Markets are desperate for good news about tariffs — or no news at all. It only took a pause on the reciprocal tariffs and vague promises of future trade deals for the bond market to stabilize and stocks to recover. And despite the continuing uncertainty and the potential for more disruption, it seems markets are not pricing in a recession.
Are traders deluded? Irrational? Or do they know something that too many prognosticators do not — namely, that tariffs will not bring about an economic calamity.
Don’t get me wrong, tariffs are a bad idea, even reduced to 10% (which is still much higher than those of other countries). But while a high tariff regime would be bad for growth, the US economy can probably withstand it. The economy has strong fundamentals, a likely positive productivity shock in its future, and the part which is dependent on trade is relatively small. No less an authority than the Yale Budget Lab estimates the tariffs will reduce GDP between half and one percentage point — which, again, is not great, but is also not a recession.
The first thing to understand is that tariffs are a tax, and when you tax something, you get less of it. So the US will trade less with other countries. That will be bad for economic growth.
But there are a lot of taxes that hurt economic growth without causing a recession. Taxes on wealth, for example, may cause people to save and invest less. Politicians routinely propose bad ideas for taxes, and we economists routinely (and patiently!) explain how they will be bad for economic growth.
We economists tend to favor (or at least not disfavor) taxes that tend to have less impact on behavior. Consumption taxes belong to this category, and since the costs of tariffs are largely borne by consumers, they can be thought of as a consumption tax. But they are worse than standard consumption taxes, because they distort behavior by favoring domestic goods.
What if the US ends up with 10% tariffs on most countries and mid-double-digit tariffs on China? That’s less than the current rates in the Budget Lab’s model, which means its estimates for the effect on economic growth will be smaller. There will be other costs for the economy: an increase in prices, higher interest rates, a slight rise in unemployment, less consumer choice, a slower and less reliable supply chain.
The impact will also be uneven and create winners and losers, as most taxes do. Small, trade-dependent businesses with thin profit margins will be harmed the most; some will go out of business. Larger firms with more scope for economies of scale and bigger profits will be more able to absorb some of the costs. Some businesses will benefit — especially those that get a dispensation. Lower-income Americans who tend to buy cheaper foreign goods will feel the effects of tariffs more.
Recessions tend to be caused by some shock to the economy — a sudden and very large trade change, a financial crisis, an unusually bad economic event. That’s the recessionary risk of tariffs: They may not be enough to cause a recession, but they will make the economy less resilient to whatever shock comes along.
The real cost of tariffs will be felt long term. They will make US industry less globally competitive, because businesses get a subsidy over their foreign rivals and have less incentive to innovate.
All of which is to say: Tariffs are very, very bad on their own terms, thank you. They will cause any number of harms over the next several years if they stay in place. But they won’t necessarily cause a recession in the next year. And my worry is that all the economists who say otherwise are risking the credibility of the profession, which needs all the help it can get.
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