The Economic Consequences of the Second Trump
Administration: A Preliminary Assessment delivers a
timely, expert analysis of the economic shifts unfolding
following President Trump’s return to office. Amid
sweeping tariffs, sharp breaks in global alliances,
assertions of presidential supremacy, government
downsizing, deregulation, and risks to the rule of law,
this volume offers thoughtful, evidence-based insights
into how these policies may affect growth, trade,
investment, inflation, stability, and the role of the
dollar.
Edited by four leading voices in economics and public
policy - Gary Gensler (MIT & former SEC Chair), Nobel
laureate Simon Johnson (MIT), Ugo Panizza (Geneva
Graduate Institute), and Beatrice Weder di Mauro
(President, CEPR) - the book draws on contributions
from global experts assessing both domestic and
international consequences. Their preliminary
assessments are clear: heightened uncertainty, lower
economic growth, and risks in the long run to US
economic leadership and the multilateral order.
Accessible yet deeply informed, this volume is essential
reading for anyone seeking to understand how President
Trump’s second term is reshaping the economic
trajectory of the United States and the rest of the world.
ISBN: 978-1-912179-94-7
ISBN 978-1-912179-94-7
187 boulevard Saint-Germain | 75007 | Paris | France
2 Coldbath Square | LONDON EC1R 5HL | UK
EMAIL: CEPR@CEPR.ORG
WWW.CEPR.ORG
9 781912 179947
RAPID RESPONSE ECONOMICS 6: THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION
This is the sixth of CEPR’s Rapid Response Economics,
a new series which is designed to publish research on
major policy issues with the utmost speed.
RAPID RESPONSE
ECONOMICS
6
The Economic
Consequences of
the Second Trump
Administration:
A Preliminary
Assessment
The Economic Consequences
of the Second Trump
Administration:
A Preliminary Assessment
WITH SUPPORT OF CEPR PARIS FOUNDING PARTNERS
CEPR PRESS
Centre for Economic Policy Research
187 boulevard Saint-Germain
75007, Paris, France
2 Coldbath Square
London EC1R 5HL, UK
Tel: +44 (0)20 7183 8801
Email: cepr@cepr.org
Web: www.cepr.org
ISBN: 978-1-912179-94-7
Copyright © CEPR Press
The Economic Consequences
of the Second Trump
Administration:
A Preliminary Assessment
Edited by Gary Gensler, Simon Johnson,
Ugo Panizza and Beatrice Weder di Mauro
CENTRE FOR ECONOMIC POLICY RESEARCH (CEPR)
The Centre for Economic Policy Research (CEPR) is a network of almost 1,900 research
economists based mostly in European universities. The Centre’s goal is twofold: to
promote world-class research, and to get the policy-relevant results into the hands of key
decision-makers. CEPR’s guiding principle is ’Research excellence with policy relevance’.
It was founded in the UK in 1983, where it is a Charity, and in November 2019 CEPR
initiated the creation of an Association under French law, in order to provide a vehicle for
an expansion in France. The members of the Conseil d’Administration of the Association
are identical to the UK Board of Trustees.
CEPR is independent of all public and private interest groups. It takes no institutional
stand on economic policy matters and its core funding comes from its Institutional
Members, projects that it runs and sales of publications. Because it draws on such a large
network of researchers, its output reflects a broad spectrum of individual viewpoints as
well as perspectives drawn from civil society. CEPR research may include views on policy,
but the Trustees/members of the Conseil d’Administration of the Association do not give
prior review to its publications. The opinions expressed in this report are those of the
authors and not those of CEPR.
Chair of the Board
Founder and Honorary President
President
Vice Presidents
Chief Executive Officer
Sir Charlie Bean
Richard Portes
Beatrice Weder di Mauro
Maristella Botticini
Antonio Fatás
Ugo Panizza
Hélène Rey
Tessa Ogden
Contents
Foreword
1 The economic consequences of the second Trump administration: Key
assessments
Gary Gensler, Simon Johnson, Ugo Panizza, and Beatrice Weder di Mauro
viii
1
Part I: Economic transformation in the United States
2 Fiscal policy and debt sustainability
Antonio Fatás and Ugo Panizza
35
3 Presidential supremacy over administrative agencies
Gary Gensler and Lev Menand
51
4 The rule of law
John Coates
67
5 The economic effects of rapid federal downsizing
Josh Bivens
81
6 Immigration and border policies
Anna Maria Mayda and Giovanni Peri
95
7 The financial sector and global dollar system
Gary Gensler, Lev Menand and Joshua Younger
111
8 Consumer financial protection
Neale Mahoney
125
9 Competition policy
Jonathan B. Baker
133
10 Artificial intelligence development and policy landscape
Gary Gensler
141
11 Will the United States continue to lead in science?
David Baker and Simon Johnson
155
12 Health care
Jonathan Gruber
167
13 Downsizing the National Oceanic and Atmospheric Administration
Valerie J. Karplus and Costa Samaras
175
14 Changes in federal climate policy
John E.T. Bistline
181
15 Rural economies and communities
Mary K. Hendrickson and David J. Peters
197
16 The (non) effect of tariffs on manufacturing employment
Michael R. Strain
209
Part II: Reshaping the international economic system
17 The global public good
Barry Eichengreen
225
18 From MFN to “reciprocal tariffs”
Kevin Hjortshøj O’Rourke
233
19 US middle-class malaise and the world trade system
Richard Baldwin
239
20 The aftermath of tariffs
Kimberly A. Clausing
245
21 First estimations of the effects of reciprocal tariffs
Antoine Bouët
257
22 Who pays for US tariffs?
Marcelo Olarreaga and Sara Santander
269
23 Seven questions about tariffs
Arnaud Costinot and Andrés Rodríguez-Clare
279
24 National security tariffs on the auto industry
Keith Head, Thierry Mayer, Vincent Vicard and Pauline Wibaux
289
Part III: Spillovers to advanced economies
25 Strategic autonomy for Europe requires economic growth
Luis Garicano
303
26 Trade wars and European monetary policy
Paul Bergin and Giancarlo Corsetti
311
27 Rethinking the governance and funding of European rearmament
Armin Steinbach, Guntram Wolff, and Jeromin Zettelmeyer
327
28 Advanced technology as Europe’s strategic imperative
Tom Enders, Jeannette zu Fürstenberg, René Obermann and Moritz Schularick
339
29 The economics of the European defence buildup
Ethan Ilzetzki
349
30 Spending targets versus military capacity
Ralph Luetticke and Gernot Müller
361
31 Ukraine and Europe
Yuriy Gorodnichenko
369
32 Canada
Mark Manger
379
33 Greenland
Bo Lidegaard, Mira Kleist and Nick Bæk Heilmann
385
34 Japan
Kenichi Ueda
397
Part IV: Spillovers to emerging and developing economies
35 Emerging markets
Robin Brooks
407
36 China
Yasheng Huang
413
37 India
Arvind Subramanian
423
38 Mexico
Alejandro Werner
429
39 Latin America: Tariffs and industialisation
Sebastian Edwards
441
40 The impact of US foreign aid cuts on global health
Charles Kenny and Justin Sandefur
459
Foreword
THE ECONOMICS OF BREXIT: WHAT HAVE WE LEARNED?
viii
The Centre for Economic Policy Research (CEPR) has long played a role in facilitating
informed, evidence-based dialogue around pivotal developments in economic policy.
In 2017 we responded to the start of President Donald Trump’s first term by publishing
Economics and Policy in the Age of Trump, a timely collection of expert perspectives
on the potential implications of his administration’s early actions. Eight years later,
with President Trump having returned to office, we again find ourselves at a moment of
considerable transition and uncertainty. This volume represents CEPR’s effort to provide
a preliminary assessment of the second Trump administration’s economic policies and
their likely effects, both domestic and international.
This collection is intended as a living book, assembled by a diverse group of scholars
who bring academic rigour to a fluid and complex policy environment. While the early
months of the current administration have already produced an array of significant
and often fast-moving policy actions - ranging from tariff restructurings and shifts in
executive authority to realignments in international alliances - the authors have sought,
as best as possible, to quantify and contextualise these developments. They do so with full
awareness of the limitations that come with early-stage assessments and in the spirit of
constructive analysis rather than prescriptive judgment.
What emerges from the pages that follow is a multifaceted and evolving picture of economic
policymaking at a consequential juncture. The editors have taken care to organise this
volume in a way that reflects the interconnections between domestic policies and global
dynamics. We hope that readers - whether scholars, policymakers, business leaders, or
engaged citizens - will find value in this work as a foundation for further discussion and
inquiry.
Our thanks go to Anil Shamdasani for his skilled handling of its production, and Sophie
Roughton and Nadine Clarke for their speed and thoroughness in facilitating this
publication, and to all the contributing experts, which number over 50 in all, who took
on this task with such tight deadlines and took on board the editors many comments and
edits with openness and grace.
Beatrice Weder di Mauro would like to thank Tokyo College for their hospitality in the
period during which she worked on this book.
As ever, CEPR remains committed to providing a platform for balanced and expert
perspectives on pressing economic issues, but itself takes no institutional positions on
matters related to economic policy.
Tessa Ogden
CEO, CEPR
17th June 2025
CHAPTER 1
Gary Gensler,a Simon Johnson,a Ugo Panizza,bc and Beatrice Weder di Maurobc
a
MIT Sloan; bGeneva Graduate Institute; cCEPR
Exactly eight years ago, the Centre for Economic Policy Research (CEPR) published
Economics and Policy in the Age of Trump, a collection of essays assessing what President
Donald Trump’s first ‘first hundred days’ in office might mean for the US and global
economy (Bown 2017). In a remarkable turn of history, here CEPR is again, taking on a
similar task assessing President Trump’s second ‘first hundred days’ in office.
In considering the title for our book this time, we chose to include an important caveat:
that this is a ‘preliminary assessment’. This reflects not only the inherent uncertainties
of such economic assessments, but more importantly, the great uncertainties inherent to
President Trump’s style of governing and policy development. Further, policies discussed
in this volume may have changed by the time of publication, and we make no claim to
provide definitive answers.
Our goal is to offer an initial assessment through a living book – one that will be updated
later this year as developments unfold. We asked the contributing authors to quantify,
whenever possible, the effects of the policies analysed. As best we could, we sought to
provide this book as an expert and non-partisan preliminary assessment.
With this in mind, though, the initial picture that our contributing authors paint is
concerning. Taken as a whole, their preliminary assessments suggest that the second
Trump administration policies are likely to lessen economic growth both in the near
term and the long term.
Much has changed since that first ‘first hundred days’ book in 2017.
The world experienced the health and economic shocks of the COVID pandemic. Supply
chains and economies have had additional disruptions from wars (Ukraine and Israel) as
well as the ongoing realignments in response to the trade wars during President Trump’s
first administration.
Inflation returned to the fore. Central banks responded by raising interest rates and
ending quantitative easing, moving yield curves back to levels not seen since prior to
the 2008 Financial Crisis. Rapid advancements in technologies including artificial
1
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION | GENSLER, JOHNSON, PANIZZA AND WEDER DI MAURO
The economic consequences of the
second Trump administration: Key
assessments
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
2
intelligence (AI), and particularly generative AI, are leading to changes in business and
labour models. Brexit is complete, with the United Kingdon having left the European
Union. US publicly held debt as a share of GDP has risen from 75% to 97%, following the
significant fiscal support provided in response to the COVID economic shock along with
the fiscal effects of the first Trump administration’s tax cuts.
Over those years, though, the United States’ dominant economic role has remained
relatively consistent. The United States remains roughly one quarter of the world’s
economy. The US dollar has remained the dominant currency hegemon for trade and
finance. US capital markets continue to dominate global capital markets, growing a bit
in terms of global market share to represent over 40% of world markets. So large are
the US capital markets that the $17 trillion total market capitalisation of the so-called
‘Magnificent Seven’ big tech stocks is greater than the $12 trillion aggregate value of the
Chinese equity markets. Indeed, some individual stocks in the Mag Seven have values
greater than the entire UK, French, or German equity markets.
This book examines the domestic and international economic implications of the policies
being implemented by the second Trump administration within the current global
economic and political context. Given the complex feedback loops between domestic and
international economies, these implications cannot be neatly compartmentalised. Many
of the policy actions discussed in this volume have intertwined effects, reshaping the
US economy while simultaneously sending shockwaves across the globe. Nonetheless,
to provide structure and help guide readers through this multifaceted analysis, we have
organised the contributions into four parts.
To help set the stage, we start this introductory chapter with a section comparing
and contrasting the ‘first hundred days’ of President Trump’s two administrations.
We then turn to sections summarising each of the four parts of this volume. The first
part examines the economic transformations unfolding within the United States. The
second part explores how President Trump’s policy agenda is reshaping the international
economic system. The third part analyses spillover effects on advanced economies, while
the fourth focuses on implications for emerging and developing economies.
THE ‘FIRST HUNDRED DAYS’ OF PRESIDENT TRUMP’S TWO
ADMINISTRATIONS
To analyse the domestic impact of the current US administration’s policies and to frame
their potential international spillovers, we compare and contrast six themes with respect
to the starts of the two Trump administrations.
First, as Chad Bown stated in the introductory chapter to CEPR’s 2017 review (Bown
2017): “In important ways, Trump’s presidency has generated considerable uncertainty
for a variety of important areas of US economic policy”.
FIGURE 1
ECONOMIC POLICY UNCERTAINTY
400
350
300
250
200
150
100
50
2023-11-01
2024-12-01
2022-10-01
2021-09-01
2019-07-01
2020-08-01
2017-05-01
2018-06-01
2015-03-01
2016-04-01
2014-02-01
2011-12-01
2013-01-01
2010-11-01
2009-10-01
2008-09-01
2006-07-01
2007-08-01
2005-06-01
2004-05-01
2003-04-01
2001-02-01
2002-03-01
2000-01-01
0
Source: Data retrieved from FRED, Federal Reserve Bank of St. Louis (https://fred.stlouisfed.org/series/USEPUINDXD,
accessed 22 May 2025).
FIGURE 2VIX INDEX (TRACKING THE MARKET’S IMPLIED VOLATILITY FOR US EQUITIES)
55.00
50.00
45.00
40.00
35.00
30.00
25.00
20.00
15.00
9/1/2024
9/8/2024
9/15/2024
9/22/2024
9/29/2024
10/6/2024
10/13/2024
10/20/2024
10/27/2024
11/3/2024
11/10/2024
11/17/2024
11/24/2024
12/1/2024
12/8/2024
12/15/2024
12/22/2024
12/29/2024
1/5/2025
1/12/2025
1/19/2025
1/26/2025
2/2/2025
2/9/2025
2/16/2025
2/23/2025
3/2/2025
3/9/2025
3/16/2025
3/23/2025
3/30/2025
4/6/2025
4/13/2025
4/20/2025
4/27/2025
5/4/2025
5/11/2025
5/18/2025
5/25/2025
10.00
Note: The vertical lines mark the US election of November 2024 and the “Liberation Day” tariff announcement
Source: Data are from FRED, Federal Reserve Bank of St. Louis (https://fred.stlouisfed.org/series/VIXCLS, accessed 22 May
2025).
3
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION | GENSLER, JOHNSON, PANIZZA AND WEDER DI MAURO
By design, elections have consequences. Policy changes rightly occur in their wake.
To most observers, though, President Trump’s second ‘first hundred days’ has led
to considerably higher uncertainty within the economy and capital markets than is
customary or was the case at the same time in his first administration. Economic policy
uncertainty (Baker et al. 2016) has reached levels close to those observed during the
COVID pandemic (Figure 1). The heightened level of uncertainty also has affected capital
market price volatility (Figures 2 and 3).
FIGURE 3
MOVE INDEX (TRACKING THE MARKET’S IMPLIED VOLATILITY FOR US
TREASURIES)
140
130
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
135
4
120
125
115
110
105
100
95
90
85
80
9/1/2024
9/8/2024
9/15/2024
9/22/2024
9/29/2024
10/6/2024
10/13/2024
10/20/2024
10/27/2024
11/3/2024
11/10/2024
11/17/2024
11/24/2024
12/1/2024
12/8/2024
12/15/2024
12/22/2024
12/29/2024
1/5/2025
1/12/2025
1/19/2025
1/26/2025
2/2/2025
2/9/2025
2/16/2025
2/23/2025
3/2/2025
3/9/2025
3/16/2025
3/23/2025
3/30/2025
4/6/2025
4/13/2025
4/20/2025
4/27/2025
5/4/2025
5/11/2025
5/18/2025
5/25/2025
75
Note: The vertical lines mark the US election of November 2024 and the “Liberation Day” tariff announcement.
Source: Data are from Yahoo Finance (https://finance.yahoo.com/quote/%5EMOVE/history/, accessed 22 May 2025).
This heightened uncertainty flows from at least three underlying sources. To begin with,
significant uncertainty arises due to the sheer number and the dramatic nature of the
shifts in policy from the prior administration.
Next, uncertainty flows from the many changes in the current administration’s policies,
announced sometimes just days or weeks after earlier announcements. One week after
the new administration, on what they called “Liberation Day”, announced reciprocal
tariffs (up to an additional 48%) on imports from approximately 60 countries (in addition
to global tariffs of 10% on all countries), and less than 24 hours after they went into effect,
the administration delayed the reciprocal tariffs for 90 days and raised tariffs on goods
from China to 145%. Four days later, exclusions were granted for certain electronics
imports from China.
Further, uncertainty flows from the challenge of predicting what courts will determine to
be the law resulting from the many legal challenges to announced policies. For instance,
as of early June 2025, the US Court for International Trade found that the President did
not have authority to impose these tariffs.1 While that ruling has been stayed pending
further appeals, the President is suggesting other tariffs, for instance doubling those on
steel.
1
See V.O.S. vs. U.S., United States Court of International Trade, Slip Opinion 25-66, 28 May 2025 (https://www.cit.uscourts.
gov/sites/cit/files/25-66.pdf).
During this time, the Trade Policy Uncertainty Index rose from approximately 200 points
in October 2024 to nearly 6,000 points in March 2025, well above its previous peak of
1,900 points in August 2019 (Figure 4).2
FIGURE 4
5
TRADE POLICY UNCERTAINTY INDEX
6000
5000
4000
3000
2000
1000
2023-05-01
2024-07-01
2022-03-01
2019-11-01
2021-01-01
2017-07-01
2018-09-01
2015-03-01
2016-05-01
2012-11-01
2014-01-01
2011-09-01
2010-07-01
2009-05-01
2008-03-01
2005-11-01
2007-01-01
2003-07-01
2004-09-01
2001-03-01
2002-05-01
2000-01-01
0
Source: The data are retrieved from FRED, Federal Reserve Bank of St. Louis (https://fred.stlouisfed.org/series/EPUTRADE,
accessed 22 May 2025).
Second, as evidenced in both his administrations, President Trump generally has been
willing to take more risk than many of his predecessors. In particular, as shown in the
course of his long history of negotiating and deal-making, the President often has been
willing to take on significant risk and effectively use confrontational public messaging.
Over his career, he has shown a keen sense of public sentiment, how to drive public
debate, and how to be at the centre of the daily news cycle.
This has led many business, political, and foreign leaders to consider yet a fourth source
of uncertainty. Where and under what terms might the administration be willing to make
deals? Further, policy goals appear to shift in the midst of highly public negotiations and
demands. Thus, many businesses, investors, and international counterparts have been
asking what the end goals might be regarding specific policies.
Whether this source of uncertainty is by design of the President’s team or not, it has
added to overall economic, business, investment, and market uncertainties.
2
The US Trade Policy Uncertainty Index is a category-specific economic policy uncertainty indexes developed in Baker et al.
(2016). It is based on the frequency of articles in American newspapers that discuss policy-related economic uncertainty
and also contain one or more references to trade policy.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION | GENSLER, JOHNSON, PANIZZA AND WEDER DI MAURO
7000
Third, as Chad Bown noted back in 2017, President Trump takes advantage of a
president’s ability to act unilaterally – through Executive Orders, regulatory decisions,
funding choices, and enforcement prioritisation – and has focused much of his policy
attention to date on those areas.
In his second ‘first hundred days’, the President has used Executive Orders even more
frequently and has gone far wider in an effort to effect policy. In this administration,
he has signed over 140 Executive Orders, compared with 33 during the same time in his
first. In the last century, no president has used this tool so frequently. Even President
Roosevelt, noted for his vigorous ‘first hundred days’ in office, signed about 100 Executive
Orders (Figure 5).3
FIGURE 5
NUMBER OF EXECUTIVE ORDERS
160
140
120
100
80
60
40
20
25
41
p
um
Tr
FD
R
20
19
33
FD
R
19
37
FD
an
um
R
19
19
45
21
100 days
Tr
Bi
de
n
20
Tr
um
p
20
a
m
ba
O
20
17
09
01
20
sh
Bu
sh
Bu
ba
m
a2
20
01
05
3
0
O
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
6
First 3 days
Note: The figure is based on data from the Federal Register (https://www.federalregister.gov/presidential-documents/
executive-orders, accessed on 22 May 2025).
Eight years ago, Bown concluded that “the flurry of activity during the Trump
administration’s first ‘100 days’ in office confirms a nontraditional approach to governing,
a still largely unknown short- and long-term strategy, and unclear economic policy
priorities”.
Most observers would agree that during President Trump’s second ‘first hundred
days’, his team has come out with an even larger and wider ranging ‘flurry of activity’.
Centralising a re-envisioned set of presidential authorities. Upending the global trade
3
See also “10 key numbers that sum up Trump’s first 100 days”, NPR, 29 April 2025 (https://www.npr.org/2025/04/29/nx-s15379554/trump-100-days-numbers-laws-immigration).
Fourth, as Bown went on to observe in 2017, “some of Trump’s almost immediate actions
on Executive Orders – and the resulting US court challenges – signal his administration’s
willingness to test historical limits that may have restrained US presidential authority”.
