Long ago, I helped bankers lending billions of dollars in Africa by teaching them a few equations related to trade deficits. Those equations are critical to understanding today's tariff controversies.
The way that these tariffs have been introduced has been chaotic and seemingly, ill-considered. However, the US is one of the few western countries without a VAT. It would be politically suicidal to suggest imposing a VAT and is never proposed by Republicans or Democrats. The Democrats talk about making the "rich pay their fair share," as if there is any way to close the current deficit with a tax on the rich and the Republicans have seemingly no solution. Isn't it possible that these tariffs are a round-about, subrosa way of imposing a quasi-VAT which would allow a reduction of marginal taxes on income (maybe a good thing) while generating some income to close the deficit?
One could hypothesize such a situation, but not with these tariffs, and not with present-day American law. I've noted before that one can justify some sort of tariffs, as long as you are imposing them to raise revenues and are not deluded into thinking that they will cause the economy to grow. It won't work as our VAT because:
-- VATs are low, predictable, and difficult to change. Congress handed Kennedy, Nixon, and Carter near-dictatorial power to unilaterally alter tariffs massively, repeatedly, and on whim. Trump is merely making use of Congress's long-ago surrenders of power.
-- That fact allows wildly varying tax rates on different nations and on different products within those nations.
-- So far as I can tell, there is no political mood to reduce marginal tax rates on income.
-- The impetus for these tariffs has a Schrodinger's Cat aspect to them. They're designed to raise revenues (which assumes that imports will continue); and they're simultaneously designed to discourage imports (which means no tariff revenues.)
Trump is currently proposing income tax cuts (extensions of his tax breaks) and specifically says he is going to use the tariff revenue to cut income taxes (yes, he can’t eliminate it, but a few hundred billion in tariff revenue a year still goes a long way).
I’d take a consumption tax on foreign goods over income taxes any day.
10% universal tariff (I will put China on the side for a minute) is like 1/10th what we spent on Covid (paying people to not work and order uber eats because of a flu). It’s tiny compared to the IRA and other Biden spending bills.
There are so many contradictions on tariff opponents.
It’s too small to cut taxes, but so large it will crash the world economy.
We capture 95% (or whatever) of the iPhone value prop, but somehow iPhones will cost $10,000 each if we tax the 5% a little more.
Only an idiot will do tariffs, but China is doing them to us and the eu is doing them to China. Why doesn’t the EU accept this windfall of being able to get cheap Chinese goods instead of calling Xi and asking him not to dump them on the eu?
Look, if the Chinese want to force their citizens to save too much and can’t find a way to invest domestically (they could try paying them to fuck and have kids so they don’t go extinct), and they are really fucking committed to that strategy, then I see no reason why we shouldn’t tax them (that’s what a tariff is) for the privilege of accessing our capital markets. Eventually they will settle on some amount that maximizes revenue.
I also don’t want to hear too much about spendings. At least Trump is proposing massive Medicaid cuts at huge political risk. What’s the alternative? The Dems will just spend and tax a bunch more, it’s what they do. The last four years have been a spending disaster.
We’ve got a ton of debt and stocks at historically high PE ratios. It ain’t going to be a fun ride and debating a few hundred billion consumption tax is deck chairs on the titanic stuff.
I do not recall any tax ever being cut as another tax came online. The problem is not too little income. The problem is too much outgo, and adding new income just encourages more outgo.
I also don't like the idea of only the rich paying income taxes. I want EVERYBODY to pay something and have some skin in the game. If only the rich pay for it, the hoi polloi will be screaming that the rich are gaming the system and not paying their fair share. Most people think we have a terribly regressive income tax. They are wrong. Read this: https://fakenous.substack.com/p/tax-breaks-for-the-rich
"The current system is like this: Five friends go out for dinner. Say they have some expenses that are common to the group (e.g., a shared appetizer) plus some items ordered by and for specific individuals. At the end of the meal, someone suggests that one of the friends, the one with the most money, should be forced to pay for everyone, even though he doesn't want to. In fact, he should be forced to pay extra in order to give kickbacks to three of the diners. This would not be accepted as a "fair division of the bill.""
And I despise tariffs for discouraging trade. People like to say consumption taxes are better than income or wealth taxes because income and wealth taxes discourage earning money and saving. Nuts to that. Every tax discourages something, and discouraging trade strikes me as one of the worst.
"Foreign manufacturers of ladies garments began adding a water-resistant lining to light coats; the lining reduced the tariff from 29.5 percent to 7.6 percent. Sen. Richard Shelby was outraged at this foreign conniving, declaring, "Essentially, these water resistant linings serve no practical purpose other than to qualify the garment for a 21.9 percent [tariff] reduction." Did Shelby spend his entire life in a desert where it never rained? Shelby proposed legislation to abolish the lower tariff rate for water-resistant garments, assuring everyone that his proposal "has the interests of all American garment manufacturers in mind.""
How many other taxes have that kind of bureaucratic corruption baked in?
Why do you get a say in who I trade with? How does my buying Chinese goods, crap or not, affect you? Why is it any of your business?
Not everything Chinese is crap. When I want cheap tools I expect to use only a few times a year, Harbor Freight is good enough — and cheap enough that if it breaks, I haven't lost much. If I want tools that I'm going to use often, I go to Home Depot any pay more.
Why is that choice any of your business? What gives you the moral superiority to force me to always waste my money on expensive tools?
Income taxes, sales tax, and property taxes don't do that. Sales taxes are regressive; income and property taxes are not. Who died and left you in charge of deciding that the poor should pay more for goods they can't afford?
Why do you get to take like half my income! Who are you to put in on who I trade my labor with!
"Sales taxes are regressive"
I'd say that *overall* taxes are massively progressive and I'm not a fan of that.
"Who died and left you in charge of deciding"
I was one of the people who voted for Trump and he and other elected officials are deciding. Maybe you wanted Harris instead. She wanted massively higher incomes taxes and even taxes on unrealized capital gains!
And lord knows the left would add a VAT if they could. Have fun paying like 4-5x as much in markup if we get a VAT rather then tariffs.
My iPhone comes from China. It's not crap. My iPad isn't crap. The rare-earth metals essential for so much of modern life isn't crap, but for now, we have no choice other than to buy it from China. The Chinese semiconductors we purchase aren't crap. Or our laptops. The notion that Chinese exports are crap is an atavistic delusion that this is 1952 and we're mostly buying little wooden toys and trinkets from China. I'm perfectly willing to entertain the notion that we should cease buying certain defense-related goods from China. But thinking their exports are "cheap China crap" is akin to thinking that Dwight Eisenhower is still president.
It's literally the same iPhone as last year and the year before that. You'll survive. I use mine until the battery wears out, then buy the cheapest one I can.
This is another one of those things where people talk out both sides of their mouth.
First I'm told that all of the value of an iPhone actually not in China at all. But I'm also told it will cost a million billion dollars per iPhone if we tariff a portion of the supply chain that everyone tells me isn't that important.
If the cost of assembling and testing an iPhone in China is really $20-$40 or whatever, then 100% tariff is going to make your iPhone $20-$40 more expensive. The Horror!
Most of the stuff in my house with Made in China on it is cheap plastic garbage that my wife's family sends the kids for every holiday or birthday that I have to throw out. They could just send me a check so I can save for their future, but no we need cheap plastic toys they don't even care for because they are cheap. It's our trade deficit in small form.
Trump can PROPOSE income tax cuts all he wants, but that requires Congressional action. He can implement tariffs today, whereas income tax reform will take years. A few hundred billion in tariffs would be small potatoes—and there’s no guarantee that you’d GET that income. You could just as easily drive a wedge between foreign and domestic markets so trade plunges, you don’t the tariff revenues, income taxes drop (because you’ve damaged economic output). Plus Congress would know that whatever they did on income taxes, this president or the next president could overturn the whole tariff regime between breakfast and lunch cause he feels like it. You say you’d prefer a consumption tax over an income tax; I would, too—though you’re likelier to get both.
A 10% tariff—and further uncertainty over whether that rate will suddenly change—can be enormously damaging to economic activity.
There is nothing whatsoever inconsistent about “It’s too small to cut taxes, but so large it will crash the world economy.” Hand businesses enough uncertainty that they go into a fetal position, and you will crash the economy, and you will not get revenues.
Xi is idiotic to do tariffs, and the EU is idiotic to respond with tariffs and we are idiotic to respond with tariffs. There are no laws of physics, economics, or biology that prevent multiple countries from being idiotic at the same time. Xi says, “We’ll use sledgehammers to break the hands of 80% of our people so they’ll stop buying American gloves,” and we respond with, “OH YEAH??? Then we’’ll use sledgehammers to break the feet of 80% of OUR people they’ll stop buying your shoes.” That is the logic of tariff wars.
Yes, Trump passing a budget this year will be an important part of his legacy and we will have to evaluate the results when they happen.
What he is proposing is good. What his opponent proposed and predecessor did was bad. That's all we know so far.
"can be enormously damaging to economic activity"
So can shutting down the entire economy and forcing everyone to stay home. So can TRILLIONS in part line spending bills under Biden that caused double digit inflation.
A 10% tariff is like a $400B tax or less. My fucking small town charges an 11% sales tax! I bitch about it, but it doesn't stop us from being one of the richest towns in the country. Get some perspective.
"Hand businesses enough uncertainty"
Literally every single building contract my wife signed in 2020/2021 ended up losing money because Biden decided to firehouse the economy with money and prices went up 10%.
"Xi is idiotic to do tariffs"
Xi was already doing "tariffs" before this with capital controls, forced and subsidized savings, FDI limitations, and IP theft.
I happen to think some of these things were idiotic, but we are also enabling their idiocy (as they are ours). Huge trade deficits financing wasteful consumption don't work out well for either the borrower or the lender. It's an unsustainable pattern of specialization and trade that has to pop at some point.
Could it be that the purpose of Trump’s tariff machinations is to prod China into imposing higher tariffs, thus crippling its economy more than it cripples ours?
At any rate, I doubt that he sees them in terms of any kind of economic theory, but rather, as somehow giving him an upper hand over other countries. He appears to have that attitude about the law - theory is irrelevant, outcome is what matters.
And I wonder how much he actually cares about the economic outcome. I just have the sense he’s frying other fish.
Great explication, Professor. Clear and concise. Thank you.
If I may, there is one other identity that is not as easily described in algebraic terms, but which seems equally immutable: there is no certainty quite so ironclad as the certainty of a presidential advisor who briefly* has the President's ear.
*one hopes it is briefly!
Finally, your description of Smoot-Hawley mentions one phenomenon we are seeing played out right now: the struggle between the Congress and the White House for dominance. I believe the Founding Fathers intended for the Congress to be the more powerful body because it is closer to the voter. But in order to fulfill that role the Congress must perform its Constitutional role, especially the budget-writing portion of their duties. Their abdication of that part of their duties has cost them authority and power, which the White House has gladly taken on.
The identity you cite is the most dangerous of all! :) And yes, Congress in the 1960s and 1970s set a trio of time bombs on trade. Fortunately, in varying degrees, all the presidents from Truman through Obama were favorably inclined toward free trade. (All of them had their unfortunate exceptions, but those were limited.) In different ways, Trump and Biden have marked a sharp departure from that post-WWII consensus.
Your problem with that statement was "relentless". It was brief, as expected by anyone not overly committed to a position or too partisan to use their brain, and you got caught up in the moment.
Trump hasn't been in office long enough, even now, for any use of the word "relentless".
"turbulent irreducible uncertainty" - yep, "disruption". It will pass, and most already has.
One problem with this is that I am totally unsure that Congress, as a whole, is anywhere close to the average American voter. They generally merely pander to the groups needed to reassure their re-election. I do not think the Founders foresaw the rise of career elected politicians.
Excellent article. On economics. Tariffs are political acts. You write (as does Arthur Laffer) that flow of goods is offset by flow of capital. That's exactly Trump's point! You see investment flowing in, Trump sees wealth flowing out. Trump doesn't like wealth flowing out. I don't think I do, either. Perhaps you can help Trump, and me, on that point.
Thanks much! Glad you enjoyed it. But I don't think it is Trump's point. I don't see where wealth is flowing out--not in the slightest. Trade in goods, services, and investments are all mutually beneficial. If a German buys a $10m stake in a Texas high-tech company, the Texas company deposits the money, and the bank lends it to a furniture company to buy inventory from Italy for its U.S. showrooms, I'm afraid I don't see any wealth flowing out. The Germans are happy. The Texas high-tech guys are happy--as are their new hires. The furniture company is happy, as are its U.S. customers and its Italian suppliers. And the bank is happy to arrange the transactions. The federal government gets tax revenues from the profits at the startup, bank, and furniture company and from the employees of all three. (I'm fleshing out this example for my next post.) I don't Trump or lots of other politicians understand this. And I know with absolute certainty that his advisor, Peter Navarro, does not understand a single word of it, including "and" and "the."
