Trump’s tariffs: A good idea?

The US president aims to accomplish quite a lot with his new tariffs regime. He wants to reindustrialize the USA, reduce the US trade deficit, and wrangle better deals with trade partners. But do tariffs make America great again? Historical evidence isn’t all that argues against that notion. Developments in recent weeks also demonstrate that there may be some catches to levying tariffs. Even the Trump administration has recognized this in the meantime. However, it is hard to backpedal, and a lot of harm has already been wrought.

The most beautiful word in the dictionary

“Tariff” is the most beautiful word in the dictionary in the eyes of Donald Trump. Ever since his first term in the White House, if not before, it has been known that Trump particularly views tariffs as a means of pressuring trade partners into making “deals.” So, renewed tariff threats were expected to arise in the Trump 2.0 era. However, what Trump actually churned out on the issue of trade policy during his first 100 days back in office likely astonished even die-hard MAGA devotees. The average tariff rate on imports to the USA has increased roughly tenfold in the span of a few weeks. Punitive tariffs of more than 100% against China are tantamount to a trade embargo. The US president would like to obtain more than just favors from America’s trade partners. The tariffs are also aimed at repatriating manufacturing to the USA, generating federal revenue, and eliminating the USA’s huge trade deficit. They are even by now aimed at rescuing Hollywood.

Well thought out? | Disruptive in any case

Average effective US tariff rate

Sources: The Budget Lab, Kaiser Partner Privatbank

Lessons from history

But are tariffs really the way to go? The majority of economists have their doubts about that. Strictly speaking, Trump and his advisors stand practically alone on this issue. A look back at history shows that question marks are warranted. The 1930 Smoot-Hawley Act, for instance, is generally considered a cautionary example of the dangers of economic nationalism in a globally interconnected world. In 1930, US President Herbert Hoover sharply raised import tariffs in a variety of industries despite warnings from economists – the average tariff rate climbed to above 20%. By two years later at the most, the harmful economic impacts were undeniable. The raised US tariffs provoked far-reaching retaliatory actions by other countries, international cooperation crumbled (in the middle of a world economic crisis), and world trade volume decreased by almost a third. Although economic historians are largely in agreement that the Great Depression was made really great by an absence of effective fiscal and monetary-policy measures and not by trade policy, it is nonetheless estimated that the high tariffs and the resulting drop in trade with foreign countries reduced US economic output by more than 3% between 1929 and 1931.

There are also lessons from Trump’s first term in office. In 2018, the president slapped punitive tariffs ranging between 20% and 50% on imported washing machines. A study published in 2020 by economist Aaron Flaaen (of Georgetown University) points out four chief consequences of that action: (1) Prices of imported washing machines climbed 12% on average. (2) Although clothes dryers were not directly affected by the tariffs, their prices increased too by the same amount. (3) Washing machines and dryers manufactured in the USA also became more expensive. (4) Companies like Samsung and LG opened factories in the United States, creating around 1,800 jobs there. At first glance, the tariffs appear to have been successful – they poured around USD 82 million per annum into federal coffers. But that was counterpoised by around USD 1.5 billion in extra costs to consumers, which works out to a cost of around USD 820,000 per newly created job. The tariffs thus proved to be an extremely expensive and inefficient way to grow employment.

Risks and side effects

This time as well, the Trump administration is hardly likely to achieve its (big) goals associated with the new tariffs regime. “Liberation Day” on April 2 thus far hasn’t done anything except liberate economic actors from having any semblance of security about future prospects. Even the 90-day suspension of most of the reciprocal tariffs does little to alter that because nobody knows what will happen afterwards. Recent US consumer and business sentiment surveys accordingly reflect an acute loss of confidence. Uncertainty prevails not just about how long ongoing tariff negotiations will take and with regard to possible retaliatory actions and final tariff rates. There are also closely related question marks about the future trajectory of inflation, economic growth, central-bank interest rates, and corporate earnings. Global supply chains risk getting ripped apart, similar to what happened after the outbreak of the pandemic in 2020. And although the long-term consequences of tariffs are deflationary, a combination of high inflation coupled with zero to negative economic growth (stagflation) looms in the near term.

Stagflation in sight | Too much of a gamble taken?

Bloomberg consensus estimates for USA for 2025

Sources: Bloomberg, Kaiser Partner Privatbank

Pro-tariff arguments put to scrutiny

When the most frequently cited arguments in favor of high tariffs get put to scrutiny, it quickly becomes clear that the logic behind Trumpian tariff reasoning is vulnerable to criticism and that the “art of the deal” negotiating tactics employed thus far are suboptimal:

