Trade Policy Rupture

>> Steven Davis: In just three months, Donald Trump has disrupted US Trade policy as never before seen. His tariff hikes and reversals are roiling financial markets and raising the prospects of recession. He is serving knuckle sandwiches to allies and adversaries alike. The economic and geopolitical consequences will be profound. As we discuss on today's show, Foreign welcome to a special edition of Economics Applied.

I'm Steven Davis, a senior fellow at the Hoover Institution, host of the show. Joining me today are two outstanding economists, with deep expertise on trade policy and its effects. They are much in demand these days, and we are fortunate to have them. Chad Bown is a senior fellow at the Peterson Institute for International Economics, former chief economist for the US State Department, and the host of Trade Talks, a podcast about international trade and trade policy.

Doug Irwin is professor of economics at Dartmouth College, senior fellow at the Peterson Institute, and author of several books on trade and trade policy, including Clashing Over Commerce, A History of U.S. Trade Policy. Doug and I were also colleagues at the University of Chicago in the 1990s. Welcome.

It's a great pleasure to have both of you on the show.
>> Chad Brown: Thanks for having us.
>> Douglas Irwin: Looking forward to the conversation.
>> Steven Davis: As am I. So you know, Doug, I was looking over your resume before the show and reminded you have another book, and it's titled Free Trade Under Fire.

It's gone through five editions, but I was thinking the next edition might need a new title, something like Free Trade Trampled, Spindled, and Mutilated, because that seems to be where we are in the present moment. And as we were also chatting about before the show, you like to study economic history of trade policy and so on, and now we're living through it.

So let me start with you, Doug, and give me the historical perspective, review the direction and central thrust of US trade policy since, say, 1945, both from the US perspective, but also from a broader global perspective. What was the role of the US in the larger international trading system?

How did it play out, let's say, up until around 2016?
>> Douglas Irwin: Right. Well, that's exactly the perfect place to start because it was after World War II that really we put the whole world economy on a different trajectory in terms of international cooperation on trade issues and monetary issues and a whole bunch of things with the creation of the Bretton woods institutions, the IMF and the World Bank.

And there was another one not negotiated here in my home state of New Hampshire at Bretton woods, but in Geneva, the General Agreement on Tariffs and Trade and what the US Did. And US, of course, was the world's leading economic Power coming out of the war is we wanted to make sure that we didn't fight another war and that we had the economic preconditions to ensure that we wouldn't fight another war, namely economic cooperation, economic prosperity.

So we'd fought In World War I, it was supposed to be the war to end all wars. It didn't. We had the Great Depression, a lot of protectionism, a lot of isolationism. And we fought World War II and now we had nuclear weapons. And we thought, we just cannot afford to fight a World War III.

So the idea was that we needed a strong and robust world economy to ensure peace. So yes, there are economic gains to global commerce, but also global peace is a pretty important one at the time. So the idea was if we can get commerce flowing between countries, that'll raise prosperity, economies will become integrated, the causes of war will sort of dissipate.

And that worked really well with our Western European allies. So the initial GATT rounds were to reduce trade barriers between the US and mainly Western Europe. Then Japan was folded in the 1950s and a few other countries joined in the 60s and 70s. But generally trade barriers were going in one direction starting from 1945 down and global trade was going up.

This is a period of miraculous European recovery. We also had supplemental institutions such as the European Economic Community, now known as the eu and successive rounds of negotiation brought those trade barriers and non tariff barriers down. So by the time we hit the 1990s or so, we have the Uruguay Round, which is the last big round that created the World Trade Organization expanded its membership to include many more countries around the world.

We never achieved perfect free trade, but the world economy was open in a way that had never been before in its history.
>> Steven Davis: Okay. So it's really striking that for several decades after World War II, leaders in the United States and around the world saw the expansion of global commerce as not just good for its economic benefits, but to reduce the risks of interstate war.

So somehow that disappeared. That doesn't seem to be the current view, at least among many. What led to the erosion of this view that global commerce and a trading system that would support global commerce was a good thing both for economic prosperity and for national security. That view seems to have lost a lot of traction, why?

>> Douglas Irwin: We did. Well, first of all, it really seemed to work, particularly in Western Europe. So there's absolutely no doubt that integration of the Western European economies really cemented their relationship and dissipated military and other tensions. But I think it was really the rise of China. This is something we'll get to when we figure out what's going on today.

Initially, it was viewed as China's rise was not a threat to the U.S. obviously, they had mass poverty, and that's why the U.S. cultivated this relationship, wanted China in the world trading system. But I think there had always been some tension because there was not as much political change as the US and Western countries had hoped for.

In China, the state sector never disappeared. It was shrunken then, sort of has grown up in more recent years, more aggressive industrial policies, pressures on the island nations, and some places in the South China Sea have raised frictions. And so I think gradually, in the sort of under Xi Jinping in particular, there's a lot more friction between the US And China.