With over four times as many Executive Orders in 2025 as at the same time in 2017, and
over 320 lawsuits challenging his actions, the President is going even faster and further
than in his first administration in testing Constitutional, Congressional, and judicial
limits.4
President Trump came into his second administration far more experienced than when
he first took office eight years ago. He also had years to consider how he might govern if
again given the opportunity. He has assembled a team with whom he is more familiar,
with many of his top advisors having worked for him during his first administration, his
2024 campaign, or through professional dealings. Those senior appointees appear more
committed to the President’s vision than many in the 2017 team.
Fifth, as Bown mentioned in 2017, President Trump’s administration is willing to test
historical limits that have restrained US presidential authority. Further, he believes in
strong executive leadership.
The second Trump administration has moved rapidly to centralise control over all
administrative agencies, including so-called independent agencies. The administration
is asserting an interpretation of the Constitution known as ‘unitary executive theory’,
which, in its pure form, holds that the president has the inherent power to fully control all
federal departments and agencies, regardless of statutory design (Gensler and Menand,
Chapter 3). The administration has taken significant steps to downsize government.
This has included dismantling entire departments such as the Department of Education,
agencies such as the Consumer Financial Protection Bureau (Mahoney, Chapter 8), and
programmes such as foreign aid (Kenny and Sandefur, Chapter 40). All of these actions
were initiated without previously seeking Congressional authority to take such steps.
Such downsizing is likely to erode state capacity and could have negative effects on longrun growth (Bivens, Chapter 5).
4
“In Court, Trump is Losing More Than He’s Winning”, Bloomberg, 8 May 2025 (https://www.bloomberg.com/graphics/2025lawsuits-against-trump-administration/).
7
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION | GENSLER, JOHNSON, PANIZZA AND WEDER DI MAURO
system with unprecedented tariffs. Curtailing immigration and instituting new
deportation campaigns. Limiting the guarantee of birthright citizenship. Rapidly
downsizing government. Dismantling entire departments and agencies in the absence of
new Congressional actions. Disrupting the flow of foreign aid and of research dollars to
academic centres. Restructuring major public health programmes. Urging Congress to
enact an over $5 trillion tax cut bill. Rolling back sustainability and diversity programmes
throughout government. Attempting to settle the Ukraine and Gaza wars. Indicating
that the United States will not rule out the use of force to take over Greenland.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
8
Sixth, while President Trump, once again, is working with Republican Congressional
majorities in the House of Representatives and the Senate, during this second ‘first
hundred days’ the slim margin in the House of Representatives (220 out of 433 in 2025,
compared to 241 out of 435 in 2017) leaves much narrower room for Congressional
leaders and the President to manoeuvre in enacting legislation.5 With such narrow
margins, legislative activity has yet to play a central role in President Trump’s second
administration.
Beyond these six themes regarding President Trump’s two ‘first hundred days’, two other
overarching aspects bear consideration as we pull together preliminary assessments of
the economic consequences of the second Trump administration.
First, questions are being raised as to the new administrations’ commitment to the rule
of law. Not only have government authorities (investigative, prosecutorial, enforcement,
procurement, grants, rulemaking, spending, tariffs, impoundment, etc.) been used
to affect policy outcomes, but also to influence businesses, academic institutions, law
firms, the media, civil society, and foreign leaders. (Coates, Chapter 4) As mentioned,
there already have been over 320 lawsuits against various policy actions of the new
administration. On 12 May 2025, Supreme Court Chief Justice Roberts, while speaking
at Georgetown Law, described the rule of law as “endangered”.6
Second, as discussed in detail in the second part of this volume, the second Trump
administration has called into question many traditional economic alliances and
relationships. Having taken an aggressive stance towards allies and global competitors
alike, the President upended the global trading system through the imposition of
unprecedented tariffs. The administration terminated important international aid
programmes. The United States withdrew from the World Health Organization (Gruber,
Chapter 12) and the Paris Climate Acord, and instituted a six-month review to consider
whether it should withdraw from any other international organisations, conventions, or
treaties (Executive Order 14199). President Trump specifically has called into question
the US commitment to the North Atlantic Treaty Organization (NATO). Live on
television, the President publicly confronted an ally, Ukraine’s President, in a contentious
Oval Office meeting. The administration has challenged the sovereignty of Greenland
(Lidegaard, Kleist and Bæk Heilmann, Chapter 33), Panama, and even Canada (Manger,
Chapter 32).
Taking these six themes and two overarching aspects into consideration, we invited a
group of distinguished economists, legal scholars, and policy leaders to make preliminary
assessments of the economic consequences of the second Trump administration. In doing
5
6
Senate Republicans had similarly tight margins at the start of the two administrations (53 out of 100 in 2025, compared to
52 in 2017).
Rule of law is ‘endangered,’ chief justice says”, Politico, 12 May 2025 (https://www.politico.com/news/2025/05/12/chiefjustice-roberts-speech-georgetown-00343406).
so, we recognise the uncertainties of such an endeavour, as well as that, with such a flurry
of policy initiatives, there may be offsetting economic effects from these policies. Further,
as mentioned, we asked contributors to provide an expert and non-partisan assessment.
The overall picture that the preliminary assessments present is concerning, suggesting
that the second Trump administration policies are likely to be negative for economic
growth both in the near term as well as the longer term.7
Consistent with these assessments, since election day, consumer confidence has declined
(Figure 6) and most public forecasters have increased their odds on the United States
tipping into recession in 2025, though there has been some easing of these odds in May
since the United States and China paused some tariff implementations.
US real GDP contracted 0.3% (annualised rate) in the first quarter of 2025 (2025 Q1),
down from 2.4% annualised growth in 2024 Q4. Though it is too early to understand all
that contributed to this slowdown, in January most economic models forecasted 2025 Q1
to be relatively consistent with the prior quarter’s growth. For instance, on 31 January
2025, the Federal Reserve Bank of Atlanta’s initial forecast predicted 2.9% annualised
growth for 2025 Q1.8 The Conference Board instead recently forecasted that growth in
2025 and 2026 will be well below 2% (Figure 7).
There also is considerable uncertainty about the evolution of future inflation. Modelbased forecasts by the Federal Reserve Bank of Cleveland indicate that inflation over
the next 12 months will be just below 3%, while expected inflation in the University of
Michigan Consumer Survey has spiked to over 7% (Figure 8).
7
8
Given the constraints of pulling this work together in a timely matter, we were unable to include contributions on the
effects of two other important policy areas, namely, tax policy and the dismantling of the Department of Education. We
hope to include such assessments this autumn in a second edition of the book.
“Initial Estimate of First-Quarter GDP Growth Is 2.9 Percent”, Federal Reserve Bank of Atlanta, 31 January 2025 (https://
www.atlantafed.org/cqer/feature/2025/01/31-gdpnow).
9
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION | GENSLER, JOHNSON, PANIZZA AND WEDER DI MAURO
PART I: ECONOMIC TRANSFORMATION IN THE UNITED STATES
FIGURE 6
CONSUMER CONFIDENCE
110
100
90
80
70
60
50
20
pr
il
A
M
ar
ch
y
20
25
25
25
20
25
Fe
br
ua
r
y
20
Ja
nu
ar
ce
m
be
r
be
r
De
Michigan Consumer Sentiment
20
24
24
20
24
20
N
ov
em
ct
ob
er
O
Se
pt
em
be
r
20
24
40
30
20
10
0
Conference Board Consumer Confidence
Sources: University of Michigan consumer sentiment are retrieved from Trading Economics (https://tradingeconomics.com/
united-states/consumer-confidence, accessed 22 May 2025); Conference Board Consumer Confidence data are retrieved
from Investing.com (https://www.investing.com/economic-calendar/cb-consumer-confidence-48, accessed 22 May 2025).
FIGURE 7
ANNUALISED QUARTERLY GROWTH FORECASTS (%)
3.5
3
2.5
2
1.5
1
0.5
0
24
Q
1
20
24
Q
2
20
24
Q
3
20
24
Q
4
20
25
Q
1
20
25
Q
2
20
25
Q
3
20
25
Q
4
20
26
Q
1
20
26
Q
2
20
26
Q
3
20
26
Q
4
-0.5
20
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
10
q/q April 4 Forecast Conf Board
q/q Actual BEA
Sources: Conference Board Forecasts are retrieved from https://www.conference-board.org/research/us-forecast, accessed
22 May 2025; BEA data are retrieved from https://www.bea.gov/news/2025/gross-domestic-product-1st-quarter-2025advance-estimate, accessed 22 May 2025).
FIGURE 8
EXPECTED INFLATION (%)
8
7
6
11
5
3
2
1
25
M
ay
20
20
pr
il
A
M
ar
ch
y
20
25
25
25
20
25
br
ua
r
y
20
Fe
24
20
be
r
De
ce
m
be
r
Ja
nu
ar
24
20
24
20
N
ov
em
ct
ob
er
O
Se
pt
em
be
r
20
24
0
Michigan 1 year Inflation Expectation
Cleveland Fed
Sources: Year-ahead inflation expectations from the University of Michigan are retrieved from Trading Economics (https://
tradingeconomics.com/united-states/michigan-inflation-expectations, accessed 22 May 2025); data on one-year expected
inflation from the Federal Reserve Bank of Cleveland are retrieved from FRED, Federal Reserve Bank of St. Louis (https://
fred.stlouisfed.org/series/EXPINF1YR, accessed 22 May 2025).
While each of the preliminary assessments of policies presents its own economic tradeoffs and considerations, there are some consistent observations raised by contributors.
First, business and financial investment may decline in the face of significantly heightened
uncertainties, challenges to international alliances, concerns of US commitment to the
rule of law, and a considerably empowered US presidency. The assertions of presidential
authorities are unprecedented and effect all the other policy initiatives of the new
administration (Coates, Chapter 4; Gensler and Menand, Chapter 3; Bivens, Chapter 5).
Second, trade and tariff policy – along with the supply chain, investment, and inflation
risks attendant thereto – are overwhelmingly raised as concerns and assessed to be
negative for US and global economic growth.
Since the beginning of the second Trump administration, Americans effectively have
seen one of the most significant tax increases in more than a generation. Tariffs – a form
of taxes – were up approximately ten-fold on average by 1 May, rising to an average of
about 25% from about 2.3% at the end of the Biden administration (Clausing, Chapter
20). Even factoring in the subsequent pause to certain China-related reciprocal tariffs,
global tariffs of 10% (as well as 25% tariffs on autos, auto parts, steel and aluminium) still
apply around the entire world.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION | GENSLER, JOHNSON, PANIZZA AND WEDER DI MAURO
4
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
12
Looking at various economic scenarios as discussed in Part 2, by 2040, US GDP is
forecast to decline by 0.7–1.5%, with some sectors (such as agriculture, autos, and
pharmaceuticals) declining by between 2% and 20% (Bouët, Chapter 21). In a separate
model of the effects of tariffs on the auto industry (Head, Mayer, Vicard, and Wibaux,
Chapter 24), the price of vehicles sold in the United States is forecast to increase by 6–7%.
One of the stated goals of the Trump administration tariffs is to promote US
manufacturing employment, as reviewed later in this volume, but it is not clear that
increased tariffs will achieve this result. Michael Strain (Chapter 16) contends that
tariffs will not substantially increase manufacturing employment as higher tariffs, while
protecting domestic manufactures from import competition, also are a tax on component
parts and business investment, putting downward pressure on domestic manufacturers.
In addition, he contends that, to the extent that other countries raise tariffs in response,
this lowers demand for US exports. While these factors may simply offset each other, it is
also possible that the net effect is negative.
Third, the declining US fiscal picture, challenges to international alliances, tariff
wars, the undermining of Federal Reserve independence, and deregulatory financial
sector policies all are seen as putting at some risk the role of the dollar internationally
(Eichengreen, Chapter 17; Gensler, Menand, and Younger, Chapter 7).
Projections from both the IMF and the Congressional Budget Office point to a structural
fiscal imbalance, with debt unlikely to stabilise over the next 30 years under current
policies. The second Trump administration’s proposals are expected to further strain
public finances (Fatás and Panizza, Chapter 2). Tax cuts remain central to the agenda and
are unlikely to be sufficiently offset by tariff revenues or spending cuts. Most estimates
suggest that, barring financial repression – such as measures possibly linked to the socalled ‘Mar-a-Lago Accord’ – real interest rates will not return to previous lows.
It is in this context, that on 16 May 2025, Moody’s became the last of the three main
credit rating agencies to downgrade the US debt rating to no longer be AAA (Standard &
Poor’s downgraded the United States in 2011 and Fitch in 2023).
Fourth, the expert and non-partisan views of these preliminary assessments generally
do not marry up with the more optimistic economic suggestions of the current
administration. The preliminary assessments, discussed above, related to the economic
consequences of tariffs, government downsizing and fiscal policies, are all examples this.
Immigration policy, science funding, and the effects on rural communities are three
other examples worth highlighting. Preliminary assessments suggest that in each area,
we are likely to see negative economic consequences from the current administration’s
new policies.
Regrading science funding, through a series of significant actions, the new administration
has cut government support for basic and applied research and development, already
curtailing funding provided by, and staffing, at the National Institute of Health
(NIH), National Science Foundation (NSF), United States Agency for International
Development (USAID), and the Department of Health and Human Services. In addition,
the administration’s proposed budget for 2026 calls for funding cuts of 40% for NIH,
56% for NSF, and 24% for NASA (Tollefson et al. 2025). Further, the new administration
has taken steps to curtail funding more broadly to US academic institutions and and the
ability of international students to attend these institutions. Through such unprecedented
cuts and actions, the United States will likely lose part of its comparative advantage,
lowering innovation, productivity, and long-term economic growth (Baker and Johnson,
Chapter 11).
After downsizing the National Oceanic and Atmospheric Administration (NOAA) earlier
this year, the new administration also is proposing substantial budget cuts (over 25%) for
2026. NOAA provides important public goods, though, that the private sector cannot
profitably replicate. Valerie Karplus and Costa Samaras (Chapter 13) argue that the cuts
to NOAA’s ability to provide essential information and services to the US economy will
be widely felt. John Bistline (Chapter 14) notes that the new administration’s Executive
Orders, regulatory rollbacks, and tariffs signal a material shift in US climate and energy
policies. Further, Bistline contends that if proposed Congressional cuts to the climate
provisions in the Inflation Reduction Act (IRA) (as passed in May by the House of
Representatives) were to be enacted, it would lead to slower growth in low-emitting
energy adoption and higher energy expenditures for businesses and households.
Regarding the economic effects on rural communities, Mary Hendrickson and David
Peters (Chapter 15) conclude that the current administration’s policies may negatively
impact already struggling rural economies and communities. They contend that tariffs
will disproportionately harm rural workers and businesses because rural economies
are more specialised in export-dependent sectors like agriculture and manufacturing.
During the 2018-19 trade war, it was only through US government emergency payments
that farm incomes were protected.9 In addition, immigration policies, by slowing the
migration of people into rural communities, could have major economic impacts, given
the demographics of agricultural workers. Further, if proposed Congressional cuts to
9
Hendrickson and Peters further contend that corn and soybean farmers, in particular, face an uncertain future given
ongoing trade disputes.
13
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION | GENSLER, JOHNSON, PANIZZA AND WEDER DI MAURO
Regarding immigration policy, Anna Maria Mayda and Giovanni Peri (Chapter 6) show
that the current administration’s immigration, border, and deportation policies will likely
reduce US GDP by almost 0.7% per year. This is based on a net reduction of 600,000 per
year in immigrants of working age. Further, Mayda and Peri forecast that the net result
on native wages would be small (0.03–0.09%).
Medicaid (as passed in May by the House of Representatives) were to be enacted (Gruber,
Chapter 12), it would be negative for rural communities, as a higher percentage of the US
non-metro population, especially children, rely on Medicaid coverage.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
14
Fifth, many contributors note that, given how early on it is in the new administration, they
cannot yet properly assess key elements of the policies or related economic consequences.
For instance, where will trade and tariff negotiations ultimately land? In particular, what
might a trade deal with China look like? What will be the results of the many novel legal
positions taken by the new administration and related legal challenges? For instance,
though many legal scholars think it unlikely, what if the Supreme Court sides with the
President’s approach limiting birthright citizenship? Such a judicial outcome might lead
to more disruptive economic consequences than nearly any other policy assessed in this
book.
Lastly, some contributors note that the new administration’s policy shifts to date have
been modest or generally in line with what has been seen with past changes in party
control. Jonathan Baker (Chapter 9) finds that the current administration’s initial moves
in competition policy suggest continuity in many core areas. He goes on to explore three
possible scenarios moving forward: policy continuity with a ‘Trumpian populist twist’,
retrenchment, and direct political influence. Baker suggests that retrenchment or direct
influence present long-term risks for innovation, productivity, and prosperity. Similarly,
and in contrast to other policy areas reviewed in this volume, AI-related policy shifts to
date have been far less dramatic (Gensler, Chapter 10).
PART II: RESHAPING THE INTERNATIONAL ECONOMIC SYSTEM
The actions of the current administration are accelerating an ongoing reshaping of the
global economic and political order. The world that emerged from the Cold War was
defined by the triumph of democracy, the expansion of globalisation, and the consolidation
of a rules-based international order centred on multilateral institutions, open markets,
and the leadership of the United States (Fukuyama 1989). Yet, over the past two decades,
cracks in the global order that Fukuyama had characterised have widened – with China’s
economic and geopolitical ascent, Russia’s resurgence as a revisionist power, and the
erosion of social cohesion in advanced economies.
While the current administration has not created these fractures, it has accelerated
and deepened them into an active process of economic nationalism, geopolitical
fragmentation, and institutional weakening. Unlike the cautious multilateralism and
conditional leadership of previous administrations, the current approach is defined by
transactionalism, confrontational diplomacy, and the use of economic tools to garner
concessions and impose costs on both allies and adversaries.
Although the US share of global GDP has declined from 40% in 1960 to 26% in 2024
(when measured in purchasing power parity, the US share went from 20% in 1990 to 15%
in 2024; Figure 9) and its share of world trade is about 15%, the United States continues
to dominate the global financial system, and nearly 60% of global central bank reserves
are still denominated in US dollars (down from over 70% in the 1990s; see Figure 10).
FIGURE 9
US SHARE OF WORLD GDP (%)
45
40
35
30
25
20
1960
1963
1966
1969
1972
1975
1978
1981
1984
1987
1990
1993
1996
1999
2002
2005
2008
2011
2014
2017
2020
2023
15
10
5
0
Market
PPP
Source: Own elaboration based on IMF WEO data.
FIGURE 10
SHARE OF GLOBAL RESERVES DENOMINATED IN US DOLLARS (%)
80
70
60
50
40
30
20
10
19
95
19
97
19
99
20
0
20 1
03
20
05
20
07
20
09
20
11
20
13
20
15
20
17
20
19
20
2
20 1
23
0
Source: Own elaboration based on IMF COFER data.
Heightened uncertainties about the independence of the Federal Reserve and central
bank cooperation have raised fears about the sustainability of the dollar-centric financial
system. Although no immediate alternative exists, the acceleration of discussions around
15
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION | GENSLER, JOHNSON, PANIZZA AND WEDER DI MAURO
For the past eight decades, the United States has played a central role in shaping the
global economic and financial order. Throughout this period, it has delivered two
essential international public goods: global military protection, which has prevented
conflicts between major powers, and financial stability, by supplying the world with
dollar-denominated reserve assets and capital markets that facilitated international
economic growth (Eichengreen, Chapter 17).
Since 2 April, there also has been a decoupling of the dollar index from the yield of the
US Treasuries.
FIGURE 11
US DOLLAR INDEX AND US TREASURY YIELDS
5.00
123.0000
4.80
121.0000
4.60
4.40
119.0000
4.20
117.0000
4.00
3.80
115.0000
3.60
113.0000
3.40
111.0000
3.20
2023-01-03
2023-02-03
2023-03-03
2023-04-03
2023-05-03
2023-06-03
2023-07-03
2023-08-03
2023-09-03
2023-10-03
2023-11-03
2023-12-03
2024-01-03
2024-02-03
2024-03-03
2024-04-03
2024-05-03
2024-06-03
2024-07-03
2024-08-03
2024-09-03
2024-10-03
2024-11-03
2024-12-03
2025-01-03
2025-02-03
2025-03-03
2025-04-03
2025-05-03
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
16
de-dollarisation and the potential creation of regional payment systems reflects an
erosion of trust in the United States as a reliable steward of global financial stability
(Eichengreen, Chapter 17; Gensler, Menand, and Younger, Chapter 7). While there are
many factors that lead to changes in cross-currency pricing, we have seen a decline in the
dollar’s value since the start of the new administration (Figure 11).
Dollar Index
10-Year Treas
Note: The vertical lines mark the US election of November 2024 and the “Liberation Day” tariff announcement.
Source: Nominal Advanced Foreign Economies US Dollar Index retrieved from FRED, Federal Reserve Bank of St. Louis
(https://fred.stlouisfed.org/series/DTWEXAFEGS, accessed 2 June 2025); market yield on US Treasury securities at 10year constant maturity retrieved from FRED, Federal Reserve Bank of St. Louis (https://fred.stlouisfed.org/series/DGS10,
accessed 2 June 2025).
Global value chains, once celebrated for their efficiency and integration, are being redrawn
along geopolitical lines, as countries seek to reduce dependencies and re-shore or friendshore critical industries. Multilateral institutions, from the World Trade Organization
(WTO) to the World Health Organization, have been weakened, sidelined, or bypassed
as disputes are increasingly addressed bilaterally or through the use of economic power.
This retreat from the provision of global public goods comes at a time when such goods
may be most needed. The United States has disengaged from global climate leadership,
pandemic preparedness cooperation, and development assistance. These actions have
undermined international efforts to address cross-border challenges, leaving the global
commons more exposed and under-governed. By undermining the institutions and
rules that have supported global prosperity and stability, these policies risk hastening a
descent into a more fragmented, conflict-prone, and unstable world economy.
