It now turns out the “formula” adopted by President Donald Trump to set the “reciprocal” tariffs around the world is not just deeply flawed, it is plain stupid
America’s Liberation Day came a day after April Fool’s Day, and the foolishness of the Donald Trump-ignited trade war was pretty obvious immediately, even if the sheer scale of the insanity of the move took a while to sink in.
The “formula” adopted by the Trump administration to set “reciprocal” tariffs is even more bizarre than the famously discredited “Laffer Curve” (named after supply-side economist Arthur Laffer) that was used by President Ronald Reagan to cut taxes in the 1980s, which were never empirically validated.
Poorest countries hardest hit
A quick look at Trump’s hit list shows that some of the poorest countries of the world -- Myanmar, Cambodia, Laos -- figure at the top, targeted by tariffs in excess of 40 per cent.
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Countries such as Botswana and Thailand are just a rung lower. India at 26 per cent is in the company of Pakistan (29 per cent), South Korea (25 per cent) and Malaysia (25 per cent), Japan (24 per cent) and several others. The “logic” is such that every country now faces a tariff of at least 10 per cent, irrespective of what tariffs they impose on goods imported from the US.
When Trump first announced his “reciprocal” tariff plan it was thought this would be based on the logic that he would set US tariffs at levels that were in some sense “equivalent” to those set by its trading partners. Even this appeared illogical because countries export and import different things to and from each other; after all, why would a country need to buy things from others when they can make cheaper or better at home?
Flawed formula
It now turns out the “formula” adopted by Trump to set the “reciprocal” tariffs is not just deeply flawed, it is plain stupid. To understand this let us unpack the “formula”.
One assumed that the starting point of the Trumpian formula would have been to calculate magnitudes of the barriers – tariff and non-tariff -- that other countries allegedly levy on American goods. Incidentally, among the non-tariff barriers considered is the alleged use of currency “manipulation” by trade partners without revealing the objective criteria used by the Trump administration to justify the contention. National taxes (GST in India, Value Added Tax in the case of the EU) were also cited as trade “distortions” that resulted in surpluses registered by trading partners.
‘Reciprocal’ measures not tariff-based
But the formula that has been adopted is not that even based on tariffs that other countries impose on American goods. Instead, the extent of the trade surplus that each country has with the US has been used as the starting point of deriving the tariff to be levied on that country’s exports to the US.
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In effect, the starting point is the assumption that any country that has a trade surplus with the US is targeted for indulging in unfair practices. The mechanical application of this “formula” is what has determined the new tariff regime.
Zero bilateral trade deficit?
This starting point basically implies that the objective is to eliminate US trade deficits with every country in the world. Effectively, this means that the US is attempting to have a zero bilateral trade deficit with every other country, a ludicrous objective in this day and age.
It also implies that the tariff rate would depend not on the tariff that American goods faced for similar goods in a particular country but the extent of the overall deficit the US has with that country. To twist the knife further even countries that do not have a trade surplus with the US now face a minimum tariff of 10 per cent.
For instance, Britain, which actually runs a trade deficit with the US, now faces a 10 per cent tariff on exports to the US. And New Zealand and Australia too are in the same boat.
A bizarre ‘formula’
The “formula” takes the extent of a country’s trade surplus with the US and divides that by that country’s exports to the US. This has been divided by two to arrive at a “discounted reciprocal tariff”. This is then rounded off to arrive at the tariff applied for that country.
As Adam Tooze, the American economic historian at Columbia University, pointed out in a blog post on April 3, Cambodia exports more to the US than it imports from that country simply because it is a poor country. It is so poor that it cannot afford to import the things America exports but yet has some things to sell to the US which would be more expensive for Americans if they were sourced from elsewhere. This has nothing to do with the tariff Cambodia sets on goods imported from the US.
Innuendo against Vietnam
Tooze points out that nothing in the conduct of the Trump administration suggests that it “actually cares about strategic relationships with major emerging economies, even with nations as large and strategic as Vietnam”. Tooze cites statistics to dismiss the innuendo against countries such as Vietnam that they act as conduits for routing goods sourced from countries like China.
He cites evidence that shows that a large fraction of Vietnam’s exports to the US consists of significant value addition within the country as well as value addition in other countries, only a part of which arises in China. This, he argues, shows only that it is integrated to supply chains based in other countries, not that its trade advantage arises from targeted tariffs levied against
American goods
Incidentally, among the worst hit shares have been that of Nike, which employs a staggering half a million people in its more than 140 factories in Vietnam. This is not surprising, given the overnight imposition of a 46 per cent tariff on goods that will be shipped from these factories.
Tooze tellingly observes that “The boss (Trump) hates trade deficits and his team of willing sycophants came up with a formula, however idiotic, that ticked the box.” It is no wonder that countries in East Asia are already now seriously considering an Asia-Pacific leadership.
US trade deficits
Economists, especially those who specialise in macroeconomics, have repeatedly pointed out that the underlying cause of the US trade deficit is the lack of savings and investment within the US economy. In order to finance consumption, it is dependent on the rest of the world. This is precisely why it has a trade deficit.