And the US Looking back, says, gee, we welcomed them with open arms into the world trading system, but things didn't work out in terms of that, leading to a good diplomatic relationship as well. Okay, but just one more question on this line.
>> Steven Davis: Okay, it's pretty evident now that the hopes that China's integration into the world economy would foster political liberalism, opening up of its society and economy more broadly, that's failed.

But nonetheless, why wouldn't the response have been, okay, let's just continue to enjoy the benefits of the liberal trading order with the rest of the world? And that seems to have been not the direction we've gone, at least not under Trump 2.0.
>> Douglas Irwin: I think there are two things going on.

First of all, there's the US Reaction to China's just astronomical rise in terms of potentially rivaling the US in terms of size of the economy. That's used as a threat, I think all of US remember the 1980s when Japan was a friend and an ally, but there was a lot of fear in the US about Japan and Japan taking over.

There are books called Agents of Influence, the Coming War with Japan, trading places. Japan's gonna become dominant, so even with an ally and a friend in a democracy, there's a bit of fear. And then, when you have an autocracy that's rising and growing in military power and economic power that's sort of threatening to the US but also I think partly it's on China's side, too.

They've invested a lot in their military. They have an enormous navy. They've exerted pressure points around the world in various ways. There's been a lot of espionage. And so I think the relationship is sort of broken down on both sides.
>> Steven Davis: Okay, both the economic prosperity side and the national security side, you're saying.

Okay, so, Chad, let me turn to you and ask you to pick up the thread from morale circa 2017 or so, 2016, and really bring us up to speed on the developments that have taken place since then. What happened during the first Trump administration, what the Biden administration kept or didn't keep, and then what's happened in 2025, which is really the, the, the huge, the huge disruption, the huge eruption.

>> Chad Brown: Yeah. And so just to pick up on, on, on where Doug left off, you have candidate Donald Trump in 2016 basically running on a, a platform that's anti trade. Right. It's anti foreign, a lot of different stuff. It wasn't just trade, it was immigration as well. But we, we remember then he was campaigning against trade with Mexico.

Nafta, the worst trade agreement ever, with the exception of the wto, which was the worst trade agreement ever. And then any other trade agreement would have been the worst trade agreement ever, either. So candidate Trump wins the election. And we've heard, you know, rhetoric from candidates in the past.

Trade is, is frequently a popular thing to, to run against. But what was different with, with President Trump is he actually put his campaign rhetoric into, into practice, at least along some dimensions. There was a lot of rhetoric that really didn't lead to all that much. Right. He didn't rip up the NAFTA at the end of the day, as he had threatened to do or put, I forget if it was 45% tariffs or something on Mexico.

They renegotiated the NAFTA into the new USMCA. There were tariffs on steel. But to be fair, all US, American administrations impose some kind of protection on steel. But the protection that really came along in the first Trump administration was the new treatment of China. And so looking at the data, average tariffs toward China back in 2017, before the US China trade war started, were only about 3%.

After all of this, this trade liberalization, the World Trade Organization, etc, Chinese tariffs toward the US were about 8%. By the end of the trade war between The United States and China. And this played out over 16 or 18 months or so. In 2018, 2019, those were both up around,19, 20% or so.

Right. So really, really substantial increase on tariffs toward each other. And those got locked in. They did sign something called the Phase One agreement, in which China promised to get rid of some, technical barriers to trade for agriculture that had been making the American side upset for. For years, decided it would, or agreed it would open up to, more financial services liberalization, treat American intellectual property rights better than they had in the past.

So there were some elements of an actual trade agreement between the two that was embodied in. In that deal. But the big piece of it was President Trump got China to agree to spend an additional $200 billion on U.S. exports over the next two years. That was the deal.

Then the pandemic hit. And while trade eventually did recover, China's economy slowed down. China ended up not actually buying any of that additional $200 billion that were embodied in that agreement. So the pandemic comes along, the 2020 election comes along, and President Trump loses, and the Biden administration comes in.

I think by now, there is now bipartisan consensus about this concern that Doug mentioned about China. Right now, it's no longer a Republican thing or a Democrat. Everybody's worried about China. So there was no political opportunity for the Biden administration to really recalibrate the tariffs. I think there was some conversations about, well, it'd be good if we could lower some of the tariffs that probably aren't that strategic for, clothing and some, textiles, things of that nature, maybe raise them in some other areas that we might be worried about, which they ultimately did on electric vehicles, things of that nature.

But for the most part, tariffs on China just kind of stayed where they were during the Biden administration. Their main approach to other countries, I think, is where the difference from the first Trump administration was. The first Trump administration was very hostile toward trade with other countries. Didn't do much with the exception of Canada, Mexico, but was relatively hostile.

They were threatening 25% tariffs on cars coming in from Europe, coming in from Japan, for essentially the entire administration. Even though those didn't happen, the Biden administration tried to repair a lot of those trade relationships, got rid of a few of the Trump administration's tariffs on steel and aluminum for Europe, Japan, the UK things of things of that nature.

