Markets around the world are reeling in response to President Trump’s “Liberation Day” tariff hikes. Judging by the stock-market plunge, investors in the United States have assessed that publicly traded companies are worth trillions of dollars less than they were prior to the announcement of the president’s tariffs. Financial markets across the developed world are likewise reeling, and talk of a looming recession has gripped Wall Street — and Main Street firms, too.
The damage will not be limited to financial markets. Around half of all imports into the US homeland are used by American manufacturers as inputs to produce goods. By increasing the costs of production, Trump’s tariffs will reduce the competitiveness of US manufacturers. This will destroy manufacturing jobs, not promote them. Higher consumer prices from tariffs and trillions of dollars of wealth destruction will reduce consumer spending, threatening recession and rising unemployment. Uncertainty will freeze business investment, likely leading to layoffs. US manufacturing exporters will be hit hard by any foreign nations that choose to retaliate.
Some of the president’s closest advisers are true believers in protectionism and are likely surprised by the market’s reaction over the last three trading days. They may still believe that Trump’s policies will eventually produce beneficial results. They’re wrong.
How can the president pivot? Three alternatives present themselves.
First, the president could declare victory. European Commission President Ursula von der Leyen offered Washington a “zero-for-zero” tariff scheme today. Trump could accept her offer. The Japanese leadership has likewise signaled a desire to reach an accommodation. Other nations would follow. Trump could herald himself as having successfully struck great deals for American workers and businesses while taking a step back from the ledge of economic self-harm.
Second, he could alter the calculations used to derive the tariff rates. Team Trump has published the formula it used to calculate reciprocal tariffs. That formula has parameters that need to be selected, and administration economists turned to the research literature for the best parameter values. But the co-author of one of the key papers on which those administration economists relied, Alberto Cavallo of Harvard Business School, correctly pointed out that the administration picked the wrong value from his paper.
“While the [US Trade Representative] tariff calculator cites [our] findings”, Cavallo wrote, “it is not entirely clear how they use our findings. Based on our research, the elasticity of import prices with respect to tariffs is closer to one. If that figure were used, instead of 0.25, the implied reciprocal tariffs would come out about four times smaller.”
This mistake has big implications: the reciprocal tariff rates that the administration calculated are four times are large as they would have been if administration economists had picked the correct parameter value from the paper.
My American Enterprise Institute colleagues Kevin Corinth and Stan Veuger calculated corrected reciprocal tariff rates, using the administration’s formula and the right parameter values. According to them, the administration should be applying 10 percent tariffs for imports from key allies, including Taiwan, South Korea, Japan, Israel, and the European Union. That is instead of the astronomical figures in the “Liberation Day” document that caused hearts to sink among political and business leaders the world over, and sent equity prices on a downward spiral.
In response to this, the president could announce that the administration spent the weekend refining its calculations. He wouldn’t have to walk back his methods or even throw any staffers under the bus; he could simply announce the new rates.
Cards on the table: I support free trade, and I would like tariff rates to be much lower than the levels at which these calculations would leave them. But applying the formula correctly would be a good start. Subsequently, as more foreign leaders follow the example of von der Leyen in offering zero-for-zero, the president could lower tariff rates to zero.
Third, Trump could announce an immediate pause and follow up with a decision to roll trade policy changes into his plans for tax reform.
To avoid a massive tax hike this year, when key provisions of Trump’s signature 2017 cuts expire, Congress and the president must act. They could take this opportunity to overhaul the tax system by replacing the corporate income tax with a national consumption tax and a tax on business cash flows. By allowing the full expensing of business investment, this would accelerate productivity growth and raise the wages of working-class Americans.
“The president could announce that the administration spent the weekend refining its calculations.”
Because some consumption goods are imported and some domestically produced goods are exported, such a tax would require a border-adjustment provision in which imports would be taxed and exports would not be.
This is not a tariff, but it sure resembles one. It would generate a lot of revenue. And unlike the administration’s current tariff policy, it would boost growth. The president could argue that this border adjustment satisfies his campaign promises and his goal to strike a better deal with other nations when it comes to international commerce.
I don’t see the problems with the economic situation of typical workers that the president sees. But even if I did, I would want to see Trump pivot from his current policy, because higher prices and more unemployment are bad for workers.
Trump has the opportunity to pivot. For the sake of the working class that sent him back to the Oval Office — and of the nation as a whole — I hope the president takes it. Some in the media, Left and Right, would no doubt crow. But there is greater heroism in reassessing a position in the face of evidence than in obstinacy.