This belief may have contributed to the administration’s dramatic trade policy shift
announced on 2 April. Although the United States has run substantial trade deficits since
the 1980s (Figure 12) and accumulated major external liabilities amounting to about 70%
of GDP (Figure 13), these trends have occurred for many economic reasons beyond the
dollar’s international role.
FIGURE 12
US CURRENT ACCOUNT BALANCE
2
1
0
-1
-2
-3
-4
-5
-6
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020
2022
2024
-7
INTERNATIONAL INVESTMENT POSITION OF THE UNITED STATES
2022
2020
2016
2018
2014
2012
2010
2008
2006
2004
2002
1998
2000
1996
1992
1994
1990
1986
1988
1982
20.00%
10.00%
0.00%
-10.00%
-20.00%
-30.00%
-40.00%
-50.00%
-60.00%
-70.00%
-80.00%
-90.00%
1984
FIGURE 13
17
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION | GENSLER, JOHNSON, PANIZZA AND WEDER DI MAURO
The United States has provided these global goods based on enlightened self-interest
rather than altruism. Dollar hegemony has long been viewed as a strategic advantage –
an “exorbitant privilege”, as then French Minister of Finance (and later President) Valéry
Giscard d’Estaing once put it (Gensler 2023). Yet, some leading figures in the United
States suggest that this role imposes too great of an economic cost. For instance, Stephen
Miran, the current Chair of the Council of Economic Advisers, argued that maintaining
the dollar’s reserve status has fuelled persistent trade deficits, undermined industrial
production, and damaged the livelihoods of working-class communities (Miran 2024).
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
18
From a macroeconomic perspective, a country’s current account balance reflects the gap
between its national savings and investment. The US deficit means that foreign capital
is funding domestic investment. Therefore, unless tariffs increase savings or reduce
investment, or change domestic production and consumption, they will not affect the
current account. It is unlikely, though, that tariffs will boost private or corporate savings.
They could raise government savings if they produced significant revenue (an unlikely
event). If they were to do so, however, such funds have been assigned to cover tax cuts
(Fatas and Panizza, Chapter 2).
Alternatively, tariffs might reduce investment. In that case, the closing of the current
account deficit would come at an economic cost. In short, attempting to shrink the trade
deficit through tariffs is unlikely to be meaningly successful without other economic
changes.
Arnaud Costinot and Andrés Rodriguez-Clare (Chapter 23) discuss the conditions under
which tariffs could be welfare-improving or be a useful tool for redistribution. They
conclude that there is no evidence that foreigners will pay for the tariffs being discussed
by the current administration and that there is no evidence that they will benefit US
manufacturing.
Everything considered, tariffs offer little protection to most middle-class Americans as
the vast majority work in the services sector, which does not have tariffs. Consequently,
for most service-sector workers, tariffs represent a cost, not a benefit. In addition, it is
unlikely that tariffs will benefit most manufacturing workers. While Keith Head, Thierry
Mayer, Vincent Vicard and Pauline Wibaux (Chapter 24) estimate that tariffs can be
beneficial for the US auto industry (at the cost of higher car prices), other industries might
suffer because of supply disruptions and possible disruption for exporters (Clausing,
Chapter 20). This is consistent with Marcelo Olarreagaand Sara Santander’s estimates
(in Chapter 22) that US consumers and importers of intermediate inputs will bear more
than half of the cost of the tariffs and Antoine Bouët’s estimates (in Chapter 21) that
tariffs will have a negative impact on US GDP.
According to Baldwin (2025), the current administration’s tariffs policy is more than a
trade dispute, it is an attack on the entire global trading system. It is a “war on trade”
that targets the principle of non-discrimination, which is the core idea behind the
General Agreement on Tariffs and Trade (GATT), the precursor to the WTO, and was
first championed by the United States itself (O’Rourke, Chapter 18). In addition, Baldwin
(2025) argues that tariffs are being used as symbolic instruments, motivated by grievance
as much as economic rationale. Given this history, the new administration’s move marked
a significant break from decades of American trade leadership.
As the United States recedes from its leadership role in trade, the rest of the world is in
the midst of deciding how to respond to the gaps that have emerged. Richard Baldwin
(Chapter 19) advises against tit-for-tat retaliation outside of WTO norms. Instead, he
contends, countries should file consistent legal complaints within the WTO framework,
PART III: SPILLOVERS TO ADVANCED ECONOMIES
The US administration’s desire to demand payments for services previously provided
as public goods is having large effects in Europe. For decades, the European Union’s
economic model was anchored in cheap energy from Russia, strong export demand
from China, and security guarantees from the United States. The war in Ukraine,
combined with the current administration’s threats to withdraw from NATO and impose
unprecedented tariffs, has upended these assumptions. Europe has found itself exposed,
both economically and strategically.
The current administration’s policy shifts follow two major recent shocks that have tested
the fabric of the European Union. The first was the COVID-19 pandemic. While this was
a global crisis, in Europe it triggered the sudden re-emergence of borders, in violation
of EU rules. National governments erected physical barriers – even dividing cities that
straddle two countries – and imposed export bans on critical medical supplies to other
member states. It seemed that, in a time of crisis, the Union had partially fragmented.
Over time, though, common market rules were reasserted, joint procurement of
vaccines was introduced, and the collective financing of the NextGenerationEU package
reinforced European cohesion.
The second shock came with Russia’s invasion of Ukraine and the abrupt end of Russian
gas supplies. This exposed Europe’s energy dependency and vulnerability. The continent
was forced to purchase gas at high prices, primarily from the United States, contributing
to a spike in inflation that peaked above 10%. The deeper realisation was that European
industries had become overly dependent on a geopolitical adversary – raising the prospect
that the entire continent could be economically held captive.
It is in this context that policy shifts by the new US administration are confronting
Europe on two critical fronts: economic and national security. The responses to these
challenges likely will shape the European Union for many years into the future.
Europe’s economic response
The economic challenges from the current administration’s policy shifts have gone well
beyond what many in Europe had anticipated based on President Trump’s first term.
Trade and tariff threats have become more intense and unpredictable. In late May, it
was announced that tariffs on key goods from Europe, which had already been proposed
at 20%, would potentially be raised to 50%, only to have that consideration suspended
within days pending further negotiations.
19
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION | GENSLER, JOHNSON, PANIZZA AND WEDER DI MAURO
reinforce support for the WTO Secretariat, and commit to defending the multilateral
trade system. Whatever the international community eventually decides to do, it is likely
to take considerable time to determine. In the meantime, the trade policies of the US
administration are likely to increase economic uncertainties, undermine stability, and
lower growth.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
20
Further, Paul Bergin and Giancarlo Corsetti (Chapter 26) contend that tariff shocks may
present the European Central Bank and other monetary policymakers with particularly
difficult choices between moderating inflation and stabilising the output gap. They
suggest that, as a consequence of a trade war, stagflation is now becoming the dominant
concern for stabilisation policies.
The European Union is not without leverage. It is the second largest economy, on par
with China, with each accounting for about 17% of global GDP (see Figure 14)
FIGURE 14
COMPOSITION OF GLOBAL GDP AT MARKET EXCHANGE RATES, 2024
Africa Middle East
2%
3% India
4%
USA
26%
Japan
4%
Other Advanced
5%
Latin America
6%
Other Europe
6%
Other Asia
10%
EU
17%
China
17%
Source: Authors’ elaboration based on IMF WEO data.
For the European Union, the recent trade challenge coincides with a growing recognition
that the European economy faces a serious productivity and growth problem. Both
Draghi (2024) and Letta (2024) offer a clear diagnosis: the European Union is operating
below its potential. It has fallen significantly behind the United States, with the gap
widening over the past decade. In purchasing power parity terms, the per capita income
gap is over 25%. A decomposition of this gap shows that while lower labour input (i.e.
Europeans working fewer hours than Americans) plays a role, the bulk of the difference
stems from weaker total factor productivity (TFP) (Figure 15)
FIGURE 15
DECOMPOSITION OF THE GDP GAP BETWEEN EUROPE AND THE UNITED
STATES
0.00%
-5.00%
21
-15.00%
-20.00%
-25.00%
-30.00%
-35.00%
2020
Labour Contrbution
2021
2022
Capital Contrbution
2023
Tot. Fact. Prod.
Source: IMF Regional Economic Outlook, October 2024.
Several structural weaknesses help explain Europe’s economic divergence. One of the
more significant contributing factors is the high cost of energy. Although industrial gas
prices have fallen from their post-invasion peaks, they remain around 3.5 times higher
than in the United States (Figure 16). Electricity prices, meanwhile, are projected to
remain structurally elevated for much of the next decade, only declining later as the
buildout of cheaper renewable energy matures. This places a core pillar of the European
industrial model – energy-intensive manufacturing – at a sustained competitive
disadvantage.
FIGURE 16
INDUSTRIAL GAS PRICE (EUR/MWH)
90
80
70
60
+345%
EU
50
40
China
30
20
10
0
2019
Source: Draghi (2024), Figure 6.
US
2023
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION | GENSLER, JOHNSON, PANIZZA AND WEDER DI MAURO
-10.00%
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
22
While the European Union faces rising external trade barriers, internal fragmentation
also persists. According to the IMF, non-tariff barriers inside the Single Market amount
to the equivalent of a 45% tariff on goods and an astonishing 110% on services (Figure
17). Putting these internal EU barriers into context, as measured by the IMF, they rival
the high-end of the current US administration’s dramatic tariff announcements to date.
FIGURE 17 ESTIMATED TRADE BARRIERS IN 2020
120
100
80
60
40
20
0
Manufacturing between US
states
Manufacturing between EU
states
Services between EU states
Source: IMF (2024: Chart 4).
Luis Garicano (Chapter 25) argues that, in the face of external economic pressure,
Europe’s best defence is to complete and deepen its own market integration. Reducing
internal barriers, particularly in services and digital sectors, would not only strengthen
Europe’s economic base but also increase its collective geopolitical leverage.
In other words, the US administration’s policies make European strategic autonomy
not just economically needed but likely essential. Europe has the talent, resources, and
institutional foundations to succeed; what it now needs is the political will. Paradoxically,
the US administration’s policies may become the very push that accelerates economic
integration, potentially unlocking Europe’s growth potential.
Europe’s security response
While the European Union is not officially at war, it is not entirely at peace. Beyond the
ongoing war in Ukraine, across the continent Russia has been disrupting underwater
infrastructure, launching cyberattacks, and attempting to manipulate media and
elections.
FIGURE 18
AVERAGE MILITARY EXPENDITURE OF EU MEMBER STATES AS A PERCENTAGE
OF GDP
4.00%
3.50%
3.00%
2.50%
2.00%
1.50%
1.00%
0.50%
0.00%
1960
1965
1970
1975
1980
1985
1990
1995
2000 2005
2010
2015
2020
Source: Authors’ elaborations based on data from https://www.sipri.org/databases/milex
Europe now faces a need to rearm both to meet its own commitments and in response
to the growing uncertainty surrounding US security guarantees (Iletzki, Chapter 29;
Luetticke and Müller, Chapter 30). A core consequence is an imperative to overcome the
fragmentation of its defence architecture. Other consequences are likely to be increased
defence funding; accelerated procurement; the European Union aligning with partners
like the United Kingdom; and spending strategically, prioritising particular sectors and
technologies.
23
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION | GENSLER, JOHNSON, PANIZZA AND WEDER DI MAURO
Until now, there was little doubt about where the United States stood. That is why, taken
as a whole, pronouncements by the current administration about Europe, NATO, Russia,
and Ukraine have been deeply unsettling for many in Europe. They have shaken the
foundations of Europe’s security architecture. Europe has long benefited from a peace
dividend and the explicit protection of NATO. In times of peace, defence spending
appeared less urgent, and capital was redirected to other uses. Military expenditures in
Europe declined from around 2.5% of GDP in the early 1990s to a low of approximately
1.5% by 2014, the year Russia annexed Crimea (Figure 18).
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
24
As argued by Armin Steinbach, Guntram Wolff and Jeromin Zettelmeyer (Chapter 27),
current EU arrangements fall well short of creating a true single market for defence or a
robust joint procurement system. To address this, they propose a new intergovernmental
institution – a European Defence Mechanism (EDM) – that would act as joint planner,
procurement agency, and owner of strategic assets.10
Beyond financing, the challenge is to spend effectively. Tom Enders, Jeannette zu
Fürstenberg, René Obermann and Moritz Schularick (Chapter 28) argue that Europe
must shift away from legacy platforms and focus instead on securing asymmetric
technological advantages. They propose a ‘SPARTA’ programme – Strategic Protection
and Advanced Resilience Technology Alliance – to fast-track investment in five strategic
areas: autonomous systems, AI and software integration, sovereign space and satellite
capabilities, modern nuclear deterrence, and hypersonic weapons.11 Such a defence effort
in Europe could become more than a security imperative – it might serve as a catalyst
for broader technological transformation and innovation, possibly including in advanced
digital and AI sectors.
Spillovers to other US allies
President Trump has mused about annexing Canada – despite being told that this
was not “real estate for sale”. The new administration also, on 4 March 2025, imposed
sweeping tariffs on Canada – 10% on energy and 25% on other goods – only to partially
roll these back days later for products covered under the United States-Mexico-Canada
Agreement. Canada, one of the few countries besides China to retaliate, responded with
targeted tariffs of its own. One consequence of these challenges in US-Canada relations
has been a shift in Canada’s political landscape: the Liberal Party gained greater traction
under its new leader, Mark Carney.
Despite the size imbalance, Canada has some real economic leverage. It supplies over 60%
of US oil and gas imports, with several US states sourcing 60–80% of their energy from
Canadian producers. Midwest refineries are specifically configured for Canadian heavy
crude, limiting substitution options. As Mark Manger (Chapter 32) notes, even a 25%
Canadian export tax on energy would have minimal costs for Canada while imposing
significant costs on the United States, with consumers absorbing most of the impact due
to inelastic demand. Like for other advanced countries, Canada’s response has been a
mix of negotiation with the United States and working with like-minded countries.
10 The EDM, as proposed in Chapter 27, would pool financial resources through paid-in capital and borrowing to invest
in shared enablers such as satellite systems and integrated air defence. It would also enforce procurement rules that
eliminate national protectionism, overcoming the limitations of current EU treaty exemptions. Importantly, the EDM would
be open to non-EU European democracies such as the United Kingdom and Ukraine, enabling them to participate on equal
footing.
11 The authors further contend that these technologies would not only strengthen deterrence but also would deliver higher
economic returns, support technological sovereignty, and reduce dependence on non-European platforms with restrictive
ecosystems. In addition, they note that efficient defence spending also will require faster, more flexible procurement
processes that favour European-led innovation.
As Kenichi Ueda (Chapter 34) argues, this may offer a political opportunity for Japan
to pursue long-overdue liberalisation in its agricultural sector – reforms that would be
difficult to enact without external pressure. Agriculture remains a heavily protected
sector, especially for staples like rice, wheat, soybeans, corn, and beef, which are protected
by high tariffs and complex regulatory frameworks. Rice is the most sensitive case: despite
reforms beginning in 1995, the Japanese government still manages imports through
tariff-free quotas and imposes high tariffs on private-sector imports. Pharmaceuticals,
another key US export, also are tightly controlled under Japan’s public health system.
Liberalising these sectors would be in Japan’s own economic interest, even if it would do
little to eliminate the bilateral trade imbalance with the United States.
The shift in the US stance towards Ukraine has been dramatic. Ukraine has been
fighting for survival and enduring daily Russian attacks on its infrastructure and
cities for over 1,200 days. The public confrontation of President Zelenskyy in the Oval
Office, followed by explicit signals that the United States no longer stands firmly behind
Ukraine, made this shift unmistakably clear. In addition, the United States has restarted
direct engagement with Russia’s leadership.
Ukraine’s macroeconomy shows the strain caused by ongoing Russian attacks: it has a
fiscal deficit of 22% of GDP and a trade deficit of around $45 billion, which have been
primarily covered through foreign aid. Despite the uncertainty created by the new
US administration, Ukraine’s direct exposure is relatively limited due to the ongoing
trade war. Bilateral trade with the United States is small – exports account for only
around 2% of Ukraine’s trade – and key sectors like IT services are exempt from new
tariffs. Additionally, capital controls and reliance on official financing have decoupled
Ukraine’s financial system from global volatility. Ukraine, however, remains acutely
vulnerable in the military domain: the United States dominates in critical systems like
Patriot missiles and intelligence capabilities, which Europe cannot yet fully replace. This
dependence already has weakened Ukraine’s defence and EU accession prospects. The
urgent challenge for Ukraine and its allies is to develop independent military capacity to
mitigate this strategic vulnerability.
As Yuriy Gorodnichenko (Chapter 31) argues, Ukraine’s survival now depends on Europe’s
ability to close ranks, overcome US disengagement, and maintain strong support.
Although Russia’s economic and military strength is limited compared to that of Europe,
25
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION | GENSLER, JOHNSON, PANIZZA AND WEDER DI MAURO
Japan has historically run a large current account surplus, even while it recently has
had a trade deficit. These trade deficits (in contrast to its current account surpluses) are
driven primarily by increased energy imports following the 2011 Fukushima disaster and
the shutdown of nuclear power plants. Nonetheless, given Japan’s trade surplus with the
United States, the new US administration has imposed a 25% global tariff on steel and
aluminium, autos and auto parts from Japan, and a 10% “reciprocal” bilateral tariff on
all other goods.
the outcome of the war remains uncertain. A determined and united European response
could help secure a just and lasting peace; hesitation could prolong the war and possibly
invite future aggression on European soil.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
26
PART IV: SPILLOVERS TO EMERGING AND DEVELOPING ECONOMIES
The new US administration’s policy shifts are likely to have significant effects on a
wide range of developing countries. Here we summarise our contributors’ findings for
the largest economies – China, Mexico, and India – and then turn to emerging and
developing economies as a group and Latin America.
Prior to doing so, we note that many developing economies remain vulnerable to
financial shocks linked to the international role of the US dollar. Many countries still
maintain de facto dollar pegs and issue a substantial portion of their liabilities in US
dollars (Eichengreen et al. 2024). Should the capital markets or reserve currency status
of the dollar come under threat, these countries could experience a sudden tightening
of financial conditions through capital outflows (Brooks, Chapter 35). Additionally,
countries that have relied heavily on US official development assistance face significant
risks from changes in US foreign aid policy.
China continues to be a primary interest of the US administration’s trade actions – and
one of the only countries that has responded with significant tariff measures of its own.
At this point, the Chinese economy is highly competitive in many high-tech sectors.
China is a global leader in electric vehicles and dominates renewable energy production.
It has shown impressive advances in closing the AI performance gap with the United
States, with competitive products by DeepSeek, Baidu, and Alibaba (Gensler, Chapter 10)
The recent unveiling of the large language model by DeepSeek shook the valuations of
typically dominant US tech firms.
These strengths, however, contrast with mounting signs of economic stress. The
current trade war comes at a time of underlying fragility. High debt levels, record
youth unemployment, and a deeply troubled real estate sector all point to growing
vulnerabilities. As Yasheng Huang (Chapter 36) argues, the Chinese economy in 2025 is
significantly weaker than it was in 2018, when the first round of US tariffs began. Debt
levels have surged, and real estate – a sector that once accounted for nearly 30% of GDP
(Rogoff and Yang 2021) – is reeling. In 2023, youth unemployment officially reached
20.4%, the highest since the data series began. China’s export sector is particularly
exposed: more than 10 million workers depend on exports to the United States. New US
trade restrictions could push GDP growth below 4%.
At the heart of the challenge lies a structural imbalance. China’s economy remains heavily
reliant on investment and net exports, while private consumption continues to account
for only a small share of GDP. In the face of an external demand shock, the government
is likely to respond with more investment, as Huang notes. Yet China already maintains
To cushion the impact of US trade measures, China would need to shift its growth model
towards domestic private consumption. Huang contends, though, that this is unlikely in
the near term, as it would require the government to reduce its direct role in economic
and financial management and instead focus on expanding social insurance and risksharing mechanisms for households.
Mexico, too, is highly exposed to US economic fluctuations and policies. It holds the
second-largest bilateral trade surplus with the United States (after China) and is the
top trading partner with the United States, primarily in manufactured goods. Mexico
plays a pivotal role in the North American automobile industry, a sector central to US
efforts at reindustrialisation and reshoring within global value chains. Automobile
exports account for 30% of Mexico’s total exports, while the auto sector represents 20%
of both manufacturing employment and total foreign direct investment inflows (Werner,
Chapter 38).
The current US administration’s use of tariffs as a multi-purpose tool – what Werner
calls an “anti-Tinbergen principle”, attempting to pursue multiple objectives with a
single instrument – has serious implications for Mexico. Beyond trade, tariffs have
been employed in an effort to influence the country on migration and drug trafficking.
This generates significant uncertainty regarding future US trade policy and its effects
on Mexico. It is likely, though, to have negative spillovers to Mexico’s growth, as well
as to erode the institutional value of free trade agreements, including their customary
arbitration mechanisms.
India, in contrast, may be the one large emerging market that benefits, at least in the
medium to long run. India has traditionally maintained high tariffs, and since 2018 has
further increased protection (Subramanian, Chapter 37). While the new administration’s
tariffs are expected to have a minor negative impact on Indian growth, they may
encourage India to reduce its own protectionist policies, ultimately benefiting the country.
Furthermore, these pressures may incentivise India to conclude a trade agreement with
the European Union. Therefore, Subramanian is cautiously optimistic, suggesting that
current dynamics could produce a “1991 moment”, referencing the liberalisation reforms
implemented by Manmohan Singh (then India’s Finance Minister) following India’s
balance-of-payments crisis. He also warns of challenges, however, including increased
incentives to promote national champions and discriminatory tax enforcement against
multinationals.
