The administration of President Donald Trump initiated a significant departure from decades of U.S. trade policy that had favoured mainly multilateral liberalisation and tariff reduction. This shift was defined by a preference for unilateral actions, bilateral negotiations backed by tariff threats, and justifications based on national security and perceived unfair trade practices by other nations.

In March 2018, the U.S. imposed tariffs of 25% on steel and 10% on aluminium imports from most countries, citing national security concerns under Section 232 of the Trade Expansion Act of 1962. Many economists and trading partners met this rationale with scepticism and viewed it as a misuse of the national security provision (Linciome et al., 2021). Moreover, beginning in July 2018 and escalating through 2019, the U.S. levied tariffs on a substantial portion of imports from China, eventually covering goods worth hundreds of billions of dollars. These tariffs, imposed under Section 301 of the Trade Act of 1974, targeted alleged unfair trade practices by China, including intellectual property theft and forced technology transfer.

The economic impacts of these tariffs have been extensively studied. A consistent finding across multiple analyses is that the costs of these tariffs were largely passed through to U.S. consumers and firms in the form of higher prices, leading to real income losses (Amiti, Redding, and Weinstein, 2019; Fajgelbaum et al., 2020; Cavallo et al., 2021). Contextually, Fajgelbaum et al. (2020) estimated that the tariffs resulted in an annual deadweight loss of approximately $16.8 billion and a real income loss of around $51 billion for U.S. consumers when accounting for tariff revenue.

Employment effects were generally found to be minimal or even negative, particularly when considering retaliatory tariffs. While some protected sub-sectors in steel might have seen small gains, these were often offset by job losses in manufacturing sectors that use steel and aluminium as inputs (due to higher costs) and in agriculture, which faced significant retaliatory tariffs from China and other countries (Flaaen, Hortaçsu, and Tintelnot, 2020; Fetzer & Schwarz, 2021). Supply chains were significantly disrupted, forcing businesses to scramble for alternative sources or absorb higher costs, creating considerable uncertainty that dampened investment (Handley, Kamal, and Monarch, 2020; Bloom et al., 2018, on general policy uncertainty). Despite the aim of reducing the U.S. trade deficit, particularly with China, the overall U.S. trade deficit widened during this period. However, bilateral deficits with China did see some reduction, often offset by increased deficits with other nations as trade patterns shifted. These actions did not occur in a vacuum; rather, they represent the latest chapter in a sharp and long-standing theoretical divide over the economic rationale for tariffs.

The economic rationale concerning tariffs is sharplydivided, with robust arguments supporting free trade and protectionism.

The Case for Free Trade

The classical case for free trade is built mainly upon Adam Smith's (1776) concept of absolute advantage, where nations benefit by specialising in goods they can produce more efficiently than others. This was refined by David Ricardo's (1817) theory of comparative advantage, which posits that mutual gains from trade arise if nations specialise in producing goods with a lower relative opportunity cost, even if they lack an absolute advantage in any good. This specialisation, followed by international trade, enhances global productive efficiency and overall welfare. The Heckscher-Ohlin model further developed this by suggesting that comparative advantage stems from differences in national factor endowments (e.g., capital, labour, land), predicting that countries will export goods that make intensive use of their abundant factors (Heckscher & Ohlin, 1993). These foundational theories generally conclude that tariffs, by distorting relative prices and interfering with specialisation, impede global efficiency, reduce overall output, and diminish aggregate welfare.

Justifications for Protectionism

Conversely, various protectionist arguments offer justifications for the imposition of tariffs. The infant industry argument, prominently articulated by Alexander Hamilton (1791) in his "Report on Manufactures" and later by Friedrich List (1841) in "The National System of Political Economy," suggests that new domestic industries, particularly in developing countries, may require temporary protection from established international competitors to achieve economies of scale, learn by doing, and become internationally competitive. Hamilton advocated this strategy for the nascent industrialisation of the United States. Simultaneously, List famously accused Britain of "kicking away the ladder" by promoting global free trade only after its industries had matured behind protective barriers (Chang, 2002). However, this argument faces significant criticism, as governments have notable informational challenges in "picking winners"—identifying industries with genuine potential for future competitiveness (Baldwin et al., 2015). Moreover, protected industries often develop a political reliance on continued protection, lobbying against its removal and potentially remaining inefficient indefinitely (Krueger, 1988). An empirical study of the 19th-century U.S. tinplate industry, often cited as a successful case of infant industry protection, found that while protection did accelerate the industry's development, it ultimately failed a social cost-benefit test due to the high costs imposed on consumers (Irwin, 1998).

