Is Trump engineering a crash? American exceptionalism was an illusion

Will a trade war make America great again? Not if you listen to most economists. Conventional theory argues that tariffs raise prices and therefore reduce consumption. In addition to raising prices, tariffs slow economic growth — thus risking stagflation. And, by protecting firms that might not be able to compete with imports, tariffs ensure that a country drifts away from the technological frontier.

But there are some economists who see things differently. A few of them have found their way into Trump’s orbit. Economists of this kind argue that tariffs can be effectively employed in a strategy to build a country’s industrial base. The classic examples of this are postwar Japan and then South Korea, each of which rebuilt their war-ravaged economies using a combination of state nurturing and protectionism. As a result, they became global manufacturing champions. (South Korea started practically from scratch.) 

The origins of this approach might be unexpected. When Japanese bureaucrats first looked around for examples of such “infant industry models”, they found inspiration in 19th-century America’s industrialisation. Contrary to its more recent policies, the US has some history of using protectionism to make itself great. 

Neoliberal economists therefore stand accused of neglecting the examples of history. Another blind spot might be political. Neoliberal mathematical models anticipate the effects of tariffs, but they lacks a theory of the state and of political economy. In their focus on the aggregate impacts of free trade, the neoliberals have too often neglected the differential impacts of opening western manufacturing to imports. 

Yes, output and efficiency rose in America when it opened up to China in the Nineties. But the gains were largely captured by large owners of capital, whereas small businesses and workers didn’t do so well. There resulted what the economist Branko Milanović dubbed the “elephant curve” of income distribution, in which a global middle class of owners and professionals grew rich while workers in Western countries fell behind. In America, where Democratic elites once represented working-class interests, the neoliberal turn initiated by Bill Clinton left them largely abandoned, and they ended up turning to Donald Trump.

Thus there is both an economic and political rationale for Trump to use tariffs to rebuild American manufacturing and restore the working class to its former glory. As Treasury Secretary Scott Bessent, “Wall Street’s done great… but this administration is about Main Street.”

The problem is that it’s hard to detect much evidence of strategy in the way Trump is going about it. First, he’s going after countries like Canada that aren’t the source of the US’s problem. The US runs a much bigger trade deficit with China than with Canada but has imposed the heavier tariffs on its neighbour. Worse, hefty tariffs on Canadian cars won’t actually benefit American carmakers. They’re highly integrated with Canadian firms, moving parts back and forth in cross-border supply chains. So American carmakers will pay the tariffs, making their products more expensive than imported models from elsewhere.

Trump’s tariffs also lack precision. The Koreans and the Japanese ensured that their tariffs supported the development of strategic industries while enabling imports in industries in which their countries were not competitive. Trump, in contrast, is slapping on tariffs indiscriminately. It’s hard to see what advantage the US would gain from raising prices on Colombian coffee, for instance, because the US has no capacity to build its own coffee industry.

Note the apparent incoherence of the tariffs on Canada. Trump has variously said that his tariffs are intended to protect American jobs, stop fentanyl trafficking, improve border security and make Canada the 51st state. Which of these, if any, is his actual goal is anybody’s guess. When asked how he’d describe the “psychodrama” of Trump’s on-again-off-again tariff announcements, the Prime Minister of Canada, Justin Trudeau, sighed and said wearily: “Thursday”.

Worst of all, Trump fiddles with the tariffs constantly, imposing then suspending them, or announcing carve-outs. His recent pivot to reciprocal tariffs goes even further, essentially outsourcing the US’s trade policy to other countries. Rather than set an economic plan and stick to it, he’s entrenched a reactive policy in which the US will play tariff whack-a-mole with trading partners.

If Trump’s idea of generalship is to tell his troops to advance, retreat, turn right then left all in a matter of hours, sooner or later they’ll give up from exhaustion. That’s already begun. Rather than respond to his tariffs by altering their production plans, businesses are starting to stand back, waiting for the fog of war to lift so they can plan better for the future. They’re postponing investment and holding off on new purchases, with the recent survey from the Institute for Supply Management revealing orders to be dropping so sharply the sector will soon be contracting. One recent business survey estimated that the manufacturing sector in the first quarter may therefore contract by as much as 3%.

This reveals another apparent flaw in Trump’s approach to this war. Like many declining empires, America is both overestimating its strength and underestimating that of its opponents. The American exceptionalism of recent years, in which its economy has grown strongly while other developed countries have stagnated, was always something of a debt-fuelled illusion. American borrowing has grown at twice the pace of GDP over the last few years. If the US had lived within its means, its economy would be as moribund as its G7 peers.

The evident limits to a debt-fuelled model started becoming apparent last year, when bond investors started driving up interest rates and thereby crimping demand. Trump took office at a time when the US economy was soaring high above its peers and its stock market was sucking capital in from all over the world, but the tide had already begun to turn. The economy was weakening, and money had begun quietly leaving the US. As America turned inward, foreign investors began to return home to Europe and Asia. Since the start of the year, the US stock market has gone negative, whereas those in Europe and Asia have been rising. Not surprisingly, Friday’s jobs report revealed an employment market that is losing steam.

And where America has been profligate, its trading partners have often been prudent. This has left many of them with ample fiscal firepower to respond to Trump’s provocations. Germany, China and the EU have all announced major increases in spending to stimulate their economies. This will help soften the impact of tariffs and further encourage investors to return home and chase the higher returns on offer. Three years ago, Liz Truss’s attempt at fiscal largesse provoked major ructions in bond markets, but no such turmoil has occurred in this new era of tariffs. It seems that investors are happy to continue lending to what have been comparatively tight-fisted money-managers.

Europe’s sudden largesse also poses a potential threat to one of the key pillars of the US’s postwar global dominance: the dollar’s role as the world’s reserve currency. Contrary to what conventional economic theory would predict, US tariffs have been accompanied by a weakening of the dollar in favour of other currencies and gold. 

The dollar has on its side the depth, liquidity and openness of America’s capital markets, as well as the dependability of its regime. No currency has ever come close to rivalling the dollar as a reserve currency. But Europe’s bond market is likely to expand substantially, just as the US has started to look less safe for foreign investors. (Trump has even hinted that the government could default on some debt.) As a result, the impossible is becoming at least conceivable.

One storyline currently doing the rounds in Trumpland is that this is all part of a plan — that Trump is deliberately engineering a downturn to squeeze excesses out of the economy before teeing up a strong rebound once his tax cuts and deregulation kick off. It would be a pugnacious approach to economic revitalisation, especially since he didn’t ask for a mandate from voters to do this. But it is at least plausible, since that’s essentially what Margaret Thatcher and Ronald Reagan once did. Still, it’s hard to square this fine-tuned strategy with the volatility of Trumpian policy-making. Besides, the tax cuts being proposed are largely baked in, being not new but an extension of the 2017 tax cuts. It’s not clear how much added stimulus they’d bring.

One can make a case that a trade war would be a just one. But Donald Trump isn’t fighting that war. In fact, other than the approval of his followers, it’s hard to tell what he’s fighting for. 

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John Rapley is an author and academic who divides his time between London, Johannesburg and Ottawa. His books include Why Empires Fall: Rome, America and the Future of the West (with Peter Heather, Penguin, 2023) and Twilight of the Money Gods: Economics as a religion (Simon & Schuster, 2017).

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