Podcast Host: Mahdi Noroozian 

Guest: Hamzeh Arabzadeh

Noroozian:
It seems that recent U.S. economic data show a rather mixed picture. On one hand, we see a booming stock market, and production figures suggest that the economy has performed quite well in the second and third quarters of 2025. On the other hand, the labour market doesn’t look particularly encouraging, and inflation has shown some renewed upward movement. Altogether, the signals appear somewhat contradictory. What is actually happening in the U.S. economy right now?

Hamzeh:
In my view, today’s U.S. economy is being shaped by three main forces whose combined effects are driving its overall dynamics. The first and most visible driver is artificial intelligence, which seems to be the key factor behind the recent stock market rally. The second is the impact of tariffs, which we are now starting to feel—especially in the latest inflation data. And third, immigration policy is playing an increasingly important role. The effects of Trump’s restrictive immigration measures are already visible in the labour market, and with some delay, we will probably see their impact on prices as well.

----------------------------------------------

Noroozian:
Let’s start with tariffs. Perhaps it’s best to first explain to our listeners, from a theoretical perspective, what the effects of free trade are—and how, in theory, Trump’s tariffs can affect the economy.

Hamzeh:
Broadly speaking, the benefits of free trade can be summarised in a few key mechanisms.
The first is the efficient allocation of resources, a classical idea formalised in early trade theories such as the Heckscher–Ohlin model. Under free trade, each country specialises in producing goods where it has a comparative advantage, which lowers total production costs and leads to both higher productivity and lower final prices. The clearest real-world example is the emergence of the modern global supply chain, which reflects decades of efficiency gains through trade integration.

The second major benefit is economies of scale. Opening markets to international trade expands potential demand for each product. As shown in Krugman’s models of trade and increasing returns, firms operating at a global scale can reduce their average production costs and improve efficiency, which boosts productivity and lowers prices.
A third advantage lies in productivity growth through competition. Trade liberalisation intensifies market competition, which serves as the main engine of innovation and productivity gains—a mechanism captured in the Melitz model of heterogeneous firms and trade.

Together, these effects explain much of the productivity growth and welfare gains observed in advanced economies since the 1980s.

Of course, free trade has also had distributional consequences that have fuelled political backlash. Greater openness has increased inequality in some regions and industries. Sectors without comparative advantage have suffered, leaving many workers displaced—a phenomenon economists refer to as job displacement—forcing them to move into less suitable or lower-paying occupations in the short term.
When trade is restricted, all these positive effects are essentially reversed, damaging the economy.
When Trump’s tariffs were first announced, economists raised several warnings:

1. Higher consumer prices, as tariffs raise the cost of final goods.

2. Higher input costs for domestic producers, reducing their competitiveness.

3. Retaliation from trading partners, hurting U.S. exporters.

4. And finally, reduced innovation and productivity, as insulating domestic firms from global competition weakens their incentives to improve.

----------------------------------------------

Noroozian:
So have those early warnings actually shown up in reality? I mean, when it comes to inflation or unemployment, do we really see the effects of the tariffs in the data?

Hamzeh:
Some of the effects show up more quickly, and others take more time. Inflation reacts faster, while things like productivity or the labour market usually move more slowly.
On inflation, there are estimates that tariffs have added about 0.3 percentage points so far. If we look at the monthly numbers, the downward trend in core inflation that started around mid-2023 basically stopped in March 2025, and in the past few months prices have started to creep up again.

You can see this even more clearly in sectors that are directly affected by tariffs. In the second quarter of this year, prices of durable goods went up by around 3 percent. Apart from the pandemic years, that’s the fastest increase we’ve seen since the early 1990s.
And there are some warning signs in the labour market too. Employment has weakened in industries that are more exposed to tariffs, especially manufacturing. Surveys such as the ISM Manufacturing Employment Index and NFIB small-business reports show that firms in these sectors are cutting hiring plans and citing higher input costs and policy uncertainty as major concerns.

Consumer sentiment has also dropped. According to the University of Michigan’s consumer sentiment survey, the index is down by roughly 20 percent compared with last year, which suggests that both firms and households are becoming more cautious.

