Trump's idea of imposing tariffs is build around the narrative of "Make America Great Again." He believes that tariffs will reduce the trade deficit by encouraging foreign companies to invest in the U.S. which will create more jobs and generate income. In 2017, when Trump took office for his first term the U.S. had trade deficit with 116 countries. In 2024, the U.S. has its largest trade deficit with China, totalling around $300 billion, followed by Mexico with over $200 billion, and a deficit of approximately $40 billion with India.

Contrary to Trump’s believe, a substantial body of academic literature suggests that tariffs are generally harmful to economic growth, global trade, and consumer welfare. One of the fundamental arguments against tariffs comes from classical economic theory, particularly the works of Adam Smith and David Ricardo. Smith argued that free trade promotes specialization and efficiency, while Ricardo demonstrated that countries benefit from comparative advantage. Tariffs, however, interfere with this natural market mechanism by artificially inflating prices and discouraging efficient resource allocation. When governments impose tariffs, domestic producers may become less competitive, leading to misallocation of resources and inefficiencies in production.

Tariffs also lead to higher prices for consumers. Studies show that the impact of U.S. tariffs on imported goods and found that the costs were primarily passed on to consumers. During his previous tenure as President, Trump's imposition of tariffs in 2018 resulted in a nearly full pass-through of costs to consumers, meaning that consumers bore the brunt of higher prices rather than foreign producers. Domestic inflation will rise, making it difficult for the Federal Reserve to cut interest rates, leading to a higher cost of capital for American businesses.

In addition to the higher cost of capital, American businesses lose out as they are part of an integrated global supply chain network. Modern global supply chains rely on the free movement of goods and components across borders. Tariffs disrupt these supply chains by making inputs more expensive, reducing competitiveness in industries such as manufacturing and technology. Tariffs reduce firm-level productivity and discourage multinational investment, leading to long-term economic disadvantages.

Tariffs induced retaliatory measures and the ensuing trade wars can destabilize the global economy. The Smoot-Hawley Tariff Act of 1930 is a well-documented example, as it led to widespread retaliation from U.S. trading partners and exacerbated the Great Depression of 1929. More recently, the U.S.-China trade war demonstrated similar effects, with studies showing that tariffs led to job losses in export-dependent industries and disruptions in global supply chains.

A detailed look at the earlier tariff wars between China and the U.S., imposed during Trump’s previous tenure, reveals that the U.S. is likely to lose more relative to China. Between 2009 and 2024, China’s GDP grew at a compound annual growth rate (CAGR) of 9.01%. Excluding China’s trade component with the US, the Chinese economy grew at a slightly lower pace of 8.62%. In contrast, the US economy grew at a CAGR of 4.78% during the same period, and without China, the US economy's growth rate drops to 4.07%. These small changes in growth rate numbers are significant in absolute terms, especially when considering the two largest economies in the world—the US at $29.16 trillion and China at $18.27 trillion in 2024.

In fact, data show US trade deficit with China continued to rise even after the major tariff announcement by Trump during his earlier tenure as President of the US. The average annual trade deficit with China was $311 billion during Barack Obama's tenure (2009-2016), rose to $361 billion during Donald Trump's first term (2017-2020), and decreased to $327 billion under Joe Biden (2021-2024).

Likewise, because of the retaliatory measures from Canada and Mexico, the U.S. is projected to experience a decline in GDP growth by approximately 0.3 percentage points due to these retaliatory measures. This translates to an estimated loss of around $75 billion in economic output over the medium term. Moreover, the tariffs are anticipated to result in a 0.25% decrease in U.S. employment, equating to over 400,000 job losses.

There are two important takeaways from these numbers. First, trade is beneficial for any country’s growth. Second, in the event of trade war, the U.S. economy is likely to lose out. Economies with protectionist policies always experienced slower growth rates compared to those with liberalized trade regimes. (IPA Service)