What Economists Got Wrong on Tariffs

Bloomberg

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00:00Credit where credit's due, President Trump made a big bet that the U.S. had a magnetic appeal,

00:08and that would enable him to get a better deal from U.S. trade partners and companies that want

00:15to do business in the United States. On the evidence of the last few months, that bet is

00:21playing out pretty nicely. Did the economics profession get it wrong on tariffs? Or is the

00:29impact just delayed? Economists don't agree on much. One thing they do agree on is that free trade

00:43is good and that tariffs are bad. If we were to trace U.S. tariffs over the last, let's say,

00:51100 years or so, there's our axes. From the end of the 19th century into the start of the 20th,

00:59tariffs were on a declining trend. Get to 1930, and we get the infamous Smoot-Hawley Act,

01:05that most economists believe contributed to and deepened the Great Depression. From that

01:11point on, we have a continuous decline in the average U.S. tariff rate, till Trump started

01:17his second term. He's jacked it all the way up to around 15 percent.

01:21For a moment, Trump escalated U.S. tariffs on China all the way to 125 percent. If you plugged

01:33the U.S. tariffs into a model of the global economy, what it said was that there was going

01:38to be a really significant drag on growth, and there was also going to be a significant

01:44upward impulse to prices. And low growth and high prices is a challenging state of the world,

01:53which economists call stagflation.

01:58Markets panicked. Let's look at the S&P 500. It looked like this. If we looked at a chart

02:05for economists' forecasts for inflation, we've got the Covid bump in inflation, we've got

02:11prices coming almost back down to target, but then, oh dear, President Trump's introduced

02:16his tariffs, and we get another inflationary bump. But when we look at what's happened

02:20to inflation over the summer, it's not come down, but it's not come up either. That inflationary

02:27bump from tariffs that the Fed was focused on as a risk before they cut interest rates, it

02:33hasn't materialised, at least not yet.

02:38We looked at lots of the different things which people in the United States buy every

02:43day. If tariffs were being passed on to consumers, we'd see a pretty tight relationship. In fact,

02:49what's happening is there doesn't seem to be a very strong relationship at all. U.S. firms

02:56are facing higher costs for their imports. So far, though, they're not passing those higher

03:01costs onto consumers.

03:05Why is that? Well, it's because U.S. importers and foreign exporters saw the Trump tariffs coming,

03:14and they rushed to front load, shipping to the United States before the tariffs could come

03:20into force to build up cheap inventories that they could then sell down after the tariffs came

03:27into place. If we look at a chart of U.S. imports, what we see is that in the first months of 2025,

03:34imports weren't exactly off the scale, but they were significantly higher than they had been in the

03:41same months in 2024 and the average of past years.

03:45One thing that's happened is that we've gone from a lot of unexpected bad news concentrated on a single

03:59day to a series of country by country deals, some of which brought good news relative to the previous

04:07status quo. We have U.S. allies like Japan and Korea, which are scrambling to make offers to the United

04:16States, promising hundreds of billions of dollars to help rebuild U.S. manufacturing as a price to

04:24retain access to the U.S. market. They're something of a Swiss cheese of exemptions and carve-outs. And

04:32smaller tariffs obviously have a smaller impact. The trade war is a drag, but it's not the only thing

04:42which is happening. We've got tax cuts with Trump's one big beautiful bill, and we've got a bonfire

04:49of regulations which is stoking the animal spirits of U.S. businesses.

04:54We've also got the artificial intelligence boom, and a huge amount of investment going into data

05:03centers. AI and the trade war kind of point in opposite directions, and investors are paying much

05:12more attention to the potential for AI to be a significant profit driver. Certainly it seems like

05:18there's enormous potential with artificial intelligence. At the same time, the international

05:24monetary fund and other economists are warning that the markets have got a bit over ahead of

05:29themselves. There's irrational exuberance. If markets have a moment where they lose their confidence,

05:36that can only mean one trajectory for stocks downward.

05:44There are signs of weakness showing up in the U.S. economy. We've gone from a labor market

05:51comfortably creating 100,000 or more jobs every month to barely expanding, and in some months,

06:00the number of jobs shrank. So a concern here is that, well, when the tariffs do start to hit,

06:07they're going to be hitting an economy where the labor market's already weak and potentially amplifying

06:13that downward trend. China, which views itself more as a peer competitor to the United States,

06:21they've turned up with their own leverage. You impose tariffs on us, we're going to impose tariffs

06:27on you. You block our access to semiconductors, we'll block your access to rare earths. And we're

06:34seeing the impact of that really clearly in the trade data. China's exports to the United States

06:40are way down relative to where they were last year, way down relative to the historical trend.

06:47So who pays for the cost of tariffs? We're seeing U.S. firms absorbing tariffs in lower profit margins.

06:59Why might that be? I can think of two reasons. The first is no one wants to be the first to raise

07:06their prices and lose market share. The second, and this is more speculative, is no one wants a vengeful

07:15U.S. president. But despite his well-known love of gold, the president is not an alchemist.

07:22He can't make something from nothing. That money has to come from somewhere.

07:29And if the U.S. Treasury is looking forward to three trillion dollars in tariff revenue over the next

07:35decade, all of the evidence so far suggests that in the end, the bulk of it is going to come from U.S.

07:43businesses and U.S. households.

07:49One way of thinking about this second Trump presidency is that it's an innovative approach

07:55to managing the fading of America's imperial moment. America was the world's single superpower. In 2025,

08:05that's clearly not the case. Trump is attempting to use that last moment of strength to get a better

08:13deal. Will President Trump succeed in reigniting the flame of American pre-eminence? Or will he just

08:21hasten the end? I think on that question, the jury is still out.

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