But then 2024 happens.
>> Steven Davis: Let me just summarize crudely what I think, you're about to tell us 2025. And I just want to lay a very clear foundation for how 2025 differs from what came before it. So correct me if I'm wrong, and this is a very crude summary, but basically coming out of World War II, there were high tariff rates around the world.

What were average US tariff rates, say in 1945? Around 10% or something, is that in the right ball?
>> Douglas Irwin: Well, 10 to 15. 20%.
>> Steven Davis: 10 to 15.
>> Douglas Irwin: I think 20%.
>> Steven Davis: Okay, and much of the rest of the world had higher tariff rates.
>> Douglas Irwin: Actually, Ted and I did a paper on this.

We tried to actually figure out, because it was very elusive what tariff rates were after World War II. We know from the US, but it turns out it's about 20% for Europe as well.
>> Steven Davis: Okay, so let's say coming out of World War II, 10 to 20%. Then decades of multilateral and sometimes bilateral or trilateral agreements brought tariff rates in the United States down.

Average tariff rates were to 2, 3% before 2017. And then the big thing that really happened in the Trump administration during 2018, 2019 is big increase in tariffs on China. There was other stuff around the margin. That's the big thing. And Biden administration essentially kept that. So that's kind of the very broad crude summary of the sweep of 75, 80 years before Trump got re-elected.

Okay, so now.
>> Douglas Irwin: There's someone.
>> Steven Davis: Now tell us, Chad, what happened? What's really just happened in the last two, three months.
>> Chad Brown: Yeah. So, boy, has it only been two or three months. It feels like a year and a half of, of Doug in my life going through this at the moment.

So, okay, so the, the Trump administration comes in and within two weeks, all of a sudden we've got 10% tariffs on China, threatened tariffs on Canada, Mexico, but only on China. That's already- Month goes past.
>> Steven Davis: That's already a five fold.
>> Chad Brown: Yeah, so now we're from-
>> Steven Davis: From where we were.

>> Chad Brown: 40% to up to 30%. Yeah. Exactly.
>> Douglas Irwin: Then on March 4, another 10%. Right. And then they do some other things. There's, we're going to have tariffs on steel and aluminum. We're going to reapply some of the tariffs that the Biden folks had had taken off. We're going to put them back on.

Okay. Then they announced tariffs on automobiles, right? And this is actually a pretty big deal. All the ones that they had threatened back in the first term, but never imposed suddenly. 25% on all the cars coming in from Japan, from Korea, from Europe. Right. So suddenly things with allies aren't looking great.

Right. And then we have the big announcement on April 2nd. Right, and this is the President.
>> Steven Davis: Liberation Day.
>> Chad Brown: Liberation Day.
>> Steven Davis: As one of my colleagues said, you have been liberated from your financial assets.
>> Chad Brown: Yeah, and, and, and this was huge. And I'll let Doug put it in grand sweep of history perspective in a moment, but essentially what happened was President Trump said, all right, the initial thing that we're gonna do is we're gonna impose a 10% baseline tariff on everyone, friend, foe, ally, whoever, everybody gets at a minimum 10%.

And then all of the countries out there with which we, the United States, run a bilateral trade deficit. Right. So if you, country X export more goods to us than we export to you, in return, you're going to get an extra special tariff.
>> Steven Davis: This is the merchandise trade deficit.

So it doesn't capture services where the US Does a lot of exporting.
>> Chad Brown: Exactly, and so those rates, those additional tariff rates ranged anywhere from 1% to north initially of say 50% or so. But then China, because they had retaliated. President Trump didn't like that. And he said, okay, China, you're going to get more than the initial number, which China's initial number was maybe 34%.

You're going to get an additional 50% on top of that, so 84%. And then they retaliated again. And that's not even enough, China, you're gonna get 125%. And that was the world that we were in. And kind of then all of a sudden, markets started start spiraling and status of the overall economy is not looking great.

And President Trump suddenly on April 9 says, okay, those reciprocal tariffs that I had announced last week that are going into effect today, I'm going to put them on pause for 90 days. So everybody get, that was gonna get an additional tariff, that's on hold, everybody still gets this baseline tariff of an added 10%, but everything else is on hold with the exception of China.

Right. So China, you still get this extra, extra, extra tariff that I have been raising against you constantly. And when you add it all up, there were a bunch of sectors that got carved out, at least temporarily. The new tariff, average tariff that we have in the United States on goods coming in from, from China is now about 124%.

So we've gone from 20% in January to now six times higher than that, 124%.
>> Steven Davis: Okay, so and there have been a lot of other announcements and gyrations. We don't, we don't have enough time to go through all of them on the show. There might be another one while we're taping.

Who knows? I'm not checking the X feed or whatever. If you really want to see the full list, there is a nice list at the Peterson Institute. They got a little website, maybe Chad, you may be the one who oversees that. I'm not sure. But, so there's been just this explosion in tariff hikes and there's been a lot of reversals and changes all the time.

