A well-designed tariff policy—targeted, sustained, and matched with domestic investment—can raise real income and preserve industrial capacity. It won’t reverse globalization, but it can tilt the playing field back toward American producers.

BY John Carney – Breitbart Economics Editor AND Alex Marlow – Breitbart Editor-In-Chief
FOR BREITBART BUSINESS DIGEST / READ AND SUBSCRIBE TO BREITBART BUSINESS DIGEST

What If Tariffs Lower Prices?

The Federal Reserve has a tariff problem—not with policy, but with theory. Its economists still model tariffs as if they’re automatic inflation machines: slap a duty on foreign goods, and prices go up. No nuance, no adjustment, no bargaining.

A new academic paper, published by three trade economists using microdata from China, says the Fed has it wrong. Tariffs don’t just get passed along—they get absorbed. And when the absorption happens on the exporter’s side of the Pacific, U.S. prices don’t rise the way the Fed expects. In some cases, they may even fall.

The paper is titled “Revisiting the Pass-Through of U.S. Trade Policy: Evidence from Firm-Level Data” by Chong Xiang (Purdue), Wei Xiong (Princeton), and Yifan Zhang (Chinese University of Hong Kong). It uses Chinese customs records from the 2018–2019 trade war and finds that, contrary to the headline data, Chinese firms cut prices in response to Trump’s tariffs. The so-called “full pass-through” we see at the product level—where prices look flat until you add in the tariff—is just an illusion created by low-price firms exiting the U.S. market. Look within products, and surviving exporters are discounting to stay in the game.

(iStock/Getty Images)

Concessions Behind the Curtain

The headline finding is worth underlining: the firm-level elasticity of price to tariff is –0.063. That means a 10-point tariff hike results in a 0.63-point price cut before the tariff is applied. And that’s the average. The authors find that above-median-price firms cut more, and firms in the top quartile slash prices by 1.7 points per 10-point tariff. These are the exporters with margin to spare—think of them as the Mercedes of widgets, not the no-name knockoffs.

Meanwhile, the low-margin firms—those with nothing left to cut—exit the U.S. market altogether. That drives up the product average, masking the price concessions made by the firms that stick around. That’s why you can look at average prices and think nothing has changed. But dig a layer deeper, and the story flips: foreign firms blinked. Trump’s tariffs worked.

A Warning for the Fed, a Guide for Markets

This isn’t just a look back. It’s a flashing red light for how to think about Trump’s new tariff regime. Fed Chair Jerome Powell has repeatedly said that everyone he talks to tells him tariffs are inflationary.

But if the Xiang–Xiong–Zhang pattern repeats, many of those foreign exporters are about to eat the cost. Not just because they have to—but because they want to. Holding onto U.S. market share matters. If you’re a German automaker or a South Korean chipmaker, you don’t surrender sales over a marginal tariff. You cut your price, lean into scale, and wait for the politics to pass.

That’s exactly what the Chinese firms did last time. And it’s what the Fed is still missing.

The Blind Spot in the Inflation Models

The Fed’s models assume tariffs are taxes on American consumers. The truth is more complicated. Tariffs can act like price pressure—not just revenue-generating tools, but negotiation devices. They force foreign suppliers to choose: hold your price and lose your customer, or cut your margin and stay in the market. In 2018 and 2019, many chose the latter.

This matters. If central bankers keep bracing for a tariff-driven inflation spike, they may over-tighten into a cooling economy. They’ll be chasing a ghost. The smarter move would be to watch import prices, monitor unit values, and pay attention to the bottom lines of foreign firms that sell here. If margins are falling overseas, tariffs are doing their job—without feeding U.S. inflation.

Trump’s first tariffs taught us something the Fed still hasn’t learned: foreign exporters have pricing power, and under pressure, they use it. Xiang, Xiong, and Zhang’s new paper puts the evidence on the table. Tariffs don’t have to raise prices. Sometimes, they bring them down.

The Optimal Tariff Is Much Higher Than We Thought

In a working paper circulated this spring, economists Oleg Itskhoki of UCLA and Dmitry Mukhin of the University of Wisconsin-Madison revisit one of the most controversial questions in international economics: when, if ever, should a country impose tariffs? Their answer, framed in elegant mathematical terms and grounded in the financial realities of today’s global economy, is both surprising and—perhaps unintentionally—vindicating of the Trump administration’s trade agenda.

Their central claim is straightforward. Even in a financially sophisticated and deeply globalized world, there is still an optimal tariff for a country like the United States. Once global capital flows, currency movements, and the structure of external assets are taken into account, the textbook logic favoring free trade weakens and in some cases, reverses.

