- Broad-based tariffs including tariffs on manufactured imports would boost U.S. economy by 7% and create 10 million jobs.
- Real household incomes rise by 10%.
- Tariffs reduce imports and stimulate domestic manufacturing output by 19%.
- Tariffs would generate $603 billion in new revenue, enabling cuts in income tax or other taxes.
- CPA modification of standard trade model allows for pro-growth results from reduced imports
National policy has recently been moving towards industrial strategy to rebuild our industrial base. Tariffs were increased under the Trump administration to the dismay of many who predicted economic disaster which did not materialize. Under Biden, Congress has approved subsidies for semiconductor and solar manufacturing in the CHIPS Act and in the Inflation Reduction Act of 2022.
As the “Washington Consensus” on trade liberalization frays, new economic analysis is needed to guide decision making in an emerging post-neoliberal era of geopolitical and industrial competition among nations. To this effect, CPA helped develop the Job Quality Index to track the quality of jobs on offer each month, as a supplement to job creation numbers. CPA also developed the Domestic Market Share Index to track the domestic producer share of the U.S. goods market to gauge the competitiveness of our home industries at home.
Trade modeling has often projected economic results from trade liberalization agreements that did not materialize (for further detail, go here). The standard trade model projects gains from trade liberalization and losses from industrial strategies to re-shore industry. But those projections are at odds with the successful growth strategies of Japan, China, South Korea and early America which grew through the use of broad tariffs and other mechanisms to restrict imports and incentivize the local growth of investment and jobs.
CPA has spent the past year analyzing and improving the standard trade model, working with some of the developers of the standard GTAP trade model, to more accurately gauge the impacts of tariff intervention as a growth strategy to create jobs and protect from future supply chain shocks.
The new CPA working paper describes the results of improving the standard trade model, demonstrating the benefits of broad-based tariffs throughout the economy. The model’s results show that comprehensive tariffs would stimulate the U.S. economy and lead to the creation of 10 million new jobs. The tariffs implemented in the model reflect the proposals of the CPA Model Tariff schedule. In our simulation, these tariffs stimulate the domestic manufacturing industry and lead to real gains in domestic employment and income. We found double-digit growth in output in most manufacturing sectors, higher incomes in all industries, and broad-based growth across the entire economy.
The CPA model used for this simulation is a modified version of the standard Global Trade and Analysis Project (GTAP) model. The GTAP trade model was developed at Purdue University in the 1990s and is widely used by academic researchers and federal government agencies to model trade policies. The GTAP model, like other computable general equilibrium models (CGE), often assumes that the total supply of labor, investment and capital in the economy is fixed, limiting the ability for domestic production to rise when trade patterns change. Our modifications to several key parameters change these dynamics by allowing firms to increase their inputs and produce more as imports decline. The tariff effectively raises returns to labor and capital as domestic output in tariffed sectors increases.
Tariffs and Benefits
The CPA Model Tariff Schedule analyzes the impacts of a 15% revenue tariff increase on all imported goods, as well as a 35% tariff increase on imported goods for economic reasons and their importance to national resilience. While we assume the U.S. imposes the 35% tariffs only on Non-Free Trade Agreement (NFTA) countries, these tariff increases can be imposed globally. For this simulation, The U.S. has Free Trade Agreements (FTAs) with 20 countries including Canada and Mexico. Non-FTA countries comprise all other countries, including China and the 27 European Union members. Industries where the U.S. has little domestic production capabilities due to physical limitations (selected minerals) receive a zero percent tariff increase.
Our simulation of the Model Tariff Schedule leads to increases in real GDP (7%) and domestic output (19%). We observe relatively large gains in chemical manufacturing (30%), textiles and clothing (54%), and electrical (52%).
Growth in domestic production requires more workers. The economy adds 9.9 million workers, including 3 million additional workers in manufacturing and 6.9 million in service sectors. Although the growth in output is led by manufacturing sectors, higher employment in the service sector supports the expanding manufacturing sector and incomes. For example, our simulation shows strong growth in health care and government employment. See Table 1 for further details of simulation results.
Tariff revenue rises sixfold to reach $696 billion a year. This is far more revenue than corporate taxation currently generates for the U.S. Treasury. In this Model Tariff scenario, the federal government could abolish corporate taxation outright or cut personal income taxes by 25%. In our simulation, we turn the $603 billion gain in tax revenue into household and business income to avoid the deflationary effect of the government absorbing more funds.
Table 1: Main Results
Source: U.S. Bureau of Economic Analysis. Figures reported here scale 2014 simulated results to 2021 data.
*All data in billions USD except Employment
The trade balance changes very little as both imports and exports fall. This result may seem unintuitive with a 35% tariff. While imports fall as the tariff makes imported goods more expensive, the GTAP model has several inbuilt dynamics that drive exports down. Export goods become relatively more expensive as the tariffs raise many input prices. Further, the model stipulates real exchange rate appreciation (a higher value for the dollar) as imports fall. In future studies of the economic impact of tariffs, we will attempt to explore alternative scenarios for exports. Lastly, lower imports will divert exports to domestic consumption, causing a reduction in exports However, the model’s implication that a comprehensive trade policy must include exchange rate regime management is valid.
Model Modifications
We added three main elements to the standard GTAP model to reflect a more realistic response to a tariff. First, we add new supply elasticities for factors of production (i.e. land, labor, capital) so that inputs and therefore output could increase in response to a trade shock–such as a tariff. The standard GTAP model does not allow for these changes in economy-wide supply, making the economy unrealistically rigid.
The second modification was to the Armington elasticities. These elasticities affect how purchasers react to the price differences between domestic goods and imports. These elasticities were modified to reflect a more realistic fall in exports and imports in the GTAP model from the tariffs. The GTAP model assumes markets are competitive and export volumes will respond strongly to any increase in the price of exports. That logic is based on the assumption of perfect competition across markets. There is evidence that U.S. exports of manufactured goods are concentrated in oligopolistic markets where prices will have less impact on volumes. We therefore modified those elasticities to reflect a more realistic response of trade quantities to price changes.
Lastly, we modified the model to return the gain in tax revenue back to consumers and producers. This adds further stimulus to GDP as it helps firms invest in production and gives consumers more spending power. This is a minor stimulus by comparison to the effects of the tariff changes.
Conclusion
Our simulation of the Model Tariff Schedule shows that tariffs on manufactured goods would deliver broad-based benefits to output, employment, and household incomes. Our changes to the standard GTAP model address some of the unrealistic rigidities built into the model. Further work is needed to strengthen the model to more accurately reflect a global response to trade policies.