US President Donald Trump’s second administration coincides with a period of rapid structural and technological change, driven by three trends. First, shocks from the COVID-19 pandemic, new wars, climate change and geopolitical tensions continue to reverberate through the global economy. At the same time, broader secular trends continue to inhibit growth and create new inflationary pressures. Those trends include rising emerging-market income levels, aging in countries that account for nearly 80 percent of global GDP, labor shortages, declining productivity and other factors that reduce the elasticity of the supply side of the world economy.
Lastly, scientific and technological breakthroughs are transforming a wide range of sectors, from digital services and biotech to energy. In each case, progress is driven by the arrival of powerful technologies and tools whose costs are dropping like a stone and hence are increasingly accessible to a global community of innovators. Artificial intelligence (AI) is already having a large and growing impact in the sciences, as last year’s Nobel Prizes in physics and chemistry highlight. Although the macroeconomic effects are not yet large, that could change fast. Many expect AI to drive a sustained surge in productivity over the next decade.
Those trends are dramatically changing the global business and policy environment. Resilience and national security have become top priorities. Supply networks are evolving rapidly. Inflation has become a major issue for the first time in three decades. And all of that was happening before Trump’s return to the White House.
Illustration: Constance Chou
The era of global interdependence driven entirely by efficiency, comparative advantage, economically rational international specialization and private-sector investment is over. Something different is emerging, and precisely what it would look like is not yet clear, especially now that the Trump administration has created so much additional uncertainty.
Growth is expected to slow significantly in the US and internationally. Trump’s tariffs have led corporations to cut back drastically on planned capital expenditures. Consumer confidence is falling fast, and inflationary pressures are rising along with expectations. The US administration has even come out and acknowledged that some short-term pain might be necessary to achieve its objectives. The question now is just how short the term would be.
The Republican-controlled US Congress is facing a tidal wave of issues all at once. While many want it to reassert its constitutional authority over matters such as tariffs, foreign aid, the federal payroll and the disposition of executive-branch entities such as US Agency for International Development and the US Department of Education, it has so far allowed the president to do whatever he wants.
In terms of domestic policy, everyone understands that significant, even radical, deregulation is on the agenda, and many would welcome measures to cut red tape, simplify processes, and promote dynamism and growth. However, there is good reason to worry that the policymaking process would be indiscriminate and haphazard, inflicting unnecessary collateral damage. The strategy for cutting federal government employment, for example, has been to fire large numbers of people and then hire them back if something breaks.
Although Trump’s blizzard of executive orders looks chaotic, the administration might well be pursuing a larger strategy, designed to dilute and weaken potential opposition. Trump and others in his administration have repeatedly said that bilateral trade deficits are signals that something is wrong — that the US is being taken advantage of, to the detriment of American industries and national security. Needless to say, that is not a perspective that one would gain from a course on international trade.
Among the top US trading partners with the largest bilateral surpluses (based on 2023 data) are China (US$279 billion), the EU (US$209 billion), Mexico (US$152 billion), Vietnam (US$104 billion), Japan (US$71 billion) and Canada (US$64 billion, owing entirely to US energy imports). The four of those targeted by Trump’s initial tariffs — Canada, Mexico, the EU and China — account for 66 percent of the overall 2023 US trade deficit (US$1.06 trillion). If you add in Japan and Vietnam, that figure grows to 83 percent.
The “Liberation Day” tariffs are broadly consistent with the targeting of large deficit trading partners. The new tariff rates for China, the EU, Vietnam and Japan are 34 percent, 20 percent, 46 percent and 24 percent respectively, and Canada and Mexico would remain on a separate track for now, with high tariffs on autos, steel and aluminum.
However, the April 2 tariffs go far beyond targeting trading partners with which the US runs large deficits. Instead, the administration is applying a 10 percent rate across the board, including to countries with which the US has a trade surplus. Moreover, the Trump administration imposed additional tariffs above 10 percent on a wide range of small economies that have minimal effects on the US trade balance, although the main Latin American economies (apart from Mexico) were exempted.
The financial market reaction was immediate. In the two trading days after Liberation Day, the S&P 500 declined by US$5 trillion, or roughly 10 percent. Business and consumer confidence continued their downward trends, and markets outside the US also generally declined, reflecting the dominance and outsize influence of US financial markets. China responded with its own 34 percent tariff on US imports, and others are considering retaliatory measures. With market and economic uncertainty deepening, expectations of a recession have grown.
