Tariffs! Tariffs! Tariffs! In Conversation With Mary Lovely

My home subject has gotten too interesting

As I mention in the following conversation, when I was in graduate school and decided to work in international trade, some people tried to dissuade me, saying that it was a boring field in which nothing ever happened.

As it turned out, a lot has happened since then. But the past 5 weeks have seen policy zigzags like nothing anyone has ever seen before: huge tariffs on our most crucial trading partners, called off at the last minute, reinstated a month later, then called off again after two days.

Fortunately, we do have experts who have been trying to keep up. So I recorded a conversation with Mary Lovely, a tariff and trade expert associated with the Peterson Institute, a boutique think tank specializing in international economics; she and her colleagues have been trying to think about and model the vertiginous policy shifts. Conversation and transcript below.

Mary Lovely & Paul Krugman — 3/6/25 — interview transcript

Paul Krugman

Hi, I'm Paul Krugman. This is the latest video, continuing to experiment with different ways of discussing this crazy world we're in. And I'm talking with Mary Lovely, who's a bona fide trade tariffs expert associated with the Peterson Institute for International Economics, which is sort of the think tank for international issues and is really, really relevant these days. I haven't done real professional modeling on these issues for a long time, but Mary has. So let's just start. Mary, tell me, what are your thoughts this week of wild tariff policy?

Mary E. Lovely

I think this week, lots of us are having trouble sleeping, thinking about the cost to the US economy. But just sticking with trade, of course, really digging much deeper than the unraveling we had already seen since 2016. So we can get into that, how we got to this at this level where we're at right now. But the Trump administration is, of course, just moving fast and breaking things when it comes to the global economy in ways that I think have really surprised particularly Wall Street analysts more so than those of us at the Peterson Institute.

Paul Krugman

Yeah, I mean, I was a little shocked that sort of the opening major round should be of all things tariffs on Canada and Mexico. I mean, that struck me as even among the range of things you can do in tariffs, one of the most destructive. What's your take on that?

Mary E. Lovely

Yeah, I think I have two views. One is just, yes, it was really shocking for a variety of reasons, not simply quantitative measures like how much trade we do with these trading partners and how integrated our economies are. But also because I think that people didn't expect that.

They really saw tariffs as kind of a panacea for everything, that they would have had some reality-based view of what global trade networks look like, or even just continental, what the North American production network looks like. We see this most recently today and yesterday with what—maybe they don't want to use the word pause—but some kind of pause or change in the tariffs, which were announced on March 4th. This is the resumption of the threat of 25% tariffs on Canada and Mexico, which was delayed from February. You know, the auto industry is basically just lost in terms of thinking about what this will do to the industry and how they will respond.

So I think the first thing is just, yeah, how could they not be aware of how complex it all is? Even if one wanted to achieve the goal of putting these large tariffs in place, of how you might go about it. I think the second thing that's surprising is that they're going after Canada and Mexico at a time when we have fairly broad support, I would say widespread support for de-risking from China. And of course, Mexico was a key part of any strategy that the US would use to de-risk from China. We saw a lot of investment into Mexico, not just from China. That's captured the headlines. You know, I was speaking with a Dutch firm yesterday. They've invested in small home appliances in Mexico to serve the American market. Making those small home appliances in the US, at US wages, would have meant that they would sell none in the United States because they wouldn't be able to compete, not just with China, but with the US producers. So, you know, it's really surprising, ironic, sad that we're going after, in particular, Mexico and Canada at a time when we really need to be sober about the need to reduce dependence on China.

Paul Krugman

Right. Let's talk about that because I think that in some ways Canada is an easier case to discuss, but Mexico is a really interesting story. It's got the advantage of being geographically close, but also still has relatively low wages. So, if you were trying to reduce your dependence on imports from China, Mexico is an obvious place. And what you're saying is that that has actually been happening, that we've actually been seeing near-shoring to Mexico.

Mary E. Lovely

Yes, and I think that more certainty about the US strategy would have led to even more investment. There was a lot of talk during the Biden administration of whether the US would go after Chinese ‘value added’ in things assembled or further processed in Mexico. And that may have had a chilling effect on some investment as people waited to see, well, what's going to happen with the election?