So that's just completely unlike anything that we saw even in Trump 1. And I guess that leads me to a question. How much of this and this, what I'm trying to get a sense across the audience, hopefully it's clear now this is just an enormous rupture from the direction of U.S Trade policy for 80 years.

And we are the central player in shaping the rules by which international trade has taken place. So this is really a big deal. Okay, so how much of this is a function of the somewhat accidental, very close call rise of Donald Trump? The 2016 election was a squeaker.

The 2024 election was. Let's just say it was anomalous in many ways, including a president who was previous president who was cognitively impaired, who withdrew late, okay, you could easily imagine a world in which Donald Trump didn't become president either the first time or the second time. Would we still be in the same place with respect to trade policy?

Do you think I'm asking you for a counterfactual here, or do you, another way to put the question, are there some deep underlying forces that have pushed us to this place, or it's partly the accident of one man's election? I'd like to hear both of you think about that.

Maybe Doug, yeah, I'll throw out an answer and we'll see if Chad agrees.
>> Douglas Irwin: So I think it's completely Donald Trump. So you kindly mentioned a book that I'd written, Clashing Over Commerce, which is the history of U.S Trade policy. And one of the themes of the book is that there's enormous inertia, enormous status quo bias, if you don't have to deal with trade, you don't deal with it.

So that's why pushing for trade liberalization, we say, there's all this momentum. It was never momentum, politicians, presidents and others had to push for it against resistance. And the same thing goes the other way. For a president to come in and say, I want to raise tariffs on China from 20% to 127% overnight.

I mean, there'd be a lot of resistance to that. Normally, in fact, most presidents wouldn't even consider such a step. Usually, a lot of trade policy is incremental. You help out this sector here, you agree or you don't agree to this trade agreement like the Transfer Partnership or nafta.

But it's all sort of. There's debate, it works through Congress. It's very slow here. I mean, what's really remarkable about Trump's second term, as opposed to his first term, is in the first term, a lot of those tariffs went through a administrative process. There's U.S. Trade rules and laws that have to be sort of obeyed.

Reports have to be issued, the issue has to be studied. This time it was really just a handful of advisors deciding on the formula for imposing these things, and boom, it's announced with an executive order.
>> Steven Davis: You made a very important point there that I want to underscore that we may come back to later.

Aside from just the specifics of the trade policy, something extraordinary has happened in the last three months that I think is worrisome on many levels. So let me say it from an economic perspective. There's a pretty sizable body of evidence on economic growth and development, often focused on less developed economies, that tells us the following.

If you don't have effective institutional constraints on the arbitrary exercise of executive power, it undermines investment, economic prosperity, and economic growth. And, boy, if you want to think about an episode where there's kind of unconstrained exercise, at least thus far, of arbitrary executive decision making, we've been living through it with respect to trade policy and maybe some other matters, too, but most consequentially in the near term with respect to trade policy, I think that's worrisome.

Beyond the direct economic effects of trade policy, if we can't figure out how to restrain arbitrary exercises of executive authority in the United States, the US Is going to be in trouble on many dimensions, not just trade policy. That's my view.
>> Douglas Irwin: I wouldn't disagree with that. So, And that's sort of where we are.

That is where we are. Things you're sort of implying is like, how much of a change in the tariff rate is this on average? And Chad noted how much it changed with respect to China. But we're actually trying to figure out what it is more generally. And first of all, the tariff rates keep changing, the country coverage changes, the product categories get excluded or included.

It's a moving target and so it's been very. It's taken us a while to figure this out, so if we can't figure it out, it's just research. Think about, if you're an investor, do you move that plant that's producing windshield wipers from Canada to the US or not?

You just don't know what the environment's gonna be like in six months, let alone a year.
>> Steven Davis: I want to get, I want to get Chad to weigh in on the counterfactual. How much of this is really, Doug says it's the Donald Trump effect. Do you agree with that?

>> Chad Brown: Yes, but I think what has also been revealed by both the first Trump administration carried through with the Biden administration and the second Trump administration is our international institutions to deal with international trade aren't really fit for purpose, right? So the WTO is a consensus driven organization, member driven organization, and it doesn't really have a working legislative function when the rules need to change.

Right. To deal with a new complexity, which is this China thing didn't really work out in the way we had anticipated. And it's what should be the relationship between the United States, Europe, all these western market oriented economies with the China thing. We can't figure that out, and if you can't come up with a way to fix it within the system, right?

The Trump administration's approach seems to be that, just then blow the whole thing up, right? So I do think there are some institutional design challenges with the trading system that are there, that maybe this would have taken longer to erupt under some, a President Trump than some other president.

But I think there were going to be challenges even if President Trump hadn't come along, that we can't just say, but for Trump, the world would have been glorious and we never would have had to worry about any of this.
>> Steven Davis: Let me give you, let me restate that or make sure I have it right.

