Tariffs, Tariffs, and More Tariffs

Tariffs all the way down

Estimating the possible impact of tariffs on imports requires you to make an assumption about the so-called trade elasticity.

For example, if a 10% tariff increase is assumed to lead to a 5% reduction in imports, then the trade elasticity is 0.5. If a 10% tariff increase leads to a 10% reduction in imports, the trade elasticity is 1.0. If a 10% tariff increase leads to a 20% reduction in imports, the trade elasticity is 2.0.

Etc.

Obviously, different products have different elasticities. For example, if the product is really easy to substitute either domestically or from elsewhere, then you would expect the trade elasticity to be high.

Alternatively, if the item is essential and you can only get it from the one place you have always imported it from then a tariff increase would have less of an impact on imports, and the elasticity would be low.

Saying that, smart people tell me that a reasonable aggregate elasticity assumption is around 2.0.

However, the exact level, assuming it is above 1.0, becomes moot once tariffs rise hit 100% and over.

Let’s take, for example, Trump’s new 145% tariff on China.

If you assume an elasticity of 1.0, a 145% tariff will result in US imports from China dropping to (sub) zero.

And assuming the US isn’t going to stop importing stuff from China entirely, a tariff of 145% probably means you are left with an elasticity of around 0.65. This is unfathomably low/conservative, but it still results in nearly all imports being wiped out.

Using 2024 import numbers, and assuming a trade elasticity of 0.65, this means US goods imports from China will fall from $438.9 billion to … $25.2 billion.

So yeah, under the most conservative assumptions possible, at current tariff levels, we’re talking about China-US goods trade collapsing.

Which is absolutely wild.

Anyway, my follow-up question is: What happens to the c$413 billion of Chinese exports that can no longer enter the US? Where do they go? What are the second-order consequences?

I think there are two obvious answers.

In response to being shut out of the US market, Chinese exports either …

1. Get diverted away from the US and into other markets. On the one hand, this means lots of cheap stuff for everyone else, on the other, producers in those markets will probably freak out and lobby their own governments for protective tariffs. [Note: this is what happened in Trump 1.0 when he imposed the steel tariffs, and the EU and others, fearing a flood of cheap steel onto their markets, did the same.]

   In picture form:

2. Some of the Chinese exports might find their way into the US via other markets, for example Cambodia, Vietnam, Mexico, and the Heard and Macdonald islands. (Yes, this is my rules of origin-related issue that I tend to badger on about … a lot.) To prevent this from happening, the US will probably (and seemingly **is**) force other countries to restrict Chinese trade and investment as a condition of maintaining a lower US tariff rate.

   In practice, this implies more tariffs on China by others, more trade diversion, and more subsequent pressure on countries to impose their own tariffs to guard against Chinese products being diverted onto their market.

   Here it is in a [much more complicated] picture format, where I assume that Canada and Mexico impose their own tariffs on China too, but at the relatively lower rate of 50% (but assume same trade elasticity [0.65], although it would definitely be higher).

   

   Can we assume the rest of the world will absorb circa $438 billion in diverted Chinese exports without kicking up a fuss?

   I suspect not.

All of this is to say that even if we assume the US-China tariffs (and I’ve just discussed the US side of this today; China has imposed its own retaliatory tariffs too) come down to slightly more sensible levels, the rest of the world is going to come under lots of pressure to introduce their own tariffs both to protect domestic industries from diverted Chinese competition, and because the US is asking/forcing countries to do so.

Have a great weekend!

Sam

P.S. If I’ve messed up some of the sums … sorry. But you’re reading something written by a guy who literally communicates using felt tip pens. So that’s kinda on you.