thinking liberal

Trying to write a considered commentary on events in America is a hazardous business. Things will change even as you write. In the middle of preparing this article President Donald Trump executed a screeching handbrake turn on his tariff policy, having paused the higher tariffs for 90 days. This leaves it as a universal 10% tariff, with massive mutual tariffs remaining with China. Stock and bond prices bounced back sharply with a huge sigh of relief. The political pressure on Mr Trump evaporated. But the dust hasn’t settled, and on any other day the remaining tariffs would have constituted a major escalation; bond market troubles may well be more deeply sourced; questions remain over the direction of tariffs in future. Disaster still beckons.

The economist Paul Krugman, whose Substack I recommend, warns against the “sanewashing” of Mr Trump’s policies – the projection of a rational strategy when none is there. This will lead to disappointment. There is not a coherent strategy behind his tariff policy – it has conflicting goals, for a start – but it flows from strongly-held beliefs, and some of his advisers have a more coherent take on it. The most important of these is Peter Navarro, who wrote an article for the Financial Times recently; I would recommend reading it if you want an insight into the administration’s outlook.

Mr Navarro presents a long list of grievances: of unfair trading practices from America’s trading partners, which are leading to a hollowing out of the United States, and a system that is tilted against it. That has led to a substantial overall deficit, and huge individual deficits with many countries. Europe bans America’s chlorinated chicken; China manipulates its currency; Vietnam acts as a conduit for Chines goods; and so on. The “reciprocal tariffs” – now in suspended animation – are a quantification of these trade barriers; he does not explain that they are simply half the ratio of trade deficits to imports, subject to a minimum of 10%. This picks up on two ideas explained in my previous post. First is the “victim narrative” of trade deficits: domestic production has been suppressed by unfair competition, meaning that it cannot fulfil domestic demand, which is in turn sustained by capital transfers from abroad. These transfers are being used to buy up American assets, ceding control to overseas interests. The second idea he picks up on is that fair trade implies that there should be no deficit at at all between countries; any imbalance is therefore evidence of trade distortion – and so as the proposed tariff is proportional to the deficit – the fewer the distortions the lower the tariff. Lost in that is the fact that 10% is still a high tariff by current international standards, and that it applies even to countries with whom America is in surplus. Mr Navarro shows that there is enough evidence for his narrative out there if you really want to believe it. I don’t know enough about the man to understand why this is – just that he has held these views for a long time. Other narratives and supporting evidence is available. After all, if America is being ripped off, why does it have the most successful economy in the world?

Mr Trump’s thinking is broadly consistent with this, though without its intellectual gymnastics. His view is more akin the idea of Mercantilism. This idea was developed by the 17th-Century French statesman Jean-Baptiste Colbert, who was first minister to Louis XIV. Colbert was a brilliant administrator, and his ideas set the tone for European statecraft for a century. He suggested that trade was about maximising exports and minimising imports so that the country would accumulate wealth, which at the time could be equated to “treasure”, the banking system being pretty crude. This was the set of ideas that were unpicked by Adam Smith and David Riccardo more than a century later. The French economy at the time consisted of a state dominated by a substantial war machine (there was barely a year when Louis was not at war) financed by excise duties and taxes on the poor. An export surplus would have implied suppressed consumption by the aristocracy (the poor had nothing left to give), which I suppose was not really a hardship. So far as Mr Trump is concerned, exports imply money coming in; imports represent money going out – so surpluses are power, while deficits mean you are being ripped off. His business philosophy is very much that if you not ripping somebody else off, you are being ripped off yourself; the idea of mutual benefit does not compute.

But Mr Trump’s love of tariffs goes further than countering perceived trade distortions. He also wants an extra source of tax revenue that he can tell his supporters that foreigners are paying rather than them. In his wilder moments he dreams of this replacing income tax. After all, income tax was brought in at first, both in America and in Britain, to compensate for the loss of tariff revenue from free trade. Of course to generate substantial revenue then the US must continue to import lots of goods. His supporters suggest this might come about through the strengthening of the US dollar, as happened to some extent in his first term, to offset the cost of the tariff. The tension between this and reducing deficits and protecting US industry is obvious.

Another aspect of tariffs for Mr Trump is that he hopes it will turn the clock back to a time when America had a lot of manufacturing jobs. Many Americans have fond memories of when many working class people had reasonably well-paid and stable (and unionised…) jobs in manufacturing. According to the MAGA mythology these were the jobs destroyed by unfair foreign competition, so rebalancing means that they jobs can come back. 

