In his first term, President-elect Donald Trump imposed tariffs on imports of steel and aluminum and on products from China. With his second term set to start in January 2025, Trump has promised to impose additional tariffs on more countries—including the United States’ closest trade partners. At the end of November, Trump announced plans to impose 25 percent tariffs on Canada and Mexico and an additional 10 percent tariff on goods from China. 

With so much talk of tariffs in the news ahead of Trump’s second term, we asked SIS professor Michael Stanaitis to explain how tariffs work, why governments use them, and why economists are concerned about their presence in the US trade landscape.

In action, how do tariffs work, and what do they do? 

Tariffs are taxes placed on imports. They are imposed by the government on companies that import goods. So, technically, tariffs are paid by domestic importers. However, most economists agree that a fair portion of the cost of tariffs is paid by consumers in the form of a higher price for the goods that are imposed with a tariff. So, when Walmart imports a TV from China, it will pay tariffs on that import to the US government, but it will likely retail that TV for a higher price than it would have been if the tariff had not been imposed.  

During his first term, Trump imposed tariffs on China that President Joe Biden left in place during his term. What impact do tariffs have on the US economy, and why do politicians choose to impose them?  

This is a loaded question that deserves its own course. Let's talk about impact first.

The direct effect of tariffs is to make it more expensive for domestic firms to import by raising the price of imports. An indirect effect of tariffs is making it more expensive for households to consume goods that are either imports upon which tariffs are imposed themselves or domestic goods that use tariffed inputs.  

The impact on domestic producers is less clear. On the one hand, economic theory holds that domestic producers should have a greater share of the domestic consumer market since domestic goods are now relatively more competitive. However, many domestic producers in the US manufacture goods for final consumption and thus depend on imports for manufacturing inputs. For instance, ceteris paribus, if the price of imported steel from China increases, it will make it more expensive for US domestic car manufacturers to produce cars, regardless of whether these manufacturers decide to continue importing Chinese steel and pass the expense on to the consumers or switch to sourcing more expensive domestic steel (or less expensive steel from another country). So, there may be a marginal benefit for domestic steel producers, but this will likely be outweighed by the increase in consumer prices. Domestic steel producers may even struggle to add jobs as many US producers are more capital-intensive and thus rely more heavily on automation to ramp up production than a country like China, which is more labor-intensive and relies less on automation.

Politicians conventionally have imposed tariffs to protect domestic producers from foreign competition, often as part of a broader industrial policy that strives to maintain close to full employment in manufacturing. On some occasions, politicians impose tariffs to protect domestic consumers from foreign goods that the domestic government deems harmful or unsafe. Finally, there are instances in which tariffs are imposed for national security interests, particularly to avoid trade in certain industries where the technology can be used for military as well as civilian purposes.  

One interesting departure from conventional usage that Trump exhibits is the willingness to use tariffs as a threat to extract concessions on non-trade related matters. For instance, Trump recently threatened to impose tariffs on Canada and Mexico to compel these countries to help to more seriously address concerns Trump has with migration and drug-trafficking. While it is unclear whether using tariffs as a form of economic statecraft will prove effective, it does represent a departure from conventional US policy and suggests that tariffs might be more of a geopolitical tool than an economic policy for Trump.

How do tariffs impact international trade? Is it common for countries to impose tariffs?

In the aggregate, tariffs should decrease trade by making it more expensive for the US to import goods from certain countries. However, this impact can be expected to be moderate if a combination of US importers and consumers are willing to eat the cost of the tariff or if US domestic producers can adjust supply chains enough to circumvent the tariff. 

From the perspective of foreign producers, it is more difficult to export tariffed goods to the US because US importers have to pay the tariff. Ceteris paribus, the imposition of a tariff should decrease foreign production. However, the global economy is so de-concentrated now compared to 50 years ago that foreign producers can often find a market for their exports in other countries. Also, foreign producers can move the last stage of pre-export production to a neighboring country upon which the US does not impose tariffs, thereby circumventing the impact of the tariff from the production side. In fact, this is something that happened earlier this year in response to tariffs imposed on China by Biden. So, these goods that originate in China can still find their way to the US consumer market, but they made an additional stop along the way. This can be expected in a global economy that exhibits a high level of intra-industry trade, whereby goods for final consumption make stops in several countries along the production process.

In the post-WWII era, it was common for most countries to maintain some level of tariffs as a part of broader industrial policy or to protect key industries like agriculture, which continued to be protected still by many countries today through domestic subsidies. However, particularly since the 1970s, there has been a move led by the US to decrease tariffs. In data going back to 1988, tariffs decreased markedly from 1994 to 2017. Trump represents a departure from this trend, but it remains to be seen what the lasting impact of his policies will be, particularly since Trump seems eager to threaten the imposition of tariffs to extract political concessions. Should Trump be able to extract some concessions, tariffs might not end up being imposed to the extent that has been suggested in political rhetoric.

 What are the downsides of tariffs? What concerns do economists have about tariffs becoming a permanent part of the US trade landscape?

Tariffs increase prices and decrease trade. For economists, this is concerning because there are inefficiencies compared to a more open trading system. The imposition of steep tariffs by the US could also ignite a trade war if those countries decided to retaliate against the US with tariffs of their own.

However, it is important to understand why there seems to be an increased appetite for tariffs in US domestic politics. The neoliberal consensus that has driven globalization since the 1970s has led to economic stagnation for many working-class families in the US, particularly in the industrial areas of the Upper Midwest, that depend on manufacturing jobs. Addressing the economic displacement caused by globalization and free trade is something with which advanced economies around the world have struggled, and this struggle can in part explain the trend toward economic nationalism and democratic decline in Europe and the US. Until this displacement is addressed effectively, we can expect the appetite for things like tariffs to remain high compared to decades ago.

The concern about increasing tariffs now is that they are subject to path dependency and unlikely to benefit the people to whom they are designed to appeal. Once an appetite for using tariffs has been established, it can be very difficult to dislodge that trend. Already the political pendulum has swung away from free trade to the point where the Biden Administration kept Trump tariffs in place from his first administration and increased tariffs on China. 

Furthermore, it is unclear whether the imposition of tariffs will end up helping the US domestic constituencies to which Trump has appealed. In August, the Peterson Institute for International Economics released an analysis showing that the typical American household will be worse off even taking an extension of the Trump tax cuts into account. In the analysis, the only group that has a net benefit is the top one percent of households. So, part of the irony here is that, if imposed, the Trump policy designed to combat the economic displacement of the neoliberal consensus of the past 50 years will largely end up reifying it in terms of its economic impact on US households, thereby further increasing economic inequality.