In constructing tariff scenarios for 2025, I took account of recent statements by policymakers and currency market movements.

Retaliation is already on the table

The details of the incoming U.S. Administration’s tariff plans, their legal basis, or timetable are not yet known, but America’s trading partners are not waiting for details. For example, Australia’s Prime Minister reminded President-elect Trump of the U.S. trade surplus with their country and their defense ties, presumably in an attempt to forestall tariff hikes. In contrast, politicians in the UK have called on their government to find common ground with the incoming Trump team, making concessions where necessary.

For its part, Chinese analysts have argued their government has prepared countermeasures should 60% tariffs be imposed on their nation’s exports to the U.S. Recall that China retaliated repeatedly to the higher import tariffs imposed on their exports during the first U.S.-China trade war.

Canada has re-established a Cabinet committee to track “critical” bilateral matters with the United States and done little to quash speculation that it would hit back against any new American import taxes. Likewise, the European Commission has set up a task force to war-game different outcomes, which include offering trade-related carrots and sticks. Given these developments, it makes sense to include scenarios with retaliatory measures in possible 2025 tariff outcomes.

Exchange rate changes should be factored in

Significant changes in nominal exchange rates and in exchange rate regimes have been prominent features of prior protectionist episodes. Recently, the U.S. Dollar has gained in strength against key trading partners. On 4 November 2024, the U.S. Dollar was worth 0.91 euros. That had risen to 0.95 euros at this writing. Likewise, a U.S. Dollar now buys 7.24 Chinese Yuan, up from 7.10 on election day.

As reported extensively in the financial press, the U.S. Dollar has risen since the presidential election on the expectation of future regulatory and macroeconomic policy changes and their likely implications for company valuations and the future course of interest rates in the United States.

Observers should be open to the possibility that the U.S. Dollar will continue to rise in value, notwithstanding Mr. Trump’s stated desire for a weaker currency. Due account of a rising U.S. Dollar is made when I consider the trade and FDI fallout from the tariff scenarios outlined below.

Tariff scenarios inform decision-making

Governments, companies engaged in cross-border investment and trade, investors, and others ought to have a structured approach to assessing the possible course of the world trading system after President Trump takes office in January 2025. Other governments have agency and the value of tariff scenarios derives from spelling out the choices available and their consequences.

Here, the scenarios focus on tariffs because President-elect Trump and those in his trade circle repeatedly emphasized raising them markedly during the campaign. Other trade restrictive measures—in particular, export controls—are expected to be adopted by the next U.S. Administration as well, motivated by the United States’ attempt to retain primacy in the economic, security, and technological domains.

Mr. Trump’s election campaign included pledges to transform America’s trade relations. It would be unwise to see these pledges as merely rhetoric, to be forgotten once in office. Indeed, his first-term track record is one of significant trade policy disruption. Back then, measures of trade policy uncertainty spiked, and a widely-used measure of global supply chain pressures rose.

Scenarios are not predictions, however. Done right, they should identify triggers for actions taken by key players. Scenarios should also help gauge the consequences that follow—in our case, the principal changes relate to goods trade and foreign direct investment (FDI) flows, with or without a rising value of the U.S. Dollar. Others have simulated the impact on national GDPs of various future tariff policy outcomes, and here I do not propose to address those important matters.

Nor does laying out distinct scenarios imply a linear process that unfolds over time. Little in President Trump’s first term suggests trade policy execution will be orderly. Still, it is valuable to highlight the key decision points for governments and how policy might unfold.

Four tariff policy choices

The infographic outlines four tariff scenarios:

1. U.S. threatens to impose import tariffs on all of America’s trading partners (“Tariff threats” scenario).
2. U.S. follows through on those tariff threats but trading partners do not retaliate (“U.S. strikes” scenario).
3. U.S. trading partners retaliate to U.S. tariff hikes by retaliating against the U.S. only (“Targeted strike back” scenario).
4. U.S. trading partners retaliate by raising tariffs against all their trading partners (“Global strike back” scenario).

Therefore, two retaliation options are considered. No assumption is made that retaliation must be made against all trading partners, although that is possible. These scenarios allow for sequential moves—for example, the second scenario may occur if the tariff threats in the first scenario do not translate into sufficient commercial gains for the United States.

Given the United States now accounts for only 13.5% of world imports, many trading partners export large shares of their goods to third markets.

The trend growth of such exports to third markets will allow dozens of nations to recoup lost exports to the United States in a few years. The latter is possible under the Targeted strike back scenario, but impossible if too many nations with economic heft opt for the Global strike back scenario.

