Import Substitution: It's A Lot Harder Than It Sounds
The Trumpies assume this one away. Big mistake.
One thing the Trump tariff mongers like to stress is that if we buy a lot more from you than you buy from us, we can hurt you more than you can hurt us. The question of why it’s in our interest to hurt you doesn’t come up, because if you trade with us, you’re by definition “ripping us off.”
There’s logic to relative trade flow point. The fact that we bought $440 billion worth of goods from China last year while they bought $140 billion from us means that we’ve got a lot more stuff to tariff than they do, and that they’re a lot more dependent on us for their export-driven growth than us on them. Trump has applied the same logic to Canada and Mexico.
But there’s a problem with this thinking that’s the subject of a new analysis from Goldman Sachs researchers (paywall). Here’s the key slide, but it needs some unpacking. I’ll explain why the fact that the graph on the left skews right and the graph on the right skews left constitutes a big problem for American businesses and consumers.
The figures plot a measure of the degree to which each country relies on the other for certain products. Forget the bar charts for a sec and consider the following. Suppose that of all the communications equipment (or tomatoes, or whatever) we import, just 5% comes from Jaredistan. Given that small share, a confiscatory tariff of…oh, I dunno…145% wouldn’t necessarily cause huge headaches for American businesses. After all, 95% of their comms equipment imports come from other countries facing much lower tariffs.
Now, consider the tallest bar in the left figure. It’s saying that about 17% of our Chinese imports in certain product categories comprise 81-90% of our imports of those products. That’s the opposite of the above example. It means “import substitution”—shopping elsewhere for what I now can’t afford to buy from China—is going to be a bear.
GS notes that:
Notably, 36% of US imports from China (around $158 billion) fall into categories where the US depends on China for over 70% of its supply - suggesting limited ability for American importers to find alternative suppliers even when facing substantial tariff increases.
The situation is reversed for China, meaning they face less concentrated reliance on us in most product categories.
[In contrast to the US case,] China’s reliance on US imports above the 70% threshold totals just $14 billion, with over half of Chinese imports from the US fall into categories where the US supplies less than 30% of China’s total demand (right chart, Exhibit 3), suggesting greater flexibility to adjust amid tariff pressures.
A simple way to understand this is that having tall bars on the right side of the figures above makes it harder to adjust to large tariffs while having tall bars on the left side makes adjustment easier.
I actually think it’s a bit worse than this because Trump has imposed tariffs on almost all of our trading partners. True, those tariffs are well below China levels, at least for 90 days (though really, who knows what’s coming next or when it’s coming), so even if you can find different suppliers, business just got more expensive.
The broader point is that team Trump’s assumption of seamless supply chain shifts and instantaneous appearance of domestic manufacturing replacements is a ridiculous fantasy that’s already meting out real pain and sky-high uncertainty for many American producers.
Thanks Jared. Really enjoying your thoughts and analysis.
One issue I don’t heard discussed much in the media is the issue of relatively profitability on the goods and services we export, as compared to the goods and services we import.
On some superficial level, people who are not economists do indeed get overly frothed up by this concept that the administration constantly harps on regarding the persistent and large trade deficit. Economists get less frothed up and see nuance in trade deficits, with some seeing it as a problem we should try to fix, and others simply talking about the great efficiencies of globalism that has benefits and costs, but is overall ok because it reflects the great improvements in productivity over decades.
But all of this discussion of trade deficits is focused on the dollar value of trade at the top line. I suspect that U.S. sales of products globally are more profitable than sales by other countries into the U.S. If mexico sells a billion dollars of tomatoes to the U.S. at low margins, but Apple sells $500 milion IPhones to Germans or Mexicans, that creates a trade deficit. But Apple is making an enormous profit on those IPhones, whic it can then use to employ engineers to create moat for their business or to pay dividiends. Who is getting “ripped off”.
Then consider the enormous margins in services, like Facebook and Google or in entertainment products. People in normal parlance use the phrase “ripped off” to mean I was overcharged for something and the seller is making a fortune. Too much profit being taken from me. But in the context of trade, this concept is turned upside down.
The question I have is why we aren’t hearing public discussion of relative profitability, which might take some of the fang and anger out of the discussion of trade flows.
Tariffs and our economy require a Phd in Economics to even get to an elementary level of understanding. But here's what we have to remember: China has 1.5 Billion-- five times our population AND almost everyone in China is an atheist or a non-believer whereas Americans love religion and believe in superstition and don't want to understand evolution; and China has been planning revenge ever since the HUNDRED years of humiliation so I don't think we should feel confident that threatening them will work for us.