Monthly Archives: April 2025

Letting Protectionist Nations Tax Themselves

22 Tuesday Apr 2025

Posted by in Comparative advantage, Protectionism, Tariffs

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First, a few more comments re: my speculative musings that Donald Trump’s tariff rampage could ultimately result in a regime with lower trade barriers, at least with a subset of trading partners. Arthur Laffer and Stephen Moore suggested last week that the White House should propose reciprocal free trade with zero barriers and zero subsidies for exports to any country that wishes to negotiate. A more cynical Ben Zycher scoffed at the very possibility, noting that Trump and his lieutenants view any trade deficit as evidence of cheating in one form or another. Zycher is convinced that Trump lacks a basic understanding of the (mostly) benign forces that drive trade imbalances.

I’ve said much the same. Trump’s crazy notions about trade could scuttle negotiations, or he might later accuse a trading partner of cheating on the pretext of a bilateral trade deficit (he’s done so already). And all this is to say nothing of the serious constitutional questions surrounding Trump’s tariff actions.

The mistaken focus on bilateral trade deficits also manifests in certain proposals made during trade negotiations: “Okay, but you’re gonna have to purchase vast quantities of our soybeans every year.” This sort of export promotion is a further drift into industrial planning, and it’s just too much for Trump’s trade negotiators to resist.

This might well turn out as an exercise in self-harm for Trump. However, I’ve also wondered whether his trade hokum is pure posturing, especially because he expressed support for a free trade regime in 2018. Let’s hope he meant it and that he’ll pursue that objective in trade talks. Please, just negotiate lower trade barriers on both sides without the mercantilist baggage.

Which brings me to the theme of this post: it would probably be simpler and more effective for the U.S. to simply drop all of its trade barriers unilaterally. There should be limited exceptions related to national security, but in general we should “turn the other cheek” and let recalcitrant trade partners engage in economic self-harm, if they must.

Okay, Wise Guy, What’s Your Plan?

I have a few friends who bemoan the lack of “fair play” against the U.S. in foreign trade. They have a point, but they also hold an unshakable belief that the U.S. can be just as efficient at producing anything as any other country. They are pretty much in denial that comparative advantages exist in the real world. They are seemingly oblivious to the critical role of specialization in unlocking gains from trade and lifting much of the world’s population out of penury over the past few centuries.

Furthermore, these friends believe that Trump is justified in “retaliating” against countries with whom the U.S. runs trade deficits. If tariffs are so bad, they ask, what would I do instead? Again, here’s my answer:

Eliminate (almost) all barriers to trade imposed by the U.S. Let protectionist nations choke themselves with tariffs/trade barriers.

Before getting into that, I’ll address one fact that is often denied by protectionists.

Yes, a Tariff Is a Tax!

Protectionists often claim that tariffs are not really taxes on U.S. buyers. However, tariffs are charged to buyers of imported goods (often businesses who sell imported goods to consumers or other businesses). In principle, tariffs operate just like a sales tax charged to retail buyers. Both raise government revenue, and they are both excise taxes.

In both cases, the buyer pays but generally bears less than the full burden of the tax. That’s because demand curves slope downward, so sellers (foreign exporters) try to avoid losing sales by moderating their prices in response to the tariff. In both cases, sellers end up shouldering part of the tax burden. How much depends on how buyers react to price: a steep (inelastic) demand curve implies that buyers bear the greater part of the burden of a tariff or sales tax.

People sometimes buy imports due to a lack of substitutes, which implies a steep demand curve. Consumer imports are often luxury items, and well-heeled buyers may be somewhat insensitive to price. Most imports, however, are inputs purchased by businesses, either capital goods or intermediate goods. In the face of higher tariffs, those businesses find it difficult and costly to arrange new suppliers, let alone domestic suppliers, who can deliver quickly and meet their specifications.

These considerations imply that the demand for imports is fairly inelastic (steeper), especially in the short run (when alternatives can’t easily be arranged). Thus, import buyers bear a large portion of the burden in the immediate aftermath of an increased tariff. By imposing tariffs we tax our own citizens and businesses, forcing them to incur higher costs. Correspondingly, if demand is inelastic, an importing country tends to gain more than its trading partners by unilaterally eliminating its own tariffs.

Tariffs on imports also trigger price hikes by import-competing producers. Sometimes this is opportunistic, but even these producers incur higher costs in attempting to meet new demand from buyers who formerly purchased imports. (See this post for an explanation of the costly transition, including a nice exposition of the waste of resources it entails.)

