This transcript is from a CSIS podcast published on February 5, 2025. Listen to the podcast here.
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H. Andrew Schwartz: I’m Andrew Schwartz, and you’re listening to The Truth of the Matter, a podcast by CSIS where we break down the top policy issues of the day and talk with the people that can help us best understand what’s really going on.
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To get to the truth of the matter about the tariffs that Donald Trump threatened Canada and Mexico with and imposed on China, we have with us Dr. Phil Luck, who is new at CSIS. He’s the director of our Economics Program and our Scholl chair. Phil, this is your first podcast with me. I’m really psyched to have you here. Thanks so much.
Philip Luck: Super excited to be here.
Mr. Schwartz: So big day yesterday. We’re talking on February 4th today. Yesterday, February 3rd, Monday, was tariff day – (laughs) – in Washington and in the United States. President Trump threatened to impose tariffs on Mexico and Canada at 25 percent, did impose tariffs on China at 10 percent. I have to ask you, you know, do you think the Trump administration views this as leverage – it is a powerful tool – or what else are they trying to accomplish here with this powerful tool?
Dr. Luck: Yeah. I mean, that’s, to me, really the open question, is, you know, there’s a bunch of people in the president’s orbit, and he himself has shown an affinity of tariffs, who seem to think that these are a good tool of what I would call industrial policy to rectify economic harms that have been, you know, put upon us.
Mr. Schwartz: I mean, most Americans hadn’t heard of tariffs before he started talking about them in the 2016 cycle.
Dr. Luck: Yeah, absolutely. I mean, you know, as a – (laughs) – as a(n) academic economist I certainly thought about them, but generally speaking they weren’t what the cool kids were talking about.
No, I mean, you know, and again, he’s always sort of termed them as this sort of magic thing that doesn’t cost us anything and gives us a lot of leverage.
Mr. Schwartz: And is that true?
Dr. Luck: No, of course not. (Laughs.) I mean, so, you know, tariffs are taxes like any tax. And any economist will tell you taxes – the burden of a tax, regardless of who it’s imposed upon, is shared by the consumer and the producer, right?
Mr. Schwartz: Yeah.
Dr. Luck: How it’s shared depends on, basically, the demand and supply elasticities, or how willing people are to absorb price changes. So it’s always going to be shared by both the consumer and producer.
It turns out, when you look at the first tariff war we had with the PRC, we paid, like, 90 percent of those tariffs, right? The passthrough was actually remarkably low in terms of how much we were able to make the PRC pay. That’s in some ways not very unexpected because a huge amount of what we were buying from the PRC that we put tariffs on we didn’t really have either domestic or even other international alternatives, right?
Mr. Schwartz: Right, so we’re stuck.
Dr. Luck: Yeah. Exactly, right? So, you know, tariffs are collected on U.S. consumers and producers, so the only way you’re going to get someone else to pay for those is if they are forced to lower their prices by the amount of that tariff. If they don’t do that, you’re stuck paying it.
Mr. Schwartz: OK. So I want to get back to the leverage in a second, but how does – a massive tariff or even a minor tariff, how does that impact regular consumers?
Dr. Luck: Yeah. I mean, so, again, tariffs are taxes. Taxes going up makes things more expensive. There is a range of estimates, but the most sort of down-the-middle estimates say that if we had imposed the tariffs on Mexico and Canada that would have raised prices or reduced the income, the real income, of households by about $1,200 to $1,500 a year, right?
Mr. Schwartz: Wow. That’s not chump change.
Dr. Luck: No, no, and you wouldn’t – you shouldn’t expect it to be chump change because, like, the North American supply chain, the North American economy is one economy, right? We’ve had about 35 years of really deep integration from the U.S.-Canada Free Trade Agreement that expanded to NAFTA that was renegotiated into USMCA. A car that is produced – you know, let’s say is exported from, quote, “Mexico,” more than 30 percent of the value of that car was made by American workers in America, right? So it’s almost a third, a third, a third, right? So imports from Mexico and Canada, you know, to call them Mexican and Canada products is in some sense, you know, a misunderstanding of what a supply chain looks like today.
Mr. Schwartz: Right. Well, I mean, it really is an incredible partnership between the three countries.
Dr. Luck: Absolutely. And that was – that was the goal, right? I mean, you know, when the U.S. was deciding to expand in 1988 to its free trade agreement with Canada, and later when it expanded it to Mexico, we were seeing regional economies starting to integrate. We saw that in Europe, we were seeing it in Southeast Asia and other places, and we wanted to be able to compete, right?
