Tag: imports

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‘Liberation day’: or start of a Trump slump?

On April 2nd, Donald Trump announced sweeping new ‘reciprocal’ tariffs. These would be in addition to 25% tariffs on imports of cars, steel and aluminium already announced and any other tariffs in place on individual countries, such as China. The new tariffs would apply to US imports from every country, except for Canada and Mexico where tariffs had already been imposed.

The new tariffs will depend on the size of the country’s trade in goods surplus with the USA (i.e. the USA’s trade in goods deficit with that country). The bigger the percentage surplus, the bigger the tariff. But, no matter how small a country’s surplus or even if it runs a deficit (i.e. imports more goods from the USA than it sells), it will still face a minimum 10% ‘baseline’ tariff.

President Trump states that these tariffs are to counter what he claims as unfair trade practices inflicted on the USA. People had been expecting that these tariffs would reflect the tariffs applied by other countries on US goods and possibly also non-tariff barriers, such as the ban on chlorine-washed chicken or hormone-injected beef in the EU and UK. But, by basing them on the size of a country’s trade surplus, this meant imposing them on many countries with which the USA has a free-trade deal with no tariffs at all.

The table gives some examples of the new tariff rates. The largest rates will apply to China and south-east Asian countries, which supply low-priced products, such as clothing, footwear and electronics to the US market. In China’s case, it now faces a reciprocal tariff rate of 34% plus the previously imposed tariff rate of 20%, giving a massive 54%.

What is more, the ‘de minimis’ exemption will be scrapped for packages sent by private couriers. This had exempted goods of $800 or less sent direct to consumers from China and other countries from companies such as Temu and Alibaba. It is also intended to cut back on packages of synthetic opioids sent from these countries.

The US formula for reciprocal tariffs

As we have seen, reciprocal tariffs do not reflect countries’ tariff rates on the USA. Instead, rates for countries running a trade in goods surplus with the USA (a US trade deficit with these countries) are designed to reflect the size of that surplus as a percentage of their total imports from the USA. The White House has published the following formula.


where:

When the two elasticities are multiplied together this gives 1 and so can be ignored. As there was no previous ‘reciprocal’ tariff, the rise in the reciprocal tariff rate is the actual reciprocal tariff rate. The formula for the reciprocal tariff rate thus becomes the percentage trade surplus of that country with the USA: (exports – imports) / imports, expressed as a percentage. This is then rounded up to the nearest whole number.

President Trump also stated that countries would be given a discount to show US goodwill. This involves halving the rate from the above formula and then rounding up to the nearest whole number.

Take the case of China. China’s exports of goods to the USA in 2024 were $439bn, while its imports of goods from the USA were $144bn, giving China a trade surplus with the USA of $295bn. Expressing this as a percentage of exports gives ($295/$439 × 100)/2 = 33.6%, rounded up to 34%. For the EU, the formula gives ($227bn/$584bn × 100)/2 = 19.4%, rounded up to 20%.

Questioning the value of φ. Even if you accept the formula itself as the basis for imposing tariffs, the value of the second term in the denominator, φ, is likely to be seriously undervalued. The term represents the elasticity of import prices with respect to tariff changes. It shows the proportion of a tariff rise that is passed on to consumers, which is assumed to be just one quarter, with producers bearing the remaining three quarters. In reality, it is highly likely that most of the tariff will get passed on, as it was with the tariffs applied in Donald Trump’s first presidency.

If the value for φ were 1 (i.e. all the tariff passed on to the consumer), the formula would give a ‘reciprocal tariff’ of just one quarter of that with a value of φ of 0.25. The figures in the table above would look very different. If the rates were then still halved, all countries with a tariff below 40% (such as the EU, Japan or India) would instead face just the baseline tariff of 10%. What is more, China’s rate would be reduced from 54% to 30% (the original 20% plus the baseline of 10%). Cambodia’s would be reduced to 13%. Even if the halving discount were no longer applied, the rates would still be only half of those shown in the table (and 37% for China).

Are the tariffs justified?

Even if a correct value of φ were used, a percentage trade surplus is a poor way of measuring the protection used by a country. Many countries running a trade surplus with the USA are low-income countries with low labour costs. They have a comparative advantage in labour-intensive goods. That allows such goods to be purchased at low cost by Americans. Their trade surplus may not be a reflection of protection at all.

