Can Trump's Tariffs Work?

This video is sponsored by Novium, creators of the Hoverpen. President-elect Donald Trump has called himself a tariff man, saying that tariffs are the greatest thing ever invented and that the word "tariff" is the most beautiful word in the dictionary. He announced last week that he would impose new tariffs on goods entering the U.S. from Canada, Mexico, and China on his first day in office. To be clear up front, this is not a political issue. It shouldn't matter if you love or hate Donald Trump. The purpose is just to discuss the issues that exist in international trade and the impact that tariffs or other government actions might have on trade, employment, and inflation.

We'll look at how they've worked and failed in the past, and how American tariffs today might be different from the disastrous Smoot-Hawley tariffs of 1930. Trump announced last week on his version of Trump Twitter—everyone has their own version of Twitter now—that he would sign an executive order for a 25% tariff on all goods coming from Canada and Mexico. These tariffs would stay in place until the flow of drugs and immigrants from these countries into the United States has come to a halt. After the announcement, the Mexican peso fell 2%, and the Canadian dollar traded at its lowest rate to the U.S. dollar in 15 years. Trump has already vowed to target China with a 60% tariff and has discussed a 200% tariff on some car imports. He says that goods coming from China will be hit with an additional 10% tariff if China doesn't take action to halt fentanyl smuggling. Tariffs, which are controversial among economists, are central to Trump's economic vision.

He sees them as a way of protecting America's economy, American jobs, growing the U.S. economy, and raising tax revenue. On the campaign trail, he told voters that his tariffs would not cost Americans anything, that they are instead a tax on another country, which many economists described as misleading. U.S. trade with China has grown enormously over the last 25 years, and while it has brought lower prices to U.S. consumers and higher profits to American multinationals, it has also come with some downsides. Both sides of the political aisle have focused on how to better balance trade and how to avoid losing access to strategically important goods and industries. While Donald Trump is a divisive politician—some people love him and others hate him—his threats to impose tariffs on foreign imports are drawing support from lawmakers of both parties.

Janan Ganesh wrote in the Financial Times a few weeks ago that Trump's biggest success during his first term in office was that he constrained the actions of his successors. He stated that Trump moved the consensus on a significant issue – foreign trade – in such a way that the next president either couldn't revert to previous policies or didn't want to. During Trump's first term, the average U.S. tariff on Chinese imports rose from around 3% to nearly 20% when Joe Biden took office four years later. Instead of reversing Trump's trade policies, Biden added more tariffs, particularly on electric vehicles, and implemented a protectionist industrial policy that included subsidies and a Buy American mandate. The Cato Institute, a libertarian think tank, described "Bidenomics" as "Trumpism with a human face" or "polite Trumpism." So, let's try to understand the issues with international trade that have been pushing the United States and other countries in this protectionist direction, and whether tariffs can be expected to improve the situation or make things worse.

We'll discuss whether Trump could impose his tariffs unilaterally on his first day in office and whether the mere threat of tariffs could be used to improve America's bargaining power. Before we go any further, let me tell you about this week's video, sponsored by Novium, a company that creates innovative high-end products designed to inspire curiosity and develop creativity. They offer amazing Christmas gifts. I love having a nice pen at my desk and don't want to have to search around in a drawer for one. The Novium Hover Pen, inspired by space, is an original and timeless gift idea.

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This is a protectionist trade strategy where tariffs push up the price of foreign-sourced goods, incentivizing consumers to switch to domestically manufactured products. This gives domestic manufacturers room to increase their own prices. The benefits that domestic manufacturers receive come at the expense of consumers, who, all else being equal, pay more for the goods they buy. For this reason, tariffs are redistributive, taking income from the household sector and transferring it to protected businesses. Now, there’s nothing too surprising about that idea, as all taxes are redistributive. However, critics of Trump's plan argue that tariffs are not just redistributive but that they will also be inflationary and harm the U.S. economy. His defenders, on the other hand, point out that this did not happen during Trump's term, and that the Biden administration considered removing Trump’s tariffs when inflation was high. However, their analysis showed that the change was unlikely to make a significant difference. Because a tariff is charged at the border, it does push up the price of imports, which is inflationary.

