Ricardo in Reverse
Monday 14 April 2025
The Trump administration’s wildly incompetent pursuit of a tariff regime has damaged the country’s global standing, and has now salted the fields of the American business landscape. The belief that companies in the aftermath of this fiasco would want to open new productive capacity in the US is absurd—to the point of tragedy. What CEO in their right mind would choose a domain that is now laced every which way, with tariffs? Manufacturers everywhere, including in the US, typically import myriad inputs to create finished products for export. If you choose the US to build things now, you must face a wall of concertina-wire that didn’t exist 100 days ago. And who wants that? Nobody.
The collective actions of the administration—from the Council of Economic Advisors to the President, from the Republican Congress to the comically inept figures of Lutnick, Navarro, and Greer—reveals they have no understanding of the well established dynamics of trade that were advanced by the British economist David Ricardo, over 200 years ago. The President’s obsession in particular not just with tariffs, but with eliminating trade deficits, poignantly also recalls the mercantilist era, dominant when Ricardo first launched his ideas. Thus, after having lived in Ricardo’s world for a couple of centuries, the crackpots and ideologues of Team Trump have attempted to put Ricardo in reverse. But it cannot work, will not work. Markets, historians, economists, trade experts, corporations, and other countries all have the same answer to this doomed attempt to flout the laws of trade: two thumbs down.
Many people understand Ricardo’s theory of comparative advantage, but generally speaking they only understand Part I, of the idea. Part II is where all the juicy dynamism is stored however, so let’s go through both. We will use the example of bike frames and bike components, with respect to the United States and Japan. (Ricardo used the example of wine and cloth, with respect to Britain and Portugal). So let’s say that the US is particularly good at making bike frames, and Japan is particularly good at making the key components, like the drivetrain, the brakes, and the shifting system. As it happens, there is a good deal of truth presently in this example. While the US does make some components (SRAM, for example) it is still the case that Shimano componentry dominates the market from the lower to the higher price range. A performance cyclist will likely choose Shimano’s Ultegra Group at minimum, or its top of the line group, Dura-Ace. At the mass market end of the bike market meanwhile, the global bike industry still chooses Shimano groupsets because not only are they cost effective, but Shimano has a company philosophy that continually shares the innovation that occurs at the high priced end of the line-up with the lower end. They call this trickle-down technology, and it means that your 14 year old child can get a good frame and an affordable Shimano drivetrain that—even at the low end—is full of the best engineering.
While bike frames meanwhile are produced everywhere, the US has in the past two decades become a prestigious maker of custom steel frames. It’s not clear exactly how this happened. The US has alot of cheap real estate that sits outside of its popular, coastal cities, and these areas have blossomed with frame-building. The US also has very affordable electricity in the commercial sector, and a pretty good tax and regulatory regime for small business. And finally, it seems like a lot of young people in the US have decided to get into frame-building: it offers creativity, independence, and a way of owning your own business. Cycling has also taken off, culturally, as a very popular sport across all ages, especially for persons who are aging, looking for low impact ways to stay fit. So you will not be surprised to learn that in the US, in Europe, in Australasia, and also in Japan, it is increasingly common to see high end bike frames made in the US, paired with Japanese components. Here is a great example: Breadwinner Bikes here in Portland makes custom steel frames, and here is their B-Road, paired with Shimano Dura-Ace:
Now, most people think of Ricardo’s theory of comparative advantage as a simple observation that “Japan makes great components, and the US makes great frames. Therefore they should trade freely with each other, so the market has the best of both worlds, and each bike is the combination of what each nation does best.” True. But that is only Part I of Ricardo’s insight. Before we get on to Part II, pause to imagine how Ricardo’s idea would have been received at the time. In his era, the dominant mode of thinking was mercantilism: the imperative to run trade surpluses and use the proceeds to accumulate gold. The notion, in that era, that you would let Japanese component makers into your bike market would have been rejected out of hand. What about the American component makers? they would shout. And over in Japan, that same view would obtain: let American bike frames into our market? What about our framebuilders?
Well, as it happens, Part II of Ricardo’s idea addresses, using math (which we won’t place here), that very question. Here is the answer. When Japan and the US allow free trade with each other in bike manufacturing, it’s true that Japanese framebuilders and US component makers are initially hurt, as tariffs are removed. But comparative advantage then delivers a rush of new strength to US framebuilders and Japanese component makers. And this is where the magic happens, where we depart the confines of linear outcomes, and enter the realm of dynamic results. Ricardo showed that when the two nations combine, and they start delivering the best possible bike, at the best possible price, with the best possible performance, that change collectively transforms the size of the market. Demand for bikes goes up. The capital which flows through the industry rises. The demand for labor expands—not just among framebuilders and component makers, but in bike shops, bike repair services, sales of tires, lights, racks, bags, clothing. This is in fact what has happened to the bike industry the past twenty years. You can now get an unbelievable array of great technology in bikes that cost $800-$1400 dollars. Why? Because strong growth promotes innovation, and innovation embeds better and better technology in each bike, creating more demand.