Also, if protection is to be used to reflect the trade imbalance with each country, then why impose a 10% baseline on countries, like the UK, with which the USA has a trade surplus? By the Trump administration’s logic, it ought to be subsidising UK imports or accepting of UK tariffs on imports of US goods.

But President Trump also wants to address the USA’s overall trade deficit. The US balance of trade in goods deficit was $1063bn in 2023 (the latest year for a full set of figures). But the overall balance of payments must balance. There were thus surpluses elsewhere on the balance of payments account (and some other deficits). There was a surplus on the services account of $278bn and on the financial account of $924bn. In other words, inward investment to the USA (both direct and portfolio) and the acquisition of dollars by other countries as a reserve asset were very large and helped to drive up the exchange rate. This made US goods less competitive and imports relatively cheaper.

The USA has a large national debt of some $36 trillion of which some $9 trillion is owed to foreign investors (people, institutions or countries). Servicing the debt pushes up US interest rates. This helps to maintain a high exchange rate, thereby making imports cheaper and worsening the trade deficit. The fiscal burden of servicing the debt also crowds out US government expenditure on items such as defence, education, law and order and infrastructure. President Trump hopes that tariffs will bring in additional revenue to help finance the deficit.

Effects on the USA

If the tariffs reduce spending on imports and if other countries do not retaliate, then the US balance of trade should improve. However, a tariff is effectively a tax on imported goods. It is charged to the importing company not to the manufacturer abroad. As we saw in the context of the false value for φ, most of the tariff will be passed on to American consumers. Theoretically the incidence of the tariff is shared between the supplier and the purchaser, but in practice, most of the higher cost to the importer will be passed on to the consumer. As with other taxes, the effect is to transfer money from the consumer to the government, making people poorer but giving the government extra revenue. This revenue will be dollars, not foreign currency.

As some of the biggest price rises will be for cheap manufactured products, such as imports from China, and various staple foodstuffs, the effects could be felt disproportionately by the poor. Higher import prices will allow domestic producers competing with these imports to raise their prices too. The tariffs are thus likely to be inflationary. But because the inflation would be the result of higher costs, not higher demand, this could lead to recession as real incomes fell.

American resources will be diverted by the tariffs from sectors in which the USA has a comparative advantage, such as advanced manufactured goods and services, to more basic products. Tariffs on cheap imports will make domestic versions of these products more profitable: even though they are more costly to produce, they will be sold at a higher price.

The tariffs will also directly affect goods produced by US companies. The reason is that many use complex supply chains involving parts produced abroad. Take the case of Apple. Even though it is an American company which designs its products in California, the company sources parts from several Asian countries and has factories in Vietnam, China, India, and Thailand. These components will face tariffs and thus directly affect the price of iPhones, iPads, MacBooks, etc. Similarly affected are other US tech hardware manufacturers, US car manufactures, clothing and footwear producers, such as The Gap and Nike, and home goods producers.

Monetary policy response. How the Fed would respond is not clear. Higher inflation and lower growth, or even a recession, produces what is known as ‘stagflation’: inflation combined with stagnation. Many countries experienced stagflation following the Russian invasion of Ukraine, when higher commodity prices led to soaring inflation and economic slowdown. There was a cost-of-living crisis.

If a central bank has a simple mandate of keeping inflation to a target, higher inflation would be likely to lead to higher interest rates, making recession even more likely. It is the inflation of the two elements of stagflation (inflation and stagnation) that is addressed. The recession is thus likely to be deepened by monetary policy. But as the Fed has a dual mandate of controlling inflation but also of maximising employment, it may choose not to raise interest rates, or even to lower them, to get the optimum balance between these two targets.

If other countries retaliate by themselves raising tariffs on US exports and/or if consumers boycott American goods and services, this will further reduce incomes in the USA. Just two days after ‘liberation day’, China retaliated against America’s 34% additional tariff on Chinese imports by imposing its own 34% tariff on US imports to China.

A trade war will make the world poorer, especially the USA. Investors know this. In the two days following ‘liberation day’, stock markets around the world fell sharply and especially in the USA. The Dow Jones was down 9.3% and the tech-heavy Nasdaq Composite was down 11.4%.

