— Scott B. MacDonald, Chief Economist
scottmacdonald@smithsresearch.net
GED Explainer: Putting Trump and Tariffs in a Historical Context
For the incoming Trump administration tariffs are a good thing, an instrument to make America great again. Although President Trump’s entry into office is not until January20th, he is already stirring the trade pot. The big question is how much of what president-elect Trump has announced is likely to happen and what is meant to be part of his often-aggressive negotiating style? We believe that the most likely outcome is that Trump will introduce more than half of his tariffs that he is threatening and many of them will be gradually implemented. Nonetheless, the process is potentially disruptive of markets and critical supply chains and has considerable downside risk, especially with inflation. The president-elect indicated that the tariffs would be part of first Executive Orders when he is inaugurated on January 20, 2025.
1. What is being proposed?
The thinking behind Trump’s tariff agenda is best explained by the president’s loyalist Peter Navarro: “Net tariffs will lower the US trade deficit and thereby boost real GDP growth while slowing the transfer of US assets into foreign hands, thereby preserving US wealth. As domestic investment and production increases and supply chains become more stable and resilient, real wages will rise, inflation will fall and our nation will be more secure. Drill, baby, drill and reduced regulatory costs will help fight inflation.” https://www.ft.com/content/8a97792f-69f9-4885-afdd-4380a2d81dd8. Much of this is oriented against China, which the incoming administration’s hawks see as a dangerous rival. This means that national security can be used to put the tariffs in place.
To push this agenda forward. the president elect has made the following threats:
· Mexico faces a 25% tariff on all imports unless it ends the flow of migrants and fentanyl into the US as well as putting on the brakes in Chinese factory construction. https://ig.ft.com/china-mexico-tariffs/.
· Canada faces the same 25% tariff on all imports.
· China faces an additional 10% increase in all imports entering the US, on top of those already in place.
· The BRICS (Brazil, Russia, India, China and South Africa plus new members) face a potential 100% tariff on their goods if they attempt to develop a common currency to rival the US dollar.
· Trump has also proposed a 10%-20% “baseline” tariff on all imports to the US from every country.
Most likely the Trump administration’s attention will be mainly focused on those countries that have the largest trade surpluses with the US, which is shown in the table below.
2. How has the US position on tariffs evolved?
Context is important. The Trump romance with tariffs has not materialized out of thin air. Tariffs have played a major role in US economic development, especially through much of the 19th and 20th centuries. They served the purpose of raising federal government revenues (important in the era before federal income and corporate taxes were imposed); limiting imports to protect domestic businesses from foreign competition; and forcing other countries into reciprocity by lowering their tariff and non-tariff barriers.[1]
Probably the most extensive of US tariffs were the Fordney-McCumber Tariff Act of 1922 and the Smoot-Hawley Tariff Act of 1930. The former was the highest tariff increase in US history, raising the average import tax on foreign goods to around 40%. It struck a blow against European economies struggling to recover from World War I and repay debt to the US. For its part, Smoot-Hawley increased tariffs on imports to the US by another 25%, which resulted in close to 25 countries raising tariffs on American goods and helping sink global trade and contributing to the Great Depression.
In the aftermath of the Second World War efforts were made to create a trade regime more oriented towards free trade, key elements of which were the Bretton Woods system (geared to provide a better trade environment through a stable currency environment) and the General Agreement on Tariffs and Trade (GATT), which later morphed into the World Trade Organization (WTO). The US was motivated to reduce tariffs by the high level of competitiveness of its industrial sector in a world recovering from the Second World War. Implementation of corporate and individual income taxes radically reduced the importance of tariffs as a source of government revenues from over 90% of government revenue in the 19thcentury through the early 1900s to around 2% currently, according to the Council of Economic Advisors.
The US love for free trade-oriented policies lasted through the 1980s and probably reached its apex with the North American Free Trade Agreement (NAFTA) which came into force on January 1, 1994. By that point there was growing concern about the loss of US jobs. Between the 1950s and 1980s, the country’s manufacturing, steelmaking and coal-producing heartland became known as the “Rust Belt”, as it suffered a major economic decline due to the combination of rising foreign competition ,the departure of US corporations looking for cheaper labor and less regulation, and managerial failures to upgrade equipment and critical infrastructure. Equally important was the belief that trade with China would help nudge that country toward a more democratic political system. This helped pave the way for China to join the WTO in 2001.
Although this placed considerable pressure on the US Midwest and Northeast and Pennsylvania, the political backlash did not come until the 2010s when China’s rise brought home that global trade was not on a level playing field. China Inc was engaged in providing massive state support for its companies, including cheap loans, preferential treatment and tariffs against US goods, not to mention engaging in industrial espionage and copyright theft. China consistently ran large trade surpluses with the US, hitting a high of $246 billion in 2016.
By 2016, with Donald Trump’s victory, the culmination of the above-mentioned forces set in motion the return of protectionism. One of the first acts of President Trump was to cancel the Trans-Pacific Partnership (TPP), a proposed trade agreement between 12 Pacific Rim countries, which aimed to lower tariff and non-tariff barriers and excluded China. Trump followed this by raising tariffs on Chinese goods and renegotiating NAFTA, which became the United States-Canada-Mexico Agreement (USMCA). The Trump administration ultimately imposed tariffs on around $300 billion of Chinese-made goods.