But we didn’t take the Chinese money and invest it in capital. We blew it on consumption and now we don’t have productive capital with which to repay it.
How you run a trade deficit is important. It’s no different than if you borrow money to start a business versus borrowing to go on vacation.
It’s one thing for say a growing power to run a trade deficit because it’s importing machinery. It’s another to run a trade deficit to finance wiping old people’s asses in nursing homes.
I in fact don't want my children being taxed to pay interest to the Chinese because the government decided to spend money wiping old peoples asses in nursing homes. I don't like the government telling me that old people ass wiping is what I have to "buy".
#3 is easily fixed with a "Buy American" for defense industries regulation.
#4 assumes IP is a real thing, and that no other country including the US has ever ever done such a thing.
#5 is the norm for all governments.
Drop all tariffs to zero.
Get rid of as much regulation as possible. 90%, 99%, that's just a start.
Stop wasting taxes on wokism, climate change, redistribution to states and local governments, and other nonsense.
The point of these last three is to let the economy boom.
Say you're going to do something about Social Security, Medicare, railroad pensions, and other Ponzi schemes, and start some serious studies. I have one scheme, which basically boils down to:
* Continue FICA taxes to pay off existing pensions.
* Add a temporary 4% FICA "nest egg" tax which goes directly into indexed mutual funds owned by the contributor.
* As pensioners die off, start paying excess FICA tax into the nest eggs of those who have already paid FICA for 10 or 20 years so they get an appropriate boost. This makes me think the FICA tax could start winding down and be gone in 20 years, but I have no calculations for that, it's just an unscientific wild assed guess.
I am no economist or financier. There's a lot of details. But I wrote a little program to see how much of a nest egg I would have at retirement if my FICA deductions had been invested in Dow Jones or S&P 500 indexed funds, starting every year since the S&P 500 was started in 1926, and the average nest eggs provided enough principle that a 5% annual withdrawal would have been 3 (DJ) and 5 (S&P) times the SSA pension. That's where the 4% FICA "nest egg" tax rate comes from. Average annual returns for the indexed funds for the previous ten years had been 10% (DJ) and 13% (S&P) leaving plenty of scope for emergencies, bad years, and standard 2% inflation.
Heh. Even the FICA nest egg scheme? I tried factoring in inflation and taxes and decided the heck with it, it's good enough for plausible fiction, and no one who could take the ball and run with it would. I haven't updated it for several years.
If you can buy a defense component from an ally—Canada, say—for less than the American equivalent, why should you not?
IP is a real thing, as much as any property is; and others’ peccadilloes in that respect do not excuse Chinese crimes. The remedy is not obvious, but the problem cannot be denied or excused.
* It didn't exist until monarchs first, then democracies, created it out of thin air, and they twiddle with its definition all the time. Contrast that with physical property.
* You can inherit physical property. You can't inherit patents. Children and grandchildren can inherit copyright royalties, but only for limited times, 50 or 70 years after death.
* Why should material copyrighted at age 20 have 50 years more protection than something copyrighted at age 70, and why should works from an author who dies at age 20 have less overall protection than from an author who dies at age 70?
* Copyright does not apply to everything. You can copyright music and words, and pictures of nature, but not mathematical formulas describing nature (E=mc^2).
* Word copyrights apply to near copies, but while you can copyright a picture in a tour book, you cannot prevent tourists taking pictures from the same spot which are indistinguishable. But if one of those tourists publishes his own book with his own picture from that same spot, is that a copyright violation?
And so on. As to why I do not fear a world without patents or copyrights, and why I do not think patents spur innovation, you can find any number of examples where patents stalled progress.
* The Wright Brothers developed their plane better than everyone else in the world. Their demonstrated control at the 1908 Paris air show stunned everyone else. Yet they sat back and waited for customers to show up and never again did anything to improve their product. They ended up in a ferocious patent battle with Glenn Curtis over whether his hinged ailerons violated their wing warping, stalling his progress while they still sat on their keisters doing nothing, and the battle was only resolved by the US government buying or stealing their patent to they could build airplanes for WW I.
* James Watt had a patent on steam engines, yet did not know how to make boilers strong enough for portable engines for railways or ships, and fought everyone else who did know how and tried to sell them. The first steam ship was built in the US because his patents did not apply there.
* Rollin White (revolvers), Eli Whitney (cotton gin), Laszlo Biro (ballpoint pens) are others who had patents which did not help them.
And then there is the old rhubarb about progress stalling without IP. Besides asking why Mozart and Beethoven wrote music and so many things were invented before kinds granted patents ...
* Copycats only copy products which have proven to be successful, leaving the copycats perpetually two generations behind.
* Reverse engineering takes time and resources away from independent research and development and does not generate the same institutional knowledge.
* Perfect copies cost just as much as the original to manufacture, distribute, and sell.
* Perfect copies marketed as the original are fraud for pretending to be something they aren't.
* People who buy copies expect lower prices, which reduces profits and quality, and impacts their brand reputation.
* People who buy cheap copies are unlikely to have bought the more expensive original.
* If the originals are not worth their higher prices, then they are a fraud imposed on the public and the copycats deserve to be rewarded for breaking their monopoly.
* Why do so many people pay extra for autographed books?
* Why do people pay millions of dollars for original paintings when cheap copies are available?
There was a story 10-20 years ago about someone who claimed to have found a way to reproduce Gucci (or some other overpriced luxury brand) quality under his own brand name for a tenth the cost, yet no one would buy it because it didn't cost enough. He had to raise his prices to Gucci level before his product would sell. I have no idea what "Gucci quality" means, but it was apparently a real thing, according to this story.
Someone, possibly Hilary Rosen, head of some copyright lobby association, gave a speech, maybe 30 years ago, decrying libraries which loaned out copyrighted material without paying royalties. She said a lot of other silly things in that speech, but my Google-fu fails me. What I mostly remember was the silly jokes about being illegal to sing in your shower or car, about having to buy a separate copy of every book you wanted to read to your children, of being illegal to quote movies ("I'll be back" in Arnie's accent), of having to be brainwashed after reading a book or seeing a movie so you couldn't remember it, and so on.
And that is only the beginning of my rant on why I believe IP is a fraud.
Land existed before man. Private property in land is as much a gradually evolved act of law as private property in ideas. The tenure in either can be as long or short, and as strong or weak, as the lawmakers please.
I myself think abrupt changes to property law are seldom wise; and strong property laws are usually better, because they lead to the productive development of more property. But lawmakers, including voters, often have different priorities than mine.
Your arguments about duration have been raised about both, and I see no principled way to answer for one kind of property that doesn’t apply to other kinds.
Oh, yeah: you absolutely can inherit a patent, and enforce it. We seldom hear of it because utility patents expire in 17 years, and inventions in the last 17 years of life are fairly rare.
One of the tremendous economic problems in West Africa was a persistent belief that land should be held communally. Nearly identical to today’s anti-IP arguments. As a consequence, no one owned any worthwhile collateral for funding entrepreneurial ventures. I have no doubt that certain kinds of IP have too long a timeframe. (See the finally extinguished Steamboat Willie IP tenure—the notion that copyrights out to linger long enough to keep Mickey Mouse’s IP extant.)
When you compare the potential value of developing a work of art and owning its commercial exploitation in perpetuity (subject to voluntary alienation, of course) against the potential value of parodies and knock-offs of Steamboat Willie and his like, I think it far from obvious that the balance favors the latter—for much the same reasons I would defend the tenure in fee simple absolute of land. Collateral for enterprise is significant among them.
I don't think the IP and tangible property arguments are the same. Tangible property ownership is control more than possession. "Self-ownership" itself implies property. I control homesteaded or bought land with a fence. I control my house with doors. I control a chair by not giving it away. If you want to think of IP as property, protect it by the same rule — keep it to yourself, don't give it away, and it remains your property.
There are ways to protect secrets. Sign a contract owing a billion dollars to see the Coca-Cola or KFC secret recipes; the debt expires on your death and becomes due the instant you disclose the secret. Don't need copyright laws for that.
I tried once coming up with a way to have more flexible patents.
* You invent something. Write down how to reproduce it, along with a royalty schedule and a time limit. Then start producing and selling it.
* If no one reproduces it within the time limit, the patent expires. Either the product was not worth reproducing for the royalties, or the description was incomplete, or would-be competitors decided to wait out your time limit.
* If someone does reproduce it within the time limit, that establishes how long the royalty period lasts, say 10 times as long. Anyone can reproduce it if they pay the royalties.
* The patentee's incentive is to either have a monopoly for the short time limit, or encourage copycats for the longer royalty period.
* Copycats' incentive is to either be first and fast enough to keep the royalty period as short as possible, or reproduce it internally and be ready for full production the instant either the time limit expires with no one reproducing it, or when some other copycat reproduces it earlier and starts the royalty period.
* A patentee who sets a long time limit, like 100 years, must think it's a really hard design to copy, or that it is such a trivial product or improvement that no one else will want to copy it. But this seems like a weakness, and maybe it would be worthwhile having a time limit limit, like one year or five years.
* No patentee will set a really short limit, like one week, because the royalty period would be similarly short, and it's more likely copycats will just ride it out and let it expire.
I never did finish polishing it up. I just don't believe in IP.
We have something similar in our country. Land on American Indian reservations is held communally by the tribe. An Indian who wants to build a house on a reservation can't pledge the house to a bank as collateral on a mortgage.
We should be making chips, and military software and hardware right here at home, in secure access controlled factories. Any place else, it is too easy for bad actors to get inside the supply chain.
Also having worked on the buy American act in the federal government, it leaks like a sieve. Any idea how that would apply to a jet fighter with a million different parts? Answer, it doesn’t. It’s kabuki paperwork.
Let's start with what I won't do: announce a bizarre set of nonsensical tariff rates on every country in the world, moving the rates up and down like 200 different yo-yos all at once, spook the markets, punish countries that are doing everything right, reward countries that are doing everything wrong. And which leave the nerves of business frayed and frightened for where the yo-yos go next. And which forces friendly countries to do MORE business with China because we have become and expensive and unpredictable trading partner.
I agree that we shouldn't be so dependent upon for critical defense goods. So stop buying defense goods from China.
IP theft is a problem. No logical reason why tariffs should fix that.
Which political establishment is stealing from its citizens? China's or ours?
Well, that is where we might disagree. What defines citizenship? As opposed to being a subject or a slave? Does the government of China meet those qualifications, or are the majority in China essentially serfs?
Citizenship is a legal definition. Like their life or not, they're citizens. There are two many valid criticisms to make without heading down this cul de sac,
I started reading this essay and almost immediately found myself in difficulty trying to make sense of it.
Let’s call [1] “How each person uses his income”. There’s no logical reason not to include buying imported goods in C, though if you want to break it out as a separate category you would add +M to the equation.
Then we could label [2] “How each person gets his income”. All of these items boil down to selling goods and services (call it W, not
ncluding exports), investment income, payments from government, and borrowing. Again, no real reason to break out exports as a separate category.
So if you insist on writing an equation, it should look about like this:
C absolutely does include the purchase of imported goods, as do I and G. That's why you add X (payments coming from foreigners) and deduct M (payments to foreigners). So there's no need for your W. And I have no idea what your E is supposed to be.
Producers sell consumption goods & services, investment g&s, and government g&s
Y: American income/expenditures for the year
C-Cf: portion of consumption g&s purchased from Americans
I-If: portion of investment g&s purchased from Americans
G-Gf: portion of government g&s purchased from Americans
X: American income coming from foreign purchasers, so not part of C+S+T
Now, Y = C+S+T = C-Cf+I-If+G-Gf+X
M: (Imports) equals Cf+If+Gf. American purchases from foreigners; not American income.
Now, Y = C+S+T = C+I+G+X-M
Economists disagree with one another over everything, but not over this. They argue about how you should measure these variables. (e.g., Is college tuition consumption or investment?) They argue over the policy implications. But they don't argue of the accounting system.
The answer as to policy is to reduce regulations and increase energy production to decrease its cost. We can then grow our economic pie while reducing our budget deficits. The trade imbalance is always offset by foreign investment. As a non-economist I’m not sure I’m correct but I do know that increased economic activity here and increased jobs makes for a happier population. A small anecdote: my friend lost his job a number of years ago as a plant manager he said his workers, while making much more per hour than the foreign competition were so much more efficient they out produced the foreign workers at the same company overseas. His factory was closed because governmental costs made his factory non competitive. Maybe we will learn that lesson in Washington but I have my doubts.
Here's a simplistic example to illustrate it what is missing in this analysis.
We used to make our own military hardware worth $1t, but over time we let Buttfukistan supply it for us. Given Graboyes' identities, holding private investment and government deficits even, that would mean the following:
1. We would stop making military hardware.
2. Buttfukistan would sell us $1t in military hardware.
3. With that money, they would buy $1t of our farmland and breweries.
4. When war comes, the stop selling us missiles and they have control of our food beer supply.
5. The "balance" is maintained in terms of cahsflows.
6. We lose the war.
Any economist would tell you that 1-5 is not an economic problem at all. But, they might have to write that analysis in Buttfukistanese.
