The Math Ain't Mathing: Why High Tariff Schemes Will Always Lower GDP

A great deal of blame for declining GDP has been placed on the impact of imports by the national conservative and protectionist crowds. Pierre Lemieux does an excellent job explaining why imports have no direct impact on GDP here, so there’s really no reason to cover that ground again. It is sufficient to revisit the fact that GDP only accounts for domestic production and consumption; the net export variable simply cancels out the part of consumption measurement that accounts for consumption of imports, reducing the effect to net zero. This renders absurd the argument for tariff increases in order to protect GDP from the influence of foreign goods and services. 

On the other hand, tariffs do have an observable negative impact on GDP.  According to the Tax Foundation, the current 10 percent baseline tariff will raise the effective tariff rate to 12.1% – before the effects of retaliation can even be factored in, – reduce GDP by 0.7 percent (again, before accounting for retaliation) and lower market income by 1.2 percent in 2026. This translates to an average tax increase of $1,190 in 2025 and $1,462 in 2026 per household, and a reduction in available goods and services. Yale’s Budget Lab paints an even more grim picture, predicting an eventual effective tariff rate if 22.5 percent, an average per household consumer loss of $3,800 due to a 2.3% rise in price levels, and a persistent GDP decline between 0.4 to 0.6 percent; these are short-run predictions that, again, do not factor in the impact of retaliation on the part of trade partners.

Growth from 1870 – 1910

None of this should surprise observers of economic history. During the 1870’s, a period of relatively high tariffs averaging some 35 percent, GDP declined by an average of 0.5%, despite accelerated development in a few protected industries. The period between 1870 to 1913 was one of a rapid transition from an agrarian economy to an increasingly industrialized one. Between 1872 and 1913, the US share of global manufactured exports grew from 2 percent to 14%, while the labor market share in agriculture fell from 48 percent to 32 percent. In roughly the same period, the share of national income paid to the agricultural sector fell by 3 percent, while the share paid to the manufacturing sector rose by 5 percent. As a reflection of this shift, the export of crude materials and foodstuffs declined slightly (people must always eat, after all, while exports of finished goods effectively doubled.

Of course, one would surmise that this should have been good for domestic growth, and it would have been had the political machine not gotten to a-lobbying and logrolling. Had manufacturers just left well enough alone, they might have realized that they possessed an inherent comparative advantage in access to raw materials. Large iron ore deposits near Lake Superior benefited iron and steel producers, while the discovery of petroleum, coal and other inputs allowed for price competition with foreign producers who had to source such inputs elsewhere. As we now know, these deposits were hardly inexhaustible, but at the time, they were relatively new and abundant.

Instead, manufacturing interests elected to seek “protection” by lobbying for high tariff rates against foreign competitors in their industries. If, as the national conservatives argue, such protection benefits the general welfare, then the evidence should demonstrate higher productivity combined with lowering prices, but that isn’t what happened. As Douglas Irwin demonstrates in Clashing over Commerce : A History of US Trade Policy, productivity growth was no more rapid in the US over this period than it was in Great Britain, which had fewer natural resources, and whose population – and thus domestic consumer markets – grew at a decidedly slower pace. In fact, productivity increased for sectors not affected by trade, such as transportation, utilities, and services, while seeing a decline in agriculture and manufacturing.

This is not to say that the scale of manufacturing did not increase; it did. However, the political nature of the imposed tariffs not only shielded American manufacturers from foreign competition, it also shielded them from the benefits of competition. Many disparate manufacturers crept onto the scene, producing less efficiently without creating necessary economies of scale. Innovation lagged behind nations such as Great Britain, because insular manufactories had no incentive to innovate. Conversely, in Great Britain, which imposed marginal tariffs when they bothered to impose any at all, manufacturing grew at an average annual rate of 2.2 percent between 1870 and 1913. During this same period, manufacturing employment grew at an average annual rate of 0.8%, and labor productivity within the sector grew at an average rate of 1.4%. Manufacturing employment increased by 30 percent during the period, with in increase of capital per worker of 76 percent. Hence, despite low tariffs, manufacturing played a huge role in Great Britain’s GDP growth during this era.

By 1890, America and Germany had begun to catch up with Britain in large part, ironically, because their low tariff structures allowed for the flow of ideas, processes, and technology both inward and outward. While America invested in formal education that trained executives to tend to the business of manufacturing, Germany focused on vocational training that combined formal teaching with apprenticeships. All of this aside, the real drive behind America matching – then surpassing – Great Britain as an industrial/manufacturing force was the population boom of the 1890s.