27
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION | GENSLER, JOHNSON, PANIZZA AND WEDER DI MAURO
extraordinarily high investment rates. Raising them further risks exacerbating
overcapacity and deepening existing imbalances. Moreover, capital efficiency has sharply
deteriorated. The incremental capital-output ratio (ICOR) – a measure of how much
investment is needed to generate an additional unit of output – has tripled from 3 to 9 in
recent years (Gill 2019).
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
28
Emerging economies as a group are not the primary targets of the tariffs imposed
by the US Administration, but they remain highly vulnerable to indirect financial and
macroeconomic shocks due to their exposure to global trade and capital flows. Robin
Brooks (Chapter 35) argues that the administration’s policies exacerbate existing
fragilities in emerging markets, resulting in downgraded growth forecasts and increased
financial instability. He highlights three key risks: (i) a decline in global growth driven
by reduced trade volumes and heightened uncertainty; (ii) US dollar volatility, which
tightens financial conditions in emerging markets and heightens debt vulnerabilities;
and (iii) the threat of capital outflows and sudden stops, especially in countries with large
external financing needs and fixed (de jure or de facto) exchange rate regimes.
Given its geographic and economic proximity to the United States, Latin America is
likely to be the most affected emerging region. Sebastian Edwards (Chapter 39) suggests
that the region’s long-standing history with protectionism offers a useful lens through
which to understand the potential adverse effects of US protectionist policies. He argues
that these measures represent steps toward the “Latin Americanisation” of the United
States, not only through tariffs but also through attacks on judicial independence and
overreliance on presidential decrees and Executive Orders. There is thus a convergence
between North and South America, though not in favour of the institutional traditions of
the advanced North. Edwards further notes that Latin American countries differ widely
in their trade practices – from Chile’s open trade policies to the heavy protectionism of
Argentina and Brazil – yet the United States is applying the same tariff policies to all.
This uniform treatment of diverse realities, he concludes, underscores the indiscriminate
nature of the current administration’s trade approach.
Beyond the effects of tariff policies, there are broad consequences for the developing world
due to the drastic cut to US foreign aid, threatening numerous life-saving programmes
funded by American assistance. On the day of his second inauguration, President Trump
announced that “the foreign aid industry and bureaucracy are not aligned with American
interests and in many cases antithetical to American values”. The White House issued
an Executive Order freezing all new foreign aid during a 90-day review, followed by a
“stop work” order for ongoing projects. Although limited waivers were granted for “lifesaving” activities, the process for implementing them has proved ineffective (Kenny and
Sandefur, Chapter 40).12 More recently, the White House has proposed a dramatic budget
reduction of 47% for USAID in fiscal year 2026 (i.e., from September 2025), totalling $28
billion.13
12 To date, the largest single cut was $1 billion in assistance to Ukraine. Ethiopia, the DRC, Uganda, South Africa, and Palestine
each saw reductions exceeding $200 million. Liberia suffered the largest cut relative to its economy (1.6% of GNI), while
Afghanistan, Palestine, and Somalia each faced reductions of more than 1% of GNI.
13 “Explainer, How Proposed U.S. Budget Cuts May Change Foreign Aid in the Americas”, AS/COA, 7 May 2025 (https://www.
as-coa.org/articles/explainer-how-proposed-us-budget-cuts-may-change-foreign-aid-americas).
CONCLUSION: CHALLENGES AND OPPORTUNITIES
In this book, we examine the domestic and international economic implications of the
policies of the new US administration. The overall picture that our contributing authors
paint is concerning. Taken as a whole, these preliminary assessments suggest that the
administration’ policies are likely to be negative for US and global economic growth both
in the near term and the long term.
The new administrations ‘first hundred days’ have led to significantly heightened
uncertainties, challenges to international alliances, concerns of US commitment to
the rule of law, and a considerably empowered US presidency. While tariffs and trade
policies, along with challenges to the global multilateral order, may have garnered the
most attention, there also has been a flurry of activity on other fronts. This has included
significant policy shifts related to immigration, deportations, birthright citizenship,
downsizing government, foreign aid, science funding, academic support, health
programs, tax cuts, and more.
The declining US fiscal picture, challenges to international alliances, tariff wars,
questions of Federal Reserve independence, and de-regulatory financial sector policies
also have raised concerns about the sustainability of the dollar-centric financial system
and the role of the dollar internationally.
In this context, investment, inflation, and supply chain risks have increased. Businesses,
financial parties, foreign countries, and the public generally are assessing what this all
means for their economic futures.
Further, the actions of the new administration have introduced sharp volatility into the
global economic and political order. As the United States recedes from its leadership
role in trade and elsewhere, this is likely to increase economic uncertainties, undermine
stability, and lower growth.
While this has unsettled many governments, it also is prompting strategic recalibration
across advanced economies. The European Union, while focused on strengthening
defence and addressing competitiveness, also is stepping up externally – seeking to
uphold global norms on trade, climate, and finance in coordination with like-minded
partners. With the United States accounting for just 15% of global trade, there is broad
scope for others to sustain open markets and reinforce multilateral rules. Elsewhere,
29
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION | GENSLER, JOHNSON, PANIZZA AND WEDER DI MAURO
Kenny and Sandefur estimate that US foreign aid saved between 2.3 and 5.6 million lives
annually before the proposed cuts, with their preferred estimate at 3.3 million. These
figures are largely attributable to programmes targeting HIV/AIDS, humanitarian relief,
vaccinations, tuberculosis, and malaria, with most benefits concentrated in Eastern and
Southern Africa and Nigeria. Using gross estimates, they project that the proposed aid
cuts could result in 515,000 additional deaths annually, rising to over 700,000 under net
estimates, primarily due to increased mortality from HIV and malaria.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
30
countries are responding along similar lines. New alliances – bilateral, regional, and
plurilateral – are being forged to protect strategic interests. Many are pursuing greater
strategic autonomy by insulating critical technologies and infrastructure. For some
countries, external pressure is also creating openings for politically difficult reforms.
Overall, the US disruption of the global trade and financial system may accelerate the
shift to a more multipolar economic order.
REFERENCES
Baker, S R, N Bloom and S J Davis (2016), “Measuring Economic Policy Uncertainty”,
The Quarterly Journal of Economics 131(4): 1593–1636.
Baldwin, R (2025), The Great Trade Hack: How Trump’s trade war fails and global trade
moves on, CEPR Press.
Bown, C (ed.) (2017), Economics and Policy in the Age of Trump, CEPR Press.
Draghi, M (2024), The future of European competitiveness, European Commission.
Eichengreen, B, R Hausmann and U Panizza (2023), “Yet it Endures: The Persistence of
Original Sin”, Open Economies Review 34: 1–42.
Gensler, G (2023), “Exorbitant Privilege: Responsibilities and Challenges”, remarks at the
Council on Foreign Relations, Washington, DC, 4 December.
Gill, I (2019), “Joyless Growth in China, India, and the United States”, Brookings, 22
January
(https://www.brookings.edu/articles/joyless-growth-in-china-india-andtheunited-states/).
IMF (2024), A Recovery Short of Europe’s Full Potential, Regional Economic Outlook,
Europe 2024.
Letta, E (2024), Much more than a market: Empowering the Single Market to deliver
Europe’s future and prosperity, Report to the European Council.
Miran, S (2024), A User’s Guide to Restructuring the Global Trading System, Hudson Bay
Capital.
Rogoff, K and Y Yang (2021), “Has China’s Housing Production Peaked?”, China and the
World Economy 21(1): 1–31.
Tollefson, D Garisto, M Kozlov and A Witze (2025), “Trump proposes unprecedented
budget cuts to US science”, Nature 2 May (https://www.nature.com/articles/d41586-02501397-1).
ABOUT THE AUTHORS
Gary Gensler is Professor of the Practice, Global Economics and Management, and
Simon Johnson is the Ronald A. Kurtz (1954) Professor of Entrepreneurship at the MIT
Sloan School of Management, where he is head of the Global Economics and Management
group. At MIT, he is also co-director of the Shaping the Future of Work Initiative and a
Research Affiliate at Blueprint Labs. In 2024, Johnson received the Sveriges Riksbank
Prize in Economic Sciences in memory of Alfred Nobel, joint with Daron Acemoglu and
James A. Robinson, “for studies of how institutions are formed and affect prosperity.” In
2007-08, Johnson was Chief Economist and Director of the Research Department at the
International Monetary Fund. He currently co-chairs the CFA Institute Systemic Risk
Council with Erkki Liikanen. He is a Research Associate at the NBER and a Fellow at
CEPR.
Ugo Panizza is Pictet Chair in Finance and Development, Department Head, and
Professor of International Economics at the Geneva Graduate Institute. He is the
Director of the International Centre for Monetary and Banking Studies, Deputy Director
of the Centre for Finance and Development, Vice President and Fellow of CEPR, Fellow
of the Fondazione Einaudi, and Editor-in-Chief of Oxford Open Economics. He was
Chief of the Debt and Finance Analysis Unit at the United Nations Conference on Trade
and Development (UNCTAD) and worked at the Inter-American Development Bank, the
World Bank, the American University of Beirut, and the University of Turin. He served as
an external consultant for the World Bank, the International Monetary Fund, the InterAmerican Development Bank, the United Nations, and the European Court of Auditors.
He has extensive work and research experience in Latin America and the Middle East
and North Africa. His research focuses on international finance, sovereign debt, fiscal
policy, and banking.
Beatrice Weder di Mauro is the President of the Centre for Economic Policy Research
(CEPR) and holds the André Hoffmann Chair of Economics, Climate, and Nature
Finance at the Geneva Graduate Institute. Previously, she was a Research Professor at
INSEAD Singapore (2015–2022) and a Professor of Economics at Gutenberg University
of Mainz in Germany. From 2004 to 2012, she was a member of the German Council of
Economic Experts. She continues to advise governments, international organizations,
and central banks, including the European Commission, the governments of Germany
31
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION | GENSLER, JOHNSON, PANIZZA AND WEDER DI MAURO
Professor of the Practice, Finance, at the MIT Sloan School of Management. Professor
Gensler previously served as Chair of the Securities and Exchange Commission (2021–
2025), Chair of the Commodity Futures Trading Commission (2009–2014), Under
Secretary of the Treasury for Domestic Finance (1999–2001), and Assistant Secretary
of the Treasury (1997–1999). He also was Chair of the Maryland Financial Consumer
Protection Commission (2017-2019) and Senior Advisor to Senator Paul Sarbanes (2002).
Earlier, Gensler worked at Goldman Sachs for 18 years, where he became a partner. His
research focuses on artificial intelligence, finance, and economic policy.
and Switzerland, the ECB, Deutsche Bundesbank, and the IMF. She has served on the
boards of major global companies such as Roche, UBS, and ThyssenKrupp, and currently
sits on the boards of Unigestion and Bosch. Her research focuses on macroeconomics,
financial crises, and climate and nature finance.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
32
PART I
ECONOMIC TRANSFORMATION IN
THE UNITED STATES
CHAPTER 2
Antonio Fatás and Ugo Panizza
INSEAD and CEPR; Geneva Graduate Institute and CEPR
1 INTRODUCTION
In the years leading up to Donald Trump’s second presidency, concerns over the
sustainability of US government debt became increasingly pronounced. Public debt had
been on a steadily rising trajectory, one that was steeper than in many other advanced
economies. The situation deteriorated significantly during the COVID-19 crisis, as
emergency fiscal measures led to a sharp increase in deficits and overall debt levels.
Although the inflationary spike that followed the pandemic contributed to a partial
reduction in the real debt burden, projections continued to indicate that US debt would
grow at a pace exceeding pre-pandemic trends (IMF 2025a).
Between 2020 and 2024, rising interest rates closed the gap with GDP growth rates,
bringing the differential close to zero. This shift imposed new constraints on fiscal
policy, making it clear that stabilising the debt-to-GDP ratio would require future
administrations to maintain deficits within tighter limits. A concrete demonstration of
these concerns is Moody’s recent downgrade of US debt, resulting in a situation where no
major rating agency assigns it the highest possible rating.
As the second Trump administration begins, significant uncertainty surrounds the fiscal
outlook. A range of proposed policies could materially affect the trajectory of public debt.
These include potential revenue increases from tariffs, the extension or expansion of tax
cuts, adjustments to Inland Revenue Service (IRS) enforcement capabilities aimed at
reducing tax evasion, and efforts by the Department of Government Efficiency (DOGE)
to reduce public spending. Beyond their direct fiscal impact, these policies may also
influence macroeconomic variables such as GDP growth and inflation, which in turn
would affect fiscal outcomes.
This chapter analyses the current state of fiscal sustainability in the US and assesses
the potential implications of policy initiatives proposed during Trump’s second term.
It begins with a brief overview of the evolution of US fiscal policy and public debt in
the years preceding the new administration. It then examines the key features of fiscal
policy under Trump’s first term and presents projections for the main fiscal variables
and the debt-to-GDP ratio under plausible policy scenarios for the current term. As all
projections point toward a continued increase in the debt ratio, we then discuss possible
strategies to stabilise public debt over the medium to long term.
35
FISCAL POLICY AND DEBT SUSTAINABILITY | FATÁS AND PANIZZA
Fiscal policy and debt sustainability
2 THE PRE-TRUMP2.0 TRENDS
Figure 1 compares gross debt of governments as a percentage of GDP for the US and the
euro area since 2000, with a projection for the coming five years. The overall increase
in the last 24 years has been significantly larger in the US than in the euro area. While
outside of crises, the euro area displays years where debt is stable or decreasing, in the
case of the US this pattern is absent except for the recent inflationary episode, where
higher inflation boosted nominal GDP and reduced the ratio. IMF forecasts for the next
five years suggest that the gap between these two economies will widen further. IMF
(2025a) estimates that, under current policies, US public debt will fail to stabilise, rising
from 121% of GDP in 2024 to 130% of GDP in 2030.
FIGURE 1
EURO AREA AND US GOVERNMENT DEBT
140
120
Percent of GDP
100
80
60
40
20
0
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
2030
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
36
In recent decades, both advanced economies and emerging markets have followed a
trend towards higher debt-to-GDP levels. For many advanced economies, the levels of
government debt reached by 2024 represented some of the highest, if not the highest,
in the post-WWII period. While these trends are quite broad, they have been steeper in
some countries than others. The US not only presents a profile that is steeper but it also
fails to display periods where debt is visibly decreasing in the last 24 years.
Euro area
US
Note: Gross debt, general government, percent of GDP.
Source: IMF World Economic Outlook, April 2025.
Projections from the Congressional Budget Office (CBO 2024a, 2024b) over a much
longer horizon suggest that if the US government were to follow current law, it will not
be able to address the ongoing structural imbalance of US fiscal policy as debt levels
increase further. CBO forecasts made using the law implemented as of 6 January 2025
portray a steady increase of US government debt to reach a level above 156% of GDP by
the year 2055 (Figure 2).
FIGURE 2
FEDERAL DEBT HELD BY THE PUBLIC, 2025-2055
170
160
37
130
120
110
100
90
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
2035
2036
2037
2038
2039
2040
2041
2042
2043
2044
2045
2046
2047
2048
2049
2050
2051
2052
2053
2054
2055
80
Note: Projection of federal debt held by the public, percent of GDP.
Source: Congressional Budget Office, March 2025.
This increase in the debt-to-GDP ratio is driven by an increase in the deficit (as a
percentage of GDP) over the coming decades. Interestingly, this increase does not come
from increasing primary deficits but is the result of increasing spending on interest
payments. While primary deficits are predicted to stay at around 2% of GDP, interest
payments are likely to almost double from 3% to around 5.5% by 2055 (Figure 3).
FIGURE 3
DRIVERS OF INCREASING BUDGET DEFICITS
8
Percent of GDP
7
6
5
4
3
2
1
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
2035
2036
2037
2038
2039
2040
2041
2042
2043
2044
2045
2046
2047
2048
2049
2050
2051
2052
2053
2054
2055
0
Primary deficit
Interest payments
Note: Projection of primary balance and net interest, percent of GDP.
Source: Congressional Budget Office March 2025.
FISCAL POLICY AND DEBT SUSTAINABILITY | FATÁS AND PANIZZA
Percent of GDP
150
140
FIGURE 4
LONG-TERM FORECASTS OF NET INTEREST (LEFT) AND INTEREST RATES
(RIGHT)
A) Net interest
B) Interest rates
% of GDP
4.50%
10
9
8
7
6
5
4
3
2
1
0
4.00%
3.50%
3.00%
2.50%
2.00%
1.50%
1.00%
0.50%
Mar-21
Jun-23
20
2
20 1
24
20
2
20 7
3
20 0
3
20 3
3
20 6
3
20 9
42
20
4
20 5
48
20
5
20 1
54
0.00%
20
2
20 1
24
20
2
20 7
3
20 0
3
20 3
3
20 6
3
20 9
42
20
4
20 5
48
20
5
20 1
54
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
38
The large increase in net interest payments is the result of combining increasing debt (an
additional 60% in these years) with a projected increase in the average interest rate from
3.1% to 3.4% during this period. 1 The average interest rate on US government debt has
increased dramatically in recent years, leading to much larger interest payments (Figure
4). Back in 2021, interest payments represented just 1% of GDP and were expected to
remain at those levels in the five years that followed. Increases in inflation and interest
rates during 2021-2023 led to a sharp increase in interest payments to levels above 3%
due to the tripling of average interest rates relative to the 2021 forecast. Interestingly,
over the long term, assumptions made by the CBO in 2021 about interest rates have been
revised downwards and the latest forecast in March 2025 assumes interest rates will stay
more than 0.5% below the levels assumed in 2021. This significantly reduces the interest
payments associated to the increasing amount of debt.
Mar-25
Mar-21
Jun-23
Mar-25
Note: Projection of net interest, percent of GDP, and average interest rates.
Source: Congressional Budget Office, March 2021, June 2023 and March 2025.
Interest rates over recent years have caught up with levels that are close to those included
in the long-term forecasts of CBO. This has a major influence in any calculation of the
sustainability of US government debt, as the difference between interest rates and
growth rates of GDP (r-g) is expected to become less and less negative over the coming
years, heading towards zero by 2050 (Figure 5).
1
Average interest rates are calculated as net interest divided by debt at the end of the previous year plus half of the
forecasted deficit for the year.
These trends translated into the need for a larger fiscal adjustment to bring budgetary
outcomes onto a sustainable path. As a result, there have been increasing concerns that
the US debt trajectory is on an unsustainable path.2
FIGURE 5
NOMINAL GDP GROWTH AND AVERAGE INTEREST RATE ON US GOVERNMENT
DEBT
4.30%
4.10%
3.90%
3.70%
3.50%
3.30%
3.10%
2.90%
2.70%
2.50%
2026
2027
2028
2029
2030
2031
2032
2033
2034
2035
2036
2037
2038
2039
2040
2041
2042
2043
2044
2045
2046
2047
2048
2049
2050
2051
2052
2053
2054
2055
4.50%
Nominal GDP Growth Rate
Nominal Interest Rate
Source: CBO (2025) and authors’ calculations
3 FISCAL POLICY DURING THE FIRST TRUMP ADMINISTRATION
To provide context, this section offers a brief overview of the fiscal policy actions
undertaken by the first Trump administration during the period 2017–2019. Fiscal
developments in 2020 are deliberately excluded, as they were driven primarily by the
emergency response to the COVID-19 pandemic.
2
We are aware that not everyone agrees with the use of the label “unsustainable”, but, at a minimum, there is universal
recognition that something needs to change. In the words of Eichengreen (2024), “US debt is both sustainable and a
problem”.
39
FISCAL POLICY AND DEBT SUSTAINABILITY | FATÁS AND PANIZZA
What constitutes a sustainable path is typically based on criteria such as stabilising either
the debt-to-GDP ratio or net interest as a percentage of GDP (Furman and Summers
2020). While, depending on the specific criteria being used, the adjustment to bring fiscal
policy onto a sustainable trajectory could be different, in all cases the adjustment that the
US needs is large both from an economic and political point of view. The IMF (2004a),
while classifying the US at low risk of sovereign stress, highlighted the medium- and
long-term risks of such a steep debt profile concluding, that there is a “pressing need
to reverse the ongoing increase”. Ascari et al. (2024) discussed several scenarios and
concluded that unless annual GDP growth were to accelerate to levels around 4%, fasttrack consolidations to stabilise debt would require “politically unfeasible hikes in tax
rates and spending cuts, with harsh consequences on the economy”.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
40
The centrepiece of the administration’s fiscal policy was the Tax Cuts and Jobs Act
(TCJA), enacted in December 2017. The TCJA permanently reduced the corporate income
tax rate from 35% to 21% and temporarily lowered individual income tax rates, with the
latter provisions set to expire on 31 December 2025. The reform also broadened the tax
base by limiting several deductions and transitioned the US toward a more territorial tax
system for multinational profits.
By the end of 2019, the TCJA had led to a reduction in general government revenues
of approximately 1% of GDP relative to 2016, and 1.5% of GDP compared to the 2019
revenue forecasts issued at the end of 2016 (see left panel in the first row of Figure 6).
Given that actual GDP in 2019 was 1.3% higher than projected in 2016 – largely due to
stronger than expected real GDP growth, with inflation slightly undershooting forecasts
(see mid and left panels in the top row of Figure 6) – the revenue shortfall relative to preTCJA expectations amounted to approximately 2.8 percentage points of GDP. Federal
revenues, as opposed to general government revenues, stood at 16.5% of GDP in 2019,
compared to the 18.1% of GDP projected by the CBO prior to the enactment of the TCJA.
This indicates that the overall drop in general government revenues was fully driven by
the decline in federal government revenues (which account for less than half of general
government revenues).
On the expenditure side, fiscal policy during 2017–2019 was marked by increases in both
discretionary and mandatory spending. A large portion of the increase in discretionary
spending went to defence expenditure, although non-defence discretionary spending
also increased. These increases reversed a prior trend of flat or declining discretionary
spending. Meanwhile, mandatory expenditures, particularly for Social Security and
Medicare, continued to rise due to demographic pressures and healthcare cost inflation.
