Misconceptions about tariffs

Strange new respect for mercantilism

By and large, the media doesn’t like Trump. Nonetheless, they are giving his trade policies more respect than they deserve. This is not because the media wishes to be fair to Trump, rather it reflects longstanding misconceptions about how the global economy functions. These misconceptions were once concentrated on the left, but have recently spread to large portions of the right. Those of us trying to preserve the wisdom of classical economics are fighting an increasingly lonely battle, like those medieval monks in Ireland trying to preserve classical learning. In this post, I’ll delve into 15 common misconceptions about tariffs and the broader economy.

1. “Real shocks frequently cause recessions.” I covered this misconception in the previous post, so I won’t rehash all the arguments. Nonetheless, the fact that the US did not immediately fall into recession after “Liberation Day” has led some pundits to wonder if the tariffs were as bad as critics complained. As I pointed out in my previous post, “bad for efficiency” and “causes a recession” are completely different issues. I doubt whether even the world’s worst economies have more frequent recessions than the US.

2. “Tariffs are not hurting the stock market.” Stocks rebounded to record highs after the sharp Liberation Day sell-off. This led some people to claim that perhaps tariffs were not in fact a negative for the stock market. On closer inspection, however, worse than expected tariff news continues to be a drag on the market, even during a bull market. Friday’s sell-off was widely linked to another tariff push by the Trump administration. You should focus on how stocks respond to new information.

   More broadly, stocks move around for all sorts of reasons, with tariffs being only one factor. If you are fan of GOP economic policies and wish to use the stock market as a scorecard, consider that the S&P500 rose about 173% during Obama’s 8 years in office, and another 75% during Biden’s 4 years in office. During Trump’s first term the market rose by 69%. Those are all very good figures, but even if you give Trump credit for the market’s rise before he took office and adjust for the Biden inflation, it remains true that stocks have had a strong upward bias under three consecutive administrations. But few people (in either party) would say that 2009 to 2025 has been a great period for the US economy. And most people who like Trump’s policies hate Biden’s policies

3. “Tariffs are a consumption tax.” I am seeing more pundits echoing my 2024 prediction that tariffs will eventually lead to a VAT. But tariffs are not a consumption tax, for two reasons. First, they apply to all goods, not just consumer goods. Some reports suggest that roughly half of US imports are intermediate goods. Second, tariffs don’t apply to all consumer goods, they exempt domestic made consumer goods and all services. Thus, the overlap between tariffs and a VAT is surprisingly weak.

4. “Tariffs are a good way to raise revenue and bring home jobs.” You might believe that tariffs are a good way to raise badly needed revenue. You might believe that tariffs will bring jobs back home. But the two views conflict. The usual explanation for this fact is that a tariff that restricts imports will raise less revenue than anticipated.

   That’s true, but it misses a much more important point. Tariffs that “bring jobs back home” tend to distort the location of production, leading to production inefficiencies. This is true of all tariffs, but it’s especially true of the poorly designed Trump tariffs, which tax things like key inputs into car-making at a higher level for US firms than for foreign firms. Restrictions on transhipments will lead to massive compliance costs and widespread cheating. Smuggling will increase. Exemptions for politically favored groups will lead to enormous rent-seeking. Anyone who has studied Latin American economic history understands all of this.

   The least bad way to raise tariff revenue would be to tax goods that would continue to be imported even after tariffs were imposed, perhaps tropical agricultural goods like coffee, cocoa and bananas. Pundits often ask, “What’s the point of putting a tariff on bananas, as there are no domestic producers to protect.” But if the goal is to efficiently raise revenue, then you should tax banana imports, and welcome Chinese EVs with open arms.

5. “Trump’s policies are pro-investment”. Don’t conflate tariff policy with Trump administration policy. Tyler Cowen recently linked to an NBER study that suggests tariffs might boost growth if the funds were used to subsidize investment. I think an even easier way to see this point is that tariffs might reduce the budget deficit, and it is widely believed that budget deficits can crowd out investment, especially in an economy at full employment (like our current economy.)

   That’s all true, but there are two problems with this argument. First, there are much more efficient ways to raise revenue and/or reduce spending. And second, the Trump administration’s broader fiscal policy pushes in exactly the opposite direction. Indeed, when you adjust for the current position of the business cycle, both the first and second Trump administrations have been arguably the most recklessly expansionary in US history, along with the Biden administration. We’ve had these sorts of big deficits before, but not during periods of peace and prosperity.

   Trump is using a very inefficient fiscal technique to slightly reduce the damage from extremely reckless fiscal policies in other areas. Even if his tariff policy is pro-investment, in isolation, Trump’s economic policy as a whole is not pro-investment. Tyler Cowen puts things in perspective:

I’ll say it again: tariffs bad, bad, bad! But they are bad because they are a revenue grab, which will lead to consumption taxes being a new and major source of enhancement of government power and influence. Current policy may well evolve into some sick, distorted version of a VAT, with larger government to boot. But from a normal “Democratic Party, economics PhD view of government,” there is nothing so especially terrible about tariffs, at least not compared to other modes of taxation.