President Donald Trump moves charts in the Oval Office of the White House on August 7, 2025. (Yuri Gripas/Abaca/Bloomberg via Getty Images)

The numbers are eye-catching. In a stylized benchmark with balanced trade, they find a welfare-maximizing U.S. tariff of 34 percent, with a revenue-maximizing rate approaching 80 percent. When calibrated to reflect actual U.S. economic conditions—persistent trade deficits and a large stock of dollar-denominated foreign liabilities—the “optimal” rate falls to around nine percent. Still positive. Still economically justifiable. But importantly, smaller than pure goods-market logic would suggest.

That shift comes down to what the authors call “valuation effects”: the fact that imposing a tariff strengthens the dollar, which in turn reduces the dollar value of U.S. foreign assets. In other words, part of the gain in trade terms is offset by a hit to America’s international investment position.

No Retaliation, No Problems

But the real-world implications of the paper may go further than its authors explicitly argue. While the theoretical framework assumes symmetric retaliation—a so-called Nash equilibrium of mutual tariffs—recent history offers a different pattern. Over the past six years, the United States has imposed sweeping tariffs on dozens of countries, including China, the European Union, and Japan. But instead of a cycle of tit-for-tat escalation, the response has often been negotiation and accommodation.

Japan signed a bilateral deal. The EU resumed trade talks. Even China, after a prolonged standoff, agreed to large-scale purchase commitments. India, targeted earlier this month with a new round of tariffs due to its imports of discounted Russian oil, has thus far responded diplomatically. The worst-case scenario envisioned in many economic models—a full-scale tariff war—has yet to materialize.

That reality changes the math

As Itskhoki and Mukhin emphasize, the costliest outcomes in their model come from retaliation. But if partners choose instead to accept tariffs and offer concessions—cutting their own barriers, pledging investment, or agreeing to quantity-based trade deals—the welfare gains from U.S. tariffs become significantly larger. The authors do not model these kinds of side payments, but they would act as additional terms-of-trade improvements, directly increasing U.S. income while reducing the necessary tariff rate to achieve trade-balance goals.

Put simply, when tariffs serve as a negotiating lever rather than a permanent regime, and when they succeed in eliciting economically valuable concessions, the underlying logic of the paper tilts further toward support.

There is also a political and legal nuance the paper nods to obliquely. In theory, production and export subsidies are the most efficient way to raise employment in tradable sectors—especially manufacturing. In practice, however, such subsidies are often difficult to implement, politically controversial, or prohibited by trade agreements. Tariffs, by contrast, are straightforward, enforceable, and legally authorized under U.S. trade law. Managed-trade agreements with investment and purchase pledges effectively mimic the model’s subsidy channel—just delivered through diplomatic means rather than fiscal transfers.

Modern Trade Theory Supports Tariffs

What makes Itskhoki and Mukhin’s contribution so significant is not just its conclusions, but its modern framing. Rather than viewing tariffs as a throwback to a pre-global era, they present them as a macro-financial instrument, with predictable effects on the trade balance, the exchange rate, and the international investment position. Their work offers a rigorous counterpoint to the dominant narrative that tariffs are inherently disruptive or self-defeating.

To be clear, the paper is cautious. The authors acknowledge that their calibration is approximate, that sectoral frictions and long-run dynamics remain outside their scope, and that their results are sensitive to assumptions about asset composition and currency denomination. But the broader message is unmistakable: the debate over tariffs deserves a more nuanced, updated economic treatment.

With Donald Trump now back in the White House and tariffs once again at the center of U.S. trade policy, Itskhoki and Mukhin’s paper may stand as the most rigorous academic defense yet of the administration’s approach. The tariffs are already in place. Retaliation, for the most part, never arrived. What followed instead were trade agreements, investment pledges, and targeted purchase commitments—exactly the kinds of negotiated concessions that amplify the model’s predicted gains. Viewed through their framework, Trump’s tariff policy wasn’t a departure from sound economics. It was the real-world application of a theory that the profession is only now beginning to formalize.

Patrick J. Buchanan: The Prophet of American Trade Policy

When Pat Buchanan campaigned for the Republican presidential nomination in the 1990s, he made tariffs a central pillar of his platform. He warned that unchecked globalization would hollow out American industry, erode the middle class, and leave the nation vulnerable to economic dependence. His message resonated—he won the New Hampshire primary in 1996 and reshaped the conversation within the GOP.

A new working paper released this month asks what would have happened if the country had adopted Buchanan’s ideas sooner.

