Tariffs and deficits
patterns of trade rather than eliminating the overall deficit. Whilst imports from China did in fact fall, imports from other countries, such as Vietnam, Mexico and various other countries increased. An analysis by the Federal Reserve states that ‘tariffs on Chinese imports did not reduce the trade deficit but merely altered its geographic composition’ (Jeon et al., 2025, p. 4). The retaliatory tariffs placed by China on U.S. exports of agricultural goods and manufactured goods led to a reduction in export volume of these goods. The overall outcome of the tariffs was that the overall trade deficit still remained comparable to the prior value, while the bilateral deficit with China shrank marginally. The IMF’s External Sector Report supports this view, emphasizing that external trade deficits reflect domestic structural saving and investment patterns, rather than bilateral politics. The IMF concludes that ‘tariffs are unlikely to have a large impact on a country’s trade balance’ (IMF, 2023, p. 37). The U.S. saving shortfall – that is primarily driven by household demand and fiscal deficits – continued to generate the large current-account deficits, regardless of tariffs. The composition of the current account Even if tariffs succeed in the reduction of imports in goods trade, the other components of the current account are left either unaddressed or worse off. The U.S. runs a constant goods deficit (–4.2% of GDP in 2022) but a surplus in services (+1.0% of GDP). Tariffs are primarily targeted upon goods, leaving services untouched. In addition, net income payments to foreign creditors remain negative due to the accumulation of external debt and financing. Tariffs have no effect upon this income balance, which is structurally linked to the borrowing needs of the U.S. Therefore, while tariffs may change the composition of the current account deficit, its fails to address its magnitude. For example, the goods imports from China were partly replaced by imports from other countries, such as other Asian countries and Mexico. Meanwhile, U.S. exports decreased to China due to retaliation tariffs, worsening the service and agricultural balance. As Bellocchi and Travaglini summarize, ‘protectionist measures merely reshuffle trade flows without correcting the underlying imbalance’ (Bellocchi & Travaglini, 2025, p. 231). Exchange rate effects The interaction between tariffs and fiscal deficits has substantial effects on the exchange rate. Tariffs lead to a reduction in demand for foreign currency, which may lead to a strengthening of the domestic currency, in this case, the dollar. Furthermore, fiscal deficits, by leading to a raise in interest rates over time and attracting capital inflows, also appreciate the exchange rate. Joshi and Vines argue that ‘if the exchange rate is floating, tariffs tend to reduce exports’ because they ‘strengthen the exchange rate directly’ (Joshi & Vines, 2025, p. 3). The Trump-era policy combination coincided with a strong U.S. dollar. According to the IMF (2023, p. 22), the U.S. real effective exchange rate appreciated by roughly 8% between 2017 and 2019, making U.S. goods less competitive in an international market. This negated any advantage from tariffs and further cemented the trade deficit. Krugman and Obstfeld explain the mechanism: ‘the dollar’s foreign exchange value tends to rise when total spending rises’ (Krugman & Obstfeld, 2018, p. 319). Fiscal expansion, combined with the use of tariffs, resulted in precisely this result.
Domestic employment One of the political justifications of tariffs was the promise of the increase of manufacturing jobs. However, evidence suggests that the opposite outcome was achieved. Strain (2025, p. 7) found that
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