None of this is missing from the analysis. The analytical framework is extraordinarily flexible as to the questions its capable of addressing.
--If you're worried about our access to military hardware in a war, pass a law that says, "We're not buying military hardware from China." And add to it, "Oh, and if you start a war, our Army will seize the farmland and breweries that you purchased here in America."
On December 6, 1941, Germany and Japan owned loads of businesses, patents, real estate, personal property, restaurants, banking agencies, vineyards, silk caches, bakeries, and importing firms here in the U.S. After Pearl Harbor, Germany and Japan didn't own these things any longer. In a world of international trade and cross-border investments, one reason to avoid war is the knowledge that your valuable properties will be seized the moment the first shot is fired. Ask the Confederates about this, while we're at it.
The Liberation Day tariff approach is, "Hey, wowza, China's dangerous, so let's put a 25% sales tax on our purchases of nukes from them. No WAIT--a 125% sales tax. No WAIT, let's negotiate on the sales tax. And while we're at it, let's put a 46% sales tax on purchases of chairs from Vietnam--thereby killing the American market for Vietnamese chairs and forcing them to sell chairs to China. And let's wreck our reputation with the rest of the world as a reliable, predictable trading and investment partner. And let's crater our economy so we can't afford to manufacture those nukes here in the U.S. of A."
The analysis I presented here is at the heart of the National Income and Product Accounts (NIPA). The reason the NIPA was developed is telling. The federal government was grappling with the Great Depression. But then, the big push came when WWII broke out, and policymakers wanted to have a coherent view of economic realities, rather the head-up-the-ass running-in-circles fire drill that led to the Smoot-Hawley tariffs. And it worked, by the way.
There's a very good argument to be made that these identities won the war against Germany and Japan. Their war efforts were hampered by slipshod, economic improvisation, while America and the Allies had a focused, logically coherent, internally consistent method for estimating how we could best use our resources to win the war without bankrupting our population.
When Hitler put a bullet through his own brain, a strong contributing factor was the incoeherence of his economic management.
Hitler's economic policy was coherent but it made war inevitable. He had spent 92% of German gold reserves in four years. He had reduced unemployment from 34% to 14% through vast increases in government employment but half the work force was still below the poverty line. They could ill afford a tax increase. He enacted price controls to protect the working poor but the price controls created shortages, as price controls generally do. Imports quickly dried up. He could not build up exports without devaluing the mark to compete with the devalued British pound and American dollar, but a policy of inflation wouldn't fly in a country which keenly remembered the hyperinflation of 1923. Germany eventually had just two months' supply of raw materials for rearmament and had little foreign currency left. Debt was rapidly compounding as the government increasingly relied on short term loans. Hitler could either go out of power or go to war, so he launched the Second World War. Source: "Hitler 1889-1936: Hubris", by Ian Kershaw
Hitler's policy was coherent for a government that lacked the analytical tools America was developing. The National Income and Product Accounts (which is what this whole essay is about) gave the U.S. a strategic advantage over the Axis Powers is taking the greatest advantage of our economic potential. Somewhat related to this was the development of the Simplex method--a set of tools for maximizing the efficiency of resource allocation. While not fully realized till the start of the Cold War, Simplex development was classified info during WWII. I can pose a question of whether this development or the Manhattan Project's development of the A-bomb was the more important technological development in finishing off the Axis.
If worried about access to any military needs not obtainable from Allies, a subsidy to incentivize producers to produce needed supplies would be a better way to go about it than via a tariff.
And yes proper resource allocation is underestimated as to its importance.
What is the possibility that Trump’s tariffs aren’t about reducing the trade deficit or raising income through tariffs? Might he be using them as ammunition in a global economic war whose main purpose is to damage and possibly neuter China strategically, politically, economically, and by extension, militarily? It seems to me the purpose of the 100-country tariff tactic is China’s isolation, I.e., forcing other countries to choose between the US and the PRC. Is it coincidence that the countries most interested are all threatened by China: Taiwan, Australia, South Korea, Vietnam, and Japan?
From what I can see, the structure of those tariffs will drive countries toward. Gina, not away from China. The kind of guesswork you’re suggesting is precisely what markets cannot cope with. Firms can deal with risk, but not uncertainty—which is something entirely different. It’s groping in the dark, trying to guess what the hell he’s thinking. I wrote an earlier piece about the extreme uncertainty over what he wants to do on tariffs: https://graboyes.substack.com/p/the-gulf-of-trump
My non-political free-trade hardliner friend Don Boudreaux just write a paean to Reagan's relatively unique comprehension of the importance of trade: https://cafehayek.com/2025/04/ronald-reagan-in-1982-on-free-trade.html. Don't post has a brief video of Reagan discussing free trade, which Don introduced as follows: "When President Ronald Reagan delivered this address in November 1982, I was a 24-year-old graduate student. Radically libertarian at that point for almost six years, I was sufficiently astute enough to know that Reagan wasn’t terrible on most of the issues that I cared about, but I was nevertheless insufficiently mature and astute enough to appreciate just how superb Reagan was for a man who achieved the office of U.S. President. Compared to any president since he left office in January 1989 – and certainly compared to the ignorant, capricious, and unprincipled current occupant of 1600 Pennsylvania Ave., NW – Ronald Reagan was an Adam Smith, a Bastiat, a Milton Friedman."
The main error that is made here is that Trump is using the tariff issue as a purely Mercantilist way. He is also using it as a geopolitical level. For many years the USA has imported goods from around the world with low or zero tariffs while most other countries are using tariffs and other methods to limit USA imports into their own countries. I believe that Trump's goal is to force these countries to remove their tariff barriers which is why he is using reciprocity with respect to the tariffs. There are also national security concerns with the di-industrialization that has been going on. You do not really want to be in a position in which international supply chain disruptions will leave you with a collapsing economy and society.
In the previous article I wrote: “Here’s the one and only legitimate defense that one can muster for Trump’s April Tariffs—that they are specifically designed to look insane and cataclysmic, thereby scaring the world into eliminating tariffs altogether and moving to a regime of freer trade. … … I doubt that this explains the April Tariffs, but if this is what happens, I’ll tip my hat, admit I didn’t see it coming, and say ‘thanks.’”
So yes, I recognize that possibility, also wrote about it my earlier “The Gulf of Trump,” and very much hope that’s the plan. Right now, I doubt it, but I’m happy to hedge my bets.
As for military supply chains, I’ve discussed that elsewhere in the comments, so look around a bit if you have time. The short version is that if that’s your fear, don’t assume a sales tax will protect you from th problem. Just ban defense purchases from China.
Good point and very well considered. But please do consider this. Tariffs are simply another version of 'Consumption Taxes.' And I do recall libertarians, certain conservatives, and some followers of Bastiat being quite in favor of 'Consumption Taxes' - as opposed to Income Taxes. Regressive Taxes, pure and simple, the more one buys and uses (consumes), the more one proportionately pays. I consider "Consumption Taxes" the following. First and foremost, the notorious Value Added Taxes, (VATs) used by about EVERY COUNTRYIN IN THE WORLD EXCEPT THE UNITED STATES. In Europe they are generally north of 20%+!!! Know this for a fact - lived in VAT world for a long time. Add to that, counterintuitively, "Corporate Income Taxes" (they are paid by the customer - the Corporate Income Tax is, in effect, a business expense (long time in accounting and cost accounting worlds in my career).
To round it out one gets Payroll Taxes (pure regressive taxes) and US Sales Taxes. A tariff and a VAT are "EXACTLY" the same thing. The reasons for their being imposed on the surface different, but the exact same results. I Germany or Swedeen - EVERYTHING ONE BUYS OR SERVICE THEY USE, they pay a 23% premium (vat tax) hidden in the sales price of the goods. If one includes VATs and high Payroll Taxes, and high Corporate Tax Rates are considered as Tariffs, which is what they really are - then on average, as of 2025, the United States charges LESS tariffs on their imports than our Trading Partners charge on our exports. Simple fact - and most people don't even know this - gee whiz - I wonder why.
I'd be delighted to switch from the income tax to a VAT. My fear is that we would get both. Yes, those of a classical liberal bent (like me) tend to favor consumption taxes--but not taxes where a single individual in invested with the power to apply radically different rates to different sellers and different product--completely on whim and subject to seismic changes whenever it suits him. That is the nature of Trump's tariffs. It's a terrifying power that Congress handed, in stages, to Kennedy, Nixon, and Carter, and Trump is merely the most enthusiastic holder of that power.
I also believe that Trump is trying to push all of these countries into a block opposing China and their specific brand of trade and corrupt mecantilism. I would also suggest that one of Trumps purposes with his engagement with Russia is to try to separate them from China.
So, wreck trade relations between America and all of these smaller countries, while China sits, poised to milk its people dry to curry favor with the countries now watching their economies hammered by American tariffs. As the Internet meme goes, "It's a bold strategy, cotton. Let's see if it pays off for 'em." https://www.youtube.com/watch?v=9HVejEB5uVk
A little bit emotive there mate you may need to take a breath. I believe that Trump has started a process to have all of the USA trading partners arrange deals that can get some tariff equalizations to diminish the tariff differences between their countries and the USA. I do not understand why most of the countries on the planet can have large trade barriers against the USA but the USA is evil for wanting some for themselves. The EU is one of the biggest problems here with trade barriers other than tariffs in place. Most of these countries are now engaged with the US in this process. I believe Trump is trying to sort this out in order to isolate the Chinese. One issue that I am sure that will be discussed in how China uses any of these countries to trans-ship goods to the US thereby avoiding tariffs.
As the biggest customer for most of these countries if the US can arrange deals to allow them to still trade and prosper while China is excluded then China's economy could be in serious trouble and they will need to negotiate with the US on Trump's terms. If all of this can happen then it may become advantagous for Russia to begin to also delink from China if the right conditions for re-engaging with the West are put in place. This may also help to derail the further development of BRICS.
There are a lot of ifs here but having watched Trump for many years, in business as well as politics, and read his books it is the sort of long term strategic thinking he does.
Again, my main point still stands. It is short sighted to look at what is happening on a single issue basis such as "just tariffs". I am sure Trump and his advisers area as fully aware of the issues with tariffs if misused.
Really nice article - and Bastiat is one of my favorites, and I would say most influential economists ever. And in perfect world of humans that dealt logically and with good faith in all things - profound worlds indeed. And they are highly useful.
But, alas, we do not live in a perfect, laboratory controlled, world. International trade is NOT about logical people of good faith, sitting around trying to maximize the incomes and wealth of all the citizens of the world.
True, there is an element of logic, but also some vicious competition and advantage seeking, and like a good game of 'poker' - lots of lying and bluffing. Some of the players have 'destruction,' not 'construction' in their minds. International trade is a continuation of war for them. If one can take advantage of someone in the short run, they will. And in the end, WHERE things are made matters. So please, stop trying to treat the profound and vital works of Bastiat like the writings of Karl Marx. Bastiat never claimed to have a time machine.
Take ship building. It's true that other countries can build ships cheaper than the United States in 2025. We have pretty much let our ship building prowess slip away over the years - comforted by the mantra of free trade. China's shipbuilding capacity now dwarfs that of the United States. The United States is historically a naval power, the greatest naval power since the end of World War I. The greatest naval power ever. We are in an existential struggle with China and the CCP over all of the Western Pacific region. The country that can build the most and best ships will win the war. But his seems to somehow go by the purist in Bastiat's world. Wake up. It's not quite as simple as your equations make it sound. Once again - Bastiat was simply giving his most resound opinions based on the facts as he saw them. And he was profound and brilliant - one of the greatest and most useful economists to ever live. So sad that he died relatively young. But he never claimed to be Karl Marx who had a 'time machine' - had converted economics to a hard science - and knew the future. He didn't predict the future - he knew the future - OR SO HE THOUGHT!!!!!
"But, alas, we do not live in a perfect, laboratory controlled, world. International trade is NOT about logical people of good faith, sitting around trying to maximize the incomes and wealth of all the citizens of the world. "
And this is a best summary of the issue that I have seen.
All the rigorous mathematical analysis in the article above utterly ignores this.
The rigorous mathematical analysis above ignores not one iota of this. As I said to the commenter whom you quote, "It is the pro-tariff crowd that emulates Karl Marx in its faith that smart politicians can know the future and manipulate its shape via tariffs and other clumsy tools."