Other Forms of Blood Letting

Beyond tariffs, certain barriers to trade make it more difficult or impossible to purchase goods produced abroad. This includes import quotas and domestic content restrictions. These barriers are often as bad or worse than tariffs because they increase costs and encumber freedom of choice and consumer sovereignty.

Another kind of trade intervention, export subsidies, must be funded by taxpayers. Subsidies are too easily used to protect special interests who otherwise can’t compete. Currency manipulation can both subsidize exports and discourage imports, but it is often unsustainable. The common theme of these interventions is to undermine economic efficiency by shielding the domestic economy from real price signals.

Let Them Tax Themselves

Suppose the U.S. simply turns the other cheek, eliminating all of our own trade interventions with respect to country X despite X’s tariffs and other interventions.

To start with, the existence of barriers means that both countries are unable to exploit all of the benefits of specialization and mutually beneficial trade. Both countries must produce an excess of goods in which they lack a comparative advantage, and both countries produce too few goods in which they have a comparative advantage. Both incur extra costs and produce less output than they could in the absence of trade barriers.

Unilateral elimination of U.S. tariffs and other barriers would reduce high-cost domestic production of certain goods in favor of better substitutes from country X. But Country X gains as well, because it is now able to produce more goods and services for export in which it possesses a comparative advantage. Therefore, the unilateral move by the U.S. is beneficial to both countries.

On the other hand, U.S. export industries are still constrained by country X’s import tax or other restraints. These would-be exporters are no worse off than before, but they are worse off relative to a state in which buyers in country X could freely express their preferences in the marketplace.

What exactly does country X gain from tariffs and other trade burdens on its citizens? It denies them full access to what they deem to be superior goods and services at an acceptable price. It means that resources are misallocated, forcing abstention or the use of inferior or costlier domestic alternatives. Resources must be diverted to relatively inefficient firms. In short, the tariff makes country X less prosperous.

Empirical evidence shows that more open economies (with fewer trade barriers) enjoy greater income and productivity growth. This study found that “trade’s impact on real income [is] consistently positive and significant over time.” See this paper as well. Trade barriers tend to increase the income gap between rich and poor countries. The chart below (from this link) compares real GDP per capita from the top third and bottom third of the distribution of countries on a measure of trade “openness”. Converting logs to levels, the top third has more than twice the average real GDP per capita of the bottom third. And of course, the averaging process mutes differences between very open and very closed trade policies.

The chart also shows that countries more “open” to trade have more equal distributions of income, as measured by their Gini coefficients.

An important qualification is that domestic production of certain goods and services might be critical to national security. We must be willing to tolerate some inefficiencies in that case. It would be foolish to depend on a hostile nation for those supplies, despite any comparative advantage they might possess. It’s reasonable to expect such a list of critical goods and services to evolve with technological developments and changing security threats. However, merely acknowledging this justification leaves the door open for excessively broad interpretations of “critical goods”, especially in times of crisis.

Setting a Good Policy and Example

Here’s an attempt to summarize:

  • Tariffs are taxes, and non-tariff barriers inflict costs by distorting prices or diminishing choice
  • Trade barriers reduce economic efficiency and produce welfare losses
  • Trade barriers deny the citizens of a country the benefits of specialization
  • Both countries gain when one trading partner eliminates tariffs on imports from the other
  • The demand for imports is fairly inelastic, at least in the short run. Thus, the gain from eliminating a tariff will be skewed toward the domestic importers
  • Both countries gain when they agree to eliminate any and all trade barriers
  • Across countries, trade barriers are associated with lower incomes, lower income growth, and more unequal distributions of income

The U.S. has a large number of trading partners. Every liberalization we initiate means a welfare gain for us and one trading partner, who would do well to follow our example and reciprocate in full. Not doing so foregoes welfare gains and leads to incremental losses in income relative to more trade-friendly nations. Across all of our trading relationships, a unilateral end to U.S. trade barriers would almost certainly convince some countries to reciprocate. Those that refuse would suffer. Let them self-flagulate. Let them tax themselves.

The Tariff Games

08 Tuesday Apr 2025

Posted by in Protectionism, Tariffs

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Donald Trump’s imposition of higher tariffs — much higher tariffs — on our trading partners carries tremendous risk. See this article for a good summary of the tariffs Trump levied (and now paused for 90 days) on imported goods from different countries. The President believes he can win major concessions from other nations in terms of trade barriers as well as foreign policy objectives. But he would also have us believe that we’ll be better off even if those concessions fall short of his hopes.

