The economic consequences of Donald Trump’s second coming

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Granted, since Donald Trump dropped his bombs on Iran’s nuclear facilities last weekend, it’s the military and not the economic policy choices of the US president that are most immediately reshaping the world. But those economic policy choices have not gone away. So, today, I report on the most comprehensive effort so far to make economic sense of Trump 2.0. And as I have promised before, I return (surely not for the last time) to the question of what this implies for how the rest of the world needs to act.

The Centre for Economic Policy Research, a network of many of Europe’s best economists, has worked up quite a trade in producing “rapid response” economic insights into current affairs. It shone, for example, at the start of the Covid-19 pandemic when unprecedented lockdowns required an entirely new perspective on economic policy. The group’s “rapid response” programme has now produced a 40-chapter ebook, comprising almost 500 pages of analysis, on the economic fallout from the second Trump administration.

Among other things, the analyses put numbers on views we have also developed here at Free Lunch. For example, even if you think it’s a good thing to expand manufacturing as a share of the economy, Michael Strain’s chapter shows that Trump’s radical trade policy is unlikely to boost US manufacturing output or jobs by much (a possibility I discussed here and here). The ebook also features a very important chapter by John Coates, which goes through the economic costs of undermining the rule of law (it was evident the Trump administration was doing so within days of taking office). Anna Maria Mayda and Giovanni Peri show how the crackdown on immigrants will shrink the US economy, a theme also addressed by my Free Lunch co-conspirator Tej last Sunday.

Other chapters explore the prospects for groups that Trump’s policies are supposed to help, in particular the middle class and those in rural areas. The answer is: not well. Richard Baldwin highlights how many more middle-class Americans are working in services, not in manufacturing, and therefore stand to lose out in purchasing power when tariffs make manufactured goods more expensive and do nothing for service sectors. Mary Hendrickson and David Peters examine the fallout for rural areas from tariff retaliation against US agricultural exports (as well as immigration crackdowns and healthcare subsidy cuts). As they remind us, US farmers only got through the US-China trade war of the first Trump administration thanks to financial support from the federal government.

But I want to home in on what insights the studies have for the rest of the world and, in particular, how the “rest of the west” — other liberal democracies — should respond to the US going rogue. There are three types of questions I think this work casts light on.

One is how Trump’s tearing up of the global economy works itself out on the ground differently in different places. Here I can only refer you to the many country- and region-specific places. The book even includes a chapter about Greenland and the history of US-Danish relations over the island.

The second is: how does the US-shaped hole in the global economic system actually look — that is to say, what are the ways in which the US used to anchor the governing edifice of cross-border economic efficiency but has now given up on. Barry Eichengreen’s chapter is excellent on the global public good of (usually) stable finance. That is not, of course, the only way in which Trump has pulled the rug out from under global governance as practised for the past 75 years or so. Another important aspect is the abandonment of most-favoured-nation status in its tariff policy, which Kevin Hjortshøj O’Rourke writes about.

Finally, what can we say about how other countries ought to respond to Trump’s disruptions? Among the several chapters that estimate the cost of US tariffs, Marcelo Olarreaga and Sara Santander ask who will pay the cost they impose, by estimating the degree of pass-through of tariffs to final prices — and not just for the US but for the biggest trading partners. Two of their findings are particularly important for policymakers. (The three charts further down are reproduced from Olarreaga and Santander’s chapter.)

First, the pass-through is far from complete in the US — 53 per cent for the median good, although with a lot of variation between sectors. Intermediate inputs have a higher pass-through, for example, meaning that US manufacturers will bear much of the burden. But still, on average, almost half the cost of tariffs will fall on foreign producers. That’s in line with theory — a very big economy should be able to force others to absorb more of the cost of the tariffs they choose to impose. It also means Trump is not entirely wrong to claim that foreigners will “pay the tariff”.

Second, the pass-through from across-the-board tariffs is significantly higher in America’s main trading partners than in the US itself — from two-thirds for the EU to more than 80 per cent for Mexico. The implication for policy strategy is that other countries that are thinking of protecting themselves against trade diversion with tariffs of their own stand to lose more from their measures than Americans have from theirs.

If retaliation is carried out purely bilaterally and not on a most-favoured-nation basis, however, the pass-through drops to about one-third.

The authors take this as a reason to eschew broad tariffs and instead adopt ones narrowly targeted on sectors of greater political consequence and with more domestic alternatives. I would add more generally that the big difference in pass-through should focus countries’ minds on identifying the cost to themselves of the retaliatory measures they have to choose from. That does not mean not retaliating, but it does mean carefully selecting the measures that get the most political gain for the least economic pain.

That should make policymakers look for responses against US exports of services — for example, through higher digital services taxes or, in the EU, the use of the bloc’s new “anti-coercion instrument”. This allows the European Commission a lot of latitude in selecting economic instruments to respond to economic bullying, far beyond traditional trade restrictions. The current discussion inside the EU seems to be opening a space for this.

Beyond the specifics, there is a general assessment through many of the chapters that the challenges Trump has thrown at the global economy are here to stay. So while policymakers must be allowed to live in the hope of short-term improvement, and design their own immediate response accordingly, they clearly have a different long-term task. That is to refit their economies to thrive in a global economy from which America has permanently detached itself. How to do so is a question we will keep returning to in Free Lunch. Send us your ideas and reactions: freelunch@ft.com.

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● Enrico Letta urges the EU to grasp the opportunity offered by the US’s detachment by boosting its own strength: turbocharging the single market through a common “28th regulatory regime” and providing a safe euro-denominated asset through more common borrowing.

● How have Ukrainian refugees fared in Europe’s labour markets? Sarah O’Connor investigates.