Dear reader, let’s take a moment to analyze the “Liberation Day” tariff scheme—an initiative so flawed that it defies comprehension. Announced on April 2, with Donald Trump proudly displaying a board filled with what appeared to be arbitrary figures, economists were left scrambling to decode this jumble. The numbers seemed completely detached from reality and bore no relation to the concept of reciprocity. Initial speculation suggested these figures were derived from the bilateral trade deficit adjusted by imports from the respective country, a notion hastily denied by the USTR, which subsequently revealed its calculations. To everyone’s surprise, the reality proved even worse.
One would assume that a model focusing on “reciprocal” tariffs would account for the tariffs imposed by other nations. However, the U.S. legal framework and economic theory already contain established methods for determining appropriate reciprocal tariffs in response to unfair trading practices. Section 301 of the Trade Act of 1974 and the Reciprocal Tariff Act outline various remedies. The introduction of this new model, which fails to consider existing tariffs or non-tariff barriers, serves no practical purpose in addressing reciprocity or correcting “unfair” trade practices.
Instead, this model operates under the flawed assumption that bilateral trade deficits are inherently indicative of unfair practices. While one could argue that overall trade deficits carry negative implications (though such arguments are conditional rather than absolute, particularly for nations holding the status of international reserve currency), bilateral deficits are a different matter entirely. Trade between two partners need not be perfectly balanced; we do not live in a barter economy. The very essence of currency is to facilitate these imbalances. For example, I enjoy a trade surplus with my employer, which does not imply exploitation. Similarly, my trade deficits with various local businesses—whether at the grocery store, butcher shop, or brewery—do not suggest that I’m being taken advantage of. Without currency, we would be forced to achieve bilateral trade balance, requiring me to precisely match the needs of Rouses for my daily groceries (I doubt they desire my economics research). Thus, the fundamental premise of this model fundamentally misrepresents the very nature of monetary economic exchange.
However, let’s entertain the idea that the model’s premise holds water. Examining the model reveals that the USTR defines it as the balance of trade with a specific country divided by price elasticity of imports (ε) multiplied by tariff passthrough (φ) times imports. Unfortunately, this equation is devoid of meaning; it obscures its lack of substance with Greek letters, but ultimately, it fails to have any interpretable significance. The efficacy of this model remains questionable, and as of this writing, no comprehensive analysis has been conducted on its logic. Therefore, even if we grant validity to the premise, there exists no prima facie justification for believing that the model itself aligns with the premise.
Let’s continue to assume the model is valid. The parameters selected, however, are illogical. The USTR has applied the same values for ε and φ across all countries, an assumption that lacks foundation. Both ε and φ are influenced by country-specific factors. For instance, goods with numerous substitutes will exhibit a higher ε (or a lower one if they have few substitutes). This inconsistency suggests that the calculated tariff rate could be erroneous—either too high or too low.
Even if we assume that all countries share identical ε and φ values, the selected numbers themselves are questionable. The authors claim:
“Recent evidence suggests the elasticity is near 2 in the long run (Boehm et al., 2023), but estimates of the elasticity vary. To be conservative, studies that find higher elasticities near 3-4 (e.g., Broda and Weinstein 2006; Simonovska and Waugh 2014; Soderbery 2018) were drawn on.”
Those may be estimates, but the assertion that an elasticity of 4 is “conservative” is misleading. Numerous studies indicate that the elasticity may reach 5-7, particularly following trade shocks (see, for example, here). Furthermore, the authors arbitrarily set φ at 0.25 without citation. Their sole justification is:
“The recent experience with U.S. tariffs on China has demonstrated that tariff passthrough to retail prices was low (Cavallo et al, 2021). [link added]
However, retail prices are not the crucial metric here; we need a comprehensive understanding of total passthrough. What Cavallo et al. actually articulate (emphasis added) is:
“At the border, import tariff pass-through is much higher than exchange rate pass-through. Chinese exporters did not lower their dollar prices by much, despite the recent appreciation of the dollar. By contrast, U.S. exporters significantly lowered prices affected by foreign retaliatory tariffs. In U.S. stores, the price impact is more limited, suggesting that retail margins have fallen. Our results imply that, so far, the tariffs’ incidence has fallen in large part on U.S. firms.”
The authors of the USTR report have completely misinterpreted Cavallo et al.’s findings. Instead of supporting the notion of low passthrough, their analysis indicates a nearly complete passthrough burdening American consumers. This is a striking example of cherry-picking by the USTR. Moreover, research suggests φ is closer to 0.8, not 0.25. This means that both ε and φ are underestimated, leading to systematic overestimation of the tariff calculations.
And yet, let’s assume their chosen values for ε and φ are correct. The real kicker lies in their statement:
“Assuming that offsetting exchange rate and general equilibrium effects are small enough to be ignored…”
This assumption is monumental. If it fails, the entire model collapses. The problem is that the very purpose of these tariffs is to create exchange rate and general equilibrium effects! The authors acknowledge this repeatedly, as do the economic advisors of the Trump Administration. Thus, the essential assumptions of the model are fundamentally flawed, rendering the entire structure untenable ab initio. In fact, within just 24 hours of unveiling the tariff scheme, the stock market experienced its worst two-day decline on record, and the dollar depreciated. I don’t believe I’ve seen a model discredited so swiftly—24 hours might just be an unprecedented record. Even the disastrous COVID lockdown models took months to unravel.
Once more, I emphasize: it is exceedingly difficult to overstate how catastrophic this model is. From start to finish, it is riddled with inconsistencies, flawed assumptions, and a complete lack of coherent reasoning. This is not the product of analytical thought; it is a disheartening display of scientism.
*Incidentally, this is why observers initially presumed the model was merely the trade balance divided by imports. With ε set at 4 and φ at 0.25, and the denominator being ε * φ * imports, the product ε * φ equals 1, reducing the whole denominator to imports alone. The fact that the USTR overlooked this is a significant concern.
