Assessing Trump’s tariff threats and the potential risks to the UK

Tariff man knows his trump card

During president-elect Donald Trump’s campaign for the White House, he stated that “the most beautiful word in the dictionary is tariff”. Trump, a self-proclaimed dealmaker, is adamant that the US is being taken advantage of by foes and allies across a host of trade and geopolitical areas. He threatens painful tariffs on US imports to bring foreign leaders to the negotiating table. If his means are clear, so too are his ends. Echoing the objectives of his first term in 2017-2021, Trump wants to narrow or eliminate US trade deficits, force European NATO members to meet their military spending commitments, and to press on with US efforts to contain an ever-expansionary China.

To be even-handed, in some respects Trump has a point. Many NATO members still fall well short of their pledge to spend 2% of GDP on defence (Figure 1). Amid ongoing conflicts in Eastern Europe and the Middle East, spending more on security should be obvious. The US, which remains the biggest overall NATO contributor, is within its rights to ask rich European countries to pay their fair share too. Likewise, the genuine threat that only China poses to American global hegemony argues for a more active containment strategy from Washington. Whether tariff threats are the best way to achieve such ends is an open question, however. Time will tell. 

The major problem with Trump’s penchant for tariffs is his apparent inclination to view trade deficits like losses on a corporate balance sheet. This is misguided. Even though all deficits and surpluses must balance, global trade is not a zero-sum game. Trade promotes prosperity and economic growth by allowing countries to optimise production according to domestic factor endowments and buy from abroad what cannot be made efficiently at home. The level of overall trade thus matters far more than the trade balance.

Large US trade deficits and its trading partners’ corresponding surpluses reflect a combination of excess US demand relative to domestic production and overproduction aboard. Yes, it would be better if the likes of China and Germany did more to stimulate their domestic demand, which would reduce their own trade surpluses and raise demand for US and global exports, but tariffs are a wrongheaded solution. They will reduce the overall level of US trade and, by acting like a tax on consumption, make US consumers poorer. When Trump started to impose tariffs in 2018 during his first presidency, the result was a dual shock to US exports and imports (Figure 2).

The world needs America more than America needs the world. And Trump knows it. The US economy remains unparalleled in richness, dynamism, and relative self-dependence. Even if trade wars hurt America, Trump bets that the pain will be worse for other countries – which will ultimately force concessions. A primitive approach to economic policy often goes hand in hand with strongman politics. With a Republican sweep in Congress, Trump will probably hope to take the sting out of higher costs for US consumers coming from tariffs by further deregulating domestic markets and through lower taxes for businesses and workers.

This time will be different

During Trump’s first term in the White House, he waited a year before enacting tariffs. As a result, the initial impact of his presidency on the global economy was positive. His pro-growth agenda of tax cuts and deregulation underpinned a synchronised upswing that lifted economic momentum in Europe and Asia as well as in the US. This time will be different. Whereas Trump and his team were largely unprepared for office the first time around and dragged their feet on tariffs for a while, for the past four years he has run a de facto administration-in-waiting. For a better-prepared Trump, tariffs may be one of the first items on the policy agenda following his inauguration on 20 January 2025.

On the campaign trail, Trump had threatened a 10-20% blanket tariff on all US goods imports and a 60% tariff on goods from China. The relevant question may be whether he will enact tariffs before inviting those he inflicts them upon to negotiate new terms or instead use the threat of tariffs as a device to initiate talks. The latter approach would do significantly less harm and could help to contain the risk of an escalating trade war.

A high-risk strategy

Trump inherits a different economy today than he did in 2017. Federal deficits are bigger, interest rates are higher, and the US economy is running hot (Figure 3). The risk is that his economic plan for tariffs and tax cuts, alongside immigration curbs, will reignite US inflation, trigger a rout in the US treasuries market, and even weaken the dollar. If financial markets began to anticipate his inflationary policy mix and move against him – especially in case of a sharply weaker dollar and big spike in treasury yields – it may cause him to think twice before aggressively increasing tariffs. But if it takes time for US price pressures to fully react to such a policy mix, Trump could trigger serious disruption to international trade before markets impose any decisive constraints upon him.

What could Trump mean for the UK?

While Trump has made clear that he plans to go after China, the EU, and Mexico, he has said little about the UK. This begs several questions: 1) Will Trump slap tariffs on UK exports too? 2) Should and how might the UK respond? 3) What could be the economic impact on the UK of US tariffs?

