On 2 April, President Donald Trump took the market by surprise with the size and extent of the tariffs on US imports he implemented via a presidential order. Global share markets sold off massively. Clearly, investors are concerned by what many regard as a totally irrational policy initiative. Such an emotive topic is best understood through the history of tariffs, expounded by Sandy McGregor, who touches on why they were discarded as an economic tool and why Trump wishes to reinstate them.
Tariffs have a very long history. In Europe they originated in the Middle Ages as a form of taxation to fund state institutions and as a tool to protect domestic production from foreign competition. They act as a stealth tax, which is always more politically acceptable than more visible levies. Tariffs are paid by the importer who then recovers this cost through higher prices paid by the ultimate consumer. Our modern, brutally efficient, tax-collection system is a relatively recent phenomenon. Prior to the 20th century, tariffs played an important role in financing the state because they could be more efficiently collected than other taxes.
Classical economists argue tariffs are economically irrational
Before the end of the 18th century, a mercantilist paradigm prevailed. Gold and silver played the role of what we now call reserve currencies. They were seen as the ultimate store of value. The purpose of trade was to acquire wealth in the form of these metals. Mercantilists believed that tariffs promoted this agenda by reducing imports of goods that could be made domestically. This thinking was challenged by classical economists, such as Adam Smith and David Ricardo, who claimed that far from making a nation wealthier, tariffs had the opposite effect. In 1817, Ricardo published his ideas about comparative advantage between nations. He argued that if each nation applied its scarce capital resources to the activities where they had a competitive advantage, through trade all countries could become wealthier. Consumers would benefit by sourcing their purchases from the lowest-cost producer, and the benefit from buying cheaper would enable other purchases. These ideas gradually gained acceptance, first in England and then elsewhere. In 1842, the British Prime Minister Sir Robert Peel tabled a famous budget which embraced the idea of free trade.
Tariffs are replaced by income tax
Other countries embraced free trade more slowly. The size and activities of government were limited compared to what prevails now. Tariffs met their revenue requirements and were easier to collect than other forms of taxation. However, with the outbreak of the First World War in 1914, government spending ballooned, and new sources of taxation were required. Income taxes and value-added tax (VAT), which have a much larger base than imports on which tariffs can be levied, became the principal source of fiscal revenue worldwide. The United States is an exception in that it does not have a national sales tax and cannot implement VAT for political and constitutional reasons. Accordingly, the US federal government is largely funded by taxes on incomes and profits. In 2024, tariffs accounted for only 1.8% of its revenues.
The end of American isolationism
The concept that America is a fortress protected by two oceans which is a safe and secure haven in a turbulent world has long resonated among the majority of Americans. Disillusion caused by America’s participation in the First World War reinforced this isolationist constituency, a grouping similar to those who have now elected Trump for a second time. In 1930, these isolationists successfully passed through Congress the Smoot-Hawley Tariff Act, which imposed the highest level of tariffs since 1828, when there was an attempt to impose such high tariffs which became known as the Tariff of Abominations. The proponents of Smoot-Hawley claimed it would make America richer and boost employment by replacing imports with domestic production. The outcome was very different. By 1933, tariffs averaged 19.8%. The world was plunged into a tariff war, which decimated global trade and contributed to turning a serious economic downturn into the worst global depression in modern economic history. American exports and imports declined by 67%.
American isolationism continued to be a powerful political force until 1941 when Japan attacked Pearl Harbour. This united the nation in support of the war against Germany and Japan and subsequently in support for America’s global leadership. After the disastrous sequence of events following the Smoot-Hawley Tariff Act, tariffs were regarded as flawed economically and America actively promoted global free trade. Initially, lower tariffs supported American interests because it was the leading industrial power but, in time, the major beneficiaries became Europe, Japan, East Asia and most recently China, which achieved prosperity through growing exports. Globalisation lifted billions of people out of poverty. The American consumer also benefited through a plethora of cheaper and better-quality imports, which reduced the cost of living.
