In our increasingly polarised society, political messages are more frequently being ‘hidden’ within economic analyses. With the US presidential election approaching, the number of these messages is growing, with the truth often bending slightly to accommodate them.
If Trump is re-elected, new import tariffs are high on the agenda. According to a legion of economists, this has two clear consequences: lower prosperity and higher inflation. But although this sounds logical, it’s nonsense. History shows repeatedly that import tariffs are deflationary; prices, in fact, tend to decrease overall.
The explanation is brief and simple, which suits a column written from the ‘magical’ Disneyland Paris. The ‘income effect’ of import tariffs is much greater than the direct price effect of those tariffs. It’s a classic example of what we learn at school and which proves true in practice as well. It’s a case of ‘P x Q’. In other words, total output is a function of price (P) and volume (Q). Historical data repeatedly shows that price increases due to import tariffs have a much larger impact on Q than on P. The chart below from Alpine Macro illustrates this well.
Chinese tariffs
The most recent round of tariffs, initiated by then-President Trump, fits perfectly within this pattern. After the first increases in 2018, inflation in America fell for two years! Janet Yellen’s pleas, years (!) later, as the US Treasury Secretary, to lower those tariffs to reduce inflation, was a brilliant piece of theatre. It was her own department, along with the Federal Reserve’s bizarre policies, that pushed inflation upwards.
To conclude that both prosperity falls and prices rise runs entirely contrary to the empirical evidence.
Who foots the bill?
This could already conclude my holiday column, but that would overlook other inaccuracies. In certain ‘analyses’ from a large Dutch bank, it is fervently claimed that consumers ultimately foot the bill for those import tariffs. Unfortunately, that too is incorrect. This can already be deduced from the P x Q analysis, but it’s also straightforward to investigate.
And that’s precisely what Gita Gopinath, now the face of the IMF, did with other professors not long ago. Two important conclusions emerged: although there were occasional temporary price increases, it was primarily retailers who bore the impact through shrinking profit margins. As retailers do understand that Q is key, they strive to protect it by lowering prices.
Source: Tariff Passthrough at the Border and at the Store: Evidence from US Trade Policy; Alberto Cavallo, Gita Gopinath, Brent Neiman, Jenny Tang.
In addition, a clear trend was observed among American exporters, who widely lowered their prices following China’s retaliatory actions in order to remain competitive.
A phrase like, ‘But as any economist knows, it’s American households who will foot the bill,’ is therefore an example of injecting a subjective message into what could have been an objective analysis. Moreover, it’s blatantly untrue.
Do you know what does drive inflation up? Monopolies. And I should know because I’m about to step onto a rollercoaster – in what is truly an extreme example of monopoly.
Jeroen Blokland analyses eye-catching, current charts on the financial markets and macroeconomics in his newsletter, The Market Routine. He is also the manager of the Blokland Smart Multi-Asset Fund.