Mr. Schwartz: Right.
Dr. Luck: We have a large economy, but you know, wage rates are lower in Mexico. That’s because of – you know, they have different comparative advantages. There are certainly high-labor-intensive parts of supply chains that it’s helpful if you have lower wage rates, right? So comparative advantage means that by splitting supply chains across a few different places with different comparative advantages, different sort of what they’re good at – for lack of a better term – you can make the overall production cheaper, which both makes our exports more competitive, it makes goods cheaper for U.S. consumers, and it drives growth.
Mr. Schwartz: So now back to President Trump’s leverage on these tariffs – or, on these countries, rather. Is he using them – you know, ostensibly when he first started talking about tariffs it was about American jobs.
Dr. Luck: Yeah.
Mr. Schwartz: Because, as you just mentioned, lower costs of labor in Mexico undercut U.S. manufacturing. Those manufacturing jobs evaporated in the United States, hurt people all over the country, especially in purple states and red states. So there’s that.
But it certainly seems to me that this latest round of tariffs isn’t quite about American jobs. In fact, it would hurt the American economy if they go forward, especially the Mexico/Canada ones. So what is this really about?
Dr. Luck: Yeah. To your point, I think what I am curious about – and I think a lot of people, including our partners, are curious about – is how I determine this is, is this a(n) industrial policy strategy or a course of leverage strategy, right? You kind of can’t have both, right?
Mr. Schwartz: OK.
Dr. Luck: So if this is an industrial policy strategy, what you are trying to do is change relative prices, change incentives for firms. They will relocate production to the United States. They will open up factories. They will produce things here. And they will not, by and large, use imported inputs because those will be very expensive. To do that – that’s a strategy. I think that will result in really high costs for U.S. consumers, low competitiveness for U.S. firms, and in the long run I don’t think it’s a good strategy. But it’s a strategy.
To do that, to provide firms the right incentives to do that, you need certainty. These are big long-term investments. If you’re going to set up a factory, not only is it a huge fixed cost, it’s a sunk cost, meaning you’re not going to be able to get all that back if tomorrow the policy changes. So you need to give people certainty. That’s why trade agreements are great, because they pass by an act of Congress. That gives political will and the certainty of industry to say: I think this is a stable relationship; I can make decisions based on the current policy environment.
Mr. Schwartz: It lays out a roadmap.
Dr. Luck: Exactly. And it gives certainty, which is what businesses want when they have big investments.
That is kind of diametrically opposed to what you’d want to have leverage. Leverage you need to be able to pretty quickly and deftly turn on pain and turn off pain depending on responses.
Mr. Schwartz: Which, as we know in trade, turning things on and off overnight doesn’t really work. It’s a longer-term strategy.
Dr. Luck: Exactly, right? So you can use it as course of leverage, but you’re not going to give industry the right incentives. If you give industry the right incentives, you really neuter your course of leverage because you can’t turn it on and off, right?
So what I’m curious about is which of these is going to win out. What I’m concerned about is they’re going to try to play in the messy middle and you’re going to kind of neuter both tools.
Mr. Schwartz: OK. So what ended up happening yesterday was quite interesting and maybe proves President Trump’s theory that he does have leverage. He spoke with Mexican President Claudia Sheinbaum Monday morning. They agreed to a 30-day temporary hold on the tariffs in return for some concessions that Mexico gave the United States, but also in return for some concessions that we gave Mexico. And I want to ask you about that. Basically, the same thing happened with our neighbors to the north. Justin Trudeau seemed to ruefully go forward with this. Would have cost Canada a massive amount of jobs and sent them into recession, so they really didn’t have much of a choice. But in your words, what happened yesterday? And why was it so interesting for, you know, us to follow?
Dr. Luck: Yeah. Interesting is one word for it. (Laughter.)
I would say this felt like entertainment in some sense, right? It felt like programming.
I would say in terms of the concessions –
Mr. Schwartz: And he’s good at entertainment. There’s no question about that.
Dr. Luck: Yeah. Yeah, I’m tired, but yeah. (Laugher.)
In terms of concessions, you know, I think basically almost nothing happened, right? These are concessions that, you know, Canada set up a fentanyl czar. Other than, like, putting a title on a guy or a gal, basically everything else they had already agreed to do. There is essentially no problem of fentanyl crossing the northern border.