The optimal tariff theory has early conceptual origins in the work of Robert Torrens and John Stuart Mill and was later formalised by economists such as F.Y. Edgeworth and Nicholas Kaldor (1940). It posits that a large country possessing significant market power (monopsony power in import markets) can improve its terms of trade by imposing a tariff. By restricting import demand, the large country can compel foreign exporters to lower their pre-tariff prices, effectively shifting part of the tariff burden onto them and increasing the importing country's welfare (Broda et al., 2008). However, this theory is heavily criticised for several reasons. Firstly, it assumes the absence of retaliation from trading partners—a highly unrealistic scenario in the modern global economy, where retaliatory tariffs can quickly erode any initial terms-of-trade gains and lead to mutually damaging trade wars (Johnson, 1953). Secondly, the practical difficulty of accurately calculating the "optimal" tariff rate, which depends on complex export supply elasticities, is immense. Thirdly, even if successful for one country, it reduces global welfare, making it a "beggar-thy-neighbour" policy (Irwin, 2017).

While theoretical arguments provide the rationale for tariff policy, empirical research reveals its real-world consequences. A vast body of empirical research largely indicates that tariffs, especially when broadly applied or met with retaliation, impose net economic costs. They typically lead to higher domestic prices for both the directly taxed imported goods and their domestic substitutes, as foreign exporters attempt to pass on tariff costs and domestic producers exploit the reduced competitive pressure to raise their prices (Amiti, Redding, and Weinstein, 2019; De Loecker et al., 2016). This price increase directly reduces consumer purchasing power and erodes real wages. Furthermore, tariffs can limit product variety available to consumers and intermediate inputs available to firms, stifling innovation and productivity (Goldberg et al., 2010).

Macroeconomically, sustained periods of tariff increases are generally associated with declines in real GDP and slower economic growth. For instance, research analysing historical trade liberalisations often finds positive impacts on growth (Estevadeordal & Taylor, 2013; Wacziarg & Welch, 2008), suggesting symmetrically that tariff increases would have deleterious effects. Recent studies on the U.S. tariffs imposed from 2018 onwards provide a powerful modern example of these effects, confirming significant pass-through of tariff costs to U.S. importers and, ultimately, consumers, with little evidence of foreign exporters absorbing these costs by lowering their prices (Fajgelbaum et al., 2020; Amiti, Redding, and Weinstein, 2019).

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The rise of global value chains (GVCs) over the past few decades has added complexity to analysing tariff impacts. GVCs describe the phenomenon where different stages of the production process for a single good or service are located across different countries, with components and services crossing borders multiple times before the final product reaches the consumer (Antràs & Chor, 2022; Hummels, Ishii, and Yi, 2001). This international fragmentation of production has allowed firms to optimise costs and leverage specialised expertise globally.

Tariffs can be particularly damaging in a world characterised by GVCs for several reasons. When intermediate inputs cross borders multiple times, tariffs can be levied at successive stages of production. This so-called "compounding effect" means that the total tariff burden on a final good can be substantially higher than the nominal tariff rate on that good itself, as tariffs are paid on already tariff-laden components (Yi, 2003). This significantly increases production costs for firms reliant on GVCs. Moreover, GVCs are built on intricate networks of suppliers and producers.

Moreover, GVCs are built on intricate networks of suppliers and producers. Tariffs can render previously efficient GVC linkages uneconomical, forcing firms to search for alternative suppliers or reconfigure their entire production networks—a costly and disruptive process. This process of adjustment is often slow and uncertain and can involve significant write-offs of relationship-specific investments (Baldwin & Lopez-Gonzalez, 2015). Firms that use imported inputs to produce goods for export (a common feature of GVC participation) are hit twice by tariffs on intermediates. Their input costs rise, making their final products less competitive in global markets. This is particularly problematic for developing countries seeking to integrate into GVCs as a pathway to industrialisation (Koopman, Wang, and Wei, 2014).

Imposing tariffs, especially if unpredictable or part of a broader trend towards protectionism, creates significant policy uncertainty. This uncertainty can deter firms from long-term investments in GVCs as the future cost and accessibility of critical inputs and export market access become precarious (Handley & Limão, 2017).

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