Tariff Nonsense!

The combination of slower GDP growth AND higher prices just isn't likely!

In our increasingly polarized society, political messages are often woven into economic analyses. With the U.S. presidential election on the horizon, such messages are multiplying, frequently distorting the truth.

P x Q

If Trump wins re-election, new import tariffs are expected to be high on his agenda. Many economists argue that this will lead to lower prosperity and higher inflation. While this may sound logical, it’s actually nonsense. History shows that import tariffs are often deflationary; overall prices tend to fall.

The reasoning is brief and simple, which is convenient given that I wrote this piece from the “magical” Disneyland Paris. The “income effect” of import tariffs has a much more significant impact than the direct price effect of the tariffs themselves.

This is a classic example of the "P x Q" concept we learn in school, where total output is a function of price (P) and volume (Q). Historical data consistently shows that price hikes due to tariffs impact Q (quantity) far more than P (price). The chart below from Alpine Macro illustrates this trend.

Chinese Tariffs

The last round of tariffs, set in motion by then-President Trump, fits this pattern perfectly. Following the initial tariff hikes in 2018, U.S. inflation actually declined over the next two years. Janet Yellen’s calls to cut tariffs to curb inflation were nothing more than political theater. It was her own department and the Federal Reserve’s policies that stoked inflation.

Suggesting that tariffs simultaneously lower prosperity and increase prices goes against historical evidence.

Who Pays the Bill?

I could end my column here, but that would ignore other misconceptions. For example, certain analyses by a major Dutch bank claim that consumers ultimately foot the bill for these tariffs. However, that’s also incorrect. This may be derived from the P x Q framework and but has also been thoroughly investigated.

Gina Gopinath, now managing director at the IMF, along with other economists, studied the question of who pays the tariff bill in depth. Their research revealed two main findings: while tariffs caused temporary price increases in certain areas, it was retailers who bore the bulk of the impact through reduced profit margins. Understanding the importance of the Q in P x Q, retailers protected sales volume by absorbing costs and keeping prices lower.

Source: Tariff Passthrough at the Border and at the Store: Evidence from US Trade Policy by Alberto Cavallo, Gita Gopinath, Brent Neiman, and Jenny Tang.

A similar pattern was observed among American exporters, who lowered their prices after China’s retaliatory tariffs to remain competitive.

So, statements like "American households will pay the bill" insert a subjective angle into what could otherwise be an objective analysis—and they’re simply untrue.

Do you know what does drive inflation up? Monopolies. And I should know, as I’m about to hop on a rollercoaster in what certainly is an extreme example of monopolism.