Perhaps he’s posturing, but Trump seems to thinks tariffs are some kind of elixir. That is nonsense for a variety of reasons. I’ve discussed several of those previously and I’ll add more in a subsequent post. Here, I’ll attempt to give Trump his due. I’m highly skeptical, but I’ll be happy to eat crow if he is successful in achieving a trade regime with lower tariffs and other barriers across many of our trading partners.

Markets

The tariff announcements last week on “Liberation Day” spooked markets, prompting a continuation of the classic flight to safety we’ve witnessed since Trump began to rattle his trade saber. This has driven bond prices up and long-term interest rates down, though now we’re seeing a partial reversal (if it holds). Will lower interest rates help save the day for Trump? It will bring lower borrowing costs to many borrowers, including the federal government, and it should help to buttress stock values, softening the blow to some extent.

The tariffs, should they remain in place, are likely to boost inflation temporarily (a one-time increase in the price level) and could very well tip the U.S. economy into recession. Depending on the severity, those developments would undercut the GOP’s hopes of maintaining a congressional majority in the 2026 mid-term elections. Then, he’d truly have managed to cut off his nose to spite his face. Still, Trump thinks he knows something about tariffs that markets don’t.

Dominoes

Bill Ackman has expressed a view of how markets are reacting and how they might evolve under Trump’s trade policy. He thinks markets would be fine had the President set tariffs at levels matching our trading partners (doubtful at best), but Trump went bigger in order to jolt other nations into negotiating. Ackman thinks there might be a “tipping point” when countries line up at the negotiating table. And indeed, as of April 7, the administration said “up to” 70 countries had reached out to enter new trade negotiations with the U.S. That probably helped bring investors out of their doldrums, pending actual deals.

Elon Musk states a desire to see tariffs eliminated between the U.S. and the EU, and the EU has made a limited offer along those lines. This might be indicative of similar thinking by others in the administration. But Trump insists he’ll always revisit tariffs wherever he sees a bilateral trade deficit. Contrary to all economic logic, he is convinced that trade deficits are harmful, when in fact they mainly reflect our relative prosperity.

Hard-Nosed, High Stakes

Economists have been almost uniform in their condemnation of Trump’s approach trade. To some extent, that’s a visceral reaction to Trump’s pro-tariff rhetoric and revulsion to his opening moves. But is there an economic rationale for this type of aggressive attempt to bargain for lower trade barriers? Yes, and it’s not a terribly deep insight, and it carries great risks in the real world.

From a game-theoretic perspective, it’s possible that a dominant trading partner, in repeated rounds, can ultimately achieve lower bilateral trade barriers through the threat or imposition of higher barriers to imports from a trading partner. The key is the difference in costs that barriers impose on the two nations. One is in a position to leverage its dominant position, inflicting greater costs on the other nation as an inducement to gain concessions and achieve improved conditions for mutual trade.

The U.S. is almost uniformly the dominant partner in bilateral trade relationships. That’s because U.S. GDP is so large and U.S. trade with any given country is a comparatively small fraction of GDP. But dominance can mean different things: there are countries that supply critical goods to the U.S., like oil, semiconductors, or rare earths, which may give certain countries disproportionate leverage in trade negotiation. Those products along with many others are exempted from Trump’s tariffs.

Other Cards

Nevertheless, the U.S. has economic leverage over individual trading partners in the vast majority of cases, which Trump certainly is willing to exploit. And Trump has another powerful tool with which to negotiate with some trading partners: U.S. military protection. Using it might expose the U.S. to strategic disadvantages, but don’t put it past Trump to bring this up in negotiations!

Trump is doing his best to prove a readiness to escalate. That might build his credibility except for a couple of critical facts: first, his actions have already violated at least 15 existing treaties. Why should they trust him? Second, some groups of nations are likely to present a united front, putting them on a more equal footing with the U.S. This makes a trade war between the U.S. and the rest of the world more likely. One nation in particular stands ready to capitalize on severed relations between other nations and “Donald Trump’s” America: Xi Jinping’s China. Bilateral trade with China might just be the Super Bowl of these tariff games. Unfortunately, it could be a Super Bowl where everyone loses!

An additional complication: while the U.S. has dominance in most of its trade relationships, the barriers to U.S. goods erected by other nations are often supported by powerful special interests. Trump’s ability to strike deals will be complicated where governments are captive to these interests, which might be concentrated among powerful elites or of a more diffuse, nationalist/populist nature.

Deep In the Woods

There is optimism in some quarters that a few successful trade deals will lead to a “tipping point” in the willingness of other nations to negotiate with Trump. Despite the sudden clamor among our trade partners to negotiate, we’re a long way from getting solid agreements. Investors still assess a greater risk of a world trade war than vanishing barriers to trade.

