Trump's Tariffs 🛃
Three Things #156: February 9, 2025
I’ve been watching the markets with a feeling of confusion, frustration, and consternation these past few days as Trump announced aggressive tariffs, then announced that most of them were on hold, and then announced that more are coming. Both the crypto and stock markets have fallen on the news, and the crypto markets in particular experienced a rapid, violent sell-off, from which they have yet to recover. Companies in particular hate uncertainty, and many are holding back on investments, which will have knock on economic consequences.
One of the strangest things about the present moment is that almost no one seems to understand what’s going on or why. People are confused about why Trump is insisting on implementing tariffs, a campaign promise on which few expected he’d actually follow through. I thought it would be interesting this week to explore the topic and try to get to the bottom of it.
Thing #1: Left Curve: Tariffs Bad 🤪
Consult any elementary economics textbook and you’ll learn that tariffs are bad because they reduce the efficiency of the market. Modern economics dictates that trade is good, and anything that impedes trade or makes it less efficient is bad. The fundamental idea here, and one which undergirds international trade, is the law of comparative advantage, which says that everyone wins when we each do the thing that we’re best at, relative to everyone else. In other words, everyone does best when resources are put to the most efficient use, and this can only happen with abundant, unfettered international trade.
The most immediate impact of tariffs is that prices go up. A tariffs is ultimately a consumption tax, so consumers ultimately bear much of the cost of the tariff in increased prices or decreased consumption. This already makes tariffs seem self-defeating: while they’re intended to inflict pain on foreign trade partners, in fact, depending on the specific economic circumstances (elasticity of supply and demand), those partners can often pass most or all of the cost of the tariff up the supply chain to, ultimately, American consumers.
But it’s worse than that. Once imports become more expensive, there are higher-order consequences. Domestic producers who weren’t competitive versus cheap imports with free trade are suddenly more competitive. Tariffs reduce economic efficiency, and rather than being put to their most efficient use, tariffs cause domestic capital and labor to instead be directed towards less efficient uses. This hurts everyone. In other words, it results in a misallocation of resources as less efficient producers are able to stay in business when those same resources could be better used in other sectors where they’d be more competitive.
Let’s look at a simple if contrived concrete example. Acme Manufacturing can make widgets at $10 each, but the same widgets can be imported for $9, so most Americans buy imported widgets for a bit less. Acme isn’t competitive internationally in the widget market, so it instead produces gizmos. Producing gizmos is slightly less profitable for Acme than producing widgets, and it would prefer to produce widgets, but while it can’t produce widgets competitively with free trade, it can produce gizmos competitively and still makes a small profit from selling gizmos. In this scenario, everyone benefits as resources are put to their most efficient use. Foreign suppliers produce widgets, which they’re able to do competitively, and profit from American imports. Acme produces gizmos and sells them at a slight profit. American consumers pay less than they might otherwise have on widgets, which means they have some money left over to buy gizmos, and other things besides. More domestic consumption means the government collects more taxes and can spend more on public benefits.
Now imagine that the government imposes a 20% tariff on widget imports. A widget that used to cost $9 when imported now costs $10.80. Suddenly, Acme can produce and sell widgets competitively in the domestic market at $10 each, undercutting foreign suppliers when factoring in the tariffs. While in the narrow sense it’s true that a domestic producer benefits from the tariffs, everyone else suffers. Foreign suppliers may or may not be able to sell the same widgets at the same price elsewhere, depending on demand. Domestic consumers pay more for widgets, which mean they now have less money left over to buy gadgets and other things. And some other firm that was efficiently and competitively producing servos in a free trade regime may now decide to produce widgets or gizmos instead, making the servo market less efficient and causing the price of servos to go up in turn. Domestic consumption and expenditure fall, as do tax revenues.
As you can see, even in this tiny, contrived example, the economy is incredibly complex and interfering in the market, imposing a tax or tariff that changes the price of even a single good, can have severe knock-on consequences throughout the economy. Now consider the severe effects of Trump’s proposed tariffs on broad categories of goods.
As if that wasn’t bad enough, we also have to consider the risk of an escalating trade war. While targeted, short-lived tariffs might sometimes make sense, once a trade war escalates, as happened between the USA and China during Trump’s first term, the negative economic effects multiply. In a trade war, the US would raise even greater tariffs, resulting in even greater economic displacement and inefficiency. And in retaliation, severe counter-tariffs imposed by trade partners would make US exports more expensive, less competitive, and less desirable abroad, which would have even greater negative knock-on consequences for the domestic economy. Producers who rely on exports would struggle and, again, resources won’t be put to the most efficient use, hurting everyone.
In sum, tariffs lead to a phenomenon that economists call deadweight loss: a pure overall economic loss that benefits neither producers nor consumers, neither Americans nor their trading partners. Everyone suffers as transactions that would otherwise have occurred and would’ve created economic value simply never happen due to higher prices and lower efficiency, reducing overall beneficial economic activity.
