It's hard to keep up with all the tariff announcements coming out of Washington. On February 1, the US president, Donald Trump, announced the introduction of 25% tariffs on most imported goods from Canada and Mexico, and an additional 10% levy on goods from China. The tariffs against Canada and Mexico were soon postponed by a month following some token gestures.
Author
- Lukasz Rachel
Assistant Professor of Economics, UCL
A week after that, Trump signed an executive order imposing 25% tariffs on all steel and aluminium imports. These tariffs are set to take effect on March 12, a few days after the broad tariffs against Canada and Mexico supposedly come to pass. Trump has now vowed "reciprocal" duties on countries that target products made in the US.
This may all sound very familiar. Trump imposed tariffs during his first presidency - for example, on steel and aluminium imports in 2018. Studies of this policy are already available. They show that the tariffs led to rising raw material costs and weakened the competitiveness of US manufacturers.
It is also true that the subsequent US-China trade war of 2018 and 2019 did not collapse the US or global economy. But the tariffs this time round are more comprehensive and cover a larger number of key products and trading partners. Unlike the previous tariffs on China, which were introduced gradually, the current restrictions are to be introduced in one move.
Dubious justification
Trump justified the tariffs on Canada and Mexico as a measure to counter the "serious threat" posed by illegal immigration and the influx of drugs, including fentanyl, across US borders. It is difficult to take such an explanation seriously.
The fentanyl problem essentially exists at the southern border. In 2024, US Customs seized about 19kg of fentanyl at the border with Canada, compared with nearly 9,600kg at the Mexican border. The same is true for migrants. Imposing tariffs on Canada therefore makes little sense.
The more likely reason for all of Trump's tariffs lies in his desire to protect domestic producers from foreign competition. Trump and his strategists often refer to the need to reduce the US trade deficit with the rest of the world.
The basic problem is that in today's world of globalised supply chains, many components are imported. Goods often cross borders multiple times before reaching consumers in their final form. A good example is the automotive production complex near Detroit, where semi-assembled cars frequently cross the Canadian-American border.
It is difficult to predict what effect Trump's tariffs would have on such organised production. But they would probably amount to a very expensive and inefficient reorganisation of production processes. If the tariffs on Canada go ahead, Canadian and American companies, as well as their employees, would suffer.
Not all areas of production would be affected so drastically. But for the many components that are imported into America, an increase in their prices would translate into cost pressures. This may lead to financial problems for American companies, layoffs or higher prices for final goods.
Paradoxically, tariffs could also decrease the competitiveness of American production, at least when it comes to sales in third markets. Cost pressures caused by more expensive components will affect US manufacturers, but not rival manufacturers in, say, China or Europe - at least until they have responded with a trade war.
Another reason why Trump's logic may not work is the US dollar exchange rate. The dollar has soared in recent months, especially when Trump has spoken about tariffs , rising more than 5% against the euro since the election. These moves weaken the competitiveness of American manufacturers on global markets.
That said, Trump has often expressed his desire for a weaker dollar and, following the delay in the implementation of the tariffs, it has come down in value.
But, notwithstanding this, US businesses are by no means delighted. The tariffs on Canada, Mexico and China were condemned by groups such as the American Chamber of Commerce. And the Wall Street Journal described the move as "the stupidest trade war in history".
That's not all. The primary effect of tariffs is an increase in the price of imported goods. If prices go up, consumers will be less than enthusiastic. High price levels were, after all, a key part of why Trump won November's election.
The direct inflationary impulse from the announced tariffs is not, so far, catastrophic. While the inflationary effects of tariffs are not a given , many economists fear they will trigger a mechanism of increasing inflation expectations. This may happen, especially given the likelihood of retaliation by affected countries.
Before Trump had paused the tariffs, the Canadian prime minister, Justin Trudeau, had announced retaliatory levies of 25% on American goods worth a total of US$107 billion (£84.9 billion). Canada is also considering restrictions on exports of critical minerals crucial to the US tech industry.
China, on the other hand, announced retaliatory tariffs and measures against US businesses including Google. And the EU has stood firm on its plans to retaliate should Trump implement tariffs against the bloc.
Should they arise, higher inflation expectations may prompt the US Federal Reserve to raise interest rates. According to recent research , the increase in the cost of credit is a serious reason for dissatisfaction among American consumers and companies alike.
Reducing the trade deficit
If tariffs don't help consumers and hurt a significant number of domestic producers, perhaps they can at least close the US trade deficit? Unfortunately, they also miss the mark here.
Economists agree that the deficit is due to macroeconomic conditions - specifically, the balance between national investment and saving . The US has a surplus of investment relative to savings, so borrows money from the rest of the world.
This is, simply put, because the US economy does not produce as much as the American people consume. When net domestic debt increases, the trade deficit also increases because the borrowed money is spent on foreign goods and services.
Reducing the trade gap can be done through policies that lower domestic debt. Either households and businesses must save more, or government deficits must shrink. In this sense, tariffs are a poor tool.
Trump's tariff strategy will create havoc. This will bring opportunities as well as challenges. Europe and other affected countries should stand united against Trump's tariff threats, responding firmly while promoting trade liberalisation across the world at the same time.
Lukasz Rachel does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.
