The Chaotic, Fantastical World of Donald Trump's Tariffs

Time​ Magazine

4 days ago

President Donald Trump has vociferously portrayed import tariffs as an instrument of economic policy for rewriting the global trade script in favor of the United States. The sales pitch is alluring: tariffs as a tool to negotiate better terms and extract concessions from trading partners, boost government revenues, eliminate trade deficits, and revive manufacturing jobs on American soil.
As is well understood by economists, a country's trade policy, which includes tariffs, is not an important determinant of its balance of trade. Any country's trade surplus or deficit is determined by its macroeconomic conditions, as reflected in the gap between what that country saves and what it invests. The core drivers of trade deficit or trade surplus are fiscal and monetary policies: the government's decisions on taxation and public spending and those by a central bank to influence the money supply and credit conditions.
Moreover, import tariffs won't generate the revenues Trump promises as the U.S. negotiates numerous bilateral trade deals. And Trump's pitch of bringing back manufacturing jobs for American workers is wishful thinking. If manufacturing revives in the U.S., those jobs will go to robots; the firms won't be hiring American workers, whose high wages they can't afford.
The seductive rhetoric of Trump tariffs hides a combination of contradictions, wishful thinking, and superficial understanding of economics, which sells America a mirage and threatens to weaken the stability of the global trading system.
The fault with the numbers
Combining economic nationalism with his flair for the dramatic, President Trump christened April 2 as 'Liberation Day' and announced 'reciprocal tariffs' on imports from virtually all countries. The tariff hikes were calculated to eliminate the U.S. trade deficit with each country by reducing its imports by an amount equaling America's current bilateral trade deficit with that country. Then, a 50% discount was applied on the calculated tariffs and the 'reciprocal tariffs' were announced. And a base rate of 10% was put in place to ensure taxation on imports from every country.
The tariffs imposed by the U.S. were hardly reciprocal: 46% on Vietnam, whose own average import tariff is 9%; 32% on Taiwan, whose own import tariffs on average are barely 2%; 26% on India, with an average import tariff of 12%; and 25% on South Korea, whose import tariffs average 8%.
Foreign exporters alone don't pay for tariffs. The Trump Administration significantly underestimated the impact these tariffs would have on American consumers. The administration's calculations incorrectly assume that American consumers of imports—including American producers who use imported inputs—bear only 25% of the cost of tariffs. But most high-quality studies show that nearly all the cost of tariffs is passed on to these consumers and businesses. If that faulty assumption were corrected, the 'reciprocal tariffs' would have been half their proclaimed rates and much less costly for America's trading partners, its own consumers and import-using producers.
Equally important, the Trump Administration overstated the benefits of its tariffs and underestimated their economic costs by neglecting the role of exchange rates and the nature of global supply chains. An increase in tariffs induces exchange rate movements that at least partially offset the effects of the tariffs on the trade balance. American industries rely on global supply chains, and imported inputs are necessary for the production of American exports. Import barriers also act as export barriers and higher import tariffs hobble the competitiveness of American corporations in global markets.
Moreover, the Trump Administration has been inconsistent with its stated objective of using tariffs to eliminate their bilateral trade deficits. The administration announced a baseline 'Liberation Day' tariff of 10% even on countries—Australia and Brazil, for instance—with whom the U.S. has a trade surplus. The U.S. generally has a surplus in service trade with many countries but the administration seems to have disregarded it. One of the most important American service exports is higher education but the Trump Administration in this case has displayed blatant disregard for trade balance with its multi-pronged attack on universities and its hostility to international students.
Read More: Trump's War on Education Is Driving Academics Like Me to Europe
Rattling the global economy
Unsurprisingly, the Trump 'reciprocal tariffs' had an immediate negative impact on global stock markets and the U.S. bond market and forced a 90-day pause in their implementation. The administration announced that during these 90 days, the U.S. will be clinching 90 trade deals.
The deadline for finalizing bilateral trade deals was extended from early July to August but the likelihood of concluding even a small fraction of the Trump Administration's target of 90 deals by then is remote. Trade deals have been finalized with the United Kingdom in June, with the Philippines and Japan in July. Framework deals with China and Vietnam have been agreed upon, and a mini-deal with India is expected soon.
