The indirect impact of Trump's tariff war
[MILAN] An overwhelming majority of economists are convinced that, contrary to what US President Donald Trump apparently believes, tariffs cannot mitigate a current-account deficit. But there is little recent evidence for this position, for the simple reason that tariffs have been running at very low levels globally, with most developed economies maintaining average tariff rates in the low single digits. So, what explains the consensus?
For starters, high tariffs did prevail during the interwar period, in the 1920s and 1930s, and there was no evidence that tariffs improved a country's current account. The US was running a trade surplus when president Herbert Hoover enacted the infamous Smoot-Hawley Tariff Act of 1930. While global trade subsequently plummeted, America's trade balance did not improve.
But even without first-hand evidence of the impact of high tariffs on current-account balances, economists can reach credible conclusions, because we know what determines those balances: the difference between an economy's aggregate savings and investment. In the US, the national savings rate amounts to 17 per cent of gross domestic product. In the European Union, that rate is about seven percentage points higher, at 24 per cent of GDP. Since these two continent-sized developed economies share very similar investment rates, the difference in savings is reflected almost directly in the current-account balance, with the US posting a deficit of nearly 4 per cent of GDP in 2024, and the EU achieving a surplus of 2.7 per cent of GDP.
To be sure, the Trump administration's tariffs – particularly the 'reciprocal' tariffs that were announced on Apr 2, and 'paused' on Apr 9 – focus primarily on the balance of trade in goods, which is only one component of the current-account balance. But the other factors that influence the current account – the services balance and investment income – tend to be much smaller and more stable.
In any case, two developments could cause a rapid improvement in an economy's current-account balance: a sharp increase in savings, or a significant decline in investment. Trump's tariffs could achieve this if they continue undermining confidence, especially if they induce a recession. Persistent uncertainty could undermine investment, and rising import prices could cause consumers to reduce their spending, pending more information about the cost and availability of goods.
But that information will soon arrive – probably within a few months. After all, the Trump administration is already announcing trade deals – starting with an agreement with the United Kingdom, following only a few days of negotiations – and has temporarily suspended its massive tariffs on Chinese imports. Given Trump's voracious appetite for dealmaking and lack of commitment to delivering particularly radical results, many more trade agreements will likely be concluded before Trump's three-month suspension of his 'reciprocal' tariffs ends.
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As policy uncertainty declines, the US will probably return to the low-savings, high-investment pattern of the past, especially given American firms' continued AI dominance. So, even if America's current-account balance improves temporarily, the overall deficit is likely to persist, as will the surpluses of other major economies, such as China, the EU and Japan.
While Trump's tariffs will probably have little lasting impact on America's current-account balance, they can upend bilateral trade balances. We have seen this first-hand: since 2018, when Trump's first administration began imposing high tariffs on China, the country's share of US imports has fallen from over 21 per cent to about 14 per cent. Meanwhile, China's share of EU imports has risen slightly from its 2018 level of about 20 per cent.
The narrowing in the US-China deficit might be enough for Trump, who is fixated on bilateral trade balances, making them the basis of his reciprocal-tariff calculations. The US-China trade talks just yielded a preliminary agreement that both countries will substantially reduce import tariffs, at least temporarily. Even so, US tariffs on Chinese goods will remain 30 per cent higher during the just-agreed 90-day 'pause' than they were at the start of the year.
As a result, Chinese exports to the US are set to fall further, with Chinese producers diverting US-bound goods to other markets – especially the EU. But increased imports from China will not affect the balance of savings and investment in these markets, as they will be offset either by reduced imports from other countries or by higher exports, including to China, which will be importing less from the US. Meanwhile, the countries facing the lowest US tariffs will have higher bilateral trade surpluses with the US, while their trade balances with China and other countries deteriorate.
So, a major reshuffling of bilateral trade balances is in the offing. This process will demand considerable flexibility from industry, which will have to adjust production to meet the needs of consumers in different markets. It will also require policymakers to resist the temptation to protect their domestic markets from 'surging' imports from countries such as China. These changes in bilateral trade flows between non-US markets constitute a more diffuse – and possibly greater – challenge to the global trading system than the direct impact of US tariffs. PROJECT SYNDICATE
The writer is director of the Institute for European Policymaking at Bocconi University
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