That’s almost identical to my own view, with the proviso that the smartest economists on the left do understand that tariffs are an inefficient way to raise revenue. And I would say they are bad only partly because they’ll lead to a VAT that boosts total government revenue—they are also especially inefficient. (I would favor a VAT that did not lead to more total revenue, but short of a constitutional amendment banning income taxes, how would we get that guarantee?)

One reason why the Democrats are in such disarray is that they don’t seem to know how to respond to the tariffs. These taxes are unpopular with the public, but the Dems refuse to come right out and say that they’ll repeal them after they again take power. That speaks volumes.

In another post, Tyler sees a similar problem:

A good debate would be “the Trump tariffs” vs. “a more comprehensive VAT with lower rates and a broader base.” But, rightly or not, Democratic Party intellectuals likely would lose that debate in the eyes of the public and perhaps even in their own party. They probably would not lose it with professional economists, though in this regard I am an outlier in terms of the spending cuts I would favor.

I have fairly strong views on the sort of fiscal policy I’d like (something like Singapore), but weaker views on what second best options are optimal in a world where I cannot get my way. Second best problems are quite tricky, as the correct answer in one decade may be different from the correct answer in the previous decade.

6. “Tariffs will create more jobs.” We are at full employment. Where are the workers supposed to come from? Immigration?

7. “Tariffs will create more manufacturing jobs.” This one is more debatable, but I’m highly skeptical of claims that tariffs will revive employment in manufacturing. (Output doesn’t need to be revived, as the US is already a manufacturing powerhouse.) Adam Ozimek has an excellent post debunking many claims made about the US auto industry:

The protectionist argument for insulating the American auto industry from foreign competition not only draws the wrong lessons from history, it gets the history itself wrong. It rests on four myths, all of which I debunk in this analysis:

a. The U.S. auto industry has collapsed.

b. Globalization caused the death of Detroit.

c. Japanese imports nearly destroyed the auto industry in the early 1980s…

d. … until auto protectionism saved it.

8. “Tariffs cause high inflation”. Under most plausible Fed policy responses, tariffs cause a modest one-time rise in the price level. Tariffs are indeed “bad, bad, bad” but not because they cause inflation. The biggest problem is that they tend to reverse globalization, one of the best things that ever happened.

9. “Tariffs help the working class.” Only a small percentage of the working class is in manual jobs in manufacturing, and even many factory workers will be hurt as tariffs reduce exports and increase the cost of imported intermediate goods. The vast majority of working-class Americans will suffer from lower living standards. I spend only a very small share of my income on goods impacted by tariffs and thus won’t suffer any significant harm. But I’m not working class.

10. “Tariffs will reduce the trade deficit.” This one might be true, but I doubt it. The first Trump administration failed to reduce the trade deficit. If it does happen, it will likely be due to an entirely different factor. Thus, if Trump succeeds in deporting millions of workers, that might modestly reduce the trade deficit. If Trump‘s policies lead to much slower GDP growth, then that might reduce the trade deficit. Neither of those happened during the first Trump term.

11. “Trump is winning major concessions from other countries, such as promises to boost investment in the US, or buy US commodities.” I’m very skeptical here. Recall the accounting identity that the US current account deficit is equal to our capital account surplus. If we actually were to get more foreign investment, then our trade deficit would get even “worse”. I’d be fine with that outcome, but how about the Trump administration? In any case, those investment commitments are empty promises. As for the promise to purchase US commodities, the effect is mostly to make the global economy slightly less efficient, by increasing transportation costs. Commodities are fungible and the global price doesn’t change unless countries promise to consume more commodities.

12. “The cost of tariffs won’t be passed on to consumers.” In any other context, people would laugh at this argument. Imagine a 15 cent rise in the gasoline tax. Try telling consumers they won’t have to pay it. Imagine raising the sales tax from 6% to 8%. Or the cigarette tax. Right now, major companies have Trump breathing down their necks. Thus, they are quietly doing things like reducing auto price discounts and raising financing costs, rather than increasing the sticker price. That will come later.

13. “Tariffs can solve our fiscal problems.” Sorry, the deficit problem is much too large to be addressed by tariffs (although they will certainly have some effect. I see Republicans arguing that the deficit won’t be as bad as advertised, as the CBO is using a bad model. They also said this in 2017 and were wrong at that time. One problem is that the CBO is forced by law to accept all sorts of Congressional accounting gimmicks at face value. Promises that tax cuts will expire after a few years, or that spending on popular programs will be reduced—but not now. Have we accounted for the impact of the next recession? The next international crisis? the next pandemic? A Taiwan invasion? The fact that the IRS will be gutted and tax evasion will rise? That Trump will pardon tax evaders? The way that stablecoins will facilitate tax evasion? Or is the CBO pricing in perfection?