Globalisation’s critics
Globalisation has always had its critics. More recently, a new group of critics has emerged who see the issue from a purely American standpoint. Prior to 1982, the US was largely self-sufficient, running a balanced current account. Before 1966, imports were less than 3% of GDP and while they grew to be 8% of GDP in 1982, there was a compensating expansion of US exports. It was in the 1980s that globalisation as we now know it really took off. A critical catalyst was the widespread abolition of exchange controls, which allowed capital to flow freely across borders. In this environment the US has a unique privilege. The dollar is the world’s reserve currency. Excess savings tend to be held in dollars. For the past 40 years access to these savings has allowed the US to consume more than it produces. Economic policy is like water. It flows downhill by the easiest path. Without recourse to VAT, the US federal government is totally dependent on personal income tax. Voters are hostile to tax increases, so it has become almost impossible politically to significantly increase taxation needed to fund a growing financial burden of welfare and healthcare obligations. As the world was willing to finance US fiscal deficits, it was inevitable that US politicians would take the easy path and condone ever-growing fiscal deficits which the market would never have tolerated elsewhere. Annually this deficit is now running at US$2tn, equal to 6% of GDP. Half of this is financed from abroad with a current account deficit running at US$1tn.
Excess US demand is being supplied by the import of goods running at US$3.2bn annually, equal to 11% of GDP. This is offset by US$2.1bn of exports of items where the US has a competitive advantage and a US$300bn surplus on the service account. The US is now a net importer of many items where it was previously self-sufficient. This includes about half its motor vehicles and 30% of its steel. The American critics of globalisation argue that it benefits other countries at the expense of the United States, allowing foreign competition to erode its industrial base and eliminate well-paid jobs. Accordingly, they demand tariff protection which will promote domestic production and boost employment. This view has started to resonate among middle class Americans who are struggling to make ends meet. While top earners are doing very well, this is not true of the majority. The post-pandemic inflation has had a devastating impact on this middle-income group who collectively are no better off than they were five years ago. It is here that the majority who voted for Trump in the 2024 election are to be found.
Trump’s tariff agenda
Long before he first became president, Trump was a proponent of tariffs and argued that they could be used to recover America’s leading position in industries such as autos and steel. Tariffs would make America great again. He is a mercantilist who believes trade deficits are evil and does not accept the widely held paradigm that tariffs are economically damaging. He is not alone in this regard. Scott Bessent, his secretary of the Treasury, is the member of his administration who is most rationally articulate about why tariffs are a good idea. He says they offer three benefits. Firstly, they can be used as a bargaining chip in negotiations. Secondly, they will generate revenues which will help reduce the fiscal deficit. Thirdly, they encourage domestic production, which will reduce the trade deficit. For Trump who wants everything to be transactional, the first benefit is extremely important. However, for the United States, reducing the fiscal deficit is the strongest argument in their favour. Tariffs can be imposed by presidential order, avoiding the congressional paralysis which blocks tax increases. Currently tariffs are probably the only way the US can significantly increase fiscal revenues which, given America’s bloated fiscal deficit, are desperately needed.
Trump initially used tariffs in his first term as president to conduct a trade war against China, on which a tariff of 20% was imposed. However, China only accounts for 14% of American imports. In 2018, the average tariff charged was 1.6%. In 2021, the year after Trump left office, this had increased to 3.3%. Such a marginal increase did not have a significant impact on the US economy and its trade deficit continued to grow. Perhaps the most important consequence of Trump’s trade policy in his first term was China’s response. It embarked on a massive investment programme to expand and modernise its manufacturing capacity, so that it could reduce its dependence on America. China is now the world’s manufacturing superpower and is flooding the world outside America with goods.
Trump encountered resistance in his first administration to his ideas about tariffs. During his four years in exile, he has had time to brood about this issue and has concluded he should now pursue their implementation far more aggressively. He has appointed a cadre of public officials who are totally loyal to him and will do whatever he asks and is culling public servants who might resist his programme. Bureaucratic opposition has been swept away. Trump is now in a position to move aggressively to implement his tariff agenda.
Liberation Day
Trump revealed his full tariff programme on 2 April, which in his bombastic style he called Liberation Day, so named because he claims the rest of the world has been exploiting American goodwill and that this must now cease. This programme includes:
- A previously announced 25% tariff on imports of motor vehicles, steel and aluminium.
- A standard 10% tariff on all other imports.
- Additional “reciprocal” tariffs on exports from countries which have trade surpluses with the US. These tariffs are not actually reciprocal. They are calculated pro rata to the size of its trade surplus relative its exports to the US, reflecting Trump’s extreme mercantilist attitude to trade.
