Tariffs vs. Comparative Advantage

Economist Alex Tabarrok recommends reading a Maurice Obstfeld piece at the Peterson Institute for International Economics, titled "Trump's Tariffs Are Designed for Maximum Damage -- to America."

I found this interesting because it elaborates on the consequences of something I suspected when I heard (on the Yaron Brook show, I believe) that Trump's "reciprocal" tariff formula was based not on tariffs being levied against American imports by any given country, but in large part on the trade deficit with the particular country. I suspected correctly that the more our trade with any given country is saving us money, the more punitive the tariff.

Obstfeld lays this out as follows:

The tariff plan displays a basic misunderstanding of the reasons why nations trade in the first place -- reasons that imply the United States will run deficits with some trade partners (bilateral deficits) and surpluses with others (bilateral surpluses). The reasons reflect the operation of comparative advantage. For example, the US imports aluminum from countries that can produce it most efficiently, while embodying it in exports where it has the advantage, such as aircraft. This will tend to lower US trade balances with efficient aluminum producers and raise them with aircraft importers. The same is true for households and businesses. I have a surplus with my textbook publisher, Pearson, because I am relatively better at writing textbooks while they are better at publishing and distributing. But I chose to have a deficit this year with my ophthalmic surgeon rather than trying to remove my cataracts myself.

Yet the USTR [US Trade Representative] report reveals up front that their "calculation assumes that persistent trade deficits are due to a combination of tariff and non-tariff factors that prevent trade from balancing." This is a fundamental misconception and suggests that Trump's administration did not even try to calculate the true heights of trade barriers. For example, Korea was hit with a tariff of 26 percent, even though it has a free trade agreement with America and its tariff rate on US imports was only 0.79 percent in 2024. The tariff's entire justification was Korea's sizable bilateral surplus in goods with the United States, much of it due to Americans' taste for Hyundai and KIA vehicles. [bold and link for comparative advantage added]

The piece goes on to discuss further costs that switching suppliers to dodge high tariff rates might also incur.

One part of the piece that I found not as clear pertains to the overall trade deficit: This deficit reflects that Americans spend more than they produce, obliging them to import the difference from abroad. This would seem to run counter to the fact that, as the philosopher Harry Binswanger once pointed out in "Buy American Is Un-American:

The lucrative workings of free markets do not depend upon lines drawn on a map. The economic advantages of international commerce are the same as those of interstate, intercity, and crosstown commerce. And if we kept crosstown trade accounts, the "trade deficits" that would appear would be as meaningless as are our international "trade deficits." Fact confirms theory: the U.S. ran a trade "deficit" practically every year of the nineteenth century, the time of our most rapid economic progress.

While perhaps in the modern era we do overall have a massive debt to other countries, I wonder if, say, foreign investment in the US isn't being accounted for, or I am simply unclear on that point. But surely it is inaccurate to look only at material goods bought and sold in international trade when such things as investment opportunities and services are also major components of any economy.

Like wage (which simply means "labor price"), the term trade deficit is unfortunate for the cause of clarity in economic discussions.

If we replaced the term wage with labor price, it would be easier to see the similarities between wages and other production costs.

The term trade deficit, which merely describes aggregations of individual transactions across a border, bears an unfortunate and confusing resemblance to terms like the federal deficit, which reflects a shortfall of money taken in by the government relative to its expenditures. These similarly-named phenomena are fundamentally different: The first is merely a result of trade (and none of the government's business) and thus harmless; the second should be avoided or eliminated.

-- CAV