Mr. Schwartz: Tiny amount.
Dr. Luck: Tiny, tiny amounts, right? Illegal migration, also a tiny, tiny problem. That, to be fair, was a little bit higher last summer – in the last summer the Biden administration. We worked hard with them, quietly, and we got that problem solved, right?
Mr. Schwartz: And they put more troops at the border. We worked closely with them. It was a – you know, as allies would cooperate.
Dr. Luck: Exactly, yeah. So I would say –
Mr. Schwartz: Especially Five Eye(s) allies.
Dr. Luck: Yes, yes. (Laughs.) Yes, exactly. So I would say, in terms of what actually – what we got out of this, it looks more for show than anything else. So that’s a signal to partners, like, look, maybe you can just, like, let Trump claim victory, and we go away from these things.
I would say that there’s a cost to that though, obviously, right? And there’s two costs to that, I would say. One is, a similar thing happened with Colombia about a week ago, right? They decided they didn’t want to accept two planes because they were military planes. And that drew the ire of the administration. And they threatened secondary financial sanctions in addition to tariffs, right? That, under IEEPA, secondary financial sanctions, that’s something we’ve used on Iran, Syria, Russia, North Korea, right? This is not a type of tool that we’ve tended to use against close partners, like Colombia.
Mr. Schwartz: Partners and allies, like Colombia, where we do have a free trade agreement.
Dr. Luck: Exactly, right? So I would say, yes, at the end of the day the tariffs didn’t go on, which, as an economist, I think is good. And at the end of the day, we reached an agreement, which I guess is good. The broader point I would make here, outside of the economics – putting on the hat of my previous position as the deputy chief of economist at the State Department – is this is day-to-day diplomacy, right? This is stuff that, like never should make the front page. There are a million of these bilateral irritants all over the globe every day, right? And to say that you’re going to weaponize the U.S. financial system or weaponize our mutually beneficial trade relationships to, you know, deal with these types of things – out of what appears to be, you know, programming – (laughs) – that will make countries think differently about interacting with the U.S.
Mr. Schwartz: But did we get anything real from Mexico in this? I mean, she did agree to put 10,000 troops on the border. We agreed to police the guns going into Mexico from the United States, which she says is fueling their drug wars, their cartels. Tell me what we got with Mexico, if anything.
Dr. Luck: Yeah. So, I guess the caveat to what I just said – so, you know, again, speaking as an economist, I’m glad the tariffs didn’t go on. The caveat to everything I just said was there were a broader set of bilateral irritants with the Mexico situation, right? Amador (sic; Obrador) did not really take these things seriously. And, you know, that was a problem. So she kind of – I think there was work to be done there. And I’m glad that, you know, we’re moving in that direction. Do I think we needed to, you know, get to the 11th hour of pretty massive trade war with our – one of our closest partners?
And the largest trading partner of the United States, overtaking the PRC – (laughs) – which is something we wanted, right? You know, we want to reduce our dependency, in certain ways, on the PRC. A big part of that is indigenizing production in the Western Hemisphere, right? So, again, I think, you know, we are creating more uncertainty. Even if firms – let’s say we have, you know, auto producers in Japan, Germany, South Korea, who say, OK, we hear the music. We understand what’s happening. We need to indigenize more production in the Western Hemisphere. This is making that more uncertain, a more uncertain proposition.
Mr. Schwartz: OK, so uncertainty for economists, for people who follow the stock market, for politicians, and for just about anybody, really, isn’t so great.
Dr. Luck: It’s not the best. (Laughs.) The way economists like to think about this is, if you have something that’s, like, what I call a sunk-cost investment – meaning, if I put it down – you know, it’s your gym membership. If I pay a gym membership, I got to – you know, I’m not getting that back, right?
Mr. Schwartz: That’s right. You better use it or lose it.
Dr. Luck: Exactly, right? Now when you have situation like a sunk cost, there’s – and there’s uncertainty about the – you know, the payout to that cost, it’s always beneficial to wait. You can always wait and do it tomorrow, right? And so what we’re doing here is we’re increasing people’s incentives to delay investments, right? And if we want to secure supply chains in critical minerals, pharmaceuticals, semiconductors, we’re on a clock. We need to do that quickly. And anytime we incentivize people to wait, and wait for tomorrow, it’s lost time.
Mr. Schwartz: Now, along the lines of leverage and accomplishment, President Trump knows probably better than anyone that you drive for show you putt for dough. (Laughter.) So where’s the dough here for the United States?
