Tariffs: The Geopolitical Weapon Masquerading as Economic Policy

Tariffs are back as the topic du jour—again. Indeed, they have ascended beyond trade policy tools; they have been fully weaponized. Tariffs, and the full-on escalation into trade wars, take center stage from time to time, when nationalism rears its ugly—yet mesmerizing—head. While tariffs are immediately self-harming, even if one might cheer at the great pain inflicted on others, they nonetheless find popular support when dressed up in slogans: “Bring back American jobs,” “Get tough on China,” and “Fair trade, not free trade.” They sound good. Righteous, even. But as usual, slogans are just that. They don’t make for good economics, much less rational policies.

And yet, here we are—where slapping taxes on imports is being sold as a cure-all. It will raise tax revenue to subsidize our government deficit. It will bring back well-paying manufacturing jobs and close the income inequality gap. Foreign countries will buy more American goods, thus significantly improving American profits from global trade. Before we let another round of economic nationalism pass as policy wisdom, let’s take a moment to cut through the pseudo-patriotism and bad economics.

Who’s Afraid of the Trade Deficit?

Let’s begin with the villain of the story: the trade deficit. The U.S. runs an enormous trade deficit against Asia. Simply put, we buy more from China, Taiwan, Korea, Vietnam, and Japan than they buy from us. Some call this a sign of a flawed U.S. policy—that we are being exploited by our trade “partners,” essentially lifting them out of poverty with little in return. Others argue that the U.S. is spending itself into poverty, attributing the trade deficit for our astronomical $36 trillion in government debt.

But both narratives misunderstand what the U.S. trade deficit actually is. In fact, the word “trade” is a red herring. Trade, in the classical sense, assumes that the U.S. is producing milk while Asia is producing eggs. Unfair trade, then, would be the U.S. buying eggs from Asia, while Asia refuses to import milk in return.

However, that is not the nature of U.S. trade. In reality, Asia produces both eggs and milk. The U.S.—with its printing press that produces the one and only “world” currency, the mighty Dollar—sends Asia digital money and receives trillions in manufactured goods in return. Economists famously refer to this as “The U.S. prints, Asia sweats.” This is, of course, not trading. It’s just American firms paying Asian factory workers $3 an hour to work 80-hour weeks making iPhones and Nikes.

What we classify as a “trade deficit” is really just payroll—what Apple pays Foxconn factory workers to assemble iPhones. This is, plain and simple, American firms outsourcing work to China to reduce labor cost and increase firm profit, while lowering prices for consumers.

Once you understand this economic reality, you also realize that the Chinese could each buy another iPhone without reducing the U.S. trade deficit. Why? Because iPhones are made in China! Apple would, however, net billions in new profits.

At the end of the day, the data speak for themselves. The outsourcing of manufacturing, which has led to a persistent U.S. trade deficit, has also led to 40 years of strong American profit growth, resulting in a spectacular bull market and wealth creation. And, importantly, low-cost Asian goods afforded Americans a 2.5% inflation despite what one might argue as decades of wanton government money printing.

Trade Deficit Has Increased American Wealth!

The word “deficit” has a very negative connotation. It is unsurprising that the average Joe assumes a persistent trade deficit would lead to disaster. But a simple analogy should dispel this misconception. A runs a trade deficit with B when A buys more from B than B buys from A. Thus, Apple runs a consistent trade deficit with its engineers—it buys billions in labor hours from them without reciprocation. Similarly, these engineers run a consistent trade deficit against Starbucks. These trade deficits are not wealth destroying!

Spending money, in and of itself, is not bad. What matters is whether you’re getting good value on your purchase. Spending more than your labor income doesn’t necessarily lead to poverty—if you invest wisely to grow your wealth. The U.S. has steadily done both as it runs a trade deficit with Asia. In the last 40 years, aggregate U.S. household wealth has grown by 10x, increasing from ~$17 trillion to ~$170 trillion. During the same period, the annual trade deficit increased from ~$100 billion to ~$1 trillion. The data tell us that the American economy—the aggregation of its households and firms—has optimized its spending, outsourcing, and investments extremely well! Global free trade doesn’t look unfair from this lens.

Yes, Asia has also lifted itself from poverty to prosperity— but not at the expense of the U.S. Trading is not a zero-sum game. Global trade has made all participating countries more prosperous.

Bring Manufacturing Jobs Back to America?

As American firms outsourced manufacturing over time, global trade has resulted in a substantial loss of manufacturing jobs in the U.S. And, at one point in American history, manufacturing jobs were some of the best paying jobs. Today, smart phone, laptop, and auto assembly line workers make $3 an hour in China (minimum wage averages US$1.60). If we bring these jobs back to the U.S., the estimated labor cost (matched to US skill-cost equivalent) would be $30 an hour, or $60,000 annually.

Prohibitively high tariffs “might” force Apple to bring iPhone manufacturing back to the U.S. Consumers might still buy iPhones at double the current price. However, an important question remains: Do we have enough college graduates wanting a $60,000 factory job—especially in the age of a work-from-home and flex-hour gigs economy?

What problem are we trying to solve? We have 4% unemployment and just recently came off a period of 9% inflation. We have a tight labor market where job vacancy duration and unfilled job openings are both near historical highs. Of the 6.5 million job openings right now, half a million are in manufacturing. The U.S. isn’t dying for more manufacturing jobs; it’s struggling to fill the manufacturing positions we already have!

At its core, bringing manufacturing back to America is driven more by nostalgia than sound policy analysis. A longing for the post-war golden age of American industry—when GM employed hundreds of thousands, unions bargained hard, and wages rose reliably.

