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Explainer: How do tariffs work and how will they impact the American and global economy? [1]
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Date: 2025-05
Q: Among the reasons given for tariffs is the need to protect U.S. jobs and reshore or inshore manufacturing. Is there evidence that this will happen?
The central claim is that America can be revitalized and indeed the American middle class can be revitalized; workers without college education can be helped, and left-behind places can be restored if we stimulate manufacturing production in the United States. But at the moment it's important to realize and recognize that only just over 8% of Americans work in manufacturing and even if we were to entirely close the trade deficit that we have in manufactured goods, it's likely that manufacturing employment would increase by somewhere between one or two percentage points. So instead of around 8% of Americans working in manufacturing, 10% of Americans would work in manufacturing.
Manufacturing is simply too small to have a significant impact on the American labor force and both Presidents Biden and Trump have been obsessed with restoring American manufacturing. In my own view, the claims that they make that somehow this is going to have a significant impact on the availability of jobs for the middle class is completely unrealistic.
There are some manufactured products that are very important. We need semiconductors—they're important for artificial intelligence, they're important for national security. We need to decarbonize, and so electric vehicles and solar panels are important. So there are certain kinds of products which can help us meet national goals. But it is unrealistic to see manufacturing as a policy that is going to have a significant impact on the major problems of less educated Americans.
Both Biden and Trump are in a sense appealing to nostalgia for a world that no longer exists, in which manufacturing is a major driver of access to the middle class. They're about 30 to 40 years out of date because, as a result of both automation and the way we spend our money today, manufacturing has shrunk and is a relatively small part of our economy.
Q: Will tariffs help raise revenues, as the administration has claimed?
It's problematic, because the higher the tariffs that you impose, at some point the less revenue you're actually going to receive. The kind of estimates we're seeing from the administration are that they will raise $600 billion. I think that's an extremely optimistic view because as you make products more expensive, consumers will pay less or will be prepared to spend less on those imported products. In addition, one of the purposes of the tariffs is to get foreigners to come and invest in the United States. Well, if they do, they'll no longer be paying the tariff. So ironically, the long run achievement of goals like bringing a lot of investment into the United States to replace the imports is going to undermine the goal of raising revenue, and that's why it's very difficult to know exactly how much is going to be raised.
But it's important to point out that people, as they get richer, spend less and less on goods and more on services, and that means that tariffs have a regressive incidence because they take much more out of the pockets of poor Americans than they do of rich Americans. So to the degree that we now raise revenue using tariffs and use the money we save or the money we raise to reduce the taxes patented after the previous Trump tax cuts, this is an extremely regressive move for American households and the estimates are that the typical household is going to spend an additional $2,000 to $4,000, depending on which economist you believe.
There's also an exaggeration of the employment impact that you're going to get from tariffs. Let's take the example of a tariff on steel. You might create more jobs in the steel industry, but you will also raise input costs for the users of steel, and this in turn affects somewhere between 60 and 80 jobs for every one you save in the steel industry itself. So in the aggregate, the tariffs can be counterproductive, especially if they're put on inputs which are used in producing other products.
Q: Is the United States’ large trade deficit sustainable?
I think firstly there's an obsession with goods that isn't the right measure. What we ought to be looking at is not only our trade in goods, but also our trade in services, and we have a significant surplus in our trade in services. Therefore, when you aggregate the two together, you get a much smaller percentage and a smaller number relative to our GDP.
The second point is that we've been running deficits for 30 or 40 years, and what it means is that the United States is borrowing much more from the rest of the world than we lend, and therefore our net position has been declining over time. But remarkably, Americans earn more from, or earn just about as much from, their total investments abroad as foreigners earn in the United States. So if you look historically, we have felt no additional pressure about sustainability of our position. As long as we borrow the money and use it productively to increase investment in the United States, it is eminently sustainable, as with any investment.
Q: How would U.S. exports be impacted?
One of the effects of the tariffs is going to be over the medium term to strengthen the American dollar because Americans will need less foreign exchange in order to import, and when the dollar gets stronger, this affects all American exporters, whether they are exporting goods or whether they are exporting services.
A second point is that foreigners are not going to take these tariffs lying down. They are going to retaliate. Much of their retaliation can take the form of higher tariffs on American exports of goods, but in addition, foreigners are talking about levying taxes on the sales of American services and indeed some of the information technology company services that are being sold abroad. So there are going to be an adverse impact on exporters virtually any way you look—there are going to be higher input costs, they are going to have to sell into markets which are closing to them because of foreign retaliation, and the currency is going to get stronger and so their products are going to get more expensive.
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[1] Url:
https://www.hks.harvard.edu/faculty-research/policy-topics/public-finance/explainer-how-do-tariffs-work-and-how-will-they
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