Ch9: Comparative Advantage and the Gains from International Trade

Glenn’s Policy Advice to President Trump

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Note: In this opinion column, Glenn discusses issues—including the U.S. current account deficit, the role of the U.S. dollar in the international financial system, and the effect of the exchange value of the dollar on the U.S. economy—covered in Macroeconomics, Chapter 18 (Economics, Chapter 28).

This opinion column first appeared in Project Syndicate.

The Policy Pivot Trump Needs

US President Donald Trump’s administration believes that the dollar’s reserve-currency status has tilted the global playing field against America and undermined the country’s competitiveness. While wrong about the dollar, the White House is right about an issue that economists—who, unlike voters, abstract from the exchange rate’s distributional effects—often ignore. As November’s midterm elections approach, the administration needs a policy pivot if it is to meet its rebalancing goals and strengthen the US economy.

To be sure, the dollar’s global role, all else being equal, increases its value but also leaves the United States running larger current-account deficits than it would otherwise. But focusing solely on a reserve currency’s challenges overlooks its benefits and, importantly, the non-tariff policy tools that can address domestic spillovers—the impetus for Trump’s “Liberation Day” tariffs, which aimed to rein in imports and promote exports.

Economists have responded to the Trump administration’s concerns about US Federal Reserve swap lines with foreign central banks by arguing that they are a feature, not a bug, of the dollar’s position, which requires the US to supply greenbacks when needed. They have also pointed out that while current-account deficits may be associated with a strong dollar, the US has had large trade imbalances, with the attendant fretting, even when the greenback’s foreign-exchange value has been relatively low.

Instead, economists emphasize the dollar’s “exorbitant privilege,” including lower borrowing costs and the ability to impose financial sanctions on geopolitical adversaries. Moreover, they counter that tariffs are not an effective response to the dollar’s impact on US exports because they raise domestic manufacturing costs (roughly half of US imports are intermediate goods) and do not reduce the macro imbalances driving the overall trade deficit.

These arguments are correct, but also incomplete. In fact, Trump’s concerns reflect a crucial political-economy question: the distributional implications of dollar dominance.

To see why, consider Robert E. Rubin’s tenure as US Treasury Secretary in the Clinton administration. His mantra was that “a strong dollar is good for America.” He could have been referring to the features of the US economy that underpin the dollar’s status, such as institutional and policy stability and deep financial markets. Whatever the exact meaning, his stance reflected the prevailing view on Wall Street, which benefited from the stronger dollar implied by reserve-currency status.

But for all the benefits that accrue to financiers and consumers, a stronger dollar makes it harder for US industry to compete globally, to the detriment of industrial employment, incomes, and communities. Trump’s position is thus reminiscent of the political tug-of-war in 1925 in the UK over returning pound sterling to its pre-World War I exchange rate under the gold standard. Despite supporting financial interests and the stronger pound, then-Chancellor of the Exchequer Winston Churchill said: “I would rather see finance less proud and industry more content.”

Trump’s economic agenda recognizes the adverse effects of globalization and technological advances on certain parts of American society, in contrast to economists’ emphasis on averages and overall benefits. But Trump misses the simple insight that there are more—and better—ways to help US manufacturing and its left-behind workers than through a weaker dollar alone. He has several policy instruments at his disposal that can address these voters’ concerns and help achieve his administration’s goals while preserving support for the dollar’s reserve-currency role.

For starters, the administration can support a robust industrial sector by increasing public funding for basic research, which advances technology, and a network of applied research centers to diffuse advances in industrial processes. Streamlining regulatory approvals for construction and electricity transmission will also be crucial.

Second, to help workers develop new skills, the administration could channel more resources toward community colleges, while a substantially expanded Earned Income Tax Credit would increase rewards for work. Lastly, more targeted place-based aid could help those areas facing severe disruptions from globalization and technology.

By focusing on the problems associated with a stronger dollar, Trump and his economic advisers have asked an old question in a new way. Their mistake is insisting on answering it with the wrong instrument. Weakening the dollar, including by eroding policy predictability and the economic institutions underpinning its hegemony, will exacerbate the affordability pressures many Americans face and harm the country’s fiscal position. The question now is whether the administration will see the need for a policy pivot in time to affect the midterms.

Why Doesn’t Apple Manufacture the MacBook Neo in the United States?

Image of the MacBook Neo from apple.com

The United States hasn’t exported more goods and services than its imported since 1975. The following figure shows the U.S. trade deficits since 1949 as a percentage of GDP. (In this figure, we’re measuring the trade balance as net exports rather than the trade balance as reported in the balance of payment accounts. The two measures are highly correlated.)