Recall our earlier look at the growth in non-traded sectors such as transportation and communication. Eventually, this allowed for national markets with goods and services that moved in every direction. As people moved back and forth more freely, transportation costs continued to decrease as demand drove improvements in transportation, allowing laborers to move away from rural areas to more densely populated urban ones. As more labor became available, large factories began to supplement the smaller workshops and foundries that had marked the beginnings of the manufacturing boom. Agricultural workers outnumbered their manufacturing counterparts in 1880 by a factor of three, but by 1920, the number of manufacturing workers had increased from 2.5 million to 10 million.

Not all of this growth in the labor force – and the subsequent growth in GDP – was endogenous. Because of a relatively sudden surplus of available higher-wage jobs, 1890 marked the beginning of a large surge in immigration. Between 1870 and 1900, the native-born population doubled, due in large part to higher wages, increased living standards and access to the more advanced medical technology available in the urban areas that large segments of the population were flocking to. Beginning in 1890, the immigration also doubled, from some 7 million to 14 million. With the exception of San Francisco, the new wave of immigrants converged mostly upon the industrial cities of the Northeast and Midwest; cities such as Boston, Chicago, New York, Cleveland, Buffalo and Milwaukee. By 1920, 23 million children had been born to those 14 million immigrants, meaning that one-third of the population belonged to that community.

Despite the tariff missteps of the 1870s which rendered productivity in manufacturing inefficient and depressed GDP, this population boom combined with the growth in non-traded sectors eventually complimented an industrial boom resulted in economic growth and increasing productivity; in fact, many economic observers consider this to be the beginning of the American Middle Class. This happened in spite of tariffs, not because of them, and as those such as Klein and Meissner  demonstrate, would have happened a lot sooner without them.

The Folly of Smoot Hawley

I have often observed that there is scarcely a bad idea that government will not adopt, and certainly none that they will fail to repeat. In many ways, the Smoot Hawley Tariff Act of 1930 was just an inverse reflection of late 1800s measures such as the McKinley Tariff Act of 1890. By the 1920s, American manufacturing had come to dominate global markets, engendering less political concern on the part of politicians. A fall in commodity prices in 1920, triggered by an overall post WWI slowdown of global commodity markets, resulted in an agricultural depression that predated the Great Depression and lasted nearly a decade and a half. In essence, a world no longer at war no longer needed massive amounts of foodstuffs from American farmers, who were now the victims of overproduction and overextended credit. Moreover, a large number of soldiers returned from European theaters of war to their farms, exacerbating the problem.

The factors underlying this crisis for farmers should have been obvious for legislators, but rarely are politicians either cognizant of or concerned with proximate cause. Congress’ initial effort to deal with this issue was the McNary–Haugen Farm Relief Act, first introduced in 2024, which called for both a series of protective tariffs and a series of price supports to bolster the profits of farmers. It called for the creation of a Federal agency that would maintain agricultural price levels from 1910 -1914 by purchasing surplus crops, selling them overseas, and therefore taking any loss at taxpayer expense. President Coolidge, perhaps understanding that no market for crops meant no market for crops, vetoed the Act in 1927 and 1928, killing passage both times. Coolidge did commit to then-Commerce Secretary Herbert Hoover’s plan to have a farm board “stabilize” prices via cooperatives , so he can’t be given too much credit.

The sorry plight of farmers became a major issue in the election of 1928, with both Democratic candidate Al Smith and Republican candidate Herbert Hoover pledging to revise the Fordney–McCumber Tariff of 1922 in order to create “tariff equality” for agricultural goods. With little daylight between the candidates and most voters outside of farmers enjoying a period of prosperity, the electorate opted for continuity and Hoover won. Soon after his victory, Ways and Means Chairman Willis Hawley announced a hearing on revising the tariff. As Irwin notes, some 1100 individuals provided statements to the committee, resulting in 10,684 pages of testimony that comprised 18 published volumes. Soon, Hawley joined forces with Utah Senator Reed Smoot, and instead of a revision of the Fordney-McCumber Tariff, they supplemented it with their own.

Democrats vociferously opposed the bill; Tennessee Senator and future Secretary of State Cordell Hull opined that it would be a feeding trough for the worst logrolling and special interests, while Texas’ Cactus Jack Garner lambasted it as completely lacking in common sense or knowledge of any economic principle. Notwithstanding that they likely would have supported such measures if their party controlled the White House and Congress, they didn’t have the votes to impede it, and the measure passed on June 13, 1930. Hull was right; the Act was over 200 pages, and while its ostensible purpose was to protect American agriculture from foreign competition, it imposed as many duties on manufacturing imports as it did on agricultural. 

In a telling mirror of current events, 1028 economists signed a statement published on the front page of the New York Times reflecting a consensus that the tariffs, especially those on manufactured products, were a mistake, as domestic factories at the time already supplied Americans with 96 percent of manufactured goods consumed, leaving exports as the only viable option for expansion and prosperity. Smoot dismissed such concerns as the idiotic prattling of eggheads with no understanding of practical realities, unlike the sugar men and other representatives of special interest with whom he had conversed.

