Economic Commentary

Last month, Republican candidate Donald Trump won the U.S. presidential election. Republicans also earned majorities in the Senate and the House of Representatives. Election years bring a mix of clarity and complexity. While we now know which political leadership will guide the country, questions remain about how policy proposals will materialize and their implications.

Campaign proposals are one thing, but actual policy implementation can be quite another. It’s easy to draw oversimplified conclusions based on assumptions that only account for the first order impacts of policy decisions. In this article we will explore open questions and potential economic implications of policy proposals with a focus on tariffs and trade policy.

On the campaign trail, President Trump proposed tariffs of up to 60% on Chinese goods. He also proposed much broader tariffs of 10% to 20% on all other imports and potentially a 200% tariff on autos imported from Mexico. For comparison, the current effective tariff rate on Chinese imports is estimated at 10-20% while the average tariff rate on imports from the rest of the world is around 3%. Taken at face value, these proposals represent a significant change to current policy and if implemented in full, would have far-reaching implications for global trade.

When President Trump implemented tariffs during his first term, the result was an almost one for one increase in the prices of imported goods which were borne by some combination of U.S. corporations and consumers. Directionally, we would have to expect a similar dynamic this time around, only bigger. But what would the impact be on profit margins, consumer spending and inflation? Will there be retaliatory trade actions? To what extent, and by whom? How quickly will global trade be re-routed through countries with more advantageous duty requirements? And how will currency rates adjust as a net result of all these changes?

While we expect President Trump to pursue incremental tariffs soon after taking office, the extent of those tariffs is uncertain. On November 25, Trump stated that upon taking office, he would immediately impose additional 10% tariffs on goods from China and 25% tariffs on imports from Mexico and Canada. These figures differ from the more dramatic proposals outlined during the campaign, highlighting how policy proposals can evolve.

So why impose tariffs at all? Governments typically impose tariffs to raise revenue or to protect domestic industries and jobs from foreign competition. President Trump cites national security as the grounds for the newly proposed tariffs on China, Mexico and Canada arguing that the new taxes are necessary to address issues related to border security and migration.

From an economic perspective, tariffs make imported goods more expensive, and therefore less attractive to consumers. In turn, demand for domestically-produced substitutes should increase. Higher prices translate to lower sales volume for foreign producers or lower profitability if they can absorb the added cost of the tariff. This interference with what would otherwise be considered free trade results in an economic inefficiency known as “net welfare loss” or “deadweight loss.” Benefits to domestic producers (more volume, higher prices) and the government (tariff revenue) do not offset the reduction to consumer surplus otherwise supported by free trade.

While their use can be tactical and targeted with specific intentions, tariffs can also cause a range of negative side-effects. For example, tariffs can:

• Reduce competition making domestic industries less efficient
• Increase prices and degrade purchasing power for domestic consumers
• Create tension (even at home) by favoring certain industries and/or regions over others

Perhaps most importantly, global tensions and retaliatory responses from trading partners can quickly escalate into a counterproductive policy exchange or trade war. Taken to an extreme, higher prices and reduced demand for goods and services can erode global GDP growth, perhaps contributing to a global economic recession and/or market downturn.

The conclusion of the Presidential election removed a large branch from the tree of possibilities but plenty of branches remain. The range of potential scenarios highlights the challenges with predicting the precise economic and market impacts today. Fortunately, there are a few things we do know. We know that U.S. stocks have historically performed well under both Republican and Democratic Presidential administrations. We know that U.S. stocks have been up 86% of the time over rolling four-year periods dating back to 1928 – suggesting that four years is an ample time period from which to expect growth out of your portfolio regardless of who is in the White House. We also know President Trump emphasized the strength of the economy as a focus on the campaign trail. This focus could serve as a mitigant against policy excesses that would harm the economy or markets. As we navigate this next presidential term, we will monitor policy developments and adjust strategies to align with the fundamental impacts of trade and other economic policies.