As we discuss in Macroeconomics, Chapter 18 (Economics, Chapter 28), a trade deficit is driven by the relationship between a country’s national saving and domestic investment rather than by the competitiveness of a country’s exports or by the trade agreements a country has with its trading partners.

Clearly, though, many politicians see a trade deficit as a problem. Some politicians have argued that the U.S. trade deficit would shrink if more of the manufactured goods Americans consume were produced in the United States. Would it be possible, for example, to produce more consumer electronics in the United States? A few months ago, Apple stopped assembling units of the Mac Pro, its high-end, professional workstation computer, at a facility in Austin, Texas. More recently, Apple announced that it would begin assembling its Mac Mini, a compact desktop computer that lacks a keyboard and a monitor, in a new factory in Houston. These examples indicate that Apple can produce electronic products in the United States. But the number of Mac Pros or Mac Minis Apple sells each year is very small compared with the estimated 248 million iPhones it sold in 2025.

In March, Apple introduced the MacBook Neo. At a price of $599 ($499 if you are a college student or faculty member), the Neo is Apple’s first entry into the low-priced laptop market that had been dominated by the Google Chromebook. By the end of April, sales were running far above Apple’s initial forecasts and the firm was planning to double production of the Neo from 5 million units to 10 million—all of which would be assembled in China or Vietnam.

Why doesn’t Apple assemble the Neo in the United States? There are several reasons, but the most important is that the Neo is Apple’s first entry into the low-priced laptop market that is now dominated by Google’s Chromebook—all of which are assembled overseas. Apple is able to price the Neo at $599 only if it keeps its production costs very low. Workers who assemble electronic products like laptops require substantial training. Firms such as Foxconn and Quanta Computer have been assembling electronic products for many years in countries such as China and Vietnam. As a result, these countries have large numbers of workers experienced in assembling electronic products. U.S.-based firms have many fewer workers with this experience.

Assembly lines for electronic products need to be flexible to respond quickly when firms introduce new models like the Neo. So, in addition to hiring hundreds of thousands of workers to work on assembly lines, Foxconn, Quanta, and other firms operating in China, India, and Vietnam hire thousands of engineers. Typically, these engineers do not have college degrees, but they have sufficient training to rapidly redesign and reconfigure assembly lines to produce new models. In 2010, when President Barack Obama pressed Steve Jobs, the late Apple CEO, to produce iPhones in the United States, Jobs stated that he would need 30,000 such engineers if Apple were to make iPhones in the United States, but “you can’t find that many in America to hire.”

In addition, wages are much higher in the United States than in China or Vietnam. Workers assembling electronic products in China earn about $6 per hour. Workers doing the same jobs in Vietnam earn only about $2 per hour. In the United States, according to the Bureau of Labor Statistics, in April 2026, production workers in computer and electronic product manufacturing were earning $39.32 per hour.

The factories that assemble Apple products in Asia typically have many suppliers located near them—a so-called supplier ecosystem. Some suppliers make components of the products—although other components are produced outside of Asia, including in the United States—as well as providing repair, maintenance, and other services to the factories. The lack of such a supplier ecosystem would make assembling Neos in the United States very difficult. According to an article in the New York Times, when Apple started producing the Mac Pro in Austin, Texas, it had trouble finding a local firm to produce the custom screws needed in assembling the computers. According to the article, “In China, Apple relied on factories that can produce vast quantities of custom screws on short notice. In Texas, … [Apple had to rely on a] 20-employee machine shop that … could produce at most 1,000 screws a day.”

Production of some electronic goods—notably computer chips—has been expanding in the United States. In 2022, Congress passed the Creating Helpful Incentives to Produce Semiconductors (CHIPS) and Science Act. The Act authorized the federal government to pay subsidies to help firms increase chip production in the United States. Intel, TSMC, Samsung, and Micron have all constructed new chip factories in the United States. As we mentioned earlier, Apple intends to assemble its Mac Mini in a new factory in Houston.

But the United States lacks a comparative advantage in the assembly of high-volume electronic products like the iPhone or MacBook Neo. So it’s unlikely that the expansion of U.S. chip production will be followed by a similar expansion in the assembly of smartphones and computers.

2-28-26 Podcast – Glenn Hubbard & Tony O’Brien revisit Tariffs and AI!