And yet another reason to like tariffs is that it allows Mr Trump to throw his weight around on the global stage and make deals. He gets high on what he sees as grovelling by foreign governments to reduce tariffs by dismantling trade barriers; he makes sure that his fellow Americans see their humiliation. Many of Mr Trump’s cheerleaders from the business world thought that this was the main point of his tariff talk, and that they were just a negotiating tactic. Just like Russia’s military buildup on the Ukrainian border in early 2022 was supposed to be something called “power diplomacy”. But the Liberation Day system is so comprehensive that it appears negotiation will be just around the edges. Anyway you can’t do 70 highly personalised bilateral deals at once. It is now unclear what future negotiations will be about. Will some countries be allowed to escape the 10% lower limit? Is it about modifying the suspended “reciprocal” scheme? Or will the focus be on the special regimes for cars and steel – as the British government appears to believe. Nobody, including Mr Trump, knows.

But problems are coming in multitudes. The first is that, whatever Mr Trumps says, tariffs are a tax on American consumers. Americans cannot avoid buying imported goods (often as components of more complicated things like cars), and prices will rise across a wide range of goods. America is less dependant on trade than many economies, but even so they will have a significant impact. There will be a temporary bump to inflation. The Federal Reserve might be induced to raise interest rates. I think that risk is overdone; it is a temporary adjustment, and unless a wage-price spiral is threatened, there is no longer term threat. Weakness in the wider economy reduces that risk. The main problem is political: Mr Trump suggested that he would cut prices rather than raise them. The MAGA faithful will accept that this is a short-term adjustment and that better times are around the corner; many other Trump voters will feel let down, or even betrayed.

Next the economy will weaken, perhaps to the point of recession. The problem here is less the extremity of this particular policy (which has been softened after all), but the perception of instability across the whole of American public policy, which has become dependent on one mercurial individual with little grasp on reality. Mr Trump talks of vast amounts of inward investment, as firms promise factories in America to avoid the tariffs. But long term investments require a stable economic outlook; companies will delay doing much until things settle down – which could take some time. Exports are likely to suffer too, from retaliatory action by foreign governments (and especially China) and from a loss of confidence in America generally. Foreign visitors, especially students, are alarmed by the arbitrary application of policy that can see visas revoked on a whim, and detention at the border. This might help reduce the current account deficit – but through making Americans poorer. 

The questions really start to arise when trying to picture the American economy the Trump administration is trying to create. He wants to shield US businesses from competition. That means that inefficient businesses are given a lifeline, and more efficient businesses don’t need to try as hard. That is not a recipe for economic dynamism – and thus has been the experience of most highly protected economies in history. A partial exception has been Asian economies that have used protectionism as part of an industrial strategy to allow the build-up of new industries. There is no such strategy in America. To be fair, America is a naturally competitive economy, and large enough not to need foreign trade as much as others to keep it so. But still, high tariffs will make America less efficient and wealthy, not more. 

And it is hard to see those old industrial jobs returning. Technology, more than foreign trade, was responsible for their demise, and there has been a Baumol shift towards services, as Americans see to bank productivity gains in manufacturing by consuming more services. A more rational expectation is that America becomes a powerhouse of modern manufacturing business, in highly automated businesses, which export much of their output. But that entails a level of investment that will not happen in the current chaotic policy environment – and tariff barriers are not a particularly good way to achieve it. President Joe Biden’s use of subsidies was a more realistic idea.

But am I overdoing it? Will it be a matter of disappointment rather than disaster? Well, maybe. But that will entail the Trump regime rowing back on its revolutionary mission. Anything is possible in Trump World.

First published on Substack 12 April 2025

It is hard to overstate the significance of President Donald Trump’s Liberation Day US tariff plan, announced last week. It is a rewriting of the world order – and America’s place in it. It’s going to take more than one article from me to explore its significance. This time I want to look at the general context – as this is essential to understanding how things might develop from here – and it is very widely misunderstood by even expert commentators. The president’s action looks like one of the most colossal acts of self-harm in history – but the impact on the rest of the world may not be as bad as many suggest.

