Economics for the Real Economy

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Trade theory must catch up with tariffs, industrial policy, and the costs of globalization.
The return of tariffs and import regulations creates an opportunity to update old assumptions and dated models with the hard evidence of real-world data and experience.
President Donald Trump is crafting a new international economic order predicated on balance, reciprocity, fairness, and resilience; economists should “catch up with the world as it is.”

Post–World War II architects prioritized national sovereignty and security alongside broad-based prosperity; the General Agreement on Tariffs and Trade allowed robust use of tariffs for essential security, to prevent damage to domestic industries, respond to unfair competition, foster economic development, and address balance of payments challenges.
The Coordinating Committee for Multilateral Export Controls aligned export control policies across the United States and its allies during the Cold War.
By the 1990s, hyperglobalization—eliminating barriers to trade—became dominant, leading to institutions such as the World Trade Organization and NAFTA and to widespread offshoring by multinational firms.

Americans lost millions of high-quality manufacturing jobs; more than 70,000 plants shut down.
Working-class wages fell behind; the industrial base weakened; innovation slowed; real productivity in manufacturing declined.
The goods trade deficit exploded to $1.2 trillion annually, which fed the country’s unsustainable current account deficit.
A study by Amy Finkelstein and coauthors found that areas with average exposure to Mexican import competition under NAFTA experienced a sustained 0.68 percent increase in annual age-adjusted mortality; the mortality impact more than erased the welfare gains identified in a leading economic analysis of NAFTA.
Research by Susan Houseman indicates oft-touted gains in US manufacturing output were driven by how we measure increasing computing power; accounting for distorted computer industry figures, US real manufacturing output fell 6 percent between 2007 and 2016.
David Autor and others documented that geographic mobility declined in trade-exposed places; cross-sector reallocation of former manufacturing workers was minimal and returned jobs were lower-skill and went to different people.

Common trade models often assume full employment and seamless worker transitions between industries and geographies.
Models focus primarily on long-run efficiency gains (sourcing at lowest-possible cost) and treat these gains as unalloyed social goods.
Models frequently ignore sector-level linkages, supply-chain complexity, rules of origin effects, labor market frictions, distributional consequences, and public health outcomes.
Data limitations and measurement issues (e.g., computer industry measurement) hinder accurate empirical analysis of trade’s real effects.

Contemporary economics must account for scale economies and government intervention that create structural trade imbalances divorced from comparative advantage.
Examples cited: the United States runs a trade deficit in agriculture despite abundant cropland; South Korea became a steelmaking powerhouse despite limited natural resources.
Recent IMF research: persistent trade imbalances harm deficit economies and benefit surplus ones by reallocating productivity gains.
Bank of England finding: when a country “combines industrial policy with different forms of consumption suppression—such as weak social safety nets, capital controls, or high precautionary saving—subsidies generate persistent trade surpluses and become a beggar-thy-neighbour policy with negative international spillovers.”
The IMF acknowledged imbalances are “concentrated and persistent” and noted the US current account deficit raises the risk of an eventual disorderly external rebalancing.

The IMF recommends large-scale tax increases (including a 10 percent federal sales tax) and austerity measures (including deep cuts to popular entitlement programs) to address imbalances, while admitting these would have at best only a moderate effect and require surplus nations to boost demand.
The IMF’s Global Integrated Monetary and Fiscal (GIMF) model shows tariffs would have a negligible effect on narrowing current account imbalances, but the model does not account for “tariff jumping through the cross-border reallocation of production.”
“Tariff jumping” is identified as the mechanism through which protective tariffs and other trade measures induce reshoring of production and change trade patterns.

President Ronald Reagan’s restrictions on Japanese autos in the early 1980s incentivized an onshoring boom that produced over 100,000 new American auto jobs at more than 300 new production facilities by the 1990s.
President Trump’s 2018 safeguard tariffs on washing machines triggered investment, including large new facilities by Samsung and LG in South Carolina and Tennessee.
Mercedes-Benz is investing $4 billion in its Alabama plant, explicitly citing tariffs as the cause.
McKinsey’s research shows recent tariffs have caused a large-scale reordering of supply chains around the world.
The US trade deficit with China was down 32 percent, year over year, in 2025.
The overall trade deficit in goods has decreased, year over year, every month since President Trump began implementing his reciprocal tariff policy in April 2025.

Models should be updated to capture:
- distributional consequences of trade,
- labor market frictions,
- network and scale effects in manufacturing,
- effects of regulatory arbitrage on workers and producers,
- impacts of detailed rules of origin on global production networks,
- public health outcomes linked to trade shocks.
Tariffs that directly target the primary sources of the deficit are presented as a simpler and more flexible solution than complex alternatives (e.g., import certificates, market access charges on foreign financial inflows).
Durable rebalancing requires action by both surplus and deficit economies; without real pressure a surplus economy has no reason to act, but deficit countries need not remain inert.
The United States is using tariffs and agreements on reciprocal trade to encourage inbound productive investment, increase incentives for domestic production, and open markets for US exports.

Economic modeling and empirical tools must be richer and better aligned with real-world supply chains, labor market realities, distributional effects, and public health outcomes to enable smarter policy.
“Economic conditions are constantly changing, and each generation looks at its own problems in its own way.” It is urgent that economists update models and policies to reflect contemporary global economic realities.

Economics for the Real Economy
- Economics for the Real Economy (Markdown version)
- Economics for the Real Economy (PDF)