Tariffs and American protectionism

International trade issues, which were largely absent from the U.S. political economy in the early years of the 21st century, have come to play a more important role in recent years. America’s persistent trade deficits, especially the large bilateral deficit with China, have served as the backdrop for the renewed attention to international trade issues. Moreover, the loss of nearly six million manufacturing jobs in the first decade of the current century, which some observers associated with a flood of imports, also stoked public consciousness of trade policy issues. President Trump raised tariffs on many of America’s trading partners starting in 2018. The effective tariff rate on imports from China, which had been less than 3%, jumped to about 9%.

President Biden subsequently rescinded the Trump tariffs on non-Chinese trading partners, but he largely kept in place the existing tariffs on Chinese goods. More recently, the president announced on that he was raising tariffs on roughly $18 billion worth of imports from China. The affected products include steel and aluminum, semiconductors, electric vehicles, batteries, solar cells, ship-to-shore cranes and some medical products. The new tariff rates on these products range from 25% to 100%. Should former president Trump regain the White House in this year’s presidential election, he has vowed to enact an across-the-board 10% tariff on all imports and would raise the tariff rate on Chinese imports to 60%.

Considering that many foreign economies levied their own tariffs on American products in 2018 and 2019, prospects of retaliatory tariffs by trading partners in future years, should the U.S. announce its own levies, are not unrealistic. At least Trump will most likely want to deal with unfair trade agreements with Europe.

With American imports of goods totaling roughly $3 trillion in 2023 and with the U.S. economy producing roughly $28 trillion of nominal GDP last year, tariffs on only $18 billion of imports simply do not have a marked effect on major U.S. macroeconomic variables. Prospects of retaliatory tariffs by America’s trading partners in future years are not unrealistic.

In the past, Fed policymakers seem to have placed equal weights on deviations of inflation from their 2% target as they did on the output gap. But given the surge in inflation a few years ago and the FOMC’s determination to return it to target, one could reasonably argue that Fed policymakers actually place a greater weight on inflation at present than they do on the unemployment rate/output gap. If the levying of tariffs causes inflation to jump higher, then the FOMC may not cut rates as aggressively as expected.  

In short, across-the-board tariffs on America’s trading partners would impart a modest stagflationary shock to the U.S. economy. The simultaneous rise in the unemployment rate and the inflation rate would not approach the degree of stagflation that was experienced in the late 1970s and 1980s. The so-called “Misery Index,” which is the sum of the CPI inflation rate and the unemployment rate, shot up from roughly 12% in September 1973, which immediately preceded the first oil price shock, to about nearly 20% in early 1975. It receded over the next few years but surged again to more than 20% following the second oil price shock in early 1979.

The stagflation of that earlier era was kicked off by the oil price shocks of 1973 and 1979. The price of oil shot up 150% between Q3-1973 and Q1-1974. After grinding steadily higher over the next few years, oil prices jumped another 150% between early 1979 and mid-1980. Because oil was a widely used input in the U.S. economy at that time—not only did motorists use oil products but homes and factories were heated by oil—the oil price shocks had a significant stagflationary effect.

Fast-forward a few decades. The value of goods imports is equivalent to only 11% of nominal GDP at present, and the price rises induced by the potential tariffs pale in comparison to the moonshot in oil prices in the 1970s. Higher prices erode growth in real income, which causes real GDP growth to slow, if not contract. The unemployment rate would rise. In short, the tariff increases would impart a modest stagflationary shock to the economy.

However, a redux of the 1970s and early 1980s probably would not occur. It is clear though that the U.S. has entered an era of protectionism, and this will most likely continue regardless of if Trump or Harris wins. Trump will likely cause more global trade tension as it is a well-known fact that he wants to deal with the unfair trade agreements with Europe.