The Trump administration has announced “reciprocal tariffs” on practically every country in the world, bar Russia, North Korea, and a few others, and some entities which barely register as entities. However, the tariffs are not in any way reciprocating tariffs, or even non-tariff barriers, that other countries may be placing on U.S. goods.
Instead, as the Office of the U.S. Trade Representative has summarised the:
“tariffs are calculated as the tariff rate necessary to balance bilateral trade deficits between the U.S. and each of our trading partners. This calculation assumes that persistent trade deficits are due to a combination of tariff and non-tariff factors that prevent trade from balancing. Tariffs work through direct reductions of imports.”
An approach that seeks to balance all bilateral trade, and only such trade in goods, is bizarre at best. There is no reason to target such outcomes. It is more than 200 years since David Ricardo set out The Theory of Comparative Advantage.
In our personal lives most of us run deficits with almost all economic actors we engage with, bar our employers. Why should I consider it a problem if I give my local shop money and get to take home goods in return? Now, in overall terms I may wish to ensure that I am living within my means but that’s more a concern with what I do rather than the activities of my local shop.
Regardless, the approach of the Trump administration is apparently one of eliminating bi-lateral trade imbalances. Continuing, the Office of the U.S, Trade Representative sets out, what this might mean:
Consider an environment in which the U.S. levies a tariff of rate τi on country i and ∆τi reflects the change in the tariff rate. Let ε<0 represent the elasticity of imports with respect to import prices, let φ>0 represent the passthrough from tariffs to import prices, let mi>0 represent total imports from country i, and let xi>0 represent total exports. Then the decrease in imports due to a change in tariffs equals ∆τi*ε*φ*mi<0. Assuming that offsetting exchange rate and general equilibrium effects are small enough to be ignored, the reciprocal tariff that results in a bilateral trade balance of zero satisfies:
This formula is then used to calculated the tariffs “imposed” by other countries on the U.S. A value of –4 was chosen for ε, the elasticity of imports with respect to import prices and a value of 0.25 was chosen for φ, the passthrough from tariffs to import prices. Multiplying these gives an answer of -1, so that just gives –mi in the denominator.
In simple terms, the "tariff" that country i is said to be imposing on the U.S. is the trade balance (xi – mi) divided by the negative of the level of imports, –mi.
We can do this for the E.U. using 2024 goods trade figures from the BEA.
- U.S. Goods Exports to the E.U. = $372,439m
- U.S. Goods Imports from the E.U. = $609,192m
Thus the calculation becomes ($372,439m – $609,192m) / (–$372,439m) and we get an answer of .389. This then becomes the 39% tariff that the E.U. is apparently imposing on the U.S., though actual tariffs feature nowhere in the arithmetic.
Then for reasons of “generosity” the reciprocal tariff is put at half of this and, after a bit of rounding, we get the announced 20% tariff to be placed on most U.S. goods imports from the E.U. Of course, this is nothing more than a reverse-engineered methodology, with some half-baked approach devised to best fit the intended results.
Indicatively, this would have resulted in tariffs of $118 billion if imposed universally in 2024 on all U.S. goods imports from the E.U. ($609.2bn x .20 = $118.4bn).
From an Irish perspective, it is worth looking at what would have happened if the tariffs were imposed by individual E.U. Member State, rather than treating the E.U. as a whole. Again, we can use BEA data on goods trade to see this and note that a minimum tariff of 10% will be applied regardless of the outcome from the above formula.
The countries are ranked by the size of the U.S. balance of goods trade deficit with them. The goods deficit with Ireland in 2024 was the largest. Applying the formula and halving the answer gives a “reciprocal tariff” of 42% on U.S. goods imports from Ireland.
This is one of the highest rates shown, but not the highest. Even though they have significantly less trade with the U.S. higher “reciprocal tariffs” result for Slovakia and Slovenia.
If universally applied to all U.S. goods imports from Ireland at 42%. the amount of additional tariffs due in 2024 would have been $43.4 billion. Of course, Ireland’s largest export to the U.S. are pharmaceuticals and, for the time being at least, these remain exempt from the newly announced tariffs.
The total amount of additional tariffs due on U.S. imports from E.U. Member States would have been $160 billion if a “by country” approach was applied. This is because the large goods surplus the U.S. has with The Netherlands is not included when we go by country, as a minimum 10% tariff is imposed regardless of the trade balance.
Finally, it is worth considering why the US runs a trade deficit: it is mainly because, as a whole, the spending of the economy exceeds the income it generates. We can see this with the Net Lending / (Borrowing) positions of the economies sectors.
The large government deficit exceeds the net lending of the private sector (domestic business plus households) resulting in the U.S. economy as whole being a net borrower.
If I am spending more than my income I could blame the local shop and demand I be given a job there. Alternatively, I could try other means to raise my income, perhaps in something I may have a comparative advantage in. Or, I could adjust my spending to bring it in line with my income.
Or, if people are willing to lend to me, should I not just continue to enjoy the benefits of the goods I am able to buy? Not if I am the U.S. economy it seems. Will the U.S. Congress step in to stop all this? That would seem like their job. Checks and balances and all that.
Posts
