On April 2nd – sorry, Liberation Day – President Trump revealed his new package of “reciprocal tariffs”. There has already been a lot of commentary and analysis by economists and others, and it is difficult to find anyone having something positive to say about this package that is grounded in facts. The package, of course, has very little to do with reciprocal tariffs. The method used by the Trump administration has not been to estimate the tariffs in other countries: in fact, the tariffs other countries apply don’t seem to play a role at all. It follows that this package isn’t about reciprocal tariffs.
What the administration does is to propose tariffs that are targeting bilateral trade balances (yet only for goods; US bilateral trade surpluses in services are conveniently neglected). If the assumption behind this approach is that the desirable outcome is to have an even bilateral trade balance with all countries, we should expect much more protectionism to come.
The general trade balance is, in the first place, connected to many other factors than actual trade policies: the balance between savings and consumption in a country is a good place for the curious mind. Bilateral trade balances are driven by many more factors connected to the relative structure and performances of economies. Attempting to even out bilateral exports and imports with the type of tariffs the Trump administration now has proposed just won’t achieve this outcome. Other – and much more drastic – measures are required. Unless the administration goes for such policies, the result is that these new tariffs won’t erase bilateral trade balances. And this is the conclusion even before we consider the likelihood that countries now exposed to higher tariffs in the US will retaliate and reduce bilateral US exports to these countries.
The Trump administration deserves more – and harder – criticism. I know this isn’t an original view, but we should still take a moment just to reflect on what this policy says about the political personality of Donald Trump and the character of his regime. The charlatanism is obvious – the constant use of metaphors and fake economic concepts, and other habitual postures that masquerade as serious policy-making. They are pulling many others into their world of lies and intellectual corruption. With the current centralisation of power, there is of course the risk of much more direct forms of corruption too. Using emergency powers, the president can trade favours with companies and countries. The tariff schedule the US is likely to end up with is probably going to have even less association to the tariffs that US exports face in the recipient country. These tariffs are rather going to reflect corporate power balances in the US: a trade policy designed for crony capitalism.
Much more could be said: these tariffs will hurt the US economy and US workers and consumers. In the short term, recession risks have increased, and it seems to be a safe forecast that the tariffs will negatively impact on the business cycle. Prices of imported goods will go up. Stock markets have reacted badly, wiping out the value of savings. If and when retaliatory measures come, US output in the trade-oriented sectors will go down.
The long-term economic effects are equally worrying, if not more. A standard insight in international economics is that protectionism does not change the number but the type of jobs in an economy. In effect, general protectionism reallocates assets and production factors in an economy – away from outward-oriented sectors to inward-oriented sectors. For the most of it, this means shifting output between higher-productivity output to lower-productivity output – or from higher-paying jobs to lower-paying jobs. When the cost of imports goes up, consumers will partly shift from an imported product to a domestically produced product. But a bigger effect is that they will shift the type of consumption: they buy less of the products that are exposed to tariffs and re-allocate their income and spending to other expenses.
I could stay in this topic for a long time: we have only scratched the surface of the damages of President Trump’s tariff assault. But it is also important to reflect on how other countries now should respond. Obviously, we have already heard from several governments affected by these tariffs – and many of them hope to be able to reduce them by negotiating with the administration. This is a good start. While many will react with the gut and talk the muscular language of retribution, governments should remember that they aren’t absolved of responsibility for economic violence just because the other guy punched them first. Equally, when it is now blatantly obvious that the US is injuring itself with the tariff package, it just is not responsible leadership by other countries to rush into retaliatory actions that will inflict even more injury on their economies. So: don’t do anything stupid!
Retaliation will, however, happen, and it is clear that the EU is planning to take such actions. There is a logic to retaliation, of course, and the political argument for retaliation that has any real grounding in economic analysis is that it may be necessary in order to nullify or reduce the initial trade assault – in this case, the US tariff package. We can formulate some good principles for how such a retaliatory response should be designed.
1. Don’t escalate! While a package of retaliatory measures should be strong and hurtful to the other side, it should not escalate the process of tit-for-tat protectionism by expanding the volume of trade covered or by opening up new fronts for aggressive actions, like services and intellectual property rights.
2. Protectionism or liberalisation! For retaliatory tariffs to achieve the stated goal of nullifying or reducing the initial trade assault, a package or retaliation should come with an alternative proposal: more trade and more market access. In practice, the Trump administration will have to make a choice between accepting the cost of retaliation or pocketing the benefits of having more access to another market. In other words, a constructive proposal of liberalization will increase the cost of going for tit-for-tat protectionism.
3. Liberalise trade with others! The US tariff package will injure other economies, but over some years the loss of trade with the US can be absorbed by trading more with others. This requires active coordination and, ideally, more and better trade agreements. Such actions can be taken now and don’t necessarily require trade negotiation that run over many years. Just the signalling effect of such actions can be powerful at a moment like this.
4. Build economic strength! Countries and the EU should accelerate their own work to build better policy foundations for innovation, productivity, and economic growth. A dynamic economy or an economy that is moving in that direction is much better positioned to negotiate with other countries. Some of the strongest political cards the EU could play in talks with the Trump administration is that it is pursing reforms to reduce regulatory burdens and to make it easier to invest and innovate in Europe. Likewise, policies to build stronger defence capacities are important too since more military spending means more procurement power and better opportunities to share military platform development costs with other countries. Individual countries that want to exploit huge dissatisfaction in the US with Trump’s policies should improve the attractiveness of inward FDI and talented labour. Economic strength is essentially about having assts and qualities that others want or need to access: a growing and innovative economy is the strongest assets of them all!