Effects on the rest of the world

The effects of the tariffs on other countries will obviously depend on the tariff rate. The countries facing the largest tariffs are some of the poorest countries which supply the USA with simple labour-intensive products, such as garments, footwear, food and minerals. This could have a severe effect on their economies and cause rapidly increasing poverty and hardship.

If countries retaliate, then this will raise prices of their imports from the USA and hurt their own domestic consumers. This will fuel inflation and push the more seriously affected countries into recession.

If the USA retaliates to this retaliation, thereby further escalating the trade war, the effects could be very serious. The world could be pushed into a deep recession. The benefits of trade, where all countries can gain by specialising in producing goods with low opportunity costs and importing those with high domestic opportunity costs, would be seriously eroded.

What President Trump hopes is that the tariffs will put him in a strong negotiating position. He could offer to reduce or scrap the tariffs on a particular country in exchange for something he wants. An example would be the offer to scrap or reduce the baseline 10% tariff on UK exports and/or the 25% tariff on UK exports of cars, steel and aluminium. This could be in exchange for the UK allowing the importation of US chlorinated chicken or abolishing the digital services tax. This was introduced in 2020 and is a 2% levy on tech firms, including big US firms such as Amazon, Alphabet (Google), Meta and X.

It will be fascinating but worrying to see how the politics of the trade war play out.

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Articles

White House publications

Questions

  1. What is the law of comparative advantage? Does this imply that free trade is always the best alternative for countries?
  2. From a US perspective, what are the arguments for and against the tariffs announced by President Trump on 2 April 2025?
  3. What response to the tariffs is in the UK’s best interests and why?
  4. Should the UK align with the EU in responding to the tariffs?
  5. What is meant by a negative sum game? Explain whether a trade war is a negative sum game. Can a specific ‘player’ gain in a negative sum game?
  6. What happened to stock markets directly following President Trump’s announcement and what has happened since? Explain you findings.
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‘Tariff is the most beautiful word.’ Not for economists!

In an interview with Joe Rogan for his podcast, The Joe Rogan Experience, just before the US election, Donald Trump stated that, “To me, the most beautiful word – and I’ve said this for the last couple of weeks – in the dictionary today and any is the word ‘tariff’. It’s more beautiful than love; it’s more beautiful than anything. It’s the most beautiful word. This country can become rich with the use, the proper use of tariffs.”

President-elect Trump has stated that he will impose tariffs on imports of 10% or 20%, with 60% and 100% tariffs on imports from China and Mexico, respectively. This protection for US industries, combined with lighter regulation, will, he claims, provide a stimulus to the economy and help create jobs. The revenues will also help to reduce America’s budget deficit.

But it is not that straightforward.

Problems with tariffs for the USA

Imposing tariffs is likely to reduce international trade. But international trade brings net benefits, which are distributed between the participants according to the terms of trade. This is the law of comparative advantage.

In the simple two-country case, the law states that, provided the opportunity costs of producing various goods differ between the two countries, both of them can gain from mutual trade if they specialise in producing (and exporting) those goods that have relatively low opportunity costs compared with the other country. The total production and consumption of the two countries will be higher.

So if the USA has a comparative advantage in various manufactured products and a trading partner has a comparative advantage in tropical food products, such as coffee or bananas, both can gain by specialisation and trade.

If tariffs are imposed and trade is thereby reduced between the USA and its trading partners, there will be a net loss, as production will switch from lower-cost production to higher-cost production. The higher costs of less efficient production in the USA will lead to higher prices for those goods than if they were imported.

At the same time, goods that are still imported will be more expensive as the price will include the tariff. Some of this may be borne by the importer, meaning that only part of the tariff is passed on to the consumer. The incidence of the tariff between consumer and importer will depend on price elasticities of demand and supply. Nevertheless, imports will still be more expensive, allowing the domestically-produced substitutes to rise in price too, albeit probably by not so much. According to work by Kimberly Clausing and Mary E Lovely for the Peterson Institute (see link in Articles below), Trump’s proposals to raise tariffs would cost the typical American household over $2600 a year.

The net effect will be a rise in inflation – at least temporarily. Yet one of Donald Trump’s pledges is to reduce inflation. Higher inflation will, in turn, encourage the Fed to raise interest rates, which will dampen investment and economic growth.

