A modest attempt to analyse Donald Trump’s tariff policies.
Alfred Marshall, whose text book was still in use 40 years after he died wrote ‘every short statement about economics is misleading with the possible exception of my present one.’ (The text book is 719 pages.) It’s a timely reminder that any short analysis of Trump’s tariff initiatives is likely to be misleading and any long one will be so riddled with caveats that it will be impenetrable.
Over the period during which this column was drafted and checked, there were numerous developments in US tariff policy. It’s become a bit of a rolling maul in which it is not clear whether the man with the ball even knows which kind of football he is playing. The aim of this column is to set out some of the analytic issues which are likely to be relevant, irrespective of where the ball runs.
Who Ultimately Pays a Tariff?
Suppose the US imposed a tariff of 10 percent on New Zealand’s exports of casein to it. New Zealand producers could not pass the additional cost on because they are competing with other exporters. They would have to reduce their price to the US supplier; they would pay the tariff. Suppose instead, that the tariff was imposed on all external suppliers and there was no US production of casein. Then the tariff would be passed on to US consumers. In casein’s case, there is some US production so the burden will be shared between foreign producers and American consumers.
The balance of the sharing will depend on numerous factors (and change over time) so we cannot tell. Trump sometimes talks as though the tariff will be borne by the external producers but his promise of a positive output response by American producers requires domestic prices to rise. Most commentaries, including the Fed’s (the US central bank), expect the US prices to rise so at least some of the tariff is to be paid by US consumers.
(Hardly as an aside, at some point raising tariff rates become ineffective, because people just stop importing. The US rate on China is now 145 percent. China’s response is likely to be much more selective – and hurtful.)
Does that mean there will be American inflation?
The general view is that the price rises from the tariff will trigger further domestic price rises, so there will be some inflation. That probably means the Fed will raise its interest rates, which will impact on the world as a whole. We don’t know by how much.
What about the exchange rate?
There is a scenario which expects the US dollar to rise against other currencies. If that were to happen by 10 percent, that would offset a tariff hike of 10 percent (there are caveats). But US exporters would get a lower return. In effect they would carry the burden of the tariff. However, at the time of writing, the US dollar has fallen relative to other major currencies (much to everybody’s surprise). It’s not obvious why it has. Capital markets are fickle; they may be losing confidence in the US dollar as a safe haven. The effect of a fall in the US exchange rate is to add to inflationary pressures.
Why then are share prices volatile – all over the place?
They began falling when Trump announced his ‘reciprocal tariffs’ (more below), probably because investors were mystified by what he meant. Investors like certainty in public policy. They fell further after the more detailed announcement and then recovered a bit when he had the tariff pause.
Falling share prices do not cause a recession. Rather, in this case they signal that shareholders expect a recession, probably because of an expectation that the tariff hikes and the resulting tariff war will cause a recession (or worse).
This collapse was compounded by volatility in the bond markets, with interest rates rising. The danger they would cause a significant financial crisis enabled US Treasury Secretary Scott Bessent to persuade Trump to pause his more extreme tariff hikes (China excepted.) On is reminded of the remark of Clinton’s political adviser James Carville ‘I used to think that if there was reincarnation, I wanted to come back as the President or the Pope or as a 400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.’
But wont the tariffs create new opportunities for capital investment?
That is Trump’s intention – in the US anyway. But the policy is so badly worked through, that businesses seem to be putting their investment plans on hold in the expectation there will be further developments. Among them are that Trumps’s tariff implementation is incomplete, not covering some countries* and products**; he is likely to have to change some of what has been announced; they may also change because of US legal*** and political**** developments. Moreover, many tariffed countries promise to retaliate while Trump counter-promises to escalate if they do. A prudent business will hold over its investment plans; how consumers will respond is more speculative.
(* Including Belarus, Cuba, North Korea, Russia.
** Including copper, oil, pharmaceuticals, semiconductors, wood products, and some minerals not available in the US.
*** Including that Trump is taxing without representation.
**** Including that Trump may lose much authority following the 2026 congressional elections.)
What about the (temporarily suspended?) reciprocal tariffs on top of the 10 percent?
They add to the complexity. And they certainly don’t make rational sense. I won’t go on about them but just add one further illustration. New Zealand exports more to the US than we directly import. (We were fortunate not to face a higher tariff because of this fact.) However, we indirectly import from the US by purchasing products from Australia which started off in America. Trump’s strategy focuses on bilateral exchanges and ignores that we live in a multilateral world.
Doesn’t the Trump strategy mean that since I run a deficit with my supermarket, I should charge them a reciprocal tariff?
Your parallel is bizarre enough to illustrate the underlying thinking. To extend it, you will ultimately pay the tariff levy, not the supermarket.
But I buy things from the supermarket because I want them.
Absolutely, and so does the US from the world’s ‘supermarkets’. That is because US consumers (and the American Government) choose to spend more than their revenue. Trump’s tariff policies are not doing very much to address the excess spending. Probably it will continue.
One further complication is that Trump’s tariffs focus on goods exports and imports. They ignore services which the US exports more than it imports.
Why is that?
One reason is that services are hard to tariff. A customs officer can see a container crossing the border. But how to tariff an American tourist who buys services offshore?
The other main reason is that Trump seems to have a fetish about manufactures (just as he has one about property). If so, it would be a very distorted view of the US economy where nowadays 70 percent of its production is services and 30 percent goods. It is almost as if Trump has not grasped that the world has changed since he was at university 60 years ago.
You seem very gloomy.
Most serious commentators are. The expectation is that the world is going into a Trump-induced recession – possibly a prolonged one – and that, when it comes out of it, the world economy in general and the US in particular will be less productive. The size of the downturn may depend upon whether the reciprocal tariffs proceed. But there is still the 10 percent general tariff and higher ones on aluminium, cars, steel and China (also on select Canadian and Mexican goods), plus the promised ones on the current omissions.
What does that mean for the Global Order?
That’s a future column but, briefly, rather than making America great again, Trump may be accelerating its downward slide.
Footnote: One of Trump’s Rose Garden statements was that with tariffs ‘we can be so much wealthier than any country, it’s not even believable’. That short statement may be correct.