The Balloon Effect: How Tariffs Create More Problems Than They Solve

Last week, Ontario Premier Doug Ford launched a $75 million ad campaign featuring Ronald Reagan’s own words warning against tariffs. The ad has aired during major sporting events, quoted Reagan from his 1987 radio address: “High tariffs inevitably lead to retaliation by foreign countries and the triggering of fierce trade wars.”

The reaction was swift and predictable. President Trump called it “fraudulent” and threatened to terminate trade talks with Canada, eventually slapping an additional 10% tariff on Canadian goods. The Ronald Reagan Foundation complained that the ad misrepresented Reagan’s views, pointing out that he did in fact impose some tariffs during his presidency.

And you know what? They’re both right. Which is exactly why this whole episode is such a perfect teaching moment about unintended consequences.

The Reagan Reality Check

Reagan did impose tariffs, sort of. In 1987, he placed duties on Japanese semiconductors after clear violations of an antidumping agreement. In 1983, he imposed tariffs on motorcycles as part of a global safeguard action. But the big one, the one that gets cited as proof that “even Reagan used tariffs to protect American industry,” wasn’t actually a tariff at all.

In 1981, the Reagan administration negotiated what’s called a Voluntary Export Restraint (VER) with Japan on automobiles. Japanese automakers “voluntarily” agreed to limit their exports to 1.68 million cars per year (later raised to 1.85 million in 1984 and 2.3 million in 1985). It functioned like a tariff in that it restricted supply and raised prices, but it was technically voluntary. You know, the kind of voluntary where someone holds a gun to your head and you “voluntarily” hand over your wallet.

The VER was supposed to give Detroit’s Big Three breathing room to retool and become competitive again. It did create that breathing room. The question is: what did they do with it?

Press Here, Bulge There

Here’s where it gets interesting, and where we see what I call the balloon effect in action. When you press down on a balloon in one spot, it bulges out somewhere else. The VER was designed to reduce Japanese car imports and help American automakers. Mission accomplished on the first part. But watch what happened everywhere else.

First, the price of Japanese cars in America jumped by about $1,200 per vehicle (in 1983 dollars) during the peak years of 1986-1990. That’s a 14% increase. American consumers paid an estimated $8.9 billion extra for cars during the first four years of the VER alone. That works out to about $334,000 per job “saved” in the U.S. auto industry. Not exactly a bargain.

But here’s the kicker: faced with limited competition, American automakers did what any protected industry would do. They raised their prices too, about 1% across the board. More importantly, they got comfortable. That price umbrella from reduced competition meant they could keep churning out lower-quality vehicles without the normal market pressure to improve. While Japanese manufacturers were relentlessly pursuing quality improvements, Detroit was cashing checks and patting themselves on the back.

The protection that was supposed to force improvement actually delayed it. Between 1980 and 1990, the quality gap between Japanese and American cars didn’t shrink. It grew. Japanese cars still required fewer repairs, and the gap in reliability actually widened. Economic theory tells us that competition drives innovation; protection from competition does the opposite.

The Ripples Keep Going

But wait, there’s more. The VER included a provision that cars built in the U.S. were exempt from the export limits. This created a clear incentive for Japanese automakers to build factories in the United States. Honda had already announced plans for its Marysville, Ohio plant in 1980 and it opened in 1982. By 1990, every major Japanese automaker had followed: Nissan, Toyota, Mazda, Mitsubishi, Isuzu, and Subaru all built U.S. manufacturing facilities.

On the surface, this sounds like a win. American jobs, right? And the administration could claim that the VER encouraged foreign investment. But these “transplant” factories brought with them Japanese management practices, Japanese supplier networks, and eventually, even more competition for Detroit, this time from inside the United States itself. The domestic automakers had been protected from import competition only to find themselves competing with world-class manufacturers in their own backyard, manufacturers who were hiring American workers and teaching them better ways to build cars. Definitely a win overall, but not for the industry it was designed to protect.

Meanwhile, Japanese automakers were also expanding production in other regions not covered by the VER. They built up supplier networks and manufacturing capabilities globally, which eventually allowed them to outmaneuver U.S. automakers on the world stage. Detroit’s “protection” at home left them even more vulnerable abroad.

And here’s one more twist: with Japanese cars artificially constrained, who rushed in to fill the gap? South Korean manufacturers like Hyundai and Kia. Hyundai entered the U.S. market in 1986, right in the middle of the VER, with the Excel, selling it for under $5,000 and capturing the entry-level market that American manufacturers had abandoned. Kia began shipping cars through Ford in 1987. The VER didn’t reduce import competition; it just changed which countries we were importing from.

Why Does This Keep Happening?

The fundamental problem is that tariffs are blunt instruments being applied to complex, interconnected systems. Modern supply chains don’t respect borders. A car assembled in America might contain parts from Mexico, electronics from China, steel from Canada, and design work from Germany. When you slap a tariff on imports, you’re not just affecting the final product. You’re affecting every link in that chain.

Companies like Cummins, which imports parts from its own factories in China for use in American plants, now face tariffs on their own components. When the U.S. imposed tariffs on China, China retaliated with tariffs on American agricultural products, hurting farmers who had nothing to do with the original trade dispute. The interconnections mean that actions taken to protect one industry inevitably harm others.

This is what the WTO Chief Economist Ralph Ossa means when he says that “tariffs are a policy lever with wide-ranging, and often unintended consequences.” Trade policy uncertainty alone has a dampening effect on economic activity, even before the tariffs themselves kick in. Companies delay investments. They can’t plan. They can’t optimize their supply chains when they don’t know what the rules will be next month.

The Real Cost

I’m not saying there’s never a legitimate case for trade intervention. Let’s be honest: countries like China really do take advantage of the system. When your manufacturing costs are lower because you don’t have to worry about environmental regulations, worker safety standards, or labor benefits that other developed countries require, that’s not exactly fair competition. It’s an unlevel playing field, and it does need to be addressed.

The problem is that tariffs are the blunt hammer when we need a scalpel. Reagan’s 1987 semiconductor tariff on Japan was relatively targeted. It was a response to clear violations of an existing agreement, it was specific to one industry, and it was designed to be temporary. Even then, it came with all the caveats and concerns he laid out in that radio address.

What we really need are specific, negotiated agreements that address the root causes. If China is dumping steel by subsidizing production, the answer isn’t to slap tariffs on everything from semiconductors to sneakers. It’s to negotiate enforceable agreements about subsidies. If environmental standards are giving some countries an unfair advantage, we should be working through international bodies to establish baseline standards, not launching trade wars.

But broad, sustained protection, the kind we keep reaching for, rarely delivers what it promises. It costs consumers more. It delays the improvements that competition would force. It spawns new competitors we didn’t anticipate. It invites retaliation that hurts completely different industries. And most insidiously, it gives the protected industries a false sense of security that prevents them from making the hard changes they actually need to make.

The Reagan ad was right: high tariffs do lead to retaliation and trade wars. The Reagan Foundation was right too: Reagan did impose some tariffs. But the real lesson from Reagan’s experience with the auto VER is neither of those things. The real lesson is that when you try to solve complex problems with simple solutions, when you press down on the balloon, you’d better be prepared for where it’s going to bulge out next.

And you’d better be pretty sure that where it bulges isn’t going to be worse than your original problem.