I’ll close with a take on the situation by the reliably funny Iowahawk:

Choosing DOGE Over a Prodigal State Apparatus

03 Thursday Apr 2025

Posted by in Big Government, DOGE

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I prefer a government that is limited in size and scope, sticking closely to the provision of public goods without interfering in private markets. Therefore, I’m delighted with the mission of the Department of Government Efficiency (DOGE), a rebranded version of the U.S. Digital Service created by Barack Obama in 2014 to clean up technical issues then plaguing the Obamacare web site. The “new” DOGE is fanning out across federal agencies to upgrade systems and eliminate waste and fraud.

A Strawman

For years, democrats such as Barack Obama and Joe Biden have advocated for eliminating waste in government. So did Bill Clinton, Al Gore, Bernie Sanders, Chuck Schumer, and Nancy Pelosi. Here’s Mark Cuban on the same point. Were these exhortations made in earnest? Or were they just lip service? Now that a real effort is underway to get it done, we’re told that only fascists would do such a thing.

I’m seeing scary posts about DOGE even on LinkedIn, such as the plight of Americans unable to get federal public health communications due to layoffs at HHS, while failing to mention the thousands of new HHS employees hired by Biden in recent years. As if HHS was particularly effective in dispensing good public health advice during the pandemic!

Those kinds of assertions are hard to take seriously. For reasons like these and still others, I tend to dismiss nearly all of the horror stories I hear about DOGE’s activities as nitwitted virtue signals or propaganda.

Many on the left claim that DOGE’s work is careless, and especially the force reductions they’ve spearheaded. For example, they claim that DOGE has failed to identify key employees critical to the functioning of the bureaucracy. The tone of this argument is that “this would not pass muster at a well-managed business”. A “sober” effort to achieve efficiencies within the federal bureaucracy, the argument goes, would involve much more consideration. In other words, given political realities, it would not get done, and they really don’t want it to get done.

The best rationale for the ostensible position of these critics might be situations like the dismissal of several thousand provisional employees at the FDA, a few of whom were later rehired to help manage the work load of reviewing and approving drugs. However, thus far, only a tiny percentage of the federal force reductions under consideration have involved immediate layoffs.

Of course, DOGE is not being tasked to review the practices of a well-managed business or a well-managed governmental organization. What we have here is a dysfunctional government. It is a bloated, low productivity Leviathan run by management and staff who, all too frequently, seem oblivious to the predicament. Large force reductions at all levels are probably necessary to make headway against entrenched interests that have operated as a fourth branch of government.

Thus, I see the leftist critique of Trump’s force reductions as something of a strawman, and it falls flat for several other reasons. First, the vast bulk of the prospective reduction in headcount will be voluntary, as the separating employees have been offered attractive severance packages. Second, force reductions in the private sector always feel chaotic, and they often are. And they are sometimes executed without regard to the qualifications of specific employees. Tough luck!

Duplicative functions, poor data systems, and a lack of control have led to massive misappropriations of funds. The dysfunction has been enabled by a metastasization of nests of administrative authority inside agencies with “incomprehensible” org charts, often having multiple departments with identical functions that do not communicate. These departments frequently use redundant but unconnected systems. A related problem is the inadequacy of documentation for outgoing payments. Needless to say, this is a hostile environment for effective spending controls.

It’s worth emphasizing, by the way, DOGE’s “open book” transparency. It’s not as if Elon Musk and DOGE are attempting to sabotage the deep state in the dark of night. Indeed, they are shouting from the rooftops!

Doing It Fast

Every day we have a new revelation from DOGE of incredible waste in the federal bureaucracy. Check out this story about a VA contact for web site maintenance. All too ironically, what we call government waste tends to have powerful, self-interested, and deeply corrupt constituencies. This makes speed an imperative for DOGE. In a highly politicized and litigious environment, the extent to which the Leviathan can be brought to heel is partly a function of how quickly the deconstruction takes place. One must pardon a few temporary dislocations that otherwise might be avoided in a world free of rent seeking behavior. Otherwise, the graft (no, NOT “grift”) will continue unabated.

The foregoing offers sufficient rationale not only for speedy force reductions, but also for system upgrades, dissolution of certain offices, and consolidation of core functions under single-agency umbrellas.

The Bloody Budget

It’s difficult to know when budget legislation will begin to reflect DOGE’s successes. The actual budget deficit might be affected in fiscal year 2025, but so far the savings touted by DOGE are chump change compared to the expected $2 trillion deficit, and only a fraction of those savings contribute to ongoing deficit reduction.

