How do Nations Choose Tariffs during Trade Wars: An

Empirical Investigation

Rishabh Gupta

Shreyes Jayaram

Shreya Shukla

Symbiosis School of Economics

International Relations - Trade Wars
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Abstract

After decades of increased globalization, the imposition of tariffs and other restrictions
to trade has recently returned as tools of macroeconomic policy. Tariffs are typically levied by
nations to alter the relative foreign price of targeted goods and thereby generate artificial
competitive advantages, thereby protecting industries from competitors and external shocks.
According to conventional economic theory, when a country levies import tariffs on the goods
produced by a second country, the second country typically responds with retaliatory tariffs, or
tariffs imposed on goods imported from the initial tariff levying country. While the welfare
effects of tariffs have been discussed in detail, the decision-making process regarding for which
sectors should retaliatory tariffs be levied has largely been ignored in the current literature.
This paper seeks to elucidate this decision-making process through two explanatory
frameworks: a mathematical framework and a political economic framework. The
mathematical framework is based on the application of an inoperability input output model.
The model is devised to rank sector of the economy by the order in which external shocks
causes the greatest production loss. The key proposition behind the mathematical framework
suggests that countries will impose retaliatory tariffs on imports of goods belonging to those
sectors with the greatest potential for production loss due to external shocks. The key
proposition behind the political economic framework is that countries imposing retaliatory
tariffs typically impose tariffs based on the initial tariff levying country to create political
pressure to withdraw the tariffs. This typically takes the form of placing import tariffs on goods
produced by politically important sub-groups, like producers, residing in key marginal states
especially during the United States Presidential elections. This paper evaluates empirically
these two propositions to test how well they explain decision-making with respect to the
imposition of retaliatory tariffs.
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I. Introduction

International Trade has assumed significant importance in the maintenance of the

present global order. An estimated $42 trillion of trade in goods and services took place in 2016
and the quantum of international trade is only growing (“WSDBHome”, 2018). The history of
international trade however, has not been one of continued progress, but is characterised by
significant upswings and downswings. The Smoot Hawley tariffs of the 1930s drastically
reduced the quantum of international trade and global trade did not recover till the Second
World War. However, since the end of the Second World War, the American hegemony has
promoted free trade through multilateral institutions that enabled it to shape a post-war
international system that despite promoting its interests (Stokes, 2018), maximised global
welfare.

Despite years of sustained trade liberalisation across the globe supported by both major
political parties of the United States, the recent election of Donald Trump as the 45th President
of the United States has seen the imposition of tariffs return as a tool of trade policy. In January
2018, the Trump administration imposed tariffs on solar panels and washing machines ranging
between 30 to 50%. Later, in March 2018, tariffs on steel (25%) and aluminium (10%) were
imposed on most other countries (Grant, Ning, & Peterson, 2018). These tariffs originally
exempted Canada and Mexico, however on June 1st 2018, U.S. Commerce Secretary, Wilbur
Ross, announced that the U.S. tariffs will apply to Canada and Mexico as well. Mexico
responded immediately by imposing new tariffs on U.S. steel, pork, cheese, whiskey, potatoes,
and apples, among other goods ("DOF - Diario Oficial de la Federación", 2018).

Black (1959) identifies three primary reasons for countries to levy tariffs: to affect the
distribution of income, to affect the balance of payments, or to affect the composition of
production and consumption. The infant industry argument is the most common form of the
latter. The argument, first propounded by American founding father Alexander Hamilton, and
extended by Frederick List is that when some countries have outdistanced others in
manufacturing, the other countries are justified in levying tariffs to protect industries to
generate domestic capacity for production (Shafaedin, 2000). Levying tariffs also generate
government revenue and transfer income from the rest of the world to domestic producers.
 5

While Trump’s rhetoric supporting his tariffs follows the three basic arguments for
tariffs that Black outlines, the Trump administration is utilising tariffs as a form of coercion
(Whiting, 2018). While Trump regularly claims that his tariffs will protect jobs particularly in
steel and manufacturing, popular literature finds itself in a near consensus that Trump is
utilising tariffs to coerce countries to re-negotiate trade deals (Bown, 2018). Utilising tariffs
as a method to influence the behaviour of other parties has precedence as a tool of American
policy, with the threat of tariffs influencing several Asian nations into signing the Multi-Fibre
Agreement (Farer, 1985).