The Trump tariffs shocked the emerging economies, which have benefitted considerably from free trade and globalization over past three or four decades. China, India and Vietnam have experienced phenomenal annual economic growth—six to 10%—and lifted hundreds of millions of their citizens above the poverty line. They are bound to resist barriers on their products entering the massive American market.
Economic nationalism and domestic politics impose important constraints on every country. Major economies like China and India have been negotiating trade deals with the U.S. and so far they have strongly resisted being bullied into accepting all of Trump Administration's demands. In fact, they have been quite aggressive in their negotiations with the U.S. and ready to retaliate. Beijing responded to Trump's 145% tariff rate with a 125% tariff rate of its own.
After that dangerous escalation in their trade war, the U.S. and China agreed to a temporary truce in May. China reduced its tariffs on American imports from 125% to 10% and the U.S. reciprocated by reducing its tariffs on Chinese goods from 145% to 55%. In late June, Washington and Beijing arrived at a framework agreement to make their temporary truce more permanent. The U.S. has relaxed restrictions on visas for Chinese students. Beijing has adopted a system of licenses to somewhat ease rare-earth export controls and Washington has lifted some controls on technology-related exports.
India is a strategic ally but that doesn't make it a pushover as it negotiates a trade deal with the United States. The considerable political power Indian farmers wield has led New Delhi to refuse the American demand for complete access to the country's agricultural and dairy markets. Washington complained at the World Trade Organization (WTO) of India's protectionism, objecting to its veterinary certification requirements for dairy products coming in. India proposed imposing retaliatory tariffs—that comply with WTO rules—in response to the high steel, aluminum and auto-parts tariffs by the U.S.
An interim mini-deal between India and the U.S. is expected to be completed by August to avoid India being slapped with the 'Liberation Day' tariffs. The deal is expected to incorporate the straightforward parts: a reduction in U.S. import tariffs on Indian textiles and apparel from 26% to 10%; Indian tariff reductions on U.S. grown nuts and some fruits. And some reductions on the automotive sector. The trickier questions of food grains and major dairy products are expected to be left out for now. The mini-deal will likely be transformed into a more comprehensive one by late fall.
A framework deal with Vietnam, a much smaller country and a strategic partner, has been much more asymmetric than in the case of India and China. The Trump Administration agreed to a reduction in the 'Liberation Day' tariff rate of 46% on Vietnam to a base rate of 20% but it insisted on a 40% tariff rate on transshipped products, aimed mainly at Chinese companies trying to dodge the high American tariffs on China's exports to the U.S. However, it needs to be recognized that in this age of global supply chains a manufacturing hub like Vietnam is likely to be processing inputs imported from other countries. Since 2001, the U.S. and Vietnam had a bilateral trade agreement of very low tariffs, and the new framework deal requires Vietnam to continue with imposing zero tariffs on American exports. The Trump deal imposes substantial costs on Vietnam, one third of whose GDP comes from exports to the United States.
Read More: American Health Care Will Suffer Under Trump's Tariffs
America, the unreliable
Nobody knows what Trump will do tomorrow. The Trump tariffs are creating uncertainty for the American and the global economy. Companies need stability in economic policy to decide on the location and quantum of their investments, on the scale of hiring workers, on building new production capacities, and supply chains. The uncertainty adversely affects output and employment in America and the rest of the world.
Most countries negotiating trade deals with the U.S. are aware of Trump's proclivity for reneging on agreements. In his first term, President Trump signed the U.S.-Mexico-Canada Free Trade Agreement and had the highest praise for it. Trump began his second term by reneging on that deal and announcing high tariffs on Canada and Mexico—offering the rationale of growing fentanyl supply and illegal immigration to the U.S. from both countries, a justification especially flimsy in the Canadian case.
Recently, Trump threatened to impose an additional 10% tariff on BRICS countries for their alleged efforts to create an alternative to the U.S. dollar in international transactions. And the U.S. president later also threatened a 50% tariff on imports from Brazil to try to stop the prosecution of his friend and former Brazilian President Jair Bolsonaro. Such threats are illegal under American and WTO laws.
Given this uncertain state of affairs, the Liberation Day tariffs might ultimately steer emerging economies toward working on negotiating additional trade agreements with other major economies, in order to ensure a large enough market for their products. By erecting these extremely high tariff barriers and undermining and weakening the WTO, the Trump Administration has seriously damaged the world trading system. Consequently, it might end up pushing the rest of the world away and sowing the seeds of American own isolation and irrelevance.