The "we do not live in a perfect, laboratory controlled, world" is the standard point of departure for socialist tendencies--of which tariff-based industrial policy is nothing more than the flavor of the week. Bastiat, like Adam Smith and David Ricardo, was under no "purist" delusion of the world. (And I am under no such delusion, either.) At one level, the world is, indeed, as simple as the the equations I shared here. Once stated, one can argue endlessly over how best to measure the variables involved and which policies to apply to this system. But the four identities presented above are merely a check on the baser instincts of those who deign to control the economic interactions of hundreds of millions of people. No matter how smart, no masterful a negotiator, Donald Trump cannot devise any scheme that will result in both a net flow of capital investment into the U.S. and a reduction in the U.S. trade deficit. And the four identities also clarify why tariffs will almost never generate economy-wide economic growth. It is the pro-tariff crowd that emulates Karl Marx in its faith that smart politicians can know the future and manipulate its shape via tariffs and other clumsy tools.
"No matter how smart, no masterful a negotiator, Donald Trump cannot devise any scheme that will result in both a net flow of capital investment into the U.S. and a reduction in the U.S. trade deficit."
Yes, by definition, that is correct. It is also useless. Our goals in the situation don't actually care about any of that. At all. We want things to happen here so people have good jobs, so the actual economic activity benefits the people who live here. Whether that's foreign investment here or domestic funds choosing to invest here instead of elsewhere is irrelevant to almost anything except your math.
"And the four identities also clarify why tariffs will almost never generate economy-wide economic growth."
You are ignoring human behaviour. People don't care about your math.
The events of the world, since you posted that, are proving you wrong, rather actively. Tariffs themselves are indeed a "clumsy tool", but they can still get people to change behaviour, which is what was needed.
"It is the pro-tariff crowd that emulates Karl Marx in its faith that smart politicians can know the future and manipulate its shape via tariffs and other clumsy tools. "
Tariffs can indeed manipulate the shape of the future. You believe this just as much as I do, or you wouldn't worry about them. Should you compare yourself to Marx now?
Not perfectly, of course, but incentive structures are really, REALLY easy to understand at the most basic level.
Previously, make a car factory in Mexico, where it costs X to make a car, then ship it to the US (nearly free), or make a car in the US where it costs 1.2X to make a car. Duh.
Now, make a car factory in Mexico, where it costs X to make a car, then ship it to the US and pay a tariff (that costs .25X) or make a car in the US where it costs 1.2X to make a car. Again, duh.
Obviously, I grabbed those numbers from nowhere, but the general point stands. And what happens to the economy? Well, the money that would have been paid to workers in Mexico goes to workers here. Considering how much of the cost today is labor, that injection into our economy is more than the cost of the higher prices. (Or at least, that's the goal - you are correct about politicians generally sucking.)
Before, ALL the money paid for the car went elsewhere. Now, even if the factory is foreign investment, only the profits go elsewhere. Everything else stays here, part of OUR economy.
How is this hard to understand? Where do the large majority of people get their money? From a job. What drives our economy? The spending of the average Joes. Better jobs = more spending. If that spending is going to pay workers in another country, that's a loss. If it's going to pay workers here, it's a win. (*OBVIOUSLY* oversimplified, yes. Comment is already too long.)
The point of tariffs is to keep them from getting paid as much as possible. To change human behaviour in ways useful to the country imposing them.
(That's not to say that they can't be used badly. Every tool can be used badly.)
They definitely change human behaviour. Whether that works out as desired is difficult, of course. If you have a private-market, non-governmental means of doing this (when most of the reasons to NEED to do this are because of government action in the first place... see the next point), feel free to expound.
The other thing you are leaving out with tariffs is that they act to re-add the costs we apply to ourselves to countries that don't apply that to themselves. For maximum oversimplification, we have OSHA, and China doesn't. Moving our manufacturing to China lets us still pay prices as if we were using slavery, peony, and sweatshops while pretending we don't use them ("That's China, not us!" we tell ourselves).
As best I remember, the Laffer Curve stated a counterintuitive argument that a reduction of the corporate net profits tax rate would provide an increase in federal income. Lowering taxes would result in more income was the voodoo part.
Perhaps you should have at first refreshed your memory, because that explanation isn't even close.
Here's Google's AI explanation, and maybe you can expose your purported counterintuitive argument from it:
The Laffer curve posits that at extremely low tax rates (near 0%), the government collects very little to no tax revenue. As tax rates increase, the tax base (the amount of income and wealth subject to taxation) may initially increase, leading to higher tax revenue. However, beyond a certain point, higher tax rates can disincentivize work, investment, and other economic activities. This can reduce the tax base, causing the total revenue to decline even as the tax rate increases.
The Laffer Curve refers to taxes in general, not just corporate taxes, and no "voodoo" is required. You already understand the basic concept of the Laffer Curve, even if you think you don't.
It has 3 parts:
- At 0% tax rate, there is 0 tax receipts - no money going into the treasury.
- At 100% tax rate, there is 0 tax receipts - no money going into the treasury. (OK, at 100%, a few people might still pay in some... bump the number to 200%, or whatever number you like.)
- In the middle, there are tax receipts - actual money going into the treasury.
This means there is a "curve" with zero at both ends. The actual shape of the Laffer "Curve" is unknown and much debated - it could have multiple peaks and valleys, or just be a simple, nice "curve" as named. Probably impossible to ever know for sure, as any changes take significant time to work through the system.
But I can say with some significant confidence that we are on the wrong end of the Laffer Curve for increasing rates to actually increase receipts. Every major tax RATE cut in my lifetime has resulted in increased tax RECEIPTS in short order, so it's not close.
THe mistake during the Reagan years was assuming that we were on self-destructive side of the Laffer Curve and that tax rate reduction would raise revenues. The logic wasn't wrong, but the point of the curve was a matter of faith, not of adequate data.
Adequate data has thus-far proven to be impossible to have before hand. You make the changes and see what happens.
And since every major RATE cut in at least my adult lifetime has resulted in higher REVENUE, I'm going to assume we're on the wrong side, always and forever... until we get a rate cut that *doesn't*.
At that point, sure, let's discuss stuff - we're at least in the ballpark. At this point, the data we have shows us that every single rate cut *except the last one* was still not enough.
We won't know about the last one until we do another one... or someone develops some massive breakthrough in understanding the Laffer Curve, which seems, frankly, impossible due the massive number of factors that inherently we can't have a control group for (since we only have one reality to try stuff in).
It was voodoo to George H.W. Bush, but it was not voodoo to logic. The nature of the Laffer Curve had been known for centuries and is not much in dispute as a concept. In 2023, Bastiat's Window published an article by Grace-Marie Turner, who was in attendance when Laffer created the curve that would ultimately bear his name. As the article notes: "affer noted that the concept behind the curve had been articulated in different forms by Ibn Khaldun in the 14th century and John Maynard Keynes in the 20th century. He credited future Nobel Laureate Robert Mundell (whom I wrote about a few weeks back) as the source of his ideas. Others have noted that antecedents can be found in the writings of Adam Smith in the 18th century and Andrew Mellon in the 20th. But Laffer’s impromptu sketch made the opaque intuitive, and so it is his name that is forever attached to the idea." In fact, Adam Smith's treatment of the future Laffer Curve dealt with the optimal level of tariffs. Read the rest of the story here: https://graboyes.substack.com/p/birth-of-the-laffer-curve
Interesting essay. There's one thing I don't quite understand. Perhaps you can clarify for me.
"Y" is Gross Domestic Product: what a country produces in its borders in a given time period. Ignoring Net Exports for the moment, C+I+G are what we do with what we have produced. Tweaking C or I or G will not affect Y; it will affect the other areas to which Y is distributed. (This is, I believe, a fundamental mistake that government makes when it tries to "stimulate" the economy. More "G" does not cause more "Y". It simply reshuffles Y's allocation in C, I, and G.)
In Table 3, how does the implementation of tariffs cause GDP to decrease? One thing that could happen, as we go from Table 1 to Table 3 is that C increases by $1t (the tariffs are passed to the consumer) and M goes up by $1t (the imports are more expensive). On total GDP, that is a wash. On the C+S+T side*, C goes up, S goes down, another wash. Trade Balance goes to -2, Private Saving goes to 0, Government Budget remains at -2, overall a wash. GDP stays at 29.
Furthermore, the essay seems to overlook that we are in a world economy where other countries tariff US goods, and the US doesn't tariff their goods at the same rate. One possible outcome of Trump's tariffs could be an increase in X, as US goods become more affordable to foreign buyers.
The lower S caused by the tariffs could have a dampening effect on future GDP. But even that could be offset if X increases.
I'm sure I'm wrong. I just don't see where.
*Shouldn't that be Americans' Spending, rather than Americans' Saving?
Great essay, as usual, Robert. I will be using this essay tomorrow in my ECON principles class. These identities cannot be ignored, but the stories we tell around them are complex. One missing piece that I think is mighty important is that Y also equals aggregate production of goods and services. How increasing tariffs affects aggregate output is a big deal, both in the short run and especially in the long run as investment is likely to to fall through the floor.
Now, if only I could somehow get my students to read this essay and begin to ask good questions about the stories we can tell around them ... hey, I can dream, can't I?
David, I also considered using the article in my Principles classes. I got hung up at the same place you did: in the short run, how do tariffs affect Y?
This is the same concern I have with macroeconomics as taught today. There seems to be an assumption that the equation Y=C+I+G+NX is an equation that runs in both directions, so that Y can be increased by increasing G. I tend to believe that increasing G comes at the expense of either C or I or both, leaving Y unchanged.
Government "stimulus" programs make the economy better the same way heroin makes the body feel better: only in the short run, with long-run damage.
The essay acknowledged that the identities do not preclude the possibility that a tariff could, in theory, boost national income. But, it went on to note, assuming that is the case requires additional, far-fetched assumptions (e.g., insensitivity of consumption and saving to levels of taxation). And, the essay suggests that historical examples of tariffs boosting national income are few to non-existent. The equations do not REFUTE the case for protectionism—but they make the case an extremely heavy lift.
Thank you. I'm not sure I was arguing that tariffs would boost national income in the short term. Rather, I tend to view Y as pretty much constant in the short run. So, tariffs would cause C to increase, since the price of M has increased; this could be offset by an increase in X (if the tariffs drive other countries to lower their tariffs on US goods) and/or a decrease in I (as Americans lower their savings to pay for the increase in C) and/or a decrease in T (as some taces can be reduced due to tariff income to the government.)
In the long run, to the extent that tariffs drive up C and drive down I, GDP will grow at a slower rate, so future Y will not be as large as it would have been without tariffs.
The tables in your essay seem to assume that Y would be affected by tariffs in the short run, rather than the effects of tariffs being absorbed by the other categories into which Y flows. Unless I've misunderstood, which is a distinct possibility, and the reason I ask the question.
Seems to me that the outcomes of protectionism are many. Won't it depend on what outcomes, over what calendar runs, and over what economic runs Trump has in mind? I wish we truly knew what outcomes are intended. I personally cannot say that I know.
The identities are a useful framework, because they are identities. The behavior of people must be filled in by the stories we tell. Tariffs are taxes. Taxes increase market prices. Tariffs are differential taxes, which means that relative prices can and typically do change. All the variables on the RHS of the identities are potentially in motion.
Calendar time makes a huge differences. In the very short run, Y is fixed. How long is that time? You tell me; I don't know. The stories we tell are so incomplete that it's hard to say what happens to any of the variables involved in the identities. All we know for sure is that the identities are true mathematical statements.
The way that these tariffs have been introduced has been chaotic and seemingly, ill-considered. However, the US is one of the few western countries without a VAT. It would be politically suicidal to suggest imposing a VAT and is never proposed by Republicans or Democrats. The Democrats talk about making the "rich pay their fair share," as if there is any way to close the current deficit with a tax on the rich and the Republicans have seemingly no solution. Isn't it possible that these tariffs are a round-about, subrosa way of imposing a quasi-VAT which would allow a reduction of marginal taxes on income (maybe a good thing) while generating some income to close the deficit?
One could hypothesize such a situation, but not with these tariffs, and not with present-day American law. I've noted before that one can justify some sort of tariffs, as long as you are imposing them to raise revenues and are not deluded into thinking that they will cause the economy to grow. It won't work as our VAT because:
-- VATs are low, predictable, and difficult to change. Congress handed Kennedy, Nixon, and Carter near-dictatorial power to unilaterally alter tariffs massively, repeatedly, and on whim. Trump is merely making use of Congress's long-ago surrenders of power.
-- That fact allows wildly varying tax rates on different nations and on different products within those nations.
-- So far as I can tell, there is no political mood to reduce marginal tax rates on income.
-- The impetus for these tariffs has a Schrodinger's Cat aspect to them. They're designed to raise revenues (which assumes that imports will continue); and they're simultaneously designed to discourage imports (which means no tariff revenues.)
Great question from you, though!
Trump is currently proposing income tax cuts (extensions of his tax breaks) and specifically says he is going to use the tariff revenue to cut income taxes (yes, he can’t eliminate it, but a few hundred billion in tariff revenue a year still goes a long way).
I’d take a consumption tax on foreign goods over income taxes any day.
10% universal tariff (I will put China on the side for a minute) is like 1/10th what we spent on Covid (paying people to not work and order uber eats because of a flu). It’s tiny compared to the IRA and other Biden spending bills.
