Trump’s Misguided Tariff Formula
A Recipe for Disaster
US president Donald Trump reportedly delayed the launch of his global “reciprocal tariffs” until after April 1. If his goal was to avoid being dismissed as a fool by the rest of the world, it is not at all clear that he has succeeded.
A Formula Flawed
Trump’s so-called “reciprocal” tariffs are based on a peculiar formula: the tariff on any country, k, is set at a maximum of either 10% or a higher value, 0.5 times k*, where k* is what the White House determines as a comprehensive tariff equivalent of all trade barriers that k imposes on the US. This is computed as k’s trade surplus with the US in 2024, divided by its exports to the US in the same year.
Conceptual Flaw
The formula’s conceptual foundation is its belief that US trade deficits are driven entirely by foreign trade barriers or other unfair trade practices. Textbook macroeconomics tells us that a country’s trade balance reflects the difference between national savings and investment.
South Korea, for example, runs a trade surplus because it saves more than it invests. The US, by contrast, runs a trade deficit because it suffers from a savings shortage relative to its investment.
Blaming the Wrong Factor
A country’s saving-investment ratio can be influenced by many factors unrelated to its trade policies. For example, a major shale-gas discovery in Texas could boost Americans’ expectations of future wealth.
In response, US consumption rises, and savings fall, resulting in an increase in its trade deficit. If developing the shale-gas field also raises the overall US investment rate, the trade deficit will widen even further.
Flawed Assumptions
Raising Tariffs Won’t Reduce Imports
The second major flaw in the Trump administration’s tariff formula is the assumption that raising US tariffs will reduce imports without significantly affecting exports. In fact, tariff hikes are often followed by retaliatory measures, leading to a sharp drop in US export volumes.
China, for example, has already announced it will match the administration’s “reciprocal” rate by imposing an 84% tariff on US goods, after Trump imposed a 104% tariff on Chinese goods.
A Recipe for Disaster
Even if no foreign country chose to retaliate, American exports would still be likely to decline. With unemployment near historic lows, the US economy has little slack.
Tariffs may encourage previously uncompetitive firms to expand – but only at the cost of diverting labour and capital away from more competitive companies, particularly in export-oriented industries.
The Consequences
A Global Market Reaction
The fallout hasn’t been limited to US markets: Japan’s Nikkei 225 index fell by 7.8%, Hong Kong’s Hang Seng Index plunged by 13.2%, and the pan-European Stoxx 600 declined by 4.5%. In China, which is grappling with domestic economic pressures, the Shanghai Composite Index fell by 7.3%.
A Warning from Stock Markets
Because stock prices represent investors’ expectations of future corporate earnings, the fall in US equities suggests that investors are not buying Trump’s claim that tariffs will benefit the US economy in the long run. As a result, American households now suffer simultaneously from a decline in the value of their retirement savings and the prospect of sharply rising prices.
Conclusion
Trump’s tariff formula is misguided, flawed, and potentially disastrous. It is a recipe for a trade war that will harm American households, the global economy, and ultimately, the US economy itself. It is time for the Trump administration to reconsider its approach and adopt a more nuanced and evidence-based strategy to address the US trade deficit.
FAQs
What is the Trump tariff formula?
The Trump tariff formula sets the tariff on any country, k, at a maximum of either 10% or a higher value, 0.5 times k*, where k* is what the White House determines as a comprehensive tariff equivalent of all trade barriers that k imposes on the US.
What is the conceptual flaw in the Trump tariff formula?
The formula’s conceptual flaw is its belief that US trade deficits are driven entirely by foreign trade barriers or other unfair trade practices, when in fact, a country’s trade balance reflects the difference between national savings and investment.
What are the consequences of Trump’s tariff policy?
The consequences of Trump’s tariff policy include a global market reaction, with stock prices falling across the globe, a decline in US exports, and a rise in prices, ultimately harming American households and the global economy.
What is the Lerner Symmetry Theorem?
The Lerner Symmetry Theorem states that tariff hikes are often followed by retaliatory measures, leading to a sharp drop in US export volumes, and that any tariff-induced reduction in US imports will be accompanied by a corresponding decline in US exports.