History is full of evidence that tariffs harm economic performance. This column assesses the two waves of globalisation in modern history and how they were interrupted by barriers to trade. The first wave started in the mid-19th century and lasted until WWI, while the second wave started after WWII and lasted until the Global Crisis of 2008-09. The most likely scenario going forward will feature tariffs around 12-14% on average, a mild recession, and a small hit to US longer-run potential. However, achieving diplomatic normalcy may take years of good US behaviour, and it is unlikely during the Trump administration.
President Trump’s tariffs and threats to manage interest rates and the US dollar and dramatically cut the US’ global financial and diplomatic roles would materially harm US and global economic performance and upend the world order, with the US playing a more isolated role. In this column, we assess the two waves of globalisation in modern history and how they were interrupted by tariffs and barriers to trade. We then describe different scenarios, with the highest probability policy outcome involving significantly lower-than-feared average effective tariffs. Unfortunately, Trump’s erratic policymaking and belligerence toward allies have already dented US credibility and will have lasting negative impacts on important global relationships.
Economic theory and common sense reveal the flaws in Trump’s advocacy of tariffs, and history is replete with evidence that tariffs harm economic performance and fail to achieve desired outcomes. Adam Smith’s Wealth of Nations (1776) and David Ricardo’s Law of Comparative Advantage (1817) refute the doctrine of mercantilism, the perceptions of the world as a zero-sum game, and the objectives of maximising the balance-of-trade surplus. Many of these issues are highlighted and modernised in Richard Baldwin’s “The Great Trade Hack” (Baldwin 2025) and Maurice Obstfeld’s “What policymakers got wrong about US trade deficits” (Obstfeld 2025).
Trump’s notions that tariffs will generate sufficient revenues and improve US government finances are wildly unrealistic. Tariffs generated a large portion of revenues in the 19th century when government finances were small and before income taxes were established in 1913. Today, tariffs would harm the economy and fail to improve deficit financing. Trump’s hope of returning to the mid-19th century era of labour- and capital-intensive US manufacturing ignores massive technological advances as well as the United States’ comparative advantages and strengths in high-tech services, and he does not distinguish between national-security-oriented and other manufacturing. He overstates US leverage in imposing and negotiating tariffs, understates damaging retaliation, and ignores the negative consequences of isolating the US and alienating its allies.
The first era of globalisation was ushered in by the free-trade movement in the UK, initiated with the repeal of the Corn Laws in 1846 and the Cobden-Chevalier Treaty of 1860. The industrial revolutions in the UK and subsequently the US benefited from soaring global trade, as shown in Figure 1 (Bordo et al. 2003, Meissner 2024). The US ran a nearly constant trade deficit from 1865 through WWI, when the dramatic rise in capital inflows financed its industrial development.
Figure 1 Global trade, 1500-2023
(world exports/world GDP)
Source: Meissner (2024)
Sizeable immigration contributed to the US economic boom. However, the influx of immigrants and a sharp rise in the foreign-born share of the population stirred mounting resentment. This fed popular support for heightened controls of immigration, global trade, and cross-border capital flows.
Restrictions on global trade and capital flows were ramped up during WWI, beginning an extended era of US protectionism. New US laws sharply curtailed the flow of immigrants, and the Fordney-McCumber Tariff Act of 1922 imposed tariffs of 14% on all imported goods. At the onset of the Great Depression, the Smoot-Hawley Tariff Act imposed effective tariffs of 20% on imports (Crucini and Kahn 1996, Irwin 1998). This accentuated the severity of the economic contraction and initiated a period of constrained international trade and capital flows and immigration.
The second era of globalisation began after WWII and gathered steam until the Great Financial Crisis of 2008–9. Global trade and growth boomed, and the portion of people worldwide living in poverty shrank dramatically. Beginning in the 1970s, the US ran a nearly persistent trade deficit (Figure 2), benefiting from capital inflows that helped finance technological innovations and economic advances.
The US initiated many critical international reforms that promoted global trade and capital flows, including the General Agreement on Tariffs and Trade (GATT), Bretton Woods, the International Monetary Fund (IMF), and the World Bank. Notably, in 1999, the US promoted China’s acceptance into the World Trade Organisation (WTO), conveying favoured nation status and lower trade barriers (Bordo 2017). China’s subsequent emergence as the world’s manufacturing hub with its very large bilateral trade surplus with the US has made it a primary focus of Trump’s tariff policies.
Figure 2 US trade deficit as percentage of GDP
Source: Haver Analytics
During the second era of globalisation, some nations failed to reduce their tariffs and barriers to trade, and they paid the price in terms of economic growth and progress. India and Argentina were notable laggards, and other least developed countries (LDCs) followed. Jawaharlal Nehru of India believed in import substitution, and India maintained high tariffs from the 1940s to the 1990s. Raúl Prebisch of Argentina pursued the same approach from the 1930s to the 1980s. Their economies stagnated.