Some of that impact is offset by changes in exchange rates, where the currency of the tariff-charging country rises against the currency of the country subjected to tariffs. Additionally, foreign companies sometimes reduce their prices in order to remain competitive. An analysis by LPL Financial found that tariffs imposed in 2018 affected producer prices more than consumer prices in the United States, as wholesalers absorbed some of the price increase. Long-term viewers are probably aware that I believe in free markets and limited government intervention. From a free market perspective, the correct response to foreign governments subsidizing exports is to do nothing.

In fact, an argument can be made that a country should welcome other nations' export subsidies, which Milton Friedman has described as a form of foreign philanthropy. He stated that if another government wants American citizens to enjoy its goods and services at artificially low prices, Washington should tell them to bring it on. The problem is that persistent subsidized imports can eventually displace domestic production of often strategically important goods. The concern is that unfair foreign competition can bankrupt domestic producers, after which prices can be hiked up by a foreign-owned monopoly. The example often given of strategically important production is steel, which I discussed in a recent video about how Britain was planning on paying huge subsidies to foreign-owned steel mills to keep them open in the UK. Some of the top comments noted that if China is willing to ship steel to Britain for less than it costs to produce, the billion-pound subsidy should instead be spent on buying finished steel and setting it aside as a strategic reserve. Trump argues that tariffs on America's trading partners are necessary to protect U.S. businesses and the American worker at a time when U.S. manufacturing jobs have dropped from their peak in the late 1970s.

Trump's supporters point out that some of his tariffs did appear to work when he was last in office. They give the example that tariffs on imported washing machines may have created new jobs, as they were imposed at the same time that Whirlpool was building a new factory in the United States, and the tariffs helped the new factory succeed. The results of trade policies, like these, are unfortunately not always clear, as there are many moving parts, making it a bit like dietary science. For instance, a person might exclude sugary drinks but then eat a bit more food, offsetting most of the benefit. The Federal Reserve's analysis of Trump's first-term tariffs found that many of the benefits were offset by the higher costs of imported raw materials that American manufacturers had to buy, as well as retaliatory tariffs from other nations. Overall, they found that there was a small decline in the number of U.S. manufacturing jobs during Trump's first term, but several factors, such as the onset of the pandemic, could explain that outcome. Now, it has become a bit of a cliché when discussing Donald Trump to say that you should take him seriously, but not literally.

And while that might be a cliché, it's still probably true. So while the specifics of what he will do about trade once in office are not clear, the thing that is really clear is that foreign trade is the topic he cares about the most. You can find videos online dating back 40 years of Trump on daytime talk shows, where he is mostly pleasant until the topic of foreign trade comes up. Back then, Japan was his main target, while today it's China.

Janan Ganesh wrote a few weeks ago that trade is almost all that Trump cares about, with immigration coming in as a distant second. He observes that over the last 40 years, Trump has held an intense belief that running a current account deficit with another nation equates to losing to it. While the exact mechanics of how Trump plans to deal with trade are unclear, I believe it makes sense to take him at his word that this is the issue he cares about the most. How he will implement tariffs is perhaps the most ambiguous part of his plan. However, I think it’s unlikely that he'll impose them on inauguration day, as he has suggested; doing so would likely require him to declare a national state of emergency. This was the same scenario Richard Nixon faced when he imposed 10% tariffs on all imported goods after suspending the convertibility of the dollar into gold in 1971. Nixon enacted those tariffs to prevent American producers from being disadvantaged amid the anticipated exchange rate volatility around the world.

Now, if tariffs were applied to Canada and Mexico on products like oil and gas, it would be quite inflationary, which is the opposite of what Trump promised on the campaign trail. So, I don't think that this is very likely. The USMCA trade agreement, which replaced NAFTA in 2020, is up for a scheduled review in 2026, and it seems extremely likely that Trump will use that deal as a bargaining chip to negotiate with Canada and Mexico over issues he cares about, like immigration. This is exactly what he did in the past. In 2019, under the threat of tariffs, Mexico agreed to step up immigration enforcement to prevent migrants from entering Mexico from Guatemala in the south and to stop them from leaving for the U.S. in the north.

