The second Trump administration has aroused a great deal of disquiet in both left and right-wing American political circles in regard to its protectionist-isolationist policies, and Wall Street has also reacted with a sharp correction in the stock markets. Is this a negotiating tactic by Donald Trump, or is it a serious intention to create prosperity through tariffs? History shows that tariffs are not a driver of development – on the contrary, harsh tariff policies are a producer of recessions and even stagflation.
It is not yet clear what “Trumponomics” will bring. On the one hand, the Trump administration has already imposed tariffs of 25 percent across-the-board on goods imported from Mexico and Canada, and an additional 10 percent on goods imported from China. However, it has since postponed the Mexican and Canadian tariffs twice – most recently until April.
It is important to note here that it is not entirely clear what the US administration is trying to achieve at all, since the free market agreements currently in force are the work of the first Trump administration. Trump is also threatening the European Union with a trade war – Washington has imposed 25 percent tariffs on European steel and aluminium, and the EU is drawing up plans to retaliate, to which Trump has already threatened 200 percent tariffs on EU wine and spirits. The US President has promised further tariffs for April, which will hit the EU. Apparently, Trump sees his closest Western allies – at least when it comes to trade – as enemies.
Only time will tell whether this is just a flexing of American muscles or whether it is genuine. The USA can certainly afford tough negotiations – with the EU, with Canada and with China, as US consumers account for a third of global consumption. The question is whether Trump really believes that a trade war will bring American prosperity or whether it is a negotiating tactic – or even, as some speculate, a speculative shorting exercise that benefits some bearish investors on Wall Street.
Is it just muscle flexing?
According to some statements made by President Donald Trump, he really believes that the USA will “buy” prosperity for itself by imposing tariffs. There was a lot of talk about this in his first term, but in the end, apart from cosmetic adjustments in world trade, practically nothing changed (trade with China and the EU remained at similar levels to before). Will it be different now?
It is certainly worth pointing out that, historically speaking, no customs war in history has ever produced a winner. Everyone lost: both the national budgets and the consumers of the countries involved in trade wars. Why is this so?
Higher revenues for the budget cannot be achieved by simultaneously higher domestic production
Naively speaking, in the long term, tariffs are supposed to ensure that producers move to a country where they are highly taxed and thus avoid higher tariffs. This is the rhetoric that Donald Trump is selling to his voters. But there are many internal inconsistencies in this logic:
Trump is promising higher revenues for the budget and, at the same time, more domestic production. However, both of these things cannot happen at once. If the country gets more money from higher tariffs, it means that companies will still produce abroad and import their products into the US, but the difference in price will be paid by consumers – so the higher revenues to the fiscus would be paid for by the Americans themselves. However, if indeed all companies were to start manufacturing in the US – which is already logistically practically impossible – there would be no increase in revenue for the budget. Yet many Americans believe that both will happen. But what about the consequences?
The consequences could be catastrophic
If the US were to raise tariffs on imports from the EU and China, there would be a number of negative economic consequences, including inflation, recession and even stagflation.
This is because tariffs act as a tax on imported goods, raising prices for final consumers, as well as businesses. Import-dependent businesses pass on the higher costs to their customers, which increases the general price level – the result is inflation. Tariffs on German-made vehicles would result in a significantly higher price for US consumers. And even with tariffs, German manufacturers do not have sufficient incentives to relocate their entire production to the United States of America.
In addition, many US companies depend on imported raw materials and intermediate goods – for example, steel and semiconductors, which have just become more expensive for them. If these become more expensive, the cost of domestic production also rises, further pushing up prices. It is therefore an illusion to expect European steelmakers to move production to the US. If companies reduce imports because of higher tariffs, there may be a shortage of the raw materials needed to produce semi-finished products and manufactured goods, which will push up prices even further.
Inflation and higher prices can significantly reduce private (consumer) spending, leading to lower demand and weaker economic growth, while higher production costs further reduce the profitability of companies, discouraging them from investing in new projects or hiring additional labour. This in itself would cause a recession.
And if the EU and China retaliate with their own tariffs on US products, the latter will become more expensive and less competitive in foreign markets, which could hit key US industries, such as agriculture, manufacturing and technology, hard. This could lead to layoffs, in addition to a general recession. An additional factor in a trade war could be uncertainty in the markets, which would entail a number of things: from a reduction in investment, uncertainty in investment funds where pensioners also save, a further reduction in consumer confidence, etc.
In a really extreme case, if there really was reciprocity of action, where countries raised each other’s tariffs, there would even be the possibility of stagflation – a dangerous combination of high inflation and slow economic growth.
Central banks would find themselves faced with an impossible dilemma: raise interest rates to curb inflation (which could worsen the recession) or keep them low to stimulate growth (but risk even higher inflation).
Trump loves McKinley, but McKinley lived in a very different world
What Trump actually believes is impossible to predict given the current chaotic nature of his statements, which sometimes contradict each other. Trump has repeatedly expressed his admiration for US President William McKinley in the past – so much so that, at the beginning of his second term in office, he ordered by executive order that Mount Denali be renamed Mount McKinley (which is what it was originally called).
McKinley was known for his protectionist, interventionist and isolationist stance – he tried to force Canada to join the US through tariffs, among other things, but to no avail or even counterproductively – Canada started to integrate economically with the European continent during his term.
Just how successful McKinley’s tariff policy actually was is a matter of economic and intellectual debate – it certainly did not make manufacturing move from abroad to the USA, but it did not bring about a recession. It should be made clear, however, that McKinley lived in a different time – a time before industrial globalisation. Today, virtually every product you hold in your hands is made from materials sourced from all over the globe, and dozens of companies around the world have been involved in its manufacturing process. This is not just true of complex products – even the desktop calculator is a joint product of international retail chains that the average mortal cannot even imagine. Tesla’s cars, which Americans proudly say are purely American, are almost 70 percent made from components manufactured outside the USA.
McKinley lived in a world where prosperity, as we know it today, was beyond the wildest imagination of any mortal. However, the average African today lives a life that is richer in goods than that of the average American in 1897. But the prosperity we live in would not be possible without global trade, which makes it possible to price products very close to the cost of production – prices that are only possible through economies of scale, which are impossible within a single country (even one as large as China or the USA).
China, the EU and the USA are thus snapping at each other, while they are also totally dependent on each other – this was also the guarantor of the last 80 years of peace, among other things. People were too busy trading to fight. Russia’s military expansionism is probably also one of the clear signs of the Russian Federation’s economic impotence.
A trade war has the potential to upset the delicate balance of international trade. The consequences could be even worse than recession, inflation and stagflation. The result could be that instead of one Russia, we get four ‘Russias’, fighting with tanks for their space on Earth.
Mitja Iršič
