He's making a list, he's checking it twice...

The geostrategic rationale for Trump's tariffs, some microeconomics and why the UK must not align with the EU's SPS regulations.

The world of economics is twittering about trade – a subject that most of them have never looked at carefully or don’t understand. The Old Guard are sure Trump's new tariff rates will drive the world back to the 1930s style depression, and the Young Turks are using AI to reengineer the maths behind the tariff rates while also ignoring all of the countries given a 10% tariff rate that don’t fit their model.

Both groups claim the tariffs are illegitimate, but neither has looked at actual trade figures or even read the publications that explain the change in the US’s attitude to trade. Before commenting, they should read the publications from the USTR regarding global trade barriers and from the White House explaining the increased tariffs.

The big picture is that the US - the world’s Apex consumer - can’t negotiate trade deals if its trading partners already benefit from liberal access to the US market. Why would their trading partners bother? The mercantilists, who believe imports are bad for their economy (I don’t, by the way), can presently sell into the US’s massive consumer market without buying anything in return. But a trade agreement would force them to open their market to US goods – the mercantilists don’t want that. The worst ones, China for example, don’t even seem to want their own citizens buying the goods they are making for export to the US.

Trade bargaining chips

By applying tariffs of at least 10% to every country, Trump just gave himself a lot of trade agreement bargaining chips. A sensible country, hopefully like the UK, will immediately start negotiating a trade agreement with the US and accept that it must now allow more US goods into its market. The less sensible, like the EU, will threaten to apply even higher tariffs to US goods, but this won’t have much effect on US exports because the EU imports very few US goods other than fuel and pharmaceuticals, which have zero tariffs. This is due to the EU’s already high tariffs and many other trade barriers on US goods. For example, the US exported just under 400,000 tonnes of fresh or chilled beef in 2024, but only 11,000 tonnes were exported to the EU, due to the EU’s eye-watering tariffs on beef and its unscientific SPS regulations. If the EU increases these tariffs, it will not be a large blow to US beef exporters.

The naughty list

The countries Trump singled out for tariffs above 10% need to reduce their other trade barriers. This is especially true of the EU. The USTR Trade Barrier report lists 35 pages of EU trade barriers, not just the EU’s high tariff rates. Many of these barriers were introduced after the UK left the EU, hence why the UK got a lower tariff rate of only 10%, while EU exports will now face US tariffs of 20%.

However, the UK should not be too relaxed: the USTR report does warn that the UK has retained many of the EU’s ‘unscientific’ SPS regulations and some EU technical trade barriers. The USTR’s research was done when the UK was moving away from the EU’s precautionary principle. If the present UK government reveres this and aligns more closely with the EU, then we should also expect our US tariff rate to be increased to the EU’s 20% level.

As the US is the UK’s largest trading partner, aligning with EU SPS regulations would be a very expensive mistake. SPS regulations mainly relate to raw agricultural products, and the UK doesn’t export a lot of raw food to the EU; we import it from them, which doesn’t require SPS alignment. Aligning with EU SPS would make it more difficult for the UK to agree to a trade deal with the US.

Geopolitical issues

But there are other issues at stake. I couldn’t help noticing that not just China, but also its satellite countries with Chinese-owned factories, and countries with ports and military bases connected to China’s Belt and Road initiative, were hit with the highest rates of tariffs. This is a warning to these countries: firstly, China can’t move its factories to other countries to avoid the US tariffs, and secondly, countries can’t take loans from China that end up giving control of their infrastructure to China and still expect to continue to sell freely to the US market – the US doesn’t trust you anymore.

The first warning is just to avoid trade diversion. This isn’t unusual. Avoiding trade diversion also happened to Chinese-owned British Steel under the first Trump administration’s tariffs on China. UK steel exports got a special mention in the US Harmonised Tariff Schedule lists of all of the US import restrictions due to Sections 301, 302 and 203 of the US Trade Act of 1974. For the record, Trump's Tariffs on China were retained by the Biden administration, and many were doubled by Biden before he left office. But strangely, the economic commentators now apoplectic about Trump’s latest round of tariffs weren’t so worried about Biden’s tariffs – not even his 100% tariffs on Chinese-made EVs. Apparently, Biden tariffs don’t cause recessions, inflation or trade wars. Who knew?

