tariffs just become one more political tool, carrot or stick, for politicians to use to extract rents and political support in exchange for governmental goodies. That obviously opens things up for more corruption and foreign influence. That’s a real problem and I predict that, if we really launch these new broad tariff schemes, then in 10 years we’ll see more and more corruption stories, blame politician X for helping industry Y and country Z is now involved and so forth. It’ll get messy. It’s really the worst sort of political outcome for us all in the long term.
Economically speaking, do you think that leads to a more or less efficient use of economic resources? Are those businesses more or less likely to be growing because they are more efficient and hence lowering prices and freeing our collective resources to everyone’s benefits? No. Of course not.
And the fact that Trump will also use some tariffs in a targeted political way will, again, maybe lead to some initial gains in GDP and employment for specific sectors, but only worsen the longer-term negative political-economy consequences.
Global Effects
As the US uses tariffs more and more, it encourages other countries to do the same. That means all those problems worsen in every other country as well. All the negative effects get amplified. And the doors for such tariffs-and-politics policies remains open no matter who is in the White House. Notice, after Trump’s first term, Biden didn’t undo any tariffs. He actually raised some! Now Trump will raise them more. Whoever is next will do the same. Remember, they all compete for the same voters and need something to offer different unions, business groups, and so on.
The EU is already talking about tariffs on U.S. products. The Chinese are responding by increasing subsidies for their businesses even more. Just think about it: If the new tariff on a Chinese product is 20%, that makes it 20% more expensive for an American to buy it. Because of that, Americans buy less of it. That’s the whole point of the policy.
China’s optimal response is thus to subsidize those industries even more so the cost drops by more than 20% to offset the effect of the tariff. Rather than discourage the Chinese from subsidizing industries, it will encourage them to subsidize them even more!
Again, all the effects magnify the politicization of business and economics all around the world even more. And, again, this effect will be small at the beginning and only grow with time. Hence my mantra that these things inevitably lead to some short-run gains but come with serious and long-term costs. In my estimation the long-term costs always far outweigh any short-term gains.
What’s The Point Of My Column?
We’re past the point of attacking or defending policies. My personal position is that the Unites States should unilaterally set all tariffs to zero or move toward that over say 4-5 years. Period. Full stop.
My policy is not on the table. The Trump administration will impose tariffs and there’s a pro-tariff mood around the world today, and certainly in both US political parties. So, I wanted to think through what’s likely to happen and what it’ll mean in the coming years.
I think the most likely policy - based on my armchair logic alone - is that the Trump Administration will impose some strategic and very high tariffs immediately (i.e., aiming at certain industries they want back in the US or are key for China, etc.) and there will be many threats of other strategic/high tariffs for negotiating purposes.
I think it’s very likely that they’ll impose some across-the-board tariffs immediately, but I don’t expect 20%. Maybe 5%. I’m guessing, of course, but I think they want the political win of meeting a campaign promise and therefore will impose something right away. I then think, because it would be smart in my opinion, that they’ll argue to phase the remaining tariffs in over time in order to maximize the announcement effects and minimize the costs as I mentioned at the beginning of the column.
The effect, I believe, will be some short-run economic boom and the damage will all just worsen over time.
So, that’s what I expect. We’ll see how it plays out. My hope (sadly, not my prediction) is that the initial tariffs are indeed minimal but that there is some boom and re-shoring and that these gains satisfy the appetite for more tariffs so that the bigger ones never materialize. We’ll see.
I hope this helps you think through the implications of tariffs and informs you on what to watch for over the coming months.
Thank you for reading.
APPENDIX: Further Materials on Trade and Tariffs
Those interested should read my friend, Prof. Freytag’s, excellent piece on understanding trade deficits and whether they are “good” or “bad”: The Trade Balance and Winning at Trade, CATO Institute
I did a series of videos on the macroeconomic effects of tariffs when Trump was first elected. They use basic macroeconomic models that undergraduates learn. The videos are here, below. You can see the implications (higher price, lower GDP). It’s this analysis that I had in mind in writing today. I think it’s right, just happening over a much, much longer horizon.
Again, I do not think this is realistic. A standard argument against this is that, if it were really better to re-shore and expand in the US market in a way that doesn’t raise prices overall, then companies would do this already, supply each other and everyone would be better off. They haven’t done this and don’t. Therefore it’s likely that this isn’t the effect. The counter is that individually no company wants to risk it but tariffs would act like a coordinating device to help “all” companies move back at once and it’s this group effect that generates the collective benefits. Again, I don’t think this is accurate but one can legitimately argue it and would need to show me some data suggesting it could be the case, but it’s possible.
These are also things that make everything less efficient, by the way.
In all fairness, you can do this with all politicians, the support they try to attract and their policies. No tax on tips was a policy both Trump and Harris proposed in order to get the Catering Service Union support in Nevada, for example. No EVs attracted traditional energy producers in Pennsylvania. Subsidies for Black Startups to attract black voters. And so on.
Thanks, as always. Good question. Funny too, I had a section on this and deleted it because it was getting too long. Maybe I'll write a separate column just on this. Trump and Team commented more than once that they would gladly investigate if you could replace income taxes with tariffs. My quick take: At one level you are 100% right and in practice it doesn't work. (Technically, "income" can come from any source foreign or domestic, but let's ignore that for now.) And, it's a valid economic inquiry as to whether we finance government via income taxes, consumption taxes or tariffs, or some combo. To see one reason, however, it's not quite the same, imagine pure tariff financing. People could, in principle import zero goods. Then government revenue would be zero. People can't, in practice, generate zero income for themselves. They have to live. So the two can't just be switched out. ... But your basic intuition isn't too wrong. Whatever we tax we get less of and people have long argued we should tax consumption (demand side) not income which is generated from the supply side of the economy. Again, we can't consume zero. We'd die. So, it's feasible. ... Thanks again. Keep asking your questions and sharing thoughts. They're always appreciated and this time, I think, will inspire me to write a short follow up on this topic since it might come back up anyway.
The thing I always wonder in these discussions is: Are tariffs worse than income taxes? Income taxes seem like basically a tariff on domestic production, which I would think would have similar distortionary effects as tariffs on imports, and we can see governments trying to offset some of those distortions by offering deductions (and subsidies), which in turn lead to further distortions, much like we expect to happen for tariffs and exceptions to tariffs. Governments need to make money somehow, so, on the margin, how do we know if it it's worse to raise tariffs by $X or to raise income taxes by $X?