So, where does the US government see us going and how can they provide some certainty? Of course, it was important to have some level of certainty there because of the US, Canada, Mexico Free Trade Agreement. So people said, this is a great place to do it because the US isn't going to add tariffs on things coming from Mexico. And of course, President Trump blew a hole in that, like, right away. So, well, maybe now the certainty that the U.S. will not adhere to its trade treaties, I think has certainly left a lot of producers wondering where they can go that's safe to serve the U.S. market. The plan that the administration has, they've been quite explicit, is that all this manufacturing should come back to the United States. And I hope that we'll talk about that and whether that is a realistic goal. Among other things, I think that’s the plan. And so the idea that some activities really need to be done in countries with wages lower than the US, that idea has just simply been tossed out the window.

Paul Krugman

Do you have specific examples? I think I know what, but there are particular activities, particularly within the auto industry that are in Mexico. Have you been looking into that? I mean, the things that would be really expensive to do back in the United States?

Mary E. Lovely

A lot of components are made in Mexico. So for example, seats that go into vehicles. Various parts of the vehicle. Certainly some assembly is done in Mexico, but there's a lot of assembly still done in the US. Smaller parts that are done by original equipment manufacturers that go to the big auto manufacturers; maybe roof racks, various bumpers, parts of the vehicle. And of course, this means that even if, in the end, President Trump decides to exempt vehicles, there's an enormous amount of trade in auto parts, which is still at risk here.

Paul Krugman

OK, I'm going to ask a question that will probably baffle everybody. Trump is obsessed with bilateral trade imbalances. Canada, I think, is easy to explain. But Mexico. Is there a particular story there, or is it just that we need a place for labor-intensive stuff, and Mexico is right there?

Mary E. Lovely

I'm a little reluctant to discuss this with the guy that wrote the first paper I ever read on trade. A bit on these issues was written by you way back when.

Paul Krugman

Yeah, well.

Mary E. Lovely

Obviously, we are using Mexico as a platform for doing certain component production. That means that we're a net buyer from them. Then those inputs get further processed within the US and are sold either to the domestic market or are exported. Mexican production is important to US exports because there's Mexican ‘value added’ in the things that we export.

So there's absolutely no reason why we should have balanced trade with Mexico. Mexico is in some sense our supplier, and then we sell to others the things that we make from them, as well as consume some of it ourselves, in particular things that aren't manufactured, like fresh fruits and vegetables.

Paul Krugman

Yeah, we're already heading for a millennial avocado crisis, I think.

Mary E. Lovely

[Laughs]

Paul Krugman

But, question about that. The free trade agreement is not exactly free trade. There are still some remaining tariffs, but Mexican tariffs on U.S. manufactured goods are really quite low, aren't they?

Mary E. Lovely

Yes, we're working on looking at the tariff lines, comparing where are they higher and lower. You know, when we look both at Mexico and Canada, we see many sectors where the number of tariff lines where the US has higher tariffs than our trading partner is large. It's particularly interesting on producer input. So metals, wood, chemicals, plastics. So these are all things that, yes, we may import certain things that fall in these categories, but largely it's American firms that import these things. So there's already been some protectionism, and this is just looking at sort of applied rates, not looking at anti-dumping duties or countervailing duties, which would raise those tariffs.

Paul Krugman

For people who don't know, countries are ruled to have dumped, basically by selling below cost, or so it's claimed, or when they have subsidies. So we have anti-dumping tariffs, we have anti-countervailing stuff. So there's a bunch of stuff that happens. It's kind of legal under trade law, maybe. Actually, I am a little bit baffled by what authority Trump even used for this week's tariffs.

Mary E. Lovely

Well, that's really interesting. I actually wrote an op-ed for the New York Times about two weeks ago on this because Congress is really on the sidelines here. And that's interesting. He used what's known as EIPA, the International Emergency Powers Act. So, he said it was an economic emergency. He linked it to migration flows and to fentanyl.

Paul Krugman

Yeah.

Mary E. Lovely

Those two were necessary to claim that this is a national security emergency, which I would say most neutral or if not all outside observers would say is simply not true. Sure, more cooperation is good and more could probably be done, but both countries were already willing to work with the United States. And certainly after the first terror threats had offered additional resources at the border. Why he decided at the end of February that nothing had been done by these countries and he still had to levy tariffs, we really don't know. There was no specific… the progress wasn't enough. Even though, of course, border crossings at the southern border are way down and border crossings in the north were just never really a big issue.

Paul Krugman

Yeah, and what’s odd is the tariff. I mean, U.S. trade law does give the president huge discretion, but mostly to deal with trade-related issues. You can deal with import surges. You can deal with unfair foreign competition. I didn't think that fentanyl would have been on the list of things you would have considered as a tariff issue.

