What Tariff World Are We In?

A consistent theme in the analysis of President Trump’s April 2 Liberation Day speech has been uncertainty. The root cause of that uncertainty lies in the multiple possible policy worlds that could emerge, some of which are decidedly worse than others and all of which contain important contradictions. We identify five such worlds, and walk through their implications. Despite the purported deal with Great Britain and the extraordinary retreat of the Trump administration with respect to its initial China tariffs, all of these options could still be in play.

World 1: Reciprocal Tariffs

On Liberation Day, President Trump outlined a radical tariff program that broke completely with the fundamental principles of the existing system. The multilateral trading order under the 1947 General Agreement on Tariffs and Trade (GATT) and its successor, the World Trade Organization (WTO), rested on the idea of most-favored-nation status or nondiscrimination; countries might differ in how they tariff their imports, but once negotiated through multilateral processes, those tariffs applied to all members of the WTO equally. Donald Trump, by contrast, proposed a system in which the United States imposed different tariffs on different countries, depending largely on the size of their bilateral surpluses with America. These ranged from 10 percent for countries such as Singapore, the United Kingdom (UK), and Brazil to 124 percent for China after two rounds of retaliation.

The reciprocal tariffs in excess of ten percent are now on pause, except for an additional 20 percent levy on China, nominally linked to cooperation on fentanyl. But in one possible trade policy world this approach is reinstated in whole or part, and large country-by-country differences in tariffs resurface. This outcome is mind-bogglingly complex and economically damaging. The United States would need to undertake a protracted bargaining process with each individual country, tariffs could vary arbitrarily, and it would be difficult to converge on a stable set of shared expectations. Without guiding principles for agreement, commitments on either side would never be credible. Moreover, these negotiations would require complex rules of origin to prevent transshipment of goods from high-tariff countries through low-tariff jurisdictions. In such a world, it is inevitable that Chinese businesses, for example, will seek to route exports through Singapore or some other country in order to circumvent the tariffs. Policing such a world will require sustained costly efforts, compounding uncertainty.

World 2: A 10 Percent Multilateral Tariff

In a second world, trading partners line up to negotiate with the United States, make offers to avoid the pain of reciprocal tariffs, and succeed. The reciprocal tariffs are negotiated away, but the baseline 10 percent tariff remains, as it did in the framework U.S.-UK agreement announced with great fanfare last week. The tax burden would be shared between producers and consumers, and all parties would eventually adapt.

Although this outcome appears marginally more likely following the pause on reciprocal tariffs, this 10 percent across-the-board tax will never be truly universal. The administration will almost certainly have a separate policy toward China—even with the friendliest of meetings in Switzerland—and it maintains the desire to target specific sectors across countries, such as pharmaceuticals, autos, steel, and aluminum.

But there is another important downside to this world that has been overlooked. The Trump administration has heard the message from the markets and is now anxious to reach deals quickly to show progress. U.S. negotiating partners—including China—know that and have every incentive to offer deals with some dramatic low-hanging fruit but little else; by initial indications, the UK deal is pointing down this road. A cookie-cutter checklist is already emerging: promise to invest in the United States, buy billions of dollars’ worth of American commodities—particularly energy—and offer to eliminate or revise, on some timetable, a defined list of non-tariff barriers.

But what is really being offered in these investment, purchase, and policy promises? In the last trade war, China made commitments to purchase goods and ended up buying nothing beyond what they would have bought anyway. Reducing complex nontariff barriers would genuinely benefit American companies, but they are unlikely to be resolved quickly. They might never be resolved if the administration proves unable to manage so many complex negotiations simultaneously—or simply loses interest. Although still subject to at least 30 percent tariffs, China is unlikely to make major concessions given how quickly the United States sought negotiations when China demurred.

World 3: Corruption and Cronyism

In another world, tariff relief is not granted based on what our partners do, but as the result of deals with constituents in the United States and even cronies of the administration. Want to get the tariffs relaxed on goods your company imports, like cellphones or auto parts? Line up and kiss the ring. The Trump administration is already making exemptions, and could allow firms to petition for relief. But as in the first Trump administration, there would be little transparency to the process and arbitrary outcomes as a result. This world would not only feature a complex tariff regime with U.S. trading partners, but an equally or even more complex web of exemptions accompanied by other tariffs that could be a matter of life or death for many small businesses.

