Optimal Tariff vs Retaliatory Tariff

An optimal tariff maximizes a country's welfare while holding its trading partners' policies fixed. By restricting imports, a large country uses its market power to lower the world price of what it buys. The Liberation Day tariffs paper estimates a roughly 19 percent uniform optimal tariff for the United States.

Retaliatory tariffs arise when every government chooses policy strategically. Each country sets its tariff to maximize its own welfare given the tariffs chosen by others. The resulting Nash equilibrium has higher tariffs, lower trade volumes, and welfare losses for nearly all participants. The global tariff war paper quantifies this equilibrium and finds that its costs have doubled over 15 years with the deepening of supply chains.

The two calculations answer different questions. A 19 percent unilateral tariff produces a small welfare gain when foreign tariffs remain fixed. If every country follows the same logic, the resulting Nash equilibrium produces losses on the order of several percent of real income. The revenue paper adds a fiscal margin: roughly half of trade-tax revenue disappears when retaliation contracts the tax base.

An optimal-tariff calculation compares a unilateral policy with the status quo. In a trade dispute, the relevant comparison is instead between a strategic equilibrium and the status quo. This distinction matters most for large economies, whose tariff choices provoke the strongest responses.