And then I want to ask a follow up question. So what I hear you saying is that there were some underlying forces that would have led to some kind of rupture in trade, trading, trade relations, trade policy relations anyway. Doesn't mean it would have taken the form that it's taken with Trump.

But there were pressure points building. So that leads me to the question, what is it? I don't know the answer to this, but what is it about the WTO that has this inflexibility? I don't think the GATT rounds, I mean the GATT went through multiple rounds, which means, and you know, in round three you can kind of address concerns that have arisen since rounds one and two.

But somehow when we went from the multiple GATT rounds to wto, we got Locked into a system that, as you said, Chad wasn't able to respond effectively to these unforeseen developments. So what, what's the technical difference there? I just don't know.
>> Chad Brown: Well, I think part of it is back, back in the GATT era, it was basically all like minded, for the most part, Western market oriented democracies that were doing the negotiations, right?

Yes, there were some developing countries, but they were given special preferences under things like the general system of preferences. So they didn't really stand in the way of changes. You know, there were prior episodes of GATT history where things weren't going great and people were saying at the time, the GATT is dead.

Right. The system's about to blow up, you know, in the 1970s or, you know, 1980s when, when things weren't going well. So today is certainly much worse than, than I think those eras. But it's not unheard of to have the system that's floundering. But I do think the big difference today is to just have a, an economic system like China that's very different from everybody else.

Plus the national security concerns, right? Russia, Soviet Union weren't in the GATT, China doesn't come into the WTO until 2001. So it's a different kind of world trading with potential adversaries.
>> Steven Davis: Then, let me go back to the man who wrote Free Trade Under Fire. And we've been talking about how we got here and some of the big picture issues at the of geostrategic level.

But give us the, we haven't yet covered the standard grounds. Why do economists think that lower tariff rates are better than higher tariff rates or another way? What are the economic consequences of the huge hikes in tariff rates and the perspective prospectively even larger hikes that have come under Trump 2.0.

Why is that a bad thing, Doug?
>> Douglas Irwin: Well, because in general, trade is a positive sum activity where both the exporter and the importer gain. You gain access to a wider variety of products at lower prices, different qualities. You're able to specialize in goods that you can produce relatively well.

So your productivity goes up. So there are productivity gains, there's variety gains, there's just enhancement of the number and availability of goods to an economy. So it goes back to Adam Smith's wealth of nations, division of labor, specialization, gains from trade. It's all very fundamental. So there are gains when you put economies together and then when you begin to pull them apart.

And here's where the tariffs come in the trade war, as you pull them apart, you lose some of those gains. And once again, there's multifarious, it's quality, it's productivity, it's variety, access to specialized intermediates, all sorts of things. All those things get diminished and lower welfare.
>> Steven Davis: Okay, so this is kind of the, if you take an international economics course from Doug or others, you'll, you'll read about this in the, in the sections on trade.

But we should go back to something that, that we chatted about a little bit earlier. Aside from all those standard negative economic effects of hiking tariffs, the way in which the Trump administration has gone about it has created additional economic cost, at least in the short run. So there's all this uncertainty about what the tariff rates will be, both in the near future, but where they will eventually settle.

That uncertainty creates anxiety among consumers, makes consumers more cautious about certain kinds of discretionary spending or spending on durables, things that can be postponed. But perhaps even more important, and I think Doug mentioned this earlier, businesses now say, look, I don't know what the tariff landscape's going to look like in six or 12 months.

That means I don't know where I should build my factories, what products I should build versus purchase from abroad, how I should structure my supply chains. Because any decision that I might make in those respects will a be costly to reverse and might look like a wrong decision 6, 12, 18 months down the road.

So what happens? You put things on hold, you wait with respect to investments and hiring and so on. So that's been the big near term negative effects on the real side of the economy, as I see it. Do you agree with that, Chad?
>> Chad Brown: Absolutely. I mean, we'll see what the data ultimately tells us once we once it rolls in over the next couple of months.

But I think that's the really, really big fear right now. And when I talk to companies out there, they don't know, right. Is it used to be the last couple of years the thinking was, well, if our big concern is China, if we just put tariffs only on China.

But we move our supply chains to a Vietnam or a Thailand or Korea or Taiwan or something, that'll be okay. We'll be able to export to the United States from those places. But now, if those countries are gonna get hit with tariffs too, whether it's even just the baseline tariff or maybe this extra reciprocal tariff, those calculations could change.

But President Trump seems to keep changing his mind. So what is it today was anyway? Yes, is the answer to your question.
>> Steven Davis: Okay, I should just add, too. I have two trade people here, but you, Mr. Steve Davis, you are Mr. Policy Uncertainty and its impact on investment.

>> Douglas Irwin: So your viewers, readers watchers, should refer to your website and look at all the work you've done on this very important topic. And you've really highlighted it in a way that we hadn't sort of appreciated before.
>> Steven Davis: Yeah, thanks, Doug. And I think I gave a little summary.