Uncontrolled spending is the root cause of the deficit, as opposed to insufficient tax revenue, as evidenced by a relatively stable ratio of taxes to GDP. The spending problem was exacerbated by the pandemic, but Congress and the Biden Administration never managed to scale outlays back to their previous trend once the economy recovered. Balancing the budget is made impossible when the prevailing psychology among legislators and the media is that reductions in the growth of spending represent spending cuts.

Federal spending is excessive on both the discretionary and mandatory sides of the budget. Ultimately, eliminating the budget deficit without allowing the 2017 Trump tax cuts to expire will require reform to mandatory entitlements like Social Security, Medicare, and Medicaid, as well as reductions across an array of discretionary programs.

DOGE’s focus on fraud and waste extends to entitlements. At a minimum, the data and tracking systems in place at HHS and SSA are antiquated, sometimes inaccurate, and are highly susceptible to manipulation and fraud. Systems upgrades are likely to pay for themselves many times over.

But all indications are that it’s much worse than that. Social security numbers were issued to millions of illegal immigrants during the Biden Administration, and those enrollees were cleared for maximum benefits. There were a significant number of illegals enrolled in Medicaid and registered to vote. While some of these immigrants might be employed and contributing to the entitlement system, they should not be employed without legal status. Of course, one can defend these entitlement benefits on purely compassionate grounds, but the availability of benefits has served to attract a massive flow of illegal border crossings. This illustrates both the extent to which the entitlement system has been compromised as well as the breakdown of border security.

On the discretionary side of the budget, DOGE has identified an impressive array programs that were not just wasteful, but by turns ridiculous or politically motivated (for example, the bulk of USAID’s budget). Many of these funding initiatives belong on the chopping block, and components that might be worthwhile have been moved to agencies with related missions. In addition, authorized but unspent allocations have been identified that seem to have been held in reserve, and which now can be used to reduce the public debt.

Research Grants?

Of course, like the initial scale of the FDA layoffs, a few mistakes have and will be made by DOGE and agencies under DOGE’s guidance. Many believe another powerful argument against DOGE is the Trump Administration’s 15% limit on indirect costs as an add-on to NIH grants. Critics assert that this limit will hamstring U.S. scientific advancement. However, it won’t “kill” publicly funded research. As this article in Reason points out, historically public funding has not been critical to scientific advancement in the U.S. In fact, private funding accounts for the vast bulk of U.S. R&D, according to the Congressional Research Service. Moreover, it’s broadly acknowledged that indirect costs are subject to distortion, and that generous funding of those costs creates bad incentives and raises thorny questions about cross-subsidies across funders (15% is the rate at which charities typically fund indirect costs).

No doubt some elite research universities will suffer declines in grants, but their case is weakened politically by a combination of lax control over anti-Semitic protests on campus, the growing unpopularity of DEI initiatives in education, and public awareness of the huge endowments over which these universities preside. Nevertheless, I won’t be surprised to see the 15% limit on indirect research costs revised upward somewhat.

More DOGE Please

I’ve criticized the numbers posted on DOGE’s website elsewhere. They could do a much better job of categorizing and reporting the savings they’ve achieved, and they have far to go before meeting the goals stated by Elon Musk. Be that as it may, DOGE is making progress. Here is a report on a few of the latest cuts.

As I’ve emphasized on numerous occasions, the federal government is a strangling mass of tentacles, squeezing excessive resources out of the private sector and suffocating producers with an endless catalogue of burdensome rules. There are many examples of systemic waste taking place within the federal bureaucracy. For example, since its creation by Jimmy Carter, the Department of Education has managed to piss away trillions of dollars while student performance has declined. The Small Business Administration has doled out millions of dollars in subsidized loans to super-centenarians as well as children. The U.S. Postal Service keeps losing money and mail while deliveries slow to a crawl. Big projects become mired in endless iterations of reviews and revisions, such as Obama’s infrastructure plan and Joe Biden’s infrastructure and rural broadband initiative.

And again, regulatory agencies are often our worst enemies, imposing burdensome requirements with which only the largest industry players can afford to comply. Indeed, the savings achieved through the DOGE process might pale in comparison to the resources that could be liberated by rationalizing the tangle of regulations now choking private business.

A significant narrowing of the budget deficit would be a major accomplishment for DOGE. Even one-time savings to help pay down the public debt are worthwhile. In this latter regard, I hope DOGE’s work with the Department of Interior helps facilitate the sale of dormant federal assets. This includes land (not parks) and buildings worth literally trillions of dollars, and sometimes costing billions annually to maintain.