Trump’s tariff threat: An economic gamble with global stakes

Although economists can have significantly different opinions on various issues, it's not difficult to find a relatively long list of topics on which they mostly agree. This is the case with international trade. The vast majority of them believe that free trade is beneficial to the welfare of all countries involved. In other words, protectionism, including raising tariffs, is considered harmful—though permissible when protecting specific markets, fledgling industries, or national security.

Studies among members of the American Economic Association (AEA) indicate that about 90 percent oppose tariffs and non-tariff trade barriers. When the questions are more precise, even more remarkable unanimity prevails. In a 2012 panel of economists organized by the University of Chicago, 98 percent agreed that NAFTA (North American Free Trade Agreement) benefits Americans.

Four years later, 100 percent of respondents agreed that raising tariffs on importing certain goods to the USA to increase local production is a misguided idea. Similarly, in 2018, widespread opposition was to the concept (implemented) of raising tariffs on aluminum and steel imports to the USA.

These economists' views are reflected in trade liberalization, which has been progressing systematically for the past century. Another consequence of economists' conviction about the advantages of free trade is widespread criticism in this profession of U.S. President Donald Trump for his fondness for tariffs. Even during the campaign before his victory in the November 2024 elections, Trump said that "tariff" is the most beautiful word in the dictionary. At another time, he opined that "tariffs are the greatest invention of mankind." Less than a month had passed in his presidency when these preferences of the U.S. President were reflected in his decisions.

Over the weekend, the occupant of the White House signed an order introducing a 25-percent tariff on all goods from Canada (except oil and gas, which were subjected to a lower, 10-percent rate) and Mexico, as well as an additional 10-percent tariff on imports from China. Even the "Wall Street Journal," which usually sympathizes with Republicans, wrote that this is the "dumbest trade war in history." Undeterred by criticism, Trump announced that he would impose higher tariffs on the European Union. But by Monday, it turned out that the blow aimed at Canada and Mexico was postponed by a month.

The majority of economists oppose protectionism. They believe in the beneficial effects of competition. The stronger the competition in a given goods and services market, the better the quality and lower the prices. Eliminating trade barriers significantly expands the field of competition.

Secondly, international trade creates an environment for specialization, which brings with it economies of scale. Again, specialized international companies can provide products and services more cheaply than small and unspecialized entities. Since trade allows for lower prices without reducing the quality of the goods and services it involves, it also increases consumption (according to the rule that lower prices accompany higher demand). For economists, broadly understood consumption is an equivalent of material prosperity.

By imposing tariffs on imports, Trump not only hits America's trading partners but also impoverishes Americans themselves. He forces them to consume more expensive imported products or their domestic alternatives, if available, or to limit their consumption.

How strong are these effects? For example, analysts from Oxford Economics estimate that even if the tariffs on goods from Canada and Mexico applied only for part of 2025, the growth rate of U.S. GDP would be 0.7 percentage points lower for the year than in the previously assumed scenario.

This would result from weaker consumer demand growth and higher interest rates. Since tariffs would increase prices, the Federal Reserve would refrain from the previously forecasted further interest rate cuts and only resume them once prices stabilized.

These adverse effects in the U.S. will occur regardless of how countries targeted by the American tariffs react. Economists are most concerned about the vision of retaliatory actions. History teaches that such a spiral of protectionism is hard to halt, and a global trade war impoverishes all its participants in several ways.

Everyone exports less due to higher prices in sales markets, but this effect is compounded by an economic slowdown or even a recession. Additionally, in light of weaker sales prospects, investments collapse. In addition to the decline in both domestic and foreign consumer demand, countries involved in the trade war also experience a drop in investment demand.

A textbook illustration of these processes is the trade war that began in the 1930s, exacerbating the Great Depression. Its symbol is the Smoot-Hawley Tariff Act of June 1930, which President Herbert Hoover signed despite massive opposition from economists.

Its effect increased the average rate of imported goods from 40 to 48 percent. Because the law came into effect during deflation, and the tariffs were generally fixed in amount, by 1932, the average tariff reached nearly 60 percent. It was only once higher than this in the history of the USA.

A dozen or so countries with which the USA maintained close trade relations introduced retaliatory measures. This, along with the global recession, caused the value of world trade to fall by about two-thirds over the four years the Smoot-Hawley Act was in force. Some historians believe that the trade war intensified nationalist sentiments, contributing to the outbreak of World War II. This history is especially alarming when considering that if new tariffs on imports from China, Mexico, and Canada come into effect, the average tariff rate in the USA will be the highest since the 1940s.