With luck, the UK may be able to either escape US tariffs or quickly strike a deal to avoid them. Consider the facts. First, Trump cannot claim the UK is taking advantage of the US on trade. Afterall, the US reports a small trade surplus in goods with the UK – unlike China, the EU, Mexico, and even Canada, where the US reports large deficits (Figure 4). Second, the UK consistently meets its NATO commitment to spend 2% of its GDP on defence while also playing a compliant junior partner to the US on almost all key strategic and geopolitical issues. And third, unlike China or even the EU, the UK is not a major geostrategic or economic rival to the US. In reality, the UK is much too small to really matter for the US.

Remember Brexit?

During his first term in office, Trump had been a major advocate of Brexit. Whether his motivation to support the UK’s break from the EU was to gain a relative advantage for the US by dividing Europe or because he is an anglophile who genuinely believes Brexit it is in the UK’s long-term interest does not really matter. Either way, it would seem counterintuitive for Trump to reunite the UK and the EU in a common cause against US tariffs.

The Farage factor

Nigel Farage MP, the outspoken leader of Reform and arch-Brexiteer, is close to Trump. Remember the old adage: in politics, the enemy of my enemy is my friend. Thinking along these lines, I wonder whether the Labour government will try to leverage Farage’s ties with Trump to try and avoid tariffs on UK exports? While left-wing Labour and Farage's right-wing Reform are not natural political bedfellows, it may serve both sides' interests cooperate. At the 4 July general election, with just c.34% of the popular vote, Labour won 411 out of the 650 seats in the House of Commons. The huge gap between Labour’s total electoral support and the number of seats they have in parliament is a quirk of the UK’s first-past-the-post electoral system. The Conservatives and Reform, meanwhile, won a combined popular vote share of c.38%. With c.24% of the popular vote, the Conservatives won just 121 seats and with c.14% of votes, Reform won a meagre five seats.

For Labour, elevating Farage by using him to play a crucial role managing UK-US relations may help maintain support for Reform, thereby keeping the right-of-centre support in the UK divided between Reform and the Conservatives – to the detriment of the latter and to the advantage of Labour with eyes on the next general election. For Farage, playing an instrumental role in UK-US diplomacy can help him signal that he has genuine policymaking credentials – thereby strengthening his claim that he is a serious politician and not just a firebrand political campaigner.

Britain’s choice

In case Trump applies a tariff to UK goods exports to the US, should the UK react in kind? In my view, no. Suppose, for instance, that the UK faces a choice between striking a deal with the US to avoid tariffs, or even suffering a one-off tariff hit and moving on, versus allying with the EU in a tariff war against the US, the ‘realpolitik’ choice would be to do the former.  

Just as US tariffs would make little sense, there would be no economic logic to the UK imposing retaliatory tariffs either. Doing so would arbitrarily raise UK import prices and make consumers poorer. Moreover, it would inflict trivial harm on the US. Indeed, it may even further agitate Trump to find new ways of making life hard for the UK. In my view, the wise decision for the UK would be to accept the tariff hit, hope that sterling depreciates against the dollar to soften some of the shock to export demand, before trying to negotiate better trade terms with the US.

If Prime Minster Keir Starmer and Chancellor Rachel Reeves are genuinely serious about going for growth, as they repeatedly emphasised on the campaign trail and since coming into office, they would be much better off trying to enhance economic ties with the dynamic, innovative, and fast-growing US than siding ideologically with the sclerotic, slow-growing, and structurally challenged EU (Figure 5).

What if?

The UK earns little more than 2% of its GDP from goods exports to the US (Figure 6). Even if a 10% US tariff on UK exports was fully passed on to demand, it would shave about 0.2% from UK GDP. That is small potatoes. As long as Trump does not combine tariffs with import quotas to limit the volume of goods the US can buy from the UK, a likely weakening of sterling versus the dollar in response to tariffs would partly cushion the hit anyway.

But even if the direct impact on the UK would be small, and even if the UK manages to avoid such an outcome, the UK would face a host of broader challenges coming from of a wider tit-for-tat tariff escalation between the US and the EU and China. Even though the UK is a domestic services-oriented economy, it remains a highly open. Exports are a major source of demand and imports provide essential supplies. If the three big global economic heavyweights get tangled up in a messy tariff war, the UK would undoubtedly suffer a chill from the headwind to global growth.