----------------------------------------------

Noroozian:
But still, the inflationary effect you’re describing sounds much smaller than what many economists had warned about earlier. I remember that when Trump announced the tariffs on April 2, a lot of economists were talking about runaway inflation and even the risk of recession. But that hasn’t really happened. The inflation impact seems quite moderate, and the U.S. economy doesn’t show signs of heading into a downturn. Even the stock market, which in a way acts as a barometer of the economy, looks very strong. After that sharp drop in the days following “Liberation Day,” U.S. equities have rebounded impressively. From the April lows, the S&P 500 has gained nearly 40 percent.

Hamzeh:
In fact, the initial market reaction confirmed those early worries — that tariffs would hurt the economy. When Trump made the announcement, the response was immediate: within two days, the S&P 500 lost almost 10 percent. And more recently, when he threatened to impose 100 percent tariffs on Chinese goods, the index again dropped by about 2.5 percent. So clearly, investors don’t see tariffs as something positive.
But other forces have offset these concerns and kept investor sentiment surprisingly strong. Robust corporate earnings, the ongoing AI-driven tech rally, and expectations that the Federal Reserve may start easing rates later this year have all lifted the market. According to Bloomberg and Refinitiv data, almost 80 percent of S&P 500 companies beat earnings expectations in the second quarter of 2025 — one reason investors have stayed upbeat despite the trade tensions.

In fact, we can see how AI is affecting the economy in other ways: it has created a gap between output growth and employment growth. The Federal Reserve Bank of Atlanta’s GDPNow model — and similar Fed Nowcasts from New York and St. Louis — estimate that real GDP grew by about 3.8 percent (annualised) in the second quarter of 2025, with forecasts pointing to a similar pace for the third. But the labour market doesn’t reflect that strength. From May to August, net job creation in non-farm employment averaged only about 27,000 per month, one of the weakest readings outside the pandemic period. In 2024, the same figure was roughly 147,000 per month — more than six times higher.
This disconnect has been highlighted by several institutions. Moody’s Analytics recently described the situation as a “labour market recession,” while The Conference Board also noted a sharp drop in hiring intentions in its latest CEO survey. Meanwhile, the Bureau of Labor Statistics (BLS) data confirm that productivity per worker has surged, especially in sectors with high AI adoption.

It’s a striking divergence: output keeps expanding, yet employment is stagnating. A big part of that likely comes from AI-driven efficiency gains — firms are producing more without adding much labour.

So, in short, two main forces are shaping the U.S. stock market right now — the positive momentum from AI and the negative, though temporary, impact of tariffs — and for now, the first is clearly stronger.

----------------------------------------------

Noroozian:
Still, the impact of tariffs doesn’t seem large enough to drag down the stock market, despite other headwinds. And even on inflation, the situation looks very different from what economists warned about early in Trump’s presidency. The U.S. economy doesn’t appear to be heading into a recession at all. All of this contrasts sharply with the pessimistic forecasts we were hearing just six months ago.

Hamzeh:
Exactly. Despite the visible effects on inflation and the labour market, these impacts have been much smaller than the warnings suggested. When we look at other indicators, there’s still little sign of the severe consequences many feared. For example, most forecasts for 2025 place U.S. GDP growth between 1.5 and 2 percent. That would indeed mark a slowdown from 2.8 percent in 2024 and 2.9 percent in 2023 — but it’s still comfortably above recession territory.

There are clear reasons for this gap between the predictions and reality. Much of the early pessimism was based on the assumption that all of Trump’s announced tariffs would actually take effect, and that other countries would retaliate aggressively by raising tariffs on U.S. goods. In practice, that didn’t happen.

Back in April, analysts expected the average U.S. tariff rate to rise to nearly 28 percent. But by the end of August, it was closer to 11 percent. In the case of China, for example, Trump initially threatened 145 percent tariffs on Chinese imports, but by August, the effective rate was roughly one-third of that. For South Korea, tariffs fell from 25 percent to 15 percent. In some cases, tariffs were never implemented at all; in many others, enforcement was delayed.

A large share of goods were also exempted. Smartphones and computers were excluded from new tariffs altogether. In Brazil’s case, about 700 product categories were granted exemptions from the 50 percent rate, which meant the country’s effective tariff ended up closer to 30 percent. On pharmaceuticals, Trump had announced 100 percent tariffs on imported drugs starting in October, but later excluded generic medicines — which account for nearly 90 percent of U.S. drug consumption.

