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Economic Insight
20.02.2025President Trump’s actual imposition of trade tariffs has so far been less than threatened during the election campaign. However, current uncertainty over trade policy could dampen growth whether big tariffs are eventually imposed or not. In such an uncertain environment, business confidence takes a hit, negatively impacting investment spending. The president’s recent threat to start imposing “reciprocal” tariffs in April, if followed through, could weigh on global trade because first, it would bring non-tariff measures such as VAT and others to the forefront, and second, the consequences in terms of new duties imposed will be significant. We think the administration’s overriding tariff strategy aims to achieve several goals, namely, tackling the US’s huge trade deficit, raising federal revenues, and extracting trade as well as non-trade concessions from other countries. The manner in which, in last minute negotiations, the decision to impose tariffs on Canada and Mexico was backtracked, after seemingly securing only marginal concessions from them, adds to the uncertainty while weakening the credibility of future tariff threats.
On the campaign trail, President Trump pledged blanket tariffs of 10-20% on most imported goods and a higher rate of 60% on imports from China. However, since he assumed office, the actual imposition of new tariffs has been significantly less with only a 10% universal tariff on Chinese goods already taking effect and a 25% tariff on steel and aluminum imports to take effect on 12 March. A blanket 25% tariff on Mexican goods and 10-25% on Canadian goods was declared but then postponed for one month in last-minute negotiations. The threat of tariffs has been raised against many other countries and economic blocks such as the EU and the BRICS nations in addition to sweeping sector-specific tariffs related to auto, oil, semiconductors, and pharmaceuticals, among others.
Recently, the strategy seems to have switched towards threatening “reciprocal” tariffs starting April, customized for each trading partner and beginning with the economies with which the US has the largest trade deficit. This development is significant because “reciprocal” is intended to not simply mean equal tariff rates to those imposed on US goods, but also to incorporate non-tariff measures such as value-added tax (VAT), regulations/standards, subsidies, among other matters as well. This approach, if followed through, would greatly impact the trade climate. For example, as per the IMF, more than 160 countries use VAT or similar consumption taxes, and hence, treating VAT as equivalent to a tariff will result in a sharp increase in “reciprocal” tariffs imposed by the US on its trading partners. And while President Trump has never been shy in announcing that he is genuinely pro-tariffs in general, differing with orthodox economics about their adverse impact, his actions since taking office show that he is using the tariff threat also as a means to extract concessions from trading partners.
The US has been suffering from continuous and large merchandise trade deficits
The US has run large merchandise trade deficits, equivalent to around 4-4.5% of GDP since 2012 (the overall trade balance is usually about 1-1.5% of GDP lower due to a surplus on services). For 2024, the goods trade deficit stood at $1.2 trillion, which is 4.1% of GDP, not far from the levels seen in 2013-17, i.e. before Trump raised duties during his first term. Despite an increase in the average levy on dutiable goods from 4.7% in 2017 to 7.4% in 2024, the deficit continued to expand, raising doubts about the success of a strategy to narrow trade deficits through increased tariffs going forward. The major import items have usually included vehicles, electrical/office machinery, petroleum, pharmaceuticals, and agricultural products, which accounted for around half of total imports in 2024. While in terms of exports, petroleum, agricultural products, vehicles, and transport/electrical equipment usually represent the bulk, accounting for 40% of total exports in 2024.
In terms of trading partners, the EU was the largest followed by Mexico and Canada with the top eight trading partners accounting for 72% of total trade in 2024. In terms of trade deficits, the steepest one is with China, noting that the US has a significant deficit with each one of its top trading partners, with the top eight partners accounting for 91% of the total deficit in 2024. We also note that the GCC overall, and each of the six countries within it, tends to run a trade deficit with the US ($24 billion in aggregate in 2024 according to estimates from the Office for the US Trade Representative), meaning that the region is unlikely to be a high priority target for US tariffs, and may even escape ‘reciprocal’ measures altogether. Aluminum exports from the UAE and Bahrain (both among the top 10 US aluminum suppliers), however, could be subject to 25% tariffs if these go into effect in March.
