The Economic Consequences of Trump’s Trade Policies

Tariffs have had a negative impact on the U.S. economy, but a relatively limited one to date. Pain is obviously felt more in some areas than others, but the cumulative impact is growing and a continued escalation in trade tensions would further dampen growth. The fallout of the trade war does not appear to be enough, by itself, to push the U.S. into a recession, but it’s not helping.

A full timeline of Trump’s trade war can be found here. We can look at the trade war with China as having three broad phases. The first round was 25% tariffs on $50 billion in Chinese goods, mostly intermediate inputs and capital equipment. The second phase was a 10% tariff on $200 billion in Chinese goods, mostly capital goods and some consumer goods (including mobile phones, laptops, and clothing) – which was raised to 25% on May 10. Trump has also threatened a third phase, which would impose 25% tariffs on the remaining $300 billion or so of Chinese imports, which would be mostly consumer goods. The third phase would have a more significant impact on consumer spending (retail margins are generally low, leaving firms with less ability to absorb price increases).

Tariffs are a tax, but one paid by the U.S. importer, not China, and passed along in higher prices to U.S. consumers and businesses. Tariffs raise costs, disrupt supply chains, invite retaliation, and raise the level of uncertainty in capital spending decisions. Anecdotal evidence suggests increased strains for U.S. manufacturers that use Chinese parts and supplies. Retaliation has harmed farmers and firms exporting machinery and equipment. It’s estimated that the cumulative impact of tariffs, including the possible third phase, would be to shave about half of a percent from GDP growth this year, although that doesn’t include possible multiplier effects – still, not enough, by themselves, to push the U.S. economy into a recession.

It appears that expectations of higher tariffs pulled forward imports in 2018, widening the trade deficit and boosting the pace of inventory accumulation. In 1Q19, we saw a correction. Imports, which have a negative sign in the GDP calculation, fell back. Net exports added a full percentage point to first quarter growth. That doesn’t mean that “trade policy is lifting growth.”

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The current account deficit, the broadest measure of U.S. foreign trade, should have narrowed in the first quarter (the figures will be released on June 20). However, the current account deficit is trending at 2.0-2.5% of GDP, not particularly high by historical standards (in comparison, we saw it reach more than 6% of GDP in 2005). Why does the U.S. run large trade deficits? It’s not because of bad trade deals. We consume more than we produce, or in other words, we don’t save enough – and remember, the federal budget deficit (nearing $1 trillion per year) is part of national savings.