It is generally accepted as part of the economic canon that countries upon which tariffs
have been levied, levy retaliatory tariffs on goods from the initial tariff levying country.
Scitovszky’s analysis (1942) in particular draws out the rationale for doing so: that the initial
tariff levying country levies tariffs to improve its terms of trade, after which the second country
levies retaliatory tariffs back on the first country to mitigate the worsening of its terms of trade.
This, in turn, typically induces the first country to levy further tariffs, culminating into a trade
war. Each successive levying of tariffs reduces the volume of trade and thus global welfare;
however, the two countries will eventually arrive at some agreement reducing the accumulated
tariffs. The purpose of levying retaliatory tariffs is to reach some sort of “policy equilibrium”
(Johnson, 1953).

For the United States at least, these explanations seem to hold good. Donald Trump has
placed tariffs on aluminium, steel, washing machines and solar panels by executive order
bypassing the United States Congress. Aluminium and steel are primarily produced in the
swing states of Pennsylvania, Ohio, and West Virginia (Tran, 2003). Washing Machines and
Solar panels are at higher levels of value addition and thus follow Balassa’s thesis (1967)
wherein he argues that tariffs in industrial countries tend to increase with the degree of value
addition present, thereby acting as a disincentive to export of goods at higher levels in the
production process by developing countries. But these explanations don’t hold as good for
Mexico’s retaliatory tariffs. As stated previously, Mexico responded by placing tariffs on U.S.
steel, pork, cheese, whiskey, potatoes, and apples. Steel production in Mexico is largely
concentrated geographically in the northern portion of the country (Kennelly, 1954). Pork too
is concentrated in production with 6 among 31 states controlling nearly 60% of its production
(“Mexico Pork Market”, 2016). Cheese, whiskey, potatoes and apples are all goods where
Mexico is expected to have a comparative advantage and not disadvantage at ("OEC - Mexico
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(MEX) Exports, Imports, and Trade Partners", 2018), despite Ray’s (1981) suggestion that
tariffs are levied on sectors where a country has a comparative disadvantage with respect to the
rest of the world.

This poses a challenge to the conventional literature on the structure of tariffs. Mexico’s
retaliatory tariffs are neither geographically dispersed nor designed to protect industries that
suffer a comparative disadvantage. However, if we ignore the rationale of structure of tariffs
in favour of the rationale for enforcing compliance Mexico’s actions have several precedents.
The North American Free Trade Agreement (NAFTA), signed in 1993 had provisions to open
up the transportation markets, enabling Mexican truckers to transport their loads across both
sides of the border. However, the U.S. government, in 2009, continued to block Mexican
trucks. Eventually Mexico levied retaliatory tariffs, amounting to $2.4 billion a year, on goods
ranging from Florida orange juice to Wisconsin paper, to Oregon Christmas trees and
Washington pears (O’Neil, 2018).

The above example demonstrates that Mexico has previously used retaliatory tariffs as
a tool for compliance. For retaliatory tariffs to work as a tool for compliance, they must
generate sufficient losses to the payoff of the other player to influence them into co-operating.
This paper proposes a normative analysis to suggest two methods by which a country can
reduce the payoff to the other country to force it to withdraw tariffs. It then compares these two
suggested methods with the actual retaliatory tariffs levied by Mexico in 2018. The first method
utilises the framework of a Leontief Input-Output Model. The second method utilises a political
economic method based on key marginal areas or swing states. Both methods produce a list of
proposed sectors/goods upon which retaliatory tariffs should be imposed to reduce the payoff
to the initial tariff levying country. These lists are then compared with the list of goods upon
which tariffs are actually levied using a Jaccard Index.

The rest of this paper is organized as follows: section (ii) provides a brief review of
earlier studies on tariffs and retaliation; section (iii) specifies the data sources and study
methodology; section (iv) is concerned with the outcome of the two frameworks of analysis;
section (v) provides some concluding remarks on retaliatory tariffs and the importance of
targeting them based on our normative analysis.
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II. Review of Literature

The welfare effects of tariffs have been dealt with quite thoroughly by the existing
literature. Tariffs raise prices for consumers and generate deadweight losses, estimated to be
about 40 cents for each dollar of revenue generated by the government through import duties
(Irwin, 2010), however, the levying of “optimal tariffs” or tariffs that maximise welfare of the
tariff levying country, assuming no retaliation, generates a mean welfare gain for the tariff
imposing government of 1.9% and a mean welfare loss for the other governments of -0.7%
(Ossa, 2014). When retaliation does take place, the resultant reduction in volume of trade
makes all countries worse off, resulting in mean welfare losses of -2.9% (ibid).

