What economists 'don’t get' about Trump tariffs

Over the past two weeks or so, quite a few Japanese businesspeople have likely lost sleep as they are virtually forced to wake up to U.S. President Donald Trump reversing his "reciprocal" and other tariff decisions on an almost daily basis.

To help rectify the situation, the government's tariff czar, Ryosei Akazawa, flew to Washington on Wednesday. The U.S. president himself not only abruptly showed up at the “supposedly ministerial” negotiations on tariff and trade, but even suggested that he would raise security issues, possibly including cost sharing for the U.S. forces in Japan.

Still, none of what is happening should come as a surprise. Global stock markets have swung daily over the past week or so, with Trump’s tariff rates seeming to shift just as quickly. One evening tabloid in Japan sneered at him as the “mad president,” while some pundits here defended him, claiming he has a clear strategy. Neither side is right.

The economists

Why economists don’t get it is simple: Trump, through the tariff issue, is practicing “intuitional politics,” not economic or trade policy. Economists cannot explain this approach from an economic perspective. When faced with a policy they don't understand, talented economists and experts tend to condemn it as reckless, harmful and foolish.

They are right of course, but such criticism alone does not help us understand the nature of Trump's tariff policy.

So what is the essence of this? My view is that the U.S. has started to prepare seriously for a long-term competition with China for global dominance. China has the world’s strongest manufacturing base, fueled by its 1.4 billion population, a highly educated workforce and mercantilist economic policies under the Chinese Communist Party.

In contrast, the U.S. manufacturing industry has been in decline since the 1980s, leading to a hollowing out of its production capacity. As a result, America now struggles to produce enough products, including advanced weapons and ammunition, which will be crucial if there is a military crisis.

Financial liberalization

The insights of economist Richard C. Koo are instructive. According to him, the U.S. began liberalizing global capital flows in the 1980s. Until then, since such movements had been restricted, trade imbalances were controllable by depreciating the currency of a country with a trade deficit and appreciating the currency of a country with a trade surplus.

But when capital movements were liberalized, contrary to expectations, funds flowed from trade-surplus countries like Japan and in Europe to the U.S., where interest rates were much higher, causing the dollar to continue strengthening.

This was the main cause of the hollowing out of the U.S. manufacturing industry. While the U.S. saw its international competitiveness weaken due to the persistent strength of the dollar, China joined the World Trade Organization and the liberalization of the flow of goods, money and people progressed rapidly on a global scale. As a result, China developed powerful manufacturing capabilities and became the “world’s factory.” It is ironic that the U.S., which promoted the liberal global economic system, ended up being a victim of it, while China, an authoritarian regime, benefited most from economic liberalization.

Trump's levies

Why tariffs now? This is also easy to explain. Even those within the Trump administration, who understand that such duties are not a cure-all, likely see no other viable options. The liberalization of the flow of goods, money and people was the best economic policy for the U.S. as long as no other country challenged its dominance.

Even as domestic manufacturing industries were hollowed out, the U.S. as a whole still prospered. However, as China grew stronger politically, economically and militarily, the U.S.' weakened manufacturing base could no longer compete with China’s so-called quantity strategy.

In particular, if competition, confrontation or armed conflict with China were to drag on, the question of how much weaponry and ammunition could be stockpiled quickly and how much could be procured in an emergency would become a critical issue. The urgency of this is evident when we consider the ongoing war in Ukraine, now in its fourth year. It's clear that this issue is a top priority for the U.S. military, especially the Indo-Pacific Command.

In short, while the hollowing out of manufacturing can be offset to some extent by the U.S. service sector from an economic standpoint, from a national security perspective, the decline in manufacturing capability is more than a jobs issue — it poses a serious risk to America’s ability to maintain deterrence.

Trump is a "pacifist" who disdains armed intervention, so he's unlikely to provoke China militarily in the near future. However, he probably believes it's possible to weaken China in the medium to long term by decoupling it from the U.S.-centric economic system.

As I pointed out in my previous column, the real threat to U.S. hegemony is not Russia or Iran, but China. At the same time, since the U.S. can no longer fight "two major wars" simultaneously, it must leave the security of Europe and the Middle East to its regional allies and friends, and devote its remaining strength to maintaining the status quo in the Indo-Pacific and deterring China. If this is the Trump administration's true intention, his tariff policy may not be the cause of the global chaos that is to come, but rather the result of the U.S.’ desperate efforts to prepare for that chaos.

What should Japan do?

Following the first round of talks in Washington, Akazawa stated that “exchange rates were not discussed,” with Trump implying that discussion on security issues had taken place.

Prime Minister Shigeru Ishiba described the discussions as “frank and constructive” without going into details. This suggests that no concrete agreements had been reached on substance, except as it pertains to moving forward on future negotiations.

No wonder these negotiations are not about bilateral economic and trade issues but more about how to jointly compete with China in the long run. Is Japan prepared for this? The prospect of future Japan-U.S. talks will be far from optimistic.