Donald Trump tends to behave transactionally rather than ideologically. He is probably hoping that a rapid introduction of tariffs will then give the USA a strong bargaining position with foreign countries to trade more fairly. He is also hoping that protecting US industries by the use of tariffs, especially when coupled with deregulation, will encourage greater investment and thereby faster growth.

Much will depend on how other countries respond. If they respond by raising tariffs on US exports, any gain to industries from protection from imports will be offset by a loss to exporters.

A trade war, with higher tariffs, will lead to a net loss in global GDP. It is a negative sum game. In such a ‘game’, it is possible for one ‘player’ (country) to gain, but the loss to the other players (countries) will be greater than that gain.

Donald Trump is hoping that by ‘winning’ such a game, the USA could still come out better off. But the gain from higher investment, output and employment in the protected industries would have to outweigh the losses to exporting industries and from higher import prices.

The first Trump administration (2017–21), as part of its ‘America First’ programme, imposed large-scale tariffs on Chinese imports and on steel and aluminium from across the world. There was wide-scale retaliation by other countries with tariffs imposed on a range of US exports. There was a net loss to world income, including US GDP.

Problems with US tariffs for the rest of the world

The imposition of tariffs by the USA will have considerable effects on other countries. The higher the tariffs and the more that countries rely on exports to the USA, the bigger will the effect be. China and Mexico are likely to be the biggest losers as they face the highest tariffs and the USA is a major customer. In 2023, US imports from China were worth $427bn, while US exports to China were worth just $148bn – only 34.6% of the value of imports. The percentage is estimated to be even lower for 2024 at around 32%. In 2023, China’s exports to the USA accounted for 12.6% of its total exports; Mexico’s exports to the USA accounted for 82.7% of its total exports.

It is possible that higher tariffs could be extended beyond China to other Asian countries, such as Vietnam, South Korea, Taiwan, India and Indonesia. These countries typically run trade surpluses with the USA. Also, many of the products from these countries include Chinese components.

As far as the UK is concerned, the proposed tariffs would cause significant falls in trade. According to research by Nicolò Tamberi at the University of Sussex (see link below in Articles):

The UK’s exports to the world could fall by £22 billion (–2.6%) and imports by £1.4 (–0.16%), with significant variations across sectors. Some sectors, like fishing and petroleum, are particularly hard-hit due to their high sensitivity to tariff changes, while others, such as textiles, benefit from trade diversion as the US shifts demand away from China.

Other badly affected sectors would include mining, pharmaceuticals, finance and insurance, and business services. The overall effect, according to the research, would be to reduce UK output by just under 1%.

Countries are likely to respond to US tariffs by imposing their own tariffs on US imports. World Trade Organization rules permit the use of retaliatory tariffs equivalent to those imposed by the USA. The more aggressive the resulting trade war, the bigger would be the fall in world trade and GDP.

The EU is planning to negotiate with Trump to avoid a trade war, but officials are preparing the details of retaliatory measures should the future Trump administration impose the threatened tariffs. The EU response is likely to be strong.

Articles

Questions

  1. Explain why, according to the law of comparative advantage, all countries can gain from trade.
  2. In what ways may the imposition of tariffs benefit particular sections of an economy?
  3. Is it in countries’ interests to retaliate if the USA imposes tariffs on their exports to the USA?
  4. Why is a trade war a ‘negative sum game’?
  5. Should the UK align with the EU in resisting President-elect Trump’s trade policy or should it seek independently to make a free-trade deal with the USA? is it possible to do both?
  6. What should China do in response to US threats to impose tariffs of 60% or more on Chinese imports to the USA?
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Anyone for Chinese style pork?

The growth of emerging economies, such as China, India and Brazil brings with it both good and bad news for the once dominant countries of the West. With growth rates in China reaching double digits and a much greater resilience to the credit crunch and its aftermath in these emerging nations, they became the hope of the recovery for the West. But, is it only benefits that emerge from the growth in countries like China?

Chinese business has grown and expanded into all areas, especially technology, but countries such as the USA have been reluctant to allow mergers and takeovers of some of their businesses. Notably, the takeovers that have been resisted have been in key sectors, particularly oil, energy and technology. However, it seems as though pork is an industry that is less important or, at least, a lower risk to national security.