Any discussion of the economics of trade must start with the idea of comparative advantage – first articulated by David Riccardo 200 years ago. It is one of the most powerful economic ideas out there, and it is also one of the most neglected. I don’t want to go back to Economics 101 here. Suffice to say that the theory shows that trade is driven by opportunity costs and not productivity. There is a limit to how much each country can produce – and if each one specialises where it is relatively the most efficient (but not necessarily in absolute terms) then production across the world is maximised and everybody should benefit. Differences in actual productivity are taken care of by exchange rate differentials. It is why equilibrium exchange rates do not conform to purchasing power parity. “Comparative Advantage” may sound rather like “Competitive Advantage”, and we may often make an analogy between a country and a firm (“UK plc”) – but they are very different things. In economics firms compete but countries do not – they optimise. Tariffs, meanwhile, distort pricing signals and lead countries to sub-optimise.

This theory does a wonderful job of explaining the world we see today – why there is so much trade, and why and how exchange rates differ from purchasing power parity (i.e. currencies buy different amounts of goods and services in different countries). What it doesn’t do is help with the sort of fine-grained predictions needed for economic models. That requires a very detailed understanding of economies and what the opportunity costs are – way beyond the capabilities of current economic data and analysis. Attempts to model it at an intermediate level, by looking at broad factors of production (land, human capital, etc.), have failed. In modern economics, if you can’t put it into a model, it’s no use at all. So while most economists have a general idea about comparative advantage, it’s a distant memory from their undergraduate days. They haven’t thought about it very much. Politicians and political commentators pick up on the general idea but garble it – falling into a fallacy of composition (assuming that the production side of an economy is analogous to a firm) and muddling competitive and comparative advantage.

Two insights get lost in all this. The first is that the theory has nothing to say about trade deficits and surpluses. In the standard exposition, exchange rates should adjust so there are no deficits or surpluses – though whether this applies country to country, or to countries across all their trading relationships is an interesting question that I’m unable to answer. I will come back to that. The second is that the benefits of trade are driven by difference – and that the more similar economies become the fewer gains from trade there will be. Let’s take a closer look at that in the context of the US and China.

In 1990, when trade between the two countries started to open up, the US was one of the world’s most advanced economies and China one of the least developed, after the failure of Maoist Communism. Most of China’s workforce was tied up in massively unproductive agriculture. Only a tiny proportion of America’s was in its hyperproductive productive agriculture. America had a massive comparative advantage in agriculture; China therefore had a comparative advantage in pretty much everything else that was tradable, apart from technologically advanced goods that were beyond its capability. To put this another way, China’s hideously unproductive agriculture sector meant that Chinese wages were tiny compared to America’s, which meant that even very inefficient manufacturing businesses were highly competitive. And so they had the basis of massively beneficial gains from trade. America exported agricultural products and advanced goods, while importing cheap manufactured goods. Both countries benefited from cheaper inputs. 

So far, so good. But the situation was dynamic. Rural workers in China responded to the demand for extra manufacturing jobs; rural productivity improved. Chinese manufacturing invested; infrastructure was improved; productivity and wages rose. America and China converged. It follows that the gains from trade diminished. This has mostly been at America’s expense. Chinese goods became more expensive relative to domestically produced ones. Meanwhile, because productivity was advancing rapidly, in China the lost gains from trade were compensated for by gains from productivity. This has been replicated on a global scale as the dynamic between developed and less-developed countries. There were massive gains from trade in the early days, and a convergence between the two sides that has seen the biggest ever eradication of extreme poverty. But the gains from trade are now much less. This is one of the reasons that living standards in the developed world have struggled since the mid-2000s; access to ultra-cheap goods from the less developed world has drastically diminished. This development is almost unacknowledged by economists; the late great Paul Samuelson has been to the only one that I have seen to point this dynamic out – largely before it happened. Instead people are bewailing the loss of a system of global trade that delivered so much benefit in the past.

The world has progressed in another way. Manufacturing productivity has advanced steadily, mainly through automation, but also through better process management. This has tilted the balance of developed economies towards services that are largely untradable. This means that the impact of trade on developed economies is steadily diminishing. 

This doesn’t mean that gains from trade have disappeared. Surely it still makes sense for Apple to make its iPhones in intermediate economies? But it does mean that strategic considerations are weighing more heavily than commercial ones. In particular both America and China are worrying about what would happen if war broke out between them – an increasing risk given China’s ambitions to absorb Taiwan. It also doesn’t mean that the reordering of manufacturing supply lines that the Trump administration seeks won’t be painful and disruptive for both America and its trading partners – especially those in East Asia. But it does mean that ultimately it will almost certainly be worse for America than anywhere else. I want to talk about the impact on America in more detail in my next post. 

