One thing I’ve been saying when I write periodically about the economic outlook is that the Trump administration’s trade actions have had negative effects on the economy, but those effects have not been very large and they’ve been more than offset by other factors: positive economic trends not driven by public policy; broadly good monetary policy; and other Trump administration actions that have boosted economic output, at least in the short term, such as the tax cut.
Most of our economy is based on domestic production and consumption of goods and services, and most imports and exports have not been subjected to Trump’s tariffs. Prior to the round of tariffs imposed this month, Trump’s tariffs applied to 12 percent of U.S. imports, and retaliatory tariffs imposed by other countries applied to only 9 percent of our exports, according to calculations by Ernie Tedeschi of the investment research firm Evercore ISI. These small percentages are why the economy has remained good, even though the president’s trade policy is generally bad for the economy.
The question weighing on the financial markets in recent weeks is: What if those trade actions keep getting bigger, to the point where they matter a lot?
We have had tariffs on Chinese imports for over a year now, but earlier this month, President Trump raised the tariff rate on a broad list of Chinese imports from 10 percent to 25 percent. He’s also threatening to nearly double the list of goods subject to the elevated tariff. That means the punitive China tariffs may soon be five times as large as they were during their first year.
When the Congressional Budget Office evaluated the president’s more limited tariffs as of January, they estimated they would reduce GDP by one-tenth of a percentage point by 2022. Tedeschi, who was a Treasury Department economist before joining Evercore, tells me he estimates the president’s expanded version of the China trade war would cut U.S. economic output by one-half to one percentage point, compared to a counterfactual where the U.S. and China had maintained their pre-Trump trade policies. And he says the recent declines in stock prices and long-term interest rates reflect market participants deciding that scenario has become significantly more likely in recent weeks.
A one-half to one-point hit to the GDP is not enough, on its own, to push the U.S. economy into recession. But it would constitute a significant slowdown, which would likely result over time in slower job growth and weaker wage growth, not to mention slower growth in corporate profits. And Tedeschi notes there could be a snowball effect: If the expectation of a trade-related slowdown in growth encourages corporations to cut their capital expenditures, that could lead to reductions in domestic demand.
Back in December, I wrote about three key policy risks that were worrying the stock market. The overall economic outlook was positive, but the markets were afraid of three things: that the Federal Reserve would pursue an inappropriate path of interest-rate hikes even if the economy softened; that a government shutdown would lead to wider fiscal-policy dysfunction that would harm the economy; or that the trade war with China would escalate. The stock market recovered its December swoon when all three of those risks appeared to abate.
The Fed and shutdown risks are gone, but the trade war has roared back, so the negative market reaction should be no surprise. It is still not the case that a recession is more likely than not. Growth will probably continue to be positive, but the danger signs are increasing.