What hasn’t been dealt with in sufficient detail is how nations choose which sectors or
goods to place tariffs on, also referred to as the structure of tariffs. The literature regarding the
structure of tariffs focuses on the structure of tariffs in the initial tariff levying country. Ray
(1981) finds that tariffs in the United States are primarily levied on goods from industries where
developed countries have a comparative disadvantage with respect to the rest of the world.
Pincus (1975) finds that forces in developed countries tend to behave similarly leading to very
consistent outcomes in tariff structure in other developed countries. Ray & Marvel (1984) find
that tariffs in industrialised nations tend to discriminate systematically against import of
agricultural products, textiles and consumer goods in general. However, Balassa (1967) argues
that tariffs in industrial countries tend to increase with the degree of value addition present,
thereby acting as a disincentive to export of goods at higher levels in the production process
by developing countries.

Another key current in the study of the structure of tariffs is the role played by pressure
groups and key political-economic factors in the determination of tariff structures. Downs
(1957) argues that the primary goal of any government is to secure re-election. Based on this
framework Caves (1976) postulates that the greater the geographical dispersion the greater the
influence of an industry in seeking tariffs in a first-past-the-post voting system. However, the
United States, with its peculiar electoral college system actually finds that total geographical
dispersion doesn’t affect the structure of tariffs, but dispersion in key marginal regions
(commonly referred to as swing states) in the federal elections does impact the structure of
tariffs (Muûls & Petropoulou, 2008). However, this particular system of the electoral college
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only exists in the United States, and all other countries with first-past-the-post electoral systems
like Canada and Mexico are more influenced by general geographical dispersion, rather than
dispersion in key marginal areas. Pincus (1975) illustrates that in the United States Congress,
which is elected through first-past-the-post unlike the President who is elected through the
electoral college, geographical concentration in swing states does not play a significant role,
and that geographical dispersion like in other countries with similar systems increases the
likelihood of receiving tariff protection.

However, if we ignore the literature on trade policy in favour of the literature on

cooperation and compliance, a new paradigm emerges. Oye (1995) argues that the “shadow of
the future” influences behaviour in repeated or iterated games. If players recognise that they
shall repeatedly engage with each other (and trade is an example of an ongoing process where
players continuously engage with each), the losses felt by defecting eventually influence both
players to co-operate rather than defect. Simulations involving actual individuals acting as
players suggests that under iterated Prisoners' Dilemma games the incidence of cooperation
rises significantly (Rapoport & Chammah, 1965).

Downs, Rocke & Barsoom (1995) argue that in the case of tariffs, if one side defects,
the other side must defect as well for at least some specified period of time. The argument in
favour of retaliation is that by retaliating at least for some period, the player reduces the payoff
to the initial tariff levying country or initial defector. This punishment forces the initial player
to cooperate in the future. Based on this framework, the rationale for retaliatory tariffs becomes
less the arguments that Black (1959) favours or the political economic rationale elucidated
above, but to generate losses to the initial defector to force them to co-operate in the future.
Mexico in particular has utilised tariffs to punish defections previously.

Leontief’s Input Output Model (1941) is a useful framework for analysing the
interconnectedness of all industries in a country’s economy. In the Leontief model, the
economy of a country is partitioned into n industrial sectors. The crux of the model is an n x n
technology matrix where each element i, j a is a coefficient that represents the amount of
production from sector i that is consumed to produce one unit of commodity in sector j. Haimes
and Jiang (2001) applied the Leontief input output model to inoperability modelling, which
attempts to quantify and estimate the cascading effect of a reduction in final demand of a good
on the entirety of the economy (Dietzenbacher & Miller, 2015). Leontief models are typically
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used to for risk control analysis, to quantify the losses from certain shocks, like natural disasters
(Khalid & Ali, 2018), terrorism (Santos & Haimes, 2004), and international trade disputes (Wu,
Wang, Yang, et al., 2015).

