Host: Hasti Rabiei
Guest: Hamzeh Arabzadeh

Hasti: During his previous term, Trump showed a strong inclination toward imposing tariffs. This has once again been a central theme in his current election campaign and political rhetoric. What explains his enthusiasm for tariffs?

Hamzeh: Trump's positive stance on tariffs stems from several factors. One of the key aspects is that he sees tariffs as a negotiation tool in diplomacy. By threatening to impose tariffs, he aims to extract economic and political concessions from other countries. A clear example was his threat to impose a 25% tariff on Mexican and Canadian exports. That threat alone was enough to pressure Mexico and Canada into increasing their commitments to border security, allocating more resources to controlling their shared borders with the U.S.

In exchange for these concessions, Trump announced that he would delay the tariffs for a month on Mexican and Canadian goods. This essentially means that if Mexico and Canada want to prevent the tariffs from being enacted permanently, they will likely have to offer further concessions. If they fail to do so, then some level of tariffs will likely be implemented regardless.

So, one key dimension of Trump’s tariff strategy is turning tariffs into a tool of economic and political leverage, using them as bargaining chips to extract favorable deals from other nations.

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Hasti: But imposing tariffs also comes at a cost for the U.S., right? What exactly gives America the upper hand in using tariffs as a political weapon? Trade typically benefits both sides, so how can tariffs function as a one-sided pressure tool?

Hamzeh: You're absolutely right, and I’ll elaborate further on the negative effects of tariffs on the U.S. economy later. However, the burden of tariffs is not equally distributed between trading partners.

The larger an economy or an economic bloc, the more resilient it is to a trade war—especially when that economy holds a technological advantage. This structural factor gives the U.S. a relative edge in using tariffs as a pressure tool.

Take the case of Mexico and Canada. Canada’s exports to the U.S. account for nearly 20% of its GDP, and Mexico’s exports to the U.S. make up about 30% of its GDP. Meanwhile, U.S. exports to both of these countries combined amount to only around 3% of U.S. GDP.

This asymmetry means that even if Mexico and Canada retaliate with their own tariffs on American goods, the overall impact on the U.S. economy would be far smaller than the damage inflicted on Canada and Mexico. It’s a game of economic brinkmanship, where the smaller players have far more to lose than the U.S. does.

That said, this does not mean that the U.S. economy is immune to the effects of a trade war. For instance, analysts estimate that a 25% tariff on imports from Canada and Mexico could effectively erase the profits of major American automakers like General Motors, Ford, and Stellantis. Over the past few decades, these companies have leveraged free trade agreements to shift part of their production to Mexico and Canada, benefiting from lower labor costs and integrated supply chains. If tariffs are imposed, their production costs will rise significantly, potentially pushing them into short-term losses.

We have already seen how the financial markets react to such developments. When Trump first announced his plans to impose tariffs on Mexico and Canada, the S&P 500 index dropped nearly 3%. The markets clearly view tariff warfare as a negative signal for economic stability.

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Hasti: So, can we assume that Trump’s trade war threats are purely a negotiation tactic, or are there real reasons to believe he will actually enforce these tariffs?

Hamzeh: It appears that Trump genuinely believes that tariffs are beneficial for the U.S. economy. His trade war with China went beyond mere threats—he actually raised tariffs on Chinese goods by 10%. In response, China retaliated with tariffs of up to 15% on some American exports.

Trump has also announced plans to impose tariffs on European goods, making it unlikely that all of these threats are merely bargaining chips.

In Trump’s economic worldview, tariffs serve two critical purposes. First, they act as a source of government revenue. Second, he believes that tariffs can help revive American industry by discouraging imports and boosting domestic production.

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Hasti: Let’s break these two points down. First, from a fiscal standpoint—why are tariffs appealing to Trump?

Hamzeh: The U.S. has been running large budget deficits in recent years. The deficit increased during Trump’s first term compared to Obama’s second term. Under Biden, even after the pandemic, it remained high—exceeding 6% of GDP in both 2023 and 2024.

One key reason for this was Biden’s expansionary fiscal policies, including pandemic-related stimulus and support for strategic industries, which we have previously discussed on Farcast. Another major factor was Trump’s tax cuts, which were introduced during his first term and later extended under Biden.

However, many of those Trump-era tax cuts are set to expire at the end of 2025. Neither Trump nor the Republican Party supports raising taxes, so they are likely to push for extending these tax cuts. This is why tariff revenue becomes an attractive option—it allows them to raise government funds without increasing taxes.

