The tariffs announced on 'Liberation Day' undermined a trade system built up over decades. How does Trump want to change it?
How exactly do tariffs work?
Tariffs are taxes imposed by governments on goods imported from abroad when they enter the country, usually "ad valorem" – meaning a percentage of the wholesale price of the goods. Importers pay tariffs to the government of destination, but economists find that the bulk of the costs are passed on to consumers – though importers may share the cost, as may exporters, who may cut prices to keep market share. The Budget Lab at Yale estimates that as a result of the tariffs introduced by President Trump, retail prices for clothing and textiles will rise by 10% to 20%, because these goods are mostly manufactured in China (which faces a new 34% tariff), Vietnam (46%), Sri Lanka (44%) and Bangladesh (37%). Household appliances are likely to rise by 10%, and automobile prices by 8%.
Why is Trump raising tariffs?
He says the system is unfair to America. "For decades," he said, "our country has been looted, pillaged, raped and plundered by nations near and far, both friend and foe alike." He thinks free trade has eroded American manufacturing, and that other nations take advantage of the US by imposing higher tariffs. His answer to this is a blanket 10% "baseline" tariff on imports to the US. But at the end of the 90-day delay announced by Trump this week, 60 countries stand to face higher rates: up to 50%. China now faces 34%, plus an earlier 20% tariff, plus a punitive 50%, totalling a whopping 104%. The EU faces a 20% tariff. "Reciprocal: that means they do it to us and we do it to them," he said. "Very simple." He had already imposed a series of sectoral tariffs: 25% on all car imports, and 25% on steel and aluminium. In total, these are the US's highest tariffs since the 1930s, when the Smoot-Hawley Act raised them to nearly 40%. This is the textbook example of why tariffs don't work: the act raised the price of imports and triggered a trade war, contributing to the Depression.
How does the tariff system work?
In 1947, the US and its allies established the General Agreement on Tariffs and Trade (Gatt), which set in motion a series of elaborate negotiations, during which nations mutually lowered tariffs. Gatt and the World Trade Organization (WTO), its successor, succeeded in bringing tariffs down across most of the world – ushering in the era of globalisation, which saw much manufacturing moved to the developing world, particularly Asia. The WTO system kept tariffs low (the average tariff, weighted by trade volume, is around 5%) but allowed governments to suspend the rules to protect their economies in certain cases: national security (protecting defence industries), unfair practices (where other nations' exports are subsidised) and dumping (where firms export goods below cost to destroy foreign competitors). Farming has long remained widely subsidised and protected. As a result, there are many ways of distorting free trade; even before Trump's interventions, low-level trade wars often erupted.
Is the system unfair to the US?
There's some truth to his claim that the US offered its trading partners more favourable terms than it got in return. As a proponent of free markets, it has long been more open to trade than many other countries. WTO figures show the US had an average tariff rate of 2.2% in 2023, compared with 2.7% in the European Union, 3.4% in Canada, and 3% in China. There are also some stand- out examples of unbalanced rates. The EU has long charged 10% tariffs on cars to the US's 2.5%. Canada charges dairy tariffs of up to 299%. Developing nations also often have higher tariffs to protect their economies, which is authorised by the WTO: India's average rate is around 12%. And China has many extensive non-tariff barriers to foreign companies: heavily subsidising its own industries; and imposing quotas and complex, discriminatory regulations.
How were Trump's rates reached?
Not according to actual tariff rates, but rather based on the US's trade deficits – i.e. when imports exceed exports – a subject that has long preoccupied Trump. The formula, released by the US trade representative, takes the trade deficit for the US in goods with a particular country, divides that by the total goods imports from that country and then cuts that number in half (the last bit is because he wishes to be "lenient"). The rate is meant to be an index of unfair trade practices, but mostly it isn't. It penalises nations that sell more to the US than vice versa, regardless of whether the tariffs they impose are reciprocal: South Korea, for instance, faces 25% tariffs, though the two nations have a free-trade deal. Madagascar, which exports a lot of vanilla that the US can't grow, and is too poor to buy US goods, faces rates of 47%.
Will his approach work?
According to orthodox economics, absolutely not. "This is to economics what creationism is to biology," said the former treasury secretary Larry Summers. Trade balances are driven by a host of factors, not simply tariff levels. There is no reason to have balanced trade with all countries. As a matter of basic economics, some countries produce things that others can't: the US can't grow vanilla, or bananas or coffee beans, on a meaningful scale. The whole point of free trade is that it makes nations devote resources to businesses in which they have a comparative advantage. Does the US really want to go back to low-value shoe making rather than its strengths – hi-tech manufacturing, say, and services (banking, IT, etc.)? Trump seldom mentions that, though the US had a goods-trade deficit of around $1.2 trillion last year, it had a surplus of services exports of $293 billion. Globalisation, while generally boosting Western economies, has certainly had a detrimental impact on low-skilled workers. But Trump's tariff wall – if he actually maintains it – is unlikely to reverse this. It is likely only to drive up inflation and slow growth globally.
Trump vs. the dollar
Donald Trump has three long-term economic obsessions: he loves tariffs; he hates trade deficits; and he thinks the dollar is too strong. The dollar is strong, spurred by high interest rates and the strength of the US economy, but also because it is the world's reserve currency: it accounts for 59% of global foreign-exchange reserves, held by central banks and so on; US Treasury bonds – state debt – are the world's piggy bank ($8.5 trillion worth are held by non-US savers). This allows the US to balance its books despite its deficits, and gives it great power to, say, impose sanctions. But it also raises the price of US exports. Trump and his vice president, J.D. Vance, think that a strong dollar is a drag on US manufacturing, and makes America a giant sink for the world's exports. ("We borrow money from Chinese peasants to buy the things those Chinese peasants manufacture," as Vance put it.) Trump believes a weak dollar and tariffs will boost US exporters and slash the trade deficit. Economists argue that this will have to be done very carefully. An unravelling of the US Treasury market could bankrupt the US and cause global financial chaos.
