As someone who teaches international economics to students, I find the current situation truly shocking: the postwar free trade system has become shaky and the shift to protectionism is gradually becoming clear. In the field of international economics, generally speaking, the objective function (end goal) is how to maximize the economic welfare of a country, and discussions focus on maximizing that welfare. However, the so-called Trump tariffs are not intended to maximize the economic welfare of an entire country but are considered to be focused on specific protected manufacturers and workers, and tariff revenues.
How should Japan interpret the purposes of the Trump Tariffs and deal with their current and future effects?
Effects of Trump tariffs on the U.S. economy
The Trump tariffs are sure to have negative impacts on an economy-wide basis, as the negative effects on consumers considerably outweigh any benefits. This is textbook economics. If exporting countries lower prices in response to drops in imports due to the U.S. tariff hikes, the United States will enjoy the benefits of falling import prices (terms of trade effect). However, an empirical study that was conducted when an additional tariff of 25% was imposed against China in 2018 did not find such a positive terms of trade effect. As the tariffs were mostly passed on to domestic prices, the tariff hikes even had a negative impact on the U.S. economy in the form of the burden on importers and consumers when the benefits of tariff revenue were taken into account (Amiti et al., 2019; Fajgelbaum et al., 2020). Rather, it became clear that U.S. exporters lowered prices of goods exported to China in response to the Chinese retaliatory tariffs, which means that the tariff war generated a negative terms of trade effect on the U.S. economy (Cavallo et al., 2021). Whereas many goods imported from China are differentiated goods such as intermediate goods, whose prices are resistant to downward pressure from competition, goods exported to China, such as soybeans and other agricultural products, are difficult to differentiate from competition, so lowering prices is somewhat inevitable. If all of these issues are taken into consideration, the initiation of the Trump tariffs is expected to have strong negative effects on the U.S. economy in addition to generating inflationary pressure.
Divided popular opinion
Both theoretical and empirical findings indicate that trade liberalization brings benefits in the form of the expansion of consumption, lower prices, increased variety of goods and services that can be consumed, and improvements in productivity, which translates into wage growth. Many people are presumably enjoying the benefits of liberalization in their daily lives, even though the benefits may be invisible on the surface and might express opposition to protectionism in opinion polls. Indeed, according to a Pew Research Center poll of Americans conducted at the end of March, before the steep tariff hikes were implemented, (published on April 8), 24% of the respondents viewed the tariff hikes on imports from China as “good” for the United States, while 52% viewed them as “bad.” The problem is that the benefits of free trade are not equally shared nationwide. What is interesting about the poll is the contrast in stances of Republican and Democratic supporters: among Republican supporters, 44% viewed the tariff hikes as good and 24% viewed them as bad, while among Democratic supporters, 5% had a favorable view and 80% had an unfavorable view. In particular, working-class people without a college degree, who are assumed to represent a large portion of the Republican support base, are presumably in favor of the Trump tariff hikes. The effects of inflation will be felt once tariffs are passed on to domestic prices, so it is important to monitor whether that new inflation will affect the attitudes of Trump supporters.
The goal of the tariff hike is protecting Trump supporters
In order to forge a positive consensus on promoting free trade, it is important to provide compensation to people who suffer losses and implement policies that encourage the flow of labor to other sectors, but the reality may be that it is rather difficult to do so. In the United States as well, there are trade adjustment support programs which provide income compensation and reemployment support to workers dismissed as a result of the effects of imports and the relocation of business operations to foreign countries, but it appears that those programs are not necessarily delivering consistent results (Endo, 2023). Behind that situation is the fact that labor market adjustments (e.g., shifting workers to growth industries) in regions affected by import shocks take time because changing jobs and relocating entails a non-negligible cost of movement (Autor et al., 2016; Caliendo et al., 2015). That is also true in Japan. A questionnaire survey that asked respondents whether they supported or opposed free trade found that while levels of academic achievement and income affected responses, reluctance to relocate tended to lead to opposition (Ito et al., 2019). Given that people displeased with free trade represent President Trump’s rock-solid support base, it is clear that the main goal of the tariff hikes is protecting the jobs of working-class people who form the majority of his supporters. Therefore, discussing the effects on macroeconomic indicators, such as GDP and prices, may not be persuasive as a basis of argument or a bargaining chip.
Will tariff-jumping FDI be a solution?
Foreign direct investment (FDI) that is established in order to shift to local production for the purpose of evading the burden of tariff hikes is known as “tariff-jumping FDI.” Indeed, at the time of the Japan-U.S. trade friction in the 1980s, many Japanese companies, such as automakers, shifted to local production in the United States in order to avoid the effects of the friction. The U.S. tariff hikes are presumed to be based on the calculation that new jobs will be created in the United States if foreign companies transfer production to U.S. locations in response to higher tariffs. On the flip side, vehicles produced by American automakers in the United States and therefore protected by the U.S. tariffs will be exposed to competition with models from foreign manufacturers who are then relieved of the tariff burden. One empirical study, which focused on the impact of antidumping duties (ADDs), found that the tariff-jumping FDIs that followed the imposition of ADDs reduced corporate profits in the United States (Blonigen et al. 2004). FDI can take the form of either the establishment of a corporation through new investment (greenfield investment) or the acquisition of an existing company (M&A). It has been found that new investment projects tend to generate a greater negative impact than M&A deals. In that sense, for the United States, the acquisitions of American companies by foreign companies may be more favorable. However, the number of new jobs created by M&As is likely to be fewer than the number created by new investment projects, and the U.S. government and population may have a strong aversion to M&As, as exemplified by the case of Nippon Steel’s proposed acquisition of U.S. Steel. According to a questionnaire survey of Japanese individuals as well, more people express opposition to acquisitions of Japanese companies as a form of investment in Japan than to greenfield investments (Ito et al., 2023). Even if the Japanese side uses the shift to production in the United States as a bargaining chip, the negotiations over matters such as the balance between job creation and the competitive environment and the assessment as to which type of investment is desirable are likely to be problematic. Establishing new production bases or expanding existing ones will take several years, and it would be unrealistic to transfer all operations, including parts procurement, so companies will have to endure some production inefficiencies.
What will export declines bring to Japan?
In economics, it is generally assumed that export declines will lead to lower prices in Japan (on the assumption of a simple partial equilibrium analysis), a situation that benefits Japanese consumers by increasing their purchasing power while putting producers at a disadvantage by reducing their profits. As the disadvantage for producers outweighs the benefits for consumers, the impact will be negative on an economy-wide basis. The problem is, as may be expected, that declining exports will have negative effects on employment. For example, according to the results of an empirical analysis of the effects on the Japanese labor market resulting from boycotts of Japanese products in China, companies exporting goods to China responded to the boycotts by reducing the number of non-regular workers in Japan (Tanaka et al. 2019). It is necessary to develop readiness to flexibly take actions that minimize the negative effects of the reduction of domestic production and job losses in Japan due to declining exports and shifts to local production, while patiently conducting negotiations with the United States.
April 16, 2025
>> Original text in Japanese