Of the aforementioned papers the one by Santos & Haimes (2004) is of significance
importance, as the paper introduced the framework to identify the top n economic sectors
perceived to suffer the greatest economic losses. Based on this framework we have constructed
a Trade Tariff Inoperability Input-Output Model (TT-IIM), which measures the impact on the
domestic economy of a tariff being placed on all goods from a country (blanket tariffs). We
follow Santos’s (2003) analysis, where after measuring the reduction in demand caused by the
imposition of tariffs, we measure the inoperability in the American economy, or the normalized
production loss as a direct result of a disruption to an industry within the economy. This
identifies upon which sectors placing retaliatory tariffs causes maximum economic damage to
the initial tariff levying country.

However, placing tariffs on these sectors may not cause sufficiently reduce the payoff
of the initial tariff levying country to enforce compliance. Johnson (1953) found that for a large
country, placing optimal tariffs is advantageous irrespective of whether the smaller country
places retaliatory tariffs or not. The reason is that when a large country places tariffs on the
small country, even if the small country responds with retaliatory tariffs, the retaliatory tariffs
will not influence the terms of trade between the two countries enough to make the initial tariff
levying country worse off but will make the smaller country worse off by reducing the volume
of trade. Hence, a country may not choose to place tariffs on goods where it causes maximum
economic damage to the initial tariff levying country, because by reducing the volume of trade
it causes economic damage to itself. In such a scenario, a country can still retaliate, if it targets
its tariffs to cause a maximum reduction in the initial tariff levying country’s payoff without
drastically reducing its own volume of trade.

Designing a retaliatory tariff structure to target key marginal areas is an example of a

strategy used by U.S. trade partners after being hit with tariffs. In 2002, after the United States
levied tariffs on Steel under the Bush II administration, the EU responded with tariffs on
Harley-Davidson motorcycles, Tropicana orange juice textiles, and steel (Tran, 2003). In the
United States, the key marginal areas are swing states, or states that could reasonably be won
by a candidate of either major political party in any given election (Sabato, Kondik, & Skelley,
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2016). States are typically swing states because the popular vote margin or the difference in
vote shares between the top 2 candidates is extremely miniscule. According to Nate Silver
(2011), the best economic indicator for predicting an election is the manufacturing index (ISM
Manufacturing Index). The ISM Manufacturing Index is based on surveys of more than 300
manufacturing firms by the Institute for Supply Management (ISM). The ISM Manufacturing
Index is a composite index of employment, production, inventories, new orders and supplier
deliveries (Kenton, 2018). Levying tariffs on goods whose production is concentrated in swing
states will reduce demand for manufacturing output of those goods, thereby reducing
employment in those states. Ma & McLaren (2018) confirm the importance of swing states,
estimating that the value of a swing state voter is 30% greater than the vote of a voter outside
a swing states.

In the current study, we propose two methods by which countries can design their
retaliatory tariff structure. The first utilises an Inoperability Leontief Input Output Model to
rank sectors of the American economy most likely to suffer cascading effects from a reduction
in demand associated with Mexico levying import tariffs on their goods. The second compares
industries concentrated in swing states with the goods and services where U.S. and Mexico
have significant trade to propose a list of goods upon which targeting tariffs is most likely to
influence a Presidential candidate’s likelihood of re-election.
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III. Data Sources and Methodology

This paper utilises two frameworks of analyses to propose optimal tariff structures for
a country to design its retaliatory tariffs to reduce the payoff matrix for the initial tariff levying
country such that it withdraws its tariffs and ceases to levy taxes in the future. These two
frameworks are:
i. Trade Tariff Inoperability Input Output Model (TT-IIM) Framework
ii. Swing States Tariff Framework

The Input-Output Model (IO Model) was invented by Wassily Leontief, for which he
was awarded the Nobel Prize in Economics in 1973 ("Winners of the Nobel Prize for
Economics", n.d.). The Input-Output model is essentially a framework which not only depicts
how industries interact with each other but also how to optimize the output to be produced by
industries in an economy in such a way that it satiates the demand of the economy for the said
commodity.

Building on Leontief’s work, Haimes and Jiang constructed an Inoperability IO Model

(IIM) in 2001. Herein, ‘inoperability’ refers to the system’s inability to execute its desired
functions. The system’s inability to function is represented as a percentage of the system’s
desired production level. The IIM attempts to predict the resultant economic losses and
inoperability suffered by all sectors caused by a direct disruption to a particular sector. The IIM
can estimate the economic losses to a particular sector due to external circumstances like trade
wars. This paper applies an Inoperability Input-Output Model to quantify economic losses due
to the reduction in demand caused by a trade partner levying import tariffs.