That said, the economic impact is likely to be largest in the US and in those trading partners with the greatest exposure to US demand. Since the US economy accounts for about 26 percent of nominal global GDP, or 15 percent to 16 percent when adjusted for purchasing power parity, ringfencing it would deliver a large shock to the entire system. While every country would face tariffs on exports to the US, there would be varying degrees of exposure: medium for China, fairly high for Vietnam, and very high for Mexico and Canada. Fortunately, other countries still have the rest of the world to sell to and the rest of the world is not small.
By contrast, US consumers and companies would face inbound tariffs on everything from every other country in the world. Companies would likely also face higher “reciprocal” tariffs when they try to access external markets and major countries might restrict outbound foreign direct investment (FDI) to the US, partly defeating one of the Trump administration’s stated purposes for US tariffs.
In other words, while the economic damage would be widespread and variable across countries and regions, the largest impact is likely to be on the US, owing to its growing isolation from the rest of the global economy.
Do US economic policymakers understand that asymmetry? It is not clear whether the Trump administration believes that tariffs would lead to a rebalancing of trade, or whether they are designed to impel trading partners and businesses to shift production and jobs to the US. Trump himself supports FDI as a way to support his agenda on deficits and employment, and tariffs presumably add another incentive. In the 1980s, then-US president Ronald Reagan restricted Japanese auto imports (using quotas instead of tariffs) to encourage Japanese auto giants to invest in US manufacturing and assembly. In the event, that is what they did.
Whatever one thinks of the administration’s diagnosis and prescribed treatment, its goal is clear: to shift the structure of global trade and FDI in favor of domestic US manufacturing and employment. However, that agenda faces a powerful headwind, owing to the global attractiveness of US debt and equities, and the status of the US dollar as an international reserve currency. Unless it intentionally diminishes the attractiveness of dollar-denominated assets, which would require a partial closure of the capital account, the dollar’s reserve currency status is unlikely to change.
Perhaps the US is targeting not just trade, but also more recondite aspects of capital account management (such as exchange rate and reserve accumulation policies) in various countries. Some members of the administration do seem to understand the nature of the challenge. Council of Economic Advisers chair Stephen Miran has written in detail about the “narrow” corridor for achieving such a restructuring without incurring excessive collateral damage to US growth, employment, and international stature and influence.
However, there is no plausible alternative to the current system. A growing global economy needs an expanding monetary base to function. Rather than reducing its US$1 trillion trade deficit, the US is more likely to redistribute it across countries, which probably would not lead to the kind of domestic restructuring that Trump envisions.
Whether the administration’s policies are inflationary is a more difficult question. In the short run, costs and prices can be expected to jump. However, inflationary pressure stems from a persistent tendency of demand to exceed supply across sectors. Tariffs, including retaliatory measures, would certainly add costs and reduce supply elasticities immediately, but Trump’s deregulatory agenda would push in the opposite direction. The negative effects on growth and on business and consumer confidence would reduce domestic aggregate demand and foreign demand would fall off, too. Thus, there are too many variables in play to make confident predictions about longer-term inflationary pressures.
Trump’s aggressive bilateral approach to trade (and foreign policy more broadly) has its own consequences. Longstanding US allies are reeling. The Canadians have relatively few defenses, other than defiance and reciprocal tariffs and European leaders have concluded that the US is no longer a reliable guarantor of the continent’s security. European defense expenditures are now poised to grow, and that might also help the EU to move to close the digital technology gap that has opened between it and other major powers.
China, with its large domestic economy, can withstand tariff shocks. It already needs to boost domestic aggregate demand, and it would surely see the Trump administration’s defunding of basic science and technology research at US universities as a windfall, given the damage that it would do to the US’ long-term competitiveness.
More broadly, the loss of trust between the US and its former friends and allies would reduce Washington’s options for collective action in the future. Since the Trump administration has no interest in multilateral approaches, many multilateral institutions might be reconstructed over time with sponsorship from Europe, China, and various emerging markets and developed economies.
That brings us to the last big issue. Academics have long shown that previous rounds of digital technology adoption put downward pressure on middle-class “routine” jobs and incomes. Whether that would be a feature of the adoption of AI in the coming years remains an open question. While no one has a detailed roadmap for how that would play out, it is reasonable to expect that the effects could be as large as, or larger, than those associated with the new global patterns of trade and investment.
If the Trump administration has a strategy for managing that job-related technology challenge, it has not revealed what it is. Yet it would be a mistake to assume that restructuring international trade and investment would be sufficient to benefit US workers. There are other factors in play and policymakers ignore them at their peril.
Michael Spence, a Nobel laureate in economics, is emeritus professor of economics and a former dean of the Graduate School of Business at Stanford University, and a coauthor (with Mohamed El-Erian, Gordon Brown and Reid Lidow) of Permacrisis: A Plan to Fix a Fractured World.
Copyright: Project Syndicate
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