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Trump's tariffically bad idea

President Trump's tariffs will harm the people he most wants to help.

Paul Samuelson, a Nobel Laureate in economics, was once challenged by a sceptical mathematician to name one proposition across all the social sciences which was both true and non-trivial. 

Samuelson shot back with David Ricardo’s theory of comparative advantage: “that this idea is logically true need not be argued before a mathematician; that it is not trivial is attested by the thousands of important and intelligent men who have never been able to grasp the doctrine for themselves or to believe it after it was explained to them”.

Economists disagree on almost everything, but no proposition is more widely held among them that international free trade generally benefits the citizens of both exporting and importing countries. But here we are again now, questioning that logic, with the introduction of a 25 per cent tariff on steel and a 10 per cent tariff on aluminium by the US government – on imports from Canada, Mexico, and the EU.

President Trump’s protectionism is a “tariffically bad idea”. It fails on its own terms. The steel unions themselves oppose the tariffs – they are well aware that any jobs saved by tariffs will be vastly outweighed by the job losses further up the supply chain when companies will be hit by much higher raw material costs. The US Chamber of Commerce estimates that the imposition of steel and aluminium tariffs could cost 500,000 American jobs. Throw in withdrawal from Nafta, and the Chamber estimates around 2.5m jobs could be at risk – many of them in the Midwest rust belt states that Trump claims he is championing by pursuing his “America first” policy.

Abba Lerner’s Symmetry Theorem (from 1936) is also relevant. Lerner argued that a tax on imports is equivalent to a tax on exports. In restricting imports, governments are also levying a tax that restricts exports, because tariffs raise the price of imported inputs to the export industry.

At root, a tariff is nothing more than a tax, paid not by those countries exporting to the US, but by American consumers in the form of higher prices.

But despite the economic illiteracy behind the imposition of tariffs, this is not a time to panic. We are not yet in a scenario heralding a repeat of the Great Depression and the Smoot-Hawley tariffs of 1930. Smoot-Hawley was a disastrous piece of legislation – US imports fell 40 per cent in two years – but the cause of the Depression was a failure of monetary not trade policy.

Tariffs change relative prices and undoubtedly reallocate resources across industries, but they are unlikely to impact aggregate output to the extent of triggering a major economic downturn. The US Congress passed the Fordney-McCumber tariff in 1922, which raised tariffs more sharply than Smoot-Hawley, but that still didn’t stop the boom of the roaring twenties.

Let's hope the US-China spat is all part of “the art of the deal”, with Trump’s ultimate aim being reciprocity and leverage in trade negotiations, in order to come to a deal on issues such as intellectual property protection. 

We are not in a global trade war yet. Nonetheless, the world could use a refresher course in Ricardo’s theory. History teaches that trade spats can get out of hand, especially if there are wider geopolitical considerations, such as the rise of China militarily.