No matter how President Donald Trump frames it, the US has much to lose from a trade war. Global trade dynamics will likely be radically reshaped. Fabio Sabatini discusses the economic costs for the US and the rest of the world.

In his speeches, president Donald Trump frequently suggests that tariffs will finance public spending while simultaneously allowing for tax cuts, thanks to a massive influx of resources from abroad. Now that the first trade barriers against Canada, China, Mexico, and the European Union have taken effect, American citizens are beginning to realise how misleading this claim is.

Tariffs are not paid by foreign taxpayers but by consumers and businesses in the country imposing them. The economic consequences for both the United States and its trade partners will be severe, driving up prices, reducing employment, and weakening long-term competitiveness.

It is no coincidence that the Federal Reserve Bank of Atlanta recently downgraded its growth forecast for the US economy, predicting a 2.8 per cent drop in the annualised GDP growth rate for the first quarter of 2025. Although this estimate contradicts the New York Fed’s more optimistic projection of +2.9 per cent, pessimistic forecasts align with the rapid deterioration of key economic indicators, such as declining retail sales and plummeting consumer confidence, observed within the first two months of the Trump administration. The uncertainty generated by the trade war has likely led many firms and consumers to postpone investment and spending decisions.

Higher prices and market distortions

Generalised tariffs, such as those imposed by the Trump administration, effectively function as a broad-based consumption tax. While the prices of imported goods will rise in direct proportion to the tariff rate, domestically produced goods will also become more expensive due to higher costs for imported energy, raw materials, and intermediate goods. These increased costs are typically passed on to consumers through higher prices. For instance, the US automobile manufacturers’ association has warned that tariffs will compel car manufacturers to raise prices by up to 25 per cent.

Moreover, industries shielded by tariffs no longer face international competition, allowing protected firms to charge higher prices without pressure to remain efficient. In this sense, tariffs act as a subsidy for domestic producers—funded entirely by consumers. In principle, such an approach might be justified—though risky and with uncertain outcomes—to temporarily shield an emerging industry, granting it time to develop international competitiveness. However, this is not the case with the current tariffs, which indiscriminately target all imported goods from Canada, China, and Mexico and, according to recent announcements, will soon extend to all European products.

Inflation, interest rates and deportations

The price-inflating effects of tariffs are among the reasons why the Federal Reserve recently halted its interest rate cuts after three consecutive reductions. To make matters worse, inflationary risks are exacerbated by the mass deportation of immigrants currently underway. Undocumented immigrants constitute at least six per cent of the US workforce, primarily working in construction, food services, agriculture, and hospitality—often in low-wage, unprotected, and hazardous conditions.

Historical precedents suggest that deportation does not create jobs for American workers. During the Obama administration, for every eleven undocumented immigrants deported, at least one American job was lost. According to the Peterson Institute for International Economics, if even a quarter of the promised deportations were carried out, the US would face a permanent 0.6 per cent drop in employment.

The mechanism is straightforward. Americans are unlikely to take over the jobs currently held by undocumented immigrants. The sudden reduction in labour supply caused by mass deportation will drive wages up, raising production costs for businesses. These costs will then be passed on to consumers in the form of higher prices. The real estate sector will face particularly severe labour shortages, triggering a supply shock. While housing demand remains stable, construction slowdowns will lead to rising home prices, disproportionately affecting low-income households.

Over time, businesses will compensate for labour shortages by accelerating automation, which will displace low-skilled workers, increase unemployment, and reduce consumer spending—further fuelling economic stagnation and inflation. While rising unemployment might exert deflationary pressure, the difficulty of adjusting in key sectors like construction and agriculture will keep prices high. Overall, mass deportations will likely cause both job losses and rising inflation, exacerbating the economic disruptions triggered by tariffs.

Businesses, workers and trade retaliation

As consumers should brace for a new wave of inflation, businesses have even less reason for optimism. Historical precedents suggest that rising production costs and lost competitiveness will entirely compensate any short-term price benefits. Over time, domestic firms will suffer as resources—such as skilled labour and financial capital—are diverted to protected industries regardless of their efficiency. Meanwhile, more innovative and productive sectors will struggle, as higher production costs weaken their competitiveness both domestically and internationally.

For workers, the negative effects of rising prices are unlikely to be offset by employment gains or wage increases. Empirical evidence from Trump’s first-term tariffs suggests that higher costs for intermediate goods, weaker domestic demand, and export declines due to retaliatory tariffs will harm employment and wages, significantly worsening conditions for American workers.

Assessing the full extent of the economic damage caused by these policies is challenging. However, estimates based on the effects of 2017 tariffs suggest that if the administration proceeds with its full tariff plan the resulting price hikes will impose an annual cost equivalent to 1.8 per cent of GDP on consumers. These projections may even be optimistic, as they do not account for the long-term consequences of declining competitiveness, tariffs on European products and raw materials, and retaliatory measures from trade partners.

Adding to the economic strain, retaliatory tariffs are already in motion. As US trade partners respond in kind, demand for American exports will contract, forcing firms to adjust production decisions. This, in turn, will reduce labour demand, weaken employment prospects, and exert downward pressure on wages. Despite an already alarming economic outlook, Trump’s threatening announcements—warning of further tariffs should key trade partners dare to retaliate—suggest that the trade war is likely to escalate further in the coming weeks.

Regressive impact of trade policies

The fiscal impact of tariffs remains highly uncertain. Revenue generation will depend on multiple factors, including how consumers and producers adjust to higher domestic prices, how trade partners alter their strategies, and the broader economic slowdown caused by weakened competitiveness—which, in turn, reduces government tax revenues from income and production.

According to estimates from the Peterson Institute, tariff revenues will fall short of financing the promised tax cuts or the social safety nets needed to mitigate the impact of rising prices and job losses. From a distributional perspective, tariffs operate as a highly regressive tax. In economic terms, a tax is considered regressive when it disproportionately burdens lower-income households. Since these consumers spend a larger share of their income on essential goods, inflationary policies like tariffs hit them the hardest. Meanwhile, wealthier households—who allocate a smaller portion of their income to consumption—will be far less affected.

A trade war with no winners

History shows that no one truly wins a trade war. While the US administration frames tariffs as a tool to boost American competitiveness and strengthen the labour market, these measures risk reshaping global trade dynamics in ways that introduce significant economic costs—including higher consumer prices, supply chain disruptions, substantial job losses, and strained international partnerships.

• This article first appeared at LSE Business Review. 
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• Note: This article gives the views of the author, and not the position of USAPP – American Politics and Policy, nor the London School of Economics.