The Trump administration has made a doomed attempt to throw Ricardo into reverse. There’s a whole layer-cake of mistakes they’ve made, not least of which is that you cannot administer medicine that’s worse than the disease. Indeed, let’s assume we all agree some adjustments need to be made to global trade. Fair enough. You would never go about it this way. As someone pointed out, the tariff regime imposed on the US is the same sanction regime the US and other western nations place upon rogue states, like Russia, with the express intent of hurting their economies. Yes! Exactly. The administration just delivered a shock to the US economy, and every piece of evidence suggests they had no plan for it. And everyone watched them do it, so now it’s all self-evident too. They tried to fight a law of economics. And the law won.
• Further reading: Ricardo’s Difficult Idea, by Paul Krugman, 1999, MIT. •
Support of free trade is the only viable position for those concerned with climate. Without free trade, we move instead in the direction of autarky, which would mean erecting redundant manufacturing capacity worldwide, and would massively increase the call on natural resources. A world of autarky is a world of even higher emissions, and stronger emissions growth. Support of free trade is also not in conflict with the steps we can take to 1. use targeted and time-limited tariffs to curb access to both product-dumping or goods that are made with slave-labor 2. share the benefits of globalization through the creation of national health care, and other social-safety nets. Indeed, anyone who is serious about plugging the gaps in free trade would of course consider these offsets first, and would definitely not consider blowing up free trade as an opening gambit. A political economy called the free-market welfare state—the one that mostly obtains in the US and Europe—recognizes that one cannot simply jettison capitalism or trade as they are the engines of growth, from which social policies can be maintained. Again, Ricardo teaches us that there are dynamic gains to trade. Since that’s true, we should share those gains more broadly. We shouldn’t take a pass on getting the gains in the first place. That would be foolish.
And when it comes to climate, there is also the matter of deployment speed, and our ability to mount as much new low-carbon infrastructure in a compressed compressed time period. If you do not like the fact that China makes most of the world’s solar panels, heat pumps, batteries, electrolyzers, and wind power equipment that’s fine. But until you can figure out a way to start manufacturing those engineered products at scale and at a mostly competitive cost, just stay out of the way. | see the 2023 IEA Energy Technology Perspectives report.
A whiff of capital flight has appeared in US financial markets the past few weeks as the country’s equities, government bonds, and the currency have fallen steeply. When you begin to more fully absorb Ricardo’s insight—that the gains to trade are not linear but dynamic—the puzzle pieces start falling into place. Markets see way beyond the mere stated percentages of tariffs, or the claim they can raise revenue. Instead, financial markets have reacted to the tariff chaos by pricing in a recession, a steep drop in corporate profits, and in the bond market the risk that total US government debt grows more steeply, while tariffs add to inflation. That’s a heady mix. And a nasty one, at that.
Trade is also a key component of the global financial system, and it’s the main process by which the rest of the world accumulates US treasury bonds and dollars. The bond market right now sees two things up ahead that it does not like: 1. Higher prices in the US which will eventually bleed into inflation readings. 2. Less trade with the United States which will lower the demand for dollars, and US treasuries. Typically US treasury bond prices rise at the front end of a financial crisis, or a bear market, or at the start of a recession—or even the growing likelihood of recession. But not this time. Treasury bond prices have fallen. That’s unusual, and particularly worrisome, because US treasury bonds, along with the dollar, have long been a safe haven in times of stress. Here is a chart of the US Dollar Index:
What are the prospects for a change in US trade policy, and a return to stability? Because the Trump administration has now gone rogue—alienating its most important constituency, the business community—we are largely depending on the formation of an opposition to push back against the madness. In military terms, this is often referred to as encirclement. Because Trump policies threaten the economy, the rule of law, in addition to hurting small business and many of his own voters, the US needs these disparate groups to come together. In encirclement, a large and dangerous player is eventually surrounded by a large coalition of smaller players, who would not normally form alliances. However, when a large player goes rogue by threatening deeply held principles, that’s when encirclement can form. In addition to small business and large corporations, some splintering will also be required in both houses of Congress which are now controlled by the Republican Party. But as readers understand, political shifts are slow. And because of that timeline to action, the risk of a recession is now high.
Much of the misunderstanding around trade comes from a failure to understand common tendencies of economic development. The US and most other countries in the West have progressed over centuries from the agricultural era to the modern era, all having passed through the industrial era. Today, we have outsourced the manufacture of mobile phones to workers who earn $500 per month in Asia, while phone designers and engineers make $250,000 per year. This is not a problem which needs solving. Nostalgia for manufacturing is just that, and nothing more. Americans have no interest in returning to work in factories, or assembly lines. | see: FT graphic: American manufacturing has moved up the value chain.
—Gregor Macdonald