Dr. Luck: This kind of, to me, comes back to, what is the objective? So, you know, I think in the Colombia case I don’t know what the objective was. I think it was just coercive leverage. You know, I think he’s testing things out. I do think, you know, the tariffs did go onto the PRC, as you noted at the beginning.
Mr. Schwartz: Yeah, and so – and what did that accomplish, though? I mean, that’s just – it’s a day old. But what does that accomplish? Does it ratchet up the trade war in the United States and China? What does it do?
Dr. Luck: Yeah, I mean, it certainly will. I mean, so the first thing to note is we actually have, at this point, pretty substantial tariffs on a large amount of imports from the PRC. You know, in the first Trump administration, through a 301 trade investigation which was initiated due to the PRC’s theft of U.S. IP, which it certainly does. It steals an enormous amount of U.S. IP. We imposed tariffs on about $400 billion worth of imports, right? Huge amount. Those tariffs range from 7 ½ percent to 25 percent. The Biden administration, as a result of a congressionally mandated review about four years in – we finished that review about six years in – increased those tariffs to between 50 and 100 percent on Chinese EVs, which we don’t really import. So there’s a pretty substantial trade restriction already. These are 10 percent on top of those sort of 25, or 50, or 100 percent tariffs.
In addition, there were certain things that we were not tariffing that we’re now tariffing. These are broader. Look, again, there’s a lot of things that we import from China right now that we – there really are not alternatives. It’s been a little unclear to me whether there’ll be an exemption process for these. That’s a normal process. Normally if you put a tariff on a country for a particular good code, right – they’re called harmonized tariff code systems – you usually put them on at a sort of somewhat aggregate level, like maybe a six-digit code. Those codes go down to 10 digits, right? They get really specific about, you know, the type of bolt, right? The, you know, size and weight and all that stuff, and the type of steel.
There’s often cases where a company will petition the government and say, hey, nobody else makes this. Nobody in the country makes this. So, you know, they’re clearly just going to make me pay the tariff. So I would like this thing to be exempt, right? In the first trade war, this process led to just enormous administrative burden of doing all these tariff exemptions, because the tariffs were very broad. This is even broader, right? So if there’s an exemption process that will allow us to sort of fine-tune these – but that also increases a lot of uncertainty, right? Firms don’t know if they’re going to get that exemption approved or not. They’re going to hire a bunch of lawyers to get this done.
Mr. Schwartz: Costs a lot of money.
Dr. Luck: Costs a huge amount of money. So that’s – you know, that’s wasted money. Again, while firms are trying to decide about their production six, nine, 12 months out. They don’t know how much this thing is going to cost. So that’s a lot of uncertainty as well.
Mr. Schwartz: So, Phil, you know, I guess part of this also is some Americans are confused. Why did we slap 10 percent on China, really our adversary, 25 percent on our allies?
Dr. Luck: So this is a point I’ve been trying to make, which is, you know, a 10 percent tariff on the PRC and 25 percent tariff on Canada is a relative tariff reduction on the PRC. (Laughs.) Right, relative?
Mr. Schwartz: Right.
Dr. Luck: So, you know, I don’t know. I mean, one argument you could make is we already have some pretty high tariffs on the PRC. So, you know, in that sense. But, you know, going – it’s going from 50 to 60 percent.
Mr. Schwartz: And tariffing the PRC is one of the few things that Democrats and Republicans actually agree on.
Dr. Luck: Yeah, there’s a – I mean, so, yes, in the administration, you know, this is a bipartisan consensus at this point that there are certain areas where we would like to reduce our exposure to the PRC. Both because of their – a lot of unfair trade practices. They have high subsidies in critical industries – EVs and semiconductors and shipbuilding. And we’ve had a very difficult time using the WTO and other multilateral institutions to rectify that. So we don’t want to be exposed to those subsidies that would harm U.S. industry. And then, you know, the PRC has a pretty long track record of using its – countries’ dependence on it coercively.
Mr. Schwartz: Phil, I want to sort of bring this home by asking you, you know, what do we really, you know, get out of this in the short term? What do we really get out of it in the long term? Is this an actual useful tool of foreign policy?
