Economic Consequences of Protectionist Policies

Published November 14, 2024 –  By Paul Beland, Global Head of Research – Wealth Management 

Key Takeaways

Higher Prices and Potential Inflation: Broad-based tariffs and deficit spending could lead to rising costs for consumer goods. With tariffs adding significant costs to imports and passing them on to consumers, inflationary pressures may increase, keeping interest rates elevated and impacting purchasing power.

Retaliation Risks and Global Trade Tensions: Protectionist tariffs risk igniting trade wars, as seen with past U.S.-China trade disputes. Retaliatory measures from other countries can dampen economic growth, disrupt supply chains, and make U.S. exports less competitive, especially with a stronger U.S. dollar.

Sustained Deficit Spending and High Interest Rates: Continued U.S. deficit spending may lead to prolonged high interest rates as government borrowing “crowds out” private investment. This trend can complicate efforts to reduce debt and delay lower interest rates, affecting consumers and private investments alike.

Did the United States vote for higher prices? Between much higher deficit spending expected under a Trump administration and a potential trade war in 2025, there could be buyer’s remorse from higher prices and financing costs for consumer goods.

Trump’s Tariff Proposals

Hopefully, Trump’s recent broad-based tariff proposals are more rhetoric than reality, but if implemented, these tariffs could have significant implications on global economic growth, interest rates, and the foreign exchange market. 18th century economist Adam Smith is certainly turning in his grave. Smith’s The Wealth of Nations laid the economically sound case for specialization of labor and free trade. Even a quarter millennium ago, Smith knew the U.S. would not be able to make their own iPhones efficiently.

As the global economy is finally recovering from the highest inflationary period in decades, protectionist trade policies could upend this progress, risk economic growth, and keep interest rates elevated.

Higher Costs Likely

The tariffs will significantly increase the cost of imported goods to the U.S. and impact the country’s trading partners across the globe. U.S. personal consumption expenditures on imported goods is over 10% of the U.S. economy, so a blanket 10% to 20% tariff could add 1% to 2% to costs overall. The increase in costs from the tariffs would likely flow right to the end consumer. For example, if the U.S. levies a 60% tariff on washing machines made in China, which are then imported and sold in the U.S., the domestic retailer will be paying the 60% tax to the U.S. Customs and Border Protection Service. Most businesses will simply pass this additional cost on to consumers.

Typically, the goal of the tariff is to shore up domestic producers by making foreign-made goods more expensive. The issue here as it relates to inflation is that country imposing the tariff likely does not have a comparative advantage in making the good – hence, Smith’s thesis on the specialization. As a result, domestic manufacturing of the newly tariffed goods might ultimately be more expensive given a lack of specialization and inexpensive labor. Simply put, buying “Made in USA” will often be much more expensive or completely impractical from an infrastructure requirement standpoint.

Retaliation Risks

A tariff’s initial, one-time cost increase can also spiral into a trade war as we’ve seen in the past. In 2018, when Trump levied tariffs on China, the Chinese government retaliated and introduced tariffs of 15% and 25% on certain food and agricultural products from the U.S. Even very close U.S. allies, Canada and the EU, retaliated against Trump’s 2018 tariffs on steel and aluminum products. This retaliatory behavior raises the risk of lower economic growth, offsetting any economic benefit intended to shore up domestic production. In addition, higher potential U.S. inflation from the tariffs will keep interest rates high, strengthening the U.S. dollar. A strong U.S. dollar can benefit U.S. consumers, and even offset some of the tariff costs by making imports cheaper. However, the stronger dollar will impact domestic manufacturers and multinational corporations with overseas operations. First, the stronger dollar makes U.S. exports less competitive globally. Second, U.S.-based multinationals will be hit by foreign exchange headwinds when converting foreign currencies back into U.S. dollars.

In sum, tariffs can do more harm than good and have repeatedly proved detrimental to the global economy.

Unsustainable Fiscal Spending

Excessive U.S. fiscal spending is showing no signs of slowing. Since 2020, the annual deficit as percentage of the economy is at levels not seen since World War II. This trend will likely continue and potentially worsen under a Trump administration. With the election now over and a unified Republican government (Trump administration + GOP House/Senate) set to take over in January, we expect to see an even larger $4-$5 trillion increase in deficit spending over the 10-year budget window. Most of the impact would come from extending and/or expanding the Trump tax cuts. Republicans will look to repeal/curtail certain provisions in The Inflation Reduction Act of 2022 (e.g., green energy tax benefits) and cut spending elsewhere, but there is limited low-hanging fruit, in our view. Even Trump’s newly announced Department of Government Efficiency will be challenged in finding material spending reductions that will offset the ballooning deficit.

Related Macro Research: Hedging Against Unsustainable Fiscal Spending

Interest Rates Higher for Longer

It is our view that the excess fiscal spending has and will increase interest rates and the ultimate neutral rate. In addition, as the government borrows more, this borrowing “crowds out” private investment. There is also a point at which this fiscal spending and required debt financing can cause a fiscal crisis, even with the Federal Reserve as a backstop U.S. debt buyer. As such, there is a limit to debt’s ability to effectively maintain economic growth. Currently at about 125% of GDP, U.S. government debt is more than double that proportion since clocking in at 53.1% of GDP in 2001. Current CBO baseline estimates suggest this percentage will only increase and this baseline does not even factor in our anticipated additional deficit spending by Trump. There’s only so much demand to own U.S. Treasuries, so the Federal Reserve’s rate easing attempts will be challenged by investors demanding higher yields given growing credit risks.

As a result of the expected deficit spending, consumers hoping for lower interest rates to finance big-ticket purchases might be waiting a bit longer.

Global Asset Allocations Should Continue to Favor U.S. Equities

Despite the economic shock risks from broad-based tariffs, U.S. economic exceptionalism should continue in the near term and continue to support growing global asset allocations into U.S. equities, in our view. Moreover, the increased deficit spending should keep interest rates high and support a strong U.S. dollar. The U.S. economy remains strong, with our base case for a soft landing intact. Supporting the economy remains a remarkably resilient consumer, a decent job market, and robust government spending. Within U.S. equities and to Adam Smith’s point on specialization, the U.S. continues to lead in technology and innovation, supporting our overweight sector recommendations in Information Technology and Communication Services.