Why Are You Doing This Mr Trump?

As a retaliatory measure, Canada immediately announced 25 per cent tariffs on C$ 30 billion (US$ 20.7 billion) worth of US imports, with the potential to extend these measures to an additional C$ 125 billion (US$ 86.2 billion) if the US tariffs remain in place beyond 21 days. Likewise, China has announced an additional 10-15 per cent tariffs on various US products.

Trump's idea of imposing tariffs is built 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 US, which will create more jobs and generate income.

In 2017, when Trump took office for his first term the US had a trade deficit with 116 countries. In 2024, the US has its largest trade deficit with China, totalling around US$ 300 billion, followed by Mexico with over US$ 200 billion, and a deficit of approximately US$ 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 specialisation 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 US 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 will lose out as they are part of an integrated global supply chain. 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 destabilise the global economy. The Smoot-Hawley Tariff Act of 1930 is a well-documented example, as it led to widespread retaliation from US trading partners and exacerbated the Great Depression of 1929.

More recently, the US-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 US, imposed during Trump’s previous tenure, reveals that the US 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 per cent.

Excluding China’s trade component with the US, the Chinese economy grew at a slightly lower pace of 8.62 per cent. In contrast, the US economy grew at a CAGR of 4.78 per cent during the same period, and without China, the US economy's growth rate drops to 4.07 per cent.

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 US$ 29.16 trillion and China at US$ 18.27 trillion in 2024. 

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

Likewise, because of the retaliatory measures from Canada and Mexico, the US 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 US$ 75 billion in economic output over the medium term. Moreover, the tariffs are anticipated to result in a 0.25 per cent decrease in US employment, equating to over 400,000 job losses. 

Finally, under World Trade Organisation (WTO) rules, the US cannot impose differential tariffs. Tariffs are non-discriminatory, meaning they are country-specific rather than firm-specific. This implies that if the US imposes a 10 per cent tariff on Chinese steel, it will also apply to steel from all other countries with which the US has Most Favoured Nation (MFN) status.

The exception applies to countries with which the US has bilateral trade agreements, such as Free Trade Agreements (FTAs) or Economic Unions. But for most other countries, including India, with which the US does not have an FTA, differential tariffs cannot be imposed. Essentially, what Trump is suggesting could be logically implemented if the US were to withdraw from the WTO.

Regardless, Trump’s tariff will impact the US more, as trade is crucial for any country’s growth. Economies with protectionist policies always experienced slower growth rates compared to those with liberalised trade regimes.

(The writer is a professor at Mahindra University. Views are personal)