Of course, another element of Trump’s fiscal approach is his push to reduce government spending and streamline federal agencies, which he claims will help address the deficit.

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Hasti: Do we have any estimates on how much revenue tariffs could generate for the U.S. government?

Hamzeh: That depends on the extent to which tariffs are implemented.

During his campaign, Trump repeatedly stated that he plans to increase tariffs on all imports by 10 percentage points. If fully implemented, this could generate revenue equivalent to around 1% of U.S. GDP, a figure roughly comparable to the revenue lost due to Trump’s tax cuts.

However, there are two major problems with this. First, a 10% tariff hike across the board is a drastic move, making full implementation unlikely. Second, the economic distortions caused by tariffs are typically far more severe than those created by tax increases.

To put this into perspective, the total value of U.S. imports is about 13-14% of GDP. Higher tariffs would reduce import volumes, but even with a 10-percentage-point increase, the U.S. government could still generate between 1-1.2% of GDP in tariff revenue.

If the U.S. wanted to raise the same amount of revenue through income taxes, it would have to increase payroll taxes by 1.6 percentage points, meaning income tax rates would have to rise by 4-5% across the board.

This comparison illustrates how using tariffs as a substitute for tax revenue would come at the cost of major economic disruption. The effects of such a shock would likely be much harsher than those of an equivalent tax increase.

This kind of protectionist approach isn’t new in American history. The U.S. has experimented with high tariffs before, most notably with the Smoot-Hawley Tariff Act of 1930, which was introduced during the Great Depression. The goal was to generate revenue for the government and protect American industries and agriculture. The act raised the average U.S. tariff from 13% to nearly 19%, an increase of 6 percentage points. Even back then, this was considered an extreme move, and it triggered widespread retaliation from America’s trading partners. The result? U.S. exports plunged by 60% between 1929 and 1933, exacerbating the economic downturn.

Given that current U.S. tariffs are around 2% on average, a 10-percentage-point increase today would be five times more severe than the Smoot-Hawley tariff hike. If history is any indication, the economic fallout could be substantial.

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Hasti: That’s an important historical parallel. Could you briefly explain the impact of the Smoot-Hawley Tariff Act on the U.S. economy? It might give us a clearer picture of what to expect if Trump follows through with his trade war.

Hamzeh: The Smoot-Hawley Tariff Act was a textbook case of protectionism gone wrong. Many of America's trading partners, including Canada, the United Kingdom, and France, retaliated with their own tariffs. As a result, U.S. exports collapsed by 60% between 1929 and 1933. The policy didn’t just hurt global trade—it backfired on the U.S. economy itself. Many economists argue that the Act contributed to deepening the Great Depression by worsening unemployment and stifling business activity.

It’s also important to remember that today’s global economy is far more interconnected than it was in the 1930s. Supply chains are deeply integrated across multiple countries, meaning that a modern tariff war would likely cause even greater disruptions. The economic cost of dismantling these supply chains would be far higher now than it was nearly a century ago.

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Hasti: What about the impact of tariffs on American industry? Trump often argues that his tariffs will bring about a manufacturing renaissance, creating jobs and boosting industrial production. Is there any truth to that claim?

Hamzeh: The idea that tariffs can revive American industry is not supported by economic theory or historical precedent—at least not in the way Trump envisions.

Historically, tariffs have been used to support industrialization in developing countries or in cases where a country lacked technological or capital accumulation to compete internationally. In such cases, temporary tariff protections helped domestic industries get off the ground before eventually integrating into global markets. East Asian economies like South Korea and Taiwan followed this strategy successfully.

But the U.S. is not an emerging economy struggling with weak technology or inadequate capital. America’s challenges are different, and high tariffs could actually harm U.S. industry rather than revitalize it.

One major issue is that many industries rely on imported intermediate goods—raw materials and components used in production. When tariffs increase the cost of these inputs, production costs rise, making domestic goods more expensive. This reduces the competitiveness of U.S. industries, both at home and in global markets.

Retaliation is another major risk. When the U.S. imposes tariffs, its trading partners respond with their own, making it harder for American exporters to compete abroad.

Then there’s the impact on consumers. A large share of the tariff cost ultimately falls on American consumers, as companies pass on higher costs through price increases. This has an inflationary effect, which could force the Federal Reserve to raise interest rates further, putting additional pressure on businesses.

Finally, from a long-term perspective, tariffs distort resource allocation. In a competitive, open-market economy, resources naturally flow toward the most productive and innovative firms. But when tariffs artificially shield inefficient industries from competition, capital and labor are misallocated, ultimately weakening overall industrial efficiency.