• Tariffs make American manufacturing great again: Even if the USA wanted to resume producing a variety of manufactured goods itself overnight, it wouldn’t be able to do that because it lacks sufficient production capacity. It takes years and loads of money to (re)build manufacturing capacity in the USA, and doing that is unattractive for all but the fewest of companies, due in no small part to the political uncertainty under the Trump presidency. Last but not least, the USA lacks the requisite amount of skilled personnel needed to reindustrialize the nation. Although tariff uncertainty alone can induce a company to resume making future investments in the USA, it’s questionable whether that would also create many jobs – highly automated factories and few real jobs for workers are the likelier outcome. It seems certain that under a regime of high tariffs, products made in America ultimately would be much more expensive than before.
• Tariffs generate revenue and reduce the trade deficit: The US federal government anticipates USD 150-200 billion of annual revenue from tariffs. Yet, not only is the federal budget deficit vastly larger than that at almost USD 2 trillion, any revenue generated from tariffs is likely to be more than offset by the prospect of tax cuts put forth by Trump. Despite the trade deficit, the United States has been an economic success story over the last several decades. The presidential obsession with the trade deficit is also problematic at root because it is based on an erroneous understanding of fundamental economic interrelations. The real reason for the deficit is that Americans consume more on the whole than they save. The federal government’s large deficits and the USA’s attendant higher interest rates, but also the country’s allure as a preferred place to invest and do business, attract more net capital inflows than outflows, causing imports to exceed exports. The USA’s current-account deficit is thus neither good nor bad. Higher import tariffs cannot change that at all because they have only a very indirect impact, if any, on the propensity to save in the USA. The only way that tariffs could reduce the USA’s current-account deficit is by plunging America into a recession.
• Tariffs make good deals possible: Certain preconditions are needed in order to make deals. For instance, verbal threats or actual actions on the way to a deal should hurt the adversary more than they inflict self-harm. What may go for South Korea and India in the case of the current Trump tariffs doesn’t hold for the big trade partners like China and the European Union. The bigger loser is the US economy. Moreover, demands must be clear to the adversary, which needs know what concessions it is expected to make. Clarity of this kind seemed to be missing lately even on the part of US trade representatives, which doesn’t exactly facilitate the ongoing negotiations. Furthermore, the counterparty must feel sure that a concluded deal won’t be undone soon. However, Trump by now has gained a reputation as a deal breaker, and the USA’s trade partners accordingly have little willingness to make hastily improvised concessions. Expert negotiators know that good deals take a lot of time. And last but not least, if the USA’s main aim in the end is to confront and contain its ultimate adversary, China, a concerted course of action coordinated together with other trade partners would be the most expedient approach. But Trump’s impulsive conduct toward friend and foe alike is the diametric opposite of that.

Good deals take time | Quick wins are unlikely

Length of time taken to conclude US trade agreements (in months)

Sources: Apollo, Kaiser Partner Privatbank

There is a general consensus among economists that global free trade benefits everyone involved on the bottom line – exceptions confirm the rule. Enterprises relocate their production to wherever comparative advantages exist. Tariffs, however, suppress comparative advantage, divert capital to less productive uses, and take pressure off businesses to compete on price or quality. Although tariffs can preserve jobs in the short run in those industries affected by them, overall they cause a general increase in unemployment. Free trade, in contrast, admittedly displaces individual domestic industries occasionally, but it lowers prices, increases consumers’ disposable income, and creates new jobs in other fields. Tariffs flip this effect: they benefit few producers, make goods more expensive, reduce purchasing power, and brake economic growth and employment. Whoever wishes to maximize per capita economic output as a measure of standard of living should therefore be skeptical about tariffs. A general raising of the tariff level does not improve the standard of living. Slower growth in prosperity is the economic price of raising tariffs. Although there are winners and losers in any trade policy, free trade exhibits a much more positive net balance. If Trump’s tariffs gamble ultimately were to result in lower tariffs around the world, that would be beneficial in the long run. But if it leads to heightened trade barriers – and it looks like that’s where things are headed right now – then the USA and the world economy will bear the costs.

Not shortchanged | The USA has fared well to date with its trade deficit

Per capita economic output in US dollars

Sources: Bloomberg, Kaiser Partner Privatbank

Deal or no deal?

The disruptive tariff tempest may not be over yet, and a number of sectoral tariffs loom as well in the near future. Meanwhile, the adverse consequences of Trumpian trade policy will soon become visible also in hard economic data and in the form of empty supermarket shelves, which is bound to stoke public discontent. The Trump administration will gradually face mounting pressure to present successful achievements soon. So, one can expect to see headline-grabbing news of “fabulous” deals in the near future.

But while the USA and trade partners like Japan and the European Union may be able to reach agreements tolerable to both sides in the weeks ahead, the trade war with China is likely to go on for longer because the call from Xi Jinping that officials in the White House initially expected and lately have been hoping for hasn’t happened yet. Beijing, however, knows that regardless of how many concessions are made to the Americans, Washington will further tighten the thumbscrews on China and will try to sabotage the country’s rise. The government of China therefore has braced itself for a prolonged dispute and is well prepared for it. Against this backdrop, the USA should not anticipate quick negotiation wins. China also has no shortage of means of exerting pressure, holding bargaining chips that include a mountain of US Treasury bonds (that it could dump on the market) and a quasi-monopolistic position in the business of processing rare-earth metals and minerals. Donald Trump, meanwhile, has neither time nor patience. So, he has already caved in to a degree, has allowed tariff exemptions for electronic goods from China, and has since early May floated the prospect of cutting tariffs against China a bit. In fact, the reduction in tariffs to 30% announced on May 12 was once again greater than expected. After a de-escalation phase, a face-saving deal for Trump and Xi now seems possible before the end of this year. A deal of that kind wouldn’t alter the rivalry between the two countries, but would keep attractive commercial relations alive for both sides.

However, it is highly unlikely that the average US tariff rate will revert back to single-digit percent territory under President Trump. Realistically, the trade chaos won’t come to an end unless and until Congress wrests control over trade policy from Trump. To do that, enough Republicans in the House of Representatives and the Senate must be willing to override his veto (which requires a two-thirds majority in both chambers of Congress). Since that is very unlikely to happen, the trade-war rollercoaster ride looks set to continue. Last but not least, a return to substantially lower tariffs is improbable also because Trump will rate and sell the by-now gushing tariff revenue as a triumph. The truth, though, is that Trump’s tariffs have not only harmed economic growth for 2025, but have also already inflicted a lot of damage – some of it irreparable – well into the future. However, the vibrant rally since mid-April on equity markets reflects a certain degree of optimism. The market evidently is proceeding on the assumption that the US administration will strike a lot of deals soon and that only a general 10% tariff on imports will remain while trade partners will be able to negotiate away most of the other punitive tariffs. If the Trumpian rollercoaster ride really does continue, though, investors shouldn’t expect stock-price performance to stay on a one way street.