But that America doesn’t exist anymore.

We live in an economy of code, not coal. Software eats the world. Automation replaces muscle. Artificial intelligence does the work of 20 analysts. Trying to reanimate the manufacturing heyday through tariffs is like reviving Blockbuster with late fees. The world has moved on.

Did Trade Cause Wealth Inequality?

It is true that while the U.S. attained historic prosperity from outsourcing to Asia, wealth inequality has also worsened during that period. Let’s examine the linkage.

American corporate profits have soared, in no small part, driven by low-cost outsourcing to Asia. At the same time, American median wages have stagnated, largely as a result of the same outsourcing decisions. Those who own stocks or work corporate jobs have benefited. Those whose skill levels are more comparable to the Asian laborers have suffered.

It isn’t wrong to lament that allowing American firms access to global labor pools has created wealth inequality. Profits have soared, but they have disproportionally rewarded capital. While this logic is sound, is it actually useful?

At the core of outsourcing is the profit motive of American corporations. Lowering labor costs—whether through outsourcing or automation—will always be a priority. This has little to do with globalization or trading; this is the very core of capitalism. Both Marx and Keynes predicted that unmanaged capitalism would lead to troubling wealth inequality. Imagine that robots were discovered before Nixon and Deng Xiaoping unlocked China’s cheap labor. In that parallel universe, the T-800, instead of China, would be the boogeyman and the villain of our inequality problem.

Tariffs: It Is Really Just Consumption Tax

As a minor technical note, tariffs are an additional tax on American consumers when they buy imported goods. This would inflict pain on consumers and American firms—and thus the stock market—long before manufacturing jobs would flow back from Vietnam and China to the U.S. That is if manufacturing jobs aren’t taken by robots from Boston Dynamics first.

Yes, the price hike will reduce U.S. demand for iPhones, laptops, etc. That will hurt Chinese workers and factories significantly as well. But the objective here isn’t to hurt China?! We want to solve problems for American households.

We have a social issue rather than a trade issue. But, understandably, social issues like income inequality are notoriously hard to discuss and solve. They require self-reflection, sacrifice, and a lot of painful medicines—namely, more aggressive progressive income and capital gains taxes, higher estate taxes, and more welfare transfers. There will also be horrible side effects in slower growth and wasteful bureaucracy administering the medicine.

Consumption tax, which disproportionally hurts lower income households, is usually not what’s prescribed as relief. It would be adding insult to injury.

Tariffs as a Baseball Bat

However, it appears the Trump administration is using tariffs entirely as a negotiation tool. I am often reminded not to take President Trump literally, but to take him seriously. If you focus too literally on what he says, it’s easy to dismiss him—the stated strategy often seems incoherent, sometimes even illogical, and the goals and measure of success are ever changing.

But if you listen intently to understand President Trump, you will find a man who is exceedingly clear. Everything else—the pivots, the reframing of narratives—are just tactics to deliver on his otherwise singular goal: President Trump is forcing countries to the negotiation table, where his deal-making experience, backed by the full might of the U.S. economy and military, will extract significant concessions. Whether it’s Taiwan increasing its arms purchases or Japan and the UAE committing a trillion dollars in investments in the U.S.

You might not like the execution. You could quibble with the path to the ultimate victory. You could question whether the victory is really a victory given the erosion of global trust in the U.S. But you shouldn’t be surprised if President Trump ultimately wins.

In the end, if you can ignore the economic errors behind the trade narratives—they are red herrings—you might just appreciate the political theater. Whether it’s defense deals, energy deals, agriculture deals, or investment deals—implicitly tied to tariff leniency—they are American geopolitical gains repackaged as trade justice. Everyone gets their sound bite.

Asian Countries and Their Tariffs

Indeed China, Taiwan, Japan, Korea, and Vietnam all apply tariffs on imports. Respectively, they are estimated at 7.5%, 6.6%, 4.2%, 13.6%, and 9.6% prior to recent negotiations. When compared to the U.S. tariff at 3.4%, these numbers do seem “unfair.”

At some point in the past, these tariffs were part of a coordinated industrial policy, which arguably helped these Asian economies industrialize and develop manufacturing. However, today, these tariffs are more of a legacy—protectionist and nationalistic—than they are useful. They mostly serve to protect unproductive State-Owned Enterprises (SOEs) and are otherwise more self-harming than useful for the local economy.

It would actually be beneficial for these Asian countries if President Trump succeeds in negotiating the elimination of all tariffs with these trading partners.

In Summary

The U.S. trade deficit is not the result of unfair trade practices. It is simply the result of the U.S. outsourcing to Asia. And that outsourcing has been a critical factor in driving American corporate profit growth and U.S. prosperity. In the name of social justice, one could cripple American firms through tariffs to eliminate outsourcing; perhaps this would lead to more jobs and higher wages. However, the fix would be temporary. Instead of employing low-cost Chinese factory workers, U.S. firms would deploy AI-driven androids to reduce costs and increase productivity in places like Arkansas. High-paying manufacturing jobs are not coming back.

But our attempts to understand and critique President Trump’s trade economics likely miss the point. “The Donald” isn’t really planning to eliminate our trade deficit and stop U.S. outsourcing. Tariffs are a blunt instrument to force negotiation. When it comes to the art of the deal, no one is more masterful at simultaneously charming, grinding, confusing, and bludgeoning the opposition into conceding.

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The views expressed herein are those of the author and do not necessarily reflect the views of Rayliant Investment Research. The material is for informational purposes only and should not be considered investment advice. Rayliant and its clients may hold positions in the securities discussed.

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