Tariffs

Tariffs Are Not Smart Industrial Policy

Zachary Bartsch2 Comments

Economists overwhelmingly see tariffs as clearly welfare-reducing. Tariffs on imports result in higher prices, fewer imports, less consumption, and more domestic production. In fact, it is the higher prices that solicit and make profitable the greater domestic production. We don’t get the greater domestic output at the pre-tariff price. We can show graphically that domestic welfare is harmed with either export or import tariffs. The basic economics are very clear.

However, the standard model of international trade makes a huge assumption: Peace. That is, the model assumes that there are secure property rights and no threats of violence. All transactions are consensual. This is where the political scientists, who often don’t understand the model in the first place, say ‘Ah ha!. Silly economists…’ They proceed to argue for tariffs on the grounds of national security and the need for emergency manufacturing capacity. But is an intellectual mistake.  

Just as economists have a good idea for how to increase welfare with exchange, we also have good ideas about how to achieve greater or fewer quantities transacted in particular markets. This is not a case of economists knowing the ideal answer that happens to be politically impossible.  Rather, if it pleases politicians, economists can provide a whole menu of methods to increase US manufacturing, vaccine manufacturing, weapons manufacturing… Heck, we can identify multiple ways to achieve more of just about any good or service. Let the politicians choose from the menu of alternatives.

The problem with tariffs is that they reduce consumer welfare a lot, given some amount of increased production in the protected industry. Importantly, this assumes that the tariffs aren’t hitting inputs to those industries and are only being applied to direct foreign competitors. The below argument is even stronger against imperfectly applied tariffs, like the US tariffs of 2025.

What’s the alternative?

The alternative is a more focused tack. If the government wants more missile or ship production, then what should it do? There’s plenty, but here’s a short list of more effective and less harmful alternatives to tariffs:

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Do Tariffs Decrease Prices?

Zachary Bartsch2 Comments

Much of what economics has to say about tariffs comes from microeconomic theory. But it’s mostly sectoral in nature. Trade theory has some insights. But the effects on the whole of an economy are either small, specific to undiversified economies, or make representative agent assumptions that avoid much detail. Given that the economics profession has repeatedly said that the Trump tariffs would contribute to inflation, it seems like we should look at the historical evidence.

Lay of the Land

Economists say things like ‘competition drives prices closer to marginal cost’. Whether the competitor lives abroad is irrelevant. More foreign competition means lower prices at home. But that’s a partial equilibrium story. It’s true for a particular type of good or sector. What happens to prices in the larger economy in seemingly unrelated industries? The vanilla thinking that it depends on various elasticities.

I think that the typical economist has a fuzzy idea that the general price level will be higher relative to personal incomes in some sort of real-wages and economic growth mental model. I don’t think that they’re wrong. But that model is a long-run model. As we’ve discovered, people want to know about inflation this month and this year, not the impact on real wages over a five-year period.

Part of the answer is technical. If domestic import prices go up, then we’ll sensibly see lower quantities purchased. The magnitude depends on the availability of substitutes. But what should happen to total import spending? Rarely do we talk about the expenditure elasticity of prices. Rarely do we get a simple ‘price shock’ in a subsector. It’s unclear that total spending on imports, such as on coffee, would rise or fall – not to mention the explicit tax increase. It’s possible that consumers spend more on imports due to higher prices, or less due to newly attractive substitutes. The reason that spending matters is that it drives prices in other parts of the economy.

For example, I argued previously that tariffs reduce dollars sent abroad (regardless of domestic consumer spending inclusive of tariffs) and that fewer dollars will return as asset purchases. I further argued that uncertainty makes our assets less attractive. That puts downward pressure on our asset prices. However, assets don’t show up in the CPI.

According to the above discussion, it’s unclear whether tariffs have a supply or demand impact on the economy. The microeconomics says that it’s a supply-side shock. But the domestic spending implications are a big question mark.

What is a Tariff Shock?