The basic Leontief IO Model is given as:

x = ax + c {xi = ∑ j aijxj + ci }

x = Total production output of each industry xi: x is an (n x 1) matrix

a = Ratio of the input of industry i to industry j: a is an (n x n) matrix
c = Final demand for the ith industry: c is an (n x n) matrix
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When one country levies tariffs on another country (e.g. Mexico levying tariffs on
goods from the United States) due to increase in final prices for Mexican consumers, demand
for American goods declines, leading to lower production levels in the exporting country (here,
the United States). Consider a reduction in final demand in the American economy by blanket
tariffs affecting all goods imported from the United States, for simplicity, specifically

where, ĉ is the ex-ante final demand vector and c̃ is the “degraded” final demand

vector representing the final demand in the American economy after reducing Mexican
demand on account of higher final prices. From Kee, Nicita, & Olarreaga (2008) we have
taken the weighted average of Mexico’s import elasticity across a bundle of goods as -1.34.
Based on this we have calculated that levying tariffs of 74.6% will reduce U. S. exports to
Mexico to $0. This reduction in final demand triggers a reduction in production, δx, which
we described as

x̂ is the ex-ante production and x̃ is the degraded production levels

The fall in production and consumption vectors are linked to the basic Leontief IO Model in
the following way:
δx = Aδ x + δc
Through this, we arrive at the final Leontief Inoperability IO Model
q = A*q + c*
i. c* is known as the demand-side perturbation vector. It is normalized and
expressed in degraded final demand (i.e., ex ante final demand minus actual final
demand, divided by the ex-ante production level)
ii. A* denotes the interdependency matrix. It indicates the degree of
coupling of the industry sectors. The elements in a particular row of this matrix can
tell how much inoperability is contributed by a column industry to the row industry
iii. q is the inoperability vector expressed in terms of normalized economic
loss. The elements of q represent the ratio of unrealized production (i.e., ex-ante
production minus degraded production) with respect to the ex-ante production level
of the industry sectors.
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Consider the economy of the United States represented as the adversary country to
Mexico using the terms defined above. Let ciMexico represent the demand for sector i by
Mexico from the United States, which we assume is equal to the amount of sector i that is
exported to Mexico. We assume that Mexico demand for sector i cannot be replaced by demand
from another foreign country. Thus, if U. S. exports fell to $0 in sector i, it would degrade final
demand according to:

c̃i– c̃i = ci Mexico

The vector c* is “the demand-based perturbation vector expressed in terms of the normalized
degraded final demand” (Santos, 2003). For sector i, we have:

ci* = (c̃i– c̃i) / x̃i

This indicates that ci* is the difference between ex-ante final demand and degraded final
demand, normalized by ex-ante production.

Now, we must derive the Leontief technical coefficient matrix A. We generate the
Leontief technical coefficient matrix by collecting data from the OECD database of Input-
Output tables, particularly the table entitled, “LEONTFT: Leontief Inverse Matrix (total)” for
the United States in the year 2009. We denote this table Q^-1 and we derive A according to:

(Q-1) -1 = Q
Q = I-A
A = -Q+I

The vector q is the “demand-based inoperability vector expressed in terms of normalized

production loss” (Santos, 2003). For sector i, we have:

qi = (x̃i –x̃i) / x̃i

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Our objective function for the Trade Tariff Leontief Inoperability Input-Output Model
is to maximise the economic loss suffered by the American economy on account of a reduction
in final demand for a particular sector of the economy, which has cascading effects on other
sectors of the economy due to interlinkages. The loss suffered by the American economy is
given by:

δxi = q* x̃i

The model overestimates the damage caused to the American economy on account of
Mexico levying import tariffs, since it assumes Mexico increases the weighted average of its
tariffs to a level which reduces U. S. exports to $0, which is unlikely to take place in real life,
considering the country with the highest weighted mean tariffs is Bermuda, with a weighted
mean tariff of 18.7% ("Tariff rate, applied, weighted mean, all products (%) | Data", n.d.),
significantly lower than the 74.6% we have assumed here, however, we are merely using this
framework to rank the sectors of the economy according to the economic loss sustained. To
rank the sectors, we take each δxi and divide by SUMMATION δxi.

