Brian Easton asks: What can Econ101 tell us about Trump’s tariffs?

This is a re-post of an article originally published on pundit.co.nz. It is here with permission.

Before reviewing the economics of tariffs as indirect taxes, here is a brief account of their constitutional role.

In particular, in some jurisdictions, including New Zealand, taxes and therefore tariffs are the preserve of Parliament, not that of the executive or kings. England’s civil war is complicated – wars always are – but one factor was that King Charles I was raising taxes without the approval of Parliament. The issue was eventually settled in the 1689 Bill of Rights – now a part of New Zealand law – which clearly states that only Parliament can raise taxes. One factor in the American colonists’ revolt against Britain a century later was ‘no taxation without representation’, which is enshrined in their constitution in its first article.

It is true that sometimes Parliament or the US Congress gives the executive the power to raises some taxes in an emergency but that power is usually for circumscribed situations. President Trump has claimed that such situations give him the power to raise tariffs. One American court has ruled that the increases are not legal, although reverting tariffs back to the pre-Trump levels has been suspended until the US Supreme Court makes a ruling. There is a view that the Court will back down on the constitutional principle as fast as Taco Trump always chickens out.

It is necessary to go through this because it is not certain that the Trump-imposed tariffs are firmly in place, adding to the uncertainty that the world economy faces. This column is going to assume that the Trump tariffs are permanent – until the times do alter.

It is a routine Econ101 exercise to distinguish between the apparent incidence of an indirect tax – who pays it – and the actual incidence – who ultimately pays it. Excise duty on beer is paid by the brewery to the government, but they then pass the tax on in higher prices to the drinker who bears (most of) the burden of the excise hike. I have said ‘most of’ because consumers may reduce their consumption and that will affect the brewers’ profit. As the Econ101 student learns, this balance between the suppliers’ burden and consumer’s burden depends upon the elasticities (responsiveness) of supply and demand.

Trump wants to have it both ways. Part of his rhetoric is that the burden of his tariffs will be borne by the exporters, as a punishment for their country running a trade surplus with the US or for its (alleged) political misdemeanours. In which case, US consumers will not face price rises. Another part of his rhetoric is that it will stimulate competing US production, but that requires US consumers to face higher prices so that the US producers find it more profitable to increase supply.

Both will happen to some degree. The conventional wisdom is that most of the burden of Trump’s tariffs will be pushed onto consumers. The expected price hikes are only dribbling through because exporters and those purchasing from them are uncertain as to how long the tariffs will apply.

Given the complexity of Trump’s tariff changes it is difficult to assess their quantitative impact, especially over time. Among the educated guesses is that the impact on output in the long run may be small – a reduction in output of much less than 1 percent. It will be even smaller in the short run. There is a view that the distributional changes will be larger than the aggregate output changes. In particular, it is argued that the working class – who tended to vote for Trump – will be hit most heavily. The tariffs will contribute to government revenue (although not sufficiently to cover the deficit form the ‘Big beautiful bill’).

Trump’s tariffs may contract the world economy. The uncertainty of it all is probably its greatest difficulty the world currently faces. If you export to the US, do you start looking for alternative markets? If you are a US producer do you invest to expand production? The additional output will take time to come on stream and by then the tariffs may be wound back. Better at the moment to tai hoa. Thus, we may see extra US inflation which will affect US – and hence the world’s – monetary policy with some fall-off in demand. Trump prides himself on his ‘weaving’; his negotiating strategy is based on the uncertainty it generates. What this ignores is that businesses (generally) want as much political certainty as possible; it’s hard enough dealing with market uncertainty.

(The analysis is further complicated by what happens to the US dollar; it has fallen relative to the US’s trading partners since Trump became president – but no further than the level it was during the last two Biden years.)

The analysis of tariffs compared to other indirect taxes is complicated by only some suppliers being taxed. Think what would happen if only North Island brewers, say, were levied excise duties. It would be even more complicated if North Islanders north of the Bombay Hills were levied differently from those to their south. That is why every country wants to get the tariffs it pays to the US down. They are put at a competitive disadvantage relative to those countries where Trump has imposed lower rates.

Moreover, unlike in much of Econ101, external suppliers can look for alternative markets. After all, across the board the US only absorbs about 10 percent of the world’s exports even if it produces about 18 percent of the world’s output. (Large ‘generalist’ economies tend to export relatively less than small specialist ones; we don’t classify a sale of a New York-made product to California as an export.) The likelihood is that proportion will be even smaller in the future.

As an economist, I am enthralled by Trump’s tariff experiments; it allows us to test theories and measure magnitudes. As a citizen of the world, I am appalled.

*Brian Easton, an independent scholar, is an economist, social statistician, public policy analyst and historian. He was the Listener economic columnist from 1978 to 2014. This is a re-post of an article originally published on pundit.co.nz. It is here with permission.