That’s the title of a recent working paper from the Federal Reserve Bank of San Francisco. It’s a fun paper and I won’t review the entirety. They start by summarizing historical documents and interpreting the motivation of tariffs going back to 1870. They argue that tariffs are generally not endogenous to good or bad moments in a business cycle and they’re usually perceived as permanent. The authors create an index  to measure tariff rates.

Here’s the fun part. They run an annual VAR of unemployment, inflation, and their measure of tariffs. Unemployment in negatively correlated with output and reflects the real side of the economy. Along with inflation, we have the axes of the Aggregate Supply & Aggregate Demand model. Tariffs provide the shock – but to supply or demand?.  Below are the IRF results:

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What Tariffs Mean For Your Finances

James BaileyLeave a comment

That’s the title of a talk I’ll be giving Saturday at the Financial Capability Conference at Rhode Island College. Registration for the conference, which also features personal finance speakers and top Rhode Island politicians, is free here.

A preview: after many changes, the average tariff on the goods Americans import has settled in the 15-20% range:

If the tariffs stay in place, which is far from certain, this will represent roughly a 2% increase in overall costs for Americans (a ~17% tax on imports which are ~14% of the economy predicts a 2.4% increase, but a bit of that will be paid by foreign producers lowering prices).

This is bad for US consumers, but not as bad as the Covid-era inflation, and likely not as bad as our upcoming problems with debt and plans to weaken the dollar. It is more valuable for most people to make sure they are getting the personal finance basics right than to think about how to avoid tariffs, though they may want to consider investments that hold their value with a weakening dollar.

The Supreme Court Case on Trump’s Tariffs

Jeremy Horpedahl1 Comment

Today is a big day not only for Supreme Court watchers, but for everyone following economic policy: the Court will hear oral arguments for the case Learning Resources, Inc. v. Trump. The case concerns whether Trump’s tariffs imposed under the International Emergency Economic Powers Act are legal, which includes the famous “Liberation Day” tariffs from April 2025.

You should be able to livestream the arguments from the SCOTUS website starting at 10am ET (though it may start a little later). SCOTUS blog has a liveblog which should cover most of the legal arguments, but if you want to follow the economic arguments there are several people you can follow on Twitter, such as Scott Lincicome and Phil Magness (you can follow me too).

Does Trump Weaken the US Dollar?

Zachary Bartsch2 Comments

Talk to some economists and they’ll tell you that exchange rates aren’t economically important. They say that exchange rates between countries are a reflection of supply and demand for one another’s stuff. So, at the macro, it’s a result and not a determinant of transnational economic activity.

For individual firms at the micro level, it’s the opposite. They don’t affect the exchange rate by their lonesome and are instead affected by it. If you have operations in a foreign country, then sudden changes to the exchange rate can cause your costs to be much higher or lower than you had anticipated. The same is true when you sell in a foreign country, but for revenues. This type of risk is called ‘exchange rate risk’ since it’s possible that none of the prices in either country changed and yet your investment returns change merely because of an appreciated currency.

Supply & Demand

Exchange rates are determined by supply and demand for currencies. Demand is driven by what people can do with a currency. If a country’s goods become more attractive, then demand for those goods rise and demand for the currency rises. After all, most retailers and wholesalers in the US require that you pay using US dollars. Importantly,  it’s not just manufacturing goods that drive demand for currency. Demand for services, real estate, and financial assets can also affect the supply and demand for currency. In fact, many foreigners  are specifically interested in stocks, bonds, US treasuries, and other investments. The more attractive all of those things are, the more demand there is for them.

Of course, the market for currency also includes suppliers. Who does that? Answer: Anyone who holds dollars and might buy something. Indeed, all buyers of goods or financial products are suppliers of their medium of exchange. In the US, we pay in dollars. Especially since 1972, suppliers have also included other central banks and governments. They treat the US currency as if it’s a reserve of value, such as gold, that can be depended upon if they need a valuable asset (hence the name, “Federal Reserve”). This is where the term ‘reserve currency’ comes from – not from the dollar-denominated prices of some internationally traded commodities. Though, that’s come to be an adopted meaning.  

