Macro Signposts | 20 June 2024
I would like to thank Libby Cantrill, head of public policy, for her insights and contributions to this edition.
Unless explicitly stated, views expressed do not constitute official PIMCO views.
Trade Policy Under a Potential Trump Administration: Emphasis on Tariffs
Former President Donald Trump remains a strong supporter of tariffs as a trade policy tool and a revenue engine. If elected to a second term, we fully expect he would hike tariffs - a policy that would create winners and losers, but likely also weigh on U.S. growth and boost inflation, at least in the near term.
First, to address a recent spate of news: On 13 June, in a private meeting with Republican lawmakers, Trump reportedly floated the idea of an "all-tariff policy" that would replace all of the revenue generated from the federal income tax with revenues from tariffs on U.S. imports. We think such a policy is highly unlikely to be implemented: Mathematically, it would be virtually impossible to generate enough revenue from tariffs to offset the loss in revenue from income tax. The likely net effects would be much higher inflation, a material disruption in trade, and a substantially wider federal deficit. Even if it were mathematically possible, members of Congress would be highly unlikely to vote for the legislation necessary to make those tax changes.
Tariffs would likely rise under a second Trump administration
Although Trump's all-tariff policy seems unlikely to advance beyond a talking point, Trump should be taken seriously on his more general affection toward tariffs as a favored economic policy. He's said as much for decades. Robert Lighthizer, the U.S. trade representative under President Trump, underscores this point in his new book, "No Trade is Free." During Trump's first term, he implemented tariffs on steel, aluminum, solar panels, and washing machines, in addition to establishing a broader tariff regime on China.
Trump is not the only policymaker focused on tariffs and trade. His proposed policy changes are significantly broader in scope than current policy, but notably, the Biden administration did not roll back higher Chinese import tariffs levied during Trump's first administration. The Biden administration also recently announced higher tariffs on Chinese electric vehicles, followed by similar announcements from European policymakers. Emerging markets countries including Mexico and Brazil have also recently levied tariffs, quotas, and anti-dumping duties on Chinese imports of steel and other items, while many other developed market policymakers are following the U.S.'s lead on inbound investment restrictions and export controls.
Still, should Trump be elected to a second term, he may take broader, more aggressive actions against what he believes to be unfair trade practices by other countries. He has campaigned about hiking the tariffs on China to 60% across-the-board and adding a 10% "baseline" tariff on all other imports.
Economic impact of higher tariffs
Depending on their scope and scale, higher tariffs could hinder growth and stoke inflation, while also helping boost federal revenues: Currently, the U.S. collects about $100 billion in customs revenue, according to the CBO, and this could meaningfully increase under either the 60% China tariff or 10% baseline tariff proposal (although even a significant increase in tariff revenue is likely to have only a modest impact on the overall U.S. fiscal deficit, which the CBO projects to run about $2 trillion this year).
Trump and some of his close advisors have argued that higher tariffs can help close the trade balance, boost U.S. growth, and increase manufacturing jobs - all areas that have been affected by the globalization of manufacturing and the rise in Chinese manufacturing in particular. The U.S. economic effects of decades of increasing import competition are uncontroversial: a severe loss of U.S. manufacturing jobs coupled with lower prices on most consumer and producer goods.
Trump's proposals are extremely broad in both scope and scale, and because they could materially disrupt the supply of goods into the U.S. economy, the short-run economic effects could be painful. The U.S. doesn't currently have the manufacturing capacity to competitively produce what is now a cheap foreign source of goods - manufacturers would need to make significant investments and build capital over time. Implementing policies that would raise the effective tariff rate by almost 20% overnight would likely raise costs for consumers, reduce product choice, decrease competitiveness of U.S. exports in global markets (due to increased production costs and retaliatory levies), and heighten business and consumer uncertainty.
Estimating the magnitude of the economic impact of such a large increase in the effective tariff rate is highly uncertain given the complexities of global supply chains. However, by using some data-based assumptions along with the 2018 experience, when Trump first levied tariffs on China, we can start to quantify the potential outcomes.
For potential inflationary effects, we can make a rough approximation by calculating the hypothetical additional government revenue from imposing 60% tariffs on imported Chinese goods and 10% tariffs on all other imported goods today. This would amount to just under 1.8% of GDP in annualized additional costs, based on census data. How much of this cost would be passed on to consumers? The answer will depend on changes in currency exchange rates, the extent to which these goods can be substituted with potentially less expensive alternatives, and any discounting by foreign producers.
A comprehensive study by Amiti, Redding, and Weinstein (published by the Federal Reserve Bank of New York, link here) of the economic effects of tariffs imposed during Trump's first administration found that producers were able to pass on a majority of the additional costs - in other words, import costs essentially went up 1-for-1 with the tariffs. Other studies found producers tended to be more opportunistic and used the tariffs as an excuse to raise prices by more than the cost of the tariff. If that remains the case, the proposed 60%/10% tariffs could drive inflation over 2 percentage points higher as the 1.8% of GDP cost is eventually borne by U.S. consumers. This would be a one-time price level adjustment rather than an ongoing trend, so the inflationary impact would eventually diminish as prices settle at higher levels.
The 60%/10% tariff policy would also likely hinder U.S. economic growth. The extent of the drag on real GDP growth would depend on the availability of alternative domestic supplies as competitive substitutes and on how much of the tariff's government revenues are redistributed into the economy and where they are allocated.
In general, higher prices would tend to reduce the real consumption of many goods, and make investments more expensive. Building out the domestic manufacturing capital stock would likely require a good amount of imported content, which would also be hindered by the tariffs.
In theory, some of the negative impact on real economic activity could be mitigated if the government were to redistribute the additional revenues generated by higher tariffs - for example, by lowering household and income taxes, as Trump has recently proposed. Indeed, the first Trump administration sought to do this by pairing the Tax Cuts and Jobs Act with its trade policies. Nevertheless, if a second Trump administration manages to redistribute revenues effectively, we would still expect a negative growth impact (what economists call "deadweight losses"), because at least some import substitution (likely away from Chinese producers toward lower-tariffed foreign goods) would limit actual government tariff collections.
Overall, the Trump campaign's proposed tariff policy could be stagflationary. In our analysis, the negative economic impact to consumption and investment would probably overwhelm the potential benefits to domestic industries that the tariff policy is trying to foster and shield.
Implications for the Federal Reserve
Fed policy uncertainty amid the proposed 60%/10% tariffs creates further complexity in judging the ultimate economic and financial market outcomes from this kind of trade policy. The Fed would have to weigh the risk that inflation expectations start to adapt higher in response to another bout of above-target inflation against the potential drag on growth and employment and any financial stability risks.
Depending on how the Fed judges these trade-offs, the so-called second round effects from monetary policy could also be important. For example, an inflationary trade policy that pressures the central bank to keep rates elevated while dragging down nominal growth could squeeze profit margins and tighten financial conditions.
Overall, we believe the Trump campaign's proposed tariff policy is a recipe for uncertainty, volatility, and nonlinear economic effects.
We welcome your questions about the global macro landscape. Don't hesitate to suggest themes or data for us to analyze and discuss: Please email [email protected].
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