Trump S Misguided Tariff Formula

---

 
US president Donald Trump reportedly delayed the launch of his global “reciprocal tariffs” until after April 1. If his goal was to avoid being dismissed as a fool by the rest of the world, it is not at all clear that he has succeeded.
Despite the branding, Trump’s “reciprocal tariffs” are nothing of the sort. Consider South Korea: the country collects no tariffs on most US imports under its free trade agreement with the US, yet it will now face a 25% tariff.
Meanwhile, Hong Kong – recognised by the World Trade Organization as a separate customs territory from mainland China – imposes no tariffs on US imports, either, but will still be hit with tariffs exceeding 100%.
Trump’s so-called “reciprocal” tariffs are based on a peculiar formula: the tariff on any country, k, is set at a maximum of either 10% or a higher value, 0.5 times k*, where k* is what the White House determines as a comprehensive tariff equivalent of all trade barriers that k imposes on the US. This is computed as k’s trade surplus with the US in 2024, divided by its exports to the US in the same year.
By this formula, if a foreign country (say, the UK) runs a trade deficit with the US, the US will charge an extra 10%. If a foreign country runs a large trade surplus with the US, and its trade surplus is 60% of its exports to the US, the US will charge a 30% tariff.
To give Trump’s tariffs a semblance of intellectual rigour, the Office of the US Trade Representative has pointed to academic studies that purportedly support certain elements of the formula for setting rates, citing estimates of how import prices respond to US tariff hikes and how import volumes decline as those prices rise. Yet, despite this scholarly veneer, the formula devised by Trump’s team suffers from two fatal flaws.
The first critical error is its conceptual foundation: the belief that US trade deficits are driven entirely by foreign trade barriers or other unfair trade practices. Textbook macroeconomics tells us that a country’s trade balance reflects the difference between national savings and investment.
South Korea, for example, runs a trade surplus because it saves more than it invests. The US, by contrast, runs a trade deficit because it suffers from a savings shortage relative to its investment.
A country’s saving-investment ratio can be influenced by many factors unrelated to its trade policies. For example, a major shale-gas discovery in Texas could boost Americans’ expectations of future wealth.
In response, US consumption rises, and savings fall, resulting in an increase in its trade deficit. If developing the shale-gas field also raises the overall US investment rate, the trade deficit will widen even further.
But under Trump’s “reciprocal” tariff framework, any such increase in the deficit, rather than reflecting good news in the US economy, would be blamed on other countries’ unfair trade practices.
The notion that a country’s trade surplus with the US must be the result of unfair trade policies is risible. By Trump’s logic, the US – which runs a large and persistent trade surplus in services with China, the European Union, and many other countries – must be engaging in unfair trade practices on a massive scale. In reality, of course, that surplus reflects America’s strong comparative advantage in high-value service sectors.
The second major flaw in the Trump administration’s tariff formula is the assumption that raising US tariffs will reduce imports without significantly affecting exports. In fact, tariff hikes are often followed by retaliatory measures, leading to a sharp drop in US export volumes.
China, for example, has already announced it will match the administration’s “reciprocal” rate by imposing an 84% tariff on US goods, after Trump imposed a 104% tariff on Chinese goods.
But even if no foreign county chose to retaliate, American exports would still be likely to decline. With unemployment near historic lows, the US economy has little slack.
Tariffs may encourage previously uncompetitive firms to expand – but only at the cost of diverting labour and capital away from more competitive companies, particularly in export-oriented industries.
Consequently, any tariff-induced reduction in US imports will be accompanied by a corresponding decline in US exports. This principle, known as the Lerner Symmetry Theorem, helps explain why Trump’s sweeping tariffs are more likely to shrink both exports and imports than to reduce the overall trade deficit.
The only way to “solve” the trade deficit problem through tariffs would be to raise them to a prohibitively high level – say, 500% – effectively shutting down all trade. At that point, the US economy would begin to resemble that of North Korea, which achieves a near-balanced trade position by eliminating both imports and exports.
While Trump insists that his trade war will strengthen the US economy, the stock market tells a very different story. In the aftermath of his tariff announcement on April 2, the S&P 500 and the Nasdaq each dropped by roughly 12%, wiping out trillions of dollars in market value.
The fallout hasn’t been limited to US markets: Japan’s Nikkei 225 index fell by 7.8%, Hong Kong’s Hang Seng Index plunged by 13.2%, and the pan-European Stoxx 600 declined by 4.5%. In China, which is grappling with domestic economic pressures, the Shanghai Composite Index fell by 7.3%.
Because stock prices represent investors’ expectations of future corporate earnings, the fall in US equities suggests that investors are not buying Trump’s claim that tariffs will benefit the US economy in the long run. As a result, American households now suffer simultaneously from a decline in the value of their retirement savings and the prospect of sharply rising prices. - FMT
Shang-Jin Wei, a former chief economist at the Asian Development Bank, is professor of finance and economics at Columbia Business School and Columbia University’s School of International and Public Affairs.
The views expressed are those of the writer and do not necessarily reflect those of MMKtT.

---