Not All Tariffs Are Created Equal

The Trump administration’s rollout of its tariff strategy on “Liberation Day,” April 2, was a debacle of historic proportions, causing the greatest stock market crash since the COVID-19 pandemic and the threat of an even more frightening flight from the dollar as a safe asset. Nevertheless, from the wreckage some useful policies might be salvaged. After all, the central initiative of President Franklin D. Roosevelt’s New Deal in his first term, the National Recovery Administration, collapsed in chaos and confusion even before the Supreme Court ruled it unconstitutional in 1935. But elements of the NRA’s grand scheme were re-created by the Social Security Act of 1935 and the minimum wage established in 1938 by the Fair Labor Standards Act. In the same way, some of the components of the Clinton administration’s failed effort at comprehensive health-care reform, the proposed Health Security Act of 1993 (“Hillarycare”), were repurposed and included in the more modest and successful Affordable Care Act of 2010 (“Obamacare”).

In sifting through the rubble of Liberation Day, in search of useful policies, we can distinguish among tariff policies that are good (sector-specific tariffs and country-specific tariffs), bad (“reciprocal tariffs” which are not really reciprocal), and ugly (the global or universal tariff).

Let’s begin with sector-specific tariffs. With the exception of libertarian ideologues, thoughtful Americans, right, left, and center, recognize the need for protection and some promotion for manufacturing supply chains critical to national defense and independence. In 1791, in his Report on Manufactures for Congress, America’s first Treasury secretary, Alexander Hamilton, stressed the need for promoting American manufacturing industries that would allow the United States to be “independent of foreign nations for military and other essential supplies.” The emergence of China as a superpower rival on all fronts—military, industrial, commercial, and diplomatic—makes the need for a high degree of American industrial independence as urgent in the 21st century as it was in earlier eras.

How broadly should “defense-critical” manufacturing be defined? Clearly it should not be defined so broadly that every domestic industrial lobby, no matter how minor, can successfully claim that its products deserve protection because they are essential to national security.

At the same time, the definition of defense-critical manufacturing cannot be limited narrowly to what is misleadingly called “the defense industrial base”—corporate defense contractors that make weapons and specialized goods only for the U.S. military and the militaries of U.S. allies and clients. The success of the Union in the Civil War, and of the United States in the world wars, came about because it was possible to convert and expand preexisting civilian industrial production for military purposes. The decision of U.S. leaders after the Cold War to allow much of America’s civilian manufacturing base to erode, in the hope that a small set of specialized defense industry contractors would be sufficient to maintain America’s great power status, in hindsight was one of the greatest strategic blunders in world history.

The Chinese Communist Party state has adopted a strategy of “military-civil fusion” (MCF). According to the U.S. State Department:

As the name suggests, a key part of MCF is the elimination of barriers between China’s civilian research and commercial sectors, and its military and defense industrial sectors. The CCP is implementing this strategy, not just through its own research and development efforts, but also by acquiring and diverting the world’s cutting-edge technologies—including through theft—in order to achieve military dominance. … Key technologies being targeted under MCF include quantum computing, big data, semiconductors, 5G, advanced nuclear technology, aerospace technology, and AI. The PRC specifically seeks to exploit the inherent “dual-use” nature of many of these technologies, which have both military and civilian applications.

The true scale of the military spending of China, a secretive autocracy, is disputed. What is not disputed is that in the last generation, with help from unpatriotic American investors and unpatriotic American corporations such as Apple, authoritarian China has used state-led industrial and trade policies to become the world’s dominant manufacturing power.

In 2023, China’s share of value-added production in manufacturing was 29 percent of the world total—more than the United States, Japan, Germany, and India combined. China’s lead in global gross manufacturing production in 2020 was even greater: 35 percent, more than the combined total of the United States, Japan, Germany, India, South Korea, Italy, France, and the United Kingdom. Today China produces a third of global automobile manufacturing, half of the world’s steel, and 80 percent of the global civilian drone market. China is second only to Japan in manufacturing robots and is the world’s leader in factory robot installations. While China controls half of global commercial shipbuilding, America’s share of the global shipbuilding market has dwindled to 0.1 percent. What this means is that while the United States may lead China in the number of overseas bases and military spending, China would find it much easier than the self-weakened, partly deindustrialized United States to convert its superior civilian manufacturing base to military production.

Most Republicans and Democrats alike now share the goal of reducing America’s dependence on China for at least some critical manufactured goods and supply chains, like the semiconductors subsidized under the CHIPS and Science Act. One option for partial decoupling from China involves “friendshoring,” the sourcing of key manufactured goods and inputs from U.S. allies or other friendly nations.

