Tariffs and technological hegemony

The Trump administration’s sweeping tariff measures are intended to increase the competitiveness of US firms – especially in high-tech sectors – and reduce US trade deficits. This column discusses the impact of trade policies on innovation and technological hegemony. The analysis suggests that large and persistent changes in tariffs are likely to affect firms’ innovation decisions and the pattern of technological hegemony. However, countries should be wary of using trade policies to boost innovation by their domestic high-tech firms, since the strategy may easily backfire.

With the advent of the second Trump administration, the US has declared a trade war against the rest of the world. The underlying hope is that import tariffs will increase the competitiveness of US firms – especially in high-tech sectors – and reduce the US trade deficits (Miran 2024). Whether these goals will be attained, however, is far from clear (Baldwin 2025, Obstfeld 2025). Moreover, this trade war has caught the rest of the world off guard. Take the case of the EU, which has chosen not to retaliate against the tariffs imposed by the US. While this decision was grounded on the idea that retaliation would amplify the losses that US tariffs will inflict on the EU, some commentators have seen this move as a strategic error (Hinz et al. 2025).

In this column, we contribute to this debate by discussing the impact of trade policies on innovation and technological hegemony. We are motivated by the rising importance of innovation-intensive firms, and more broadly of intangible investments, for national output and international trade (Corrado et al. 2022). In addition, as highlighted by the literature on trade and growth (Akcigit et al. 2018, Melitz and Redding 2021), considering how tariffs affect firms’ innovation allows us to gain insights on their impact over the medium run – say, at a five- to ten-year horizon.

The rents from technological hegemony

In a recent paper (Fornaro and Wolf (025), we provide a two-country endogenous growth framework to study how tariffs affect the geographical allocation of innovation activities. Our model has two key features. The first is the presence of high-tech clusters, populated by innovation-oriented firms that sell their high-tech products on the global markets. Consistent with empirical evidence (Moretti 2021), innovation generates positive knowledge spillovers toward other firms located in the same cluster. Silicon Valley’s Big Tech companies, Seattle’s computer industry, or the EU pharmaceutical sector are good examples of the high-tech clusters that we have in mind.

The second key element of our theory is that innovation requires specialised innovation inputs. Innovation inputs are in limited supply in the global economy and are geographically mobile. Some good examples are researchers, venture capital, and specialised equipment and materials, such as computers and rare earths, which are all key inputs in the innovation process.

These two elements generate an incentive for countries to compete to gain technological hegemony. In our model, the technological hegemon earns technological rents by exporting high-tech goods and importing innovation inputs. The reason is that the suppliers of the innovation good are paid only the private return to innovation, which is lower than its social return. The social return to innovation, in fact, includes the knowledge spillovers towards other firms located in the same cluster. From a national perspective, importing innovation goods thus generates technological rents, equivalent to the spread between the social and private return to investing in innovation.

The temptation to use tariffs to gain technological hegemony

Since private firms do not fully internalise the impact of their investment decisions on the technological rents earned by their host country, policy interventions by national governments that attract innovation inputs from abroad may thus increase national welfare. In our model, this logic implies that national governments are tempted to impose tariffs to gain a position of technological hegemony. However, the model also suggests several reasons why this strategy may end up failing.

To see where the temptation to use trade policies comes from, suppose that a country imposes a tariff on imports of foreign high-tech goods. Foreign high-tech firms will suffer a loss in sales and profits, leading them to cut on their investment innovation. As a result, innovation inputs will flow toward the protectionist country, which will enjoy a boost in innovation and higher technological rents.

To make a concrete example, imagine that the US were to impose a large tariff on imports of pharmaceutical products from the EU. Lower global sales and profits will likely induce EU firms to reduce their investment in innovation and perhaps fire some top researchers. These researchers may be hired by high-tech firms located in the US. Over time, their innovation activities will increase the profits of US high-tech firms.