As we know, Smoot-Hawley shielded neither agriculture nor manufacturing from market realities. By not repealing and replacing Fordney-McCumber, it added to the tariffs already in place; it added a 15 percent tariff increase to the already extant Fordney-MCumber increase of 64 percent. Given exemptions and other negotiated relief, this resulted in average tariff rates of roughly 60 percent, and global markets responded. To say that the timing of this trade war was bad would be putting it lightly, as America’s stock market crash was already exerting recessionary pressures on global markets that were more closely integrated than global leaders would admit. Nations which instituted direct retaliatory measures against the US reduced their imports by an average of 28-33 percent, while some nations indirectly protested by reducing their imports from everyone, resulting in a decline of US imports to their nations by 15 to 22 percent. As Mitchener et al. observe, the scope of de facto retaliation exceeded official acts of retaliation.

The Depression was its own beast which would have happened without any ill-advised trade war. The decline in global GDP would have hampered trade in any case. Because of this, national conservatives tend to argue that Smoot-Hawley was of little consequence, but a less insular outlook that acknowledges the impact global markets have on its members would reveal otherwise. The entire stated impetus of the tariff was to benefit farmers, who were suffering from credit defaults based on loans extended during WWI, the defaults themselves resulting from lower demand for American produce. Retaliatory measures exacerbated this even further; moreover, manufacturing – which had been doing brisk business in exports – also fell victim to retaliation, significantly weakening the one sector which had been doing well. As such, the resulting trade war had a significant impact on trade flows independent of other factors and exacerbated the decline in global – and American – GDP.

Having gone into detail on previous instances of high tariffs failing to generate the desired results and instead creating a decline in GDP, it must be mentioned that another favorite argument of national conservatives and protectionists is that early revenue tariffs, as a function of Henry Clay’s “American System,” were responsible for the nation’s growth and economic development. The error  of this argument has been addressed ad  nauseum, including by myself at American Institute for Economic Research’s The Daily Economy. Therefore, those counterarguments, important and valid as they are, will not be repeated here. 

A major error made by many when assessing tariffs, even some opponents, is viewing them linearly, as shocks to an otherwise perpetually fixed structure. In essence, while discussions (correctly) center around exogenous impacts such as distorting bilateral trade volume, disrupting supply chains or exacerbating inflationary pressures, few observers address that from a general equilibrium perspective, tariffs endogenously distort the interconnecting networks of global trade flows. In other words, they exert network effects with infinite non-linear differential coefficients impacting prices, availability of supply, and general welfare across the network. Simply put, they redirect exports in an inefficient manner which generally benefits no one. Even if this is not by the design of the politicians who impose tariffs, it is the inherent nature of tariffs to impact markets in this manner. Ceteris paribus, a thing can only be what it is.

It is also inherent to tariffs that the higher they are, the more they will negatively impact GDP. It is just in the math of the matter. Let us take a brief look at that math:

GDP = C + I + G + (X – M) 

Where: 

C = Consumer spending 

I = Business investment 

G = Government spending

X = Exports

M = Imports

Once again, as a practical matter, imports have no direct impact on GDP, as the import variable simply cancels out the portion of consumption that measures spending on foreign products. However, as will soon be demonstrated, high tariff schemes can cause imports to have a negative, indirect impact on GDP. To begin, as one would expect, high tariffs should result in an increase in government revenue, which they may in the short-run. This may also result in an increase in government spending, which may generate future inflationary pressures as these added revenues invariably will not last (this, however, is another, even if related, discussion).

Higher tariffs will lower the availability of imports, which is essentially meaningless for measuring direct domestic consumption, but does have an indirect impact via investment. As tariffs distort supply chains, increase the cost of inputs (and, as a function thereof, end prices) and generally decrease profit margins, resources are inefficiently shifted to less import-reliant domestic firms at the expense of choice and availability. Additionally, firms decrease investment when the risk of uncertainty increases, and global trade disputes are often rife with uncertainty. The subsequent higher prices, and hidden costs such as loss of employment in those import-reliant sectors, decreases consumption.

Additionally, the retaliation of trade partners has an invariably negative impact on exports, further depressing investment, consumption, and the revenue needed to increase government spending without inflationary pressure. This has always been the impact of  high tariff rates, from the late 1800s, to the onset of the Great Depression. In terms of our current Administration, not only will the outcomes be predictably grim, but as it has added an even greater degree of uncertainty with its bombast, pauses and generally inscrutable whims, they may turn out to be worse than once might predict or imagine.