Beyond these exemptions and revisions, there’s also a big difference between the legal tariff rate on paper and the tariff actually being collected. Estimates from the Budget Lab at Yale and the Peterson Institute show that the effective tariff rate today is roughly half of what the current policy framework — even after all carve-outs — would suggest.

----------------------------------------------

Noroozian:
What explains this gap between the tariffs that were officially announced and those that are actually being enforced?

Hamzeh:
Part of it comes down to loopholes and tariff evasion. For instance, China’s own export data to the U.S. differ quite a bit from the import figures reported by U.S. customs. That gap likely reflects the re-routing of goods through third countries and other ways of avoiding direct exposure to tariffs.

Another factor is timing. Many firms rushed to import goods before the new tariffs came into effect, since the duties don’t apply to shipments that were already registered for transit. During the summer, this led to a surge in imports as companies stockpiled goods in advance. That front-loading blunted the immediate inflationary impact of the tariffs.
So to sum up, the pessimistic forecasts were based on the tariffs Trump announced back in April. But in practice, those tariffs were heavily watered down. They included a long list of exemptions, a large share was bypassed, and many firms used existing inventories or early shipments to cushion the blow — at least in the short term. Of course, that doesn’t mean the effects have disappeared; it mostly means they’ve been delayed.
Another important point is that the original forecasts assumed strong retaliation from other countries — that they would sharply raise tariffs on U.S. exports. But most of them didn’t. Instead, they preferred to negotiate or quietly reach side agreements with Washington.
Altogether, these factors explain why the real impact of tariffs today looks very different from what many economists were predicting six months ago.

----------------------------------------------

Noroozian:
Let me ask something that might seem a bit off-topic, but I think it’s an important question. What kind of impact does the stock market’s strong performance have on the broader U.S. economy? In other words, can the rally in equity prices itself help offset or neutralise the negative effects of tariffs? I’m asking partly because in Iran, too, there’s often this idea that channeling liquidity into the stock market can stimulate economic growth.

Hamzeh:
When money flows into the stock market or when stock returns rise, it doesn’t directly boost production. That’s because trading activity mostly just shifts liquidity from one investor to another — it doesn’t immediately inject new money into firms. When a company’s stock price goes up, nothing changes in its balance sheet or productivity on its own.

However, there are indirect effects. For example, if a firm’s market value rises, it becomes easier for that firm to raise capital through new equity issuance — meaning it can raise more funds per share if it decides to sell new stock. But that only happens when the firm actually issues new shares, which isn’t always the case.

Another indirect channel comes through foreign investment. A hot stock market can attract new foreign investors, which effectively brings new capital into the country — though of course that doesn’t apply to Iran’s situation today.

And then there’s the wealth effect. When investors feel richer because their assets are worth more, they tend to spend more. That extra consumption raises aggregate demand, giving the economy a short-term boost.

At the same time, rising stock prices can also signal stronger expectations for future earnings. That optimism can encourage firms to expand investment, both because their cost of capital falls and because corporate sentiment improves. But again, this effect depends on expectations being realised — if profits disappoint, the positive impact quickly fades.

So yes, all of this can have indirect effects, but the rally itself doesn’t automatically create real economic growth. It’s not that a booming stock market, by itself, drives higher production.

In fact, The Economist recently warned about this very dynamic. If tariffs or other shocks eventually hit the real economy hard, the current market boom could actually make the fallout worse. A sharp market correction would reverse those indirect benefits — the wealth effect would turn negative, amplifying the downturn instead of cushioning it.

----------------------------------------------

Noroozian:
So, to sum up, Trump’s tariff policies so far have had limited effects on inflation and on some parts of the labour market, though much less than economists predicted six months ago. That’s mainly because he scaled back the tariffs, most countries didn’t retaliate, and many effects take longer to appear. If that summary is right, what do you think about the longer-term effects of these tariffs on U.S. inflation?