Given that we know broad-based, long-term tariffs don’t work and hurt everyone, they should obviously be avoided, and Trump’s use of them is unfortunate and ill-advised. He simply doesn’t understand, and doesn’t care to understand, economic policy and the consequences of his rash actions.
Thing #2: Mid Curve: Bargaining Tool 🧐
The first and most obvious way that tariffs can be beneficial is if they’re used in a specific, directed way. Tariffs have certain benefits as bargaining tools, including the fact that they can be implemented immediately, they can be precisely targeted, they’re scalable, they’re easily reversible, and they can have an asymmetric impact.
Indeed, this does seem to have been at least part of Trump’s intention for leveraging new tariffs against close trading partners including Mexico and Canada. Interpreted in this light the tariffs seem to have worked, as both countries quickly sought an accommodation and the tariffs on both were quickly put on hold.
As I’ve written before, international trade and diplomacy are complicated and messy. We tend to focus on multilateral trade agreements and international organizations like the IMF and the World Bank that promote order but in reality international relations are quite anarchic. Notwithstanding the existence of these international organizations, which exist due to national laws and treaties and cannot really compel nations to act in a certain way, there is no “world government” to govern these relationships. Increasingly, there isn’t even a single, accepted set of norms upon which these relationships are based (more on this in a moment).
The result is that, in international relations, nation states tend to act like kids in a playground. They constantly jockey for position and act in their own interest, in order to strengthen relations with allies and improve their own lot. The United States isn’t nearly as dominant as it once was on the world stage, but the reality today is that it’s still the big kid on the block, especially when it comes to international trade. China is a close second, but no country, not even China, can match the combination of American sticks and carrots: trade, sanctions, and the threat of military intervention.
A core part of Donald Trump’s message is that, in spite of its heft and importance on the world stage, the United States doesn’t get the respect it deserves globally. There are multiple reasons for this, but one is our strong preference to maintain friendly relations with our allies, and our hesitation to use our weight and strength to our advantage. In other words, the foreign policy regime of the United States has been much more liberal (seeking to build trust, cooperate, and relying on international institutions) than realist, at least in recent years. Trump is much less reluctant to play power politics than his predecessors, especially where he thinks it will unlock a better deal for the United States.
Tariffs are one example of this. While tariffs on Canada and Mexico are painful, and, as discussed above, can be expected to cause prices to rise, in both cases the pain is disproportionately on the counterparty. Canada represents around 17% of American exports, but nearly 80% of Canadian exports are bound for the United States. So the impact of bilateral tariffs on Canadian consumers would be substantially more severe than they would on American consumers. The situation is even more imbalanced with US-Mexico trade. Having said that, it’s not 100% clear what Trump’s aims are with respect to these two relationships, but his stated objectives are to secure the border, and in particular to reduce the flow of both migrants and illegal drugs. After the tariffs were announced, both countries quickly made superficial commitments to cooperate more on these priorities.
It’s important to note that the general wisdom with respect to tariffs is that they only make sense in specific cases and only when used in specific, targeted ways. Trump appears to be using tariffs as a blunt instrument, and not in ways that make sense. For instance, while it can make sense to use tariffs to promote national security by fostering domestic manufacturing capacity, and while targeted tariffs on China could work in this way, Trump’s tariffs aren’t targeted at specific industries and his tariffs on Canada and Mexico actually work against this goal by disrupting North American supply chains. (For more on this topic I highly recommend this excellent article by Noah Smith.)
And then there’s China. China is another creature entirely, and unlike Canada and Mexico its economic and diplomatic heft rival those of the United States. While both Mexico and Canada rolled over quickly and made concessions to put tariffs on hold and avoid a trade war, China has done no such thing, and indeed has announced retaliatory tariffs on a huge number of American imports. The markets have responded quite negatively to this situation. While targeted tariffs on China could, in theory, be an effective bargaining tool, these tariffs are likely to backfire. The last time targeted tariffs were levied on China they led to a protracted trade war that’s still ongoing—and, again, these tariffs aren’t targeted!
The evolving nature of the US-China relationship brings us to the third thing.
Thing #3: Right Curve: The Changing World Order 🧙♂️
There’s a broader context at work. It’s easy to get hung up on the question of tariffs, but tariffs are just one very small manifestation of a much bigger phenomenon. That bigger phenomenon is the rapidly changing world order. The world is changing all the time and change is obviously nothing new, but as Lenin said, “There are decades where nothing happens; and there are weeks where decades happen.” This has been one of those weeks.
