DESMOND LACHMAN: The economic consequences of Mr Tariff Man

A spectre is haunting the global economy. It is that of an aggressive US import tariff policy that triggers an international trade war. US President Donald Trump’s early actions have heightened this possibility and with it the likelihood of a world economic recession this year.

In his first three weeks in office, Trump has acted in a manner fitting of his “Tariff Man” appellation. In flagrant violation of treaty obligations, he imposed a 10% tariff on Chinese imports, a 25% tariff on all steel and aluminium imports, and 25% tariffs on Canada and Mexico that he then suspended for a month.

As if this were not reason enough to worry about the world trade system, Trump has warned Europe and Japan that he will take tariff action against them too if they do not reduce their US bilateral trade deficits. He also threatened to retaliate against any country that retaliated against the US tariffs.

The explicit objective of Trump’s policy is to reduce the US trade deficit and bring manufacturing jobs back home. However, he is accompanying his tariff policy with a proposed policy of budget-busting tax cuts. According to the Committee for a Responsible Budget, over the next decade those tax cuts would increase the US budget deficit by $7.75-trillion.

By reducing national savings through an increased budget deficit and incentivising investment through tax cuts, Trump will cause a widening in the country’s trade balance. He will do so by causing a deterioration in its savings-investment balance. That risks Trump taking even more aggressive action on tariffs in the mistaken belief that tariffs are a cure-all for the US’s trade deficit.

Another factor that risks returning us to the economically destructive beggar-thy-neighbour policies of the 1930s is that America’s trade partners are almost certain to retaliate. China has already done so by raising its tariffs and restricting the sale of rare metals, while Europe, Canada and Mexico have indicated that they stand ready to retaliate if need be. This would seem to be a recipe for an escalation in the trade war. That could be the kiss of death for the globalisation of the world economy that underpinned the world’s post-war economic prosperity.  

It is never a good time to start a trade war. However, it is a particularly bad time to do so when the world economy is not in good shape, as is the case at present. China, the world’s second-largest economy, is in the middle of the bursting of its housing and credit market bubble and is experiencing mild deflation and a loss of investment confidence; Germany is in the second year of its recession and experiencing heightened political uncertainty; France is beset by public finance problems and political dysfunction; and the UK and Japan are experiencing only modest economic growth.

Contrary to what Trump might have us believe, the US is not an economic island. Important sectors of its economy, such as agriculture, are dependent on foreign sales. More important yet, about 40% of the S&P500’s profits are derived from overseas operations, while — as we learnt from the 1997-98 Asian currency crisis, the 1998 Russian debt default and the 2010 Greek debt crisis — the US financial system is vulnerable to economic mishaps abroad.

If nothing else, Trump’s tariff policy is more than likely to cause his beloved stock market to swoon. That might give us hope that he will make a trade policy U-turn before he triggers a world recession. However, hope is not a strategy. World economic policymakers would be well advised to make contingency plans for the eventuality that Trump will not back down from his aggressive tariff policy, as is now looking all too likely.

• Lachman, a former deputy director in the IMF’s policy development & review department and chief emerging market economic strategist at Salomon Smith Barney, is a senior fellow at the American Enterprise Institute.