14. “The Trump tariffs are legal.” Even a Trump appointed judge has ruled they are illegal. I do expect the Supreme Court to eventually uphold the tariffs, for the same reason the Supreme Court upheld FDR’s decision to revoke the gold clause in contracts—fear of the fiscal consequences of upholding the law. The Supreme Court is perhaps slightly less afraid of Trump than the Speaker of the House, but on important issues I expect that they’ll do as they are told.

    In recent years, the Supreme Court has been obsessed with the separation of power between Congress and the President. But this Supreme Court is likely to be more motivated by fear than principle when it comes to going up against Trump.

15. “The Swiss trade surplus is a problem”. I assume you guys already know that bilateral trade balances are completely meaningless, but the 39% tariffs recently imposed on Switzerland suggest that the administration has yet to get the message. (I suspect the administration will eventually back off on the 39% figure, and Swiss investors seem to agree.) Here’s Bloomberg:

The country is the world’s biggest gold-refining hub, thanks to a longstanding reputation for quality and discretion. Billions of dollars worth of gold is constantly flowing into and out of the nation, from mines in South America and Africa to banks in London and New York.

Flows of the precious metal cause big swings in the country’s trade balances, even if the Swiss refiners capture only a small portion of the value of the commerce. . . .

Record bullion exports of more than $36 billion made up more than two-thirds of Switzerland’s trade surplus with the US in the first quarter, according to Swiss customs data.

Photo by Zlaťáky.cz on Unsplash

Is Trump “winning”? I think it depends on what you mean by winning. Trump is certainly getting many of the deals that he wishes to get. But as Lars Christensen recently pointed out, the Europeans were wise to refrain from shooting themselves in the foot in response to Trump’s self-destructive policies. In other respects, Trump is not winning:

a. Popularity (his poll numbers are down.)

b. Respect (even his supporters fear him more than they respect him.)

c. His actual economic policy goals (His actions won’t do what he thinks they will do.)

d. A cherished place in the history books. (In the end, it’s hard to imagine him not being viewed as one of the worst presidents ever.)

I recall Democrats being very optimistic during Biden’s first year—even calling him the most consequential president since Lyndon Johnson. This blogger never drank the Biden koolaid, and I’m not drinking the Trump koolaid either.

So why this strange new respect for Trump in the media? I see a mix of factors. Most people in the media are left of center and look favorably on an activist government. Many have insufficient appreciation for the benefits of a free market. It’s not that they favor Trump’s tariffs, rather they have too little appreciation of their downside.

PS. On not beating a dead horse. Nearly a decade ago I started doing posts on how the US was becoming a banana republic. Commenters laughed at my “TDS”. Now it’s become conventional wisdom, even among conservative pundits. If you are curious, this post from 2020 described the characteristics of banana republicanism, for those who don’t know:

1. Actual fake news in the media, and false accusations of fake news by politicians. Weird conspiracy theories.

2. The cult of the “man on horseback”, who rides into the capital to rid it of corruption.

3. Highly corrupt governments, especially governments elected on anti-corruption platforms.

4. Packing the Supreme Court with loyalists.

5. Attempts to end term limits for the current president, or to replace the president with his spouse to evade term limits. (Not having term limits at all is not evidence of being a banana republic.)

6. Corrupt police and violent vigilantes.

7. A strong president and subservient Congress.

8. No trust in election fairness. (This is perhaps the most distinctive characteristic of BRism)

9. Presidents blame foreigners for domestic economic problems.

10. Frequent impeachment attempts.

11. Opponents are demonized, electorate is highly polarized.

12. Schools teach propaganda.

13. President’s family members become important policymakers.

14. Governments spend money like there’s no tomorrow. The national debt soars. High inflation.

15. New governments routinely prosecute members of the previous administration.

16. Unwritten rules and norms of civic culture erode away; politics becomes the law of the jungle.

17. Presidents demand loyalty from other government officials, including law enforcement.

18. Statist economic policies that favor cronies of the president.

19. Voters focus on personalities, not policies.

20. The government manipulates economic data to look good.

Note the final item. Trump’s decision to fire the head of the BLS is sort of the cherry on top. Right? Ironically, Friday’s jobs figures were actually quite supportive of Trump’s policies. Unemployment remains low, and labor force growth is slowing as many workers are deported. Trump got what he wanted, and yet he doesn’t even realize it. In my view, that’s an even bigger story than the banana republicanization of the BLS.

I’m not going to respond to every Trump outrage, as they are now coming multiple times a day. Rather I’ll assume my readers are smart enough to understand what’s happening to the US. And if not, perhaps this blog’s not for you.

PPS. The list cited above was from a September 2020 post. I understand that it is now official GOP dogma that Biden was president at the time of both the 2020 lockdowns and the huge 2020 crime surge, but . . . well, I think you guys know better.