A paper published by the National Bureau of Economic Research in 2019 sheds much-needed light on how President Donald Trump’s tariff strategy may play out—and what the president is trying to accomplish.
In his paper, Douglas A. Irwin of the Dartmouth College Department of Economics examines “the broad changes in U.S. trade policy over the course of the nation’s history,” with special attention to the effects of import tariffs as historically a central element of trade policy.
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The United States has used tariffs for three main purposes over its history, with changes in regional and political party dominance driving the changes in intent, Irwin writes:
Import tariffs have been the main instrument of trade policy and have had three main purposes: to raise revenue for the government, to restrict imports and protect domestic producers from foreign competition, and to reach reciprocity agreements that reduce trade barriers.
Those policy intentions are generally well-known, but Irwin adds value with his observations about their prevalence in different periods of American history and the interests that drive them. Irwin provides a chart illustrating the changes in U.S. tariffs over the years, and he identifies the changes in purpose:
In Figure 1, one can see a rough delineation of these three eras. In the revenue period from 1790 to 1860, average tariffs rose from about 20 percent to 60 percent and then fell back down to 20 percent. In the restriction period from 1861 to 1933, the average tariff on dutiable imports jumped to 50 percent and remained at about that level for several decades. In the reciprocity period from 1934 to the present, the average tariff fell sharply, and then leveled off at about 5 percent. (In 2018, there is a very slight uptick in the average tariff as a result of the Trump administration’s duties on imports from China and on imports of steel.)”
In the first two eras, the tariffs worked as intended. The United States raised sufficient revenue (for a much-smaller government than we have had since then), and the nation experienced a Gilded Age of great economic growth and hugely successful industrialization after the regional war of 1860-1865. I attribute that in great part to the sound dollar backed by gold during that era.
After the establishment of the Federal Reserve System in 1913, the U.S. economy suffered continual currency manipulation and consequent unreliability, plus ever-increasing direct and indirect government interference in the economy (and of course in nearly every other aspect of life).
Irwin documents the big effect inflation has on tariffs:
… [E]xogenous fluctuations in import prices have sometimes produced large changes in average tariffs, even when there was no change in the actual rates of duty set by policymakers and applied to imports.
Most of the dramatic reduction in the average tariff during and after World War II reflects the higher inflation of that period. The average tariff on dutiable imports dropped from 33 percent in 1944 to 12 percent in 1950; about two thirds of this decline was driven by higher prices and one third by the tariff reductions negotiated at the first GATT conference in 1947. Irwin (1998a) finds that about 80 percent of the decline in tariffs from their peak in the early 1930s to the early 1950s was due to higher prices.”
With that in mind, the decrease in inflation in the past few months suggests that the United States should now experience the opposite of how tariff rates changed after World War II: they should rise, even without any change to the nominal rates set by the government.
However, the dollar is falling against other currencies (down 4 percent since Trump’s announcement of reciprocal tariffs on April 2, though it rose through April 9) and against gold. (The price of gold in U.S. dollars is up 6 percent in the past month and 63 percent over the past two years.) If that continues—and it seems to be part of Trump’s strategy, as he has frequently complained about tight monetary policy—it will make imports more expensive in nominal-dollar terms and thus push imports down and exports up.
That should tend to stabilize the exogenous effects on tariffs and make any changes in “the actual rates of duty” more consequential. As a result, Trump’s changes in tariff rates should directly affect import and export prices and quantities as he intends—and push trading partners to seek reciprocity through mutual reductions of trade restrictions, which is what Trump says he wants.
Trump’s changes in tariff rates should directly affect import and export prices and quantities as he intends—and push trading partners to seek reciprocity through mutual reductions of trade restrictions, which is what Trump says he wants.
This has a further implication for the present situation. Trump’s goal may include reciprocity, but his policy is apparently not driven entirely by that. “To judge from his Tweets, President Trump approves of tariffs for their ability to achieve all three goals of revenue, restriction, and reciprocity simultaneously,” Irwin writes. That is a reasonable interpretation of Trump’s many comments on tariffs, trade, currency, and the U.S. job situation over the years, and it still holds true.
Nonetheless, in contrast to his often-confusing, mercurial, and contradictory public statements on trade, Trump’s actions last week suggest that reciprocity is in fact a central goal of his current tariff plan. What makes the president’s recent actions on tariffs confusing is his hard line against China, which Chinese General Secretary Xi Jinping is feeding into with intransigence of his own.
Trump’s singling out of China indicates that he means to leave China out of the reciprocity invitation and force other nations to choose between China and the United States as an economic ally and trading partner. That seems to be Trump’s real endgame.