So, rather than sparking an industrial renaissance, tariffs could push resources toward lower-productivity sectors while increasing costs and eroding competitiveness.

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Hasti: To wrap up, one of Trump's key arguments is that tariffs can help reduce America’s trade deficit. How much truth is there to that claim?

Hamzeh: This is another flawed argument that misdiagnoses the root causes of the trade deficit. Trump frequently portrays the trade deficit as if it’s some kind of economic failure—a sign that America is being exploited in unfair trade deals. But that’s not how trade deficits work.

Trade deficits are fundamentally driven by macroeconomic factors, not by unfair trade policies. The U.S. trade deficit is mainly a reflection of the fact that both the government and American households consume more than they produce.

Let’s take the government first. The U.S. runs large budget deficits, which it finances by issuing government bonds. Foreign investors buy these bonds, sending capital into the U.S. and strengthening the dollar. A stronger dollar makes American goods more expensive for foreign buyers while making imports cheaper for U.S. consumers. The result? A widening trade deficit.

This is what economists call the twin deficits hypothesis—when a government persistently runs fiscal deficits, it often leads to a trade deficit as well.

Now, looking at American households, the low savings rate is another key factor. Americans tend to spend more relative to their income compared to many other advanced economies. Credit is widely available, and consumer spending is a major driver of the U.S. economy. When households spend more than they save, they import more than they export, leading to trade imbalances.

Trump’s claim that tariffs can fix the trade deficit ignores these fundamental dynamics. Even if tariffs reduce imports, they won’t necessarily boost exports, especially if they lead to a stronger dollar and retaliatory trade barriers abroad.

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Hasti: Since we’re discussing savings, it might be worth explaining why the U.S. savings rate is so low compared to other countries.

Hamzeh: That’s an important point, and it ties directly to the trade deficit.

One major factor is the global demand for the U.S. dollar. The dollar’s status as the world’s primary reserve currency means there’s constant demand from foreign central banks and investors who want to hold U.S. assets. This demand keeps interest rates in the U.S. relatively low, making borrowing cheaper for both the government and private individuals. When borrowing is cheap, people and businesses are more likely to take on debt rather than save.

Then there’s the policy environment. In many European countries, there are caps on interest rates for consumer credit, which limits risky borrowing. But in the U.S., such restrictions are minimal, making it much easier for people to take out high-interest loans. Similarly, credit card regulations in Europe are stricter, while in the U.S., credit card spending is deeply embedded in consumer culture.

Retirement savings policies also play a role. In many European countries, pension and insurance contributions are mandatory, forcing individuals to save a portion of their income. In the U.S., these requirements are much looser, especially for lower-income workers. Many people don’t contribute to retirement plans or insurance programs, which reduces national savings.

The housing market is another factor. Mortgage structures in the U.S. encourage borrowing over saving. Thirty-year fixed-rate mortgages are common in the U.S., making homeownership more accessible with lower initial payments. In contrast, in Europe, mortgages tend to be shorter-term and variable-rate, which means people have to save more upfront before buying a home.

Student loans also play a significant role. Many American graduates start their careers with significant debt, which means they have little room for additional savings. In contrast, in countries where higher education is publicly funded, young professionals enter the workforce with far less financial burden.

All of these factors combine to create a system that incentivizes consumption and borrowing rather than saving. And because lower savings rates often translate into higher trade deficits, this structural issue is much bigger than just trade policy—it’s embedded in the broader economic model of the U.S.

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Hasti: Let’s bring everything together with a final question. What’s the outlook on where this trade war is heading?

Hamzeh: It’s highly unlikely that Trump will fully implement the extreme tariff policies he’s been promoting. Raising tariffs across the board by 10 percentage points, for example, would be an enormous shock to the U.S. economy, and the financial markets would react negatively. We already saw this when he threatened tariffs on Mexico and Canada—the S&P 500 fell, and investors panicked.

Trump is very aware of how financial markets react to his policies. He takes stock market performance as a personal report card on his economic leadership. Given that, it’s unlikely he would push a tariff policy that causes a significant market sell-off.

That said, many analysts predict that trade tensions will escalate if Trump returns to the White House. Even if tariffs don’t reach the extreme levels he has suggested, the overall trend is likely to be one of increased protectionism.

This shift won’t just impact the U.S. It will ripple through the global economy, affecting supply chains, trade flows, and investment decisions worldwide. For businesses that rely on stable trade relationships, the next few years could bring significant uncertainty.