Another major supplier of currency is the US central bank. It has the advantage of being able to print US dollars. But it doesn’t have an exchange rate policy. So, it’s not targeting a particular price of the US dollar versus any other currency. The Fed does engage in some international reserve lending, but it’s not for the purpose of supplying currency to foreign exchange markets.  

The US Exchange Rate in 2025

One of the reasons that the US has such popular financial assets is that we have highly developed financial markets and the rule of law. People trust that, regardless of the individual performance of an asset, the rules of the game are mostly known and evenly applied. For example, we have a process to follow when bond issuers default. So, our popularity is not merely because our assets have higher returns. Rather, US investment returns have dependably avoided political risk – relative to other countries anyway.

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The 2018 Tariffs in Many Graphs

Zachary Bartsch2 Comments

Did president Trump’s first term tariffs, enacted in 2018, increase manufacturing employment or even just manufacturing output? Let’s set the stage.

Manufacturing employment was at its peak in 1979 at 19.6 million. That number declined to 18m by the 1980s, 17.3m in the 1990s. By 2010, the statistics bottom out at 11.4m. Since then, there has been a rise and plateau to about 12.8m if we omit the pandemic.

Historically, economists weren’t too worried about the transition to services for a while. After all, despite falling employment in manufacturing, output continued to rise through 2007. But, after the financial crisis, output has been flat since 2014, again, if we omit the pandemic. Since manufacturing employment has since risen by 5% through 2025, that reflects falling productivity per worker. That’s not comforting to either economists or to people who want more things “Made in the USA”.

https://fred.stlouisfed.org/graph/?g=1LxMV

Looking at the graphs, there’s no long term bump from the 2018 tariffs in either employment or output. If you squint, then maybe you can argue that there was a year-long bump in both – but that’s really charitable. But let’s not commit the fallacy of composition. What about the categories of manufacturing? After all, the 2018 tariffs were targeted at solar panels, washing machines, and steel. Smaller or less exciting tariffs followed.

Breaking it down into the major manufacturing categories of durables, nondurables, and ‘other’ (which includes printed material and minimally processed wood products),  only durable manufacturing output briefly got a bump in 2018. But we can break it down further.

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Tariff Tilly (Satire)

Joy BuchananLeave a comment

Satire news shows are, in my opinion, one of the higher forms of art that my country has produced (and an example of our exports). “Meet Tariff Tilly, the perfect replacement for the 37 dolls your kid does not need” from The Daily Show

“Tariff Tilly” builds. There is even a comment on interest rates (addressed in my previous post).

In this house, we believe in economists writing about dolls. You can find more at https://economistwritingeveryday.com/?s=barbie or https://economistwritingeveryday.com/?s=dolls

Anti-Tariff Declaration

James Bailey2 Comments

The Smoot-Hawley Tariff of 1930 was opposed by a thousand economists, but passed anyway, exacerbating the Great Depression. Now that the biggest tariff increase since 1930 is on the table, the economists are trying again. I hope we will find a more receptive audience this time.

The Independent Institute organized an “Anti-Tariff Declaration” last week that now has more signatures than the anti-Smoot-Hawley declaration, including many from top economists. One core argument is the sort you’d get in an intro econ class:

Overwhelming economic evidence shows that freedom to trade is associated with higher per-capita incomes, faster rates of economic growth, and enhanced economic efficiency.

But I thought the Declaration made several other good points. Intro econ textbooks say that tariffs at least benefit domestic producers (at the expense of consumers and efficiency), but in practice these tariffs have been mainly hurting domestic producers, because:

The American economy is a global economy that uses nearly two thirds of its imports as inputs for domestic production.

I get asked to sign a petition of economists like this every year or so, but this is the first one I have ever agreed to sign onto. Most petitions are on issues where there are good arguments on each side, like whether to extend a particular tax cut, or which Presidential candidate is better for the economy. But the argument against these tariffs is as solid as any real-world economic argument gets.

The full Declaration is quite short, you can read the whole thing and consider signing yourself here.

