By Dani RODRIK
By wielding the threat of imposing across-the-board tariffs against Canada, Mexico, and China for no justifiable reason, US President Donald Trump has demonstrated that he is a major risk for America and its trade partners.
But how other countries respond to Trump’s reckless policies will ultimately determine how much damage the global economy will sustain. America’s trade partners need to keep their cool and resist the temptation to magnify the insanity.
Most analysts seem to believe that responding in kind is the right thing to do. As expected, Canada and Mexico both threatened retaliation and eventually reached deals with Trump to avert the tariffs temporarily.
But it is not clear why retaliation should be regarded as normal and desirable when the tariffs that trigger them are viewed (correctly) as crazy. Policymakers elsewhere must not lose sight of the truth that Trump has chosen to disregard: the costs of tariffs are borne mainly at home.
The instinct to retaliate is natural. To deter a schoolyard bully, one must confront him with determined opposition. But far from dissuading Trump, other countries’ tariffs will further feed his misplaced grievances. More importantly, the logic of retaliation fails in this instance. The tit-for-tat model works to ensure cooperation in certain circumstances, such as the prisoners’ dilemma. In this scenario, each actor benefits from their own unilateral move, but is made worse off when the other actor responds in kind. Trump’s tariffs do not fit this characterization.
Contrary to what Trump claims, US tariffs are paid mostly by American consumers and firms that use imported inputs. Thus, the “optimum tariff” argument by which a country could gain by exercising monopoly power on world markets does not seem to apply.
Selective trade protection can occasionally play a positive role as part of a broader agenda for development or greener growth. But across-the-board tariffs hurt the US economy, and more so than they do other economies. Trump’s America is a prisoner entirely of its own making.
Likewise, retaliatory tariffs imposed by Canada and Mexico would mainly harm their own economies. As smaller players in world trade, they have even less ability to pass the costs of tariffs on to the United States. The presence of supply chains in North American trade (as in auto manufacturing) magnifies the costs of disruption, but does not alter the fact that the costs of import tariffs are essentially domestic. In the language of game theory, retaliation through import tariffs is not a “best response.”
Returning to the schoolyard bully analogy, imagine that you face an aggressor who is attacking you for no good reason. He seems mad, hitting himself with each wild swing of his arm. What should you do? You could respond in kind and mimic what he is doing, but that would be equally mad, since you would be hurting yourself even more in the process. The best strategy, then, is to minimize the damage by staying as far from the bully as you can and waiting for him to punch himself out and crumple in a corner.
To be sure, Canada, Mexico, China, and other countries that will bear the brunt of Trump’s trade actions do not have the luxury of insulating themselves from the US. They will feel some pain for sure. But they should not make things worse for themselves by “pulling a Trump” on their own economies. Some surgical retaliation against industries that support Trump politically may be unavoidable for domestic political reasons. But common sense and moderation should prevail, for the sake of their own countries and the global economy on which they depend.
Some worry that Trump might feel vindicated if others do not mount a strong response. But the surest way to put him in his place is to downplay his threats and treat him as weak. The most effective message America’s trade partners can give Trump is: “You are free to destroy your own economy; we do not plan to do the same. We will turn instead to other, more reliable trade partners, thank you very much.”
Moreover, America’s trade partners – even the small ones – are not entirely powerless vis-à-vis the US. They have instruments other than trade policy at their disposal. They can, for example, impose profits taxes on domestic subsidiaries of specific American multinational corporations. Gabriel Zucman of the Paris School of Economics has suggested that Canada and Mexico place a wealth tax on Elon Musk and make Tesla’s access to the Canadian market conditional on paying it. This approach has the advantage of potentially generating direct fiscal benefits at home.
In the wake of Trump’s actions, we should worry about the prospects of a calamitous race to the bottom. During the 1930s, a cycle of retaliation sent international trade into a tailspin and exacerbated the global depression. Avoiding such an outcome today is of the utmost importance. The good news is that the worst of the damage can be contained, and the costs will be borne mostly by the US, if others don’t overreact. America’s trade partners should keep calm and carry on.
Dani Rodrik, Professor of International Political Economy at Harvard Kennedy School, is President of the International Economic Association and the author of Straight Talk on Trade: Ideas for a Sane World Economy (Princeton University Press, 2017).