No major reforms were enacted to curb this trajectory. Overall primary expenditure in
2019 was about half a point of GDP higher than expected (see left panel in the second row
of Figure 6), and the primary deficit was two points higher than expected (see mid panel
in the second row of Figure 6). Additionally, interest payments exceeded projections
during this period, contributing further to elevated spending levels (see right panel in the
second row of Figure 6). By the end of 2019, overall general government expenditure was
0.8% of GDP higher than end-2016 forecasts (left panel of the bottom row of Figure 6).
The combined effect of significant tax cuts and spending increases was a widening of
the overall budget deficit. While the deficit for 2019 had been projected at approximately
3.5% of GDP, it instead reached nearly 6%, up from 4.5% in 2016 (see mid panel of the
bottom row of Figure 6).
Despite this marked fiscal deterioration, the increase in debt held by the public was more
muted than expected. Over the 2016–2019 period, the debt-to-GDP ratio rose by only
2 percentage points, and in 2019 it was just 1 percentage point higher than projected
in 2016 for that year (see right panel of the bottom row of Figure 6). This discrepancy
between fiscal flows and debt accumulation is explained by changes in the Treasury’s
cash balances, intragovernmental financing, and off-budget financial operations.
Government revenues/GDP
32
Real GDP growth
GDP deflator
3
31.5
31
30.5
30
2.5
2.5
2
2
1.5
1.5
2015
2016
2017
2018
2019
1
2015
Primary expenditure/GDP
33.8
33.4
33.2
33
2016
2017
2018
2017
2018
2019
2016
2017
2018
2019
2018
2019
2016
-6
2015
2017
2018
2019
Debt/GDP
79
78
77
76
75
74
-5
2019
2015
Government balance/GDP
-4
2018
2017
Interest expenditure/GDP
-3
2017
2016
2.3
2.2
2.1
2
1.9
1.8
2015
Government expenditure/GDP
2016
2015
Primary balance/GDP
2019
36
35.8
35.6
35.4
35.2
35
2015
2016
-1.5
-2
-2.5
-3
-3.5
33.6
2015
41
FISCAL VARIABLES DURING THE FIRST TRUMP ADMINISTRATION
2016
2017
2018
2019
2015
2016
2017
2018
2019
Note: This figure plots the actual (in light blue) and forecasted (in dark blue) values of key fiscal variables, along with the
components of nominal GDP growth, during the first three years of the Trump administration. For most variables, forecasts
are taken from the October 2016 edition of the IMF World Economic Outlook database, while actual values are from the
October 2022 edition. The World Economic Outlook data are for general government (as opposed to federal government)
revenues and expenditure. Data for the debt-to-GDP ratio refer to debt held by the public and are sourced from the
Congressional Budget Office.
4 FISCAL POLICY DURING THE SECOND TRUMP ADMINISTRATION
As discussed in Section 2, US public debt is currently at a historically high level and on
a rising trajectory, even under the assumption that the temporary provisions of the 2017
Tax Cuts and Jobs Act (TCJA) will expire as scheduled at the end of 2025. In this section,
we analyse how some of the proposals being discussed by the Trump administration as
well as some initiatives that are already being implemented could affect the budget deficit
and the debt trajectory.
4.1 Fiscal variables
Expenditures
The newly created Department of Government Efficiency (DOGE) has started with
large ambitions about a large reduction in government spending. Initially, Elon Musk
suggested that it would be possible to reduce federal expenditure by up to $2 trillion.3
3
More recently these estimates of potential saving have been substantially reduced to figures as low as $150 billion.
FISCAL POLICY AND DEBT SUSTAINABILITY | FATÁS AND PANIZZA
FIGURE 6
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
42
Table 1 shows why the potential reduction in public expenditure associated with this
initiative might be much smaller. When it comes to the magnitude, $2 trillion represents
nearly 30% of total federal spending in fiscal year 2024 and exceeds the entire annual
discretionary budget of the federal government. In addition, approximately 50% of total
discretionary spending goes to defence (see Table 1), and another significant portion
is allocated to veterans and homeland security – areas the Trump administration has
pledged to expand (Dynan and Elmendorf 2025).
A key DOGE strategy involves reducing the non-defence portion of discretionary
spending by downsizing the federal bureaucracy through hiring freezes and layoffs. Total
federal civilian compensation is about $250 billion per year; even eliminating 25% of
non-defence federal jobs would save only around $60 billion per year (CFRB 2025a).
This is approximately 0.24% of GDP and 0.8% of total federal expenditure. Given that
previous administrations have already captured many easier savings, further deep cuts
risk degrading public services while yielding only modest improvements to the deficit
(Donahue 2025). Even if fully implemented, these savings would be insufficient to close
the current fiscal gap, let alone offset the revenue loss associated with making the 2017
tax cuts permanent (see below for estimates of the fiscal cost of this policy).
The largest federal outlays are mandatory programmes such as Social Security, Medicare,
and Medicaid. Since President Trump has committed not to cut Social Security or
Medicare benefits, DOGE is not targeting these programmes. Smaller social safety nets –
such as food assistance and welfare – could be considered for cuts. For example, a recent
House Republican proposal suggested a 22% reduction in the Supplemental Nutrition
Assistance Program (SNAP) through tighter eligibility rules. However, even aggressive
reductions in food stamps would result in relatively limited savings. Major entitlement
reforms – like raising the retirement age or reducing benefits – could yield substantial
fiscal savings, but there is no indication that the current administration intends to
pursue such politically unpopular measures. Therefore, meaningful savings from social
programmes remain limited unless these core entitlements are addressed.
DOGE also aims to boost government productivity by modernising federal IT systems.
Improved software and better inter-agency data sharing could reduce redundant tasks
and prevent administrative errors. For instance, upgraded systems might help reduce
the estimated $175 billion in annual federal overpayments. However, these gains would
materialise slowly and require significant upfront investment. Moreover, the removal
of Inspector Generals – key figures in identifying waste and fraud – may ultimately be
counterproductive (Dynan and Elmendorf 2025).
DOGE has targeted politically contentious spending areas such as diversity programs,
climate initiatives, and research grants. While these measures receive public attention,
the actual budgetary savings are relatively minor. A potentially more impactful target is
corporate subsidies (or ‘corporate welfare’), which totalled approximately $181 billion in
2024 (Edwards 2025). Nevertheless, these subsidies have largely been left untouched by
DOGE, likely due to political resistance and lobbying pressure.
TABLE 1
COMPOSITION OF FEDERAL EXPENDITURE IN FISCAL YEAR 2024
Amount (billion USD)
Share of total
Mandatory expenses
Social Security
1,458
21.5%
Medicare
875
12.9%
Medicaid and CHIP
585
8.6%
Other mandatory
1,166
17.2%
Total mandatory
Net interest
4,083
881
Mandatory + interest
60.2%
13.0%
4,965
73.2%
Discretionary expenses
Defence
853
12.6%
Other discretionary
962
14.2%
Total discretionary
Total
6,780
1,815
26.8%
6,780
100%
Source: Own elaborations based on CBO data https://www.cbo.gov/publication/61181
Revenues
Tax revenues are likely to decrease through the implementation of tax cuts proposed by
the Trump administration, particularly the extension of TCJA provisions. The Committee
for a Responsible Federal Budget estimates that extending the expiring TCJA provisions
could add nearly 50 percentage points of GDP to the federal debt over the next 30 years
(CFRB 2025b). Similarly, Auerbach and Gale (2025) estimate that making the temporary
TCJA provisions permanent would increase the debt-to-GDP ratio to 134% by 2035 and
to 209% by 2055.
Tariffs could be a potential source of additional income for the government, but it is
unlikely that they would contribute to a large increase in revenues on two grounds.
First, Clausing and Obstfeld (2024) and McKibbin and Shuetrim (2025) argue that the
43
FISCAL POLICY AND DEBT SUSTAINABILITY | FATÁS AND PANIZZA
In sum, while there is a long history of attempts to ‘reinvent government’ – from the
Hoover Commission in the 1940s, to President Reagan’s Grace Commission, to VicePresident Al Gore’s initiative in the 1990s – there is broad consensus that achieving
trillions in genuine savings through efficiency alone is unrealistic without confronting
the core drivers of federal spending.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
44
potential revenues associated with tariffs are limited because of the existence of Laffer
curve-type dynamics.4 Higher tariffs lead to lower imports and therefore lower revenues.
This effect can be magnified if tariffs have a negative effect on GDP. Second, the initial
reciprocal tariff rates have been put on pause until negotiations with individual countries
on trade deals are finalised, so there is a large amount of uncertainty over the actual
tariffs that will be in place during 2025 (IMF 2025b). Finally, the US administration has
presented tariffs as a potential replacement of other revenues such as income taxes rather
than as a way to increase the overall revenues of the government.
What about the potential growth effects of the proposed tax changes? Estimates from
the Yale Budget Lab (2025) indicate that the proposed tariffs could reduce annual GDP
growth by approximately 0.35 to 0.56 percentage points. Similarly, Goldman Sachs (2025)
projects that, although the expansionary fiscal package may yield a modest positive net
effect on growth in the short term, this would not be sufficient to offset the negative impact
of the tariffs. The Penn Wharton Budget Model (2025) provides long-term projections for
the Trump campaign’s proposed tax and spending plan – excluding the effects of tariffs –
and finds that, if the measures are temporary, they would increase real GDP growth after
2023–2024 by only 0.3–0.4%, primarily through supply-side mechanisms. However, if the
tax cuts were made permanent without corresponding offsets, the model suggests that
the long-term effects on growth would become negative due to a rising debt burden and
upward pressure on interest rates. This suggests that any short-term gains from fiscal
stimulus may ultimately be outweighed by longer-term fiscal constraints.
Putting together taxes and spending proposals
Table 2 summarises the potential impact on the budget of some of these possible changes
in spending and tax revenues. Tax cuts could reduce revenues by as much as 1.7% of GDP.
And even under the most optimistic assumptions, compensatory measures identified
so far could yield at most 1% of GDP annually. This upper bound assumes substantial
reductions in the federal workforce and optimistic projections for revenue from the
tariffs proposed for implementation in 2025 – tariffs that might not be implemented (at
least in their original form). Given these estimates, to maintain the debt at its current
share of GDP under the Trump campaign’s proposed tax policy, Auerbach and Gale
(2025) estimate that compensatory measures – either in the form of revenue increases or
expenditure reductions – equal to 3.7% of GDP per year would be required if implemented
in 2026, or 4.4% if delayed until 2031. To limit the debt ratio to 150% of GDP by 2055, the
required annual adjustment would still range between 1.9% (if implemented in 2026)
and 2.3% (if implemented in 2031).
4
Preliminary data indicate that tariffs revenues increased by $6 billion in April 2025 because of a sudden increase of
imports. But even an increase of $300 billion per year, which is the upper bound estimate of McKibbin and Shuetrim
(2025), would be enough to compensate for the reduction in revenues brought about by the extension of the TCJA.
TABLE 2
FISCAL IMPACT OF PRESIDENT TRUMP’S PROPOSED POLICIES (% OF GDP)
Annual savings
or revenue
increase
Extension of TCJA
1.22%
Laying off federal employees
0.1%-0.4%
45
Reinstate phased-out
business investment
incentives
0.17%
DOGE
0.15%-0.3%
New proposal from Trump
campaign*
0.33%
Tariffs announced in 2025
(including retaliatory tariffs)
0.4%-0.8%
Total
1.72%
FISCAL POLICY AND DEBT SUSTAINABILITY | FATÁS AND PANIZZA
Annual
cost
0.65%-1.5%
Note: *no income tax on tips and part of overtime wage, Expanded SAL deduction, and 15% corporate rate for domestic
production. The table shows estimates of the budgetary implications of some of the main policy proposals put forward by
the Trump administration. The data are from Goldman Sachs (2025) and the Yale budget lab.5 All values are in percent of
GDP.
4.2 Potential fiscal effects of macroeconomic changes
Interest rates
As discussed in the previous section, the explosive path of public debt is partly due to
higher interest payment. Building on the framework introduced by Poszar (2024),
Miran (2024) argues that it is possible to have low US financing costs while deliberately
weakening the dollar. This approach, often referred to as the Mar-a-Lago Accord, can
be pursued either through international cooperation or a series of unilateral US policy
actions.
In the ‘cooperative’ version of the accord, Miran envisions the US using its geopolitical
leverage to pressure its security and trade partners into reducing their dollar reserves
and converting the remainder into long-duration US Treasury securities (‘century bonds’
with low yields).6 Miran presents this as a realignment of global risk, in which foreign
reserve holders take on interest rate risk previously borne by US taxpayers.
One version of the unilateral approach envisions a ‘user fee’ on foreign official holdings
of US Treasuries – effectively a partial withholding of interest payments. Miran argues
that such a measure would compensate the US for the burden that foreign reserves place
on its export sector by inflating the value of the dollar. Miran acknowledges that this is
a risky approach, potentially leading to a large-scale sell-off of Treasuries, sharply rising
interest rates, and a disorderly decline in the dollar. He advocates gradualism and the
implementation of country-specific fees, with higher rates for geopolitical adversaries.
The market turmoil of April 2025 confirmed that these concerns were well-founded.
5
6
https://budgetlab.yale.edu/research/where-we-stand-fiscal-economic-and-distributional-effects-all-us-tariffs-enacted2025-through-april
The ‘carrot’ in this arrangement is continued access to the US defence umbrella, while the ‘stick’ consists of potential
tariffs or other trade barriers.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
46
Miran also discusses alternative forms of unilateral intervention, including the
accumulation of foreign exchange reserves through the Treasury’s Exchange Stabilization
Fund (ESF). His most radical option involves the Federal Reserve directly purchasing
foreign assets through its System Open Market Account. This proposal is fraught with
risk. If such purchases are sterilised – offset by selling domestic assets to prevent inflation
– the fiscal cost could be significant. If they are not sterilised, the expansion of the money
supply would likely be inflationary.
As discussed in Section 2, in the absence of the radical policy measures envisioned
by Miran, borrowing costs are expected to rise. In recent months, real yields on US
government bonds have risen notably, and updated IMF projections suggest a growing
risk of further interest rate hikes. The IMF (2025b) warns that mounting debt levels
could place additional strain on long-term interest rates and the cost of government
borrowing. For example, a 10 percentage point increase in US public debt as a share of
GDP between 2024 and 2029 could push the 5-year forward 10-year rate up by 60 basis
points. A comparable impact is seen on the 10-year Treasury nominal yield.
Inflation
In terms of inflation, the administration’s policies may generate a positive demand shock
due to the large budget deficit, combined with a negative supply shock stemming from
the imposition of tariffs and increased deportations. The interaction of these two shocks
raises the risk of a return to stagflation. Additionally, the need to finance a growing
public debt could place pressure on the Federal Reserve and potentially threaten its
independence, further elevating inflation expectations.
The IMF (2025a) has raised it inflation forecasts for 2025 by 1.0 percentage point with
respect to its October 2024 forecast. This revision is driven by ongoing price increases
in the services sector and the potential impact of newly announced tariffs. The most
recent data show that the likelihood of US headline inflation surpassing 3.5% in 2025 has
climbed to over 30% – more than double the 13% probability estimated in October 2024.
High unexpected inflation could contribute to reduce the deficit but could also increase
borrowing costs and possibly lead to higher real interest rates – unless one believes that
the financial repression mechanisms spelled out in Miran (2024) can be effective.
While it is early to assess the inflationary impact of Trump’s policies on inflation,
some key measures of inflation expectations, such as those collected by the University
of Michigan survey, increased in March 2025 to levels that are higher than during the
inflationary spike after 2021. Other measures of expected inflation, such as the 5-year
breakeven inflation derived from TIPS, have not reached similar levels but they have
been consistently increasing since Trump’s inauguration.
Recent productivity figures have shown that the US is delivering a faster growth rate
than other advanced economies, but the pace of labour productivity growth is not much
higher than 2%, falling short of what is needed.
TABLE 3
LABOUR PRODUCTIVITY
Euro area
US
1996Q1-2007Q4
1.30%
2.71%
2008Q1-2019Q4
0.72%
1.50%
2020Q1-2024Q4
0.24%
2.10%
Note: Labour productivity calculated as GDP per hour worked for the whole economy (euro area) and nonfarm business
sector (US).
Sources: ECB and Fred.
Looking at long-term trends, many advanced economies are beginning to experience
demographic shifts marked by a shrinking working-age population, which directly
impacts labour supply and productivity. In contrast, the US has so far been better
positioned, largely due to robust immigration inflows (IMF 2025a). However, the
administration’s increasingly restrictive immigration policies could undermine this
advantage, potentially reversing the positive demographic dynamics that currently set
the US apart from its peers.
The latest IMF estimates have revised down short-term US growth forecasts, lowering
the 2025 projection from 2.7% to 1.9% and the 2026 forecast from 2.1% to 1.7%
under the baseline scenario – declines of 0.9 and 0.4 percentage points, respectively.
These adjustments reflect growing policy uncertainty and escalating trade tensions.
Additionally, the updated projections indicate a 37% probability of a US recession in
2025, up from 25% in the October 2024 forecast (IMF 2025a).
5 CONCLUSIONS
Projections from both the IMF and the Congressional Budget Office indicate a structural
imbalance in US fiscal policy under current trajectories, with public debt unlikely to
stabilise within a 30-year projection horizon. These imbalances reflect persistent deficits
and rising interest payments that outpace economic growth.
47
FISCAL POLICY AND DEBT SUSTAINABILITY | FATÁS AND PANIZZA
GDP growth
As highlighted by Ascari et al. (2024), fast growth rates could reduce the need for a
fiscal adjustment to control stabilise the debt-to-GDP ratio. But the rate of GDP growth
required to stabilise debt without budgetary adjustments will be in the order of 4%, a
number that is more than double the forecasted potential growth rate by most analysts.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
48
The policy proposals put forward by the Trump administration are expected to further
strain public finances. Tax cuts remain central to the administration’s agenda, and they
are unlikely to be offset by revenues from proposed tariffs or by only modest reductions in
primary expenditures. As a result, government revenues may fall short of what is needed
to support fiscal sustainability.
Short-term growth prospects appear increasingly fragile, with downside risks dominating
the outlook. At the same time, inflation is expected to remain above the Federal Reserve’s
target. This combination of sluggish growth and elevated inflation could worsen the US
fiscal position. Low growth directly weakens revenue collection and raises the debt-toGDP ratio, while the impact of inflation depends heavily on the trajectory of real interest
rates.
Most current estimates suggest that, in the absence of financial repression – such as
policies possibly associated with the so-called ‘Mar-a-Lago Accord’ – real interest rates
are unlikely to return to the low levels of previous years. This would compound the
challenge of debt stabilisation by increasing debt servicing costs and undermining the
potential benefits of inflation on public finances
REFERENCES
Auerbach, A J and W G Gale (2025), “The Fiscal Outlook at the Beginning of the New
Administration”, Brookings Institution, 25 February.
Ascari, G, G Corsetti, T Horvath, and R Trezzi (2024), “The U.S. Fiscal Mess: Some
Unpleasant Fiscal Simulations”, VoxEU.org, 26 July (https://cepr.org/voxeu/columns/usfiscal-mess-some-unpleasant-fiscal-simulations).
CBO – Congressional Budget Office (2021), The 2021 Long-Term Budget Outlook,
Washington, DC.
CBO (2023), The 2023 Long-Term Budget Outlook, Washington, DC.
CBO (2024), The Long-Term Budget Outlook: 2024 to 2054, Washington, DC.
CBO (2025), The Long-Term Budget Outlook: 2025 to 2055, Washington, DC.
Clausing, K and M Obstfeld (2024), “Can Trump Replace Income Taxes with Tariffs?”,
PIIE Blog, 20 June.
CRFB – Committee for a Responsible Federal Budget (2025a), “Potential Savings from
Shrinking the Federal Workforce”, 7 March.
CRFB (2025b), “Tax Cut Extensions Would Add $3.7 Trillion to Debt by 2054”, 24 March.
Donahue, J D (2025), “The Soft Targets Fell Long Ago: HKS Experts on Prospects for
a Radical New Initiative Reductions”, Harvard Kennedy School (https://www.hks.
harvard.edu/faculty-research/policy-topics/public-finance/what-awaits-departmentgovernment-efficiency-hks).
Eichengreen, B (2024), “America’s Debt Is Both Sustainable and a Problem”, Project
Syndicate, June.
Furman, J and L Summers (2020), “A Reconsideration of Fiscal Policy in the Era of Low
Interest Rates”, Harvard University and Peterson Institute for International Economics.
Edwards, C (2025), “Corporate Welfare in the Federal Budget”, Policy Analysis No. 990,
Cato Institute.
Goldman Sachs (2025), “U.S. Economics Analyst: Fiscal Policy Won’t Offset the Drag
from Tariffs”, 27 March.
IMF – International Monetary Fund (2024), “Article IV Consultation: United States”,
July 2024, Washington, DC.
IMF (2025a), World Economic Outlook, April 2025,Washington, DC.
IMF (2025b), Fiscal Monitor, April 2025, Washington, DC.
McKibbin, W J and G Shuetrim (2025), “The U.S. Revenue Implications of President
Trump’s 2025 Tariffs”, PIIE Briefing 25-2.
Miran, S (2024), A User’s Guide to Restructuring the Global Trading System, Hudson Bay
Capital.
Penn Wharton Budget Model (2025), “The Economic Effects of President Trump’s
Tariffs” (https://budgetmodel.wharton.upenn.edu/issues/2025/4/10/economic-effects-ofpresident-trumps-tariffs).
Pozsar, Z (2024), “Money and World Order”, Ex Uno Plures 2(8).
Yale Budget Lab (2025), “State of U.S. Tariffs” (https://budgetlab.yale.edu/research/
state-us-tariffs-april-15-2025).