The answer: the United States would likely be richer and more industrially balanced today.

Photo from the 1996 campaign of Republican presidential hopeful Pat Buchanan speaking in front of a building for lease with the sign “GONE TO MEXICO” for a business that outsourced jobs due to U.S. trade policies. (Steve Liss/Getty Images)

In “Trade Policy and Structural Change,” economists Hayato Kato, Kensuke Suzuki, and Motoaki Takahashi simulate the effects of a major policy shift—what if the U.S. had raised tariffs on imported manufactured goods by 20 percentage points starting in 2001? Their model finds that such a policy would have boosted national welfare by 0.36 percent and raised the manufacturing share of the economy by about one percentage point.

What does a 0.36 percent welfare gain mean in real terms? It’s equivalent to a permanent increase in real consumption—enough that, over a lifetime, the average American household would have enjoyed the purchasing power of an extra $7,200. By contrast, economists’ estimates of the gains from the now-defunct Trans-Pacific Partnership (TPP) ranged from just 0.1 to 0.12 percent of GDP—making the modeled benefit from Buchanan-style tariffs roughly three times larger.

That counterfactual tracks remarkably closely with what Buchanan advocated: a return to national industry, bolstered by protective tariffs, to restore economic sovereignty.

Tariffs, Income, and the Shape of the Economy

The paper does more than revisit a political argument. It challenges how economists have modeled trade and growth for decades.

Unlike standard trade models, which assume consumers always spend in fixed proportions regardless of income, the authors use a more realistic assumption known as nonhomothetic preferences. That means as people get richer, they shift their spending toward services and away from goods. The model also includes sectoral complementarity—the idea that manufacturing and services aren’t easy substitutes, but interlinked in production and consumption.

These dynamics help explain structural change, the long-term transition in advanced economies from goods production to service provision. By raising the relative price of imported goods, tariffs partially slow this drift and redirect spending—and capital—back into domestic industry. That shift, in turn, raises income. The two effects pull in different directions: higher prices favor manufacturing, but higher incomes pull spending toward services. In the model, the price effect wins, leading to more manufacturing and a lasting improvement in real income.

The Retaliation Question

The authors also model what happens if other countries respond with identical tariffs of their own. In that scenario, U.S. welfare falls by 0.12 percent—a modest loss that wipes out the gain from unilateral action.

But theory doesn’t always match practice.

When President Trump imposed broad tariffs during his first term, many U.S. trading partners responded not with retaliation but with negotiation. Canada and Mexico agreed to rewrite NAFTA. Japan and South Korea entered new trade talks. China signed the Phase One agreement. More recently, as the Trump administration has introduced a new round of tariffs on computer chips, cars, and green tech, foreign governments have mostly refrained from counter-tariffs.

Instead of matching duties, many countries have sought exemptions, adjusted their export strategies, or reduced their own barriers. As the authors acknowledge, the real-world response to U.S. tariffs has looked far more like strategic accommodation than tit-for-tat escalation.

A Modest Gain, But a Real One

No one argues that a 0.36 percent welfare gain is transformational. But in economic policy, it’s not trivial. It’s larger than the projected gains from nearly every modern trade agreement, and—importantly—it is permanent. The authors’ result implies a permanently higher level of real consumption, one that grows in value over time.

And the shift in sectoral composition is notable: a one-percentage-point increase in the manufacturing share of GDP is significant in the context of an economy that saw that share fall from 16 percent in 1999 to just under 11 percent today.

The authors are careful not to oversell their result. Their model assumes efficient recycling of tariff revenues, frictionless capital markets, and gradual adjustment. But they also show that older models—those assuming fixed preferences and easy substitution between sectors—tend to overstate the costs of protection and understate its structural impact.

Pat Buchanan says the Pledge of Allegiance at a celebration of the Republican National Coalition for Life on Aug. 13, 1996, in San Diego, CA. (AP Photo/Bob Galbraith)

A Different Starting Point

The economic debate over tariffs is no longer binary. Policymakers no longer start from the assumption that any deviation from free trade must be distortionary. Instead, the new question is what trade policy is for—what national goals it serves, and what tools are available to shape long-run economic structure.

This paper offers one answer. A well-designed tariff policy—targeted, sustained, and matched with domestic investment—can raise real income and preserve industrial capacity. It won’t reverse globalization, but it can tilt the playing field back toward American producers.

It also affirms something Buchanan understood early: free trade is not neutral, and neither is its retreat. The shape of an economy is a policy choice.

Had the country made a different choice in 2001, the model suggests, Americans might be $7,200 richer today—with more factories still running.