While it is reasonable to expect Trump to try and extract concessions during these negotiations, both Mexico and Canada do run persistent trade deficits, much like the United States. Overall, they are on the same side as the United States on this issue. It's worth remembering that during his first term in office, Trump's cabinet mostly moderated his protectionist instincts, along with the stock market reaction, which he saw as a measure of voter approval. It looks like he might have a less conservative cabinet this time around, but he likely still cares about the stock market. So, what are the problems in international trade that Trump is aiming to fix? Well, the hyperglobalization that began in the late 1990s made the world better for most people.

It almost eliminated extreme poverty and reduced global inequality. Consumers in wealthy countries benefited from cheap imported goods, which kept inflation low and standards of living, as measured by per capita income, increased around the world. While the average person was doing much better than before, blue-collar workers in developed countries were struggling as manufacturing work moved abroad where labor was cheap. While global inequality had fallen, inequality within the United States had grown. On top of all this, Western governments were becoming concerned that China and some other surplus economies were engaging in unfair competition by subsidizing manufacturing while imposing restrictions on foreign companies in exchange for access to their markets.

This became more of an issue as China developed and could no longer claim to be a poor developing country. Western economies began to see it as a problem that China had the highest manufacturing share of GDP and the lowest consumption share of GDP in the world. By agreeing to absorb China's excess production, deficit economies like the United States were allowing their most aggressive trade partner to set their trade policies for them. The economist Michael Pettis argues that surplus countries subsidize their manufacturing industries and pass on the costs of these subsidies to deficit countries, like the United States. He contends that a free trade country with open capital markets, when trading with a planned economy, is not really engaging in free trade.

They're instead accepting the inverse of their trade partners' trade and industrial policies. So how does China subsidize exports? Well, Chinese exports receive considerable direct subsidies, but the indirect transfers they receive are even larger. Chinese power plants and banks are mostly government-owned, meaning that policymakers can decide to provide cheap energy and low-interest rate loans to favored businesses. There are a variety of other ways a government can support its manufacturing sector as well, most of which involve transfers from the household sector to the business sector.

Trade surplus countries often have undervalued currencies. This helps exporters at the expense of importers. Manufacturing businesses are usually exporters, while households are net importers. Keeping interest rates artificially low benefits borrowers at the expense of savers, and once again, businesses are net borrowers while households are net savers. Overspending on transportation infrastructure, such as railways, roads, and ports, supports businesses at the expense of households as well.

Repressive labor laws, restrictions on worker mobility, and low penalties for pollution additionally help the manufacturing sector at the expense of the household sector. In China, industrially zoned land is an order of magnitude cheaper than residential land, representing another transfer from households to businesses. When all of these policies are combined, there are substantial transfers from households to businesses in China. As a result, while businesses can prosper, households cannot afford to consume the goods that are being produced. In a closed economy, this would mean that businesses would be forced to either raise wages to increase consumption or reduce production due to a lack of demand. However, in a globalized trading system, the surplus production can be exported. This trade surplus doesn't necessarily give China an advantage.

It's a result of flawed policies and the means of dealing with a huge disadvantage, which is extremely low domestic demand. This doesn't just affect China; however, a surge in a country's exports that are not balanced by a surge in imports means that manufacturers in deficit countries find themselves partially funding the Chinese subsidies with their lost income. The imbalances in China move the production of goods away from where they might be most efficiently manufactured under the law of comparative advantage and cause all sorts of trade distortions. When exports are high and imports are low, a country starts accumulating the currency of its biggest trade partners as savings. Chinese savings are not high due to any culture of frugality in China.

It's simply a function of keeping wages low and exporting without importing. You don't just keep the proceeds of trade in dollar bills in a vault; instead, you usually invest them in various things. China's excess savings are mostly sent back to the United States, where there are deep capital markets. This means that there is more capital in the United States than is needed for investment purposes, which can be seen in the huge cash balances that U.S. companies are sitting on. So, can Trump's tariffs offset Chinese subsidies and help to rebalance global trade? Well, possibly, but not if Trump's tariffs only impose tariffs on Chinese imports.