Hamzeh:
As I mentioned earlier, we’ll probably see core inflation rise gradually in the coming months. Over time, the costs from tariffs will feed through more clearly into both intermediate and consumer goods. Until now, many U.S. firms have absorbed a big part of those costs — either because they stocked up on inventories before the tariffs took effect or because their profit margins were strong enough to take the hit. But as inventories shrink and margins tighten, those costs will start showing up in final prices.
Some estimates suggest that tariffs could reduce household purchasing power by around 2,400 dollars a year on average. And because the tariffs were implemented gradually, their inflationary effects are also expected to appear gradually over several quarters.
Another likely consequence is that this renewed inflation pressure could make the Federal Reserve more cautious about cutting rates further. In other words, monetary easing might slow down.

There’s also another important factor: immigration policy. The Economist’s latest issue discussed this in detail. Trump’s trade policies aim to bring jobs back to the U.S., but his anti-immigration stance works in the opposite direction by reducing labour supply. From 2000 up to the Biden era, net immigration averaged about one million people a year. Under Biden, that rose to nearly 2.5 million. But this year, estimates suggest net immigration could fall close to zero, or even turn negative.

That naturally pushes up labour costs. And if wages rise while productivity growth doesn’t fully match it, that becomes another source of inflation — and it also hurts the competitiveness of U.S. firms. We can already see this in the data: despite very weak job creation over the past few months, the unemployment rate has barely changed. That clearly shows a slowdown in labour supply.

So overall, it’s likely that the effects of Trump’s tariffs and his immigration policies will reinforce each other, both putting upward pressure on prices. The open question now is whether advances in AI and automation can offset some of those pressures by improving productivity and easing labour shortages.

----------------------------------------------

Noroozian:
That makes sense. But maybe the bigger question, in the long run, is about productivity. What happens to it under Trump’s tariff and immigration policies?

Hamzeh:
Yes, that’s really the core issue. In the long term, the main risk from tariffs isn’t just higher prices — it’s weaker productivity growth. Building tariff walls around the economy reduces competition, and when competition fades, firms have less incentive to innovate or improve efficiency.

There’s also a misallocation effect. Tariffs protect less efficient firms and sectors that wouldn’t normally survive in a competitive environment. Because of that protection, resources like labour and capital are pulled away from the more productive parts of the economy and redirected toward lower-productivity sectors. Over time, that isolation makes the whole economy less dynamic. So tariffs hurt productivity both by lowering the drive for innovation and by distorting how resources are allocated.

And here, Trump’s immigration policy could reinforce those same negative effects on productivity. Limiting migration doesn’t just reduce the number of available workers; it also weakens the economy’s ability to innovate and adapt. The United States has long relied on immigration as a key engine of growth — not only for labour supply but for technological progress.

High-skilled immigrants, in particular, play an outsized role. While they represent only about 5 percent of the U.S. workforce, they account for around 10 percent of total labour income and are overrepresented in the most research-intensive sectors of the economy. Data from the National Science Foundation show that roughly 45 percent of workers with doctorates in STEM fields were born abroad. Among Silicon Valley start-ups valued at over one billion dollars, more than half were founded or co-founded by immigrants.
Research by Rebecca Diamond at Harvard University and her co-authors finds that immigrants contribute to roughly one-third of all innovation in the United States, measured through patents, and that their presence boosts the productivity of their native-born colleagues as well. Other studies from Stanford and the National Bureau of Economic Research show similar results: cities and firms with larger shares of foreign-born talent tend to produce more patents per worker, export more, and recover faster from recessions.

Cutting off that flow of skilled labour therefore has long-lasting costs. It slows the rate of technological diffusion, weakens competitive pressure, and makes the economy more inward-looking. Combined with tariffs that already reduce international competition, restrictive immigration policies risk turning short-term protectionism into a deeper, structural drag on American productivity. Over time, that means slower growth and weaker innovation.

----------------------------------------------

Noroozian:
Let me ask something more general. Over the past few years, we’ve heard a lot about a shift away from globalization — what some call “deglobalization.” Even under Biden, the U.S. moved toward more protectionist policies, like the Inflation Reduction Act and the CHIPS and Science Act. To what extent can Trump’s recent policies be seen as part of that same trend? And how are his protectionist policies different from Biden’s?

