The Global Impact of a Protectionist US Trade Policy

Since the election of Donald Trump, there has been a growing danger that U.S. trade policy increasingly relies on protectionist measures. The aim of this policy is to secure jobs and income in its own country. In reality, however, protectionist measures mean that the weakening of international trade triggered by the U.S. is leading to a loss of income worldwide, especially in the U.S.

How does an import tariff work?

The simplest means of protection against foreign products is an import tariff. This means that products imported from abroad are subject to a levy. This increases the price of a foreign product in the country that imports this product. A country that imposes such levies on foreign goods and services is aiming to protect domestic companies from competition from abroad. The domestic companies can then sell more products at home. This increases domestic employment and income – or so it is hoped.

However, in reality, these objectives cannot be achieved by isolating the domestic economy. On the contrary: if, for example, the U.S. imposes import duties on foreign products, this increases the prices of imported consumer goods and intermediate products and services. The result is a rise in the price level in the U.S. and thus an increase in production costs. This deteriorates the international competitiveness of the U.S. economy and thus reduces U.S. exports.

These and other consequences can be demonstrated by a simple example. Let’s say that the U.S. applies a higher import tariff to all Canadian products. This would result in several economic consequences for Canada, the U.S. and the rest of the world.

Consequences for Canada of a U.S. import tariff on Canadian products

If the U.S. imposes a higher import tariff on goods and services imported from Canada, this would mean that Canadian products in the U.S. would be more expensive. American consumers would therefore reduce their demand for Canadian products. For Canada, this would mean lower demand. Canadian companies would adapt to the lower level of demand. They would reduce their production and in turn their employment. The result would be a decline in the gross domestic product (GDP) and income in Canada.

The economic slowdown would have an impact on the U.S. economy. The drop in income in Canada would mean that Canadian consumers could buy less goods and services. The decline in consumer spending would also relate to goods and services from the United States. American exports to Canada would therefore decrease. The result would be a decline in production, employment and income in the U.S. (see Fig. 1).

Consequences for the United States of a U.S. import tariff on Canadian products

In addition to the outlined repercussions on U.S. exports, a U.S. import tariff on Canadian goods and services would have further implications for the U.S. economy (see Fig. 2):

• American consumers would have to pay a higher price for products that continue to come from Canada. This would reduce their purchasing power and real income. Because of the lower purchasing power, the demand for U.S. products would fall. Therefore, production, employment and income would decline in the U.S.
• American companies that purchase intermediate products and services from Canada would also have to pay a higher price for these products. As a result, production costs would rise and international competitiveness would fall. The consequences would include a drop in U.S. exports and thus a decrease in production and employment.
• Some sectors, however, could experience positive production and employment effects. This applies to sectors that are not competitive without the import tariff imposed on Canadian suppliers and that would become competitive again after the import tariff has increased prices for Canadian products. However, this would also lead to an increase in price levels in the U.S. because American companies could only sell these products at a higher price due to the increased production costs.

Finally, it is important to note that tariff revenue increases the income of the American economy. If the state spends this revenue on American goods and services, production and employment would increase in the U.S.

It is not possible to say with certainty whether net income and employment would rise or fall in the U.S. because of the contradicting developments outlined above. However, the growth-dampening effects (reduced purchasing power of U.S. consumers, decline in international competitiveness of U.S. companies, fewer exports to Canada) are likely to outweigh the growth-enhancing effects (restoration of competitiveness among certain U.S. sectors, additional state revenue through tariffs). This is especially true if the dynamic effects of economic isolation are taken into account: If the competitive pressure in the US were to subside because of reduced Canadian competition, US companies would be less compelled to increase their own international competitiveness through higher productivity. In the long term, this would be detrimental to American economic growth.

Consequences for third countries of a U.S. import tariff on Canadian products

Third countries such as Germany would be affected by an American tariff on Canadian products (see Fig. 3):

• If German consumers buy U.S. products, they would have to pay a higher price because of the general price increase in the U.S. This would weaken real income in Germany and thus have a negative impact on demand and production in Germany.
• Production costs would increase for German companies that need American intermediate products. This would lower the international competitiveness of these companies and reduce German exports to the rest of the world.
• Furthermore, German exports to Canada would decrease because the decline in Canadian real income or Canadian GDP would reduce demand for German products.

At the same time, German exports to the U.S. would increase. This would happen if Canadian products were no longer competitive because of the import tariff in the U.S. and American consumers switched to German products instead.

On balance, production, employment and income in Germany could even rise due to the American import tariff on Canadian products: If Germany imports only relatively few products from the U.S., the associated price increase would be of little consequence. If, however, the additional exports to the USA are relatively high, the resulting positive production and income effects could more than offset the outlined negative effects of this import tariff.

Conclusion and outlook

Even the direct and indirect effects of a single trade-restricting measure – a one-sided U.S. import tariff on Canadian goods and services – have far-reaching implications for the entire global economy. If the U.S.’s protectionist measures were directed against several countries or even the rest of the world, all the countries concerned would suffer even more from the negative economic effects outlined.

The magnitude of the loss of income for the global economy will depend on the extent of the protectionist measures taken. The following aspects are decisive: How high are the import tariffs? Will non-tariff trade barriers also be increased? And if yes: How much will they be increased by? How many countries will be targeted by the protectionist measures: only a few or the whole world? And how will the affected economies behave? Will they respond with protectionist measures of their own in retaliation against the initiator of the trade restrictions?

In order to provide answers to the global impact of a possible protectionist U.S. trade policy, the GED Project will next week publish a study in which we present various scenarios of a protectionist trade policy in the United States.