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Tariffs back in the spotlight
As the 2024 election season continues, trade policy and tariffs could again become a key driver of heightened macro uncertainty. Regardless of which presidential candidate prevails, the US appears poised to maintain a protectionist stance toward China. We expect Chinese investments into the US will continue to be scrutinized, tariffs will persist for the foreseeable future and could rise even further, and export controls and investment restrictions on key industries in China will likely stay in effect.
Most of the tariffs implemented by former President Trump during the 2018-19 trade dispute – including 25% tariffs on approximately $250 billion of imports from China and 7.5% tariffs on approximately $112 billion of Chinese imports – remain in place today under President Joe Biden and continue to have an impact on the US economy. The Tax Foundation estimates that tariffs will reduce long-run GDP by 0.21%.
Furthermore, President Biden recently imposed new tariffs on Chinese imports in several strategic sectors, including electric vehicles (the tariff rate will increase from 25% to 100% in 2024), semiconductors (from 25% to 50% by 2025), advanced batteries (from 7.5% to 25% in 2024), solar cells (from 25% to 50% in 2024), and steel and aluminum products (from 0-7.5% to 25% in 2024). However, with only $18 billion of Chinese imports affected by these new tariffs, the macroeconomic impact is likely to be minimal and the US administration’s move is more symbolic and preventive.
In general, higher tariffs lead to higher prices on US imports, pushing consumer prices higher and weighing on business and consumer spending activity. Moreover, targeted economies tend to retaliate with their own form of trade barriers, which would weigh on US exports.
Researchers at the National Bureau of Economic Research showed that the costs of the higher tariff rates implemented by the Trump administration in 2018 were largely passed through as increases in US prices, affecting domestic consumers and producers who buy imported goods, rather than foreign exporters.
Scenario analysis: ‘trade dispute 2.0’
While we expect both presidential candidates will continue to pursue more protectionist policies, recent campaign trail statements indicate a second Trump presidency could result in a more substantial escalation in trade tensions between the US and China.
To gauge the risk to the US and global economy, we built a scenario using Oxford Economics’ Global Economic Model. We assumed that former President Trump imposes 60% tariffs on China and 10% tariffs on all other major trading partners starting in 2025, in line with his recent proposal. We then assume that the rest of world responds with tariffs of the same magnitude, consistent with the immediate retaliations from key trading partners observed during the 2018 trade dispute. Our analysis does not account for other potential policy changes, including tax reform or increased or decreased government spending.
1. A significantly constrained US economy
The immediate imposition of such tariffs would constrain US real GDP by 1.2ppt in both 2025 and 2026. The peak impact would be reached in Q2 2026, when the level of GDP would be 2.4% lower than the baseline. It is worth noting that if tariffs were imposed more gradually starting in 2026, the peak impact would be felt in early 2028.
As tariffs rise substantially, businesses face higher costs that they mostly pass on to consumers. Growth slows rapidly as inflation rises, and real households’ incomes are squeezed as businesses scale back their hiring and wage plans.
In this scenario, real disposable income would be $150 billion lower in 2025, representing an average loss of $1,145 per household. Importantly, the impact wouldn’t be felt evenly across the income distribution as the effects of tariffs tend to be regressive and impact lower-income households more negatively than higher-income households.
While households in the top income quintile stand to lose 0.7% of their real disposable income in this scenario, the burden for households in the bottom quintile would be more than twice as large at 1.6% of real disposable income.
2. A true stagflation risk
The inflationary impact of additional tariffs is a key source of concern given the persistent inflationary pressures. We find that the substantial increase in tariffs would generate a significant inflationary impulse with the overall rate of consumer price inflation a full percentage point higher by Q4 2025.
An acceleration in inflation along with depressed private sector activity would raise the risk of stagflation, a period of economic stagnation combined with elevated inflation. Ultimately, the extent to which companies can pass on these higher costs onto the consumers will determine the tariff impact on inflation. The inflationary shock could be smaller if companies were to absorb some of the cost increase via reduced profit margins.
3. Significant global economic impact
Real global GDP growth would be curbed by 0.5ppt in 2025 and 0.9ppt in 2026, pushing the global economy into a recession. Some of the hardest-hit economies include China, where real GDP would be reduced by 1.3ppt in 2026, and Mexico and Canada, where real GDP would fall 1.5%-2% below the baseline.Without a sudden increase in individual income taxes in 2026, households would benefit from higher after-tax income, which would in turn support increased consumer spending. Using the Oxford Economics’ Global Economic Model, we calculate that a full extension of the TCJA would boost real GDP growth by 0.5 ppt in 2026 and 0.4 ppt in 2027 compared to a fiscal cliff scenario (see Figure 2). The real GDP level difference versus a fiscal cliff scenario would peak at 1.1% in early 2027.
Importantly, assuming the Fed reacts to modestly higher inflation in this scenario by easing monetary policy less rapidly, the boost to real GDP would be mildly lower. In this scenario, the 2026 effect would be largely unchanged, but the peak impact would reach 0.9% of GDP in early 2027, and the boost to real GDP growth in 2027 would only be 0.2 ppt.
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Read more4. A toll on private-sector confidence
Higher tariffs would also undermine corporate and household sentiment. In 2018, consumers and businesses showed increased worries about the outlook and scaled back future spending and investment intentions. US companies were particularly concerned about the impact of tariffs on their supply chains and input costs.
An escalation in US-China trade tensions could also weigh on investor sentiment and risk asset performance, including emerging market (EM) assets and currencies. In 2018, the tariffs imposed by the Trump administration and rising prospects of a protracted trade dispute with China fueled a significant stock market correction as the S&P500 index fell nearly 20% in the last quarter of the year.
Previous tariffs implemented by President Trump also coincided with a 9% appreciation in the broad trade-weighted US dollar. Emerging markets (EM) in particular bore the brunt of the US-China trade tensions as the shift in investor sentiment led to an increase in safe-haven flows. This put EM currencies under pressure while supporting both the dollar and Treasuries. Researchers from the NBER estimated that around 22% of the dollar appreciation and 65% of the renminbi depreciation observed in 2018-19 could be attributed to the tariffs implemented by the US.
From an economic perspective, a stronger dollar puts downward pressure on import prices, providing some offset against the potential boost from tariffs to consumer prices. The stronger dollar would however represent a headwind for exporters whose competitiveness would decrease in global markets.
The views reflected in this article are the views of the author(s) and do not necessarily reflect the views of Ernst & Young LLP or other members of the global EY organization.