This allows us to rank sectors of the American economy where the most inoperability
takes place on account of the placement of tariffs. However, by placing tariffs, the Mexican
economy suffers from inoperability as well, since it is suddenly reducing U. S. exports to $0.
We therefore compute another Trade Tariff Inoperability Input Output Model, measuring the
damages to sectors of the Mexican economy on account of Mexico levying tariffs on the
American economy. This matrix acts as a proxy for the impact on Mexico of raising prices and
thereby reducing the quantity of the good upon which the tariff has been levied is available.
Central to this thesis, is the idea that in the short run, imported goods are not substitutable, and
by increasing their prices, in the short run at least, the total supply of these goods declines in
the economy. We then rank the sectors of the Mexican economy that are impacted by the
levying of tariffs. We now combine the outputs of both models by taking δxiUSA – δxiMexico,
which measures the difference between the loss to the American economy versus the loss to
the Mexican economy. By ranking these, we can find which sectors cause the maximum
damage to the American economy while causing the minimum damage to the Mexican
economy. This provides us a list of sectors upon which Mexico can cause maximum economic
damage to the United States, and thereby reduce the payoff for defecting, without significantly
reducing its own payoff.
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This study is quantitative in nature. The data was acquired from the OECD STAN
Database which contains the Leontief inverse matrices of both the United States and Mexico.
It also contains the gross output at current prices matrix taken at the year of 2009 for both the
United States and Mexico. The 2009 Input-Output Table was taken. The software utilised to
conduct our analysis was Excel. The sectors chosen for the evaluation were as follows:

Table 1: Sectors Chosen for Analysis

TTL_01T03: Agriculture, forestry and fishing

TTL_07T08: Mining and quarrying of non-energy producing products

TTL_10T12: Food products, beverages and tobacco
TTL_16: Wood and of products of wood and cork (except furniture)

TTL_20T21: Chemicals and pharmaceutical products

TTL_23: Other non-metallic mineral products
TTL_24: Manufacture of basic metals
TTL_25: Fabricated metal products, except machinery and equipment
TTL_26: Computer, electronic and optical products
TTL_27: Electrical equipment
TTL_29: Motor vehicles, trailers and semi-trailers

The second part of our analysis deals with tariff structures designed to affect goods
imported from marginal areas or swing states. To identify a list of industries to apply tariffs on
based on the marginality of the constituencies, we first rank the electoral constituencies on the
basis of the marginality. In the 2016 U. S. Presidential Elections the ten most marginal states
based on popular vote margins were Michigan, New Hampshire, Pennsylvania, Wisconsin,
Florida, Minnesota, Nevada, Maine, North Carolina, and Colorado ("Presidential Election
Results: Donald J. Trump Wins", 2016). This list is contrasted with the list of top export
categories. The top export categories in 2017 were: machinery, electrical machinery, mineral
fuels, vehicles, and plastics, and the top exports of agricultural products to Mexico in 2017
were corn, soybeans, pork & pork products, dairy products, and beef & beef products. This list
of top export categories is classified on the basis of in which states does a majority of
production take place. The commonalities in the two list are those goods which are both
 16

produced in swing states and among the top export categories of the United States to Mexico.
Placing tariffs on these goods will generate political pressure in the initial tariff levying country
to withdraw the tariffs and return to status quo ante.

From this list of top exported goods from the United States to Mexico, we identify the
top 3 states responsible for their production in the United States. Utilising a system of weights
we assign a score to each good. The first weight is based on the popular vote margin. The state
with the lowest popular vote margin out of the top 10 gets a score of 10, whereas the state with
the highest popular vote margin out of the top 10 gets a score of 1. States with a popular vote
margin greater than 10 get a weight of zero. This weight is multiplied with another weight
based on the amount of production in the state. If the state has the highest amount of production,
it receives a score of 3, the state with the next highest amount of production has a score of 2,
and the third state has a score of 1. By summing up the scores for each industry, we can identify
upon which goods should tariffs be levied on to generate the greatest political impact on the
United States, based on the extent of trade relations with Mexico, and the concentration of trade
within swing states. This study is also quantitative in nature. The data was acquired from a
post-election study by the New York Times, and other sources in the popular literature.

