FREE NEWSLETTER
IMAGINE TAKING DOLLAR bills and inserting them into a shredder. This is how you might think about a concept that economists call “deadweight loss.” As its name suggests, a deadweight loss occurs when there’s an irrevocable loss of economic output.
Deadweight losses can occur under a variety of circumstances. Among them: when tariffs are imposed. It’s for that reason that the incoming administration’s tariff plan has raised concerns. But how worried should we be? It’s worth looking at different viewpoints on this question.
The chief concern with tariffs is that they’ll result in higher prices for American consumers. Especially right now, after the recent spike in inflation, further price increases would be unwelcome. But tariffs can have even broader implications. At a macro level, when prices are higher, people buy less, causing the economy to slow. When the economy slows, corporate profits fall and that, in turn, can lead to lower stock prices. Not surprisingly, many investors aren’t excited at the prospect of new or higher tariffs.
Economists are nearly unanimous in viewing tariffs negatively. In a 2015 article, economist Gregory Mankiw, who once led the president’s Council of Economic Advisers, noted that the benefits of free trade have been understood since Adam Smith’s The Wealth of Nations, published in 1776. “Economists,” Mankiw wrote, “are famous for disagreeing with one another” on nearly every other topic, but not on this one.
A further worry is that tariffs could have unforeseen consequences. The most obvious risk: Other countries could retaliate, imposing their own tariffs on American goods. An article published by the Cato Institute painted this unpleasant picture: “Tariffs often lead to cascading protectionism and create a fertile ground for corruption. The 2018–2019 tariffs on China led to a complex process of exclusion requests, lobbying, and retaliatory tariffs, demonstrating the multifaceted harms of protectionist measures.”
To appreciate the potential fallout of a trade war, consider the so-called chicken tax. This is a 25% tariff that applies to imports of light trucks. Why is it called the chicken tax if it applies to trucks? The history is instructive.
The chicken tax was imposed by Lyndon Johnson back in 1964. He was upset at what he saw as unfair treatment of the American poultry industry, so he imposed an import tariff on poultry coming from Europe. To put further pressure on European policymakers, Johnson imposed an import duty on trucks as well. The chicken battle blew over before too long, but the tariff on trucks has remained for the past 60 years. The lesson: Once a trade war gets started, it’s hard to know where it might lead. That’s a key reason new tariffs have many people on edge.
At the same time, the chicken tax illustrates another reality about tariffs: They’re nothing new. They’ve always existed and, to one degree or another, they’ve been supported by both Democratic and Republican administrations over the years.
Alan Blinder, for example, is an economist whose views fall to the left of center. He was appointed to the Federal Reserve’s board of governors by Bill Clinton and is no fan of Donald Trump. But in a recent opinion piece, he indicated that higher tariffs may not be such a problem.
Blinder’s reasoning was as follows: Imports account for just 14% of gross domestic product. If tariffs average between 10% and 20%, the overall impact on consumer prices would be modest—between 1.4% and 2.8%. And as Blinder notes, it would likely be just a “one-shot price increase.” New tariffs wouldn’t lead to higher inflation every year.
For its part, the incoming administration has argued that tariffs wouldn’t be inflationary at all. In a recent interview, Scott Bessent, the incoming Treasury secretary, made this argument: “Tariffs can’t be inflationary because if the price of one thing goes up, unless you give people more money, then they have less money to spend on the other thing, so there is no inflation.”
Some tariff supporters go a step further, arguing American consumers will even benefit from tariffs. Why? If domestic manufacturers suddenly have a price advantage relative to foreign competitors, it stands to reason that they’ll gain market share and, in turn, they’ll hire more workers at higher wages.
Take the chicken tax. If you’ve wondered why American manufacturers thoroughly dominate the market for pickup trucks, the chicken tax is the reason. From the perspective of American auto makers—including all the workers in the automotive supply chain—this tariff is a good thing.
In the end, however, all the countervailing views on this topic highlight a reality for investors: When it comes to economics, it’s difficult to know precisely how things will turn out. Textbooks describe various economic relationships that are generally accepted, but the results aren’t guaranteed. Even Alan Blinder, who wrote one of the most widely used textbooks in economics, isn’t sure how these prospective tariffs will play out. Based on his math, the impact might be modest, but this analysis was based solely on the numbers. Others fear a broader, and more unpredictable, geopolitical impact.
