These past few months have had more than their share of decade-long weeks. Not even three months in, the second Trump administration has already totally shattered norms and scrambled the playing field, challenging everything we thought we knew about the government’s role in the economy. We thought that Congress had the power of the purse, but now that’s become a question seeking an answer. We thought that even the president had to follow instructions from the courts, but now everyone is left to wonder if that is still the case. Once sacred norms atrophy daily. 

Yet one thing the Trump administration has cast into doubt that gets little air time is the usefulness  of neoclassical economic theory in explaining the economy. 

The classical school of economics generally describes the theory of the first cohort of economists in our modern understanding of the discipline—though it was still radically different from the modern iteration, much more intertwined with studies of politics and philosophy. Most famous among these early economists is Adam Smith himself. Other notable figures include David Ricardo, Thomas Robert Malthus, James Mill, and James’ (more well-known) son John Stuart Mill. Most of modern economic theory descends from this small group of English and Scottish political economists. 

It bears mentioning that this is not because classical economists  were the first to rigorously investigate the economy, but rather because they crystallized it into a concrete area of study, whereas previously it was considered part of moral philosophy and political philosophy and history and in the study of the classics and on and on. Indeed, most of the classical economists were also philosophers—the key concept of utilitarianism is a philosophical foundation of most economic thought.

The neoclassical school, on the other hand, was a category originally used by Thorstein Veblen to group the Austrian school of thought with the “marginalists,” whose work centered around the insights to be gained by examining effects at the, you guessed it, margins. The term was later adopted and expanded by other economists.

Over the course of the twentieth century, much of the original canon of Austrian economics, and a number of significant theoretical advancements like F.A. Hayek’s theory of prices as purveyors of information, were absorbed into the mainstream. At the same time, the demand-side economic theory of John Maynard Keynes became so accepted that—from World War II through the dawn of Reaganomics—a common refrain was that “we are all Keynesians now.” This synthesis left “neoclassical economics” as a stand-in for all of the core ideas of the discipline. 

Nowadays, neoclassical economics is usually used simply to mean “mainstream” or “orthodox” economics, as opposed to heterodox schools of thought like institutional economics (of which Veblen is often considered a founder), Marxian or Marxist economics, or Modern Monetary Theory. Although it is arguably too broad of a term to be of much use, there are enough basic intellectual throughlines that we can at least gesture at a “neoclassical” school of thought.

Neoclassical economics models and theories are premised on a handful of key assumptions. They will vary slightly depending on who exactly you ask, but generally include:

1. Economic actors (usually meaning either people or firms) make rational decisions to optimize an objective.
2. Individuals seek to maximize their utility, within the constraints of their situations. Firms seek to maximize their profit, subject to the bounds of their constraints.
3. Each actor makes decisions independently.
4. Everyone involved has full information about the economic interaction.

These assumptions are obviously not universally true and most economists don’t believe them to be. Rather, the idea is that by reducing complexity, one can discern how various changes to a model will shift behavior, economic interactions, and, ultimately, the dynamics of a market. And once that’s done, those same general dynamics should approximate the more complicated real world. 

This has always been somewhat dubious and has never been short of critics—the modern Austrian school is partly a heterodox tradition because they were opposed to these formal, more mathematical models. Indeed, most cutting-edge mainstream economics is about relaxing neoclassical assumptions to create a richer picture that better captures human behavior. More so than actual professional economists, reporters and media personalities have embraced oversimplified models as a crutch for economic analysis. For instance, when opposing some modest intervention into a market, the talking heads insist on discussing the “Econ 101” (read: obvious) view. 

The irony is that the discipline itself understands the limited use of such simplistic concepts. Econ 101 introduces concepts that are increasingly complexified in further study. Because reporters and talking heads usually didn’t study advanced economics, much of the discourse winds up being unscrupulously grounded in the handful of assumptions outlined above. Nothing has shattered the illusion that we can understand complex situations with basic models like the start of the second Trump administration. 