49
FISCAL POLICY AND DEBT SUSTAINABILITY | FATÁS AND PANIZZA
Dynan, K and D Elmendorf (2025), “Don’t Look to Efficiency for Big Deficit Reductions”,
in What Awaits the Department of Government Efficiency?”, Harvard Kennedy School
(https://www.hks.harvard.edu/faculty-research/policy-topics/public-finance/whatawaits-department-government-efficiency-hks).
ABOUT THE AUTHORS
Antonio Fatás is the Portuguese Council Chaired Professor of Economics at INSEAD,
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
50
a Senior Policy Scholar at the Center for Business and Public Policy at the McDonough
School of Business (Georgetown University, Washington DC), Vice President, Research
Fellow and VoxEU Associate Editor at the CEPR (London) and a Senior Fellow at ABFER
(Singapore). He has worked as an external consultant for the International Monetary
Fund, the World Bank, the Board of Governors of the US Federal Reserve, the European
Parliament, the OECD, and the UK government. His research interests are in the area
of macroeconomics. His research focuses on the causes and shape of business cycles, the
determinants of long-term growth, and the impact that economic policies (monetary and
fiscal) have on economic outcomes.
Ugo Panizza is Pictet Chair in Finance and Development, Department Head, and
Professor of International Economics at the Geneva Graduate Institute. He is the
Director of the International Centre for Monetary and Banking Studies, Deputy Director
of the Centre for Finance and Development, Vice President and Fellow of CEPR, Fellow
of the Fondazione Einaudi, and Editor-in-Chief of Oxford Open Economics. He was
Chief of the Debt and Finance Analysis Unit at the United Nations Conference on Trade
and Development (UNCTAD) and worked at the Inter-American Development Bank, the
World Bank, the American University of Beirut, and the University of Turin. He served as
an external consultant for the World Bank, the International Monetary Fund, the InterAmerican Development Bank, the United Nations, and the European Court of Auditors.
He has extensive work and research experience in Latin America and the Middle East
and North Africa. His research focuses on international finance, sovereign debt, fiscal
policy, and banking.
CHAPTER 3
Gary Gensler and Lev Menand1
MIT Sloan; Columbia University
In the United States, the public has long benefited from the role played by administrative
agencies with a degree of autonomy from the White House, each agency with distinct
duties and authorities to implement the law as set out by Congress.
In its first hundred days, the second Trump administration has moved rapidly to centralise
control over all administrative agencies, including so-called independent agencies, which
have long operated at a greater remove from the White House than ‘executive’ agencies
like the Department of State and the Department of Commerce. The administration is
asserting an interpretation of the Constitution known as ‘unitary executive theory’ which,
in its pure form, holds that the President has the inherent power to fully control all federal
agencies, regardless of statutory design. Such presidential supremacy, in a break with
history, converts ‘independent’ agencies into ‘executive’ agencies, significantly increasing
the role of White House staff in their operations. It also changes how all departments
and agencies operate, with less insulation for their adjudicatory proceedings and less
protection for civil servants.
In this chapter, we examine what these changes may mean for the economy. We build
on the broad economic research consensus on the value of agency autonomy in central
banking (a consensus that is generally shared by political observers and policymakers in
both parties). While that research focuses on monetary policy, we think it also bears on
how increased presidential control may affect other economic agencies and, in turn, the
economy.2
We proceed in four parts. First, we explore Congress’ goals in setting up agencies and
granting them some degree of autonomy from the White House. Second, we describe five
major moves that the new administration has made to take greater control of all federal
agencies. Third, drawing on empirical evidence where available, we consider how the
1
2
The authors thank Cary Coglianese, Isabel Gensler, Simon Johnson, Jeremy Kessler, Tom Merrill, Gillian Metzger, Nick
Parrillo, K. Sabeel Rahman, and faculty at the University of Pennsylvania Law School for their helpful comments and
suggestions.
The loss of a degree of autonomy at other economic regulatory agencies, similarly, could come at the expense of long-term
economic growth by tilting decisions towards short-term actions to satisfy political considerations.
51
PRESIDENTIAL SUPREMACY OVER ADMINISTRATIVE AGENCIES | GENSLER AND MENAND
Presidential supremacy over
administrative agencies
resulting loss of agency semi-autonomy may affect the economy. Lastly, due to the critical
importance of the Federal Reserve, we assess what these changes might mean for the
conduct of monetary policy, inflation, and economic growth.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
52
CONGRESS’ REGULATORY DESIGN
Congress, using its Constitutional authority, has established the many departments and
agencies of the federal government. As of May 2025, over 400 unique units have had
authority to publish in the Federal Register, the daily journal of the US government.3
Congress has used many different designs for these agencies, depending on its goals, and
the political realities of the times, varying their mix of authorities, restrictions, funding,
leadership models, structures, and degree of autonomy from the courts and the president
(Selin and Lewis 2018, Cushman 1941).
In order to raise the quality of law and policy production, Congress has structured many
consequential parts of government as ‘independent agencies’. The model for such agencies
was the Interstate Commerce Commission (ICC), established in 1887. Congress set up
the ICC as a multimember, court-like body, initially to adjudicate grievances regarding
railroads in response to public outcry about unfair rates. Under the enabling legislation,
five commissioners, appointed by the president, served staggered six-year terms and
could be removed by the president only for good cause, such as “inefficiency, neglect of
duty, or malfeasance in office.” In addition, no more than three commissioners could hail
from one political party.4
As the US economy grew in size and complexity, Congress adapted this blueprint to a
range of regulatory contexts. Under President Wilson, Congress established the Federal
Reserve System (‘Fed’) to furnish an ‘elastic currency’ and the Federal Trade Commission
(FTC) to combat unfair methods of competition and unfair trade practices. Under
President Franklin Roosevelt, Congress established the Federal Deposit Insurance
Corporation (FDIC) to stabilise and strengthen the banking system; the Securities
and Exchange Commission (SEC) to protect investors, facilitate capital formation, and
maintain fair, orderly and efficient capital markets; and the National Labor Relations
Board (NLRB) to regulate labour markets and practices.5
Congress designed these agencies to operate semi-autonomously (Coglianese 2019).
Legislators wanted them to make expert judgements in the public interest and to
reduce the influence of bald political considerations, favouritism, and special interests.
3
4
5
“Agency Filter”, Federal Register (https://www.federalregister.gov/agencies, accessed 24 April 2025).
In the early 1900s, Congress significantly expanded the ICC’s regulatory authorities to include, among other things, the
power to set rates for railroad services (Breger and Edles 2015).
Other major independent agencies include the Commodity Futures Trading Commission, Consumer Product Safety
Commission, Equal Employment Opportunity Commission, Federal Communications Commission, Federal Election
Commission, Federal Energy Regulatory Commission, Merit Systems Protection Board, National Transportation Safety
Board, and Nuclear Regulatory Commission. In total, there are nearly sixty such agencies, most led by boards or
commissions.
Especially when charging agencies (independent as well as executive) with overseeing
specific industries, Congress sought expertness and experience.6 Congress also granted
many agencies independent litigating authority (allowing them to represent themselves
in court, up to a point) (Devins 1994). These agencies engage regularly with other
members of the executive branch and Congress, and over the years have become subject
to significant degrees of presidential influence, but their leadership alone have the power,
subject to the Administrative Procedure Act (APA), to promulgate legislatively authorised
rules and, subject to judicial review, interpret their authorizing statutes.
THE ADMINISTRATION’S STEPS TO TAKE FULL CONTROL OF FEDERAL
AGENCIES
The second Trump administration has asserted unprecedented authority over federal
agencies, taking five big steps towards greater control. While the first two of these moves
primarily apply to ‘independent agencies’, it is important to note that the three later
moves apply to all agencies. Thus, through these five steps, all departments and agencies,
independent and executive alike, are coming more fully under the control of the White
House.
First, the new administration has issued an Executive Order claiming the power to
oversee rulemakings at all “independent agencies” (Executive Order 14,215). “Executive
agencies,” those whose heads can be removed by the president at will, have been subject to
6
As James Landis noted nearly a century ago, “the art of regulating an industry requires knowledge of the details of
its operation” (Landis 1938: 23). “The Federal Power Commission,” Landis pointed out, “remained moribund until its
organization as a committee of three cabinet officials was displaced by specially chosen commissioners” (Landis 1938:
26). Congress similarly gave FTC commissioners seven-year terms so that they would have “the opportunity to acquire the
expertness in dealing with these special questions concerning industry that comes from experience” (Senate Report No.
63-597: 10-11).
53
PRESIDENTIAL SUPREMACY OVER ADMINISTRATIVE AGENCIES | GENSLER AND MENAND
They intended for such agency leaders to be accountable to the president, the courts,
and Congress without being under the full control of any one of them. Thus, Congress
provided for the president to appoint the leaders of these agencies and generally to select
the chairs of commissions from among confirmed commissioners. For some agencies,
Congress granted agency leaders fixed terms in office and authorised the president to
remove leaders but only for specified causes. Where Congress put leadership authority
in the hands of independent multi-member bodies, it did so to promote compromise
and stability and it generally mandated staggered terms and partisan balance. It made
these bodies (and other agencies) accountable to the public through the Administrative
Procedure Act (APA) and other statutes that compel agency officials to engage groups
affected by their policies, provide reasons for their decisions, and interact extensively
with a wide range of actors (Bernstein and Rodriguez 2023).
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
54
this sort of oversight since 1981 (Ahmed et al. 2024).7 The new order requires agencies to
establish White House liaisons, appoint regulatory policy officers, and regularly consult
with White House staff. It also requires them to submit draft rules to White House staff
for review and approval. In practice, this means that the Office of Management and
Budget (OMB) can block a rule by declining to pass it back to an agency.
Second, the administration claims that the president can remove officials at will – that is,
without any given reason – regardless of statutory limits. To date, President Trump has
asserted this power in multiple cases, several of which are currently under review in the
courts.8 Most directly relevant, two FTC Commissioners were removed without cause,9
even though the Supreme Court in 1935 in Humphrey’s Executor v. U.S., unanimously
rejected President Roosevelt’s claim to such power.10 Humphrey’s Executor has stood as
the law of the land for ninety years.
A recent action taken by the White House starkly demonstrates a combined effect of
these first two steps. On 8 May, three commissioners of the Consumer Product Safety
Commission were removed from office, after having voted to seek public comment,
without first submitting the draft rule to OMB review, on a proposed rule on the safety of
lithium-ion batteries.11
Third, the new administration, through three Executive Orders on 9 April, asserted
new powers and processes to rescind existing rules of both independent and executive
agencies (Executive Order 14,264, Executive Order 14,267, and Executive Order 14,270)
In particular, in Executive Order 14,264, the President stated, in contrast with key
provisions of the APA, that notice and an opportunity for the public to comment on the
Department of Energy’s (DOE) change in the legal definition of the word “showerhead”
were “unnecessary because I am ordering the repeal.”12 Further, in Executive Order 14,270,
the President directed ten agencies, including DOE and the Environmental Protection
Agency (EPA), to insert ‘sunset’ provisions into a long list of existing regulations, that
unless extended through additional rule making, would automatically rescind those
regulations by October 2026.13
7
Then-Professor Elena Kagan termed the arrangement “presidential administration” (Kagan 2001). President Reagan, and
his successors, were careful to carve out “independent agencies,” bodies whose heads can be removed by the president
only for cause, recognising that Congress had designed these agencies in ways that limited the President’s ability to
control their statutory discretion. Executive Order 14,215 marks a departure from this approach by asserting constitutional
authority to override this legislative choice.
8 President Trump also removed, without cause, Gwynne Wilcox, from the multimember National Labor Relations Board;
Cathy Harris, from the multimember Merit Systems Protection Board; and Hampton Dellinger, Director of the Office of
Special Counsel.
9 “Trump’s move to fire us is a terrible warning for the US economy”, Financial Times, 24 April 2025 (https://on.ft.
com/4jB7W7i).
10 In the unanimous opinion, the Court distinguished its 1926 decision in Myers v. United States and ruled that Congress could
limit William Humphrey’s removal as an FTC Commissioner, given the FTC’s quasi-legislative and quasi-judicial work.
11 “Trump Moves to Fire Three Members of the Consumer Product Safety Commission”, New York Times, 9 May 2025 (https://
www.nytimes.com/2025/05/09/us/politics/cpsc-fired-trump.html).
12 Although the APA permits agencies to promulgate rules without notice and comment where it for “good cause finds . . .
notice and public procedure thereon are . . . unnecessary,” courts have not previously recognised presidential direction to
satisfy that requirement.
13 “Trump’s New Way to Kill Regulations: Because I Say So”, New York Times, 11 April 2025 (https://www.nytimes.
com/2025/04/11/climate/trump-regulations.html).
Fourth, the administration has asserted that the President’s opinions on questions of
law “are controlling on all employees in the conduct of their official duties” (Executive
Order 14,215). All agencies are now prohibited from advancing any “interpretation of
law . . . that contravenes the President . . . including but not limited to the issuance of
regulations, guidance, and positions advanced in litigation, unless authorised to do so by
the President or in writing by the Attorney General” (Executive Order 14,215).
By its plain language, this includes sorting out the meaning of broad legal standards,
including mixed questions of fact and law. For example, the Department of Justice,
rather than the relevant administrative agencies, now can determine what constitutes an
“unfair method of competition”, who is an “employee” within the meaning of the National
Labor Relations Act, or whether a banking practice is “unsafe or unsound”. This has the
potential to insert Justice Department and White House staff into the routine business
of agencies issuing guidance, promulgating rules, adjudicating disputes, and bringing
enforcement actions.
Fifth, through recent Executive Orders, Presidential Memoranda, and actions by the
Office of Personal Management, the new administration claims the power to remove
senior members of the career civil service, throughout the government, deemed to be in
policy-influencing positions (Executive Order 14,171, 90 FR 8481, 90 FR 13,683). Further,
the administration, and its new Department of Government Efficiency, has attempted to
remove well over 200,000 employees from the civil service14 out of a total of around two
million (Partnership for Public Service 2023). Though patronage and the spoils system
were persistent features of the nineteenth century federal bureaucracy, after many
abuses (in which offices flowed to party supporters and were distributed in exchange for
favours), reforms came in the form of the Pendleton Act of 1883 and the formation of the
bi-partisan, Civil Service Commission, a forerunner of today’s Merit Systems Protection
Board (MSPB). The new administration is directly challenging the constitutionality of
these long-held protections and has removed the MSPB Chair.15
14 “The Federal Work Force Cuts So Far, Agency by Agency,” The New York Times, 21 April 2025 (https://www.nytimes.com/
interactive/2025/03/28/us/politics/trump-doge-federal-job-cuts.html).
15 “Supreme Court lets Trump fire Democratic members of labor boards, for now”, Government Executive, 9 April
(https://www.govexec.com/management/2025/04/supreme-court-lets-trump-fire-democratic-members-labor-boardsnow/404439/).
55
PRESIDENTIAL SUPREMACY OVER ADMINISTRATIVE AGENCIES | GENSLER AND MENAND
Recent administration guidance further mandates that all agencies, executive and
independent, conduct cost-benefit analysis and route interagency communications
regarding regulatory actions through OMB staff. The guidance also extends OMB review
to any regulatory action published in the Federal Register, thus possibly covering orders
and approvals of various kinds (Interim Guidance 2025).
HOW ASSERTIONS OF EXECUTIVE POWER MAY EFFECT THE ECONOMY
We now turn to how these novel assertions of executive authority may affect the economy.16
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
56
In the United States, federal administrative agencies are among the most important
law generating institutions. According to Congressional design, they are disaggregated,
made-for-purpose organisations.
The new administration’s approach, if accepted by the courts and Congress, will disrupt
this design and result in a significant loss of agency autonomy. Drawing on the empirical
evidence where available, we contend that it could have four effects:
a. greater policy oscillation (and less legal stability);
b. more extractive economic policies (i.e. those that favour special interests);
c. greater risks to consistent ‘rule of law’; and
d. increased likelihood of errors.
A country with predictable and stable background rules, broad-based policy, rule of
law, and adaptive regulation, all else equal, has higher and more broad-based growth
(Acemoglu and Johnson 2005, Acemoglu et al. 2005, see also Chapter 6 in this volume by
John Coates). Accordingly, we expect that these changes, on balance, are likely to have,
over the intermediate to longer term, a negative effect on economic growth.
a) Policy oscillation
The new administration’s assertion of presidential supremacy over administrative
agencies is likely to increase the magnitude of policy oscillation, thereby reducing legal
stability, raising investment uncertainty, and potentially dampening economic activity.
By Constitutional design, elections have consequences, and policy changes rightly occur
in their wake.17 In crafting the federal administrative state, however, Congress sought
to achieve a balance between continuity and change (Stephenson 2006).18 It sought a
middle ground. Agencies were designed to generate law that would adapt to social and
technological change but nonetheless persist through short-term political cycles. As
the Senate put it in 1914, Congress designed independent agencies “to have precedents
and traditions and a continuous policy and be free from the effect of such changing
16 We assume, for purposes of this analysis, that they are not overturned by the courts.
17 For example, empirical studies have demonstrated that enforcement levels change when the party in power changes
(Stewart and Cromartie 1989). Changes to administrative law doctrine in the 1980s (especially the emergence of Chevron
deference) also increased shifts in legal interpretation. For example, on highly salient partisan, political issues volatility
has likely increased. For example, in recent decades the FCC and EEOC have reversed positions on internet neutrality and
sexual orientation discrimination multiple times (Devins and Lewis 2023: 1339).
18 For most of the 19th century, continuity dominated: economic governance was a product largely of law generated by
courts, and courts were slow to update legal rules. They were bound by the doctrine of stare decisis (i.e., to stand by
cases already decided), and they were limited to resolving disputes in front of them (as opposed to crafting new law
prospectively). But in moving away from courts, legislators did not want governance to become too volatile either.
incumbency [in the White House]” (Barkow 2010: 24). Or as James Landis (1938:
111) explained, granting agencies certain forms of autonomy makes “policies . . . more
permanent”.
Consider the example of the Federal Reserve. In 1935, Congress set control over the
Fed’s Board among seven officers serving staggered 14-year terms, with removal by the
president only “for cause”. Legislators hoped that long terms and protection from at-will
removal would prevent partisan domination (Cushman 1941: 155).21 By involving seven
distinct voices, Congress also hoped to produce policy outcomes that reflected plural,
diverse interests (Cushman 1941: 158-59). It further required that Board members hail
from different regions and that, in nominating candidates, the President “have due
regard to a fair representation of the financial, agricultural, industrial, and commercial
interests, and geographical divisions of the country” (Federal Reserve Act Sec. 10(1)).
b) More extractive policy
Increased presidential oversight of agencies may shift the entire policy curve towards
more extractive economic policies, i.e. those that favour special interests at public
expense. Small factions have great incentives to influence regulatory activities through
the White House and OMB processes, with increased use of political tools such as media,
campaign donations, and coalition lobbying. In many areas, policy makers also face
what economists call a time inconsistency problem. The most beneficial policy over the
long-term may conflict with actions that bring certain groups benefits in the short term,
including the president, the president’s political party, and people or firms connected to
the president.
19 By granting agency leaders fixed terms in office and protecting some from at will removal Congress reduces the rate
of personnel turnover. Where Congress puts multiple officials in charge of an agency, it reduces the effect of personnel
turnover when it does happen. Multiple membership tends, all else equal, to moderate policy through group decisionmaking. By staggering terms of office, Congress further encourages compromise, as new leaders share responsibility
with veterans in considering changes in prior policy consensus. Partisan balance requirements also create incentives for
compromise as the majority must address concerns raised by well-informed potentially dissenting colleagues. Dissents
further serve a “fire alarm” function alerting the public to decisions more out of the mainstream (Barkow 2010). Devins
and Lewis (2023: 1340), based on a survey of federal employees, argue that “policy stability goals have not been realised,”
through statutory limits on the president’s power to remove agency leaders. Devins and Lewis rely on a survey of federal
employees, in just a single year, 2020, that asked: “In your experience, how much did the policy agenda of [your agency]
change as a result of the transition?” This question does not capture policy change, and while policy direction generally
does shift with new administrations, the relevant question is what agency design better moderates policy swings and
best promotes continuity of law. The survey was also missing important agencies of particular relevance to the questions
considered here (such as the Fed and SEC).
20 Relatedly, Sunstein et al. (2004) show that three-judge panels composed entirely of judges appointed by presidents of one
party vote for more ‘liberal’ or ‘conservative’ outcomes than judges on divided panels.
21 In 1935, Congress took two ex officio members (removable by the president at will) off the Board to reduce the likelihood
of partisan policy (Cushman 1941: 172-77).
57
PRESIDENTIAL SUPREMACY OVER ADMINISTRATIVE AGENCIES | GENSLER AND MENAND
Congress designed institutional features, such as fixed terms in office and staggered
multi-member commissions with partisan balance requirements, to promote stability,
moderation, and compromise at a wide variety of agencies.19 Evidence indicates that
these design features affect regulatory activity, with executive agencies more responsive
to the political cycle (O’Connell 2008). Research also suggests that partisan balance on
multimember commission moderates outcomes (Barkow 2010: 40).20
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
58
Agencies also can be prone to regulatory capture whereby regulated businesses steer the
agendas of agencies to favour their interests (Stigler 1971). Capture can result for many
reasons including that regulated industries are overrepresented in agency processes
given their funding and organisational advantages (Acs and Coglianese 2023), are able to
hire agency personnel (through the ‘revolving door’), and have informational advantages
(Barkow 2010). Although scholars have found that regulatory capture can occur at
both semi-autonomous agencies (Gadinis 2012) as well as executive agencies (Wagner
et al. 2011), as Carrigan and Poole (2015) write, “independence can be a mechanism to
insulate an agency from capture’s effects when it is the politicians who are captured by
industry”. With review by OMB’s Office of Information and Regulatory Affairs (OIRA),
industry forces may “have the same incentive to bid for regulatory outputs at OIRA as
they do at other agencies” (Barkow 2010). Some businesses will have greater incentives
because “the president will be particularly attentive to those groups that can provide
him with the resources, support, or votes to win elections” (Bagley and Revesz 2006).