The reason this wouldn't work is that if the United States refused to buy Chinese goods but continued to buy from other countries, this would simply push the problem to another trade partner. Unable to sell EVs in the United States, China would ship them to Europe, undercutting European EVs. European manufacturers, unable to compete in their own markets, would then ship European EVs to the United States, and the overall problem would be exactly the same. If China continued to keep consumption low while exporting, Chinese savings would continue to be exported to the United States as well. The Chinese trade surplus would remain as large as before, even if it fell against the United States, and the U.S. trade deficit would continue to grow, too.

So, tariffs applied on a country-by-country basis are unlikely to have any notable effect. They would really need to be applied equally to all trade partners in order to work, but this would be very politically contentious as it would involve upsetting America's allies, who are not really to blame for the imbalances in global trade. If China is already an aggressive trade partner and the U.S. joins them, every other country would be forced to follow suit; otherwise, they would be paying the cost. This is the biggest problem with government trade intervention. A number of journalists have expressed concern that Trump's trade plans are worryingly similar to the Smoot-Hawley Act passed under Herbert Hoover, which contributed to the problems of the Great Depression. I made a video a few weeks ago about the Great Depression, and a notable difference between the late 1920s and today is that in the 1920s, America was the world's biggest exporter and had much more to lose than it does today.

In a trade war, countries that need to export are in a much weaker position than countries that are absorbing excess supply. While the Smoot-Hawley Act was a terrible idea, I don't believe that it was to blame for the Great Depression, and I don't believe that new tariffs would lead to that scale of economic catastrophe. Trump has said in interviews that he would love to entirely replace income taxes with import tariffs. I think this is mostly bluster and shouldn't be taken too seriously.

The Peterson Institute, a mostly centrist think tank, wrote a report on this recently, pointing out that last year the United States imported $3.1 trillion worth of goods but raised around $2 trillion in income taxes. Tariff rates would thus have to be over 65% to replace the income tax, assuming no fall in imports, which would be extremely unlikely with 65% tariffs. Replacing income taxes with tariffs just couldn't work. A number of big U.S. companies have been stockpiling goods in preparation for Trump's tariffs. The Economist reports that Microsoft, Dell, and Hewlett-Packard are among the American tech companies that are rushing to import as many electronic components as possible before the new administration takes office in January.

While this might help them in the short term, I doubt that they could import enough components to get them through years of potential tariffs. It is difficult to predict how Trump's trade policies will work. The U.S. could act unilaterally, as it does run the largest trade deficit in the world, and there is plenty of supply globally; the thing that is scarce is demand, which is what the U.S. brings to the table. A better option might be for the United States to work with other large deficit economies like Canada, Australia, and the U.K., where, combined, they make up about 70% of global deficits. If they struck a deal where they, as a group, placed tariffs on countries that run large, persistent surpluses, that could help to rebalance global trade.

If countries wanted to sell to that bloc, they would either have to take steps to boost domestic demand or cut production. Other countries wouldn't really need to agree, as most of the rest of the world is trying to export rather than agree to import. If they wanted to sell to these countries, they would just have to agree to the terms. A rebalancing of trade like this would be extremely painful for surplus countries like China, Germany, Japan, Russia, and Saudi Arabia, but it could be expected to boost American manufacturing and allow American businesses to compete internationally without slashing wages. This rebalancing would also mean repatriating the capital that has been flowing into the United States for decades. Foreigners own around 20% of all U.S. securities outstanding, and as trade rebalances, these savings would have to be repatriated back home, which would need to occur in an orderly manner.

It is very difficult to predict what Trump might do in his second term in office, other than to say that he'll amp up trade negotiations while likely keeping an eye on the stock market as a measure of his success. As always, I'll be interested to hear what you have to say in the comments section. If you found this video interesting, you should watch my video on whether Elon Musk can cut $2 trillion from the U.S. budget next. Don't forget to check out our sponsor, Novium, using the link in the description below. Have a great day. See you in the next video!

Goodbye.