Shaking the Foundations

Trump’s recent implementation and then partial rollback of tariffs is a good case study. Despite being a cornerstone of the president’s 2024 campaign, business leaders were reportedly surprised at the size and scope of Trump’s initial proffer. And investors clearly did not price such a dramatic intervention in trade policy into their expectations, as evidenced by the rapid gyrations of the stock market. It makes sense when you consider that political and business insiders often default to explaining decisionmaking via presumed rationality. The orthodox view was basically that this kind of sweeping and incoherent tariffs wouldn’t happen; because the costs so outweighed the benefits, such an intervention would clearly go against the government’s (ergo the president’s) basic self-interest. (An example of this sort of thinking beyond economics is political science’s rational state theory—a consequence of how neoclassical economics has colonized much of political science.)

Even though the tariffs have quickly been walked back—even if in the coming days, weeks, or months they are totally undone—the key issue is that, under a neoclassical framework, they would not have happened at all.

Now, one could retort that the market reacted exactly as even the most elementary model would predict; uncertainty made the prospects of financial markets less palatable, resulting in a scramble from investors to reduce their risk exposure, triggering a loss in valuation as the demand curve shifted down. True enough. But the fact that this played out so predictably is partially the point. Everyone knew that it would be economically harmful to impose blanket tariffs. It would obviously be antithetical to American financial interests. Yet the administration did it anyway.

There are basically two ways to reconcile the tariffs with a neoclassical model. First, the model could simply do away with the assumption of rationality. This would make it basically impossible, however, to use as a predictive tool (behavior would become too complex to easily anticipate). Second, the model could do away with the assumption that actors (governments, individuals) are optimizing for utility. Perhaps the White House is actually optimizing for profits for aligned businesses or for accumulating political influence. This type of tweaking of the “objective function,” is much more in line with existing economics, but still represents a major break from neoclassical models. 

(The fact that this sort of work is ongoing and most economists do not actually adhere to such restrictive assumptions is one good reason why “neoclassical” being used interchangeably with “modern” or “orthodox” can be confusing. Unfortunately, many pundits, journalists, and businesspeople don’t study the discipline far enough to move beyond the oversimplified worldview.) 

For the administration to take an action so clearly against the nation’s interest without breaking these assumptions, it would require believing that they have information that drastically changes the calculus. Possible, but unlikely when it comes to trade, where there’s little information opacity compared to, say, intelligence and national security. 

Speaking of information, the current administration has scrubbed enormous amounts of data from federal government websites and databases (some data have been made available again after litigation and public pressure). Everything from omitting the role of trans people in Stonewall to removing reams of medical data has happened at a rapid pace. Some of this information may not be immediately relevant to economic decision-making. Other times the path from that data to economic or commercial relevance is a straight line. New pharmaceutical undertakings will suffer a material harm to their research and development with fewer resources from the National Institutes of Health. The poultry industry might well miss CDC data on avian flu. 

But even beyond these specific applications, the withdrawal of mass amounts of previously public data fundamentally erodes the idea that economic actors will ever have anything resembling information symmetry. Not to mention how much widespread attacks on the media compound the issue.

One final issue is regulatory uncertainty. Rational, independent decision-making requires some degree of confidence in the laws and institutions governing the market you participate in. The pushing of novel legal theories—including that oral orders from judges are not binding or that the executive branch can eviscerate congressionally mandated departments and programs—makes it nearly impossible to presume that you can accurately predict the benefits or costs of any particular decision. When even gargantuan law firms prefer deference over self-defense, confidence in the rule of law no longer grants the basic trust required in a modern, global economy.

Goodbye to the Neoclassical World

One could argue that the weakening of these norms has nothing to do with economic thought, and that it’s just dirty politics. But markets are political. Institutions create rules governing behavior, including economic behavior. And a stable set of rules is necessary for any of the assumptions undergirding neoclassical models to play out. 

To the extent that we ever lived in a neoclassical world, the Trump administration is ensuring that we don’t any longer. We are long overdue for more nuanced economic discourse that doesn’t shy away from its own limitations, and that recognizes when it can and should (perhaps must) be complemented with other types of insights. As the illusion of perfect competition becomes ever more ethereal, the need for more sophisticated economic thinking and debate becomes ever more urgent.

The election results present a puzzle of sorts. On the one hand, voters expressed deep resentment towards inflation, under the belief that Biden contributed to rising prices, failed to address them, or both. On the other hand, Trump’s signature economic policy is tariffs—on imports from Mexico to Canada and now Israel—which most economists believe will raise prices. Why are voters, who are ostensibly so sensitive to high prices, willing to give Trump a pass on an obviously inflationary policy?