Further, President Trump’s recent assertion of the right to rescind rules without notice
and comment, along with inserting sunset dates in others, potentially exacerbates the
problems of under regulation posed by agency capture.
In recent decades, economists have developed a whole literature considering the benefits
of central bank independence. Most notably, economists have shown that greater central
bank autonomy leads to better monetary policy with lower levels of inflation.22
Monetary policy may still oscillate, but without autonomy from presidential direction
these oscillations will happen around a mean that is shifted toward short-term expansion
(typically before elections), at the expense of long-term price stability, economic growth,
and financial stability.23
c) Risks to the rule of law
The potential insertion of White House staff into the adjudicatory, enforcement, and
supervisory decisions of regulatory agencies risks impairing the uniform application of
law and therefore increases economic risks (Dettman 2024).
At a minimum, by requiring that every interpretation of law including “positions advanced
in litigation” align with the Department of Justice’s position or else receive clearance in
writing by the Attorney General, the new policy empowers officials outside of an agency
to stall or stymie the even-handed execution of statutes. Worse, it may encourage some
private parties to utilise political tools to influence ongoing investigations, approvals
22 For example, Cukierman et al. (1992) show that among twenty-one industrial countries higher levels of de jure autonomy
are associated with greater price stability. Alesina and Summers (1993) likewise find that central bank independence
reduces the level and variability of inflation. And, more recently, Bodea and Hicks (2015), using a dataset of 78 countries
from 1937-2008, find that more autonomous central banks are better able to discipline the rate of growth of the money
supply and produce lower inflation expectations by the public.
23 For example, Nguyen and Dang (2022) show that high levels of central bank autonomy are negatively associated with
systemic risk in the banking system and that these effects are more substantial in countries with higher levels of
democracy. Mamoon et al. (2024) meanwhile show that in countries with central banks free from political interference
banks have lower levels of non-performing loans. And Fraccaroli et al. (2025) show that “increasing the independence of
[financial] regulators and supervisors [benefits] financial stability”.
of mergers, new drug applications, legal interpretations, or government benefits.
This is especially so as the new administration has shown a willingness to bypass the
Justice Department’s Office of Legal Counsel, which is a source of continuity in legal
interpretation.24
There is substantial empirical evidence that a reduction in agency autonomy is associated
with an increase in political favouritism.25 Empirical studies also suggest that firms
lobby extensively against enforcement activity (Steel 2025), and that these efforts distort
the enforcement process in favour of well-resourced defendants (Fulmer et al. 2023,
Gordon and Hafer 2005, Correia 2014).26 The sorry tale of former SEC Chair Bradford
Cook also is worth mentioning. He lasted just 74 days in the job in 1973, having admitted
during Senate testimony, that he had succumbed to pressure from the Nixon presidential
campaign to delete politically sensitive information from an SEC complaint.27
d) Greater risk of policy and adjudicative errors and delay
In setting up separate agencies to oversee specific economic activities, Congress sought to
promote the accuracy of decision making through expertness and experience. Congress
also recognised that in sprawling political organisations, decisions may be wrested from
those who have a first-hand acquaintance with the facts (Landis 1938: 25).
On the one hand, it is suggested that unitary executive theory enhances political
accountability by inserting the president and their staff deeper into administrative
decision making. Scholars also have argued that White House review provides an
important coordination function: ensuring that agencies are not working at cross
purposes with each other and that the various actors are informed about what is going
on outside their units (Bagley and Revesz 2006). On the other hand, though, presidential
administration may reduce accountability by blurring where policy decisions are actually
24 “Trump Sidelines Justice Dept. Legal Office, Eroding Another Check on His Power,” The New York Times, 4 April 2025.
25 For example, Dahlstrom et al. (2021) show that executive departments – especially those that are more politicised –
are most likely to engage in noncompetitive contracting and to disburse such contracts in battleground states. They
further show that, following a party change in the White House, there is greater turnover in firms receiving government
contracts, but not in “independent” agencies. Rules that limit political appointee involvement in procurement decisions
(with ‘independent’ agencies having the strongest such protections) see lower political favoritism. These results have been
confirmed using political donation data. Higher donations to the party in power are associated with better government
contracting outcomes. But in the executive departments, where the President has the power to remove officials at
pleasure, the impact of donations is 2.5 times greater than in the agencies where the President lacks such power (Fazekas
et al. 2023: Figure 4).
26 These effects also extend to independent agencies, though the existing evidence indicates that these effects are likely
to increase with sharper changes in partisan balance, including the potential loss of minority commissioners. See Steel
(2024), which shows that changes to partisan control of the SEC lead to changes in enforcement and penalties in open
actions while also showing that there has not historically been evidence of bias in the initial openings of SEC investigations,
which are handled at the staff level by career civil servants.
27 “Ethical Crisis at the SEC”, Securities and Exchange Commission Historical Society, (https://www.sechistorical.org/
museum/galleries/tbi/crisis_b.php, accessed April 2025).
59
PRESIDENTIAL SUPREMACY OVER ADMINISTRATIVE AGENCIES | GENSLER AND MENAND
Congress had sought to insulate agencies from the President and White House in certain
ways “to provide some safeguard against political pressures” in decision making involving
the rights and liberties of individuals (Landis 1938: 21). As then Attorney General Robert
Jackson said, “[o]nly by extreme care can we protect the spirit as well as the letter of our
civil liberties, and to do so is a responsibility of the federal prosecutor” (Jackson 1940).
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
60
being made. It also can lead to greater errors as when the President recently asserted the
right to rescind rules without notice and comment.28 Further, it may make governance
more personal in so far as it focuses on the president’s own interests and views rather than
coordination. As Judge Henry Friendly put it, “responsibility breeds achievement”, and
the concentration of responsibility for administration in the White House may impair
the quality of policy (Friendly 1962: 153). It was in part for this reason, for example, that
Congress chose in 1934 to segregate SEC functions into a new agency rather than leave
them within the FTC.
The new administration’s reduction in agency autonomy and change of civil service
protections, in particular, may lead to an increase in policy and adjudicative errors. First,
it interposes less expert White House and inter-agency staff into agency decision making.
Second, centralising decision-making authority in the White House bureaucracy may
lead to lower quality decisions as information is diffuse (Hayek 1945). In many cases,
OIRA lacks the local knowledge of agency decision makers and also may lack the same
degree of technical expertise (Bressman and Vandenbergh 2006). Third, it may reduce
the quality of personnel at agencies, as top talent will be serving in positions with reduced
authority (Richardson 2019). Fourth, it may increase turnover in agency leadership,
since term tenures will no longer be binding on new presidents. Fifth, it may reduce the
number of expert senior career executives, as more positions will be subject to political
control rather than merit based. The loss of state capacity through the downsizing of
many agencies is likely to add to the risk of errors and delays (see Chapter 4 by Josh
Bivens).
Recent empirical work demonstrates that independent agencies that do not go through
OIRA review have significantly greater policymaking capacity (measured in terms
of expertise and experience) (Bednar 2024: 662). Of the ten federal agencies with the
highest capacity, seven have been exempt from the OIRA process (SEC, FTC, Nuclear
Regulatory Commission, Federal Communications Commission, NLRB, Consumer
Financial Protection Bureau, and FDIC). (The other three are NASA, EPA, and DOE
– which includes the National Labs) (Bednar 2025: 658). Based on surveys of federal
employees in 2014, Devins and Lewis argue that independent agencies today “are no more
expert than executive agencies” (2023: 1311). Their survey results, however, suggest that
independent agencies with significant policy making authority are indeed considered
more expert than similarly situated executive agencies.29
28 Given the Congressionally mandated procedures in the APA, such an assertion of a presidential right to rescind rules
without notice and comment also undermines separation of powers.
29 For example, the Fed, FTC, National Transportation Safety Board, and NRC ranked among the highest-skilled agencies in
the government while the lowest-skilled independent agencies (bringing down the average for independent agencies)
were more operational bodies (some of which are not even always viewed as agencies) such as Amtrak, USPS, and the
Broadcasting Board of Governors. In addition, the highest-skilled executive agencies in the study were departmental subunits that largely compiled and analyzed data or administered grants (e.g. the Bureau of Economic Analysis, the Council of
Economic Advisors, the National Institutes of Health, the Bureau of Labor Statistics, and the Administrative Conference of
the United States).
THE CASE OF THE FEDERAL RESERVE
The administration’s key Executive Order (Executive Order 14,215) directly applies to
the Federal Reserve, though it notes that it applies “only in connection with [the Fed’s]
conduct and authorities directly related to its supervision and regulation of financial
institutions” and does not apply “in its conduct of monetary policy”.
Despite the stated limit, there are at least five reasons to predict that the Executive
Order will undermine the Fed’s ability to manage the rate of monetary expansion in the
economy independent of the White House.
First, the Executive Order’s division between monetary policy on the one hand and bank
regulation on the other may be a distinction without much of a difference. Banks, by
their very design, are in the business of creating and pricing money – $20 trillion in
total in domestic bank and credit union deposits. In a sense, banks are to the Fed what
McDonald’s franchisees are to McDonald’s. Thus, bank regulations – leverage ratios,
capital requirements, reserve requirements – are all, in effect, regulations related to the
availability of money and credit in the economy (Menand 2023).
Second, even other key tools considered to be at the core of monetary policy – interest
on reserves, the discount window primary credit rate, etc. – are generally effectuated
through legal rules voted on by the Fed’s Board of Governors. In a formal sense, they are
bank regulation.
Third, it is uncertain how the current White House would consider many other tools,30
including international swap line arrangements, overnight reverse repo agreements,
primary dealer arrangements, and availability of master accounts.31 Would they consider
these tools as part of monetary policy? Or as part of bank regulation?
Fourth, the Executive Order’s other provisions, particularly regarding interpretations of
law and OMB review of agency expenditures, also apply to the Fed. This is unprecedented
in the modern history of the Fed, which to date has had full budgetary autonomy. What
if the White House or Justice Department differed with the Fed on their various legal
authorities, particularly in times of financial or economic stress? Financial stability
30 Jeffrey Clark’s April 17th OMB memo does not clarify this.
31 Each of these are critical pieces of monetary system engineering. The swap lines support monetary expansion overseas
and prevent disorderly contractions that would directly undermine monetary policy. Overnight reverse repurchase
agreements are market transactions that function as a form of base money created by the Fed to implement monetary
policy. Primary dealer arrangements facilitate orderly markets in government debt. And access to master accounts
determine what financial institutions can plug into the interbank payment system.
61
PRESIDENTIAL SUPREMACY OVER ADMINISTRATIVE AGENCIES | GENSLER AND MENAND
Given the outsized significance of the Federal Reserve, we think it important to briefly
consider what the new administration’s policies might mean for the conduct of monetary
policy, inflation, and economic growth.
events generally are fast moving and, in recent decades, have tended to involve novel
legal issues (Menand 2021). For example, in 2008, the Fed made unprecedented use of
its emergency lending authorities including to rescue the insurance conglomerate AIG.32
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
62
Fifth, the capital markets have already experienced added volatility with market
participants paying close attention to the President’s and his senior advisors’ words as to
interest rates as well as to whether the Fed Chair could or should be removed.33
Even the perception that the president may control Fed decision making on matters
relating to monetary and credit growth, let alone the removal of Fed officials, could
un-anchor inflation expectations, reducing the ability of central bankers to credibly
commit to maintaining a policy path over time, which raises cost of capital in the
economy.34 There’s also a potential effect on financial stability if a White House seeks to
boost the economy through easing bank capital requirements or rolling back other risk
management rules (Kugler 2024).
CONCLUSION
The United States’ long-established model of administrative agencies having a degree of
semi-autonomy within the Executive Branch has for decades been critical to US economic
success. While ensuring shared accountability to the president, Congress, and the courts,
this model has helped to promote more stable and durable regulations, more publicinterested policies, the rule of law, and fewer errors. These regulatory achievements, in
turn, have helped businesses and the public plan better, aided capital formation, and
lowered the cost of capital by lessening uncertainties. While it is not perfect, our system
of semi-autonomous regulators has proven quite effective in adapting and contributing
to US economic growth for nearly a century.
One of this chapter’s authors had the privilege to serve for over eight years as Chair of
two different agencies.35 Based on the many thousands of rulemaking, adjudicative,
enforcement, and supervisory actions in which he participated (averaging several per
day), this author saw firsthand the benefits of Congressional design ensuring for collective
agency leadership and some degree of autonomy from the White House. While clearly
operating as part of the Executive Branch, a degree of autonomy from the White House
insulated most decision making from individual constituent political considerations
while preserving accountability to the president, Congress, and the courts. Also,
32 Further, in 2023, in response to the failures of Silicon Valley Bank and Signature Bank, the Fed set up the Bank Term
Funding Program to lend to other banks, at par, against bond holdings even with large unrealised losses (see Lee and
Wessel 2024).
33 “Dollar Hits Fresh Lows on Worries Over Fed Independence”, Wall Street Journal, 21 April 2025 (https://www.wsj.
com/livecoverage/stock-market-trump-tariffs-trade-war-04-21-25/card/dollar-hits-fresh-lows-on-worries-over-fedindependence-3ccP2UvXvkSJR5znLdrF).
34 This problem becomes especially acute when policymakers, for whatever reason, face entrenched inflationary expectations.
The steps required to reverse such a dynamic are costly for political officials, leading to reliance on more autonomous
bodies like independent central banks (Rogoff 1985).
35 Gary Gensler was Chairman, Commodities Futures Trading Commission from 2009–2014 and Chair, Securities and
Exchange Commission from 2021–2025.
collaborating, compromising, and debating with Senate confirmed Commissioners of
both political parties, while not without its challenges, generally led to more considered
and moderated outcomes.
REFERENCES
Acemoglu, D and S Johnson (2005), “Unbundling Institutions”, Journal of Political
Economy 113: 949-95.
Acemoglu, D, S Johnson and J Robinson (2005), “Institutions and Fundamental
Determinants of Long-Run Growth,” in Handbook of Economic Growth.
Acs, A and C Coglianese (2023), “Influence by Intimidation: Business Lobbying in the
Regulatory Process”, Journal of Law, Economics, & Organization 39: 747.
Ahmed, A, L Menand and N Rosenblum (2024), “The Making of Presidential
Administration”, Harvard Law Review 137(8): 2131-2221.
Alesina, A, L Summers (1993), “Central Bank Independence and Macroeconomic
Performance: Some Comparative Evidence”, Journal of Money, Credit and Banking
25(2):151-162.
Bagley, N and R Revesz (2006), “Centralized Oversight of the Regulatory State”, Columbia
Law Review 106: 1260-1329.
Barkow, R (2010), “Insulating Agencies: Avoiding Capture Through Institutional Design”,
Texas Law Review 89: 15-79.
Bednar, N (2024), “Bureaucratic Autonomy and the Policymaking Capacity of United
States Agencies, 1998-2021”, Political Science Research and Methods 12: 652-665.
Bernstein, A and C Rodriguez (2023), “The Accountable Bureaucrat”, The Yale Law
Journal 132: 1600-1690.
63
PRESIDENTIAL SUPREMACY OVER ADMINISTRATIVE AGENCIES | GENSLER AND MENAND
The new administration’s unprecedented assertion of executive power will fundamentally
shift the relationship between the president and White House staff, on the one hand, and
administrative agencies and their personnel on the other. The locus of policy making may
move to more politically oriented staff. This could lead to more policy oscillation, more
extractive policies, potential decline in the consistent application of law, and additional
errors. Some of these effects may be felt in the near term. A loss of confidence in the
independence of the Federal Reserve would increase inflation expectations, weaken the
dollar, and prompt a repricing of long-term credit assets. Other effects may set in more
slowly as a result, for example, of an exodus of expert officials from public service and a
loss of confidence in the consistent application of the law.
Bodea, C and RR Hicks (2015), “Price Stability and Central Bank Independence:
Discipline, Credibility, and Democratic Institutions”, International Organization 69(1):
35-61.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
64
Breger, M and G Edles (2015), Independent Agencies in the United States, Oxford
University Press.
Bressman, L and M Vandenbergh (2006), “Inside the Administrative State: A Critical
Look at the Practice of Presidential Control”, Michigan Law Review 105: 47-99.
Carrigan, C and L Poole (2015), “Structuring Regulators: The Effects of Organizational
Design on Regulatory Behavior and Performance,” Penn Program on Regulation.
Clark, J (2025), “Interim Guidance Implementing Section 3 of Executive Order 14215,
Titled ‘Ensuring Accountability for All Agencies,’” Memorandum, 17 April 17.
Coglianese, C (2019), “The Semi-Autonomous Administrative State”, The Regulatory
Review, 7 October.
Correia, M (2014), “Political Connections and SEC Enforcement”, Journal of Accounting
and Economics 57: 241.
Cukierman, A, S B Webb and B Neyapti (1992), “Measuring the Independence of Central
Banks and Its Effect on Policy Outcomes”, The World Bank Economic Review 6(3): 353–
398.
Cushman, R (1941), The Independent Regulatory Commissions, Oxford University Press.
Dahlstrom, C, M Fazekas and D Lewis (2021), “Partisan Procurement: Contracting
with the United States Federal Government, 2003-2015”, American Journal of Political
Science 65(3): 652-669.
Datla, K and R Revesz (2013), “Deconstructing Independent Agencies (and Executive
Agencies)”, Cornell Law Review 98: 769-843.
Dettman, D (2024), “Upholding Prosperity: The Economic Benefits of the Rule of Law”,
American Bar Association, 13 September (https://www.americanbar.org/advocacy/
global-programs/news/2024/upholding-prosperity-economic-benefits-rule-law/).
Devins, N (1994), “Unitariness and Independence: Solicitor General Control over
Independent Agency Litigation”, California Law Review 82(2): 255-327.
Devins, N and D Lewis, “The Independent Agency Myth”, Cornell Law Review 108: 13051374.
Fazekas, M, R Ferrali and J Wachs (2023), “Agency Independence, Campaign
Contributions, and Favoritism in US Federal Government Contracting”, Journal of
Public Administration Research and Theory 33: 262-278.
Fraccaroli, N, R Sowerbutts and A Whitworth (2025), “Does Regulatory and Supervisory
Independence Affect Financial Stability?”, Journal of Banking and Finance 170(1):
107318.
Fulmer, S, A Knill and X Yu (2023), “Negation of Sanctions: The Personal Effect of
Political Contributions”, Journal on Financial and Quantitative Analysis 58: 2783.
Gadinis, S (2012), “The SEC and the Financial Industry: Evidence from Enforcement
Against Broker-Dealers”, The Business Lawyer 67(5): 679-728.
Gordon, S and C Hafer (2005), “Flexing Muscle: Corporate Political Expenditures as
Signals to the Bureaucracy”, American Political Science Review 99: 245.
Jackson, R (1940), “The Federal Prosecutor”, Robert H. Jackson Center.
Kagan, E (2001), “Presidential Administration”, Harvard Law Review 114(8): 2245-2385.
Kugler, A (2024), “Central Bank Independence and the Conduct of Monetary Policy”,
Board of Governors of the Federal Reserve System
Landis, J (1938), The Administration Process, Yale University Press.
Lee, J and D Wessel (2024), “What did the Fed do after Silicon Valley Bank and Signature
Bank failed?”, Brookings, 25 January (https://www.brookings.edu/articles/what-didthe-fed-do-after-silicon-valley-bank-and-signature-bank-failed/).
Mamoon, A, F Kwabi, E Exeani and W Hu (2024), “The Impact of Central Bank
Independence and Transparency on Banks’ Non-Performing Loans and Economic
Stability,” Journal of Banking Regulation 26(1): 25-40.
Menand, L (2021), “The Federal Reserve and the 2020 Economic and Financial Crisis”,
Stanford Journal of Law, Business & Finance 26(2):295-361.
Menand, L (2023), “The Logic and Limits of the Federal Reserve Act”, Yale Journal on
Regulation 40(1): 197-276.
Nguyen, D N and T Dang (2022), “The Relationship Between Central Bank Independence
and Systemic Fragility: Global Evidence”, Cogent Economics & Finance 10(1): 1-27.
Rogoff, K (1985), “The Optimal Degree of Commitment to an Intermediate Monetary
Target”, The Quarterly Journal of Economics 100(4): 1169-1189.
Sunstein, C, L Ellman and D Schkade (2004), “Ideological Voting on Federal Courts of
Appeal: A Preliminary Investigation”, Virginia Law Review 90: 301-354.
Stigler, G (1971), “The Theory of Economic Regulation”, Bell Journal of Economics &
Management Science 2(1): 3-21.
65
PRESIDENTIAL SUPREMACY OVER ADMINISTRATIVE AGENCIES | GENSLER AND MENAND
Friendly, H (1962), The Federal Administrative Agencies, Harvard University Press.
Stephenson, MatthMew (2006), “Legislative Allocation of Delegated Power: Uncertainty,
Risk, and the Choice Between Agencies and Courts”, Harvard Law Review 119: 10351070.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
66
Steel, R (2025), “Lobbying Against Enforcement”, Columbia Law and Economics Working
Paper No. 5005959 (https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5005959).
Steel, R (2024), “Partisan Bias in Securities Enforcement”, The Journal of Law,
Economics, and Organization 40: 1-27.
Stewart, J and J Cromartie (1989), “FTC Activity and Presidential Effects Revisited”,
Presidential Studies Quarterly 12(2): 355-361.
Wagner, W (2009), “Rulemaking in the Shade: An Empirical Study of EPA’s Air Toxic
Emission Standards”, Administrative Law Review 63(1): 99-158.
