The Trump administration’s decision to impose additional tariffs on imports into the US is bad economics, motivated at least in part by bad politics.
TTo recap, the new “reciprocal tariffs” will be set according to the 2024 figures for US trade in goods – completely ignoring trade in services. They are based on a formula where an implausibly low estimate for the pass-through of tariffs to import prices is conveniently offset by a relatively high estimate for the price elasticity of import demand. Bear with me while I try to explain how they will work…
For example, the US ran a deficit in goods with the EU of $236 billion last year, driven by EU exports of goods to the US worth $606 billion. $236 billion is about 39% of $606 billion. (Confused already? You should be…)
This 39% figure is then halved (seemingly just to soften the blow) to give a ‘discounted reciprocal tariff rate’ for the EU of 20%.
Where the US data show that the US ran a surplus in goods with a country or bloc in 2024, a baseline tariff of 10% will be applied instead.
This way of calculating the appropriate level of tariffs is weird enough, but the underlying logic is even stranger.
According to the Office of the U.S. Trade Representative (USTR), these new tariffs are based on the assumption “that persistent trade deficits are due to a combination of tariff and non-tariff factors that prevent trade from balancing.”
The USTR then goes on to say “while individually computing the trade deficit effects of tens of thousands of tariff, regulatory, tax and other policies in each country is complex, if not impossible, their combined effects can be proxied by computing the tariff level consistent with driving bilateral trade deficits to zero.”
In other words, in the absence of ‘currency manipulation’ and other artificial trade barriers, the trade in goods between two countries should always balance.
This is just nonsense. Large and persistent bilateral deficits in goods can simply result from the normal economic drivers of international trade, where each country specialises in whatever they do best. And services, apparently, don’t count.
There is a another irony here too. The US itself runs trade surpluses in goods with a number of countries, including Australia, Hong Kong, the Netherlands and UK, as well as many in South and Central America. On Trump’s logic, is this not also evidence that the US is engaging in ‘unfair trade practices’ too?
Even at the aggregate level, a persistent current account deficit may just reflect the fact that a country is consistently spending above its means (in the case of the US, because the government keeps running such large fiscal deficits).
Moreover, the benefits from trade come at least as much from imports as from exports. The import of goods and services increases choice and competition, drives down prices, and can help to boost productivity.
But in Trumpland, trade is never a win-win, and deficits are inherently bad.
Of course, a lot of this is just bad politics. In particular, Trump has been able to pitch tariffs as a means to ‘bring jobs home’. In fact, both economic theory and ample experience (including from President Trump’s first term) show that any jobs gained in protected sectors (such as steel) are more than offset by losses in others (such as the rest of manufacturing as the supply of steel falls and prices rise).
The decision to exempt Russia from the new tariffs also highlights the political nature of the process. This exclusion has been justified on the grounds that the US now does little trade with Russia, largely due to sanctions. But the US still imported goods from Russia worth $3.0 billion in 2024, with a goods trade deficit with Russia of $2.5 billion.
In contrast, the US has made the effort to impose differentiated tariffs on many tiny countries and territories that do hardly any trade with the US at all – such as Sint Maarten, and the Falkland Islands.
There are a few crumbs of comfort. One is simply that the new system is so complicated that it may not last long (especially given the harm also being done to the US economy). In practice, it will be hard to apply so many different rates for imports from different countries. Even with significant extra bureaucracy to enforce ‘rules of origin’, there will be massive scope for avoidance and evasion.
The UK has at least also qualified for the lowest 10% rate by virtue of the small surplus ($11.9 billion) in the US figures for 2024. If the UK were still in the EU the UK would have been hit by the full 20%, so this is a clear Brexit benefit. Nonetheless, as it stands the UK will still be subject to the separate sector-specific tariffs, notably the 25% on cars.
One final consolation is the reaction in bond markets, which could have gone either way. In the event, the cost of UK government borrowing has actually fallen slightly. However, this is only because the new tariffs are expected to reduce economic growth, both in the US and elsewhere. This in turn is boosting safe-haven demand for bonds, as well as making it more likely that the Bank of England will keep cutting interest rates.
In short, this is all a dog’s breakfast, and the lack of any economic rationale makes it even harder for anyone to predict what will happen next. But in the meantime, the UK should continue to resist the siren calls to retaliate by imposing additional tariffs on the US. This would add to the cost of living for UK consumers (as well as costs for UK businesses), and potentially wind up Trump further.
Plain-speaking Economics 