Narrowing the trade deficit, raising revenues and extracting concessions drive Trump’s tariff strategy
We think the administration’s overriding tariff strategy aims to achieve several goals, namely, tackling the huge trade deficit, raising federal revenues, and extracting trade as well as non-trade concessions from trading partners. As seen above, the US trade balance has been consistently in a large deficit, which is a macroeconomic vulnerability. Hence, it is natural for any US administration to seek to narrow that deficit. But big unilateral tariff hikes that trigger retaliation by trading partners, and subsequently, in the extreme, to trade wars, are unlikely to be successful. However, some success could be forthcoming for the US if the threat of tariffs drives its trading partners to come to the table and strike specific trade deals. In terms of raising revenues, higher tariffs could be used to help pay for the planned sweeping tax-cutting agenda. However, even under a best-case scenario, higher revenues from tariffs will likely materially undercut the shortfall in tax receipts. For example, in a pre-election estimate, the non-partisan Committee for a Responsible Federal Budget, estimated in its base-case that even a 10% universal tariff and 60% tariff on Chinese goods will generate $2.7 trillion over 10 years while the promised tax cuts and extensions would cost more than $9 trillion over the same period.
In addition to the above, Trump is waiving his tariff threat as a negotiating tool to extract both trade and non-trade concessions from trading partners. In other words, raising tariffs has become a versatile foreign policy tool that can be used to advance all sorts of US interests. This was at full display in the recent episodes with Colombia, Canada, and Mexico when higher tariffs were threatened to deal with non-trade related matters such as accepting deportations from the US, enhancing border security, and curbing the flow of illicit drugs. Another example was threatening the BRICS nations with at least a 100% tariff if they plan to “undermine” the global supremacy of the US dollar.
The uncertain environment risks hitting business confidence and undermining growth
The outcome of the tariff strategy will obviously depend on the scope/size of any tariffs imposed, the retaliation or not by trading partners, and the length of time during which uncertainty is high such as in the current situation. Imposing sweeping blanket tariffs as promised during the election campaign or the recently-announced across-the-board “reciprocal” tariffs, in the way they are being framed, will push up inflation and likely retaliation by trading partners, potentially leading to full-fledged trade wars that will result in a loss in global economic output. There would be few winners in such a scenario. According to projections from various agencies, in case a 10% universal tariff is applied, US GDP would drop by around 0.5%, and by over 2% if a 60% tariff is imposed on Chinese imports.
Imposing country or sector-specific tariffs, while less damaging than the banket ones mentioned above, will also likely be net negative. Referring to historical precedents, after the US slapped China with tariffs in 2018, US growth weakened (by 0.2% based on the non-partisan Tax Foundation), job creation fell, and prices increased (by 0.1% and 0.4% for consumers and businesses, respectively, as per a San Fransico Fed study). The manufacturing sector specifically, which was supposed to benefit from the tariffs as per the plan then, lost around 40K jobs in the twelve months through February 2020, before the pandemic hit. Currently, various third-party estimates point to a loss in economic output and jobs if the proposed tariffs on Canada and Mexico go into effect. For example, the Tax Foundation estimates that 25% tariffs on Canada/Mexico (including 10% on Canadian oil) and 10% on all Chinese imports would weigh on demand due to higher prices, reducing US GDP by 0.4% and resulting in job losses of around 330K. Meanwhile, the Institute of International Finance estimates that these tariffs would increase consumer price inflation by 0.4%.
Also importantly, we believe that the current environment characterized by significant uncertainty risks dampening growth whether tariffs are eventually imposed or not. What is adding to the uncertainty is that the tariffs that are being imposed are coming with a delayed effective date, which opens room for negotiations, and hence the possibility to backtrack, which is what happened in the case of Canada and Mexico. In such an uncertain environment, business confidence takes a hit, leading to delayed or stalled investment decisions. One additional risk of the current situation is the erosion of the US’s perceived reliability among its closest allies, which in fact are the country’s largest trading partners and set to lose the most from the disruption to global trade flows. Finally, another negative outcome of the current situation is less visibility in terms of monetary policy direction, with markets remaining on edge given both tariff and monetary policy uncertainties.