I think the research that has grown up in the past 15 years or so shows pretty clearly that on balance, higher levels of policy uncertainty do discourage business investment. They do lead to slower hiring. They are bad for your financial asset portfolio. And it's early on. Now those, those kind of, it's early on those, those kind of real side effects often kick in over several months and the data often lags that.

But if you look at some of the near real time data on job openings, there's a company called Linkup, for example, that, that has a nice daily and weekly series on job openings. It's turned down in the last few weeks. It kind of looks like this. And, and then when Liberation Day hits, it turns down more.

So, yeah, I'm worried about this and I do think it's in the near term, if there's going to be a recession, it's going to be a consequence, a trade policy driven recession. It's going to come partly from these precautionary forms of behavior in reaction to the uncertainty by businesses and households that leads to less demand for goods and services, less demands for workers.

There's also the disruptions in financial markets that we should talk about because they matter. Both because for some people who have considerable financial assets, they affect their spending behavior. But also what's really unusual, and I'm sure you've been following this, is we had an episode last week, I think, if I remember right, we're taping this on April 16, in which we had stock prices falling, U.S. treasury bond prices and the dollar all falling at the same time in reaction to this intense uncertainty.

The reason that's unusual. It's unusual in two respects. One, normally surges in uncertainty generate a flight to quality, flight to safety response that pushes up the demand for U.S. treasury securities, pushes up the value of the dollar. In foreign exchange markets, we saw just the opposite and is that you trade experts know the direct effect of tariff hikes is to cause your currency to appreciate.

So neither this usual uncertainty response nor the effect of tariff hikes on the exchange rate were actually the major force in play. So what it looks to me like there's a loss of confidence in the reliability of the United States as a trading partner, as a place to invest and in particular, a loss of confidence in the ability of the United States government to deliver sensible, sound policies.

That's how I read it. I want to see if you guys agree with that.
>> Douglas Irwin: I'd agree. And you know what was remarkable about the equity response is that Liberation Day, which we all remember was know the announcement was made after the markets closed Thursday morning. They opened down 4%.

Friday, they are down another 3 or 4%. Monday, they open up down. Usually you think there's some sort of level adjustment and then you sort of muddle through. We had three consecutive days where the markets were down in a major way. And then the treasury market started work were moving in this worrisome direction, which I think may have led to the pause to some extent.

So it's just absolutely remarkable, the financial market reaction to all this great news.
>> Steven Davis: Right. So I want to take on some of the arguments that are often put advanced for an aggressive tariff, an aggressive set of tariff hikes, maybe not executed the way the Trump administration has executed them, but there are, there is a considerably.

There's a policy community out there that has been advocating for much higher tariffs. So one argument, sometimes you hear this from President Trump himself, is that while tariff hikes, tariffs are a source of revenue for the government. Okay, they're a tax. They're a tax on imported goods and maybe imported services as well.

But I just want you to evaluate whether the Trump administration's tariffs are well designed from a revenue raising perspective. If you took that as, a plus of tariffs because we got to raise tax revenues from somewhere, all taxes are painful. At least all the kinds of taxes we can implement in the real world are painful.

Do you think this policy is well designed to raise revenues in an efficient, least painful manner? You wanna take that one, Chad?
>> Chad Brown: Sure. And so I think the key that you just ended with there is efficient and less painful manner. And so the challenge with using tariffs to generate tax revenue, yes, there is revenue that comes in when you impose taxes on imports.

The tricky bit is you tax them at levels that are too high and all of a sudden those imports disappear and suddenly you no longer have a tax base to be able to raise the revenue on. And that's a concern with some of the tariffs that they have been putting on out there.

But more generally, the challenge with tariffs is there are really inefficient way to raise tax revenue relative to other policies that you could be implementing. And that's really because they distort at least two different margins or economic incentives, right? So they work like a production subsidy. So they cause domestic companies to kind of produce too much relative to what society would like them to be producing.

And they also cause consumers to face higher prices than they would be otherwise and so consume too little. And so you're moving what we would like the normal economy to be operating at that sort of what economists call efficiency level. You're moving away from that along two different dimensions, meaning there's some other policy that you could be using out there that might only hit one of those different margins.

Right. It would just affect the production side or just hit the consumption side, but without doing both. And that's one of the reasons why economists really dislike tariffs as a source of tax revenue.
>> Steven Davis: Right. And there's kind of a basic principle that comes out of the economics of taxation which says under broad conditions, there are exceptions for things like externalities.

But under broad conditions, the least painful tax is the one that has a broad base and a low tax rate. The thing about tariffs is, first, it's not a broad base because it's only on imports. And second, when you have very different tariff rates for different sectors, different companies, different countries, you're further creating further unevenness of the tariff rate.

So the Trump administration's tariff policies are a violation of this basic economic principle of least cost taxation in two respects, as I see it. And that's one reason that it's not a very efficient way to raise revenues. So let's take on another one of the arguments that's often put forth, and that's that we want tariffs on goods in particular to rebuild our manufacturing base and to incentivize the creation of manufacturing jobs.