The problem with the friendshoring strategy is that most of America’s “friends” are on the other side of the Atlantic or Pacific oceans. Even worse, Japan, South Korea, Taiwan, Vietnam, and India are next to China and thus are subject to blockade or intimidation in a serious Sino-American conflict.

The United States continues to extend one-way military guarantees to countries like Japan and South Korea whose largest trading partner is China. Among America’s so-called NATO allies, Germany found its largest single trading partner in China, until the United States surpassed China as a market for German exports in 2024. America’s East Asian and European allies are too deeply integrated into the Chinese economy for an American-led bloc that limits Chinese imports to be politically realistic.

Instead, the United States should concentrate on achieving industrial economies of scale in an integrated North American bloc that includes the United States, Canada, and Mexico—which are now part of the U.S.-Mexico-Canada Agreement—and perhaps other North American countries in time. Ideally, this North American bloc would form a customs union with common tariffs (not a single common tariff, because many nonstrategic imports would be duty-free). The North American bloc would use targeted protective tariffs as part of a long-term policy of import substitution to rebuild some lost or eroded manufacturing supply chains and to ensure that new defense-critical technologies underwent production in the United States or its neighbors.

Country-specific tariffs, like those that the Trump and Biden administrations have imposed on China, can be used, along with financial sanctions and export controls, to punish American adversaries. But even a democratic, liberal, multiparty China would probably insist on maintaining most of its existing manufacturing and fostering new industries at home.

In the long run, every great power or bloc, including Europe and India as well as the United States and China, is likely to insist on having its own versions of strategic industries, from aerospace and automobiles and pharmaceuticals to drones and robotics and AI. Academic economists may object that this causes redundancy, and they may call for countries to specialize in one or a few product lines. But rational leaders of great powers will insist on a high degree of industrial independence, at the cost of higher domestic consumer prices, if necessary.

This does not mean an end to free trade altogether in a world of wholly autarkic blocs. The pursuit of strategic industrial self-sufficiency by all major powers might be compatible with a global system of mixed trade, combining protection for industries crucial to national security and prosperity with free trade in noncritical manufacturing, food, and raw materials.

If one purpose of country-specific tariffs is to protect particular defense-critical U.S. manufacturing from Chinese import competition, that purpose can be achieved by sector-specific tariffs that keep out imports from all countries, military allies and enemies alike. If a supply chain is really essential to U.S. defense, it needs to be in the United States or North America—not on the other side of the Pacific or Atlantic, not even in countries that are nominal military allies.

In addition to national or bloc-wide tariffs limited to strategic manufacturing supply chains, with no tariffs on many other goods, a rational American strategic trade policy would employ temporary retaliatory tariffs now and then, as bargaining chips to pressure America’s trading partners to open up their markets to more American exports. These retaliatory tariffs could take the form of reciprocal tariffs, exactly matching foreign tariff rates, but they need not do so. Moreover, the United States need not target the same products with retaliatory tariffs. To open the EU market to more U.S.-made automobiles, for example, the United States might temporarily impose high tariffs on French cheese or German beer. The goal of retaliatory tariffs is export promotion, not import substitution, and if they succeeded in prying open foreign markets, they would then be eliminated, unlike the permanent protective tariffs that would reshore or preserve strategic manufacturing in the United States or North America.

A third kind of tariffs—tariffs for revenue—should not be used at all in a rational American trade strategy. While protective tariffs need to be high enough to force American consumers and businesses to switch from imports to locally manufactured substitutes, revenue tariffs can only work if they are so low that they do not significantly reduce imports.

In the 19th century, agrarian countries like the early United States relied on revenue tariffs as indirect taxes on the rich, because imports tended to be luxury goods and because governments were too weak and primitive to collect personal and corporate income taxes. The revenue-collection function of tariffs became obsolete in the United States and other urban, industrialized states with competent tax agencies and adequate economic record-keeping. In advanced nations, most government revenue will continue to be raised by personal and corporate income taxes, consumption taxes, and social insurance contributions like the Social Security payroll tax.

How do the Trump administration’s tariffs fare when compared with this ideal American strategic trade policy? The tariffs that President Trump announced on Liberation Day fall into three categories: the good, the bad, and the ugly.

The good: sector-specific tariffs. Notwithstanding the administration’s decision to pause other tariffs announced on April 2, steel and automobiles remain subject to 25 percent tariffs, and sector-specific tariffs on semiconductors, pharmaceuticals, copper, and other products are being contemplated. We can debate which products and supply chains should be subject to sector-specific tariffs and whether these are best imposed for imports to the United States only or to North America as a whole. But targeted, sector-specific tariffs in dual-use, defense-critical industries are the easiest tariffs to justify.