I can’t possibly do justice to world history in the limited space we have here, but here’s a quick crash course on the last three or four decades, according to my understanding. Things were more or less stable for a while after the collapse of the USSR. This is the period affectionately known as The End of History, when autocracies were falling, democracy was on the rise and Pax Americana reached its peak. Of course, everything changed on Sept. 11, 2001, which is as good a point as any to mark peak USA and the beginning of American decline. Since that time, the United States has been tearing itself apart through endless internecine wars, including a war on terror, drugs, immigration issues, cultural issues, and political issues.
Happening in parallel throughout this period has been the rise of China. China joined the World Trade Organization at the end of 2001, which was also a turning point for that country. As China grew wealthier, it grew more assertive militarily, economically, and diplomatically. This simultaneous American decline and rise of China means that, for the first time since the height of the (first) Cold War, the world has precisely two superpowers. And a world with two superpowers works very differently than a world with a single hegemon. If the end of the Cold War represented a transition from the US-USSR duopoly to undisputed US hegemony, the last 25 years have represented the transition back to duopoly, this time with China.
The United States established a new world order after WWII, which naturally was designed to favor the USA and its allies, including the Five Eyes, Japan, and the European Union. This world order was inspired by a modern, optimistic, liberal, American world view in which an End of History was possible, we could eventually stop wars entirely, and all nations prosper most when they’re free, democratic, and trade openly with one another. This is in marked contrast to the more realistic, pessimistic world view held elsewhere, including in the USSR.
Another component of the dominant, liberal world view was the Washington Consensus: namely, the idea that the United States, as sole superpower, would guarantee security globally, and it and its allies would play nice through international organizations like the World Bank, WTO, and WHO. This would allow nations to collaborate instead of going to war with one another, it would lead to a flourishing of international trade under which everyone who played by the rules would prosper, and it would allow poorer nations to catch up. But this world order wasn’t designed for a US-China duopoly! There’s no place for China in those organizations, and the United States and its allies have not done a good job of making room for China in the current world order more generally.
The most important point here is that the previous administration, and liberal elites more generally, simply don’t, or refuse to, recognize the ways in which the world order is changing. This most recent election was about maintaining the status quo, broken as it is, versus radical change. The American people unambiguously voted for radical change, with Trump as the agent of this change. The liberal elite consensus is that the world order is nice just the way it is, thank you very much, and China should find a way to fit into it. But for various reasons, including voter discontent globally with the miserable state of affairs, the political pendulum has recently swung back in the direction of realism.
The liberal perspective today seems woefully naive and shortsighted. Our international institutions have been increasingly failing us, including the UN, the World Bank/WTO, and the WHO, and they’re looking increasingly outmoded and ineffectual. As if that weren’t bad enough, China clearly has no interest in fitting into the existing world order, and other actors including Russia and the rest of the BRICs are increasingly chafing under the present system as well. China has done plenty to establish a parallel world order in its own image, one that’s much friendlier to dictators and authoritarians. It’ll continue to do this, and other countries will probably continue to sign up for it because, among other advantages, it comes with no annoying human rights requirements.
It’s too soon to say for sure, but I think this election will mark a major historical turning point not only in the history of the United States but also in the global world order. Whatever period we’ve been in for the last couple of decades is now clearly over and we’re now clearly in a new world order, though I don’t know yet what it will be called. Radical neo-neorealist revival Trumpism? I’m sure someone will come up with a better name.
What does any of this have to do with tariffs? In order to understand the game that Trump and his allies are playing, you must first come to understand this rapidly changing world order. While tariffs might make no sense through a neoliberal lens, they just might be a useful tool for realigning the United States in this new world order.
Seen through this lens, Trump’s recently announced tariffs are, then, a recognition that the world order has changed and that the United States needs to adopt a different posture globally. In particular, it marks a shift away from neoliberal politics and back towards neorealist great power politics, one in which countries including the United States must act more in their own self interest (hence, “neo-neorealist”). For better of or worse, we’re moving into a more chaotic, anarchic world order, and in that sort of world, realpolitik and power politics matter.
Trump recognizes that the United States is no longer the sole global hegemon. It won’t get its way simply by playing nice with its allies. The country needs to look out for itself in this world before it lends a hand to its allies. And to the extent that it does help its allies, those allies also need to make the effort and contribute to shared security, something that many have been unwilling or unable to do for years. Trump feels that America’s allies have been extracting too much from the United States and the US-led world order without pulling their weight, and tariffs are one way to make this imbalance clear and force other countries to pull their weight.
Maybe Trump and his team see something that most Americans, and certainly the vast majority of democrats and liberals, simply don’t see or understand yet. Or maybe Trump really is just shooting from the hip, arbitrarily enacting tariffs without understanding the consequences. My strong suspicion is that it’s the former, and that to the extent Trump’s actions look like random, disorganized chaos, it’s just for show, to confuse other countries, and to enrage the left.
Either way, we are doubtless living in a more chaotic world, and we do need to update our national policies to respond to this new reality. Tariffs are an imperfect way of going about that, but at least they’re a recognition that the global reality has changed and an attempt to course correct.