Thursday, August 7th is now tariff day, just postponed from August 1st and originally from Liberation Day in April. Despite delayed execution, tariffs, in combination with the One Big Beautiful Bill, are central to Making American Great Again. Some may be surprised that MAGA is a plan, not just a slogan.
Last month’s Monthly Treasury Statement showed tariff revenue running already at annual rate of $324 billion, or $3.2 trillion over the next decade. In early June, the Congressional Budget Office scored Trump’s emerging tariff regime at $3.0 trillion over the decade. President Trump has just struck a trade agreement with the European Union. These admittedly preliminary results and estimates reflect revenue that offsets almost completely the $3.4 trillion increase in deficits and debt that the CBO ascribes to the OBBB.
In pure dollar terms, this should calm deficit hawks.
With the OBBB rewarding income generation and tariffs penalizing consumption, the combo is revolutionary in modern times.
Since Lyndon Johnson launched the War on Poverty, the U.S. has transformed into a consumption-driven service economy with increasing income redistribution, i.e. social welfare programs. Apparently believing that a dead-end formula, President Trump is trying to reverse all three elements: less consumption, more production and less income redistribution. The idea is that more production will generate more income at all levels, reducing the need for social welfare programs. Take note, Democratic Socialists.
Will it work? There are no guarantees. Tariffs could unleash inflation, or, worse, stagflation or, even, recession. Will it be easy? Trump himself has said it will involve some pain, mostly the aforementioned risks. More worrisome is the President veering off-course to use tariffs as an instrument of non-economic foreign policy, penalizing Canada for its Mideast policy.
In the main, though, strategic use of tariffs is rewriting economic thinking about free trade. When first developed, free trade theory did not contemplate the mobility of capital. Yet, under globalization, capital can move swiftly to locations with the lowest labor cost. Over the last two to three decades, capital moved to China to leverage its low labor costs. The result is a manufacturing juggernaut, which has an absolute advantage that overwhelms the notion of comparative advantage central to free trade theory.
Comparative advantage assumes some minimal level of parity between trading partners, that both have effective production capability – cloth and wine in England and Portugal in David Ricardo’s famous example. Portugal had an absolute advantage in both – but only 10% in cloth versus 50% in wine. So, both countries benefited if Portugal ceded cloth to England and produced only wine.
However, what if Portugal had a 75% advantage in both? Portugal’s huge absolute advantage would have put England out of business, just as China’s huge absolute advantage has put much of U.S. manufacturing out of business. That’s an outcome based mainly on lower labor costs, since capital can move wherever the lowest cost labor is located.
With much higher labor costs, the U.S. has transitioned to a combination of an information, or knowledge based, economy and a service economy. The former does not need labor in the conventional sense. Yet, knowledge flows freely and inevitably across borders. So, in practical terms, we have trouble maintaining or protecting our knowledge advantage.
Our service economy employs domestic labor despite its high cost, because most services cannot be exported or imported. An auto mechanic in China cannot fix your car, so the fact that his labor rate is one-tenth of his American counterpart is irrelevant.
Yet, even a service economy is vulnerable. Customer service call centers have been relocated overseas, as English is the global language. Even data entry operations have been off-shored, because character recognition does not even require linguistic capability.
Labor cost is paramount. This undermines the whole concept of development. If development, or being more advanced than other nations, yields economic rewards and those rewards are shared, as surely they must be in a pluralistic democratic society, they are shared mostly via higher labor rates. Yet higher labor rates push production overseas to lower-cost locations, in the process undermining the productive capacity of the developed nation. So, development itself contains the seeds of its own destruction.
What to do? Tariffs serve to level labor costs across the whole playing field. They may be a blunt instrument, but they should work.
Americans will not be able to afford as many imported “cheap” foreign goods as they become more expensive, and are replaced, at margin, by emerging more expensive U.S. products based on higher U.S. labor costs. Americans will bear the tariff tax, hopefully in awareness and support of the idea that it is necessary to rebuild the nation’s productive capacity. I will pay that tax willingly – to see more young men and women in productive jobs, rather than marking time as baristas at Starbucks. The benefits of a more productive, less consumptive America would be cultural as much as economic.
Red Jahncke is a nationally recognized columnist, who writes about politics and policy.
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