KARACHI: The Trump administration’s method of calculating which countries should be hit with what reciprocal tariffs is “so crude and misleading”, say experts.
In an over nine-minute-long video explainer released on April 4, foreign outlet ‘CBC News’ breaks down the methodology adopted by the US to hit countries with reciprocal tariffs.Douglas Irwin, professor of economics at Dartmouth College said, “I am surprised that they actually had a formula; it seemed like the tariffs were sort of random and plucked from air and it wasn’t clear what criteria one was going to use.”
Last Wednesday (April 3), US President Donald Trump celebrated ‘Liberation Day’ by announcing universal and reciprocal tariffs against almost every single country. Trump brought out a big chart with three columns: countries, tariffs charged to the US, and reciprocal tariffs charged by the US.
According to the list, the tariffs charged to the US includes currency manipulation and trade barriers that US goods face in other countries. But the actual calculation reveals that the method is arbitrary.
The Office of the United States Trade Representative has released the following formula to calculate the tariffs: the trade deficit (difference between imports and exports) is divided by the product of elasticity, pass-through and imports.
Epsilon (elasticity) takes into account how sensitive customers are to higher prices, while Phi (pass-through) calculates how likely prices are to increase. The two factors were set at 4 and 0.25. When multiplied, they cancel each other out to equal one. The simpler form turns out to be: US trade deficit with the country divided by total US imports from the country.
The US then offers a ‘discounted rate’ by dividing the tariff percentage by 2. According to the list, Pakistan imposes 58 per cent of tariffs on US goods; the discounted rate turns out to be 29 per cent.
Experts have pointed out flaws in this calculation. In the video, Irwin added that the formula is not measuring other countries’ tariffs. “It is not measuring non-tariff measures; it is not even measuring currency manipulation. It is only taking the trade deficit as an ipsso facto reflection of those things.”
In an oped published by ‘The New York Times’, titled ‘The Trump White House Cited My Research to Justify Tariffs. They Got It All Wrong’, on Monday, Brent Nieman, a Biden administration Treasury official who co-wrote trade-related academic research cited by the Trump White House, said, “reciprocal tariffs, after all, are supposed to treat other countries the way they treat us, and foreign tariffs on American goods are nowhere near these levels.”
On the methodology adopted by the US White House, he added, “I disagree fundamentally with the government’s trade policy and approach. But even taking it at face value, our findings suggest the calculated tariffs should be dramatically smaller -- perhaps one-fourth as large.
“Let’s start with the biggest mistake. The office said it calculated its reciprocal tariffs at a level that would theoretically eliminate trade deficits with “each of our trading partners,” one by one. Is that a reasonable goal?
“It is not. Trade imbalances between two countries can emerge for many reasons that have nothing to do with protectionism. Americans spend more on clothing made in Sri Lanka than Sri Lankans spend on American pharmaceuticals and gas turbines. So what? That pattern reflects differences in natural resources, comparative advantage and development levels. The deficit numbers don’t suggest, let alone prove, unfair competition.
“There are some reasonable arguments in favour of reducing the overall trade deficit, such as to reduce risks from our debt. But these arguments don’t apply country by country. The Nobel laureate Robert Solow explained why when he quipped, ‘I have a chronic deficit with my barber, who doesn’t buy a darned thing from me.’ Mr Solow also surely ran a chronic surplus with his students, and these imbalances reveal nothing about trade barriers in hair care or higher education, nor would they speak to his financial health.
On whether the US’s current approach could work, Nieman said, “Again, no. The administration’s tariff formula assumes that a tariff placed on one country won’t affect imports from any others and ignoresany implications for exports. These assumptions may work for an action against one small trade partner, but not for the broad salvo announced last week. A large tariff on Japanese auto parts could cause an increase in demand for imports from Mexico and vice versa. And the tariffs clearly invite retaliation and may over time increase the dollar’s value, both factors that would most likely depress US exports.
“Let’s keep going. Not only will we grant the government its goal, but we will also ignore flaws in its tariff formula. Do the computed tariffs then look right?
‘Guess what? They do not. The government’s formula uses four different numbers to calculate tariffs, including imports and exports for each trading partner. The part that directly relates to our research is an estimate of how much import prices change in response to the additional costs imposed by tariffs.
“The value of that term, known as the rate of pass-through, isn’t obvious and depends on how companies behave. If foreign exporters cut prices to fully offset the tariffs, leaving import prices unchanged, the pass-through would be zero. Alternatively, it could equal 100 per cent if exporters don’t budge, which means import prices would rise in step with the tariffs.
“Alberto Cavallo, Gita Gopinath, Jenny Tang and I studied the tariffs placed on Chinese exports in 2018 and 2019. (This is the ‘Cavallo et al’ reference in the government’s methodology.) We found that tariffs of, say, 20 per cent caused domestic importers to pay nearly 19 per cent more. This represents a pass-through into import prices of about 95 percent, which is the value I would have plugged into the government’s tariff formula. In simple terms, that implies that the price paid for US imports would rise almost as much as the tariff rate.
“The administration’s trade office cites our work, but mentions a different result from the paper, which found a low pass-through rate to the listed prices at two retailers. The Trump administration then plugs a rate of 25 per cent into its formula. Where does 25 per cent come from? Is it related to our work? I don’t know. The reciprocal tariffs have enormous implications for workers, firms, consumers and stock markets around the globe. But the methodology note offers shockingly few details.
“Had the trade office instead used a value closer to the 95 per cent number from our work, as I believe it should have done, the computed tariffs would have been as little as one-fourth of what they are.
“As a result of these and other methodological choices, Wednesday’s reciprocal tariffs will bring average tariff rates to their highest level in over 100 years. Their breadth is striking, hitting large economies such as China and Europe, and also small developing and emerging-market countries including Jordan and Zambia. And despite being billed as a “do unto others” trade policy, they are not calculated in line with the Bible’s golden rule.
“I would strongly prefer that the policy and methodology be scrapped entirely. But barring that, the administration should divide its results by four.”
In his conversation with The News, macroeconomist Ammar Habib Khan said that such calculations have only been used for the latest tariffs, adding “this is not really a formula for tariffs”.
“This basically penalises a higher trade deficit. The higher the trade deficit that the US has with a country, the higher the implied tariff -- which means that countries will be looking to reducing their trade deficit with the US, and import more from the US,” Khan explained.
FEARS OF INFLATION
There are concerns that these tariffs could affect pricing for US consumers. Khan sees this as an opportunity for Pakistan.
“Pakistan’s largest export to the US is textile, and that may not be affected as much -- since on a relative basis, the tariffs on Pakistan are lower than other regional competitors. Exporters [here] have an opportunity to increase their market share in the US by taking up the market share of countries that have [been hit by] higher tariffs, including Vietnam, Cambodia, Sri Lanka and Bangladesh. Pakistan should strengthen its trade relationship with the US given its relatively advantageous position.”
According to Khan, “Pakistan and the US will be negotiating lower tariffs. Pakistan should ideally be looking at reducing its trade deficit with the US, by importing more from the US, thereby reducing imports from China in the process, whether that is soyabean or RLNG.”