Why, despite this lesson, does the Trump administration threaten tariff increases? One answer is that it's just a negotiation strategy. Donald Trump doesn't want to strike against America's trading partners but wants certain concessions from them. Confirmation of this interpretation seems to be the official justification for tariffs that were to be imposed on Mexico, Canada, and China (and which, in the case of the latter country, were indeed imposed).

This was supposed to be a penalty for these countries' tolerance of illegal immigration and drug smuggling into the USA. When the authorities of Mexico and Canada committed to securing their borders, the tariffs were suspended. However, this view of Trump's rhetoric also has gaps. First and foremost, threatening high tariffs to press governments to take actions they already committed resembles shooting a cannon at a sparrow.

On the other hand, numerous statements by Trump and his advisors suggest he truly believes in the positive impact of aggressive tariff hikes on the American economy. This policy was supposed to help reduce the U.S. trade deficit, which Trump claims indicates that trading partners are robbing Americans.

For example, the American president sees the $54 billion trade deficit with Canada in 2023 (considering both goods and services exchange) as evidence that the USA is subsidizing Canada. Restricting imports would also revive domestic industry and boost the state budget.

Let's hear from one of the proponents of Trump's tariff policy, Oren Cass, creator of the think tank American Compass. "A company considering whether to close a factory in Ohio and move it to China, or a consumer considering giving up on a local brand product in favour of a cheaper imported product, probably won't consider the broader significance of producing in the USA" - wrote the economist in September in "The Atlantic."

"For the individual actor, the rational choice is the one that saves money. But these individual decisions add up, causing economic, political, and social damage. If tariffs counteract these harms, they can bring collective benefits" – added. As he explained, the industry is not only a carrier of innovation but also ensures stable jobs and helps build the country's security.

The tariffs Trump introduced during his first term did not have the positive effects that would justify their costs. For example, the share of people employed in industry continued to decline. Yes, in those sectors protected from foreign producers' competition, employment rose slightly. But there was no such effect in the entire industry. Why? because many factories that benefited from imported tariff-imposed components—like steel and aluminum—failed.

This was compounded by the effects of retaliations taken by other countries. "Restricting trade is usually a very costly method of protecting jobs for selected social groups," wrote Ngozi Okonjo-Iweala, head of the WTO, referring to the experiences of the USA in the introduction to the September WTO report.

Estimates by the Peterson Institute suggest that each new job in the steel industry costs other sectors $850,000.

Trump's decisions from his first term also did not improve the U.S. trade balance. The deficit in 2016 was 2.7 percent of American GDP and was not smaller in any of the following four years. Indeed, the real value of imports from China fell but increased in other directions. Moreover, the initial reduction in imports contributed to the strengthening of the dollar, which in turn negatively affected U.S. exports.

The effects of that wave of protectionism show that Trump's goals are mutually contradictory. Tariffs cannot simultaneously reduce imports and significantly increase budget revenues, nor can they increase local production without causing price hikes.

Today, economists expect similar consequences from any potential tariffs. They also remind us that reducing the trade deficit—even if it were to happen—would not be a positive phenomenon and, therefore, should not be a goal of economic policy.

The U.S. trade deficit is accompanied by a financial account surplus. In other words, dollars flowing out of the USA to finance imports then return as investments. This gives the American government and companies unlimited access to cheap loans.

Again, however, Trump and his advisors' arguments are inconsistent. If a trade surplus is a sign of a country's economic power, then why has Germany—a country with a giant surplus—stagnated for several years now? And why does Elon Musk think the whole of Western Europe requires reforms to restore its dynamism? It can't be that Europe is simultaneously very competitive against the USA and extremely uncompetitive.

The worst consequence of Trump's protectionist rhetoric is the uncertainty it causes. Even if the tariffs announced over the weekend do not materialize, i.e., they are only used as a bargaining chip in U.S. negotiations with trading partners, they will trigger a spiral of distrust. Countries that regarded Washington as a guarantor of the world trade order and as an ally will lose this conviction.

The global consequence of this phenomenon will be inefficient capital allocation. Companies considering investing in Mexico or Canada and planning to participate in American supply chains will think twice. Similarly, enterprises wanting to grow in the USA, expecting unfettered access to foreign markets, will reconsider.