The foundation of President Donald Trump’s tariff announcement, which continues to unsettle financial markets, is perplexing economists, who claim it is founded on misguided assumptions.
Experts assert that Trump’s formula is built on a flawed and underestimated key metric, leading to exaggerated tariff rates for various countries.
As per the Office of the United States Trade Representative, the formula driving Trump’s extensive “reciprocal” tariff strategy involves the nation’s trade deficit with the U.S., divided by its exports, and then that figure is halved. Trump also imposed a 10% baseline tariff on nearly all countries.
Nonetheless, the method Trump uses to compute tariff rates for countries globally is based on an elasticity rate that is less than ideal in practice, as stated by senior fellows Kevin Corinth and Stan Veuger from the American Enterprise Institute. The formula presumes an elasticity of import prices with respect to tariffs around 0.25, while the economists argue that this figure should be approximately 1.0 (0.945).
“Their error lies in that they derive the elasticity from the reaction of retail prices to tariffs, rather than import prices as they should have,” the analysts noted.
The tariffs imposed by Trump vary from 10% to 50% on different nations globally. If the elasticity assumptions in Trump’s formula were modified, no country’s tariff would surpass 14%, with many remaining at the 10% baseline set by the Trump administration.
For example, under the plan unveiled by Trump this week, the tariff rate for Lesotho, the nation with the highest rate, was positioned at 50%. However, if adjustments were made, it would drop to 13.2%.
A separate report issued this week by the Cato Institute also highlighted a flaw in the formula Trump used to rationalize the tariffs.
This report revealed that the trade-weighted average tariff rates employed by Trump to substantiate his reciprocal tariffs are higher than they actually are in practice.
For instance, the Cato Institute indicated that the 2023 trade-weighted average tariff rate from China stood at 3%, while the Trump administration claimed it was 67%.