If we antagonize China, for example, no one can predict how its autocratic regime might respond. Just as Lyndon Johnson targeted trucks coming in from Europe, Beijing could retaliate in any number of ways. Suppose Xi’s government suspended iPhone shipments for a month or even a year. Or worse yet, if it decided to step up its military threats against Taiwan. That could draw the U.S. into a far more difficult situation.
The bottom line: There’s a greater level of economic uncertainty today. But for investors, negative events are always a possibility, even if the risks are below the surface. That’s why, in my view, we should be prepared at all times, even when there aren’t specific risks in the news. What does this mean in practice? Holding a portfolio that’s diversified across stocks and bonds—and diversified within stocks and bonds—is, I believe, the best defense.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.
Want to receive our weekly newsletter? Sign up now. How about our daily alert about the site's latest posts? Join the list.
“Free” trade isn’t the same thing as “Fair” trade. It’s not fair when countries have tariffs on our products being imported to them but we have none on theirs. For the first 250 years of this country from 1789, through to the end of World War II, there was a protectionist policy in place that relied mostly on tariffs to fund the US government and to protect US industry and jobs. Most other countries did the same.
After the war tariffs were dropped since most of America’s international business competitors industrial bases had been wiped out by the war and were no longer considered a threat. The US also wanted to quickly repair the economies of democratic countries as an offset to the Soviet Union. The Federal Income tax became the main funding source of the government, which when it was first enacted in 1917, was only supposed to be paid by millionaires but of course has become the monster it is today.
The current tariffs were started by Trump during his first term and have been continued by Biden. Tariffs now bring in about the same amount of money as the income tax so there is a rumored proposal by Trump to get rid of the federal income tax all together, which would take the country back to pre-pandemic spending levels. Just think, no more federal income tax hanging over your head every year, no more being accused of money laundering by using cash. No more huge IRS department treating everyone like we’re potential tax cheats, all the money you make you get to keep. I hope it happens and I can’t wait.
That’s quite the tone-deaf statement from Bessent. As a member of the billionaire class, he will be insulated from any personal financial hardship resulting from Trump’s tariffs.
First, over the years, domestic vehicle manufacturers and their suppliers have taken steps to increase automation in production facilities, and will continue along that path as technology continues to improve and manufacturers try to reduce their dependence on labor. Whether or not there would be a net increase in hiring depends on the time frame being measured.
Second, tariffs will concentrate vehicle sales among a limited number of large domestic manufacturers. This decreases competition, and will likely result in increased prices. With regard to new companies entering the market, it is very difficult to scale a start-up without government assistance. Tesla was struggling until it started benefitting from tax incentives. China subsidizes its domestic electric vehicle manufacturing.
Third, the “U.S. domestic” manufacturing supply chain consists of vehicles and parts manufactured and assembled in many different countries. Quality will suffer during any transition period due to cost, inexperience and a steep learning curve among new suppliers and assemblers. Replacing the current system would take years, if not a decade or more. In the meantime, vehicles and parts will be in short supply, and again, prices for new/used vehicles and repairs will go up. And that’s without retaliatory tariffs. That’s economics.
I wish the article addressed this in more detail. It doesn’t make sense. Won’t the other thing go up too? In that case people will have to go without. How is that a good outcome?
The pricing implications of tariffs / import taxes are pretty clear to most folks. We all can tell when an imported product goes up in price after enactment of a tariff.
What may not be so clear is the product availability – and freedom of choice implications – of such taxes. When traveling in Peru last year, I had five consecutive Ubers that were Chinese-made cars. None can be imported or sold in the US. Similarly, there are numerous European-made light trucks and vans on the streets of France and Germany that American consumers simply can’t access.
I accept that the national government can impose – and a consumer may choose to pay – a tariff as a condition of buying a sought-after foreign product. That’s called public policy. But when the tariff is high enough, Americans can be deprived of our opportunity to even make that choice.
Thank you, Adam, for this additional insight on a complex topic. Never heard of the chicken tax before. Interesting how this tariff eventually became a norm. Sadly, any action such as tariffs that ruffles the feathers of foreign leaders can be used as an “excuse” for extreme responses or threats including military involvement. Perhaps for now, tariff talk is just that. It certainly got the world’s attention, good or bad.
“If goods don’t cross borders, soldiers will.”
Does Bessent’s view, that new tariffs will not spark fresh inflation, overlook the role of credit creation and use in the economy?
As a high school student, I was a budding proponent of centralized control, but Milton Friedman’s books won me over to the other side, including the necessity of free trade. I hope the new admin’s dabble into protectionism won’t cascade out of control, but how much control do I have? Only as far as my own reaction, which is to follow the advice of holding a defensive diversity.