Mary E. Lovely

No, and he wanted to do it very quickly, so he sidestepped sort of the process that we have to decide if tariffs are warranted. So in the law for things like, you know, invoking national security under trade law, so Section 232, Woodruff required a process, investigations. He also asked his U.S. Trade Representative in the Department of Commerce to begin to study how he can use these tools. And that report is coming out in April and we expect it to be basically an enabling report. That is, here's how you can use these tools to add further protection, not to actually investigate whether there are subsidies that are harming US industries and workers. So that's something to keep on the radar because it doesn't look like these tariffs are slowing down.

We just saw the application of 25% steel and aluminum tariffs across the board. Of course, for people who don't follow this, we did have in the first Trump administration widespread tariffs on steel and aluminum that he placed. The Biden administration didn't really roll that back, but he did work with allies to change them into a series of, basically, quotas. There was a negotiated settlement.

Paul Krugman

Yeah.

Mary E. Lovely

That was kind of an unhappy pause in the process, and Trump just came in and threw that off the table and said, ‘No, we're going to 25% across the board. It's going to be on everybody, friends and enemies, doesn't matter. You're getting this.’

Today we saw the publication of those rules in the Federal Register and it includes a shockingly wide number of products. So for example, 25% tariffs will be going on cooking utensils.

Paul Krugman

Good God, I didn't know that.

Mary E. Lovely

Cooking utensils, sporting equipment that includes metals. You can think of, say, if you buy a backyard soccer goal for your kid to play.

Paul Krugman

So basically anything made with steel and aluminum, not just steel and aluminum themselves.

Mary E. Lovely

It does seem to be that that's the way they're going to interpret it. Furniture. So, if you're buying patio furniture.

Paul Krugman

Yeah, wow. Just to talk for a second about Canada. That in a way was even more shocking because, first of all, Canada supplied, we think, like maybe 40 pounds of fentanyl last year, and there was never mass migration across that border.

And not that this really should be an issue anyway, but the US trade deficit with Canada is entirely energy. It's all Athabasca tar sands, oil, and Quebec hydropower, roughly speaking.

Mary E. Lovely

Yeah, I mean, there just really isn't a justification there. So the justification would be two very thin reads, although I have to say, there was a lot of disinformation on the web that Canada had become a massive money laundering country with lots of migration and fentanyl and that’s simply not true. As you know, Paul, I spent most of my career in the economics department at Syracuse University and those of us who live along the border are just absolutely perplexed and saddened by this because, you know, there's a lot of two-way traffic between the two countries. And in fact, I think it's probably the reason why most people in the northern tier of the country hold a passport, so they can go up to Canada. So the Canadians are really, really upset, talking about boycotts of US products, boycotts of US vacation destinations. A lot of Canadians come down to our beaches all along the East Coast. And we may see some retaliation there for what they see as just completely unwarranted and aggressive action against them for no reason. And it's really hard to argue with them.

Paul Krugman

Yeah. Outside of energy, the US has a trade surplus with Canada. So if we're thinking about tit for tat tariffs, it's kind of, we have more exports at risk than they do. But also the reverse: export taxes, export restraints. I know that the premier of Ontario has said he's going to tax electricity exports to the U.S. so… it's not clear whether he can do that.

Mary E. Lovely

Yeah, I think they're doing what China has done where they're looking for pressure points or choke points as the US is fond of saying with its economic statecraft. I think they're looking for ways to hurt back. Energy and electricity would clearly be one. Their tariffs, as I mentioned before, many lines are lower than the US tariff line now. So there's a lot they could do just claiming that they're going to do reciprocal tariffs on us.

The problem, of course, for both sides of the border is that production is highly, highly integrated all across New York into Pennsylvania, Ohio, Michigan. Just go right across the map. It is clear, and I just verified it with one of the major auto manufacturers. There are vehicle models that have to pass back and forth across the border seven or eight times before they're finished. So that is how integrated it is. You can think of it as if the border doesn't exist. Both sides have unionized labor and it's become commonplace. The US-China auto pack predates NAFTA.

Paul Krugman

Yes. 1988, I think, is the free trade agreement in all those, right? We kind of use it as a case study. I actually used it as an example of the efficiencies that come from trade. And, I think, even the US Census calls Detroit-Windsor a single metropolitan area. It sprawls right across the border.

Mary E. Lovely

Interesting. Yeah.

Paul Krugman

Do we have any idea of just how close the Canadians actually are to sort of extreme pressure point measures?