To succeed, however, sector-specific tariffs must be accompanied by comprehensive industrial policies tailored to each targeted sector. Sector-specific policies include local-content procurement policies, investment promotion agencies, export-import banks, specialized sectoral development banks that provide loans and loan guarantees, export processing zones, public research and public-private research consortia, grants and breaks for research and development, sector-specific infrastructure investment, industrial skills training, tailored immigration policy, securing access to foreign sources of raw materials and stockpiling, technology extension programs, and others. If policymakers in the Trump administration and Republicans in Congress really believe they can reindustrialize America simply by throwing up tariff walls, slashing regulations, and cutting taxes on the rich, while ignoring or defunding sector-specific industrial policies, their plans will fail.

So much for good sector-specific tariffs. Now for the bad: the Trump administration’s so-called reciprocal tariffs announced on Liberation Day and then hastily paused when the stock market cratered and bond markets grew “yippy,” to quote President Trump. Despite their name, these are not reciprocal tariffs at all, exactly matching foreign tariffs on U.S. exports to a particular country. Instead, they are tariffs based on a bizarre formula calculated by halving the trade surplus another country runs with the United States.

The premise on which the reciprocal-tariffs-that-are-not-reciprocal tariffs are based—the idea that all bilateral trade surpluses are bad—is erroneous. To be sure, the U.S. chronic trade deficit with China is bad. Chinese state-backed firms dump subsidized products into the U.S. market, wiping out American manufacturers. Then, instead of buying an equivalent amount of American-manufactured goods, Chinese entities invest in American real estate or purchase American financial assets, driving up the value of the dollar, to the detriment of American exporters and the benefit of Chinese exporters.

In other cases, however, the United States can run a trade surplus with one country and a trade deficit with another country with no harm done. And the absurdity of the Trump administration’s obsession with bilateral trade deficits in themselves was revealed when Lesotho, a tiny African country of 2.3 million people that exports textiles to the United States, was slapped with a 50 percent tariff, the highest “reciprocal” tariff imposed by the United States. The Trump administration’s pseudo-reciprocal tariffs should be scrapped altogether, in favor of occasional retaliatory tariffs used as temporary bargaining chips.

If Trump’s sector-specific tariffs are good and his pseudo-reciprocal tariffs are bad, his global baseline tariff of 10 percent on all imports to the United States (except those from Canada and Mexico) is ugly. Even when the United States was at its most protectionist, between the Civil War and World War II, many imports were duty-free. And there is no need for an indiscriminate, across-the-board 10 percent global tariff to be used as the baseline in trade negotiations, because the United States can use temporary retaliatory tariffs at any rate it chooses as bargaining chips in negotiations to open foreign markets to U.S. exports in particular sectors.

President Trump and some members of his administration view the global tariff and other tariffs as significant sources of federal tax revenue. Trump told reporters, “It’ll take a little while before we do that, but we’re going to be cutting taxes, and it’s possible we’ll do a complete tax cut, because I think the tariffs will be enough to cut all of the income tax.” Trump’s Commerce Secretary Howard Lutnick has stated a more modest but still radical goal: “no [federal income] tax for anybody who makes less than $150,000 a year.”

This is nonsense. If tariffs were high enough to raise enough money to replace or significantly cut federal income taxes, then the money would quickly dry up, because Americans would cease to buy the now-expensive imports, and the revenue tariff’s tax base would shrink. Conversely, if tariffs were so low that they did not impede imports, they would not promote the reshoring of American industry, and they would contribute little to federal tax revenues. A case can be made for a federal consumption tax, like the value-added tax that all other industrial democracies use; but like state sales taxes, a federal consumption would need to have a broad base, not imports alone, along with relatively low rates. The best that can be said about the proposal to replace federal income taxes with federal tariff revenues is that it is a populist gimmick based on wishful thinking—the Laffer Curve, but for tariffs.

This, then, is what a rational U.S. strategic tariff policy would look like. There would be only three kinds of tariffs: permanent protective tariffs for defense-critical industries, temporary retaliatory tariffs used as bargaining chips to promote American exports, and occasional country-specific tariffs used against foreign adversaries, along with financial sanctions and export controls. There should be no global tariff and no tariffs for revenue at all. And trade policy should be subordinated to sector-specific industrial policies that use a variety of instruments, not just the tariff. If the Trump administration, with the support of both parties in Congress, can change direction and adopt a rational strategic trade policy along these lines, then some good may follow from the disaster of Liberation Day.