President Trump’s tariffs and threats to intervene in interest rate and currency markets undercut the tenets of free enterprise. His wish to maintain the US dollar as the world’s reserve currency but desire for a weaker dollar is inconsistent, and threats to pressure the Federal Reserve towards lower interest rates would only raise market volatility.
Trump’s proposed cuts in subsidies to European defence and soft dollar initiatives in least developed countries (LDCs) would change the world order, and the US’s loss of credibility may isolate the US. This has happened before: following the Smoot-Hawley tariffs of 1930, Canada retaliated, and along with the UK and other British Empire countries, signed the Ottawa Agreement creating a tariff wall against the US (Schenk 2011), greatly contributing to Charles Kindleberger’s (1986) famous downward spiral in global trade.
The tariffs have already begun to distort global supply chains and reduce production efficiencies and have elicited foreign retaliation. As such, they will have a larger negative economic impact than similarly sized corporate tax increases. The closely followed Baker-Bloom-Davis Economic Policy Uncertainty Index has spiked (Figure 3), which points to weaker consumption and industrial production (Baker et al. 2016).
The marked decline in the US dollar and a rise in US Treasury bond yields have added risk to US government debt financing. Concerns about the loss of US government credibility and rising debt could potentially jeopardise the long-standing role of US Treasuries as the world’s safe-haven asset. Foreigners hold nearly one-third of $26 trillion of outstanding US publicly held debt, and a sharp reduction in demand could drive up yields and jar global financial markets (Bordo and McCauley 2025, Bossone 2025).
Figure 3 Economic policy uncertainty index
Source: PolicyUncertainty.com/Haver Analytics.
Another concern is the looming collision between Trump’s tariffs and the Federal Reserve’s dual mandate. Inflation is currently above the Fed’s target of 2% inflation and employment is close to maximum, with a jobless rate of 4.2%. The Fed is publicly committed to its inflation target and worries about rising inflation expectations. Historically, it tends to respond more quickly to higher unemployment than higher inflation. Trump’s threats to influence the Fed loom in the background.
Fortunately, Trump has backed off from his earlier tariffs and has signalled a willingness to negotiate lower tariffs with China, Europe, and other nations. His tariff reductions in April in response to a sharp decline in the stock market and the US dollar revealed a willingness to negotiate with global leaders and grant favours to American business leaders who pledge higher capital spending and on-shoring production.
Trump’s abrupt policy reversals in response to pain thresholds, enthusiasm for bilateral negotiations, and encouraging ‘kiss the ring’ cronyism are misguided and distasteful, and show a naïve disregard for free enterprise and markets. They nevertheless suggest different policy scenarios and consequences, as described below. Note that all scenarios involve different degrees of ‘worse’ — because free trade without tariffs or other barriers would result in the best economic outcomes.
The scenarios are:
Scenario 1. Best outcome: mild negative. 10% average effective tariffs on all imports, with select exceptions (compared to 4% before Trump); moderate uncertainties; significant US slowdown or very mild recession; US dollar and stock market remain firm and Treasury yields decline. Probability: 10%.
Scenario 2. Less-worse case. Tariffs are reduced to 12-14% average (roughly $140 consumptionor 1.4% of GDP), including negotiated lower tariffs for Canada and Mexico; limited retaliation and diminished uncertainties; a marked economic slowdown or mild recession; Fed easing supports stock market; US dollar declines modestly in an orderly fashion; US retains dominant status in the world; small hit to US longer-run potential growth. Probability: 75%.
Scenario 3. Worse case. 20% average effective tariffs, including 10% on all imports, easing of current tariffs on China (50%), 25% on Canada and Mexico; US dollar falls and US Treasury yields spike and this forces Fed intervention to stabilise markets; sizeable stock market declines; moderately deep recession; sizeable negative impact on US potential growth (-0.3% to -0.4%). Probability: 10%.
Scenario 4. Worst-worse case. Effective average tariffs of 25%. Trade war with China escalates and current tariffs on Canada and Mexico persist; Trump ramps up deportation of immigrants and makes permanent cuts in government funding of research and universities; US credibility diminishes markedly, US dollar and stock market fall; US is harmed with deep recession and potential growth is diminished by 0.5%; US exceptionalism erodes decidedly. Probability: 5%.
The highest probability, less-worse Scenario 2 seems realistic based on Trump’s revealed behaviour and preferences. However, soothing relationships with allies and achieving diplomatic normalcy may take years of good US behaviour, and is unlikely during the Trump administration. Our hope is that with an easing of tariffs and trade barriers, foreign leaders will ‘tolerate’ Trump, while continuing to appreciate the exceptional capabilities and potential of the US’s private sector and economy.
Source : VOXeu
