TRUMP THREATENED A RECIPROCAL TARIFF, AND BROUGHT ABOUT FREE TRADE

by Andrew Chalk

President Trump has just announced that the US will impose “reciprocal tariffs” on all trading partners. A reciprocal tariff is a tariff on all imports from another country that is set as the same level as the level that country sets on US exports. Commentary is overwhelmingly that this will lead to higher prices in the US as the US currently charges lower tariffs on imports than those countries charge on US imports to them.

With this background, consider what one country, Israel, just did. It announced that it will abolish all tariffs on US imports. The effect of this will be:

Israeli consumers will pay less for imports from the USA. 

GAIN FOR ISRAELI CONSUMERS

US exporters will export more to Israel, as the price of their exports, when imported into Israel, will be lower, so a larger quantity will be demanded.

GAIN FOR US EXPORTERS

US consumers will pay lower prices for imports from Israel because the US reciprocal tariff will be lowered to zero in response to Israel reducing its tariffs to zero.

GAIN FOR US CONSUMERS

Note that everybody gains in the above scenario. It is a classic example of what economists call the gains from trade. Nobody is worse off, somebody is better off. That is the argument for zero tariffs. But note how it started. With a threat to impose tariffs. 

I taught thousands of students one of the best established results in economics (it’s in every textbook): Tariffs are bad for consumers because they raise prices. 

Is that result wrong, or has something changed? 

I think the result is as valid as it ever was. But it was based on a situation where a tariff was imposed in a situation where there were extant tariffs.The tariff did raise prices, and did make consumers worse off. 

The difference is that in our world, the real world, there are already tariffs, and what the Trump administration is doing is making a negotiating gambit to impose higher tariffs on the current high tariff countries. The governments of those countries don’t want to confront higher tariffs on their exports, and there is an easy way to prevent that - lower their own tariffs on imports from the US. The Israeli government has done that, and lowered them to zero, giving their consumers the benefits of free trade.

What this illustrates is that the economics class result is a static case, but in the real world the proper economic model is game-theoretic. It is counter-intuitive, but the threat of higher tariffs lowered them.

I am sure that free trade is not the only result with respect to other countries (game theory is not like that) but I suspect that Israel is not the only case where the threat of reciprocal tariffs results in lower tariffs between the two countries. In this interview, Commerce Secretary Howard Lutnick cites a case that is ripe for tariff reduction -- India charges 60% on certain imports from the US.