Markets are struggling to guess the direction of Trump’s tariff policies amid repeated U-turns. Steep American tariff policies have been imposed on imports from Mexico, Canada and China – its three largest trading partners – after previously delaying them. However, concessions have already been made, with the auto sector being granted a one-month delay on having to pay tariffs. There still remains great uncertainty about the path of tariff policy from here.
The path of tariffs will depend in great part on what the underlying aims of the Trump administration are – whether tariffs are being used as a ‘transactional’ tool to extract concessions from trading partners, or a ‘transformational’ one to reduce the aggregate trade deficit and re-shoring manufacturing. If the latter, these goals will not be easy to achieve with tariffs alone.
During Trump’s first term, when a series of tariff increases on Chinese imports was put in place, the trade deficit with China did fall. However, the aggregate US trade deficit did not (see left-hand chart below). This was partly due to trade diversion, especially through Southeast Asia and Mexico. Broader tariffs could be used to try and tackle that. However, it also reflects the underlying truth that a trade deficit reflects an excess of domestic spending over income. If tariffs are actually used to reduce the fiscal deficit (instead of being recycled into cuts in other taxes), or reduce consumer spending, then the trade deficit will fall. But this will be painful for US (and global) growth.
Similarly, the Trump 1.0 tariffs appeared to have little positive effect on the US manufacturing, partly because they hurt export competitiveness. Tariffs push up import costs for domestic manufacturers, making goods more expensive and squeezing real consumer demand. They also reduce competitiveness for exporters – particularly as tariffs tend to lead to a stronger dollar and trade partners retaliate with their own tariffs against US goods.
The administration is unlikely to achieve a ‘quick win’ in its trade objectives. This suggests that, if the ultimate goals are ‘transformational’, we will see a continued ratcheting up and/or broadening of tariffs throughout Trump’s presidency.
However, ‘transformational’ aspirations will have to factor in economic and political reality. The tariff increases of Trump’s first term were enacted against the background of a strongly-growing economy, and followed the domestic tax cuts introduced in the first half of his term. These tariffs will be broader, deeper and more painful than under Trump 1.0, and they come against the background of an economy that may well already be slowing. How they are perceived domestically will be the key variable that determines they remain, grow, or are rolled back.