There are so many contradictions on tariff opponents.
It’s too small to cut taxes, but so large it will crash the world economy.
We capture 95% (or whatever) of the iPhone value prop, but somehow iPhones will cost $10,000 each if we tax the 5% a little more.
Only an idiot will do tariffs, but China is doing them to us and the eu is doing them to China. Why doesn’t the EU accept this windfall of being able to get cheap Chinese goods instead of calling Xi and asking him not to dump them on the eu?
Look, if the Chinese want to force their citizens to save too much and can’t find a way to invest domestically (they could try paying them to fuck and have kids so they don’t go extinct), and they are really fucking committed to that strategy, then I see no reason why we shouldn’t tax them (that’s what a tariff is) for the privilege of accessing our capital markets. Eventually they will settle on some amount that maximizes revenue.
I also don’t want to hear too much about spendings. At least Trump is proposing massive Medicaid cuts at huge political risk. What’s the alternative? The Dems will just spend and tax a bunch more, it’s what they do. The last four years have been a spending disaster.
We’ve got a ton of debt and stocks at historically high PE ratios. It ain’t going to be a fun ride and debating a few hundred billion consumption tax is deck chairs on the titanic stuff.
I do not recall any tax ever being cut as another tax came online. The problem is not too little income. The problem is too much outgo, and adding new income just encourages more outgo.
I also don't like the idea of only the rich paying income taxes. I want EVERYBODY to pay something and have some skin in the game. If only the rich pay for it, the hoi polloi will be screaming that the rich are gaming the system and not paying their fair share. Most people think we have a terribly regressive income tax. They are wrong. Read this: https://fakenous.substack.com/p/tax-breaks-for-the-rich
"The current system is like this: Five friends go out for dinner. Say they have some expenses that are common to the group (e.g., a shared appetizer) plus some items ordered by and for specific individuals. At the end of the meal, someone suggests that one of the friends, the one with the most money, should be forced to pay for everyone, even though he doesn't want to. In fact, he should be forced to pay extra in order to give kickbacks to three of the diners. This would not be accepted as a "fair division of the bill.""
And I despise tariffs for discouraging trade. People like to say consumption taxes are better than income or wealth taxes because income and wealth taxes discourage earning money and saving. Nuts to that. Every tax discourages something, and discouraging trade strikes me as one of the worst.
Read this for some nasty examples of tariff corruption by bureaucrats with a burr up their butt: https://www.fff.org/explore-freedom/article/protectionism-is-more-idiotic-than-it-looks/
"Foreign manufacturers of ladies garments began adding a water-resistant lining to light coats; the lining reduced the tariff from 29.5 percent to 7.6 percent. Sen. Richard Shelby was outraged at this foreign conniving, declaring, "Essentially, these water resistant linings serve no practical purpose other than to qualify the garment for a 21.9 percent [tariff] reduction." Did Shelby spend his entire life in a desert where it never rained? Shelby proposed legislation to abolish the lower tariff rate for water-resistant garments, assuring everyone that his proposal "has the interests of all American garment manufacturers in mind.""
How many other taxes have that kind of bureaucratic corruption baked in?
Everyone paying taxes hasn’t stopped taxes or reigned in spending.
Income taxes discourages me *trading* my labor!
And we already have taxes on goods. They are called sales taxes and VAT.
No, I’d like to keep more of my money in exchange for cheap China crap I don’t even want being more expensive.
Why do you get a say in who I trade with? How does my buying Chinese goods, crap or not, affect you? Why is it any of your business?
Not everything Chinese is crap. When I want cheap tools I expect to use only a few times a year, Harbor Freight is good enough — and cheap enough that if it breaks, I haven't lost much. If I want tools that I'm going to use often, I go to Home Depot any pay more.
Why is that choice any of your business? What gives you the moral superiority to force me to always waste my money on expensive tools?
Income taxes, sales tax, and property taxes don't do that. Sales taxes are regressive; income and property taxes are not. Who died and left you in charge of deciding that the poor should pay more for goods they can't afford?
Why do you get to take like half my income! Who are you to put in on who I trade my labor with!
"Sales taxes are regressive"
I'd say that *overall* taxes are massively progressive and I'm not a fan of that.
"Who died and left you in charge of deciding"
I was one of the people who voted for Trump and he and other elected officials are deciding. Maybe you wanted Harris instead. She wanted massively higher incomes taxes and even taxes on unrealized capital gains!
And lord knows the left would add a VAT if they could. Have fun paying like 4-5x as much in markup if we get a VAT rather then tariffs.
My iPhone comes from China. It's not crap. My iPad isn't crap. The rare-earth metals essential for so much of modern life isn't crap, but for now, we have no choice other than to buy it from China. The Chinese semiconductors we purchase aren't crap. Or our laptops. The notion that Chinese exports are crap is an atavistic delusion that this is 1952 and we're mostly buying little wooden toys and trinkets from China. I'm perfectly willing to entertain the notion that we should cease buying certain defense-related goods from China. But thinking their exports are "cheap China crap" is akin to thinking that Dwight Eisenhower is still president.
It's literally the same iPhone as last year and the year before that. You'll survive. I use mine until the battery wears out, then buy the cheapest one I can.
This is another one of those things where people talk out both sides of their mouth.
First I'm told that all of the value of an iPhone actually not in China at all. But I'm also told it will cost a million billion dollars per iPhone if we tariff a portion of the supply chain that everyone tells me isn't that important.
If the cost of assembling and testing an iPhone in China is really $20-$40 or whatever, then 100% tariff is going to make your iPhone $20-$40 more expensive. The Horror!
Most of the stuff in my house with Made in China on it is cheap plastic garbage that my wife's family sends the kids for every holiday or birthday that I have to throw out. They could just send me a check so I can save for their future, but no we need cheap plastic toys they don't even care for because they are cheap. It's our trade deficit in small form.
Trump can PROPOSE income tax cuts all he wants, but that requires Congressional action. He can implement tariffs today, whereas income tax reform will take years. A few hundred billion in tariffs would be small potatoes—and there’s no guarantee that you’d GET that income. You could just as easily drive a wedge between foreign and domestic markets so trade plunges, you don’t the tariff revenues, income taxes drop (because you’ve damaged economic output). Plus Congress would know that whatever they did on income taxes, this president or the next president could overturn the whole tariff regime between breakfast and lunch cause he feels like it. You say you’d prefer a consumption tax over an income tax; I would, too—though you’re likelier to get both.
A 10% tariff—and further uncertainty over whether that rate will suddenly change—can be enormously damaging to economic activity.
There is nothing whatsoever inconsistent about “It’s too small to cut taxes, but so large it will crash the world economy.” Hand businesses enough uncertainty that they go into a fetal position, and you will crash the economy, and you will not get revenues.
Xi is idiotic to do tariffs, and the EU is idiotic to respond with tariffs and we are idiotic to respond with tariffs. There are no laws of physics, economics, or biology that prevent multiple countries from being idiotic at the same time. Xi says, “We’ll use sledgehammers to break the hands of 80% of our people so they’ll stop buying American gloves,” and we respond with, “OH YEAH??? Then we’’ll use sledgehammers to break the feet of 80% of OUR people they’ll stop buying your shoes.” That is the logic of tariff wars.
Yes, Trump passing a budget this year will be an important part of his legacy and we will have to evaluate the results when they happen.
What he is proposing is good. What his opponent proposed and predecessor did was bad. That's all we know so far.
"can be enormously damaging to economic activity"
So can shutting down the entire economy and forcing everyone to stay home. So can TRILLIONS in part line spending bills under Biden that caused double digit inflation.
A 10% tariff is like a $400B tax or less. My fucking small town charges an 11% sales tax! I bitch about it, but it doesn't stop us from being one of the richest towns in the country. Get some perspective.
"Hand businesses enough uncertainty"
Literally every single building contract my wife signed in 2020/2021 ended up losing money because Biden decided to firehouse the economy with money and prices went up 10%.
"Xi is idiotic to do tariffs"
Xi was already doing "tariffs" before this with capital controls, forced and subsidized savings, FDI limitations, and IP theft.
I happen to think some of these things were idiotic, but we are also enabling their idiocy (as they are ours). Huge trade deficits financing wasteful consumption don't work out well for either the borrower or the lender. It's an unsustainable pattern of specialization and trade that has to pop at some point.
Could it be that the purpose of Trump’s tariff machinations is to prod China into imposing higher tariffs, thus crippling its economy more than it cripples ours?
I’d be willing to bet that it’s more that he likes tariffs. Always did.
Maybe an unintended consequence.
At any rate, I doubt that he sees them in terms of any kind of economic theory, but rather, as somehow giving him an upper hand over other countries. He appears to have that attitude about the law - theory is irrelevant, outcome is what matters.
And I wonder how much he actually cares about the economic outcome. I just have the sense he’s frying other fish.
Why do you want to “close the deficit”? Do you mean the trade deficit or not?
Enjoyed this essay very much
Delighted!
Great explication, Professor. Clear and concise. Thank you.
If I may, there is one other identity that is not as easily described in algebraic terms, but which seems equally immutable: there is no certainty quite so ironclad as the certainty of a presidential advisor who briefly* has the President's ear.
*one hopes it is briefly!
Finally, your description of Smoot-Hawley mentions one phenomenon we are seeing played out right now: the struggle between the Congress and the White House for dominance. I believe the Founding Fathers intended for the Congress to be the more powerful body because it is closer to the voter. But in order to fulfill that role the Congress must perform its Constitutional role, especially the budget-writing portion of their duties. Their abdication of that part of their duties has cost them authority and power, which the White House has gladly taken on.
Again, thanks for today's essay.
The identity you cite is the most dangerous of all! :) And yes, Congress in the 1960s and 1970s set a trio of time bombs on trade. Fortunately, in varying degrees, all the presidents from Truman through Obama were favorably inclined toward free trade. (All of them had their unfortunate exceptions, but those were limited.) In different ways, Trump and Biden have marked a sharp departure from that post-WWII consensus.
"Fortunately, in varying degrees, all the presidents from Truman through Obama were favorably inclined toward free trade."
Only if you define "free trade" is a very odd way, where everyone else is free to engage in all the things we say aren't free trade, just we don't.
The post-WWII consensus is decades out of date and has been in desperate need of change for most of my life.
All disruption is unpleasant, of course, but that doesn't mean it is bad.
This isn't disruption--it's relentlessly turbulent irreducible uncertainty--conditions ideal for tanking an economy.
And yet, it hasn't.
Your problem with that statement was "relentless". It was brief, as expected by anyone not overly committed to a position or too partisan to use their brain, and you got caught up in the moment.
Trump hasn't been in office long enough, even now, for any use of the word "relentless".
"turbulent irreducible uncertainty" - yep, "disruption". It will pass, and most already has.
One problem with this is that I am totally unsure that Congress, as a whole, is anywhere close to the average American voter. They generally merely pander to the groups needed to reassure their re-election. I do not think the Founders foresaw the rise of career elected politicians.
Just think the Capitol in "The Hunger Games" and you'll have a pretty picture of the present-day relationship of Congress to people.
Excellent article. On economics. Tariffs are political acts. You write (as does Arthur Laffer) that flow of goods is offset by flow of capital. That's exactly Trump's point! You see investment flowing in, Trump sees wealth flowing out. Trump doesn't like wealth flowing out. I don't think I do, either. Perhaps you can help Trump, and me, on that point.
Thanks much! Glad you enjoyed it. But I don't think it is Trump's point. I don't see where wealth is flowing out--not in the slightest. Trade in goods, services, and investments are all mutually beneficial. If a German buys a $10m stake in a Texas high-tech company, the Texas company deposits the money, and the bank lends it to a furniture company to buy inventory from Italy for its U.S. showrooms, I'm afraid I don't see any wealth flowing out. The Germans are happy. The Texas high-tech guys are happy--as are their new hires. The furniture company is happy, as are its U.S. customers and its Italian suppliers. And the bank is happy to arrange the transactions. The federal government gets tax revenues from the profits at the startup, bank, and furniture company and from the employees of all three. (I'm fleshing out this example for my next post.) I don't Trump or lots of other politicians understand this. And I know with absolute certainty that his advisor, Peter Navarro, does not understand a single word of it, including "and" and "the."
But we didn’t take the Chinese money and invest it in capital. We blew it on consumption and now we don’t have productive capital with which to repay it.
How you run a trade deficit is important. It’s no different than if you borrow money to start a business versus borrowing to go on vacation.
It’s one thing for say a growing power to run a trade deficit because it’s importing machinery. It’s another to run a trade deficit to finance wiping old people’s asses in nursing homes.
So, you'll be the czar of spending, ordering Americans to buy what you think they should buy.
I in fact don't want my children being taxed to pay interest to the Chinese because the government decided to spend money wiping old peoples asses in nursing homes. I don't like the government telling me that old people ass wiping is what I have to "buy".
