Trump shoots itself in the foot

 On June 3, 2025, President Trump announced that tariffs on steel and aluminum will double from the already elevated 25% (set in March) to 50%. The increase to 50% is historically exceptional. Before Trump's initial hike, nearly 80% of steel imports entered the U.S. tariff-free. Now, the U.S. is effectively taxing a key input to the manufacturing sector. 

While the move is detrimental to foreign exporters of the metals, the real damage will be borne within the US itself. 

Historically, tariffs on intermediate inputs were characteristics of failed development strategies. It is therefore surprising to see the President of the most economically advanced nation reviving a long-abandoned import-substitution strategy.

The import substitution strategy, common until the 1980s in developing countries, aimed to industrialize by protecting "infant industries" (“infant industries” in the US?) from international competition through tariffs. Trump's justification mirrors this outdated policy: by shielding U.S. steel and aluminum producers from foreign competition, he hopes to boost their profit margins and thereby incentivize domestic and foreign investment in these sectors. According to Trump, previous taxes had “not yet enabled” domestic industries “to develop and maintain the rates of capacity production utilization that are necessary for the industries’ sustained health and for projected national defense needs.” 

From an economic point of view, taxing steel and aluminum have two effects: a) to protect US producers of steel and aluminum and b) to penalize all downstream industries that use these inputs making them less competitive. Tariffs on intermediate goods are equivalent to a subsidy for US steel and aluminum producers financed by industries which utilize these products. 

The 50% tax increase, on steel and aluminum products, enables national producers of these products to raise their price by 50% above the international price.  

On June 2, the domestic prices of aluminum (aluminum delivery contract prices) in the U.S. surged by 58% above global levels, because of the tariff protection. but the increased input costs act as a tax on downstream producers, which face international competition and thus cannot pass the cost increases on to their customers. 

To estimate this de-protection effect, on the enterprises which use steel and aluminum as inputs, we use the methodology of Bela Balassa (Development Strategies in Semi-industrial Economies, WB, 1982) and Max Corden, "The Structure of a Tariff System and the Effective Protective Rate." Journal of Political Economy,  1966. These authors’ contribution shows that nominal tariff can be misleading, this is the protection to value added that matters, if you protect one sector, it will be to the detriment of others. The concepts elaborated by these economists apply to every country, including the superpowers, economic laws are not limited to "poor" countries. What is important for the producer is the value added of the firm (the value of the output minus the costs of its inputs). The value added (VA) is distributed in the form of wages, profits and taxes. 

A 50% tariff on inputs (steel and aluminum) allows domestic producers of these products to increase their prices by that amount since they are protected; if firms using these inputs cannot raise their output prices, because of international competition, then their VA declines sharply. The following table gives an estimation.

The VA of the final goods plummets from 60 to 15 (a 75% drop). Since VA comprises wages, profits and taxes, each of these components are negatively affected. The enterprises hit by the cost increase may try to raise the prices, but they are constrained by international competition. Firms will likely respond with layoffs, reduced investment and tax revenue will decline. Thus, a policy intended to artificially boost a specific sector ends up harming other sectors’ growth. Raising tariff, will contribute to lower economic activity in other sectors and therefore reduce tax collection. 

The effective rate of protection (ERP) measures the protection to value added in a sector, accounting for both tariffs on outputs and inputs.In our example, the ERP of the output firms is negative (75%). This is a dramatic negative rate rarely seen in developing countries. Most professional economists in developing countries advise reducing tariffs (see A. Krueger) – especially on intermediate goods – because high input costs undermine the competitiveness of entire industries. This is a self-inflicted wound to the US industrial competitiveness. 

Some might argue that downstream industries should also be protected. But if tariffs are extended to all final goods using steel and aluminum - automobiles, beer cans, appliances, etc. — their prices will also rise by 50%. This is not inflation in the strict monetary sense, but it is a generalized price increase, and a major distortion of the domestic price structure.

The ERP in such a scenario becomes artificially high, reducing incentives for innovation, undermining competition, and isolating the U.S. economy from global efficiency gains.

Furthermore, non-tradable sectors (construction, services) which use these products and inputs will be obliged to raise their prices. 

If the Fed’s Chairman, J. Powell, has so far resisted cutting the Fed rate, this is because he fears that Trump’s erratic trade policy may fuel price increases. 

Trump’s decision to shield steel and aluminum industries -which are no longer at the technological frontier- is emblematic of a backward-looking policy. This protection for electoral reasons comes at the expense of more dynamic industries. 

Therefore, high tariffs on steel and aluminum will contribute to:

•       Penalize all industries buying these inputs leading to higher unemployment and lower tax revenues. 

•     Increase domestic prices.

•     Harm US manufacturing competitiveness and discourage innovation due to reduced exposure to international competition. 

•     Undermine cross-border value chains, particularly with Canada and Mexico. These regional supply chains had the objectives to lower costs using available products from Canada and low wages from Mexico. Taxing inputs that cross borders multiple times will have the effect to disrupt the US manufacturing sectors.

•     Divert resources toward declining sectors and away from more innovative ones (software, AI, defense, and financial services)  (the balance of services does not exist in the Trump’s world). 

•     Risk further trade retaliation and global economic instability, source of lower world economic growth.  

High tariffs will not reduce the US external deficit, nor raise tax revenue. On the contrary, they will raise prices and depress output and employment. 

The only sustainable way to reduce imports is to reduce aggregate domestic demand, which remains higher than the country’s total output. The excess domestic demand (absorption) in the US (and in France) is largely driven by persistent and unsustainable fiscal deficits (as in France). Only fiscal consolidation will restore balance; the kind of policy implemented by the IMF – with full support from “rich” countries - towards developing countries. Yet those same “advanced” countries resist applying such policies to themselves, as if economic laws applied only to others.

Trump has shown little interest in fiscal restraint (the DOGE event was a farce), while French authorities — though more rhetorically committed — are politically paralyzed when it comes to cutting spending. As U.S. debt rises further, pressure from bond vigilantes may intensify. If investors begin to question the US debt sustainability, this loss of confidence could spread to other highly indebted economies — including Italy, Greece, and France.

Trump’s tariff policy is an example of populist economic reasoning. It brings back a trade model that failed in developing countries and imposes large hidden costs on the domestic economy. Using the framework of Corden and Balassa, we can see that when you protect one sector, you inevitably harm others. Economic laws still apply — even to “great” powers.