A bold claim from the Trump Administration suggests that tariffs are essentially a foreign tax burden. Under certain circumstances, this notion might hold some water:
- if the importing nation has monopsony power (essentially, a market dominator),
- if the exporting nation holds significant price influence, and
- if there is no risk of foreign pushback,
then a modest tariff might prompt the exporting country to reduce its prices to maintain market share. In simpler terms, the exporter could end up absorbing some or all of the tariff costs (for those keen on a deeper dive into this theory, a fascinating discussion can be found here).
In theory, the United States fits this bill quite well. We are a heavyweight in the arena of international trade, accounting for approximately 13.8% of global imports and about 8% of global exports (data sourced from the World Bank). Additionally, in several niche markets, we stand as the dominant buyer or seller.
So, logically, one might expect some of the tariff burden to be borne by foreign producers. Yet, reality tells a different story.
Research indicates that tariffs levied by the US government are predominantly shouldered by American consumers. Why does this discrepancy exist? One might be tempted to discard economic models in favor of simpler explanations like greed or political maneuvering (a sentiment echoed by the White House or the Wall Street Journal). However, discarding a well-established theory should only occur when it fails to clarify reality. Fortunately, a nuanced understanding of trade theory can elucidate this apparent paradox.
Most economic models view countries as singular entities: The United States engages in trade with Mexico. This simplification aids students in recognizing that domestic and international trade share more similarities than differences. While there are instances where treating countries as monolithic actors proves insightful, the dynamics of trade hinge on the fact that it fundamentally occurs between individuals, not nations. The exchange is not between the United States and Mexico; rather, it’s a firm in Dallas interacting with a firm in Mexico City. As a result, even though countries may wield some market influence collectively, individual entities typically do not. The practical ability to transfer tariff costs, or to compel a foreign supplier to absorb such costs, is largely absent.
But isnāt that the very purpose of tariffs? To negotiate on behalf of the collective? Can we not apply the same rationale to the ācorporate entityā we call the United States? Unfortunately, that logic falls flat. A country operates differently than a corporation. Unless we veer into the realm of outright socialism, the president cannot dictate terms for American businesses. Those businesses retain autonomy in their purchasing decisions. It is their capacity to adjust prices that matters, not some abstract concept labeled āThe United States Company.ā
The forecasts and assertions from the Trump Administration’s economists miss the mark because they overlook the principle of methodological individualism: economic decisions ultimately boil down to individuals, and that should be the starting point of our analysis. Proponents claiming that American market power allows us to shift tariff burdens onto foreign entities often zoom out too far, failing to recognize that the aggregate is a product of individual actions.
This critical misunderstanding, this glaring oversight, has been a perpetual thorn in the side of many politicians, and the Trump Administration is no exception. Reality is unyielding, regardless of how many elegant equations one employs to distort it.