Figure 1 illustrates these dynamics, by showing the impact of tariffs on high-tech goods imposed by the home country at the expenses of the foreign one. Tariffs reduce the profits earned by the foreign high-tech sector. The result is that innovation activities by foreign firms decline, and innovation goods flow toward the country imposing the tariffs. Over time, higher investment in innovation generates technological rents and income gains.

Figure 1 Impact of import tariffs on high-tech goods imposed by the home country

Notes: GDP is expressed as percent deviation from its initial free-trade steady state. The components of GDP are expressed as percent deviation from their respective steady states, weighted by their respective steady state shares in GDP.

But tariffs have also negative effects. First, tariffs trigger a drop in the imports of foreign high-tech intermediate goods, depressing domestic productivity. These efficiency losses are concentrated in the short run, that is, before the impact on productivity of higher investment in innovation by domestic firms has materialised.

Import tariffs on high-tech goods have thus an ambiguous impact on national welfare, depending on whether the long-run gains from higher technological rents outweigh the productivity losses suffered in the short run. Interestingly, when tariffs have a positive impact on welfare they are associated with trade deficits. The reason is that tariffs bring benefit insofar as they boost investment by the domestic high-tech sector. In a financially integrate world, it is optimal to finance this investment boom partly by attracting foreign capital, i.e. by running trade deficits.

Moreover, tariffs on high-tech goods cause income and welfare losses in the rest of the world, because they depress the export revenue earned by foreign high-tech firms. This loss gets amplified over time, since lower investment in innovation further erodes the profits earned by high-tech firms. In fact, we show that tariffs – while they may bring welfare gains to the country imposing them – depress global welfare.

Two reasons why tariffs may backfire

The previous discussion may lead one to think that a country has much to gain from imposing import tariffs. But there are at least two reasons to be sceptical about this argument.

The first reason is retaliation by the rest of the world. In our framework, in fact, a country gains technological rents by stealing them from the rest of the world. Of course, the rest of the world has an incentive to fight back in order to protect its own high-tech sector.

In general, the possibility of retaliation implies that the welfare gains from import tariffs are likely to be small, at best. In fact, it is easy to imagine scenarios in which the world falls into a full-blown trade war, with all the countries imposing high tariffs to protect their domestic high-tech sector. In this case, tariffs will not affect the geographical allocation of innovation activities, but they will impose large efficiency losses to the global economy.

The second reason is that it may be hard to discriminate between imports of high-tech goods and innovation inputs. Think about computers: on the one hand, computers are a high-tech good because they are produced by firms that invest heavily in innovation; on the other hand, computers are a key input in the innovation process, for instance in the development of AI models (Politano 2025).

There is thus a chance that import tariffs will choke off access to some key innovation inputs. In this case, tariffs will hurt the domestic high-tech sector and reduce its investment in innovation, causing a progressive loss of technological rents and national income. Through this channel, tariffs will have severe negative effects on the country imposing them, especially if it starts from a position of technological leadership.

Figure 2 illustrates this possibility, by considering a case in which the home country imposes tariffs on imports of both high-tech goods and innovation inputs. The home country loses, because its domestic high-tech sector can no longer rely on imported innovation inputs. The resulting drop in innovation activities depresses the technological rents generated by the domestic high-tech sector. The foreign country suffers too, because its high-tech sector experiences a drop in exports and profits.

Figure 2 Impact of import tariffs on all imported goods

Notes: GDP is expressed as percent deviation from its initial free-trade steady state. The components of GDP are expressed as percent deviation from their respective steady states, weighted by their respective steady state shares in GDP.

Taking stock, our analysis suggests that large and persistent changes in tariffs are likely to affect firms’ innovation decisions and the pattern of technological hegemony. However, countries should be wary of using trade policies to boost innovation by their domestic high-tech firms, since this strategy may easily backfire. More targeted instruments, such as subsidies to innovation or investments in public R&D are likely to be better options.

Source : VOXeu