The Future Cost of Rising U.S. Tariffs

Archive edition · Market data and company circumstances reflect 17 May 2025, when this newsletter was sent.

Long-Term Risks Hiding Behind Rising Tariffs

The United States is facing a major shift in trade policy this year, with its effective tariff rate expected to rise by about 13 percentage points—reaching levels unseen since the 1930s.

As tariffs remain elevated for the foreseeable future, investors and businesses alike need to understand the potential long-term effects on the economy, corporate performance, and investment opportunities.

What Are Tariffs & Why Do They Matter?

Tariffs are taxes on imported goods, designed to protect domestic industries by making foreign products more expensive. While this might sound good in theory, tariffs effectively raise costs for businesses and consumers alike.

In recent months, the U.S. has increased tariffs significantly as part of trade disputes and strategic economic policies.

The key question: What happens when the U.S. raises tariffs this sharply and sustains them? Historically, high tariffs have not been common since the 1930s, so analysts rely on economic models and past trade episodes to predict the outcome.

Economic Costs of Higher Tariffs

Trade economists have long studied the gains from international trade, which include more competitive prices, access to a wide variety of goods, and increased efficiency from global supply chains.

Early research suggested relatively modest gains from international trade— estimates implied that if the U.S. stopped trading altogether, it might lose less than 2% of income. However, more recent models developed by Goldman Sachs, which account for complex global supply chains, multiple industries, and fixed costs of trade, show that the gains can be much larger—sometimes even approaching infinite in highly integrated economies.

What does this mean for tariffs? Higher tariffs effectively undo some of these gains by making trade more expensive. Models suggest that a 13 percentage point tariff increase, as expected this year, could reduce U.S. real income by around 1%.

This loss reflects not just direct trade costs but also the ripple effects through global supply chains and industry specialization.

Can Tariffs Bring Manufacturing Back to U.S.?

One hope behind higher tariffs is that they will encourage reshoring, bringing manufacturing production back home to the U.S. This idea has gained traction amid recent supply chain disruptions and government incentives.

However, data show limited evidence of large-scale reshoring. Since the 2010s, including the 2018-2019 trade war and Covid-19 disruptions, U.S. manufacturing activity has not significantly shifted back from overseas.

Why? The U.S. faces substantially higher production costs compared to its trading partners. These include labor, utilities, taxes, and industrial real estate—costs that are often 50% or more higher than in countries currently exporting to the U.S.

Higher tariffs hit most successful U.S. firms hardest due to their global exposure.

In particular, the U.S. is more competitive in specialized sectors like pharmaceuticals, chemicals, and aircraft manufacturing, but for most goods, foreign production remains much cheaper.

Moreover, manufacturing production requires large fixed costs and significant time to become profitable. Uncertainty about future tariff policies makes firms hesitant to invest heavily in new U.S.-based production that may not be sustainable in the long run.

Even in industries like pharmaceuticals, where the U.S. is relatively competitive, tariffs increase intermediate input costs by about 7%, reducing the attractiveness of reshoring. Additionally, other factors, like tax policies and R&D incentives, play a more crucial role in where companies locate their facilities.

Broader Economic Effects

Tariffs increase the prices of imported equipment and capital goods. This discourages business investment, which is vital for long-term economic growth.

Data across countries show a clear link: Lower equipment prices lead to higher investment and faster GDP growth. Higher tariffs therefore risk slowing capital accumulation, which in turn lowers productivity and output per worker over time.

Models estimate that tariff-related capital costs could reduce U.S. GDP growth by about 0.75 percentage points in the long run.

Restrictive trade policies may slow firm-level productivity growth and innovation, primarily because tariffs raise the costs of intermediate inputs and reduce export market access.

Research finds that while increased competition from trade liberalization has a modest effect on productivity, disruptions to supply chains and input costs can significantly dampen innovation.

1.4.3 Rent-Seeking Behavior

Higher tariffs can encourage businesses to spend resources lobbying for favorable tariff policies rather than investing productively.

Historical data show that when tariffs were high, governments’ discretion in setting tariffs created opportunities for rent-seeking—economic activity aimed at securing protection rather than competing fairly.

Lessons from Past Trade Policy Shifts

Looking at historic shifts in trade policy can offer perspective:

These episodes suggest large tariff increases in the U.S. could have substantial, lasting negative effects on growth—echoing the 1% income loss predicted by economic models.

• Brexit (2016) caused increased tariffs and trade barriers in the UK, which research estimates led to output losses around 6% of GDP compared to peer countries.
• Uruguay Round (early 1990s): Countries that reduced tariffs by around 30 percentage points saw real income gains of approximately 12% relative to peers.

What This Means for Investors?

For investors, the evolving tariff landscape brings both challenges and openings, requiring a nimble, well-informed approach. Here are the key takeaways for investors:

• Tariffs will likely weigh on the overall U.S. economy by increasing costs, reducing income, and slowing growth, especially for firms deeply integrated in global trade.
• Expect limited reshoring of manufacturing because of high production costs and policy uncertainty, although some sectors like pharmaceuticals might see modest shifts.
• Long-run economic growth could slow due to reduced investment and innovation.
• Market participants should monitor political developments as rent-seeking and policy changes can influence which industries are protected or exposed.
• Diversification remains key, as tariff impacts will vary across sectors and companies.

Archive note

This article preserves the analysis in our weekly newsletter sent 17 May 2025. Market prices, forecasts and company circumstances reflect the time of publication and may have changed.

This material is general information, not personal financial advice or a recommendation to trade. Investing and trading involve risk, including loss of capital.