With two lists generated, one from the Trade Tariff Inoperability Input-Output Model
Framework and the other from the Swing States Tariff Framework, we compare these lists with
the actual list of goods upon which Mexico has levied tariffs. To do so, we utilise a Jaccard
index. The Jaccard index, also known as the Jaccard similarity coefficient, is a statistic used
for comparing the similarity of sample sets. The Jaccard index is given by the formula:

J(X, Y) = |X∩Y| / |X∪Y|

The outcome of the Jaccard index is a number in between 0 and 1 which indicates how
similar the two sets are.
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IV. Analysis and Discussion

The purpose of the Trade Tariff Inoperability Input-Output Model is to determine if

Mexico were to place retaliatory tariffs on the United States, placing tariffs on which sectors
would generate the maximum production loss in the American economy.
The columns in the table denote the following:
 US_exp is the sectoral distribution of exports from the United States to Mexico in 2009.
 (xi) (in thousand $) is the sectoral distribution of total output in the United States
economy in $thousands.
 c* is the percentage reduction in demand for each sector due to tariffs levied by Mexico
 q* denotes the inoperability or the normalized percentage of production not realized in
each sector.
 Δxi (in thousand $) represents the sectoral distribution of production losses in
$thousands.
 δxi/Σ δxi represents the percentage reduction in production to the entire United States
economy that can be attributed to the sector upon which a tariff was levied.

Table 2: TT-ITM United States

According to the results of the analysis, the maximum disruption within the US
economy can be caused by targeting the sector “TTL_27: Electrical Equipment”. The next best
sector to target is sector “TTL_20T21: Chemical and pharmaceutical products”, followed by
“TTL_29: Motor vehicles, trailers and semi-trailers”. The column header, δxi/Σ δxi, can be
interpreted as the interconnectedness ratio. When this percentage is smaller, it means that the
 18

respective industry is more interconnected with the economy as a whole. While a larger
percentage will imply that a demand-based perturbation will be more contained.

The ratio ranges from 0.3888% to 22.032%. For sector 27, the interconnectedness ratio,
δxi/Σ δxi, is 22.032%. This percentage denotes that 22.032% of the production loss is a result
of the industry that was sanctioned. However, the complement, 77.968% is the ratio of
production loss to all other sectors of the economy capturing the cascading effects.

However, directly utilising the output of this model is dangerous. In the short run, we
assume that there is no substitutability in the demand for American output, and thus Mexico
cannot substitute its demand for United States products with demand for products from the rest
of the world. Thus, imposing tariffs on these sectors can generate sufficient economic loss to
Mexico, that it can harm Mexico more than it harms the United States. We therefore conduct
an Inoperability Input-Output Analysis on Mexico to estimate the production losses in the same
11 sectors on account of United States exports to Mexico falling to $0.

Table 3: TT-ITM Mexico

The columns in the table denote the following:

 US_exp is the sectoral distribution of exports from the United States to Mexico in 2009.
 (xi) (in thousand $) is the sectoral distribution of total output in the Mexican economy
in $thousands.
 c* is the percentage reduction in demand for each sector due to tariffs levied by Mexico
 q* denotes the inoperability or the normalized percentage of production not realized in
each sector.
 δxi (in thousand $) represents the sectoral distribution of production losses in
$thousands.
 19

 δxi/Σδxi represents the percentage reduction in production to the entire Mexican

economy that can be attributed to the sector upon which a tariff was levied.

After the loss for each sector in both the countries is computed, the difference between
the projected losses needs to be calculated to see where the difference between American loss
and Mexican loss is maximised.

Table 4: TT ITM United States-Mexico

From the above table, we can see that it would be ideal for Mexico to levy tariffs on the
following sectors;

 TTL_16: Wood and of products of wood and cork (except furniture)

 TTL_20T21: Chemicals and pharmaceutical products
 TTL_25: Fabricated metal products, except machinery and equipment
 TTL_29: Motor vehicles, trailers and semi-trailers

From our political economic analysis, we identify our swing states from the following table
based on data from the New York Times. The following table depicts the top 10 most marginal
states in the 2016 United States Presidential elections. Accompanying each state is the absolute
value of the popular vote margin, or the difference in vote shares between the top 2 Presidential
candidates in the State.
 20

Table 5: Top 10 Swing States in the US Presidential Election 2016

State Popular Vote Margin

Michigan 0.23%
New Hampshire 0.37%
Pennsylvania 0.72%
Wisconsin 0.77%
Florida 1.20%
Minnesota 1.52%
Nevada 2.42%
Maine 2.96%
North Carolina 3.66%
Colorado 4.91%

We now generate a table, depicting the most exported goods from the United States to Mexico
in 2017. Accompanying each good are the top 3 American states in which the good is most
produced. Based on the scores we can measure the relative effect of Mexico levying a tariff on
that particular industry. An example of calculation of the score:

Table 6: Commodities Produced by Swing States and Their Effective Sector

Commodity Primary Producing State Score

Machinery Michigan, 49
Wisconsin, Minnesota,
Mineral Fuels Texas, Pennsylvania, Ohio, 16
Vehicles Missouri, Michigan, Alabama 20
Plastics California, Illinois, Wisconsin 7
Corn Minnesota, Wisconsin, Texas 29
Soybeans Minnesota, Wisconsin, Texas, 29
Pork and pork products Iowa, Illinois, Minnesota 5
Dairy products Wisconsin, Michigan, 35
Pennsylvania
Beef and beef products Texas, Nebraska, Kansas 0

Machinery: Michigan gets a weight of 10 since it has the lowest popular vote margin and is the
state where the most production takes place so a weight of 3. Wisconsin gets a weight of 7 for
popular vote, and a weight of 2 since slightly less production takes place there than in
Michigan. And Minnesota gets a weight of 5 for popular vote and 1 for production. So
Machinery’s final score is 10*3 + 7*2 + 5*1 = 49.

According to this framework, the top states for Mexico to levy tariffs on to generate
political pressure on the United States to withdraw tariffs and return to status quo ante are:

 Machinery
 Dairy Products
 Corn
 Soybeans
 21

We therefore now have two lists of proposed sectors and goods to apply tariffs on. We
shall now utilise the Jaccard index to measure their similarity with the actual goods upon which
tariffs have been levied. The Jaccard index is given by the formula:

J (X, Y) = |X∩Y| / |X∪Y|

The set proposed by the TT-IIM are:

{Wood and of products of wood and cork (except furniture), Chemicals and pharmaceutical
products, Fabricated metal products (except machinery and equipment), Motor vehicles,
trailers and semi-trailers}.

The set proposed by the Swing States Model are:

{Machinery, Dairy Products, Corn, Soybeans}

The actual set upon which tariffs have been placed are:

{Steel, Pork, Cheese, Whiskey, Potatoes, Apples}

The Jaccard index score for TT-IIM and Actual tariffs is (since Steel is a component of
Fabricated metal products):

|X∩Y| = Fabricated Metal products

|X∪Y| = Wood and of products of wood and cork (except furniture), Chemicals and
pharmaceutical products, Fabricated metal products (except machinery and equipment), Motor
vehicles, trailers and semi-trailers, Pork, Cheese, Whiskey, Potatoes, Apples.

The Jaccard index score for Swing State Model and Actual tariffs is (since Steel is a component
of Machinery, and Cheese is a component of Dairy products):

|X∩Y| = Steel, Cheese,

|X∪Y| = Machinery, Dairy products, Corn, Soybeans, Pork, Whiskey, Potatoes, Apples.

Table 7: Similarity to Actual Tariffs of Proposed Tariffs with respect to the Two Models

Method of Analysis Jaccard Index Score

TT-ITM 11.11%
Swing State Model 22.22%

From this analysis, we can see that the suggestions from our Trade Tariff Input-Output
Model share 11.11% similarity with the actual retaliatory tariffs Mexico has placed on the
United States of America. We can also see that the suggestions from our Swing State Model
share 22.22% similarity with the actual retaliatory tariffs Mexico has placed on the United
States of America.
 22

V. Conclusion
This paper introduces two frameworks to generate lists of goods and sectors upon which tariffs
can be placed. This paper synthesizes two very different types of literature, trade policy and
co-operation and compliance to suggest tariff structures for nations to retaliate. The analyses
performed here add to existing literature by explaining how countries can consider political
factors like swing states and utilise our model to maximise the economic loss of the initial tariff
levying country to engender pressure in favour of compliance and punish defection by the
initial tariff levying country.

Although a small country will find it difficult to retaliate in a trade war, since any resultant
reduction in the volume of trade typically hurts it more than the defecting trade partner, these
analyses provide countries with frameworks to generate larger repercussions for the initial
country and reduce its payoff matrix for defecting. Thus, although both countries incur losses
when they indulge in trade wars these frameworks act as normative assessments of what a
country should do to retaliate. Despite the fact that both models seem to share extremely low
similarities with the actual tariff list Mexico has chosen to levy tariffs on, we believe this is not
a negative sign, but a positive one. Countries in the future, when targeted in trade wars can
structure their tariffs based on these models and thereby protect their interests from that of
larger or hegemonic powers.
 23

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