The second warning is the most important. The US has a massive geostrategic problem – it is losing control of the means of production of everything from pharmaceutical ingredients to shipbuilding for transport and defence. As Sun Tzu advises: China is close to winning the battle before it has started. That is why Trump's first tariff increases during this administration were 25% tariffs on steel and aluminium, and many products made with them. These were not blanket tariffs as the apoplectic commentators like to imagine. If they took the time to go through the list of products subject to the tariffs by 10-digit tariff code, they would see an obvious pattern emerging. Most of these products are produced in and exported by China.

That is why both the first Trump administration as well as the Biden administration began the process of onshoring strategic production such as semiconductors, pharmaceutical ingredients and strategic mineral refining. It is also why no one wants to waste US ammunition defending Ukraine. Let the EU do that. The EU has grown fat and lazy behind its trade barriers against the US, but still feels entitled to US military protection. I suspect the EU will have to pony up with some real defence spending on US made defence equipment as well as dropping its many regulatory trade barriers, if it wants a better trade deal from the US.

Innovation comes from production

Regaining the means of production is also important for innovation. Most innovation comes from doing the work in a laborious way and thinking of ways to do it more efficiently. For example, we shouldn’t be surprised that the first dishwasher was invented by a woman, Josephine Cochrane, in 1886. Apparently, she had no formal training, but I imagine she had washed a lot of dishes.

Doing the manufacturing grunt work for the Western world has paid off for China as well. China now leads the world in innovation; of the 3.4 million patent applications filed globally in 2024, 1.4 million were from Chinese inventors. China also wants to move up the value chain – provided, of course, that the US keeps its markets open so US consumers can pay for the goods, and the US Navy keeps the shipping lanes free of pirates and terrorists’ missiles.

The US did a prodigious thing when it allowed China to join the WTO, saving millions of people from starvation and poverty, but it then created a monster by turning a blind eye to Chinese abuses of the WTO provisions for developing countries, long after China had developed. At the time, there was a widespread belief that China would eventually also become a consumer society and then a democracy. So far, this hasn’t happened, nor is it likely to. Just as many of the West's largest trading partners haven’t become democracies, but at least the populations of Singapore, Saudi Arabia, and the UAE have become consumers.

The UK is in the same boat as the US

Loss of the means of production is also a UK problem. The UK is giving up its plentiful hydrocarbon-based energy for renewables, even though it does not control the means of production needed to turn wind and sunlight into energy. It relies on China to supply these products. The UK is also losing its chemical and plastics industries, which use hydrocarbons as inputs. After that, without high-temperature combustion, the cement industry will die, as UK primary steel and aluminium production already has.

For better or worse, in 15 years' time, when the present generation of wind turbines and solar panels need replacing, it will literally be within China’s power to switch the UK off. The US doesn’t want to be in this position, and as the UK also relies on US military protection, we shouldn't want the US to be in this position either.

Tariffs do not cause inflation

As for the apoplectic economists bleating about inflation and recessions, they really need to look at some trade figures. They also need to refresh their economics: Inflation is an increase in the general price level of goods and services – not just imported cars.

Increasing tariffs would only cause inflation if the US imported everything it consumes - which it doesn’t. The US total trade to GDP ratio is only 25%, which is lower than all other developed nations. US imports to GDP are only 14%, lower than China or even Russia – and Russia wants to be an autarky! Only if the US imported all of its supplies of a commodity that was involved in all production, such as energy, could a tariff increase cause a general increase in the price of all goods and services. Instead, the US is a major exporter of energy products, not an importer. (Although this should be a warning to any country that is a major importer of US LNG and thinking of retaliatory tariffs. And yes, I am talking about you, Germany.)

Microeconomics, consumer goods and trade

Most of the (male) apoplectic economists are using cars as an example of how the tariffs will cause prices to rise. But cars are not representative of most trade, which includes large values of machinery, electronics, parts, industrial chemicals, semi-finished goods, fuels, plastics, etc that generally make up a smaller part of a finished good than domestic wages, rent, financing and taxes. Cars aren’t even representative of how most imported consumer goods are sold.

For imported finished consumer goods, such as a pair of trainers, the retail price is many multiples of the import price. Tariffs are only charged on the import price. When a consumer pays the retail price for a pair of trainers, they are paying for the convenience of buying them: when they want, in the size they want, the colour they want, the style they want and, from a store, close to them. Most of the price pays for this convenience – not for the trainers. The retail price must also cover the shop's rent, wages, energy, financing and inventory costs as well as the shop owner's profits, and the government's consumption taxes, employment taxes and business taxes. In the UK, for example, with 20% VAT, employer NIC, business rates and corporate taxes, HMRC gets the largest share of any retail sale irrespective of any tariffs.