Dr. Luck: I think that’s a really important question, and one that I think CSIS is uniquely positioned to talk about and we’re going to be focusing on a lot. I would say two things. This kind of boils down to the industrial policy versus sort of coercive leverage point again. A lot of countries want certainty about what they’re going to be dealing with, with the United States. They obviously would prefer a continuation of a low tariff rate. You know, open United States that that endorses and accepts the sort of international rules that we set up. I’m not sure that’s on the table right now. But I think they would prefer some level of certainty.
I think what a lot of people are worried about is this sort of coercive leverage point, right? You know, the Europeans have something called the anti-coercion instrument, which we were very supportive of – or, we have been supportive of, in terms of its ability to help countries like Lithuania respond to coercion from the PRC. It’s sometimes forgotten that they introduced this – or they started to develop this because of us in the first Trump administration, right, when we put tariffs on European steel and aluminum, right?
So, you know, I think countries are going to have to think about how they interact with us if we’re going to use this leverage in this way. You know, we’re the largest economy in the world. We’re incredibly integrated into the world economy. Our role – the dollar’s role as the international currency, both a reserve currency and the currency of exchange, is a massive privilege and a massive tool that can be used coercively. So we’ll have to see sort of how this goes out.
The last thing I would just say is, you know, in my previous role in the State Department as an economist we helped a lot of countries that were dealing with threats of coercion from other countries, right? The PRC is one of the big ones. You know, that’s a scary thing. The PRC is the second-biggest economy in the world. A lot of these countries are small, right? They know that they can have a lot of pain put on them by the PRC. Some of them – you know, these coercion were usually because of something the country either did or was thinking about doing, right?
Mr. Schwartz: Building an island in the South China Sea.
Dr. Luck: Yeah, or, you know, setting up a Taiwan trade office, or things like that, right? Attending an inauguration of a president.
Mr. Schwartz: It doesn’t take much.
Dr. Luck: It doesn’t take much, right? Investigating the origins of COVID, as the Australians found out was a bad idea, according to the PRC.
Mr. Schwartz: (Laughs.) Yeah.
Dr. Luck: Some of those countries decided to not go through what they thought would draw the ire of the PRC, some stood tall, right? So our track record in sort of helping partners was not perfect by any means. So we won some, we lost some in that sort of narrow sense. What I will say though is, every one of those countries afterwards thought very differently about their relationship with the PRC. And I saw that as, in none of those cases did it seem, to me, like the PRC was winning in the long run.
Mr. Schwartz: Interesting.
Dr. Luck: So I am concerned that – there’s an ability to use coercive leverage in the short run. We’re a big country. We can get concessions. But those compound. And the way in which people want to – or, countries are going to want to interact with us is going to be affected by the way in which we behave.
Mr. Schwartz: Right. And, I mean, let’s not forget at the beginning of this we pointed out that, you know, there’s a real cost. We saw it with the stock market dropping precipitously on Monday. But, you know, longer term prices go up, jobs are at risk, all kinds of things. So it’s not without risk. This leverage is not without risk.
Dr. Luck: Absolutely. Yeah, back to your original question about, like, who pays the tariffs, so you can use this as a cudgel, right? But again, we’re going to pay some of it, right? And that’s not even taking into account the fact that countries can also retaliate, right? So, you know, the Trump administration is fond of talking about tariffs as a revenue source, right? About 1.7 percent of U.S. revenue comes from tariffs. It’s not a substantial source of revenue. Looking back to the first tariff war we had with the PRC, under the first Trump administration, of all that – you know, again, those tariffs were large, but they – you know, revenue came in, right? It’s tax. Ninety-two percent of the revenue we got in was paid out to farmers to bail them out because of the – of retaliation from the PRC.
Mr. Schwartz: Because they couldn’t sell their soybeans to China anymore, and China bought them from Brazil.
Dr. Luck: Exactly, right? So even on that very narrow scorecard –
Mr. Schwartz: It’s a wash
Dr. Luck: It’s a wash, right? And that doesn’t say anything about the higher cost of intermediates that increase the cost to exporters, which harm the competitiveness of our exporters.
Mr. Schwartz: Sure. Costs a lot to move this stuff. There’s services all along the way.
Dr. Luck: Yeah. So this is – I mean, again, you can use this tool, but there’s a million ways in which this is definitely not costless.
Mr. Schwartz: Phil, I know we’re going to be talking a lot about this over the next four years. (Laughs.) Thank you very much for this insight. And welcome to your first episode, again, of Truth of the Matter. There’ll be many more.
Dr. Luck: Thank you so much. It’s been a lot of fun.
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