When I have posed this puzzle on Twitter, the standard neoliberal voices—from Jordan Weissmann to Eric Levitz to Matt Yglesias (aka “The Vox Boys”)—suggested that my brain is small. (Yes, the same Levitz who leaned entirely on an economist to interpret a contract for the counterintuitive proposition that insureds were immunized from Anthem’s proposed and now-retracted policy to restrict anesthesia coverage.) The Vox Boys reckon that voters put everyday low prices above all else. To believe this, however, you must also believe that voters don’t understand the implications of tariffs or don’t believe Trump will follow through with his threats. This neoliberal explainer is fairly unsatisfying, however, as it requires one to believe that voters are stupid.

An alternative explanation, which infuriates the Vox Boys, is that while voters care about low prices, they also care about other things like preserving blue-collar manufacturing jobs or supporting local businesses. To wit, voters tend to punish Democrats for removing trade barriers: A 2020 American Economic Review paper showed “trade-impacted commuting zones or districts saw an increasing market share for the Fox News channel (a rightward shift) … and a relative rise in the likelihood of electing a Republican to Congress (a rightward shift).” This desire to protect local businesses animates much of the New Brandeisian movement, which rejects the consumer welfare standard in antitrust, by among other things, recognizing harms to workers or small businesses.

Following the advice of her corporatist advisors like Tony West, Harris elected to attack Trump’s tariffs from the right, highlighting how the tariffs could raise prices. Indeed, the Harris campaign tweeted a video of Washington Post columnist Catherine Rampell bashing Trump’s tariffs, a few weeks after Rampell called Harris’s price gouging proposal “communism.” These attacks moved exactly no one in Harris’s direction. And no wonder: The Democrats are supposed to stand up for labor, who are the biggest beneficiaries of tariffs, especially those who work in the tariff-protected industries. Progressive advocates like Zephyr Teachout were calling for a recalibration on the anti-tariff message, but were ignored. Another victory for the Vox Boys and Girls!

When I pointed out that Trump managed to purge the neoliberal free-trading ideology from his party’s platform, appealing smartly to voters who care about jobs as well as low prices, Levitz quote-tweeted a screen shot of his summary of a 2019 study (and a link to his Vox article), purporting to show that that American exporters that were most exposed to Trump’s tariffs on their inputs—think steel, aluminum, solar panels, and various Chinese goods—experienced lower export growth in 2018 and 2019 than exporters who were unaffected by the duties. Per the Vox Boys, tariffs create harms beyond higher prices.

Before getting into the details of the study, let me note two obvious things. First, from a political perspective, the welfare of large traders engaged in importing and exporting (aka “trading firms”) doesn’t get much play in election conversations; so this anti-tariff argument will again fall on deaf ears. Second, one can’t evaluate a tariff from a cost-benefit perspective without also studying the beneficiaries of the tariffs. By focusing on the welfare of trading firms, however, this study implicitly downplays the welfare of workers whose jobs were protected by the tariffs.

Regarding the merits of the underlying study (available here), the focus on the impact of Trump’s tariffs on exporter growth is curious. If larger or faster growing exporters were more exposed to the “treatment,” then their growth would be expected to slow relative to the “control” group (smaller exporters not exposed to Trump’s tariffs); it’s easier to “grow” from a smaller base. Indeed, the authors acknowledge the difference in the size of the two study groups at page 2:

We find that U.S. importers facing import tariff increases employed twice as many workers compared to the average importing firm and about nine times as many workers as the average firm. Similarly, we find that U.S. exporting firms facing retaliatory tariffs were more than three times larger than the average exporting firm. Thus, the tariff increases hit the very largest trading firms in the U.S. economy.” (emphasis added).