Biden proved to be just as much a protectionist as Trump, maintaining that tariffs and the onshoring of US industry are critical for “good paying union jobs.” Between Trump 1.0 and Biden, China’s share of exports going to the US fell from 19% in 2018 to 15% in2023 (according to Chinese customs data). https://apnews.com/article/china-us-trump-tariffs-exports-yiwu-98701fd34985e232ae61e4f9aa4c6540. Protectionism now has considerable support in both the Republican and Democratic parties.
3. Who is the most exposed to any disruption from tariffs?
Trump assumes office on January 20. He has indicated that he will impose tariffs on day one of his administration. We believe that the most likely policy path is that Trump will ultimately impose more than half of the tariffs that he has threatened on the campaign trail. This will be part of negotiations with the Canadians, Chinese, Mexicans, Europeans and others. This would also likely stagger the inflationary impact on the US consumer and corporate earnings as well as allowing policymakers to assess the damage of other countries’ retaliatory measures.
Although tariff supporters downplay the damage to the US corporate sector, there is considerable downside risk to a broad-based tariff regime, at least over the next couple of years. According to Barclays, if the Trump administration imposes 10 percent tariffs on all imports, and a 60 percent tax on those coming from China, it would cut S&P 500 earnings per share by 3.2 percent in 2025,with an additional 1.5 percent hit after US trading partners impose their own retaliatory tariffs. https://www.marketwatch.com/story/trump-tariffs-would-hit-these-stock-market-sectors-the-hardest-76966e9e.
Many companies have already reduced their exposure to China by going to other countries, particularly those in Southeast Asia, Canada and Mexico. However, those countries are in the Trump gunsights. At the same time, onshoring to the US has its own challenges. As one trade lawyer observed: “The challenge with domestic sourcing is, of course, that you know the capacity is not what it used to be, and even if you can find domestic producers of supply, many of those inputs are from foreign countries, and so those will have a burden from the tariff increases as well.” https://www.supplychaindive.com/news/trump-tariff-preparation-guide-retail-manufacturing/735822/. Largescale deportations could also tighten the labor pool, putting pressure on wages which would be good for workers but bad for consumers.
Most US states will find a broad-gauged tariff regime disruptive. For the vast majority of states, Canada, China and Mexico are among their top three trade partners. A prolonged trade war and retaliation on the part of China, Canada and Mexico could have a substantial impact on food grain exporters such as Arkansas, Kansas, Nebraska, and North Dakota and other food producers such as Washington, North Carolina, and South Carolina. The last round of Trump tariffs resulted in lost business in the agricultural sector, with direct farm aid climbing each year of the Trump presidency from $11.5 billion in 2017 to $33 billion in 2020.Oilseeds and grains remain the US’s top export to China. The table below shows the significance of Canada, China, and Mexico to the three largest state economies.
4. Concluding thoughts
While some dismiss concern over the tariffs as progressive scaremongering, a recent Harris poll found that while most Americans are optimistic about the Trump agenda, two-thirds of them think Trump’s tariff plans will only add to rising costs if implemented.[2]Higher inflation would hurt many of the same people that were the worst hit by the Biden years inflation and to whom Trump has promised lower inflation.
If the objective is to construct a self-sufficient Fortress America, win at trade without considerations for alliances and damage China, the full-court tariff push is the right policy. If the policies work there will be considerable disruption, but the medium term will be one of renewed US economic strength, though there is a good chance that America will stand alone in a zero-sum game of winners and losers. Moreover, winning a new trade war with China is likely to be more difficult. Beijing has already blocked the export of US critical minerals used for chipmaking, constricted the supply chain for US-made drones, threatened to blacklist a high-profile US apparel company (PVH which owns Calvin Klein and Tommy Hilfiger), and begun an antitrust investigation into Nvidia.
If the plan is to create a more level playing field, exact greater reciprocity with trade and defense spending among allies, defend the border and maintain global market share, the path ahead will be one of measured and incremental actions. However, one cannot rule out Trump’s unpredictability. The bottom line is that Trump’s economic policies are a major gamble and will set the tone of global markets, both trade and financial. If nothing else, 2025 will be a year of disruptive change and market volatility and tariffs will play a major role on the global economic stage – for better or for worse.
[1] The first personal federal income tax was imposed in 1861 as part of the Revenue Act of1861, which was rescinded in 1872. State and local taxes varied.
[2] Another poll conducted by Quinnipiac University found that voters 51-38% oppose Trump’s plan to impose tariffs on imports from China, Canada and Mexico. The Quinnipiac University polling analyst Tim Mally noted: “Will tariffs targeting foreign countries, intended to level the import-export playing field, end up hurting Americans at home? The numbers could suggest that’s exactly what voters fear will happen.” https://poll.qu.edu/poll-release?releaseid=3917. Republicans (76-12%) support Trump’s plan, while Democrats (898-7%) and independents (53-34%) oppose it.