Join authors Glenn Hubbard and Tony O’Brien as they discuss how core economic principles illuminate two of the most pressing policy debates facing the economy today: tariffs and artificial intelligence. Drawing on a recent Supreme Court decision striking down broad tariff increases, Hubbard and O’Brien explain why economists view tariffs as taxes, who ultimately bears their burden, and how trade policy uncertainty shapes business decisions, inflation, and economic growth—bringing textbook concepts like tax incidence, intermediate goods, and GDP measurement vividly to life. The conversation then turns to AI, where they cut through market hype and dire predictions to place generative AI in historical context as a general‑purpose technology, comparing it to past innovations that transformed jobs without eliminating work. Along the way, they explore how AI can both substitute for and complement labor, why fears of mass unemployment are likely overstated, and what economists can—and cannot yet—say about AI’s long‑run effects on productivity, profits, and the labor market.

New Real GDP Data Shows that Growth Slowed Substantially in the Fourth Quarter … or Did It?

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Recent macro data had been showing relatively strong growth in output and steady growth in employment. This morning’s release of the initial estimate of real GDP growth for the fourth quarter of 2025 from the Bureau of Economic Analysis (BEA) was expected to show continuing solid growth. (The report can be found here.) Instead, the BEA estimates that real GDP increased in the fourth quarter by only 1.4 percent measured at an annual rate. Growth was down sharply from the 4.4 percent increase in the third quarter of 2025. Economists surveyed by the Wall Street Journal had forecast a 2.5 percent increase. The following figure shows the estimated rates of GDP growth in each quarter beginning with the first quarter of 2021.

As the following figure—taken from the BEA report—shows, the decline in real government expenditures of –0.90 percent at an annual rate was the most important factor contributing to the slowing growth in real GDP during the fourth quarter. The decline in government expenditures is largely attributable to the federal government shutdown, which lasted from October 1, 2025 to November 12, 2025.

As we’ve discussed in previous blog posts, to better gauge the state of the economy, policymakers—including Fed Chair Jerome Powell—often prefer to strip out the effects of imports, inventory investment, and government expenditures—which can be volatile—by looking at real final sales to private domestic purchasers, which includes only spending by U.S. households and firms on domestic production. As the following figure shows, real final sales to domestic purchasers increased by 2.4 percent at an annual rate in the fourth quarter, which was well above the 1.4 percent increase in real GDP and also above the U.S. economy’s expected long-run annual real growth rate of 1.8 percent. Note also that real final sales to private domestic purchasers grew by 2.9 percent in the third quarter, during which real GDP grew by 4.4 percent, and by 1.9 percent in the first quarter of 2025, when real GDP declined by 0.6 percent. So this measure of output is more stable and likely is a better indicator of the underlying growth rate in the economy than is growth in real GDP.

The BEA report this morning also included quarterly data on the personal consumption expenditures (PCE) price index. The Fed relies on annual changes in the PCE price index to evaluate whether it’s meeting its 2 percent annual inflation target. The following figure shows headline PCE inflation (the blue line) and core PCE inflation (the red line)—which excludes energy and food prices—for the period since the first quarter of 2019, with inflation measured as the percentage change in the PCE from the same quarter in the previous year. In the fourth quarter of 2025, headline PCE inflation was 2.8 percent, up slightly from 2.7 percent in the third quarter. Core PCE inflation in the third quarter was 2.9 percent, unchanged from the third quarter. Both headline PCE inflation and core PCE inflation remained above the Fed’s 2 percent annual inflation target.

The following figure shows quarterly PCE inflation and quarterly core PCE inflation calculated by compounding the current quarter’s rate over an entire year. Measured this way, headline PCE inflation increased to 2.9 percent in the fourth quarter of 2025, up from to 2.8 percent in the third quarter. Core PCE inflation fell to 2.7 percent in the fourth quarter of 2025 from 2.9 percent in the third quarter. Measured this way, both core and headline PCE inflation were also above the Fed’s target.

Today was also notable for a decision from the U.S. Supreme Court that invalidated some of the Trump administration’s tariff increases that began to be implemented in April 2025. President Trump announced this afternoon that he would impose a new 10 percent across-the-board tariff, relying on Section 122 of the Trade Act of 1974, rather than on the International Emergency Economic Powers Act (IEEPA), which the Supreme Court ruled today did not authorize presidents to unilaterally impose tariffs.

Today’s developments appeared unlikely to have much effect on the views of the members of the Fed’s policymaking Federal Open Market Committee (FOMC). The FOMC is unlikely to lower its target for the federal funds rate at its next meeting on March 17–18. The probability that investors in the federal funds futures market assign to the FOMC keeping its target rate unchanged at that meeting increased only slightly from 94.6 percent yesterday to 96.0 percent this afternoon.