At first, it might seem that the second scenario, with 10 percent universal tariffs, would deliver us from this world of arbitrary exemptions and political side deals. But that is only partially true. Today’s global production networks cross borders many times, and a certain amount of dealmaking to exempt inputs is inevitable—this has already occurred in the auto industry. While we can imagine a variety of ways in which such exemptions could go, it is inconceivable that the president would forego the bargaining power created by his ability to reward or punish specific domestic interest groups.

World 4: Trumpian Free Trade

It may seem implausible, but the reciprocal tariff idea—if taken seriously—could lead to the lifting of tariffs across the world and a fundamental freeing of trade. This is a view floated by trade softliners in the administration. How would it work? Countries line up and all offer to reduce tariffs to zero, a proposal which has the benefit of simplicity. However, these offers come with the condition that the United States do the same: after all, tariffs are reciprocal, right? It seems unlikely that Trump’s tariff hardliners would go for such a world, and the UK deal—while including carveouts—kept the 10 percent baseline trade taxes on Britain. But the possibility does underscore one contradiction in the administration’s position: that a genuine commitment to reciprocity, including “zero for zero” deals—and even the lowering of tariffs—would mean that tariffs are not likely to significantly protect American manufacturing or generate the amounts of revenue the administration has said they would.

World 5: A Mar-a-Lago Accord

Behind the discussion about the previous four worlds is a dirty little secret: not one of them will substantially reduce U.S. bilateral deficits with all major trading partners. The deficits are not primarily the result of trade policy, but of fundamental macroeconomic imbalances in the world economy. The United States spends more than it saves and other countries in the system save more than they spend, and invest a good part of those savings in U.S. financial assets to boot. China is the most extreme example, but far from the only one.

If the administration doubles down on its objective of smaller imbalances, the United States could attempt to negotiate a grand macroeconomic and exchange rate bargain akin to—but much larger than—the Plaza Accord of 1995. Under that agreement, the United States, France, Germany, Japan, and the UK agreed to coordinated interventions that weakened the U.S. dollar, thus easing American trade deficits. Under such an accord, the dollar would be allowed to depreciate gradually, thus restoring competitiveness and reducing imbalances.

The Mar-a-Lago accord remains speculative; the administration has not advanced a blueprint. Yet the contradictions in this world are even more profound than those just outlined. On the one hand, Trump has insisted that the dollar remain at the center of the global financial system, implying it would continue to serve as the world’s reserve asset and attract lenders. On the other hand, a Mar-a-Lago accord would have the stated objective of weakening the currency. Moreover, American commitment to a more balanced domestic economy is not particularly credible at the moment. Promised tax cuts portend looming fiscal deficits even if implausible spending cuts by the so-called Department of Government Efficiency (DOGE) were to be achieved. As long as the United States is running large fiscal deficits, it will continue to be a net borrower from the rest of the world with attending trade deficits. Finally, if the Trump administration does succeed in making the United States a more attractive place to invest—or compels foreign investment from our trading partners—the effect would also be to sustain high capital inflows and keep the dollar strong, the exact opposite of what a Mar-a-Lago accord would be designed to achieve.

Uncertainty Reigns

Tariffs have complex effects, but the uncertainty caused by the Trump program has generated consequences far beyond those from the tariffs themselves. For that reason, today’s tariffs are far different from the first Trump administration’s trade war of 2018. Those tariffs were on a much smaller slice of American imports—mainly from China—and the U.S. economy had plenty of macroeconomic slack to absorb a modest supply-side price shock. Inflation and interest rates were low, and the budget deficit moderate. None of these conditions hold today, and so the economic impact of the tariffs themselves will be larger. But in addition, the much more fundamental uncertainty about which policy world will unfold will have an equal or even more debilitating impact. Despite the positive market reactions to the UK deal and preliminary China talks, until clear guidance emerges from the current fog of policy, there is no reason to believe that the period of market volatility and uncertainty has passed.

Stephan Haggard is distinguished research professor at the UC San Diego School of Global Policy and Strategy and research director for Democracy and Global Governance at IGCC. Barry Naughton is the Sokwanlok Chair of Chinese International Affairs at the School of Global Policy and Strategy at UC San Diego and co-leads IGCC research on Chinese science, technology, innovation, and industrial policy.

Thumbnail credit: USDA (Flickr)