For example, in the Targeted strike back scenario, should trend growth in imports in economies outside of the United States continue and all Chinese sales to the United States were lost, then within three years every lost Chinese sale would be replaced by export increases to third markets (see Annex of our 41st briefing for this finding and for other economies).

Another complicating factor is that, given the import tariff hike on Chinese goods is expected to be larger than for goods originating in other foreign nations, the replacement of the former with the latter is possible. The extent of this export-boosting factor depends on the degree to which foreign trading partners’ exports compete head-to-head with Chinese rivals for the same customers.

Each row in the infographic describes the factors likely to influence trade policy choice (“triggers”) and the implications for goods trade and FDI.

The second column of the table of scenarios shows further appreciation in the U.S. Dollar complicates the assessment of the four tariff options. A total of eight outcomes are outlined in the infographic —four for a stable U.S. Dollar, and four for a rising U.S. Dollar.

Continued U.S. Dollar appreciation will blunt some of the effect of higher import tariffs imposed by the United States (in the U.S. strikes, Targeted strike back, and Global strike back scenarios). In those U.S. trading partners where the government can influence the central bank, this effect would be reinforced by moves to depreciate national currencies.

That the U.S. Dollar might continue to rise also introduces the possibility that those trading partners which refuse to make concessions under the Tariff threats scenario eventually witness increased bilateral exports to the United States.

Now I turn to the matter of competitive depreciation of trading partners’ currencies. Recall that a currency depreciation of 10% (say) is equivalent to the joint imposition of an across-the-board import tariff of 10% and an export subsidy of the same magnitude.

In principle, it is possible that a trading partner of the United States might combine an import tariff hike across-the-board with a currency depreciation, which puts further upward pressure on the value of the U.S. Dollar. Such a combination opens the door for a repeat of the 1930s retrenchment of world goods trade should enough economies follow this path. In the infographic, I have coded this the worst outcome in terms of trade and FDI flows.

To highlight the diversity of goods trade and FDI outcomes, I have used a traffic light system to colour code outcomes according to the threat to the exports of the United States’ trading partners. There should be no illusion: a spiral of competitive devaluations combined with across-the-board tariff increases by the largest trading nations is a possible scenario going forward. The parlous state of our international economic institutions and the G20 are unlikely to restrain governments should matters deteriorate. Trust between the major trading nations eroded long ago.

Paths to limited systemic harm

In the near-term, Washington, DC can take a decisive turn inward—but how other governments react will determine whether world trade collapses. Donald Trump cannot bring about a collapse on his own—that depends on his foreign counterparts. This point comes through clearly in the eight outcomes in the Table overleaf.

Confining retaliation to the United States is an option that will reduce goods trade and distortions to FDI flows—however, the non-U.S. trading system would continue to offer export growth potential. The President-elect’s non-trade agenda adds weight to the argument for limited or no retaliation. First, his mooted deregulation and fiscal policy moves are expected to appreciate the U.S. Dollar, which in turn reduces the damage done to trading partners by any U.S. tariff hike. Second, if as expected, the President-elect’s fiscal policy plans are enacted, they will significantly increase the U.S. federal deficit. In turn, this will reduce net saving by the United States and the current account must deteriorate further. Such deterioration is likely to lead to more imports.

In short, the incoherence between different elements of the President-elect’s policy programme should be taken into account by foreign governments. There are compelling reasons for expecting that the impact of tariff increases by the United States will be blunted by other factors, including currency movements.

Of course, it would be convenient if Mr. Trump’s election rhetoric on trade resulted in little actual U.S. policy change. However, if U.S. tariff hikes come to pass, then it is wrong to assume that a world economy with much higher import taxes is the inevitable result. America’s trading partners have agency and, guided perhaps by the factors raised in scenarios analyses such as these, they should carefully consider a wide range of responses. Retaliation is not an all-or-nothing binary choice.

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Simon J. Evenett, an international trade economist, is Professor of Geopolitics & Strategy at IMD, Business School, Switzerland. He is also Founder, of the St. Gallen Endowment for Prosperity Through Trade, home of the independent monitoring initiatives Global Trade Alert (https://www.globaltradealert.org/), Digital Policy Alert (https://digitalpolicyalert.org/) and the New Industrial Policy Observatory and Co-Chair of the World Economic Forum’s Global Futures Council on Trade & Investment (https://www.weforum.org/communities/gfc-on-trade-and-investment/).

This text was originally published in the Global Trade Alert Zeitgeist Series on 19 November 2024 and has since been updated.