The consequences of Trump’s tariff threats

Despite President-elect Donald Trump repeatedly touting that “tariff” is his favorite word, many observers, investors, and foreign government officials hoped that his promises were mere rhetoric, doubting he would actually pursue the tariff-centered protectionist agenda he campaigned on. His recent appearance on “Meet The Press,” in which he again asserted that he is “a big believer in tariffs” that “cost Americans nothing,” reinforced his earlier threats to impose 25% tariffs on all goods coming from Mexico and Canada and 10% on China. Doubts about whether Trump is serious about tariffs should be put to rest.  

Trump’s broader trade strategy reflects a worldview rooted in 19th-century mercantilism, emphasizing protectionism and an aggressive use of tariffs. Trump sees tariffs as multipurpose tools: sometimes as a means to an end—as negotiating leverage to cut a deal—and other times as ends unto themselves—both to encourage reshoring American manufacturing and to generate revenues to pay for tax cuts and spending. Under this approach, tariffs are either assumed to be “costless,” with no negative impacts borne by domestic consumers (through higher prices) or by businesses (through higher-priced inputs and disrupted supply chains), or that tariffs might increase consumer prices, but that is a price worth paying in order to revive the American industrial base. For the United States and its trading partners, the resurgence of protectionism in an interconnected world poses a slew of economic, strategic, and institutional risks.

China

For China, the announcement of a 10% tariff—less aggressive than the previously threatened 60%—likely elicited a muted sigh of relief. China’s initial reaction is likely to be limited to a devaluation of the renminbi (RMB), which effectively offsets the tariffs by lowering the dollar price of goods it exports. This was a tactic that China used effectively during Trump’s first term. While the renminbi is already weak, China can afford to weaken the RMB further to maintain export competitiveness without directly escalating tensions with the United States.

If Trump issues additional threats of further tariff and trade measures, China’s response will be a function of President Xi Jinping’s strategy for countering Trump. Xi’s position today is markedly different from when the Chinese leader engaged with Trump during his first term. Xi is now much stronger domestically, surrounded at the top of the Chinese government exclusively by allies, giving him greater latitude to navigate external pressures.

Xi could choose to take advantage of this politically dominant position and seek to constructively engage with the United States, prioritizing the mitigation of economic consequences while avoiding the risk of political instability. In the immediate term, Trump’s threatened tariffs were based on frustration about China’s limited efforts to restrict the precursors of fentanyl from making their way to the United States via Mexico and through other channels. Xi could decide to make a more serious effort to address American concerns.

China could also seek to engage Trump on a broader range of trade issues, perhaps dangling hopes of a “Phase Two” trade deal. But if China does so, Beijing is likely to adopt a strategy that includes drawing out negotiations, knowing that Trump will have a political imperative to announce a successful deal before the 2026 midterm elections.

Alternatively, China has had years to prepare for Trump’s return and Xi is far better prepared to take a more assertive posture if he decides to do so. Xi may now feel less inclined to tolerate Trump’s aggressive tactics. In the next round, Xi might not show much patience if Trump tries to bully him. A trade war under these conditions could see China deploying its full range of retaliatory tools against U.S. interests. In addition to the straightforward tit-for-tat imposition of counter-tariffs, China could further ratchet up its use of export restrictions on critical minerals, utilize its own “Unreliable Entities List,” and impose its own export controls akin to the U.S. Foreign Direct Product Rule, potentially impacting global trade anywhere where the United States is a party and where any component of a product can be traced back to China. These measures would enable Beijing to respond with greater precision, target specific U.S. companies or critical industries, and potentially inflict significant economic pain without triggering a full-scale trade war.

Mexico and Canada

For Mexico and Canada, their hope appears to be that Trump’s threats are mere negotiation ploys to which concessions can be made even before he takes office, allowing Trump to declare victory and remove, or at least delay, the actual tariffs. But that cannot be taken for granted, and the stakes in the short term at least, are high.

For the auto industry, which spans all three countries and is subject to the United States-Mexico-Canada Agreement (USMCA), a 25% tariff on all goods crossing the border would have profound implications. Each vehicle produced under the USMCA framework crosses the border an average of eight times during production, meaning the tariffs would be compounded at each stage. This would lead to significant cost increases, impacts on employment, disrupted supply chains, and higher prices for consumers.

For Mexico, tariffs could exacerbate tensions with Mexico’s new president, Claudia Sheinbaum, whose immediate reaction was to threaten retaliatory measures. Mexico is constrained because much of what Trump demands from Mexico is inconsistent with the political reality that violent cartels have become enmeshed in the country’s political system to the point where attempts to control them risk widespread domestic unrest and violence. The practical, political, and structural challenges of addressing drug cartels and immigration flows make it unlikely that Mexico can meet Trump’s demands in a way that satisfies his expectations. Sheinbaum can promise measures that demonstrate good faith efforts to address Trump’s concerns, but she might be relatively powerless to actually halt the fentanyl trade. This raises the risk that Trump imposes tariffs as punitive measures designed to project strength.

For Canada, virtually its entire trade surplus with the United States comes from crude oil exports to the United States. Some American refineries are specifically configured to process Canadian crude, and unlike manufactured goods, crude oil cannot easily be rerouted; Canada’s pipelines are immovable infrastructure. This dependency creates a bilateral monopoly, limiting both sides’ practical flexibility. Canada has few viable alternatives for exporting its crude and some American refineries have similarly few alternatives for sourcing crude to process. This is a case where both sides will suffer.

Trump’s adversarial stance risks souring bilateral relations with both Mexico and Canada and undermining the broader North American economic partnership. Regardless of whatever national emergency predicate would be used to justify them, the threatened tariffs represent a transparent violation of the USMCA, undermining the agreement’s stability and increasing the likelihood of a contentious review that is scheduled to be concluded by 2026, putting the entire trading relationship on the table once again. Even Trump’s former U.S. trade representative, Robert Lighthizer, who led the USMCA negotiations, recently noted with respect to the USMCA that “no deal is forever.”

What’s next?

While the United States remains a dominant economic power, and Trump’s unilateral policies and aggressive tactics may yield some immediate concessions, they risk long-term consequences including alienating key allies and accelerating the fragmentation of global trade networks, thereby eroding U.S. influence in the global economy. Upending those alliances is especially worrying given the Biden administration’s efforts to recast global trading relationships around the concept of friend-shoring, in which like-minded allies were treated preferentially to those seen as strategic or economic threats so as to ensure resilience.

In contrast to Trump’s short-term approach, China is playing a longer game, seeking to reduce its reliance on the United States and strengthening its trade relationships with other countries in the Global South and with U.S. allies, such as Europe and Japan. Recent signals of China’s renewed interest in joining the Comprehensive and Progressive Agreement for Trans-Pacific Partnership highlight Beijing’s efforts to position itself as a global trade leader, in contrast to Washington’s unilateralism.

Trump’s declared preference is to vigorously pursue a protectionist agenda. While domestic business interests, international allies, and trading partners are all likely to make the case against Trump’s most aggressive set of trade and tariff policies, the real check on Trump’s ability to sustain his strategy is likely to depend on the reaction of the stock market and the broader economy. A sharp decline in equity markets or a significant spike in inflation could serve as the most effective check on his policies, forcing a recalibration.

The coming months will reveal whether Trump’s strategy is a calculated bluff or a genuine shift toward economic isolationism. Either way, the stakes are high—for the United States, for its closest trade partners, and for the geopolitical and economic status quo from which the United States has benefitted for many decades.