- A decision to continue the United States-Mexico-Canada Agreement negotiated in his first term with the exception of vehicle imports. This takes some pressure off America’s neighbours.
The biggest surprise was the scale of the reciprocal tariffs, as a consequence of which tariffs on imports from China were to be 54% (later increased to 104%), from the European Union 20%, from Japan 24%, from India 26% and from Vietnam 46%. It was proposed that South Africa, which has mismanaged its relationship with the US, be subject to a 30% duty. The proposed average tariff was about 23%, slightly higher than the notorious Smoot-Hawley tariff of 1930 discussed earlier.
Given the erratic way Trump conducts public affairs it was unclear to what extent the new tariffs could be changed. He has said that “they give us great power to negotiate” and that he was willing to reduce tariffs if other nations offer something “phenomenal”. In this regard, he mentioned China selling TikTok to a US buyer. The problem is that few nations apart from China have anything phenomenal to offer and the Chinese will not make such an offer.
Trump announced on 9 April that the implementation of reciprocal tariffs would be postponed for 90 days to allow bilateral negotiations with various countries.
Trump blinks
Investors were taken by surprise by the scale of the tariffs announced on 2 April. There was widespread consensus that they would push the US into recession and significantly damage global growth. Investors reacted by selling shares. Share prices declined everywhere. The S&P 500 index fell 12%. Initially this did not concern senior officials in the Trump administration, who argued that share prices were high, and their decline would not damage the economy. Their attitude changed rapidly when the panic spread to the bond market. The benchmark US 10-year bond, which had initially strengthened slightly to 3.9%, rapidly sold off to 4.5%. This put at risk one of Trump’s major policy objectives: reducing interest rates. Simultaneously, the administration came under increasing pressure from business to reconsider its proposals. Accordingly, Trump announced on 9 April that the implementation of reciprocal tariffs would be postponed for 90 days to allow bilateral negotiations with various countries. The other tariffs on steel, aluminium and motor vehicles would continue. There would be no change to proposals regarding Canada, Mexico and China. In the case of the latter, tariffs in excess of 100% would continue. The method used to calculate the proposed reciprocal tariffs is so flawed that it is probable it will be replaced by something else. This will depend on the outcome of negotiations. Abandoning reciprocal tariffs means that all goods imported into the United States are subject to a general 10% tariff.
The economic impact of the tariff shock
Given the current value of imports, the initial tariff proposal would have generated about US$600bn of additional tax revenues annually. If reciprocal tariffs are abandoned, this declines to about US$400bn. The US$2tn fiscal deficit would be reduced accordingly. This will be an important step towards stabilising the finances of the US government. The cost will be paid by the consumer through higher prices. Tariffs will be a fiscal tightening equal to 1.5% of GDP. The increased burden on the consumer will be further exacerbated as domestic producers take advantage of the increased cost of competing imports to increase their own prices. The inflationary shock could be more than 2%. As mentioned, Trump’s trip down this road in his first term saw tariffs increase by only 1.6%, which had a marginal impact on prices. The present increase is a very different story.
When Trump announced his new tariffs US economic growth was already slowing, and the disruption caused by the new tariffs will exacerbate this decline. Prices will rise not only due to the direct impact of tariffs, but also because long-established supply chains are being disrupted. Such disruptions were an important contributor to the inflationary shock following the pandemic. Higher prices force consumers to spend more on essentials, reducing funds available for other purchases and the total volume of sales. Motor vehicle sales are particularly vulnerable because about half the cars sold in the United States are imported and are now subject to a 25% tariff. An extremely efficient production system integrating vehicle manufacturing in the US, Mexico and Canada is being shattered. The average car buyer is particularly price sensitive, so higher prices can have a dramatic effect on vehicle sales.
In a mature economy such as the United States, economic growth is driven by innovation and increasing productivity. Essentially, economic growth is making things cheaper by generating savings, which allow the consumer to make additional purchases of other items. Trump’s tariff policy is going to have the opposite effect and in the longer run its cost will be paid in slower growth and reduced incomes. It is a recipe for stagflation. However, while this is damaging, it is ameliorated by the fact that the US is largely a services economy. Services account for 68% of household expenditures. Purchases of durable and non-durable goods are only 23% of GDP. However, adjustments required to accommodate the impact of the tariff shock will still be disruptive. Tariffs will not make Americans wealthier as Trump claims. Reducing the toxic twin fiscal and trade deficits must inevitably inflict economic hardship.
