COMMENTARY: Tariffs will increase the probability of a recession

Unfortunately, research shows higher tariffs cause the economy to contract. In other words, his trade policies are recessionary.

There are several reasons higher tariffs have a negative effect on economic performance.

First, most of the tariff is passed on to consumers in the form of higher prices. This is particularly harmful to families with low or moderate incomes. These groups tend to spend a larger share of their income on goods, many of which are imported, than services. Families with higher incomes spend more on services. This implies the real incomes of lower-income Americans will decline. This will constrain demand in the economy.

Second, more than half of imported goods are inputs into business operations. Many of the tariffs target intermediate products such as steel and aluminum. This will increase production costs. Higher production costs will reduce business profits, causing these firms to produce less. Workers will be laid off, further reducing labor income and demand in the economy.

Third, the tariffs shift domestic production toward less efficient U.S. businesses. Lower productivity raises the production cost and prices of the goods being produced in protected industries.

Fourth, the U.S. tariffs will harm the economies of our trading partners. If a trade war breaks out, which is likely, these countries will retaliate with higher tariffs on U.S. goods sold in their markets. This will reduce U.S. exports, which will further slow the economy.

There is research that examines the macroeconomic ramifications of higher tariffs on economic performance. One study by the Federal Reserve Bank of St. Louis found a 3.5 or more percentage point increase in average tariffs caused U.S. gross domestic product and total annual wages to decline by 2 percentage points relative to a long-run trend for a two-year period. Domestic investment as a share of GDP declined by 1 percentage point for five years.

Other studies looked at groups of countries. They found higher tariffs caused output to decline and inflation to increase. One study found unemployment rose and productivity declined in response to higher tariffs. These studies also found that tariff changes have little or no effect on a country’s balance of trade.

One motivation for Trump’s tariff policies is to increase more direct foreign investment in the United States. His thinking is that foreign countries will directly invest in the United States to avoid the loss of sales because of the tariffs.

However, foreign multinational corporations have already made large investments in the United States. The United States is the No. 1 destination of foreign direct investment from the rest of the world. By the end of 2023 (the most recent data), foreign countries invested nearly $5.3 trillion on a historical cost basis in the United States. Manufacturing made up $2.22 trillion of these investments, while Europe invested almost $3.5 trillion.

Foreign businesses already have a strong incentive to invest in the United States. America is one of the largest and wealthiest markets in the world. Businesses want to be close to their customers. The market is lightly regulated. These businesses also want access to new technology created in the United States.

Rather than imposing costly new tariffs, the administration should pursue policies that help maintain our strengths. This means maintaining a reasonable tax and regulatory environment. Higher tariffs will deter international commerce and increase the chances of a recession.

Robert Krol is an emeritus professor of economics at California State University, Northridge. He wrote this for InsideSources.com.