Hamzeh:
There’s actually a big difference between the two, both in intent and in design.
During the Biden administration, the focus was mainly on strengthening America’s position in a few strategic sectors — especially semiconductors, clean energy, and advanced manufacturing — and on reducing dependence on China in those areas. The tariffs that were kept from Trump’s first term were largely targeted and sector-specific. At the same time, Biden introduced a broad package of incentives: tax credits, production subsidies, and public investment programs. These policies aimed to build domestic capacity in high-tech and green industries, while still keeping the U.S. economy open to allies and global supply chains. In economic terms, it’s what we’d call industrial policy.
Trump’s approach, however, is very different. For him, tariffs are not a fine-tuned tool to foster strategic competitiveness — they’re a blunt instrument, often used for political leverage. His stated goals are to reduce the trade deficit and boost domestic employment. In practice, that translates into across-the-board tariff hikes rather than selective support.

The problem is that tariffs aren’t an effective way to shrink the trade deficit. The deficit reflects an imbalance between national savings and investment — it’s a macroeconomic outcome, not something you can fix with import duties. As long as Americans consume and invest more than they produce, and the government runs large fiscal deficits, the U.S. will import more than it exports. Tariffs just change where imports come from, not how much Americans import in total.

So Biden’s policies resemble a targeted industrial strategy — trying to steer investment toward key sectors for national resilience. Trump’s policies, in contrast, lean toward a kind of economic self-sufficiency — what you might even call “autarky.” It’s less about building global competitiveness and more about walling off the domestic market in the hope that isolation itself will bring jobs and balance.

----------------------------------------------

Noroozian:
To wrap up, I’d like to ask about Iran. For years, Iran has supported certain domestic industries — like automobiles and home appliances — through tariffs and various protectionist measures, yet these policies haven’t really delivered results. Meanwhile, as you mentioned earlier, countries like Japan, South Korea, and China have successfully used forms of industrial policy that involved protection and state support, especially in earlier stages of development. Even today, some level of protectionism exists in those economies. What has made their experiences successful while Iran’s hasn’t worked out?

Hamzeh:
What we’ve seen in those successful cases is what economists classify as industrial policy — and that comes with a very specific set of elements. In all those examples, several features stand out.

First, support was concentrated on a few sectors in which the country aimed to build a comparative advantage. The logic was clear: since these countries initially lacked the technology and infrastructure to compete globally, they gave selected industries a temporary boost — through tariffs on foreign goods and targeted subsidies — to help them reach global competitiveness. But the key word here is “temporary.” The ultimate goal was to become export-oriented, not permanently shielded.

Second, these support measures were explicitly time-bound. Governments announced in advance how long the protection would last and then phased it out. Once the industry reached scale, support was withdrawn, and the focus shifted toward global competition.
Third, all of these countries made technology transfer and foreign participation central to their strategy. Japan, for instance, built its post-war auto industry by licensing American car models and producing them domestically. South Korea relied heavily on joint ventures to absorb foreign know-how, and China, especially after the 1990s, combined joint ventures with large-scale foreign direct investment to accelerate learning. None of them tried to reinvent everything from scratch under nationalist slogans about complete self-reliance.
Fourth, industrial policy was always export-driven. The aim wasn’t merely to meet domestic demand but to compete internationally, forcing firms to reach global standards of quality and efficiency.

In Iran, however, what we’ve had since the Revolution has been something very different. The broader economic strategy has been closer to self-sufficiency, not industrial policy in the classic sense. The motivation wasn’t primarily economic — it was political and ideological. Influenced by leftist and anti-imperialist thinking, the emphasis was on independence and resistance to global capitalism.

Self-sufficiency means producing everything the country needs domestically, even if it’s inefficient to do so. Once that becomes the goal, protection expands to almost every sector, and resources get spread too thin. By trying to produce everything, you lose the ability to specialise in what you can actually do well and trade for the rest. That’s the opposite of export orientation.

Another major difference is the near absence of foreign investment and technology transfer. Because of both sanctions and deep-rooted mistrust toward foreign involvement, Iran has largely kept external partners out of strategic sectors. The result is technological stagnation. Instead of learning from global leaders, Iranian industries have been left to replicate outdated models with limited innovation.

So, to sum up, there’s a fundamental difference between export-oriented industrial policy and inward-looking self-sufficiency. Industrial policy seeks deeper integration into the global economy, using temporary protection as a springboard. Self-sufficiency isolates the economy, aiming to produce everything at home — often at much higher cost. And ultimately, that economic inwardness reflects a foreign policy outlook that favours insulation rather than engagement with the world.