Your "you" and "we" doing an awful lot of work there. What you really mean is everyone else is not doing what you want.
Thank you for an extremely clear exposition.
And thank you for sharing your thoughts!
Let's go back to November 4, 2024. The U.S. has:
1) $36T in debt
2) $9.2T in treasuries that have to be refinanced in 2025
3) A supply chain dependent on China for critical components for defense and healthcare
4) IP stolen over decades from American entrepreneurs and innovators
5) A political establishment that is stealing from its own citizens
Fast forward to pre-tariff March, 2025 and you have carte blanche for the U.S. economy.
Please tell us what you would do.
#3 is easily fixed with a "Buy American" for defense industries regulation.
#4 assumes IP is a real thing, and that no other country including the US has ever ever done such a thing.
#5 is the norm for all governments.
Drop all tariffs to zero.
Get rid of as much regulation as possible. 90%, 99%, that's just a start.
Stop wasting taxes on wokism, climate change, redistribution to states and local governments, and other nonsense.
The point of these last three is to let the economy boom.
Say you're going to do something about Social Security, Medicare, railroad pensions, and other Ponzi schemes, and start some serious studies. I have one scheme, which basically boils down to:
* Continue FICA taxes to pay off existing pensions.
* Add a temporary 4% FICA "nest egg" tax which goes directly into indexed mutual funds owned by the contributor.
* As pensioners die off, start paying excess FICA tax into the nest eggs of those who have already paid FICA for 10 or 20 years so they get an appropriate boost. This makes me think the FICA tax could start winding down and be gone in 20 years, but I have no calculations for that, it's just an unscientific wild assed guess.
I am no economist or financier. There's a lot of details. But I wrote a little program to see how much of a nest egg I would have at retirement if my FICA deductions had been invested in Dow Jones or S&P 500 indexed funds, starting every year since the S&P 500 was started in 1926, and the average nest eggs provided enough principle that a 5% annual withdrawal would have been 3 (DJ) and 5 (S&P) times the SSA pension. That's where the 4% FICA "nest egg" tax rate comes from. Average annual returns for the indexed funds for the previous ten years had been 10% (DJ) and 13% (S&P) leaving plenty of scope for emergencies, bad years, and standard 2% inflation.
Great stuff. Your analysis is mostly spot-on.
Heh. Even the FICA nest egg scheme? I tried factoring in inflation and taxes and decided the heck with it, it's good enough for plausible fiction, and no one who could take the ball and run with it would. I haven't updated it for several years.
I said "mostly" do give myself plausible deniability. :)
If you can buy a defense component from an ally—Canada, say—for less than the American equivalent, why should you not?
IP is a real thing, as much as any property is; and others’ peccadilloes in that respect do not excuse Chinese crimes. The remedy is not obvious, but the problem cannot be denied or excused.
I disagree. IP is a fraud.
* It didn't exist until monarchs first, then democracies, created it out of thin air, and they twiddle with its definition all the time. Contrast that with physical property.
* You can inherit physical property. You can't inherit patents. Children and grandchildren can inherit copyright royalties, but only for limited times, 50 or 70 years after death.
* Why should material copyrighted at age 20 have 50 years more protection than something copyrighted at age 70, and why should works from an author who dies at age 20 have less overall protection than from an author who dies at age 70?
* Copyright does not apply to everything. You can copyright music and words, and pictures of nature, but not mathematical formulas describing nature (E=mc^2).
* Word copyrights apply to near copies, but while you can copyright a picture in a tour book, you cannot prevent tourists taking pictures from the same spot which are indistinguishable. But if one of those tourists publishes his own book with his own picture from that same spot, is that a copyright violation?
And so on. As to why I do not fear a world without patents or copyrights, and why I do not think patents spur innovation, you can find any number of examples where patents stalled progress.
* The Wright Brothers developed their plane better than everyone else in the world. Their demonstrated control at the 1908 Paris air show stunned everyone else. Yet they sat back and waited for customers to show up and never again did anything to improve their product. They ended up in a ferocious patent battle with Glenn Curtis over whether his hinged ailerons violated their wing warping, stalling his progress while they still sat on their keisters doing nothing, and the battle was only resolved by the US government buying or stealing their patent to they could build airplanes for WW I.
* James Watt had a patent on steam engines, yet did not know how to make boilers strong enough for portable engines for railways or ships, and fought everyone else who did know how and tried to sell them. The first steam ship was built in the US because his patents did not apply there.
* Rollin White (revolvers), Eli Whitney (cotton gin), Laszlo Biro (ballpoint pens) are others who had patents which did not help them.
And then there is the old rhubarb about progress stalling without IP. Besides asking why Mozart and Beethoven wrote music and so many things were invented before kinds granted patents ...
* Copycats only copy products which have proven to be successful, leaving the copycats perpetually two generations behind.
* Reverse engineering takes time and resources away from independent research and development and does not generate the same institutional knowledge.
* Perfect copies cost just as much as the original to manufacture, distribute, and sell.
* Perfect copies marketed as the original are fraud for pretending to be something they aren't.
* People who buy copies expect lower prices, which reduces profits and quality, and impacts their brand reputation.
* People who buy cheap copies are unlikely to have bought the more expensive original.
* If the originals are not worth their higher prices, then they are a fraud imposed on the public and the copycats deserve to be rewarded for breaking their monopoly.
* Why do so many people pay extra for autographed books?
* Why do people pay millions of dollars for original paintings when cheap copies are available?
There was a story 10-20 years ago about someone who claimed to have found a way to reproduce Gucci (or some other overpriced luxury brand) quality under his own brand name for a tenth the cost, yet no one would buy it because it didn't cost enough. He had to raise his prices to Gucci level before his product would sell. I have no idea what "Gucci quality" means, but it was apparently a real thing, according to this story.
Someone, possibly Hilary Rosen, head of some copyright lobby association, gave a speech, maybe 30 years ago, decrying libraries which loaned out copyrighted material without paying royalties. She said a lot of other silly things in that speech, but my Google-fu fails me. What I mostly remember was the silly jokes about being illegal to sing in your shower or car, about having to buy a separate copy of every book you wanted to read to your children, of being illegal to quote movies ("I'll be back" in Arnie's accent), of having to be brainwashed after reading a book or seeing a movie so you couldn't remember it, and so on.
And that is only the beginning of my rant on why I believe IP is a fraud.
Land existed before man. Private property in land is as much a gradually evolved act of law as private property in ideas. The tenure in either can be as long or short, and as strong or weak, as the lawmakers please.
I myself think abrupt changes to property law are seldom wise; and strong property laws are usually better, because they lead to the productive development of more property. But lawmakers, including voters, often have different priorities than mine.
Your arguments about duration have been raised about both, and I see no principled way to answer for one kind of property that doesn’t apply to other kinds.
Oh, yeah: you absolutely can inherit a patent, and enforce it. We seldom hear of it because utility patents expire in 17 years, and inventions in the last 17 years of life are fairly rare.
One of the tremendous economic problems in West Africa was a persistent belief that land should be held communally. Nearly identical to today’s anti-IP arguments. As a consequence, no one owned any worthwhile collateral for funding entrepreneurial ventures. I have no doubt that certain kinds of IP have too long a timeframe. (See the finally extinguished Steamboat Willie IP tenure—the notion that copyrights out to linger long enough to keep Mickey Mouse’s IP extant.)
When you compare the potential value of developing a work of art and owning its commercial exploitation in perpetuity (subject to voluntary alienation, of course) against the potential value of parodies and knock-offs of Steamboat Willie and his like, I think it far from obvious that the balance favors the latter—for much the same reasons I would defend the tenure in fee simple absolute of land. Collateral for enterprise is significant among them.
I don't think the IP and tangible property arguments are the same. Tangible property ownership is control more than possession. "Self-ownership" itself implies property. I control homesteaded or bought land with a fence. I control my house with doors. I control a chair by not giving it away. If you want to think of IP as property, protect it by the same rule — keep it to yourself, don't give it away, and it remains your property.
There are ways to protect secrets. Sign a contract owing a billion dollars to see the Coca-Cola or KFC secret recipes; the debt expires on your death and becomes due the instant you disclose the secret. Don't need copyright laws for that.
I tried once coming up with a way to have more flexible patents.
* You invent something. Write down how to reproduce it, along with a royalty schedule and a time limit. Then start producing and selling it.
* If no one reproduces it within the time limit, the patent expires. Either the product was not worth reproducing for the royalties, or the description was incomplete, or would-be competitors decided to wait out your time limit.
* If someone does reproduce it within the time limit, that establishes how long the royalty period lasts, say 10 times as long. Anyone can reproduce it if they pay the royalties.
* The patentee's incentive is to either have a monopoly for the short time limit, or encourage copycats for the longer royalty period.
* Copycats' incentive is to either be first and fast enough to keep the royalty period as short as possible, or reproduce it internally and be ready for full production the instant either the time limit expires with no one reproducing it, or when some other copycat reproduces it earlier and starts the royalty period.
* A patentee who sets a long time limit, like 100 years, must think it's a really hard design to copy, or that it is such a trivial product or improvement that no one else will want to copy it. But this seems like a weakness, and maybe it would be worthwhile having a time limit limit, like one year or five years.
* No patentee will set a really short limit, like one week, because the royalty period would be similarly short, and it's more likely copycats will just ride it out and let it expire.
I never did finish polishing it up. I just don't believe in IP.
We have something similar in our country. Land on American Indian reservations is held communally by the tribe. An Indian who wants to build a house on a reservation can't pledge the house to a bank as collateral on a mortgage.
We should be making chips, and military software and hardware right here at home, in secure access controlled factories. Any place else, it is too easy for bad actors to get inside the supply chain.
Also having worked on the buy American act in the federal government, it leaks like a sieve. Any idea how that would apply to a jet fighter with a million different parts? Answer, it doesn’t. It’s kabuki paperwork.
How is that related to tariffs?
Chartertopia
Chartertopia’s Substack
14h
Edited
“#3 is easily fixed with a "Buy American" for defense industries regulation.”
Let's start with what I won't do: announce a bizarre set of nonsensical tariff rates on every country in the world, moving the rates up and down like 200 different yo-yos all at once, spook the markets, punish countries that are doing everything right, reward countries that are doing everything wrong. And which leave the nerves of business frayed and frightened for where the yo-yos go next. And which forces friendly countries to do MORE business with China because we have become and expensive and unpredictable trading partner.
I agree that we shouldn't be so dependent upon for critical defense goods. So stop buying defense goods from China.
IP theft is a problem. No logical reason why tariffs should fix that.
Which political establishment is stealing from its citizens? China's or ours?
China doesn’t have citizens so, trick question.
?? Of course they have citizens.
Well, that is where we might disagree. What defines citizenship? As opposed to being a subject or a slave? Does the government of China meet those qualifications, or are the majority in China essentially serfs?
Citizenship is a legal definition. Like their life or not, they're citizens. There are two many valid criticisms to make without heading down this cul de sac,
I started reading this essay and almost immediately found myself in difficulty trying to make sense of it.
Let’s call [1] “How each person uses his income”. There’s no logical reason not to include buying imported goods in C, though if you want to break it out as a separate category you would add +M to the equation.
Then we could label [2] “How each person gets his income”. All of these items boil down to selling goods and services (call it W, not
ncluding exports), investment income, payments from government, and borrowing. Again, no real reason to break out exports as a separate category.
So if you insist on writing an equation, it should look about like this:
C + S + T + M = W + I + G + E
C absolutely does include the purchase of imported goods, as do I and G. That's why you add X (payments coming from foreigners) and deduct M (payments to foreigners). So there's no need for your W. And I have no idea what your E is supposed to be.
Probably energy.
One more try for you:
Here's the spending side
Y: American income/expenditures for the year
C: Our spending on consumption = Cd+Cs
(Cd purchased from domestic sources; Cf purchased from foreign sources)
S: Our saving (all of our non-tax spending that isn't consumed that year)
T: Our taxes (including levies, fees, tariffs, etc.)
Y=C+S+T
Now, let's equate that with the income side:
Producers sell consumption goods & services, investment g&s, and government g&s
Y: American income/expenditures for the year
C-Cf: portion of consumption g&s purchased from Americans
I-If: portion of investment g&s purchased from Americans
G-Gf: portion of government g&s purchased from Americans
X: American income coming from foreign purchasers, so not part of C+S+T
Now, Y = C+S+T = C-Cf+I-If+G-Gf+X
M: (Imports) equals Cf+If+Gf. American purchases from foreigners; not American income.
Now, Y = C+S+T = C+I+G+X-M
Economists disagree with one another over everything, but not over this. They argue about how you should measure these variables. (e.g., Is college tuition consumption or investment?) They argue over the policy implications. But they don't argue of the accounting system.
Hope this helps.
(Sorry, typing mistake on my phone)
Not really very useful. It just looks to me like you’re conflating things that aren’t at all identical.
We'll just have to disagree.