The United States Typically Runs Surpluses in Services as Well as Deficits in Goods

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A recent post on the blog of the Federal Reserve Bank of St. Louis reminds us that although the media and some policymakers tend to focus on the fact that the United States typically runs a deficit in trade in goods, it also typically runs a surplus in trade in services. We discuss these points in Economics, Chapter 9, Section 9.1 and Chapter 28, Section 28.1 (Macroeconomics, Chapter 7, Section 7.1 and Chapter 18, Section 18.1, and Microeconomics, Section 9.1). The first of the following figures shows U.S. net exports in services in dollar terms for the period from the first quarter of 1960 through the second quarter of 2025. The second figure show U.S. net exports in services as a percentage of U.S. GDP.

How does the United States compare to other countries? The following figure shows for 2024 the leaders in net exports of services for large economies (those with GDP of $1 trillion or more). The United States has largest value for net exports of services followed by the United Kingdom. China had negative net exports of services in 2024.

The following figure shows net exports in services as percentage of GDP among large economies. Measured this way, the largest net exporter of services is the United Kingdom, followed by Spain. The United States is included in graph (in red) for comparison and ranks ninth.

The following table from the St. Louis Fed’s blog posts shows the U.S. industries that export the most services.

The export of travel services represents largely foreign tourism in the United States. For example, if a family from France visits Walt Disney World in Florida, their spending would be included as an export of travel services.

Solved Problem: Using the Demand and Supply Model to Analyze the Effects of a Tariff on Televisions

Supports: Microeconomics, Macroeconomics, Economics, and Essentials of Economics, Chapter 4, Section 4.4

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The model of demand and supply is useful in analyzing the effects of tariffs. In Chapter 9, Section 9.4 (Macroeconomics, Chapter 7, Section 7.4) we analyze the situation—for instance, the market for sugar—when U.S. demand is a small fraction of total world demand and when the U.S. both produces the good and imports it.

In this problem, we look at the television market and assume that no domestic firms make televisions. (A few U.S. firms assemble limited numbers of televisions from imported components.) As a result, the supply of televisions consists entirely of imports. Beginning in April, the Trump administration increased tariff rates on imports of televisions from Japan, South Korea, China, and other countries. Tariffs are effectively a tax on imports, so we can use the analysis in Chapter 4, Section 4.4, “The Economic Effect of Taxes” to analyze the effect of tariffs on the market for televisions.

Use a demand and supply graph to illustrate the effect of an increased tariff on imported televisions on the market for televisions in the United States. Be sure that your graph shows any shifts of the curves and the equilibrium price and quantity of televisions before and after the tariff increase.
An article in the Wall Street Journal discussed the effect of tariffs on the market for used goods. Use a second demand and supply graph to show the effect of a tariff on imports of new televisions on the market in the United States for used televisions. Assume that no used televisions are imported and that the supply curve for used televisions is upward sloping.

Solving the Problem
Step 1: Review the chapter material. This problem is about the effect of a tariff on an imported good on the domestic market for the good. Because a tariff is a like a tax, you may want to review Chapter 4, Section 4.4, “The Economic Effect of Taxes.”

Step 2: Answer part a. by drawing a demand and supply graph of the market for televisions in the United States that illustrates the effect of an increased tariff on imported televisions. The following figure shows that a tariff causes the supply curve of televisions to shift up from S₁ to S₂. As a result, the equilibrium price increases from P₁ to P₂, while the equilibrium quantity falls from Q₁ to Q₂.

Step 2: Answer part b. by drawing a demand and supply graph of the market for used televisions in the United States that illustrates the effect on that market of an increased tariff on imports of new televisions. Although the tariff on imported televisions doesn’t directly affect the market for used televisions, it does so indirectly. As the article from the Wall Street Journal notes, “Today, in the tariff era, demand for used goods is surging.” Because used televisions are substitutes for new televisions, we would expect that an increase in the price of new televisions would cause the demand curve for used televisions to shift to the right, as shown in the following figure. The result will be that the equilibrium price of used televisions will increase from P₁ to P₂, while the equilibrium quantity of used televisions will increase from Q₁ to Q₂.

To summarize: A tariff on imports of new televisions increases the price of both new and used televisions. It decreases the quantity of new televisions sold but increases the quantity of used televisions sold.