Tariffs would do zilch to change that underlying situation. If anything, by imposing further costs on its own economy – though higher prices resulting from higher tariffs – and by slowing growth further, there is only one guarantee: stagflation. Significantly, imports, which constituted about 10 per cent of US GDP in 1990, rose to 14 per cent in 2023.
Humbug of ‘balanced’ trade
The obsession with some misplaced ideal of “balanced” trade is totally illogical given the relentless slide in not just US manufacturing but in its productivity levels. This makes it incumbent on the US to depend on outside suppliers of goods, ones that are more efficient not just because they are cheaper but also because they may be better integrated with the relevant supply chains.
The case of Vietnam, the country with the fourth biggest trade surplus with the US, illustrates this. Vietnam’s trade surplus in 2024 was $124 billion; China ($294 billion); the European Union ($236 billion); and Mexico ($172 billion) were the top three with trade surpluses in goods vis-à-vis the US.
Trade surpluses are illusory
But even if one temporarily suspended logic that trade surpluses are the primary markers of unfair trade practices, it would need to accommodate the reality of a more capacious definition of what international trade is. Given that services now account for a significant share of national output in the advanced countries, and given that these now account for significant trade flows, there is no justifiable reason to exclude from the calculation of surpluses.
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Once these are factored into the equation, the American deficits appear in a completely different light.
Trump’s claim that “Europe takes nothing from us” is blatantly wrong. In February he said: “The European Union was formed to screw the United States — that’s the purpose of it, and they’ve done a good job of it. But now I’m President.” That is a crooked argument when it is balanced by the fact that the US export of services significantly reduces its deficit with the EU.
Europe’s reality
Data from the European Central Bank show that between the third quarter of 2023 and the third quarter of 2024, the EU ran a trade surplus of 203 billion euro in goods. But during the same period, it ran a deficit of 146 billion euro in its trade of services with the US, implying that the overall magnitude of trade surpluses with the region would be much smaller than what Trump selectively chooses to focus on.
The fact that the overall trade deficit with the EU – including goods and services – amounts to just 0.2 per cent of US GDP in 2024 illustrates the phony argument used to justify the “reciprocal” tariffs.
Tariff as intimidation
It is obvious that the Trump shot across the bow is an intimidatory act, aimed at bringing trade partners to the negotiating table where America will negotiate from a position of strength. This is illusory as the hardening stance from the EU shows. The statement of European Commissioner Ursula von der Leyen shows that the regional bloc is prepared to fire its own bazooka by hitting US services exports.
In her address to the European Parliament a day before the unveiling of the Trump tariffs, von der Leyen said the reciprocal tariffs would be met by retaliatory strikes on services exports, including exports by the Big Tech American companies. These could be fresh barriers to US banks and financial service entities, and potentially even barring Elon Musk’s Starlink from most of the European continent.
Retaliatory strikes
Invoking the “anti-coercion” elements of its charter, the EU could extend retaliatory strikes to suspend of intellectual property protection rights of American entities and also bar American entities from public procurement contracts in Europe. In its response to earlier levy of additional tariffs on EU steel and aluminum, the bloc has already imposed 26 billion euro of additional levies on UDS goods. In short, nothing can be ruled out in the war.
It is significant that almost every major economy has responded in some measure. Canada has retaliated, knowing full well that the American economy is symbiotically integrated with its own.
Global reaction
For instance, a significant portion of economic activity in the northern states in the United States is linked to activity in Canada; for instance, about a quarter of Michigan state’s GDP is enmeshed in trade relations with Canada, Mexico and China, most crucially with Canada.
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China, the EU as a bloc, the countries in east Asia, Canada, the primary targets of the attack, have all reacted strongly. Even though Mexico has not yet retaliated, reflecting its relative weakness vis-à-vis the US, its President Claudia Sheinbaum’s attempt at mass political mobilisation on the issue suggests that she is taking her people into confidence on possible ways to react to the threats.
India’s standstill option
India is the only large economy to have not reacted in any manner at all, indulging in perhaps wishful thinking that Prime Minister Narendra Modi’s personal equation would somehow yield some concessions. Trump’s motive is to use the absurd instrument of “reciprocal” tariffs to bring countries into bilateral negotiations where he can pick and choose agendas means that this course will be ruinous for India.
By definition, a superpower has a portfolio of interests in which trade is just one of the many objectives. From a developing nation standpoint such “trade” deal may well mean trade-offs in realms seemingly unconnected to the trade agenda. Who knows, perhaps the Modi government’s decision to allow Starlink to operate in India may well be within the framework of such negotiations. The simple point is that a trade deal between two unequal powers is never just a trade deal.
Vulnerable India
India’s standstill or do-nothing approach, in the wake of potentially the biggest cataclysmic assault on global trade since the Great Depression a century ago, is neither here nor there. That is what makes India’s position vulnerable. In effect, it admits that it is ready to be pushed around.
The 26 per cent levy on Indian exports to the US ought to be seen in this context.
(The Federal seeks to present views and opinions from all sides of the spectrum. The information, ideas or opinions in the articles are of the author and do not necessarily reflect the views of The Federal)