Figure 3 of the study shows that cumulative growth rate in exports for the treatment group exceeded the control group in the two years leading up to the tariffs, with the gap between the two shrinking in each month. It stands to reason that, even absent the tariffs, the growth rates of the two groups would have naturally converged. In fact, the two trendlines differed by approximately 10 log points in early 2016, with most exposed export sectors exceeding all other export sectors by a comparison of 3 log points to -14 log points, respectively. This difference shrank to nearly zero by the beginning of 2018. The reversal that occurred after January 2018 reflects a continuation of the opposing pre-tariff growth directions. Yet the use difference-in-differences (DID) estimation to recover a causal effect, as the authors of this study intended, critically rests upon the “parallel trend” assumption—namely, that had the treatment never occurred (i.e., tariffs had never been imposed), the relationship between the treated and control groups would have remained constant over time. But the authors casually mention parallel trends just once in a footnote, claiming “Figure 3 suggests parallel trends in the months prior to the trade war.” While that statement might be true for the few months right before the Trump tariffs, it ignores the plainly obvious longer trend of convergence. Violation of the parallel trends assumption can bias the estimated effect, undermining the researcher’s ability to ascribe a causal interpretation to the treatment.

Finally, the magnitude of the effect, assuming it’s properly measured, doesn’t sound debilitating for large exports. The authors find a decrease in “log points” of around one (slightly smaller in 2018, slightly larger in 2019), which can be interpreted as a percent change for small differences. By comparison, exports were growing by between four and six percent in the year leading up to Trump’s tariffs, per Figure 1. A decline of one percent in the growth rate of exports for the largest trading firms that import tariff-affected inputs might be a small price to pay for protecting jobs and domestic industries.

Focus on the jobs

Levitz also points readers to a 2019 staff working paper at the Federal Reserve as evidence that Trump’s tariffs harmed workers. Setting aside any infirmities in the estimation or interpretation of results, at least this study focuses on a meaningful outcome variable. The staff working paper purports to show that U.S. manufacturing industries more “exposed” to tariffs lose more jobs from rising input costs (channel one) and retaliatory tariffs (channel two) than jobs gained or preserved from import protection (channel three). Exposure to import protection for a given industry is measured as the share of domestic absorption of that industry affected by newly imposed tariffs; exposure to the other two channels is measured similarly. It follows that for any given industry, exposure along these three channels could vary dramatically.

This study also uses a DID method to uncover the effects of the tariffs. The authors note the “issue of differing trends across industries prior to the implementation of new tariffs”—an admission that parallel trends may not be satisfied—and seek to address it by (1) removing industry-specific trends in 2017, or (2) differencing out the pre-trend path for each coefficient. After these various contortions, they find that “shifting an industry from the 25th percentile to the 75th percentile in terms of exposure to each of these channels of tariffs is associated with a reduction in manufacturing employment of 1.4 percent, with the positive contribution from the import protection effects of tariffs (0.3 percent) more than offset by the negative effects associated with rising input costs (-1.1 percent) and retaliatory tariffs (-0.7 percent).” (emphasis added). But this begs the question: What single industry would make such an equivalent move on each of these channels? If China is expected of dumping (say) solar panels, and Trump slaps a tariff on solar panels from China, why would the solar panel industry (now exposed to the import protection channel) be equally exposed to (say) rising input costs?

It would have been helpful for the authors to identify the aggregate employment effect across the three channels for any given industry. Were there industries with net job gains resulting from Trump’s tariffs? To wit, if an industry was only exposed to the import protection channel—that is, no input costs were increased by other tariffs and there was no retaliation for the industry in question—the best estimate of the jobs effect would be positive! By showing the size of the coefficients of the three channels for equal shifts in channel exposure, however, the authors have made it difficult to assess the economy-wide effects as well. We only know (assuming the specification is proper) of the relative magnitudes of the employment effects given a one percentage point exposure to each of the three channels. Tariff bashers will interpret the coefficients as if they can be summed up, but that is only for a hypothetical industry that experienced the same increase in exposure across all three channels.

This is not meant to impugn the integrity of either study. All empirical studies can be criticized. Rather, it is meant to suggest that the Vox Boys have found two studies that tell their story of tariff-induced harms and have decided to pump them up. But neither study materially advances the economic argument against tariffs. 

In summary, the neoliberal critique of Trump’s tariffs finds little support in economics or among voters. The Vox Boys and Girls, who myopically focus on low prices over all other considerations, should be ignored. And Democratic Party should recalibrate their approach to tariffs, recognizing that, to be considered the party of labor once again, promoting labor interests should be their loadstar.