The Wrong Trade Strategy…

At the center of Trump’s trade policy is a seemingly legitimate concern: the US economy has long been marked by “twin deficits”: large and persistent imbalances in the federal budget and current account (the trade balance). At the heart of these deficits is an “excess” of consumption over production: Americans spend more than they make domestically (put differently: the national savings rate is low); that “excess” spending is therefore by definition spending on imports; those imports are financed from abroad in the form of government debt (and corresponding budget deficits) and capital inflows. These inflows, in turn, reflect the high savings rates in other countries, including and especially those to which much of US capital goods production has relocated over the last decades.

In crude terms, then, it is this imbalance between savings and investment reflected in an imbalance of domestic aggregate demand and supply that leads to a corresponding imbalance between imports and exports. This should hint at the main flaw in the current trade strategy: what principally determines the trade balance is not the sum of bilateral balances but the savings and investment decisions that US households are compelled to make given the highly unequal distribution of savings throughout the economy.

Put differently: domestic distortions are to blame, not the trade policies of other countries. Those policies — such as import barriers, export subsidies, or foreign exchange management — only determine how the US trade deficit is distributed among its trading partners. It is therefore not surprising that while the US deficit with China has somewhat decreased in recent years, the overall US trade deficit hasn’t.

…Based on the Wrong Theory of Change…

How, then, are tariffs intended to address the overall trade deficit, the supposed culprit of US economic decline? In effect, this is done by transferring income from one sector of the economy to another, specifically from households to the producers of tradable goods. By increasing the cost of spending on imports (for both consumption and investment), tariffs effectively tax the former and subsidize the latter, raising prices and profits respectively.

In response to relative price changes, households are expected to reduce their “excess” spending and “net save.” For the trade balance to actually shift in the United States’ favor, however, domestic production would have to rise faster than domestic consumption is slowing. In this scenario, American households could end up consuming more even while, given the rise in production, their overall share of consumption decreases.

Though superficially plausible, this scenario is unlikely in the extreme.

Firstly, it is implausible that tariffs would act as an effective subsidy of production. For one, the cost of imports would also rise for those who are expected to produce and export more. What’s more, market power in the United States is heavily concentrated, so any tariff-induced windfall profits would only accrue to the few households that are also producers. Above all, there is no ex ante reason to believe that higher profits would lead to more production.

Secondly, it is also not likely that households will adjust their “excessive” consumption in response to higher prices. Even if the inflation induced by tariffs stifles aggregate demand by way of consumer spending, the stimulus of large tax cuts as well as the large budget deficits, which Trump seeks to continue, would more than make up for any consumption-driven rebalancing of domestic demand and output.

Thirdly, foreign exchange effects would likely worsen the trade deficit. The inflationary impact of tax cuts, in tandem with tariffs and continued budget deficits, are also set to strengthen the dollar, by attracting further foreign capital flows into dollar assets and prompting the Federal Reserve to increase interest rates to dampen aggregate demand. A stronger dollar would not only make foreign goods cheaper (thus drawing in more imports) but also render US goods more expensive and less competitive. The tax on imports would thereby also act as a tax on exports, further worsening the trade balance.

Lastly, empirical evidence lends credence to the classical model of tariffs being inflationary and thus acting as a regressive tax consumption, one in which the incidence falls squarely on the weakest households. A recent detailed study indicates that the hit to consumer expenditure under the baseline tariff scenario would disproportionately hit the lower-income group, with the three lowest quintiles (fifths of the distribution) being rendered significantly worse off. This is despite the effects of the Tax Cuts and Jobs Act (TCJA) and its extension, given how the gains from those cuts disproportionately favor the higher-income brackets, which are largely insulated from the effects of tariffs due to having to spend much smaller shares of their total income. This doesn’t even account for the other regressive elements of Trump’s economic program, such as repealing the Affordable Care Act (ACA).

…Based on a Wrong Theory of Crisis

Tariffs will not and cannot redress America’s trade imbalance. But is trade even the cause of American decline? Not really. Attempts to arrest global economic integration by curtailing trade flows are as futile socio-economically as they are hazardous geopolitically, because they misidentify the primary causes of the problems they purport to address. In part, then, they reflect a form of denial, widespread among US elites, about the aberrant nature of American political economy.

The reality is that most advanced open economies are as, if not more, exposed to the dynamics of global trade as the United States is — and not a small number of them are both wealthier and more politically stable while boasting higher levels of human development and lower levels of inequality. This is a function of their ability to more equally distribute both the burdens and benefits of successive trade shocks, largely on the back of welfare and labor market institutions not fully hollowed out during the “liberalizing” reforms of the last decades.

The United States simply lacks the institutions and the politics that would have allowed it to maintain those levels of “predistribution and redistribution” during the period of industrial decline and immiseration that started in the 1970s, inaugurated by the decision to dismantle a postwar economic system that had stopped serving US interests. This trend was accelerated in 1980s and ’90s, when much of the welfare system as it existed was undone, resulting in the nickel-and-dime mass precarity that characterizes much of the country’s vast service sector.

Tariffs as a Spoils System

While tariffs do reflect a denial about the character of the American political economy, they are also a logical expression of it. One conspicuous feature of the US economy is the outsize market power of rapaciously extractive professional class intermediaries in key sectors like health care, law, finance, and education. Relative to those in their peer countries, their rents are much larger and more secure. In this context, it is easy to think about tariffs not just as a geopolitical bargaining chip, much less as a panacea for industrial revival, but as a generator of new rents for domestic political allies.

Such a system of spoils already exists in the form of military-industrial spending. But unlike defense procurement, “tariffs by executive order” is an approach not subject to messy congressional politics. By creating a new arena of elite-oligarchic contestation and political corruption, they vest the power to discipline and reward powerful domestic and international actors (specifically by granting tariff exemptions) firmly in the office of the president.

In addition to increasing the burden for the weakest households, trade barriers risk emboldening already extractive sectors of American capital, while further centralizing power in the hands of an executive run for and staffed by plutocrats.

It is clear that this largely bipartisan trade strategy, far from addressing the fundamental or even proximate causes of economic and political dysfunction, in fact seems designed to aggravate them. The United States could be a society of mass affluence. But in the absence of a mass political movement in favor of redistribution of inclusive growth, the trend toward ever more zero-sum, extractive economic relations is set to continue unabated — until it won’t. To paraphrase the economist Herbert Stein: that which is unsustainable will not be sustained.