Number Theory: US has a problem and tariffs will not solve it

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“It’s our declaration of economic independence…For years, hard-working American citizens were forced to sit on the sidelines as other nations got rich and powerful, much of it at our expense, but now it’s our turn to prosper”, US President Donald Trump said while announcing his reciprocal tariffs on the world on Wednesday. Will the US and its people really prosper from these tariffs announced by Trump? Here are three charts which explain why this is unlikely to be the case.

Shipping containers at the Phnom Penh Autonomous Port in Vietnam on April 3. (AFP)

US has a problem and tariffs will not solve it

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  China’s economic rise coincides with a slowdown in US’s economic growth

  A country’s, and its people’s, economic fortunes are primarily determined by its GDP growth. A long-term comparison of GDP growth in the US shows that it started losing economic momentum in the 1970s. The loss of economic momentum became particularly severe in the 2000s which is when China joined the World Trade Organisation (WTO) and became an export powerhouse. While growth has revived slightly in the post-2010 period it is significantly lower than what it used to be in the pre-2000 period. It is this statistic which makes it politically tempting for a politician to sell protectionism in the US. The promise is that tariffs can revive manufacturing and growth in the US once again.
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  But such claims ignore the basic reality of US’s lack of competitiveness

  Chinese export domination in the world came via its cheap and large labour force which worked in its factories and outcompeted almost all of the world in not just production but also prices. For the US to be able to regain its dominance in manufacturing it will need both: a large supply of labour force and at cheap wages. Neither of them is likely at the moment. Labour in US is not only more expensive than emerging market economies such as China, India or Vietnam, but even most developed countries. This can be seen if one compares wages in the US with those in most OECD countries. Demographically speaking, US is also an ageing country now and it will increasingly find it difficult to find young workers to boost sectors such as manufacturing. In fact, Trump’s aggressive anti-immigration policies are likely to trigger a labour crisis in key US sectors such as agriculture which could end up harming rather than helping the cause of US’s trade surplus.
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  While it hurt growth, rising imports did help the US in containing inflation

  This is the most under-appreciated aspect of the current mercantilist turn in US policy. While rising imports from the rest of the world did destroy jobs in the US and put a squeeze on its underclass, it played an important role in keeping inflation under control in the US over a very long period. Data from the World Bank shows that US saw a huge surge in inflation in its high growth decades in the 1960s and 1970s. This was exploited by the conservative political establishment to crack down on working class gains made in the aftermath of the Great Depression especially its bargaining power. The change in political balance of power led to a prolonged period of low inflation in the US (this was only disrupted in the aftermath of the pandemic’s fiscal stimulus in the US and the disruption to global value chains) which didn’t just help incumbent governments but also helped the US strengthen its financial dominance in the world. In fact, a disaggregated analysis of US inflation shows that even the limited inflation in the US economy is largely on account of services inflation than goods which were available at cheap import prices. With massive tariffs on imports, Trump is pursuing elusive growth at the risk of a sharp rise in inflation. This is bound to spook both common people as well as financial markets.
• What the US should be doing

  That the American economic story became more and more plutocratic and the underclass faced downward rather than upward economic mobility is beyond doubt. How the American economy became an epitome of inequality and lack of opportunities for a vast mass of its people except those with high skills or a lot of capital is a question which needs careful, honest and sincere engagement rather than simply unleashing a trade war on the world which, history clearly shows, never achieves its desired objective. To be sure, a lot of problems facing the US are not very different form the problems facing many other countries. Sectors driving growth are increasingly becoming less employment generating and economic stability is becoming increasingly difficult to justify in a democracy. The solution to these problems can be found in strengthening rather than killing multilateralism in today’s age of deep-rooted interdependencies in the world economy. Trump is doing the exact opposite.