The proponents of higher tariffs believe that they will promote the reindustrialisation of the US. However, domestic production is likely to require higher prices than the imports being replaced, otherwise tariffs would have not been needed in the first place. While there may be some creation of new jobs, modern manufacturing is highly automated, so the impact on employment may be limited. If general tariffs remain at 10% it is uncertain that there will be significant impact on industrial production, but higher tariffs, which have greater impact, are damaging in other ways.
The impact on the rest of the world will be transmitted by a reduction in American imports, which are currently running at US$3.4tn per year. During previous economic meltdowns in 2001, 2009 and 2020 US imports contracted by about 10%. If the tariff shock is equally damaging, we should think in terms of a US$400bn reduction in US imports equivalent to 0.5% of global GDP, excluding the US. This burden will disproportionately impact eastern Asia. Global growth will slow with markets awash with goods previously destined for the US. The US will experience inflation but elsewhere deflation will become the norm.
A persistent theme in American history is that the architects of major tariff hikes stir up popular indignation, as a result of which they lose the next election.
Political consequences
A persistent theme in American history is that the architects of major tariff hikes stir up popular indignation, as a result of which they lose the next election. This happened following big tariff hikes in 1828,1889 and 1930. The Republican Party again faces this danger. The primary concern of voters who gave Trump a majority in 2024 was the high cost of living. He was elected to stop inflation. The Wall Street Journal reports on recent polls which find that 64% of Americans now believe Trump is not focused enough on “lowering prices” and 55% say he is too focused on tariffs. A massive price shock could severely damage Republicans in the 2026 midterm elections, in which they could lose control of the House of Representatives, where they have a slim seven-seat majority. An inflationary recession would transform Trump from a hero to a villain and destroy his political credibility. However, it must be recognised that any attempt to resolve America’s deficit problem will inevitably be unpopular.
When viewed from outside America, these events must be seen as a manifestation of the retreat of American power. The world is splitting into three zones, fortress America, Europe and the rest, which China will dominate. Trump has accelerated this trend. He has galvanised Europe to embark on a significant increase in spending on defence and infrastructure. Europe now recognises it must shake off its American dependence. China is also focused on decoupling from America. These events will accelerate the process by which China is becoming the hegemon dominating the non-American world, which it needs as a source of raw materials and as a market for its growing surplus of manufacturing goods. It is seeking to dethrone the dollar as the world’s reserve currency. The trade wars would support this agenda.
If we are subject to the standard 10% tariff, the new tariff regime should not be damaging… However, if we are subjected to a punitive tariff, our fruit exports will be in danger because we would no longer be competitive.
What of South Africa?
Assuming South Africa manages to negotiate away its reciprocal tariff, it would be subject to the standard 10%. However, there is a danger it will not achieve this. It has long conducted its foreign policy in ways that the US disapproves of, most recently by taking Israel to the International Criminal Court. As the African National Congress (ANC) is unlikely to change its foreign policy to address American concerns, it will be difficult to negotiate a more favourable trade dispensation. The concessions provided by the African Growth and Opportunity Act (AGOA) are unlikely to survive. If we are subject to the standard 10% tariff, the new tariff regime should not be damaging. Our exports to the US are mainly metals, minerals and agricultural products, which the US requires. The US consumer will have to pay the cost of any tariff. However, if we are subjected to a punitive tariff, our fruit exports will be in danger because we would no longer be competitive. Our vehicle exports to the US will be subject to similar tariffs applicable to other countries. However, the future of these exports will be determined by how international car companies restructure their supply chains. In aggregate, SA will lose some of its US export markets, but this should be manageable.
Time to adjust
Although Trump had signalled that he intended to impose draconian tariffs, he seems to be moderating his stance. The market is discounting a significant slowdown in global growth and rising inflation as supply chains are disrupted. Market economies are robust because they adjust to accommodate new circumstances. Given the magnitude of what Trump is proposing, it may take a while for the necessary changes to be implemented. However, in time they will be made, and a new normality will be established.