Smithfield Foods is a US giant, specialising in the production and selling of pork. A takeover by China’s Shuanghui International Holdings has been approved (albeit reluctantly) by the US Committee on Foreign Investment. While the takeover could still run into obstacles, this Committee’s approval is crucial, as it alleviates concerns over the impact on national security. The value of the deal is some $7.1bn, including the debt that Shuangui will have to take on. While some see this takeover as good news, others are more concerned, identifying the potential negative impact it may have on prices and standards in the USA. Zhijun Yang, Shuanghui’s Chief Executive said:

This transaction will create a leading global animal protein enterprise. Shuanghui International and Smithfield have a long and consistent track record of providing customers around the world with high-quality food, and we look forward to moving ahead together as one company.

The date of September 24th looks to be the decider, when a shareholder meeting is scheduled to take place. There is still resistance to the deal, but if it goes ahead it will certainly help other Chinese companies looking for the ‘OK’ from US regulators for their own business deals. The following articles consider the controversy and impact of this takeover.

US clears Smithfield’s acquisition by China’s Shuanghui Penn Energy, Reuters, Lisa Baertlein and Aditi Shrivastava (10/9/13)
Chinese takeover of US Smithfield Foods gets US security approval Telegraph (7/9/13)
US clears Smithfield acquisition by China’s Shuanghui Reuters (7/9/13)
Go-ahead for Shuanghui’s $4.7bn Smithfield deal Financial Times, Gina Chon (6/9/13)
US security panel approves Smithfield takeover Wall Street Journal, William Mauldin (6/9/13)

Questions

  1. What type of takeover would you classify this as? Explain your answer.
  2. Why have other takeovers in oil, energy and technology not met with approval?
  3. Some people have raised concerns about the impact of the takeover on US pork prices. Using a demand and supply diagram, illustrate the possible effects of this takeover.
  4. What do you think will happen to the price of pork in the US based on you answer to question 3?
  5. Why do Smithfield’s shareholders have to meet before the deal can go ahead?
  6. Is there likely to be an impact on share prices if the deal does go ahead?
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Shortages in Venezuela – what’s the solution?

A simple model in economics is that of demand and supply. Through the price mechanism, signals are sent between consumers and producers and this interaction results in an equilibrium market price and quantity. However, what happens when the market for a good or service is in disequilibrium?

When a market is in equilibrium, demand equals supply. However, as we discussed in a previous blog concerning baby milk in China (see Milking the economy), markets are not always in equilibrium. If demand exceeds supply, a shortage will emerge and to eliminate this, the price must rise. If, on the other hand, supply exceeds demand, there will be an excess supply and thus the price must fall to restore equilibrium.

The market in question here is toilet paper in Venezuela! A severe shortage of this product has emerged in recent months, with shops running out of supplies. In a bid to relieve this shortage, the country’s Minister of Commerce has received approval for a $79 million credit, which can be used to import this basic product in short supply. Fifty million rolls will be imported to help fill the shortage that has emerged. The shortage is not just a problem for toilet paper, but also across a range of basic consumer goods. The article from Reuters comments that:

The government says the toilet paper shortages, like others, are the results of panicked buying and unscrupulous merchants hoarding the goods to artificially inflate prices.

Opposition critics say the problem is caused by the currency controls, created a decade ago by late socialist leader Hugo Chavez, and years of nationalizations that weakened private industry and left businesses unwilling to invest.

With shortages across a variety of products, the President has begun to work closely with business leaders to address this situation. The following articles consider this basic market, the intervention and consequences.

Venezuela hopes to wipe out toilet paper shortage by importing 50m rolls The Guardian (16/5/13)
Venezuela ends toilet paper shortage BBC News (22/5/13)
With even toilet paper scarce, Venezuelan president warms to business Reuters, Eyanir Chinea (22/5/13)
Toilet paper shortage in Venezuela to end after lawmakers back plans to import 39 million rolls Huffington Post, Sara Nelson (22/5/13)
Venezuela’s toilet paper shortage ended; 3 other basic goods that went scarce in the country International Business Times, Patricia Rey Mallen (22/5/13)

Questions

  1. Using a demand and supply diagram, explain how equilibrium is determined in a free market.
  2. Illustrate the shortage described in the aticles on your above demand and supply diagram. How should the price mechanism adjust?
  3. What types of government intervention have led to the shortages of such basic consumer goods?
  4. How have currency controls created a problem for Venezuela?
  5. With an increase in imported products, what impact might there be on Venezuela’s exchange rate and on its balance of payments?