Trump’s tariffs will fail dismally — just as they did in his first term

Donald Trump takes part in a roundtable discussion with industry executives on “Opening Up America Again” in the State Dining Room of the White House in 2020.

Ever mindful of America’s trade discontents, president-elect Donald Trump has vowed to impose 60 per cent tariffs on Chinese-made goods and a 10-20 per cent across the board tariff on all US imports as part of his Make America Great Again pledge.

It is timely to recall the abject failure – and cost – of similar policies that were implemented under the first Trump ­administration.

In April 2018, Trump tweeted: “We have a trade deficit of $500bn per year. We cannot let this continue!” In response, US tariffs in 2016 (the year before Trump became president) were levied on just 2 per cent of US imported goods at an average rate of 1.7 per cent; by 2020, they were being levied on 15 per cent of imports at an average rate of 13.8 per cent.

However, over the four years of the Trump presidency the US trade deficit soared to its highest level since 2008, increasing from $481bn to $679bn.

Four principal factors help explain this failed strategy. First is retaliation by the countries facing increased tariffs on their exports, notably China and the European Union. Second, is the switching of US imports from China to other sources.

Donald Trump and Xi Jinping leaving a business leaders event at the Great Hall of the People in Beijing.

The third and more indirect factor is the contribution of the US tariffs to the appreciation of the US dollar. Raising tariffs on a country’s goods will reduce demand for those goods but also for the currency associated with them – effectively depreciating the foreign exporter’s currency and appreciating that of the country imposing the tariff.

In the four months following the imposition of US tariffs against Chinese imports in 2018, the yuan fell some 8 per cent against the dollar, prompting, somewhat perversely, accusations by then US Treasury secretary Steven Mnuchin of Chinese currency manipulation.

And the fourth, and most fundamental, factor explaining the failure to “correct” the trade imbalance through tariffs is the fiscal expansion undertaken during the Trump administration, ensuring America would continue to spend more than it produced – the underlying reason for the trade deficit.

The penalty tariffs under Trump I on steel and aluminium are a vivid illustration of the self-harm that comes from this use of the trade weapon.

It has been estimated that US steel users now pay an extra $650,000 per year for every steel job saved (Hufbauer et al How Free Trade can Fight Inflation, Foreign Affairs, June 2022) and that for each of those jobs saved in steel and aluminium from US tariffs, 16 would be lost elsewhere.

The scale and range of US tariff measures in 2018 was unprecedented – greater even than that of the infamous Smoot-Hawley tariffs of 1930 that heralded the Depression (Khandelwal and Fajgelbaum The Economic Impact of the US-China Trade War, Annual Review of Economics 14, 2022).

As is their longevity – most of the measures having been retained under the Biden administration, a practical demonstration of protectionist capture.

According to modelling by the Tax Foundation, a think tank based in Washington, tariffs remaining in place under the Biden administration will reduce long-run US gross domestic product by 0.22 per cent ($55.7bn) and wages by 0.14 per cent and will eliminate 173,000 full-time equivalent jobs.

In sum, a tax on imports is, in effect, a tax on exports, both directly by raising the cost of inputs, stifling productivity-enhancing competition, and prompting retaliation and a general worsening of trade conditions, and indirectly, by currency appreciation and by permitting wage increases in the import-competing industries, which then spill over to the economy at large.

The penalty tariffs of the second Trump administration threaten to harm both trading partners and the US itself.

Can the World Trade Organisation help avert this? Unfortunately not.

In 2018, as a likely foretaste of things to come, the Trump presidency sought to justify its steel and aluminium tariffs, under GATT Article XXI, as being “necessary for the protection of its essential security interests”. The US argued that such action precluded WTO dispute settlement panels from examining counter claims by targeted countries.

The US lost this argument and its invocation of Article XXI has been declared unjustified by WTO panels. However, WTO law also provides that once an evaluation is made, a member can still pursue the action that it considers necessary, regardless of the panel’s judgment, in a legitimate exercise of its Article XXI rights.

The WTO – whether through its law, its hobbled dispute settlement mechanism or the Multi-Party Interim Appeal Arbitration Arrangement, of which the US is not a member – is presently unable to prevent US penalty tariffs from continuing to harm its trading partners, not least dollar-debt-burdened developing countries – and itself.

In the face of this risk, there are two pressing requirements: strengthened advocacy of the gains, economy-wide, from open markets, but also better help for the discontents who don’t share those gains and who are the political force behind Trump’s tariff threat.

Ken Heydon is a former Australian government and OECD official and visiting fellow at the London School of Economics. His latest book is The Trade Weapon, Polity (Financial Times Best Books on Economics, 2023).