The Compounding Errors of Trump Trade Policy

The combination of a China penalty and a global "minimal" tariff rate of 10% is inherently unstable.

There is an inherent flaw in US President Donald Trump’s trade policy. The combination of his global tariff and China strategy poses great danger. It is likely to have a destabilizing impact on the US and Chinese economies, with worrisome collateral damage on the world at large.

Of course, it is next to impossible to know where Donald Trump will settle on any policy pronouncement — from economics and taxes to foreign affairs and immigration. But on trade policy, two key objectives are now coming into focus: the intention to put a minimal floor on tariffs for all of America’s trading partners while, at the same time, imposing a special penalty on China. The danger arises from the combination.

For the sake of argument, consider the possibility of a 10% tariff rate as America’s new minimal norm — in the words of the White House’s May 12 fact sheet, a “fair baseline that encourages domestic production, strengthens our supply chains and ensures that American trade policy supports American workers first, instead of undercutting them.” President Trump has been quite vocal in stressing the political rationale for such a baseline as America’s just compensation for having been “ripped off” for decades by the unfair trading practices of other nations.

Never mind the dubious validity of that rationale in ignoring the benefits the United States has received from trade — not just cheaper goods and expanded consumer purchasing power but also the foreign capital inflows that subsidize US interest rates which, in turn, provide support for financial wealth creation. Trump, instead, is fixated on the costs of trade, namely the carnage that purportedly arises from seemingly chronic trade deficits, especially the hollowing out of a manufacturing sector that once made America great.

Rather than attempt to resolve this contentious argument, consider, instead, the significance of going from an effective US tariff rate that has averaged just 1.8% over the past thirty years (1995 to 2024) to a new minimum floor of 10%. While the resulting 8.2 percentage point increase is only slightly larger than the 6.3 percentage point increase in effective tariffs that occurred from 1929 to 1933 following enactment of the infamous Smoot-Hawley Tariff Act of 1930, a new 10% tariff floor would represent about a five-fold increase from the low tariff regime of the past three decades. As the chart below shows, that five-fold multiple is well in excess of the 47% increase of Smoot Hawley tariffs, which, of course, occurred off a much higher base.

Moreover, the imposition of this new tariff norm would hit the US economy when goods imports amount 12.2% of GDP (in early 2025), nearly three times the 4.3% share of 1929. In other words, there is nothing minimal about Trump’s concept of a 10% tariff floor — it represents a major shock to the US economy.

A second key ingredient to Trump trade policy is the likelihood of an added penalty on China. Currently, the China premium is twenty percentage points — a China tariff of 30% versus the 10% tariff rate on all other nations. Inasmuch as most of that premium appears to be fentanyl-related, there is the mathematical possibility of a significant narrowing of the China penalty if the two nations were to come to agreement on restricting Fentanyl precursor chemicals.

I wouldn’t count on a mathematical solution to US trade strategy problems. Even in the event of a breakthrough on Fentanyl, both the White House and the Congress believe that China needs to be hit with a special penalty. After all, according to the Washington consensus, China is the major culprit behind America’s gaping foreign trade deficit, guilty of a wide range of unfair trading practices — especially, intellectual property theft, forced technology transfer, and subsidized, non-WTO complaint industrial policies. Moreover, increasingly vilified as America’s principal foreign adversary, a China is also being penalized on national security grounds.

My arguments that many of these allegations are based largely on false narratives have fallen on deaf ears. Rather than face up to problems that are partly of our making, the politics of external blame are apparently far more expedient. As such, the case for a China penalty has become an inarguable feature of US trade policy in general, and especially so in the Trump Administration. Even if a deal is struck on fentanyl, I suspect that some form of this penalty will remain intact. China is unlikely to get away with the same 10% “minimal penalty” tariff that is being imposed on America’s other trading partners.

Neither of these twin features of Trump trade policy should be considered in isolation. Instead, they are likely to come as a package deal — a multilateral tariff on the world plus a bilateral tariff penalty on China. The danger to this approach is considerably greater than the sum of the parts.

The main risk to the US is intensified trade diversion away from China toward other foreign producers. We’ve been down this road before — telltale signs of trade diversion remain a visible manifestation of the China-specific tariffs of Trump 1.0. Reflecting a chronic shortfall of domestic saving, such diversion led to a widening of the US multilateral trade deficit; over the 2018 to 2024 period, a narrowing of the Chinese deficit was more than offset by increased deficits with Mexico, Vietnam, Taiwan, South Korea, Canada, Ireland, India, and Germany. At the same time trade diversion did not have major consequences for US inflation, which was eventually driven higher by a Covid-related supply shock.

That was then. The coming trade diversion is likely to be far more deleterious. With likely passage of Trump’s so-called “beautiful bill,” an increasingly reckless fiscal policy will lead to wider Federal budget deficits that will push already subpar domestic US saving even lower. That should result in a further widening of the America’s multilateral trade deficit, with the increment consisting of higher-tariffed foreign goods.

An added complication is likely to come from the concomitant decoupling of the United States from China-centric supply chains. The de-globalization of “friend-shoring” is likely to subject US consumers to steeper costs of foreign production, assembly, and distribution. With growth under downward pressure and inflation risks shifting to the upside, US stagflation risks will likely intensify as a result.

For China, the story is the mirror image of that in the United States. Its export-led economy will take a direct hit from its largest trading partner — still the US. Moreover, China faces the distinct possibility of RMB currency appreciation that would exacerbate its recent outbreak of deflation. While China will undoubtedly respond to these pressures by underscoring the imperatives of consumer-led rebalancing, the odds of immediate paybacks are low. That will leave the Chinese economy increasingly dependent on supply rather than domestic demand. Consistent with recent statements of Chinese President Xi Jinping, that keeps China on a path to continue boosting technology-intensive output of “new quality productive forces,” exacerbating the current protectionist backlash against China.

None of this is good news for a softening global economy, already feeling the pressures of a tariff-induced slowing of global trade. With China and the United States having collectively accounted for a little more than 40% of world GDP growth since 2010, the risks of global recession will only intensify. The inherent instability of Trump’s trade solution is only making matters worse.