The answer as to policy is to reduce regulations and increase energy production to decrease its cost. We can then grow our economic pie while reducing our budget deficits. The trade imbalance is always offset by foreign investment. As a non-economist I’m not sure I’m correct but I do know that increased economic activity here and increased jobs makes for a happier population. A small anecdote: my friend lost his job a number of years ago as a plant manager he said his workers, while making much more per hour than the foreign competition were so much more efficient they out produced the foreign workers at the same company overseas. His factory was closed because governmental costs made his factory non competitive. Maybe we will learn that lesson in Washington but I have my doubts.
Here's a simplistic example to illustrate it what is missing in this analysis.
We used to make our own military hardware worth $1t, but over time we let Buttfukistan supply it for us. Given Graboyes' identities, holding private investment and government deficits even, that would mean the following:
1. We would stop making military hardware.
2. Buttfukistan would sell us $1t in military hardware.
3. With that money, they would buy $1t of our farmland and breweries.
4. When war comes, the stop selling us missiles and they have control of our food beer supply.
5. The "balance" is maintained in terms of cahsflows.
6. We lose the war.
Any economist would tell you that 1-5 is not an economic problem at all. But, they might have to write that analysis in Buttfukistanese.
--
None of this is missing from the analysis. The analytical framework is extraordinarily flexible as to the questions its capable of addressing.
--If you're worried about our access to military hardware in a war, pass a law that says, "We're not buying military hardware from China." And add to it, "Oh, and if you start a war, our Army will seize the farmland and breweries that you purchased here in America."
On December 6, 1941, Germany and Japan owned loads of businesses, patents, real estate, personal property, restaurants, banking agencies, vineyards, silk caches, bakeries, and importing firms here in the U.S. After Pearl Harbor, Germany and Japan didn't own these things any longer. In a world of international trade and cross-border investments, one reason to avoid war is the knowledge that your valuable properties will be seized the moment the first shot is fired. Ask the Confederates about this, while we're at it.
The Liberation Day tariff approach is, "Hey, wowza, China's dangerous, so let's put a 25% sales tax on our purchases of nukes from them. No WAIT--a 125% sales tax. No WAIT, let's negotiate on the sales tax. And while we're at it, let's put a 46% sales tax on purchases of chairs from Vietnam--thereby killing the American market for Vietnamese chairs and forcing them to sell chairs to China. And let's wreck our reputation with the rest of the world as a reliable, predictable trading and investment partner. And let's crater our economy so we can't afford to manufacture those nukes here in the U.S. of A."
The analysis I presented here is at the heart of the National Income and Product Accounts (NIPA). The reason the NIPA was developed is telling. The federal government was grappling with the Great Depression. But then, the big push came when WWII broke out, and policymakers wanted to have a coherent view of economic realities, rather the head-up-the-ass running-in-circles fire drill that led to the Smoot-Hawley tariffs. And it worked, by the way.
There's a very good argument to be made that these identities won the war against Germany and Japan. Their war efforts were hampered by slipshod, economic improvisation, while America and the Allies had a focused, logically coherent, internally consistent method for estimating how we could best use our resources to win the war without bankrupting our population.
When Hitler put a bullet through his own brain, a strong contributing factor was the incoeherence of his economic management.
Hitler's economic policy was coherent but it made war inevitable. He had spent 92% of German gold reserves in four years. He had reduced unemployment from 34% to 14% through vast increases in government employment but half the work force was still below the poverty line. They could ill afford a tax increase. He enacted price controls to protect the working poor but the price controls created shortages, as price controls generally do. Imports quickly dried up. He could not build up exports without devaluing the mark to compete with the devalued British pound and American dollar, but a policy of inflation wouldn't fly in a country which keenly remembered the hyperinflation of 1923. Germany eventually had just two months' supply of raw materials for rearmament and had little foreign currency left. Debt was rapidly compounding as the government increasingly relied on short term loans. Hitler could either go out of power or go to war, so he launched the Second World War. Source: "Hitler 1889-1936: Hubris", by Ian Kershaw
Hitler's policy was coherent for a government that lacked the analytical tools America was developing. The National Income and Product Accounts (which is what this whole essay is about) gave the U.S. a strategic advantage over the Axis Powers is taking the greatest advantage of our economic potential. Somewhat related to this was the development of the Simplex method--a set of tools for maximizing the efficiency of resource allocation. While not fully realized till the start of the Cold War, Simplex development was classified info during WWII. I can pose a question of whether this development or the Manhattan Project's development of the A-bomb was the more important technological development in finishing off the Axis.
If worried about access to any military needs not obtainable from Allies, a subsidy to incentivize producers to produce needed supplies would be a better way to go about it than via a tariff.
And yes proper resource allocation is underestimated as to its importance.
So you’re saying instead of imposing draconian tariffs on China, we’d be better off imposing import quotas and other non-tariff import barriers.
Probably. On selected goods. I wouldn’t go tariffing laptops and food and rugs and such.
What is the possibility that Trump’s tariffs aren’t about reducing the trade deficit or raising income through tariffs? Might he be using them as ammunition in a global economic war whose main purpose is to damage and possibly neuter China strategically, politically, economically, and by extension, militarily? It seems to me the purpose of the 100-country tariff tactic is China’s isolation, I.e., forcing other countries to choose between the US and the PRC. Is it coincidence that the countries most interested are all threatened by China: Taiwan, Australia, South Korea, Vietnam, and Japan?
From what I can see, the structure of those tariffs will drive countries toward. Gina, not away from China. The kind of guesswork you’re suggesting is precisely what markets cannot cope with. Firms can deal with risk, but not uncertainty—which is something entirely different. It’s groping in the dark, trying to guess what the hell he’s thinking. I wrote an earlier piece about the extreme uncertainty over what he wants to do on tariffs: https://graboyes.substack.com/p/the-gulf-of-trump
Theory F seems closest to what I described.
Reagan did something for us
Something that simply mystifies us
Why not simple to suss?
It has the pow’r to hypnotize us
Let us live ‘neath his spell
Do do that voodoo that he did so well
For he did something for us
That nobody now will do!
I am aware that Reagan was not, except by comparison, a paragon of free trade; but I had to ignore that to make the lyric work.
My non-political free-trade hardliner friend Don Boudreaux just write a paean to Reagan's relatively unique comprehension of the importance of trade: https://cafehayek.com/2025/04/ronald-reagan-in-1982-on-free-trade.html. Don't post has a brief video of Reagan discussing free trade, which Don introduced as follows: "When President Ronald Reagan delivered this address in November 1982, I was a 24-year-old graduate student. Radically libertarian at that point for almost six years, I was sufficiently astute enough to know that Reagan wasn’t terrible on most of the issues that I cared about, but I was nevertheless insufficiently mature and astute enough to appreciate just how superb Reagan was for a man who achieved the office of U.S. President. Compared to any president since he left office in January 1989 – and certainly compared to the ignorant, capricious, and unprincipled current occupant of 1600 Pennsylvania Ave., NW – Ronald Reagan was an Adam Smith, a Bastiat, a Milton Friedman."
Undoubtedly the wisest statesman of my lifetime.
My encomia were qualified because, as a working politician, he had to make compromises of which we private citizens have the luxury to disapprove.
The main error that is made here is that Trump is using the tariff issue as a purely Mercantilist way. He is also using it as a geopolitical level. For many years the USA has imported goods from around the world with low or zero tariffs while most other countries are using tariffs and other methods to limit USA imports into their own countries. I believe that Trump's goal is to force these countries to remove their tariff barriers which is why he is using reciprocity with respect to the tariffs. There are also national security concerns with the di-industrialization that has been going on. You do not really want to be in a position in which international supply chain disruptions will leave you with a collapsing economy and society.
Good comments.
In the previous article I wrote: “Here’s the one and only legitimate defense that one can muster for Trump’s April Tariffs—that they are specifically designed to look insane and cataclysmic, thereby scaring the world into eliminating tariffs altogether and moving to a regime of freer trade. … … I doubt that this explains the April Tariffs, but if this is what happens, I’ll tip my hat, admit I didn’t see it coming, and say ‘thanks.’”
So yes, I recognize that possibility, also wrote about it my earlier “The Gulf of Trump,” and very much hope that’s the plan. Right now, I doubt it, but I’m happy to hedge my bets.
As for military supply chains, I’ve discussed that elsewhere in the comments, so look around a bit if you have time. The short version is that if that’s your fear, don’t assume a sales tax will protect you from th problem. Just ban defense purchases from China.
Good point and very well considered. But please do consider this. Tariffs are simply another version of 'Consumption Taxes.' And I do recall libertarians, certain conservatives, and some followers of Bastiat being quite in favor of 'Consumption Taxes' - as opposed to Income Taxes. Regressive Taxes, pure and simple, the more one buys and uses (consumes), the more one proportionately pays. I consider "Consumption Taxes" the following. First and foremost, the notorious Value Added Taxes, (VATs) used by about EVERY COUNTRYIN IN THE WORLD EXCEPT THE UNITED STATES. In Europe they are generally north of 20%+!!! Know this for a fact - lived in VAT world for a long time. Add to that, counterintuitively, "Corporate Income Taxes" (they are paid by the customer - the Corporate Income Tax is, in effect, a business expense (long time in accounting and cost accounting worlds in my career).
To round it out one gets Payroll Taxes (pure regressive taxes) and US Sales Taxes. A tariff and a VAT are "EXACTLY" the same thing. The reasons for their being imposed on the surface different, but the exact same results. I Germany or Swedeen - EVERYTHING ONE BUYS OR SERVICE THEY USE, they pay a 23% premium (vat tax) hidden in the sales price of the goods. If one includes VATs and high Payroll Taxes, and high Corporate Tax Rates are considered as Tariffs, which is what they really are - then on average, as of 2025, the United States charges LESS tariffs on their imports than our Trading Partners charge on our exports. Simple fact - and most people don't even know this - gee whiz - I wonder why.
I'd be delighted to switch from the income tax to a VAT. My fear is that we would get both. Yes, those of a classical liberal bent (like me) tend to favor consumption taxes--but not taxes where a single individual in invested with the power to apply radically different rates to different sellers and different product--completely on whim and subject to seismic changes whenever it suits him. That is the nature of Trump's tariffs. It's a terrifying power that Congress handed, in stages, to Kennedy, Nixon, and Carter, and Trump is merely the most enthusiastic holder of that power.
I also believe that Trump is trying to push all of these countries into a block opposing China and their specific brand of trade and corrupt mecantilism. I would also suggest that one of Trumps purposes with his engagement with Russia is to try to separate them from China.
So, wreck trade relations between America and all of these smaller countries, while China sits, poised to milk its people dry to curry favor with the countries now watching their economies hammered by American tariffs. As the Internet meme goes, "It's a bold strategy, cotton. Let's see if it pays off for 'em." https://www.youtube.com/watch?v=9HVejEB5uVk
A little bit emotive there mate you may need to take a breath. I believe that Trump has started a process to have all of the USA trading partners arrange deals that can get some tariff equalizations to diminish the tariff differences between their countries and the USA. I do not understand why most of the countries on the planet can have large trade barriers against the USA but the USA is evil for wanting some for themselves. The EU is one of the biggest problems here with trade barriers other than tariffs in place. Most of these countries are now engaged with the US in this process. I believe Trump is trying to sort this out in order to isolate the Chinese. One issue that I am sure that will be discussed in how China uses any of these countries to trans-ship goods to the US thereby avoiding tariffs.
As the biggest customer for most of these countries if the US can arrange deals to allow them to still trade and prosper while China is excluded then China's economy could be in serious trouble and they will need to negotiate with the US on Trump's terms. If all of this can happen then it may become advantagous for Russia to begin to also delink from China if the right conditions for re-engaging with the West are put in place. This may also help to derail the further development of BRICS.
There are a lot of ifs here but having watched Trump for many years, in business as well as politics, and read his books it is the sort of long term strategic thinking he does.
Again, my main point still stands. It is short sighted to look at what is happening on a single issue basis such as "just tariffs". I am sure Trump and his advisers area as fully aware of the issues with tariffs if misused.
Bingo!
Really nice article - and Bastiat is one of my favorites, and I would say most influential economists ever. And in perfect world of humans that dealt logically and with good faith in all things - profound worlds indeed. And they are highly useful.
But, alas, we do not live in a perfect, laboratory controlled, world. International trade is NOT about logical people of good faith, sitting around trying to maximize the incomes and wealth of all the citizens of the world.
True, there is an element of logic, but also some vicious competition and advantage seeking, and like a good game of 'poker' - lots of lying and bluffing. Some of the players have 'destruction,' not 'construction' in their minds. International trade is a continuation of war for them. If one can take advantage of someone in the short run, they will. And in the end, WHERE things are made matters. So please, stop trying to treat the profound and vital works of Bastiat like the writings of Karl Marx. Bastiat never claimed to have a time machine.