But what about trade deficits and surpluses? A current account deficit represents an excess of demand (consumption plus investment) over supply; a trade deficit has a slightly narrower definition – it applies to goods – but it is much the same thing. If demand can’t be met by local supply, you need to imports to make up. This, however, tells you nothing about what caused it. The victim narrative suggests that the surplus of demand arises because domestic supply is being driven out of business by competition from abroad. The economy then runs up debt (or sells its assets to foreigners) in order to maintain demand, which has to be supported by imports, and it all ends in ruin. An alternative, boomtime narrative is that consumers are on a demand binge which domestic supply cannot meet. Foreigners are happy to finance this because this booming economy provides opportunities to make returns. Trump supporters are scarred by the sight of business closures with the excuse of foreign completion being given, or outsourcing to cheaper suppliers abroad, and point to victim narrative. Trump critics point to low US unemployment and a healthy economy, and say that there is no obvious case that the supply side is being suppressed – and so lean to the boomtime narrative.

But there is a further dynamic. Some countries, including Germany and China, enjoy trade and current account surpluses as a matter of policy. They achieve this by, one way or another, suppressing demand so that the supply side can generate a surplus to export. This might be by underpaying their workers and letting businesses accumulate profits; it can be through governments over-taxing and leaving an unspent government surplus; or it can be through a conservative public forever saving for a rainy day. Why do governments let this happen? A surplus means that the country does not require foreign finance, and that generally makes the national finances easier to manage; for dictatorships, like China, that can be especially important. If some countries run a surplus, then others must run a counterpart deficit. This pattern can help fuel the victim narrative of deficits. The alternative view is that surplus countries are selling themselves short – they could charge more for their exports and/or allow their citizens to consume more – and that deficit countries are beneficiaries of this generosity – and should be sending the surplus countries thank you notes. Which narrative (and others are available) better fits the facts depends on the circumstances. One the one hand you might have a colony being exploited by its ruling power; on the other you could have an industrial powerhouse using foreign capital to build up its infrastructure and industrial base. You need to get beyond the raw statistics to work out what is going on.

There is an argument that all trade should be in balance, and persistent surpluses and deficits show distortions from “fair” trade. This comes up quite a bit for people trying to “sanewash” Mr Trump’s actions. He himself seems to have a much cruder understanding: a surplus means you are getting one over on the other side and building up wealth; a deficit means you are being ripped off and seeing your wealth disappear into foreign pockets. The idea that surpluses and deficits may simply be a reflection of supply and demand being out of kilter runs counter to this.

What role do exchange rates play in all this? Exchange rates should adjust to an equilibrium that allows trade and capital flows between countries to balance – letting the market decide. Countries can try to lean on the market by buying or selling reserves – but this only really works to manage short-term blips where governments think the markets are temporarily distorted. Monetary policy, fiscal policy and capital controls all affect the exchange rate, and can be used to fix exchange rates – but ultimately because these policies work because they affect supply and demand, and the capital flows required to finance them. You can get too hung up on asking what a “fair” exchange rate is. 

What is the impact of the Trump tariffs on the world economy? In the short term there will be a lot of disruption, and we have only seen the start of it. There are two pressure points that will need close attention. The first is less developed economies that have been slammed with high tariffs: notably Vietnam, Thailand and Bangladesh. These do not have the resilience (or negotiating power) of bigger economies, such as China, Japan or South Korea. They may be able to divert to other markets, but long term damage looks likely. The second is in the financial system; this has been delivered a series of shocks by the Trump administration, of which Liberation Day is merely the biggest. A lot of bets made by intermediaries have gone sour and these could have ripple effects that start to endanger bigger institutions – this is what happened to Liz Truss’s government in the UK in 2023, causing its demise. A danger sign is that the price of safe haven assets, such as US Treasuries, has been sinking alongside riskier ones. An added risk is if China starts to dump its some of its substantial holdings of US Treasuries – which it might need to do to counter the disruption of trade. A new financial crisis might develop.

But this crisis is not the end of globalisation: it simply marks exit, or intended exit, of the US as a global trading power. The rest of the world can carry on trading more or less freely with itself – and that seems to be what they want to do. And in some respects America will continue as a global commercial power: Google, Meta, Apple, Microsoft and even Amazon will be disrupted but there is no fundamental threat to their business models. The globalisation of information will go on. The big question is who, if anybody, will take up America’s leadership role? China could curb its own tendency to bully; the European Union could have its moment. 

In due course, however, I expect the Trump tariff regime will collapse, and America will come back into the world system as a diminished player. But that’s another story.

First published on Substack on 9 April 2025