Imagine taking dollar bills and inserting them into a shredder. This is how you might think about a concept economists call “deadweight loss.” As its name suggests, a deadweight loss occurs when there’s an irrevocable loss of economic output.
Deadweight losses can occur under a variety of circumstances. Among them: when tariffs are imposed. It’s for that reason that the incoming administration’s tariff plan has raised concerns. But how concerned should we be? It’s worth looking at different viewpoints on this question.
The chief concern with tariffs is that they’ll result in higher prices for American consumers. Especially right now, after the recent spike in inflation, further price increases would be unwelcome. But tariffs can have even broader implications. At a macro level, when prices are higher, people buy less, causing the economy to slow. When the economy slows, corporate profits fall, and that, in turn, can lead to lower stock prices. So investors, by and large, aren’t excited at the prospect of new or higher tariffs.
It’s for this reason that economists are nearly unanimous in viewing tariffs negatively. In a 2015 article, economist Gregory Mankiw, who once led the president’s Council of Economic Advisers, noted that the benefits of free trade have been understood since Adam Smith’s The Wealth of Nations, published in 1776. “Economists,” Mankiw wrote, “are famous for disagreeing with one another” on nearly every other topic, but not on this one.
A further worry is that tariffs could have unforeseen consequences. The most obvious risk: Other countries could retaliate, imposing their own tariffs on American goods. An article published by the Cato Institute, for example, painted this unpleasant picture: “Tariffs often lead to cascading protectionism and create a fertile ground for corruption. The 2018–2019 tariffs on China led to a complex process of exclusion requests, lobbying, and retaliatory tariffs, demonstrating the multifaceted harms of protectionist measures.”
To appreciate the potential fallout of a trade war, consider the so-called chicken tax. This is a 25% tariff that applies to imports of light trucks. But why is it called the chicken tax if it applies to trucks? The history is instructive.
The chicken tax was imposed by Lyndon Johnson back in 1964. He was upset at what he saw as unfair treatment of the American poultry industry, so he imposed an import tariff on poultry coming from Europe. To put further pressure on European policymakers, Johnson imposed an import duty on trucks as well. The chicken battle blew over before too long, but the tariff on trucks has remained for the past 60 years. The lesson: Once a trade war gets started, it’s hard to know where it might lead. That’s a key reason why new tariffs have many people on edge.
At the same time, the chicken tax illustrates another reality about tariffs: They’re nothing new. They’ve always existed and, to one degree or another, they’ve been supported by both Democratic and Republican administrations over the years.
Alan Blinder, for example, is an economist whose views fall to the left of center. He was appointed to the Federal Reserve’s board of governors by Bill Clinton and is no fan of Donald Trump. But in a recent opinion piece, he argued that higher tariffs may not be such a problem.
Blinder’s reasoning was as follows: Imports account for just 14% of gross domestic product. So if tariffs average between 10% and 20%, then the overall impact on consumer prices would be modest—between 1.4% and 2.8%. And as Blinder notes, it would likely be just a “one-shot price increase.” New tariffs wouldn’t lead to higher inflation every year.
For its part, the incoming administration has argued that tariffs wouldn’t be inflationary at all. In a recent interview, Scott Bessent, the incoming treasury secretary, made this argument: “Tariffs can’t be inflationary because if the price of one thing goes up, unless you give people more money, then they have less money to spend on the other thing, so there is no inflation.”
Some tariff supporters go a step further, arguing American consumers will even benefit from tariffs. Why? If domestic manufacturers suddenly have a price advantage relative to foreign competitors, then it stands to reason that they’ll gain market share. And in turn, they’ll hire more workers at higher wages.
Recall, for example, the chicken tax. If you’ve wondered why American manufacturers thoroughly dominate the market for pickup trucks, the chicken tax is the reason. From the perspective of American auto makers—including all the workers in the automotive supply chain—this tariff is a good thing.
In the end, however, all the countervailing views on this topic highlight a reality for investors: When it comes to economics, it’s very difficult to know precisely how things will turn out. Textbooks describe various economic relationships that are generally accepted, but the results aren’t guaranteed. Indeed, even Alan Blinder, who wrote one of the most widely used textbooks in economics, isn’t sure how these prospective tariffs will work out. Based on his math, the impact might be modest, but this analysis was based solely on the numbers. Others fear a broader, and more unpredictable, geopolitical impact.
If we antagonize China, for example, no one can predict how its autocratic regime might respond. Just as Lyndon Johnson targeted trucks coming in from Europe, Beijing could retaliate in any number of ways. Suppose Xi’s government suspended iPhone shipments for a month, or a year. Or worse yet, if it decided to step up its military threats against Taiwan. That could draw the U.S. into a far more difficult situation.
The bottom line: There’s a greater level of economic uncertainty today. But for investors, negative events are always a possibility, even if the risks are below the surface. That’s why, in my view, we should be prepared at all times, even when there aren’t specific risks in the news. What does this mean in practice? If you hold a portfolio that’s diversified across stocks and bonds—and diversified within stocks and bonds—that, I believe, is our best defense.