Mary E. Lovely

We don't. It depends, I think, on what happens this week. What Secretary of Commerce Lutnick said yesterday was quite interesting because they're saying now that they may exempt trade that meets USMCA rules. Now, the USMCA is a free trade agreement. You know, basically,

all trade flows under USMCA rules. I think they may be confused on what has, sort of, ‘rules of origin,’ certain amounts of North American content or American content. And that is exclusively the province of two sectors. One is, of course, automobiles, but not all of the vehicles that pass over the border meet USMCA content requirements.

The other sector is something nobody talks about but it's important which is textile and apparel. So except for those two sectors, anything that's made in Mexico should be eligible for preferential trade, which is largely zero. There's a few sectors in which we're still moving towards zero, but nevertheless have very low tariffs, or nowhere near this 25% business.

So what do they mean by this? It's really very, very confusing. It's horribly confusing for the auto industry because they don't know if this just means them, if it means their suppliers. We also hear there's a lot of pressure on the OEMs, original equipment manufacturers that usually co-locate around production plants to move into the United States to invest in the United States and that they may be given up to a month.

Now, anybody who thinks about this will realize that there's no moving a plant in one month. I mean, even the Chinese couldn't do that when they were rolling, you know, textile making equipment across the border to Vietnam. So we still have, I think, a very high degree of really sort of lost-in-the-woods type of policy going on right now that is causing a lot of consternation for businesses that are integrated across the borders.

Paul Krugman

Yeah, I have to imagine that if you're an auto executive, you might almost be happier if you knew that there was going to be a 25% tariff and then you would just, you know, restructure all your operations around that. But maybe there is, maybe there isn't. You're being given a month, which is meaningless, as you say, for this kind of thing. And presumably, I mean, one response is to just sort of sit on cash and wait for things to clarify and the other is to have a couple of scotches before dinner. I mean, I can't imagine. Supposedly they’re going to do a study about reciprocal trade and tariff reciprocity? Let me hear your take, because obviously I have my own take, but let me hear from your words, what you think of that idea.

Mary E. Lovely

Yeah, I think it's just an excuse for more tariffs. It really doesn't make any sense. President Trump is really quite a genius at tapping into sort of the everyday understanding of certain words like “reciprocity” and he’s able to convince people that “fair” means ‘I have this tariff on a very narrowly defined product. You must have the same one.’

So that has been a bit of a genius. But of course, as Doug Irwin has pointed out, this makes no sense. It outsources our tariff schedule to other countries. So things on which they basically import and want to protect their own domestic sectors now become the things that we protect, even if we have no domestic manufacturers to protect. So we are just basing our tariff schedule on what's right for other countries.

That is not to even get at the logistics of how this would work. We already saw with the de minimis when they tried to roll back the rules that products that had $800 or less of value would come in under less formal customs rules. The complete chaos that resulted from that. So my view is that this is just another way that he is going to justify basically what I've called “whim tariffs”: tariffs for you, tariffs for you.

Paul Krugman

Yeah.

Mary E. Lovely

My colleague, Chad Bown has a trade board 2.0 tracker. And if you look at that, the number of rows is just growing by the day. And pretty soon we will have the Fortress America that Secretary Bessent mentioned.

Paul Krugman

Yeah, what really strikes me is that overall, EU tariffs on US manufactured goods anyway are extremely low as well, right? Brazil and India are one thing, although even they don't have tariffs as high as people imagine. But other advanced countries all have pretty free trade in manufactured goods among each other. So it's not clear. I'm seeing some stuff that they're going to resurrect the old value-added taxes which are a protectionist measure thing. Are you hearing that or is that just my...

Mary E. Lovely

So are you talking about imported value added? VATs? Yes.

Paul Krugman

VATs. Yeah, I mean, basically everybody but the US relies significantly on VATs, which, effectively, it's a sales tax. The implementation requires that goods that come in across the border pay a VAT just like goods produced domestically. But if you choose to pretend that the other half of that doesn't exist, it can look like a tariff.

Mary E. Lovely

Yes, I think it's clearly one part of the reciprocal tariff agenda. And economic theory would tell us that, as you mentioned, placing a tariff on things that are imported simply levels the playing field with the tariff that you're levying on your own domestic production. But there's still many lawyers in the US who argued for some kind of offset back in the 1970s and 80s and are still holding a torch for that. And apparently this crowd likes it. It's another rationale for doing what he wants to do.

Paul Krugman

Where do you think this goes? I have a theory that—assuming the North American tariff stuff does go on—that this almost has to spread to the rest of the world. I don't know. What do you see coming down the pike?

