Terrible Tariffonomics?
Trump’s tariffs reflect his belief that trade deficits weaken the US economy, but his approach may trigger economic retaliation and inflation, which could potentially isolate America and yet fail to address structural issues
A spectre is haunting this world, the spectre of Donald Trump’s tariffs. Between the 15th and 18th centuries, Europe followed a doctrine of mercantilism which posited that maintaining a trade surplus was essential for the economic prosperity of a country. Countries with trade surpluses received gold coins from their trading partners with trade deficits. Today, international trade is no longer conducted using gold as a medium of exchange. Modern free trade economics argues that if citizens prefer foreign goods, they should be free to purchase them. Countries naturally specialise in producing goods in which they have a comparative advantage, ultimately promoting global economic welfare through free trade.
So why is President Donald Trump so fixated about the US trade deficit, to the extent of disrupting the global trading system? A businessman at heart, Trump may have perceived the trade deficit as a direct financial loss for the country. A simple back-of-the-envelope calculation of national income accounting identity reveals that a trade or current account deficit reflects a country spending more than its national income. In other words, a trade deficit indicates that national savings are lower than national investment. When a country runs a trade deficit, it must borrow from foreign sources to cover this shortfall. This results in a net capital inflow. In accounting terms, if a country's current account is in deficit, its capital account must be in surplus. Thus, the trade deficit is symptomatic of a deeper issue: insufficient national savings.
National savings consist of personal savings and government savings. Personal savings refer to the portion of disposable income (after taxes) that individuals set aside, while government savings represent the surplus remaining after government expenditures are deducted from tax revenues. As of December 2024, statistics from the Bureau of Economic Analysis (BEA) indicate that the personal savings rate of American citizens stood at just 3.8 per cent of disposable income, marking a decline since 2015. Meanwhile, the Congressional Budget Office reported that the federal budget deficit had risen to 6.4 per cent of national income—nearly double the 50-year historical average. At the same time, GDP growth remained sluggish, with the economy expanding at a modest quarterly rate of 2.8 per cent, according to BEA data. In contrast, China’s economy exhibited stronger performance, with a GDP growth rate of 5 per cent and a significantly higher personal savings rate of 44.3 per cent of GDP in 2023, based on data from Statista. However, China's fiscal deficit remains comparable to that of the United States.
Rather than addressing this fundamental issue of low national savings, Trump attempts to tackle multiple economic problems using a single policy tool: tariff. He imposed steep punitive import tariff on countries that did not comply with his trade demands, particularly targeting Canada, Mexico, and China. On the fiscal front, Trump seeks to offset the budget deficit by increasing import tariffs instead of raising income taxes. He believes that imposing tariffs would strengthen domestic industries. He also proposed that foreign companies establish production facilities in the US to receive tariff exemptions and tax breaks, aiming to spur economic growth.
But will Trump's "Tariffonomics" succeed? Higher tariffs would increase the cost of imported goods. If consumers reduce their purchases of foreign products significantly, tariff revenue might even decrease, defeating the intended goal. Additionally, countries facing US tariffs would likely retaliate, imposing tariffs on American exports— something Canada, Mexico, and China were already considering. Such measures could hurt US exporters.
Predicting the outcome of this trade war is challenging. According to BEA data, Canada and Mexico had strong trade ties with the US, accounting for 33 per cent of American exports and 28 per cent of imports in 2024. In contrast, trade with China was lower, with imports at 13 per cent and exports at 7 per cent. The US has long-standing concerns over China’s unfair trade practices and intellectual property theft, justifying some tariffs. However, since US exports to China support many American jobs, a tariff war with these nations could pose significant economic risks.
As for the budget deficit, there are two primary ways of reducing it: raising taxes or cutting government spending. Since Trump has promised tax cuts to voters, it is unlikely that he will opt for tax increases. This leaves spending cuts as the only viable option for reducing the deficit. He is aggressively pursuing reductions in government spending, shutting down several government agencies and laying off employees.
Regarding economic growth, Trump envisages a fast-growing US economy driven by corporate tax cuts, deregulation and privatisation. Under Elon Musk’s leadership, DOGE has initiated the closure of multiple agencies with a view to increase government efficiency and reduce spending.
What’s really going on in Donald Trump’s mind? Is he simply a megalomaniac aggressively pushing his economic agenda, or is there a deep seated strategy behind this “Tariffonomics”? In an intriguing article published in UnHerd, Yanis Varoufakis suggests that Trump is frustrated with America’s status as a perpetual debtor nation, burdened by an overvalued dollar that enriches foreign central banks. Dollar should come down to a level which will make US export industries more competitive with restraint on imports. Tariff is an instrument to achieve this goal.
Trump views global trade as a zero-sum game and wields import tariffs as a strategic weapon to force trading partners to come to the table for a serious talk. However, his approach could have far-reaching geopolitical consequences. China might strengthen its trade relations with other Asian countries, while the European Union could distance itself from the US, particularly given Trump's stance on environmental policies and his withdrawal from the World Health Organisation and NATO. Although Trump has not yet imposed special tariffs on India, he has threatened to do so. If enacted, India will also retaliate and deepen its ties with China and Russia, further isolating the US.
Domestically, Trump faces risks as well. If the trade deficit shrinks, foreign money will cease to come to Wall Street, upsetting his favoured investors. Additionally, growing economic inequality exacerbated by tax cuts for large corporations and Elon Musk’s rapid advancements in AI risking displacement of jobs could further fuel public discontent.
The writer is Professor of Macroeconomics, Durham University Business School, UK. Views expressed are personal