And before you sell your Nike shares – the US already has tariffs on imported trainers ranging from 48% for trainers imported for less than $3 a pair, down to 20% for trainers imported for more than $12 a pair. (Yes, cheaper shoes have higher tariffs.) And yet everyone is still wearing trainers, and they probably paid around $100 for them, but they may have paid as much as $250. Nike makes its trainers in China and in Vietnam. In September 2024, a dollar bought 24,500 Vietnamese Dong, but yesterday it was trading at 25,800 to the dollar, which will help counterbalance the new US tariffs.

Cars are different

New imported cars are generally sold through a dealership network tied to the manufacturer, so the retail price is much closer to the import price. The US’s new 25% tariffs on all imported cars will make imported cars in the US more expensive. However, assuming a 30% dealer markup, if the dealer passes on the full 25% tariff, then the car price would rise by 17.5%, unless the dealer or manufacturer absorbs some of the cost, or the manufacturing country’s currency drops relative to the dollar.

This price increase will probably reduce imported car sales, especially for cheaper models, assuming there are substitute domestic cars available. Like most car manufacturers internationally, they rely on imported parts, so there may not be an immediate supply of US-made cars available to provide import substitutes. But there will be soon.

However, in the short term, imported new car sales will drop, and as we saw during Covid, the prices of second-hand cars may soar. But eventually, the same thing will happen now as happened during the Johnson administration in the 1960s, after the US increased the tariffs on imported trucks to 25% in retaliation for the EU introducing non-tariff barriers that restricted US chicken imports (plus ça change). The world’s truck manufacturers moved some of their production to the US to avoid the tariffs, and they never moved back. And this is precisely what President Trump hopes to achieve with his new tariffs.

The importance of onshoring

In the long run, it is extremely important for world security that the US retains the means of production. It would be a bonus if other like-minded countries dropped their trade barriers to US goods, but if they don’t, the US Treasury will pick up a relatively large amount of money until production is fully onshored.

A back-of-the-envelope calculation based on the US imports from the UK in 2023, worth $65.5 billion, most of these imports had zero or very low tariffs, so the US raised about $900 million in tariffs. If the US imported the same value and mix of goods at the new tariff rates: of 25% on cars, aluminium including aircraft parts, iron, steel, and articles made with iron and steel, and 10% tariffs on everything else including pharmaceuticals which were internationally tariff free, then the US treasury would have raised $8.4 billion, adding about 12.8% to the import price.

Of course, we can’t assume that the UK would continue to sell the same amount of goods if the tariff rates are increased to 25% and 10%. UK exports are already relatively expensive, and the UK currency is high relative to the Dollar, unlike the Vietnamese Dong. Other developing nations that rely on exports to the US for revenue will probably see their currencies fall to a level where their goods are the same price in the US as they were before the tariffs. US consumers will pay the same price, but a larger proportion of the price will go to US government revenue.

Universal tariffs are just consumption taxes

Trump's 10% tariffs will make the US more like the rest of the world, which charges VAT, GST or some other type of consumption tax on all goods, including imported goods. Effectively, Trump just introduced a Federal consumption tax, but unlike the UK’s VAT, it will only apply to imported goods. Tariffs are just consumption taxes after all. And if you think the difference is that a tariff is discriminatory – the UK doesn’t charge VAT on raw food, books, art and antiques, solar panels and has a reduced rate for other essentials such as energy, petrol and compulsory child car seats. This is also discriminatory. Any Blue States in the US that don’t like the new tariffs could negate them by lowering their own sales taxes, but I doubt any of them will.

The UK’s best (and only) response

UK exporters will find it difficult to replace their wealthy US consumers and industrial customers. The UK exports 80% of its car production, and according to the ONS, 27% of UK car exports by value go to the US and as do 27% of UK medicine exports. The EU won’t step up to buy UK goods—they didn’t when we were members, and they won’t now. Instead, they will try to sell us the goods that they used to sell to the US.

To make matters worse, the UK has snookered many of its traditional export industries with its energy policies. The UK’s Net Zero policies are already driving UK chemical and plastics manufacturers to the US, and it won't be long before UK Aircraft parts and UK car manufacturers join them to avoid the 25% tariffs.

The trade battle lines are being drawn up—we need to be on the US team. The UK needs a full-fat, tariff-free, quota-free, and non-tariff barrier-free trade deal. And we need it now.