So let's just set aside the question of whether that's a good policy objective or sensible policy objective, and let's just take it for granted that that's the policy objective. Doug, do you think that the Trump administration's tariff policies are well designed to achieve that objective, given that that is the.

Is the objective?
>> Douglas Irwin: Well, there's a difference between jobs and output. So we've lost a lot of jobs in manufacturing as a shared labor force. It's much smaller than it was before. That's largely driven by automation, new technology and what have you. So we might be able to get some more manufacturing production back, but the jobs won't necessarily be there because trade wasn't the major cause of job loss in the first place.

But then there's additional point. Tariffs are sort of very blunt and would argue bad instrument for bringing back jobs. So about 60% of US imports are capital goods and industrial supplies. And so when you just apply a broad-based tariff that's as you mentioned, different on different countries, and what have you're raising the cost of those industrial supplies.

And that hurts the competitive position of a lot of domestic firms that rely on those cheap inputs to be competitive, not just in the US market against other foreign rivals, but in export markets too. So a great example of that is the steel industry. So first of all we've lost a lot of jobs in steel production, but that's mainly because of automation.

So in the 1980s took 10 worker hours to produce a ton of steel. Now it takes one worker hour to produce a ton of steel. We're not producing all that much more steel because steel demand is sort of flat. And so we just have fewer workers in the industry producing what we've sort of always had.

But when we raise the price of steel domestically by keeping by those steel tariffs, it doesn't hurt us as consumers. I don't know about Chad, but I don't go out every weekend to Lowe's or Home Depot and buy a bar of steel for the heck of it. But what Caterpillar does, John Deere does, Ford does.

They buy hundreds of millions of dollars worth of steel every year for the products that they produce. And we hurt their cost position, we hurt their profitability by raising their costs, making them less competitive against other firms that produce in other markets where they don't have to pay those inflated prices on their inputs.

And that harms jobs in those downstream industries. And there are many more people employed in downstream user industries to steer than employed in the steel industry itself.
>> Steven Davis: Yeah, I was looking at the numbers on that. And if you look at iron plus steel plus aluminum, the total number of workers in those in those industry sectors in the United States is less than 200,000 people.

Okay, there's more than 150 million workers in the US economy and there are many manufacturing and other industries that use steel as an input. So somehow we are taxing steel. We're putting tariffs on steel imports, making steel more costly. We think that somehow Donald Trump apparently, and some of his advisors think that's an effective way to promote industrial activity and manufacturing jobs in the United States.

It may well, for the reasons you say, undercut the competitiveness of US manufacturing industries. Both for domestic production and export, to a sufficient extent that it actually reduces the number of manufacturing jobs in the United States. So that's just like a crazy counterproductive policy at least that's how I see it.

>> Chad Brown: No, another one would be semiconductors. No pushback on that one.
>> Steven Davis: I guess I'm preaching to the choir.
>> Chad Brown: I want to continue on, semiconductors is another example, right? They've got tariffs that are impacting imports of chips. And at this moment in time, right, where we're thinking about the future in artificial intelligence, right?

And we're building all these data centers for large language models to be able to make the United States the future hub of this very important industry. Why would you want to be raising the cost of some of the critical inputs that go into that to make that industry competitive in the United States, right?

And that's what you do with tariffs. Now, you could do it a different way. You could do it through industrial policy, right? You could do it through subsidies or investment tax credits, or something like that. It doesn't seem to be the direction that this administration is going, right?

>> Steven Davis: All right, I want to take out one more of these arguments that are, is often advanced in favor of tariffs, possibly selected tariffs. And this one might be the one that, at least, you can make a somewhat coherent case for, and that's the national security issue. So let's stipulate, just for the sake of argument, that the United States has too little manufacturing capacity in some industries that are vital to our national security.

So, shipbuilding seems like an obvious one. Munitions, weapon systems, pharmaceuticals, maybe high-end computer chips. So let's just say that you really think there's a national security case to be made for expanding US Production capacity in those industries. So then is the Trump trade policy well designed to achieve that objective?

Who wants to take this one? If not, how would you design a policy to achieve those objectives? Doug, you've written on some of this stuff, so let me turn to you.
>> Douglas Irwin: I'm deferred as Chad. Chad was just in the State Department, and I'm sure the State Department had grappled with this interface between national security and freight policy.

>> Chad Brown: I think, and to be honest, that I think I spent 150% of my time at the State Department worried about this very issue, right? And I think this is again to go to an example like semiconductors, that's another one, right? You think about the high end chips that go into weapon systems and things of that nature, right?

So I think there is a role for trying to get some of those supply chains out of where they are currently because we're worried about new adversaries that we might not been worried about in the past, right? So there's a question of how do we move some of those supply chains.

You can argue that, well, having a discriminatory tariff, so a tariff on just the country of concern might help to shift some of those supply chains out of that country, production out of that country. But then if you just do that, that's the only thing you do, then you kind of leave it to market forces for them to decide where the second-best, the next least costly place to produce those semiconductors might be, right.

