Tariffs: An Economist's POV

Tariffs are making all the headlines of late. Opinions tend to be informed by feelings towards the current administration, but having spent some time around academic economists (and being trained as one), I feel obliged to give the academic case. Spoiler: economists don’t like tariffs. Economists tend not to like taxes in general; they distort incentives. If you only take home 50% of your paycheck, there’s less incentive to show up at work, and more incentive to hit the beach. But tariffs are particularly disliked as their distortions, in theory, come at a higher cost.

A Toy Example

Since economists like numbers and models, let’s start with a simple example. Suppose the country of Aeland can make 6 widgets an hour or 12 gadgets an hour, and the country of Beland can make 12 widgets an hour or 6 gadgets an hour. Suppose people only want to work two hours (sounds good to me). Without trade, each country can only consume what they produce. For example, Aeland could then consume 6 widgets and 12 gadgets or 3 widgets and 18 gadgets. But what if they trade? Aeland makes 24 gadgets, Beland makes 24 widgets, and they can reach outcomes they could never reach on their own: 12 gadgets and 12 widgets each, for example. Everybody wins!

But what if the world isn’t fair? What if Aeland can only make 2 widgets and 4 gadgets an hour? Beland is better at everything! Well… Aeland could still specialize in gadgets. Beland can make them too, but maybe they make fewer. With trade, both countries could produce enough for Aeland to consume 4 widgets and 5 gadgets, and Beland to consume 14 widgets and 6 gadgets - more than either could produce on their own. Everybody still wins!

A common stance in economics is to view trade as a technology. It allows you to trade a product you’re relatively good (cheap) at making for a product you’re not as good at (i.e., more expensive) at producing. So don’t bother grinding away at something you’re not good at. This is clearly a simplification, but the takeaway is that trade can allow everyone to be better off, even if one country is better at making everything than another.

Trade Deficits

But what about the real world? Trade deficits are a hot political topic. The discourse around them, when viewed from a distance, seems odd. Regardless of political stance, a trade deficit is usually viewed as a bad thing. The current administration frames a deficit as trade being unfair. And regardless of political stance, most people would agree that a deficit is undesirable. It’s a deficit after all, which Google (our new dictionary on the shelf… but at least it’s not Chat GPT) defines as “the amount by which something, especially a sum of money, is too small.” Too small. Not good.

What does a trade deficit mean? It means we’re consuming more than we’re producing. But hold on, that sounds pretty good to me. If someone told me I should work more to get less, I wouldn’t be too happy about it. So why the complaint about trade deficits? National security aside (if we import something we can’t survive without, then lose the ability to import, it could take a lot of time to get up to speed producing it domestically), there are two issues. Is a deficit sustainable? And what is the impact on jobs?

The Never-Ending Deficit

It’s easy to confuse different sorts of deficits. A federal budget deficit means that future generations are going to have to consume less. We’re getting more today (roads, medicare, really expensive airplanes) at the expense of what we (or our children) can get tomorrow. Since “trade deficit” also has the word “deficit”, it’s often viewed similarly. But that’s not the case. Net exports have been negative since 1980.

Even the budget hasn’t been that consistently bad! How is this possible? Are we paying interest on this deficit?

Trade is one reason why money crosses borders. When we import a shoe from Vietnam, we pay the producer for the shoe. But money crosses borders for other reasons, and the US has had a special advantage in this respect due to the dollar’s reserve currency status. Foreign entities like to hold dollars. Those dollars might live in an American bank. Money comes in. And then - and this is the good part - that bank lends the money for way more than they’re paying that poor foreign entity in interest. All those extra returns sloshing around is a big part of why we’ve been able to maintain a trade deficit for so long. Buy more, work less.

Jobs

There’s no denying trade impacts jobs. In this respect, economists tend to be a cold, hard-hearted bunch. If someone in Vietnam is willing to make shoes for $10 a pair, and someone in the US isn’t willing to make that same shoe for less than $50 a pair, the US shoemaker will be out of a job. More accurately, he’ll choose not to work for $10 a pair. This is, again, a situation in which we can view trade as technology. The shoemaker wants to make shoes at $50 a pair, just like the blacksmith wanted to shoe horses for $1 a pop in the 1930s. But the automobile made shooing horses a lot less profitable, just like imported shoes make domestic production a lot less profitable. Both the blacksmith and the shoemaker want to work at a price the market won’t support. However, the market requires supply and demand. I’d love to do less and get paid more. But that’s not something the market will support, so I’m stuck here writing this post. If an individual wants to work at a wage no one is willing to pay for that service, well, the cold-hearted economist shrugs. What’s hard is when the market used to support that wage. Change is hard, particularly when we’ve invested time and effort into something that is no longer valued as it used to be.

In the broader context, as soon as we get the state involved in deciding who gets to work for what wage, most economists start to twitch. Not only is that inefficient, but it usually involves coercion - in this case, forcing someone to pay something that they would rather not (and in the absence of intervention, wouldn’t have to). At the risk of bringing us back to the current political situation, we’ve heard that current trading patterns are unfair. I think that’s probably true. We here in America get to consume way more than we produce, while people in China work pretty hard for a whole lot less. Not fair, but also not an imbalance I’m in a huge hurry to correct.

In Summary

So here’s where we’ve been: Trade is non-zero, meaning we can get to outcomes where everybody wins. True, the US has been running a trade deficit for a long time. But this is largely financed by the dollar’s unique position as a reserve currency, allowing us to buy more and work less without breaking the bank. And finally, yes, trade impacts jobs. But so does technology, and using the state to decide who gets to work for what wage isn’t an idea economists are comfortable with.

Post by: Seth Leonard, PhD

All opinions expressed by System2 employees and their guests are solely their own and do not reflect the opinions of System2. This post is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of System2 may maintain positions in the securities discussed in this post.

matei zatreanuApril 4, 2025