Tariffs Beyond Headlines: Part II: Innovation, Institutions, and Influence

In Part I, we examined how tariffs distort the economy's underlying machinery by disrupting capital flows, weakening the dollar, and undermining financial stability. But the effects don’t stop there.

Tariffs don’t just raise prices — they quietly corrode the systems that allow economies to thrive. They distort incentives, shrink global relationships, and dull the competitive edge that drives innovation, trust, and long-term prosperity.

American Cultural and Soft Power

Trade has always been more than commerce. It’s how America told its story to the world.

For decades, U.S. exports weren’t just physical goods — they were carriers of identity. When people across the globe bought American jeans, studied at American universities, watched American movies, or used American software, they weren’t just engaging in economic activity. They were participating in a broader idea: that the United States stood for openness, innovation, individual liberty, and possibility. Trade didn’t just enrich America — it reinforced its role as a cultural and ideological model.

Tariffs don’t just restrict imports, they send a signal: that access to America is provisional, that engagement is transactional, that trust is conditional. And that signal travels fast. It reaches future leaders choosing where to study, companies deciding where to invest, and consumers deciding which story to believe. When America pulls back, it doesn’t just lose market share. It loses narrative ground. And into that vacuum step nations with radically different values.

This shift is already underway. TikTok, not Netflix, is shaping global youth culture. China’s Belt and Road comes with universities, media packages, and digital standards. Huawei builds the telecom backbone in dozens of countries. And students in Africa are choosing Chinese scholarships over American ones.

This isn’t just a branding problem. The global demand for American cultural and technological products is tied to trust: trust in access, in institutional consistency, and in the long-term reliability of U.S. participation in global networks. If international markets begin to view the U.S. as erratic they will gradually pivot toward substitutes — regional platforms, domestic industries, and alternative standards. 

In the early 20th century, British global influence declined not merely because of reduced output, but because it surrendered its role as the organizing center of global commerce. As trade flows shifted elsewhere, so did cultural and diplomatic gravity. The same risk now looms over the United States.

This erosion is not just symbolic — it is commercially consequential. U.S. multinationals derive meaningful economic value from their association with American credibility. Luxury brands, media conglomerates, universities, and tech firms depend on the perception of U.S. excellence. If that perception erodes, so does the premium they command in markets.

Soft power is slow to build and fast to fade. Tariffs may appear narrowly targeted — designed to reshore production or address geopolitical asymmetries. But in practice, they broadcast a broader orientation: one of retrenchment, not leadership. In a deeply interconnected world, retreating in one area rarely stays isolated. It spills across sectors, relationships, and narratives — reshaping how the world relates to, and values, the American idea.

The Drift Toward Conflict

For centuries, trade has served not only as a vehicle for goods but as a stabilizing force in geopolitics. Economic interdependence raises the cost of conflict and lowers the threshold for cooperation. Markets do not eliminate rivalries, but they dull their edges. Unlike ideology, commerce thrives on predictability. Profit requires stability. Supply chains don’t thrive under shelling.

This insight aligns with an important principle: voluntary exchange is the foundation of peaceful coordination. When individuals and firms engage across borders, they weave networks of mutual interest that reduce the incentive for force. As Frédéric Bastiat observed: 

“When goods do not cross borders, soldiers will.”

Under the banner of “strategic decoupling,” the global trading system is being reengineered to reduce reliance on adversarial powers, chiefly China. While framed as a national security imperative, the broader effect is to unwind decades of integration. Tariffs are the opening salvo. Next, a more significant shift follows: a re-fragmentation of the world into rival blocs, each increasingly defined by alignment rather than efficiency.

The danger is that economic decoupling becomes a precursor to diplomatic isolation and strategic rivalry. When trade recedes, so do the mechanisms that sustain regular communication and shared interest. Nations begin to view one another not as interdependent stakeholders, but as adversaries in a zero-sum contest. Competition over supply chains morphs into competition over access to critical resources — rare earths, semiconductors, and maritime routes. And competition, unlike cooperation, can quickly turn violent. 

Trust between nations, like between people, is easier to lose than to rebuild. 

This is the logical endpoint of abandoning spontaneous order. Global trade did not emerge from central planning; it arose from billions of decentralized decisions, guided by incentives and information. Tariffs short-circuit that process. They impose artificial barriers, forcing firms and ultimately nations to pick sides. 

The 1930s offer a sobering parallel. Following the passage of the Smoot-Hawley Tariff Act, global trade contracted sharply — world exports fell by more than 30% between 1929 and 1932. Retaliatory tariffs followed. Nations turned inward. Economic misery deepened, and nationalist sentiment hardened. Within a decade, the world was at war. While no single policy caused the conflict, the collapse of economic cooperation removed one of the key stabilizers that had previously helped temper escalation.

Today, the stakes are even higher. Supply chains are vastly more complex. Nuclear proliferation introduces a layer of instability that no trade agreement can offset. And major powers now possess asymmetric capabilities in finance, cyber operations, and information warfare. In this environment, decoupling is not a return to a simpler world — it’s an invitation to strategic miscalculation.

Tariffs do not launch missiles. But they weaken the scaffolding of peace. 

Cronyism

One of the most underappreciated consequences of tariffs is political. When the state takes on the role of managing trade flows — determining which imports are “too cheap,” which industries merit protection, and which countries are designated as strategic rivals — it ceases to act as a neutral referee. It becomes an allocator of privilege. What begins as a policy tool evolves into a political economy of advantage.

In theory, tariffs are designed to serve national interests. In practice, they serve narrow ones — those with the lobbying power, legal expertise, or media influence to navigate Washington D.C..