In the absence of that, or if you want to do a complementary policy to that, because you might not think that's enough, then you can think about industrial policy, right? Subsidies, things of that nature. So I think those are more efficient policies than just blanket tariffs, certainly, because blanket tariffs are gonna raise costs in ways that we don't necessarily want to have happen.

I think the other challenge for national security is some of these sectors, they're really time between deciding you need the industry and when you can actually have it deliver for you, maybe years, right? To think about where are we going to put shipbuilding in the United States, right?

A lot of our coastal waterways have very expensive real estate that isn't gonna all of a sudden be cleared to build new commercial ships, right? Well, who does commercial shipping or, things of that nature, aside from the Chinas of the world that we're worried about, Japan, Korea, those are the other economies as well.

So working with countries like that, especially in areas where you might have common military security concerns, which, if the real big underlying concern is China, Japan has the same concern, South Korea has the same concern, right? It's a much less costly approach to do these kinds of things jointly than to just impose tariffs on everybody, right?

And when you're imposing tariffs on Japan and Korea too, they sort of scratch their head and say, wait, I thought we were gonna be working with you on these kinds of problems. Now you're gonna be targeting me as well. I don't quite understand the logic here.
>> Steven Davis: Yeah, agreed, so this is yeah, we need out.

We need Friends and allies for economic purposes, for national security purposes. And we see as I open the show, we've just been serving them knuckle sandwiches. And so it's gonna be hard, harder to get their cooperation. I wanna end with a question for Doug. Jack your way into.

But I'm going to quote something that Doug recently wrote in the Economist magazine. So here it is. If Mr Trump is willing to rip up his own agreement, that's the usmca, the successor to nafta, with Canada and Mexico, he's ripped it up effectively, then all past agreements are null and void and any future ones are of limited value.

No one can sign any such deal with confidence if tariffs can be imposed on a whim. So that's Doug writing in the Economist. So, Doug, does that mean durable tariff agreements are no more? Are we stuck with a transactional approach of Donald Trump indefinitely? Or is there some way to get back to a place where the US has enough reputation and trust that other countries will actually think that it will honor its treaty obligations?

>> Douglas Irwin: But I think it will take some time. So this administration, as Chad said, announced all these reciprocal tariffs, different tariff levels on different countries. So now the US is about to negotiate with 70 countries bilaterally with different terms for each quote, unquote agreement. These will not be good agreements in the sense that they'll be passed by Congress.

These will be enough to satisfy the administration that they can lift the executive order opposing reciprocal tariffs. So it's going to be just this incredible patchwork of, of different agreements, different provisions for different countries. First of all, that's a lot for the government to do. Negotiate bilaterally with 70 countries, even 30 countries would be challenging.

But then the fear would be no. Well, in three years, two years, the president changed mind. So we saw that with Canada. So in 2018, we reached the USMCA. And his second term, he says, there's too much fentanyl going across the board border, too much migration. And so there could always be some new excuse to impose tariffs that aren't constrained by past agreements.

And because he's shown that behavior, it just is a deterrent to other countries to say we're really locking in a relationship with the United States. I think the problem is, even after President Trump, when he leaves office, the US Reputation for such agreements has been diminished.
>> Steven Davis: Yeah.

>> Douglas Irwin: Never know if going to be another president like a J.D Vance or someone who will take the Trump approach and go right back saying, I'm going to use tariffs and Pastor Williams will not constrain me in any way.
>> Steven Davis: Yeah, that's the thing I was saying earlier.

We have now revealed ourselves, at least at the present moment, to lack the capacity to restrain arbitrary exercises of executive power. And certainly that's going to, people are going to be worried about that for the rest of the Trump administration, but maybe well beyond. And that's a very different world than we were accustomed to, a rules based type of approach the United States took in most aspects of international relations, certainly most aspects of trade policy.

And it leaves me, how to say it, both distressed and somewhat apprehensive about future economic activity in the United States and around the world. Chad, you want to end on a lighter note?
>> Chad Brown: Nope. I guess. Well, I would say the lighter note is we need Congress. Right.

So kind of paradoxically, it was Congress delegating all this authority to the executive branch to be able to do these things on tariffs and just wave a card that said national security. And you're kind of, you can do anything writ large. Congress has the power to take that away from the president if they so choose with legislation.

But that's interestingly if you want to convince the rest of the world now that your word means something and you can sign up to agreements that mean something, it's going to be a requirement of Congress to be able to make that commitment on behalf of the American people, because I don't think the rest of the world is going to necessarily believe in American president anymore.

>> Steven Davis: Yep, I think that's a good note to end on. So to all the senators and representatives of that in the House that are listening to this podcast, please get to work. Thanks, guys. It was a great conversation and I really appreciate you being on the show. Take care.

>> Douglas Irwin: Thanks, Steve.