Take ship building. It's true that other countries can build ships cheaper than the United States in 2025. We have pretty much let our ship building prowess slip away over the years - comforted by the mantra of free trade. China's shipbuilding capacity now dwarfs that of the United States. The United States is historically a naval power, the greatest naval power since the end of World War I. The greatest naval power ever. We are in an existential struggle with China and the CCP over all of the Western Pacific region. The country that can build the most and best ships will win the war. But his seems to somehow go by the purist in Bastiat's world. Wake up. It's not quite as simple as your equations make it sound. Once again - Bastiat was simply giving his most resound opinions based on the facts as he saw them. And he was profound and brilliant - one of the greatest and most useful economists to ever live. So sad that he died relatively young. But he never claimed to be Karl Marx who had a 'time machine' - had converted economics to a hard science - and knew the future. He didn't predict the future - he knew the future - OR SO HE THOUGHT!!!!!
"But, alas, we do not live in a perfect, laboratory controlled, world. International trade is NOT about logical people of good faith, sitting around trying to maximize the incomes and wealth of all the citizens of the world. "
And this is a best summary of the issue that I have seen.
All the rigorous mathematical analysis in the article above utterly ignores this.
The rigorous mathematical analysis above ignores not one iota of this. As I said to the commenter whom you quote, "It is the pro-tariff crowd that emulates Karl Marx in its faith that smart politicians can know the future and manipulate its shape via tariffs and other clumsy tools."
The "we do not live in a perfect, laboratory controlled, world" is the standard point of departure for socialist tendencies--of which tariff-based industrial policy is nothing more than the flavor of the week. Bastiat, like Adam Smith and David Ricardo, was under no "purist" delusion of the world. (And I am under no such delusion, either.) At one level, the world is, indeed, as simple as the the equations I shared here. Once stated, one can argue endlessly over how best to measure the variables involved and which policies to apply to this system. But the four identities presented above are merely a check on the baser instincts of those who deign to control the economic interactions of hundreds of millions of people. No matter how smart, no masterful a negotiator, Donald Trump cannot devise any scheme that will result in both a net flow of capital investment into the U.S. and a reduction in the U.S. trade deficit. And the four identities also clarify why tariffs will almost never generate economy-wide economic growth. It is the pro-tariff crowd that emulates Karl Marx in its faith that smart politicians can know the future and manipulate its shape via tariffs and other clumsy tools.
"No matter how smart, no masterful a negotiator, Donald Trump cannot devise any scheme that will result in both a net flow of capital investment into the U.S. and a reduction in the U.S. trade deficit."
Yes, by definition, that is correct. It is also useless. Our goals in the situation don't actually care about any of that. At all. We want things to happen here so people have good jobs, so the actual economic activity benefits the people who live here. Whether that's foreign investment here or domestic funds choosing to invest here instead of elsewhere is irrelevant to almost anything except your math.
"And the four identities also clarify why tariffs will almost never generate economy-wide economic growth."
You are ignoring human behaviour. People don't care about your math.
The events of the world, since you posted that, are proving you wrong, rather actively. Tariffs themselves are indeed a "clumsy tool", but they can still get people to change behaviour, which is what was needed.
"It is the pro-tariff crowd that emulates Karl Marx in its faith that smart politicians can know the future and manipulate its shape via tariffs and other clumsy tools. "
Tariffs can indeed manipulate the shape of the future. You believe this just as much as I do, or you wouldn't worry about them. Should you compare yourself to Marx now?
Not perfectly, of course, but incentive structures are really, REALLY easy to understand at the most basic level.
Previously, make a car factory in Mexico, where it costs X to make a car, then ship it to the US (nearly free), or make a car in the US where it costs 1.2X to make a car. Duh.
Now, make a car factory in Mexico, where it costs X to make a car, then ship it to the US and pay a tariff (that costs .25X) or make a car in the US where it costs 1.2X to make a car. Again, duh.
Obviously, I grabbed those numbers from nowhere, but the general point stands. And what happens to the economy? Well, the money that would have been paid to workers in Mexico goes to workers here. Considering how much of the cost today is labor, that injection into our economy is more than the cost of the higher prices. (Or at least, that's the goal - you are correct about politicians generally sucking.)
Before, ALL the money paid for the car went elsewhere. Now, even if the factory is foreign investment, only the profits go elsewhere. Everything else stays here, part of OUR economy.
How is this hard to understand? Where do the large majority of people get their money? From a job. What drives our economy? The spending of the average Joes. Better jobs = more spending. If that spending is going to pay workers in another country, that's a loss. If it's going to pay workers here, it's a win. (*OBVIOUSLY* oversimplified, yes. Comment is already too long.)
The point of tariffs is to keep them from getting paid as much as possible. To change human behaviour in ways useful to the country imposing them.
(That's not to say that they can't be used badly. Every tool can be used badly.)
They definitely change human behaviour. Whether that works out as desired is difficult, of course. If you have a private-market, non-governmental means of doing this (when most of the reasons to NEED to do this are because of government action in the first place... see the next point), feel free to expound.
The other thing you are leaving out with tariffs is that they act to re-add the costs we apply to ourselves to countries that don't apply that to themselves. For maximum oversimplification, we have OSHA, and China doesn't. Moving our manufacturing to China lets us still pay prices as if we were using slavery, peony, and sweatshops while pretending we don't use them ("That's China, not us!" we tell ourselves).
That's dumb and dishonest.
As best I remember, the Laffer Curve stated a counterintuitive argument that a reduction of the corporate net profits tax rate would provide an increase in federal income. Lowering taxes would result in more income was the voodoo part.
Perhaps you should have at first refreshed your memory, because that explanation isn't even close.
Here's Google's AI explanation, and maybe you can expose your purported counterintuitive argument from it:
The Laffer curve posits that at extremely low tax rates (near 0%), the government collects very little to no tax revenue. As tax rates increase, the tax base (the amount of income and wealth subject to taxation) may initially increase, leading to higher tax revenue. However, beyond a certain point, higher tax rates can disincentivize work, investment, and other economic activities. This can reduce the tax base, causing the total revenue to decline even as the tax rate increases.
Read my response.
The Laffer Curve refers to taxes in general, not just corporate taxes, and no "voodoo" is required. You already understand the basic concept of the Laffer Curve, even if you think you don't.
It has 3 parts:
- At 0% tax rate, there is 0 tax receipts - no money going into the treasury.
- At 100% tax rate, there is 0 tax receipts - no money going into the treasury. (OK, at 100%, a few people might still pay in some... bump the number to 200%, or whatever number you like.)
- In the middle, there are tax receipts - actual money going into the treasury.
This means there is a "curve" with zero at both ends. The actual shape of the Laffer "Curve" is unknown and much debated - it could have multiple peaks and valleys, or just be a simple, nice "curve" as named. Probably impossible to ever know for sure, as any changes take significant time to work through the system.
But I can say with some significant confidence that we are on the wrong end of the Laffer Curve for increasing rates to actually increase receipts. Every major tax RATE cut in my lifetime has resulted in increased tax RECEIPTS in short order, so it's not close.
THe mistake during the Reagan years was assuming that we were on self-destructive side of the Laffer Curve and that tax rate reduction would raise revenues. The logic wasn't wrong, but the point of the curve was a matter of faith, not of adequate data.
Adequate data has thus-far proven to be impossible to have before hand. You make the changes and see what happens.
And since every major RATE cut in at least my adult lifetime has resulted in higher REVENUE, I'm going to assume we're on the wrong side, always and forever... until we get a rate cut that *doesn't*.
At that point, sure, let's discuss stuff - we're at least in the ballpark. At this point, the data we have shows us that every single rate cut *except the last one* was still not enough.
We won't know about the last one until we do another one... or someone develops some massive breakthrough in understanding the Laffer Curve, which seems, frankly, impossible due the massive number of factors that inherently we can't have a control group for (since we only have one reality to try stuff in).
It was voodoo to George H.W. Bush, but it was not voodoo to logic. The nature of the Laffer Curve had been known for centuries and is not much in dispute as a concept. In 2023, Bastiat's Window published an article by Grace-Marie Turner, who was in attendance when Laffer created the curve that would ultimately bear his name. As the article notes: "affer noted that the concept behind the curve had been articulated in different forms by Ibn Khaldun in the 14th century and John Maynard Keynes in the 20th century. He credited future Nobel Laureate Robert Mundell (whom I wrote about a few weeks back) as the source of his ideas. Others have noted that antecedents can be found in the writings of Adam Smith in the 18th century and Andrew Mellon in the 20th. But Laffer’s impromptu sketch made the opaque intuitive, and so it is his name that is forever attached to the idea." In fact, Adam Smith's treatment of the future Laffer Curve dealt with the optimal level of tariffs. Read the rest of the story here: https://graboyes.substack.com/p/birth-of-the-laffer-curve
Interesting essay. There's one thing I don't quite understand. Perhaps you can clarify for me.
"Y" is Gross Domestic Product: what a country produces in its borders in a given time period. Ignoring Net Exports for the moment, C+I+G are what we do with what we have produced. Tweaking C or I or G will not affect Y; it will affect the other areas to which Y is distributed. (This is, I believe, a fundamental mistake that government makes when it tries to "stimulate" the economy. More "G" does not cause more "Y". It simply reshuffles Y's allocation in C, I, and G.)
In Table 3, how does the implementation of tariffs cause GDP to decrease? One thing that could happen, as we go from Table 1 to Table 3 is that C increases by $1t (the tariffs are passed to the consumer) and M goes up by $1t (the imports are more expensive). On total GDP, that is a wash. On the C+S+T side*, C goes up, S goes down, another wash. Trade Balance goes to -2, Private Saving goes to 0, Government Budget remains at -2, overall a wash. GDP stays at 29.
Furthermore, the essay seems to overlook that we are in a world economy where other countries tariff US goods, and the US doesn't tariff their goods at the same rate. One possible outcome of Trump's tariffs could be an increase in X, as US goods become more affordable to foreign buyers.
The lower S caused by the tariffs could have a dampening effect on future GDP. But even that could be offset if X increases.
I'm sure I'm wrong. I just don't see where.
*Shouldn't that be Americans' Spending, rather than Americans' Saving?
Great essay, as usual, Robert. I will be using this essay tomorrow in my ECON principles class. These identities cannot be ignored, but the stories we tell around them are complex. One missing piece that I think is mighty important is that Y also equals aggregate production of goods and services. How increasing tariffs affects aggregate output is a big deal, both in the short run and especially in the long run as investment is likely to to fall through the floor.
Now, if only I could somehow get my students to read this essay and begin to ask good questions about the stories we can tell around them ... hey, I can dream, can't I?
David, I also considered using the article in my Principles classes. I got hung up at the same place you did: in the short run, how do tariffs affect Y?
This is the same concern I have with macroeconomics as taught today. There seems to be an assumption that the equation Y=C+I+G+NX is an equation that runs in both directions, so that Y can be increased by increasing G. I tend to believe that increasing G comes at the expense of either C or I or both, leaving Y unchanged.
Government "stimulus" programs make the economy better the same way heroin makes the body feel better: only in the short run, with long-run damage.
The essay acknowledged that the identities do not preclude the possibility that a tariff could, in theory, boost national income. But, it went on to note, assuming that is the case requires additional, far-fetched assumptions (e.g., insensitivity of consumption and saving to levels of taxation). And, the essay suggests that historical examples of tariffs boosting national income are few to non-existent. The equations do not REFUTE the case for protectionism—but they make the case an extremely heavy lift.
Thank you. I'm not sure I was arguing that tariffs would boost national income in the short term. Rather, I tend to view Y as pretty much constant in the short run. So, tariffs would cause C to increase, since the price of M has increased; this could be offset by an increase in X (if the tariffs drive other countries to lower their tariffs on US goods) and/or a decrease in I (as Americans lower their savings to pay for the increase in C) and/or a decrease in T (as some taces can be reduced due to tariff income to the government.)
In the long run, to the extent that tariffs drive up C and drive down I, GDP will grow at a slower rate, so future Y will not be as large as it would have been without tariffs.
The tables in your essay seem to assume that Y would be affected by tariffs in the short run, rather than the effects of tariffs being absorbed by the other categories into which Y flows. Unless I've misunderstood, which is a distinct possibility, and the reason I ask the question.
My tables don’t say which variables will change—just that their movements are constrained by one another.
Seems to me that the outcomes of protectionism are many. Won't it depend on what outcomes, over what calendar runs, and over what economic runs Trump has in mind? I wish we truly knew what outcomes are intended. I personally cannot say that I know.
The identities are a useful framework, because they are identities. The behavior of people must be filled in by the stories we tell. Tariffs are taxes. Taxes increase market prices. Tariffs are differential taxes, which means that relative prices can and typically do change. All the variables on the RHS of the identities are potentially in motion.
Calendar time makes a huge differences. In the very short run, Y is fixed. How long is that time? You tell me; I don't know. The stories we tell are so incomplete that it's hard to say what happens to any of the variables involved in the identities. All we know for sure is that the identities are true mathematical statements.