In the early 20th century, U.S. tariff policy was notoriously captured by special interests — from textile lobbies in New England to steel magnates in Pennsylvania. The Smoot-Hawley Tariff Act of 1930 was a case in point: over 1,000 lobbyists descended on Congress, and the bill ultimately included more than 20,000 individual tariff provisions — many added or adjusted under pressure from constituent industries rather than any coherent economic rationale.

Government intervention in markets creates what economists call rent-seeking opportunities — situations where firms pursue economic advantage through regulation rather than innovation. Each distortion begets new inefficiencies, which then require further adjustment. The system becomes recursive. Policy replaces price as the coordinating mechanism.

Tariffs, once enacted, rarely remain fixed. They become contested. Industry groups lobby for inclusion. Competitors push for exemptions. Foreign governments negotiate carve-outs through trade diplomacy. The policymaking process becomes opaque. Economic fundamentals take a back seat to political leverage.

As firms reallocate capital toward legal strategy, government relations, and compliance infrastructure, entrepreneurial dynamism suffers. Startups lacking political capital face higher barriers to entry. Incumbents entrench their advantage — not through superior products, but through superior access. The system rewards those who play it, not those who challenge it.

Over time, this undermines public trust. Citizens begin to see markets not as arenas of fair competition, but as extensions of political favoritism. When citizens begin to believe that economic success is tied to political access, the foundations of democratic legitimacy start to crack. Markets lose not only efficiency but also authority.

Tariffs are often defended as measures to support “the little guy.” But in reality, they often empower the most connected players — the ones best equipped to shape policy in their favor. The outcome isn’t economic renewal. It’s decline.

Capital Misallocation

In a free, well-functioning economy, capital flows toward its most productive uses, not through central planning, but through the decentralized price signals and market feedback. Firms that create value attract investment. Those that fail to do so release capital and labor to more efficient enterprises. This dynamic process — often uneven and painful — drives innovation, rising living standards, and long-term economic growth.

Tariffs disrupt this process by distorting relative price signals. When imports are made artificially expensive, domestic producers with higher cost structures appear more competitive than they truly are. The illusion of viability draws financial, human, and technological capital into protected sectors, even when those sectors are no longer globally efficient. The market begins to reward insulation rather than innovation.

At first, the distortions are subtle. A struggling steel plant restarts production. A textile mill rehires a few hundred workers. Policymakers declare success. But beneath the surface, the economy begins to shift. Resources that could have fueled emerging industries — advanced manufacturing, energy innovation, and software are instead absorbed by legacy businesses whose models depend on political protection, not market demand.

This is not a marginal problem. Prices are not just transactional — they are informational. They coordinate decisions across space and time. When government policy interferes with prices, it severs that communication channel. Capital is misallocated. Production deviates from consumption. And surpluses and shortages emerge.

The result is a secular decline in productivity. Protected firms rarely face the same evolutionary pressure as those exposed to global competition. Without that pressure, adaptation slows. Innovation stalls. In many cases, protected firms actively resist change, using political influence to entrench outdated models rather than invest in reform. The aggregate consequence is slower output growth, diminished dynamism, and a declining capacity for economic renewal.

The danger is compounded when tariffs are layered atop other interventionist policies. If capital is shielded from discipline by tariffs, subsidized through politicized industrial policy, and sustained by artificially low interest rates, the economy becomes less a system of discovery and more a scaffold of state-supported inefficiency. The longer the structure stands, the harder it becomes to dismantle.

The irony is that the sectors most likely to receive protection are often the ones most in need of disruption. Rather than allowing markets to allocate capital and signal when adaptation is necessary, tariffs delay the reckoning. They preserve weakness and, in doing so, weaken the entire system.

Black Markets and the Gray Economy

When formal channels are blocked or distorted, informal ones emerge. High tariffs make smuggling more attractive. If importing a good legally involves a 25% duty, the incentive to evade customs increases proportionally. This creates an opening for black-market operators to bypass official channels. 

In the aftermath of the Smoot-Hawley Tariff Act, illicit trade surged in Canadian and Mexican border towns as U.S. consumers sought cheaper alternatives across the border. In developing economies today, sprawling gray markets — from electronics in Southeast Asia to agricultural goods in Africa — flourish under rigid tariff regimes. Even in the modern United States, complex and inconsistent tariff classifications encourage strategic mislabeling, third-country transshipment, and other forms of regulatory arbitrage.

These behaviors may seem marginal, but they have consequences. First, they undermine the rule of law. When significant portions of commerce operate outside formal systems, enforcement becomes selective, and institutional legitimacy erodes. Second, they penalize compliance. Firms that play by the rules face higher costs than those that exploit loopholes. The market begins to reward evasion over efficiency. Third, they invite corruption. When trade policy is opaque and enforcement discretionary, customs becomes a leverage point — open to bribery, favoritism, and abuse.

This is the inevitable result of treating economies as mechanical systems rather than emergent orders. Tariffs impose rigid constraints on a fluid system. In response, actors adapt  rationally, but often destructively. The more rigid and complex the regulatory regime, the more ingenuity is directed toward gaming the system rather than creating value within it.

Worse, once established, gray markets are difficult to unwind. They develop their own supply chains, enforcement structures, and distribution networks. What begins as tax avoidance can evolve into a robust shadow economy with real political and economic influence. In weak institutional environments, this dynamic can become self-reinforcing. But even advanced economies are not immune. Once legitimacy is lost, rebuilding it is far more difficult than preserving it.

Teaser for Part III

The economic distortions are more measurable, but the political consequences cut deeper. In Part III, we’ll examine how tariffs rewire politics: deepening inequality, fracturing national unity, and fueling the illusion that prosperity can be engineered from the top down.