11-07-25- Podcast – Authors Glenn Hubbard & Tony O’Brien discuss Tariffs, AI, and the Economy

Glenn Hubbard and Tony O’Brien begin by examining the challenges facing the Federal Reserve due to incomplete economic data, a result of federal agency shutdowns. Despite limited information, they note that growth remains steady but inflation is above target, creating a conundrum for policymakers. The discussion turns to the upcoming appointment of a new Fed chair and the broader questions of central bank independence and the evolving role of monetary policy. They also address the uncertainty surrounding AI-driven layoffs, referencing contrasting academic views on whether artificial intelligence will complement existing jobs or lead to significant displacement. Both agree that the full impact of AI on productivity and employment will take time to materialize, drawing parallels to the slow adoption of the internet in the 1990s.

The podcast further explores the recent volatility in stock prices of AI-related firms, comparing the current environment to the dot-com bubble and questioning the sustainability of high valuations. Hubbard and O’Brien discuss the effects of tariffs, noting that price increases have been less dramatic than expected due to factors like inventory buffers and contractual delays. They highlight the tension between tariffs as tools for protection and revenue, and the broader implications for manufacturing, agriculture, and consumer prices. The episode concludes with reflections on the importance of ongoing observation and analysis as these economic trends evolve.

https://w.soundcloud.com/player/?url=https%3A//api.soundcloud.com/tracks/soundcloud%253Atracks%253A2208512723&color=%23ff5500&auto_play=false&hide_related=false&show_comments=true&show_user=true&show_reposts=false&show_teaser=true&visual=true

Pearson Economics · Hubbard OBrien Economics Podcast – 11-06-25 – Economy, AI, & Tariffs

08-16-25- Podcast – Authors Glenn Hubbard & Tony O’Brien discuss tariffs, Fed independence, & the controversies at the BLS.

In today’s episode, Glenn Hubbard and Tony O’Brien take on three timely topics that are shaping economic conversations across the country. They begin with a discussion on tariffs, exploring how recent trade policies are influencing prices, production decisions, and global relationships. From there, they turn to the independence of the Federal Reserve Bank, explaining why central bank autonomy is essential for sound monetary policy and what risks arise when political pressures creep in. Finally, they shed light on the Bureau of Labor Statistics (BLS), unpacking how its data collection and reporting play a vital role in guiding both public understanding and policymaking.

It’s a lively and informative conversation that brings clarity to complex issues—and it’s perfect for students, instructors, and anyone interested in how economics connects to the real world.

https://on.soundcloud.com/RA09RWn30NyDc8w8Tj

Glenn Discusses Tariffs on Firing Line

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Recently, Glenn appeared on the Firing Line program to discuss tariffs. Coincidentally, Margaret Hoover, the host of the program, is the great-granddaughter of Herbert Hoover. Herbert Hoover was the president who signed the Smoot-Hawley Tariff bill in 1930. We discussed the Smoot-Hawley Tariff in a recent blog post.

The U.S.-China Trade War Illustrated in Two Graphs from the Peterson Institute

Photo of U.S. President Donald Trump and China President Xi Jinping from Reuters.

The tit-for-tat tariff increases the U.S. and Chinese governments have levied on each other’s imports have reached dizzying heights today (April 11). The United States has imposed a tariff rate of 134.7 percent on imports from China, while China has imposed a tariff rate of 147.6 percent on imports from the United States. On all other countries—the rest of the world (ROW)—the United States imposes an average tariff rate of 10.5 percent, which is a sharp increase reflecting the Trump Administration’s imposition of a tariff of at least 10 percent on all countries. The government of China imposes a tariff rate of 6.5 percent on the ROW.

The Peterson Institute for International Economics (PIIE) is a think tank located in Washington, DC. Chad Brown, a senior fellow at PIIE, has created two charts that dramatically illustrate the current state of the U.S.-China trade war. The first chart shows the changes since the beginning of the first Trump Administration in 2017 in the tariff rates the countries have imposed on each other’s imports.

The second chart shows the percentage of each country’s exports to the other country that have been subject to tariffs. As of today, 100 percent of each country’s exports are subject to the other country’s tariffs.

Finally, we repeat a figure from an earlier blog post showing changes over time in the average tariff rate the United States levies on imports. The value for 2025 of 16.5 percent is an estimate by the Tax Foundation and assumes that the tariff rates that the Trump Administration announced on April 2 go into force, although the rates are currently suspended for 90 days—apart from those imposed on China. (An average tariff rate of 16.5 percent would be the highest levied by the United States since 1937.)

Thanks to Fernando Quijano for preparing this figure.