Trump tariffs explained: what’s the potential impact?

President-elect Donald Trump has told us all that “tariff” is one of his favourite words. He used tariffs to try to get deals in his first administration. China was often singled out for especially strong treatment. Successor President Joe Biden continued with some of that approach. Markets worry that more tariffs will damage trade and push up inflation. So, how far can he –and will he – go?

Why does President Trump want tariffs?

President Trump sees international affairs as a set of deals between the US and others which he wants to use to advance US interests. This entails trying to onshore more economic activity into the US, as well as favouring peace in Ukraine and the Middle East and seeking to reduce migration. Tariffs have three main functions in this view of the world.

The first is tariffs are seen as a good way of damaging an enemy or seeking change from another country in their harmful policies. Trump will threaten Mexico with tariffs unless they police their borders with the US. He will use tariffs and trade bans against Iran and China to cut their military capacities.

The second is that tariffs are seen as a way of making home production more competitive. Where the Democrats might favour offering subsidies or other favours to domestic manufacturers, Trump is more likely to impose an additional cost on foreign competitors by levying a tariff on their goods. Overseas companies might decide to assemble or make more in the US to avoid tariffs.

The third is tariffs bring in revenue to the US state. The more he collects in tariffs on foreign goods, the less he needs to collect through taxes on US workers and consumers. It helps with his difficult budget arithmetic.

What harms do tariffs do?

Tariffs create three main harms. The first is they raise the price of goods where there are no available import replacements, or where the imposition of a tariff allows domestic producers to charge more. They are seen by bond markets as inflationary.

The second is they are, in effect, a tax on US consumers as well as a tax on overseas producers, limiting the real income gains he wants from his strategy.

The third is imposing tariffs annoys other trading nations and leads to retaliation. A tariff war will boost prices and cut output worldwide, making everyone on average worse off. Individual countries may persevere with higher tariffs, hoping they can gain a relative advantage despite the overall hit to world activity.

Can a president impose tariffs under US law?

If the president has the support of Congress, then he has the power to do as he wishes, with or without some amendment to the law. If the Democrats in Congress have enough votes with a few dissenting Republicans, on precedent the president still has considerable powers.

There is Section 232 of the Trade Expansion Act 1962 to impose tariffs for national security. There is Section 301 of the 1974 Trade Act to take retaliatory action against unfair trading practices by others. There are the Emergency Economic Powers Act and the Tariff Act which might offer other routes.

The courts might take into account that tariffs are a key plank of a democratic programme approved in a recent election. Those affected by his tariffs will likely take legal advice and see if they do have a good case to stop him through court action

World trade rules on tariffs

The US and the UK set up the General Agreement on Tariffs and Trade in 1948 with 21 other countries. It expanded greatly and through successive negotiating rounds lowered tariffs on goods substantially over the years. The GATT was incorporated into the World Trade Organisation (WTO) in 1995, giving it an expanded secretariat and more ability to make enquiries into conduct and to seek enforcement of its rules for members.

GATT rests on three main rules. The first is that a member giving a tariff or other concession to any other member must give it to all members. This is the “most favoured nation status” which all WTO members enjoy with each other. The second is the setting of maximum tariffs for all through negotiation by product. The third is the national treatment clause which says once a good is imported into a WTO member it must be treated exactly the same as nationally produced items. Emerging market economies have gained some exemptions from the general rules.

Can WTO enforce against Trump tariffs?

To stay within WTO rules, the US will have to argue there are national security or unfair trading reasons by other countries for imposing the extra tariffs. There are safeguard clauses allowing emergency actions by states. Agriculture is treated differently to other goods allowing more protection.

If the US is found to have broken the rules, the WTO empowers the adversely affected members to impose retaliatory measures on US exports to a similar level of impact. Countries can stay in the WTO even where they are accused of breaking rules or have a finding against them.

President Trump could also get fed up with seeking to satisfy the WTO. Any member can withdraw from the Treaty having given six months’ notice. This would be damaging to the fabric of world trade regulation but would free him to do as he wishes. There is no current suggestion he wants to do this.

Will there be US tariffs on the UK?

The UK is now in charge of its own trade policy, so it is free to negotiate its own bilateral deal with the US. The US is the UK’s largest single trading partner and there have not been many dispute issues between the two in recent years.

There is no guaranteed carve out of the UK from the general policy of a tariff imposed on all. If this goes ahead – and if UK diplomacy is unable to do a special deal – then UK exports will take a modest overall hit.

The UK does not have to retaliate, making UK imports more expensive and boosting UK prices. The UK has the benefit that its exports are heavily oriented towards services which are not targeted with tariffs. However, items such as whisky could be in the firing line.

What could be the impact of Trump’s tariff plan?

As tariffs are expected to be a major instrument of diplomacy in the Trump administration there will be substantial changes, with threats of high tariffs in some cases replaced by deals over matters of policy with other countries. The president is likely to want more and higher tariffs overall as part of his policy of raising extra revenue and promoting US manufacturers. China is likely to be the object of the most serious tariff threats.

We are probably going to end up with some adverse impact on prices and overall world trade, but not on a scale to derail US growth or to threaten materially higher inflation. This was what happened under the first Trump term in office. The price effects will also be partially offset by the drill baby drill policy seeking to keep oil and gas prices down. President Trump campaigned strongly against inflation, so he and his advisers will be aware of the dangers of excessive tariff-induced price rises.

Read more: What will the Trump presidency do for markets?