In recent years, the global economy has seen a dramatic shift from the principles of free trade to a resurgence of mercantilist policies, raising questions about the future of international trade and cooperation. Once advocates of free trade, many nations now favor protectionist measures to secure their interests amid growing geopolitical tensions. This shift signals not only a change in economic strategy, but potentially the emergence of a new world order— – a world in which competition and national interests overshadow cooperation and open markets. As countries navigate this complex terrain, the implications for global trade dynamics and international relations are profound and far-reaching.
Traditional trade theories form the foundation of international economics, explaining the reasons why countries trade and the benefits they derive from it. These theories, which emerged between the 16th and early 20th centuries, are still highly influential today. David Ricardo’s classical theory, commonly referred to as the comparative advantage theory of trade, assumes that the relative technological differences between countries can facilitate trade based on the comparative advantages of each country, which ultimately benefits all trading partners.
In contrast to Adam Smith’s theory of absolute advantage, which states that trade is only possible if each country has an absolute productivity advantage in certain goods, Ricardo’s theory of trade shows that economic prosperity and national income in trading countries can increase compared to a situation of autarky as long as a country produces certain goods at a lower relative price.
According to Ricardo, a trading country can benefit from trade even if its absolute productivity is lower than that of another country by specializing in the production and export of goods in which it has a comparative advantage. The Heckscher-Ohlin (H-O) model assumes that differences in relative factor endowments—especially labor, land and capital — determine the patterns of comparative advantage between countries, even when technological capabilities are identical.
Both theories have stood the test of time and have been strengthened by recent empirical evidence that confirms their principles when extended to account for multiple factors of production, goods and countries, and cross-country variations in production functions, while controlling for other factors that can also explain trade patterns. The post-World War II economic order, embodied in institutions such as the General Agreement on Tariffs and Trade (GATT) and later the World Trade Organization (WTO), is based on these classical trade theories.
The United States has historically championed free trade and supported globalization through institutions such as the GATT and later the WTO. However, during his first term as president (2017–2021), the Trump administration departed from this established free trade framework and pursued a mercantilist approach reminiscent of the 16th to 18th centuries. During the same period, the Trump administration imposed tariffs on over $350 billion worth of Chinese imports, as well as significant tariffs on steel (25%) and aluminum (10%) from various trading partners. These protectionist measures were justified on the grounds that they were necessary to address trade imbalances, protect domestic industry, and take action against allegedly unfair trade practices.
This unexpected policy shift marked a paradigm shift in US policy, moving from a commitment to free-market globalization to a neo-mercantilism in which trade is used as a tool for geopolitical influence. This view sees trade as a zero-sum game and portrays trade deficits as economic losses.
Trump’s “reciprocal tariff policy” fits perfectly with mercantilist principles, which hold that global wealth is a fixed quantity that allows one nation to increase its wealth only at the expense of others. The rationale behind this presidential action is fundamentally mercantilist. This viewpoint was further exemplified by the assertion that the post-World War II international economic system was based on three flawed assumptions: that the United States led the free market by liberalizing tariffs and non-tariff barriers and the rest of the world followed them, and that such liberalization led to greater economic convergence and increased domestic consumption among U.S. trading partners, ultimately resulting in persistent deficits in merchandise trade for the United States.
The claims of the old mercantilists have been challenged by classical trade theories, including Adam Smith’s theory of absolute advantage and David Ricardo’s theory of comparative advantage, as well as insights from economists such as David Hume. The Trump administration has falsely perceived trade deficits as inherently negative and externalized. This assertion is easily refuted by basic economic principles. Trade deficits are not caused by other trading partners intentionally taking advantage of the situation. Rather, they are the result of domestic economic policies that lead to more spending than income.
The rationale for the new tariff policy stems from the decline in manufacturing capacity in the US, which has contributed to the loss of about five million manufacturing jobs between 1997 and 2024. The claim pointed out that many of these job losses were concentrated in certain geographic areas, particularly in relation to China. However, this phenomenon can be understood as a natural outcome driven by price incentives, with labor-intensive activities likely to be concentrated in densely populated countries such as China and other Southeast Asian countries where wages are relatively low.
It is important to note that only slightly more than 8% of Americans are employed in manufacturing, suggesting that this sector is too small to have a significant impact on the U.S. labor force. US economists such as Robert Lawrence, an expert on international trade at Harvard University, Professor Jeffrey Sachs of Columbia University and others have criticized the US government’s misguided moves.
Robert Lawrence commented in an interview on the exaggerated impact of tariffs on employment in the manufacturing sector: ‘The impact of tariffs on employment is also exaggerated. Let’s take the example of a tariff on steel. You may create more jobs in the steel industry, but you also increase input costs for steel consumers, which in turn affects 60 to 80 jobs for every job saved in the steel industry itself. So overall, tariffs can be counterproductive, especially if they are levied on inputs that are used to make other products”.
Another critical issue raised by the president’s actions is that the administration is trying to reduce the deficit by increasing tariffs while providing funding for tax cuts, which will result in fewer saving for the U.S. government. This creates a contradiction in fiscal policy as efforts to raise revenue are undermined by tax cuts. Unless the US changes its spending habits to either increase savings or reduce investment and borrowing within the United States, the trade deficit is unlikely to improve.
Under the new tariff policy, the government plans to reduce domestic consumption as a percentage of GDP in the U.S. by about 68 percent, which is higher than other countries where tariffs have been lower. This means that American consumers will face challenges as the government seeks to reduce consumption, which may also restrict economic activity and affect job creation. From a consumer perspective, the relatively low tariffs in the U.S. allow Americans to purchase imports more affordably, which benefits U.S. citizens. In addition, the fact that the U.S. functions as a rules-based, open society offers significant advantages.
To analyze the theoretical economic impact of the tariffs imposed in April 2025, several important macro- and microeconomic principles must be considered. These tariffs, a 10% levy on almost all imports and significantly higher “reciprocal” tariffs on certain countries, including a staggering 145% on goods from China, represent a significant intervention in global trade flows.
In the short term, prices for imported goods are expected to rise. The general duty of 10% acts like a tax and leads to higher prices, which are primarily borne by consumers. For goods from countries with higher tariffs, such as China’s 145% tariff, the price increase will be even more pronounced, so retailers are likely to pass on some or all of the increased import costs to consumers, which may contribute to inflation across a wide range of goods for consumers.
Domestic industries dependent on imported inputs and raw materials will experience an increase in production costs due to these tariffs, which may lead to reduced production or further price increases for domestically produced goods. In addition, the high tariffs may lead to a decrease in import volumes. If import prices rise, buyers may reduce their consumption/purchases due to the fundamental price elasticity of demand. The extent of this decline depends on the availability of domestic substitutes and the price sensitivity of consumers and companies.
However, the effects on the trade balance are mixed in the short term. While imports could fall due to higher prices and lower demand, exports could also fall in response to retaliatory tariffs imposed by other countries. China, for example, has already introduced 125% tariffs on American products. The overall effect on the trade deficit will depend on the relative magnitude of these changes.
Read Part II on tomorrow’s edition
BY ALEKAW KEBEDE
THE ETHIOPIAN HERALD WEDNESDAY 14 MAY 2025