Is Every Stock a Tariff Stock?

Jeremy HorpedahlLeave a comment

Not quite, at least not in the same way that every stock was a vaccine stock in 2020, as Alex Tabarrok put it.

Today the stock market does seem to move a lot on the news about Trump’s ever-evolving tariff policy. If you see the S&P 500 is up today, you can probably guess that Trump or his advisors slightly backed off some aspect of their previously announced tariff policy. And vice versa. That much is true.

But back in 2020, the implied correlation in the market was briefly over 80% in the spring of 2020, and was over 50% for almost all of the summer of 2020. Today, the correlation is closer to 40%. That’s a bit lower than 2020, but it is a significant jump from where it was 2-3 months ago.

Here is the Cboe’s implied 3-month correlation index:

In addition to the costs of tariffs themselves, investors should be worried about this correlation because “market returns are lower when correlations among assets are increasing.”

How Scott Bessent Outfoxed Peter Navarro to Get the 90 Day Tariff Pause

Scott Buchanan1 Comment

Despite the nearly universal outcry, President Trump was standing firm on his massive tariffs. “No backing down”, etc., despite the evaporation of trillions of dollars in stock values. On Tuesday, April 8, White House spokesperson Karoline Leavitt affirmed: “The President was asked and answered this yesterday. He said he’s not considering an extension or delay. I spoke to him before this briefing. That was not his mindset. He expects that these tariffs are going to go into effect.” However, the next day, Wednesday, April 9, Trump announced on his social media platform, Truth Social, that for all countries but China, there would be a 90-day pause in reciprocal tariffs.

What happened here? The common explanations are that (1) the chaos and losses in the markets had finally grown intolerable, or that (2) the president had planned all along to pause the tariff hikes on April 9. I suspect there is some merit to both of these factors – -despite all the prior warnings, I think (1) Trump did not expect such market devastation (he sincerely believes that he is making the American economy great, so why should markets crash?), and also (2) that he had indeed planned to play around with tariff implementations in pursuit of deals.

But what some analysts pointed out as a further factor was the drop in the market value of U.S. Treasury bonds, which correlates directly to a rise in interest rates. The actions of the Administration have seemingly caused market participants, especially abroad, to question the risk-free status of U.S. debt. If the government has to pay higher interest on its debt, it is game over, as interest payments will spiral up and consume an ever-higher share of the federal budget. The chart below shows in orange the price movement of the TLT fund, which holds long-term T-bonds, plummeting on April 7, 8, and 9 (red arrow), as an indicator of rising rates. TLT price then shot upwards, along with stocks (the green line is S&P 500 fund SPY) late on April 9, in the relief following the tariff announcement:

As Treasury Secretary, Scott Bessent would be particularly sensitized to the interest rate issue, and able to communicate that to the boss. He has been a successful hedge fund trader and manager, so he understands the plumbing of the system, unlike some other presidential advisors. Up till then, however, economist Peter Navarro, who is ultra-hawkish on tariffs, had had the ear of the president.

So, what did Bessent do? (This is the part that only came to my attention a few days ago, even though technically this is old news). It seems he enlisted the support of Commerce Secretary Lutnick, and adroitly chose a time when Navarro was tied up in a meeting, and barged in on the president in an unscheduled meeting so they could get him alone. And it worked! Evidently, they persuaded him that now was the time to do the clever deal-making thing and issue a pause. It’s a mark of how readily the president can change his mind that his own press spokespeople were unaware of this volte-face, and had to scramble to make sense of it. It is also interesting that cabinet members are resorting to cloak-and-dagger tactics to get policy done.

Bessent naturally gave all the credit to the president for the decision, but he and Lutnick had photos taken to show who saved the financial world – for now:

Scott Bessent (standing, left) and Howard Lutnick (right) with President Trump as he signs 90-day pause in reciprocal tariffs.  Source: Daily Mail.

The president’s recent musings about trying to fire the supposedly independent Fed chairman have since contributed to interest rates going back up again, but that is another story.