Mary E. Lovely

I'm going to joke a little bit and say you don't need a Nobel Prize to figure that one out. Because, I think about it. If we do this to our own automakers, there is no way they can rearrange their production in such a way that this doesn't cause—some people are estimating six, seven, $8,000 increase on the cost of a vehicle. And I'm just taking the auto sector as an example. We could take lots of other sectors.

Paul Krugman

All right.

Mary E. Lovely

The US tax tariff on everybody else is 2.5%. So anything imported is going to look great when you get to the showroom. So yes, they are going to have to raise the MFN or most favored nation tariffs across the board. They cannot do this just on separate parts. And we know, or at least the Europeans are expecting, that they are going to be in the cross hairs next. We don't know how. We're seeing, you know, sectoral tariffs, country-specific tariffs, national security tariffs. We know that he has tasked the US trade rep a nd commerce with finding out what other tools he can grab from here and there to put tariffs across the board. So yes, your spidey senses are absolutely spot on.

Paul Krugman

Yeah, that's what I'm thinking: that if you massively raise the costs of US manufacturing autos in particular, then all of a sudden everybody's going to be buying Volkswagens. So then you have to have tariffs. I mean, a fair number of Volkswagens are made here as well. But…

Mary E. Lovely

I really didn't expect to see this fall at this point in my career.

Paul Krugman

I know. I mean, when I got into trade, which was, you know, an alarmingly long time ago, it was boring. Tariffs were low. There were no major moves on trade policy. I'm old enough that the menace at the time was Japan rather than China.

Mary E. Lovely

Yeah.

Paul Krugman

I find it hard to get formal modeling on this, but it feels to me as though the fact that we're in a world with these complex supply chains means that the tariffs are even more destructive. Do you have that sense as well, or is that a...

Mary E. Lovely

I absolutely do. Global supply chains came in for tons of criticism after the COVID-19 episode. And the move to reshore became all the rage, notwithstanding the fact that we got caught short when we had to close a plant for baby formula. And we saw that, you know, our target market was not necessarily the most resilient or the most protected because we didn't have baby formula to provide for all kinds of babies who needed specialty formulas. In fact, President Biden sent a military plane over to Europe to fill it up with baby formula. So it was a big politically salient issue as well, obviously.

We just are doing this at a time when it just seems that we have forgotten the values of globalization. And while there are many reasons why we think that perhaps private companies underestimated the risks, much of which are new shocks of the global economy. Instead of helping them figure out how to build more resilient supply chains, we're kind of just throwing up tons of uncertainty and barriers. And of course, it's not just the United States. We're going to see copycat behavior.

Paul Krugman

Yeah.

Mary E. Lovely

And one of the reasons why is fear of China. So a lot of other countries are saying, you know, China has over capacity. When the US closes, that's all coming for us. So we're going to have to raise our tariffs. We don't want to, but we're going to have to. So it's something that will spread, you know, like a disease across the US.

Paul Krugman

That's right.

Mary E. Lovely

We’ve forgotten the benefits noted in the old papers by you, by Wilfred Ethier, Jim Markusen and others. And people have just completely lost that notion of the efficiency. Efficiency is a bad word, but how about wealth generating? What we're going to see is gigantic asset destruction. It's what we're seeing right now because there is value in these fragmented productions.

Paul Krugman

Yeah, actually I didn't even think about all of the assets, all of the investments that were made based upon, ‘well, it's basically a free trade world’ and all of a sudden it isn't and you've got all of these stranded assets, my God. The financial consequences might be interesting too.

Mary E. Lovely

Yeah, I mean, you and I both know that the system was not always fair to everyone. And I think there are many in President Trump's cabinet, his orbit, that believe that the answer is this reindustrialization of America. In some sense, they believe this for the best of motives. But they really seem to misunderstand how supply chains have changed since the 1970s and how we might go about it in a way that doesn't actually create asset destruction and that the US might be able to actually benefit from. So, I mean, for example, textiles and apparel. I grew up in Rhode Island, which features strongly in one of your books, because there was so much concentration of things like costume jewelry and foam rubber and all these glamorous products.

Paul Krugman

Yeah.

Mary E. Lovely

You know, there's just no way that Americans are going to be able to earn a decent wage doing those functions unless, you know, a costume jewelry necklace or bracelet costs you $150 or, you know, your foam rubber pillow is now suddenly $100. I mean, people are looking at this saying, is that true? The answer is: that's true.

Paul Krugman

Yeah. Fun stuff. You know, there will be some winners from all of this. I think mostly economists who know something about trade policy. Probably good for you, probably good for me, but probably bad for 98% of the American public.

Mary E. Lovely

Yes, unfortunately.