ABOUT THE AUTHORS
Gary Gensler is Professor of the Practice, Global Economics and Management, and
Professor of the Practice, Finance, at the MIT Sloan School of Management. Professor
Gensler previously served as Chair of the Securities and Exchange Commission (2021–
2025), Chair of the Commodity Futures Trading Commission (2009–2014), Under
Secretary of the Treasury for Domestic Finance (1999–2001), and Assistant Secretary
of the Treasury (1997–1999). He also was Chair of the Maryland Financial Consumer
Protection Commission (2017-2019) and Senior Advisor to Senator Paul Sarbanes (2002).
Earlier, Gensler worked at Goldman Sachs for 18 years, where he became a partner. His
research focuses on artificial intelligence, finance, and economic policy.
Lev Menand is Associate Professor of Law at Columbia Law School and Affiliated Faculty
at the Institute of Global Politics at the School for Public and International Affairs.
CHAPTER 4
John Coates
Harvard Law School
1 INTRODUCTION
Rule of law is an essential, at times taken-for-granted basis for modern democracies, and
modern economies. Rule of law is more than law itself. As laid out in Section 2, it is a set
of commitments: to particular kinds of laws – general, public, and stable; to ‘due process’
for applying the law; to independent judges; and to independent legal advisors. Before
and since his second election, President Trump and his second administration have acted
in ways that undermine each of these components, as summarised in Section 3. Longstanding research reviewed in Section 4 establishes that economic activity is significantly
enhanced by legal institutions and adherence to the rule of law, built slowly into secure
foundations for shared prosperity. Section 5 projects how the new administration’s
conduct on law and legal institutions may not only weaken democracy, but also reduce
welfare, prevent growth, and increase investment risk – and not just for as long as his
term lasts, but well past its end.
2 WHAT IS THE RULE OF LAW?
Before reviewing early actions of President Trump’s second administration that bear on
the ‘rule of law’, it is worth briefly unpacking what that phrase means. Most basically,
‘rule of law’ is the absence of arbitrary government, as in the rule “of laws, not of men”,
John Adams’s famous phrasing still found in the Massachusetts constitution. Rule of law
is not simply the existence of law. All law, even a despot’s law, enables and limits how
people interact in a society. The ‘rule of law’ consists of commitments that limit state
coercion in concrete ways.
More specifically, rule of law consists of four complementary components. First, ‘rule of
law’ implies the law has certain characteristics. It requires laws to be general, published,
prospective, understandable, consistent, and not changed too frequently (Fuller 1969,
Hart 1983). Absent those characteristics, law devolves to discretion, which tends toward
despotism. Requiring rulers to act prospectively, to apply law to classes of behaviour
rather than to individuals, effectively raises the bar for (and the cost of) use of state
power, and so reduces its use, and protects liberty, both political and economic.
67
THE RULE OF LAW | COATES
The rule of law
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
68
Second, since Magna Carta (1215),1 rule of law has been understood to require ‘due process’.
‘Due process’ includes (1) fair notice of what law requires before it is applied, and (2) an
opportunity to be heard when (as common) reasonable disputes exist about what the law
is or how it applies. The need for due process arises from the inescapable complexity and
incompleteness of law, at least in any advanced society. (It may be useful to compare the
ideal of a ‘complete contingent contract’, also never seen in reality (Grossman and Hart
1986, Hart and Moore 1990, Hart 1995)). Law’s complexity and incompleteness means it
cannot ever be fully self-enforcing. ‘Due process’, a neutral, consistent way to resolve legal
disputes, is a critical component of the ‘rule of law’.
Third, due process implies the need for agents – judges – to be available to apply law and
resolve disputes. Commands from or punishments by a state agent applied directly to
new topics or to past actions (‘ex post facto’), such as orders that remove rights without
notice or a hearing, or changes in contracts based on crimes not charged or proven, are
not actually ‘laws’ but potentially despotic use of discretionary power. Judges in fear for
their life or position by threats, or corrupted by bribes, cannot be expected to apply law
neutrally, or interpret laws contrary to state interests. To constrain the state, those agents
must be independent of other state agents, particularly any agent with plenary political
power (i.e. the president). Without independent judges, laws can be applied in ways that
allow one party (the state) to win any dispute. Laws without independent judges reduce
to arbitrary government.
Finally, complexity and incompleteness also mean the ‘rule of law’ requires lawyers.
Legal complexity implies a need for advice and advocacy. For courts to function, lawyers
must owe basic duties to those courts (e.g. not to lie in court). In the United States, the
right to counsel is fundamental, and includes “a fair opportunity to secure counsel of
[a person’s] choice”.2 “Without the aid of counsel [anyone] may be put on trial without
a proper charge, and convicted upon incompetent evidence, or evidence irrelevant to
the issue or otherwise inadmissible.” Outside of court, neutral advice is necessary to
understand what the law is. Laws nominally ‘published’ can be obscure or contradictory.
Without freely chosen lawyers, laws cease to be general, and again reduce to arbitrary
government.
The United States proclaims itself a nation subject to the rule of law, and its Constitution
embraces the four components discussed above. Federal government power is separated
into three branches – a legislature, an executive and an independent judiciary with
lifetime tenure – to check and balance one another3 and to provide for judging to be
independent of lawmaking or enforcement. Citizens have rights against all branches,
enforced by courts. Some rights are explicit in the Constitution (e.g., due process, right
to counsel, jury trials), some developed by courts (e.g., presuming “innocent until proven
1
2
3
https://www.nationalarchives.gov.uk/education/resources/magna-carta/british-library-magna-carta-1215-runnymede/
Powell v. State of Alabama, 287 U.S. 45, 53 (1932).
Youngstown Sheet & Tube Co. v. Sawyer, 343 U.S. 579, 641 (1952).
guilty”, which dates to Roman law (Pennington 2003), and requiring proof “beyond a
reasonable doubt” for criminal convictions (Whitman 2008)). The design protects
democracy from arbitrary power and private property from confiscation.4
3 THE NEW ADMINISTRATION AND ITS SHIFT ON THE RULE OF LAW
Rule of law has been so foundational in the United States that few presidents have
attempted to pursue ‘policies’ to undermine or even meaningfully change it. Not so for
the new administration. President Trump is attempting to extend his power into domains
traditionally legislative, to override constitutional rights, to undermine the ability of
courts to enforce laws limiting his power or protect those rights, and to curtail the right
to counsel. Even in the first 100 days, the steps he or his agents have taken to challenge
the rule of law have been so numerous, disparate, and unprecedented that only a partial
summary is possible. It is also difficult to organise a narrative by the components of the
rule of law, because many of the actions are inconsistent with more than one component
at once. What follows, then, is a summary only and is organised by the nature of the
action. The bottom line, however, is clear, based on both words and actions: the current
administration is trying to change in numerous and significant ways how law operates in
the United States.
Before presenting the summary, a distinction is important to keep in mind, between legal
advocacy, which is part of the rule of law, and attacks on the rule of law, which of course
are not. A common response to critiques of the new administration’s policy on law is that
it is doing nothing not done by prior administrations. President Trump has taken novel
legal positions, but taking novel legal positions is not a qualitative change – Presidents
Bush, Obama, Trump previously, and Biden all did that too – even if President Trump’s
second administration is doing so more frequently and on more important issues. In the
category of novel legal positions, for example, the new administration is:5
• trying to “impound” (i.e. not spend) funds appropriated by Congress;6
4
5
6
Bond v. United States, 564 U.S. 211 (2011).
https://www.thefp.com/p/is-donald-trump-breaking-the-law
https://www.justsecurity.org/108132/trump-administration-impound-funds/
69
THE RULE OF LAW | COATES
Together, general and prospective laws, due process, independent courts and legal advisors
constitute basic components of the rule of law. As detailed next, the new administration
has taken a number of actions that undermine each element, by attempting to apply
power directly and inconsistently to individuals and businesses rather than executing
public and general laws, by attempting to bypass due process to interfere with contracts
and to punish not only immigrants but US citizens, and by attacking and undermining
the independence of both judges and lawyers. Laws shape the economy, and attacks on
the rule of law will have predictably negative consequences for economic activity.
• litigating who is a citizen;7
• pushing tariffs farther than before;8 and
• pursuing war-time immigration policies without a war declaration from Congress.9
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
70
As much as those positions may be critiqued as policy or political mistakes, and however
likely that the administration will lose in court (particularly on impoundment10 and
citizenship11), they could be viewed as within their authority, subject to court review.
But what is qualitatively different is that President Trump’s administration is taking
actions directed at the rule of law itself. Most prominently, the administration has not
acquiesced when judges have ordered it to stop a given exercise of power, as the courts
already have numerous times.12 The administration’s politically appointed lawyers have
refused to answer basic questions in court cases, 13 despite courts ordering them to do
so,14 and even finding a basis for criminal contempt proceedings,15 something never
having been needed before (Parillo 2018).
The administration’s efforts to deport people (often to prison in other countries) without
due process risks punishing citizens in violation of the Constitution. Part of the goal of
due process is to reduce errors (Blackstone 1765) – in determining who is a citizen, for
example. If government could deport someone who might or might not be a citizen or
imprison them, or both, without trial, that would destroy rule of law. Nonetheless, that
is what the administration is seeking to do.16 Attempts to pursue court-free deportation
so provoked the Supreme Court that it summarily enjoined the administration17 in
an unsigned late-night 7-2 order. On 29 April 2025, President Trump himself clearly
announced he would not comply.18 Such a clear statement of refusal to comply with the
rule of law is unprecedented in US history.
Because of aggressive, unprecedented use of Executive Orders (discussed below), the new
administration has been sued more often in its first 100 days than any administration
in history.19 In response, the President called for judges to be charged with unspecified
crimes and removed from office,20 not for violating law but for interpreting it differently
than would he. He threatened judges appointed by Democrats and Republicans alike.
This break with norms was so sharp it provoked the Chief Justice of the Supreme Court
7
8
9
10
11
12
13
14
15
16
17
18
19
https://www.scotusblog.com/2025/04/justices-will-hear-arguments-on-trumps-effort-to-end-birthright-citizenship/
https://www.pbs.org/newshour/economy/a-timeline-of-trumps-tariff-actions-so-far
https://www.migrationpolicy.org/article/trump-registration-alien-enemies-insurrection
https://www.vox.com/scotus/397820/supreme-court-brett-kavanaugh-trump-spending-freeze-impoundment
https://www.npr.org/2025/03/14/nx-s1-5327552/trump-takes-birthright-citizenship-to-the-supreme-court
https://www.vox.com/criminal-justice/409627/donald-trump-defy-court-order-supreme-court-boasberg-xinis
https://www.nytimes.com/2025/04/22/us/politics/trump-justice-department-abrego-garcia-el-salvador.html
https://www.reuters.com/legal/judge-consider-trumps-compliance-with-order-over-wrongly-deported-man-2025-04-15/
https://www.npr.org/2025/04/16/g-s1-60696/judge-contempt-alien-enemies-act
https://www.nytimes.com/2025/04/28/opinion/trump-constitution-rule-of-law.html
https://en.wikipedia.org/wiki/W.M.M._v._Trump
https://www.nytimes.com/2025/04/29/us/politics/trump-abrego-garcia-deported.html
https://www.usatoday.com/story/news/politics/2025/04/30/trump-100-days-executive-orders-tests-presidentialpower/83262621007/
20 https://www.npr.org/2025/03/18/nx-s1-5332086/trump-lawsuits
Even after court orders have been appealed to the Supreme Court, the administration
has publicly resisted complying.28 The potential for conflict between courts and the
new administration has grown to the point that judges are reported to be in active
discussions about whether US Marshals (who enforce court orders but report to the
Attorney General) might be forced to choose between loyalty to the president and loyalty
to the Constitution.29 Again, the extent of the administration’s open conflicts with courts
are unprecedented.
The administration has attacked not only judges, but thousands of lawyers. In a record
number30 of early Executive Orders,31 the President has claimed the administration is, on
the one hand, trying to “end the weaponization32” of the government, including through
the legal system, but also, on the other hand, dramatically stepping up its own efforts
to use the legal system to attack his political rivals, including by appointing a director
of the FBI who had published what has been characterised as an ‘enemies list’.33 The
President has repeatedly referred to ordinary judicial functions and portrayed his own
felony convictions34 not as the application of law but as “lawfare”35 – that is, raw politics
by other means. An Executive Order commanded36 a review of the prior administration’s
enforcement decisions to look at whether to bring action against people, a potential
escalation of lawfare.
21 https://www.pbs.org/newshour/politics/chief-justice-roberts-rejects-trumps-call-for-impeaching-a-judge-who-ruledagainst-him
22 https://thehill.com/homenews/house/5213176-trump-administration-judges-impeachment/
23 https://www.nytimes.com/2025/03/19/us/trump-judges-threats.html
24 https://www.justice.gov/jm/jm-1-7000-media-relations
25 https://www.cnn.com/2025/04/26/politics/patel-wisconsin-judge-photo-violate-conduct/index.html
26 https://www.reuters.com/investigations/these-judges-ruled-against-trump-then-their-families-came-underattack-2025-05-02/
27 https://www.reuters.com/world/us/sister-us-supreme-courts-barrett-target-bomb-threat-police-say-2025-03-13/
28 https://www.nytimes.com/2025/04/11/us/politics/us-maryland-man-deportation-delay.html
29 https://www.nytimes.com/2025/04/25/us/politics/trump-judges-marshals-threats.html
30 https://www.wbaltv.com/article/trump-100-executive-orders/64286166
31 https://www.whitehouse.gov/presidential-actions/2025/04/addressing-risks-from-susman-godfrey/
32 https://www.federalregister.gov/documents/2025/01/28/2025-01900/ending-the-weaponization-of-the-federalgovernment
33 https://www.nytimes.com/2025/01/30/us/politics/patels-enemies-list.html
34 https://manhattanda.org/d-a-bragg-announces-34-count-felony-trial-conviction-of-donald-j-trump/
35 https://www.lawfaremedia.org/article/'they-call-it-lawfare'--trump-faces-sentencing
36 https://www.whitehouse.gov/presidential-actions/2025/01/ending-the-weaponization-of-the-federal-government/
71
THE RULE OF LAW | COATES
likewise to break norms and criticise the administration for doing so.21 Some members
of Congress have sponsored bills calling for judicial impeachments,22 and judges have
been threatened with violence.23 In violation of Department of Justice (DOJ) policy24
and the presumption of innocence, the FBI director showcased a photo of the handcuffed
‘perp walk’ of a state judge accused but not yet convicted of immigration-related crime.25
Family members of eleven different judges have been targeted,26 including a bomb
threat aimed at Justice Amy Coney Barrett,27 appointed by President Trump to the
Supreme Court, after she joined a court majority who preliminarily ruled that one of new
administration’s cuts to foreign aid was unauthorised.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
72
The Equal Employment Opportunity Commission is “investigating a list” of law firms,37
without prior notice or judicial review. A series of orders labelled firms as “dishonest”38
if – at any point in the past – they had employed individual lawyers who had worked for
political rivals.39 Lawyers have been attacked – some high-profile,40 some not41 – who had
engaged in advocacy that the administration deemed “partisan”, or filed lawsuits against
or investigated the President’s first administration, even if courts previously ruled against
the administration on those same issues,42 or simply represented immigrants.43 Orders,
premised on vague and unsupported claims of “national security risk”, removed security
clearances without notice or hearings, banned lawyers from government buildings, and
threatened firms’ abilities to function. Three orders have already been permanently
enjoined by courts;44 another is temporarily enjoined pending further review.45 The
administration extracted promises46 from other firms to represent causes47 it favours for
free. Some orders purport to ban all businesses working with the government from using
those firms – a government-mandated secondary boycott. In response, some companies
dropped the targeted firms,48 although these actions are so unprecedented and
controversial that other companies are continuing to use the firms,49 or even switching
to them.50 Whatever the net effect, the goal of the orders appears to be to undermine the
right of parties to retain counsel in disputes with the administration,51 not simply firms
targeted, but in expectation of the same treatment for any lawyer defending against the
administration.
In other actions, the new administration has undermined the courts’ and the public’s ability
to rely on the truthfulness and good faith of government lawyers. All administrations
change personnel, including political appointees in the Department of Justice (DOJ).
But this administration has terminated hundreds of career lawyers with civil service
protections,52 and stripped53 the DOJ of independence,54 even in specific cases where
37 https://www.eeoc.gov/newsroom/eeoc-acting-chair-andrea-lucas-sends-letters-20-law-firms-requesting-informationabout-dei
38 https://www.whitehouse.gov/presidential-actions/2025/03/addressing-risks-from-perkins-coie-llp/
39 https://www.nytimes.com/2025/03/06/us/politics/trump-perkins-coie.html
40 https://docs.google.com/document/d/1Ni12135f2SqHJDfUvtlig9V9fESyZkYp5Ujnk1pUlt4/edit?tab=t.0
41 https://slate.com/news-and-politics/2025/04/trump-administration-authoritarianism-fear-deportations-threats.html
42 Trump v. Clinton, 653 F. Supp. 3d 1198, 1207-08 (S.D. Fla. 2023) (dismissing suit against one of the law firms President
Trump is now attacking through executive orders).
43 https://slate.com/news-and-politics/2025/04/trump-administration-authoritarianism-fear-deportations-threats.html
44 https://www.courtlistener.com/docket/69725919/185/perkins-coie-llp-v-us-department-of-justice/
45 https://storage.courtlistener.com/recap/gov.uscourts.dcd.278932/gov.uscourts.dcd.278932.9.0_4.pdf
46 https://www.nytimes.com/2025/04/16/us/politics/law-firms-deals-trump.html
47 https://www.whitehouse.gov/presidential-actions/2025/03/addressing-remedial-action-by-paul-weiss/
48 https://www.wsj.com/politics/policy/trump-perkins-coie-law-firm-executive-order-578b42da
49 https://www.businessinsider.com/donald-trump-big-law-executive-orders-decisions-damage-2025-4
50 https://www.nytimes.com/2025/05/01/business/microsoft-drops-trump-compliant-law-firm.html
51 https://www.nytimes.com/2025/03/12/us/politics/trump-law-firms-perkins-coie.html
52 https://www.nytimes.com/2025/04/28/us/politics/trump-doj-civil-rights.html
53 https://www.lawfaremedia.org/article/trump-s-attacks-on-justice-department-independence--then-and-now
54 DOJ decisions to charge, on legal tactics, and on sanctions were traditionally walled off from the White House, governed
by policies designed to prevent reputational harm to targets of investigations, and never included in Executive Orders,
instead leaving it to the DOJ to charge crimes after a full investigation in a formal complaint and prove the charges in
court. President Trump broke those norms in his first term, but only in a small subset of politically charged decisions. In
President Trump’s second term, he has already broken the norms against an array of defendants, and has done so through
a record number of executive orders.
At the President’s direction,60 enforcement of the Foreign Corrupt Practices Act – passed
in 1977 in the wake of Watergate and enforced since with bipartisan business support – was
suspended for six months.61 The President directed all agencies to review all regulations
and cease to enforce any deemed in their discretion contrary to ten court decisions,62
without normal administrative procedures, opportunities for public comment, or
judicial review. While priorities vary with administrations, the US Constitution charges
the president with an obligation to “take care” to enforce faithfully all valid laws. It is
unprecedented to suspend wholly enforcement of specific and uncontestably valid laws
– particularly those widely supported by both major political parties. Nor has any prior
president engaged in sweeping deregulation based on executive officials’ views of the law,
without compliance with regular process for changing regulations.
Directly relevant to the economy are the new administration’s efforts to add,63
dismantle64 or degrade65 agencies and regulations. The President quickly fired twenty
non-partisan, independent “inspectors general” who Congress intended to investigate
“waste, fraud, and abuse at government agencies”.66 The head of an agency designed to
protect government whistleblowers was removed.67 Ethics rules from President Biden’s
administration were revoked68 and more permissive rules were put in place.
55 https://executivefunctions.substack.com/p/the-trump-executive-orders-as-radical
56 https://www.lawfaremedia.org/article/trump-s-petty-purge-of-15-young-jan.-6-prosecutors
57 https://apnews.com/article/prosecutor-firings-justice-department-white-house-25226702173e7b0aa86633d6c471c37e
58 https://www.lawfaremedia.org/article/a-lone-bove-in-federal-court
59 https://executivefunctions.substack.com/p/the-dangerous-legacy-of-the-adams
60 https://www.whitehouse.gov/presidential-actions/2025/02/pausing-foreign-corrupt-practices-act-enforcement-tofurther-american-economic-and-national-security/
61 The FCPA led over time to the establishment by the Organization for Economic Cooperation and Development of the
Anti-Bribery Convention (1997) and the adoption by numerous other countries of anti-bribery legislation, such as the UK
Bribery Act (2010) and similar laws in France, Spain, Canada, and Brazil. Moments after taking office, the Attorney General
also suspended enforcement of the Foreign Agents Registration Act, which had begun in earnest only in President Trump’s
first administration, but which came to be seen by some as a threat to business interests under President Biden.
62 https://www.whitehouse.gov/fact-sheets/2025/04/fact-sheet-president-donald-j-trump-directs-repeal-of-regulations-thatare-unlawful-under-10-recent-supreme-court-decisions/
63 https://www.govinfo.gov/content/pkg/FR-2025-01-29/pdf/2025-02005.pdf
64 https://www.nytimes.com/2025/02/21/opinion/hiv-usaid-freeze-doge.html
65 https://www.nytimes.com/2025/04/27/business/cfpb-layoffs-trump-musk-doge.html
66 https://apnews.com/article/watchdogs-trump-mass-firing-inspectors-general-5b4629fb34a168322bf61170286efb76
67 https://www.politico.com/news/2025/03/06/federal-workforce-watchdog-who-was-fired-by-trump-drops-legal-fight-toget-his-job-back-00215891
68 https://apnews.com/article/trump-revokes-ethics-rules-drain-swamp-b8e3ba0f98c9c60af11a8e70cbc902bd
73
THE RULE OF LAW | COATES
government lawyers have obligations as court officers. The Office of Legal Counsel,55
which traditionally gave neutral advice to the White House and to government agencies,
has been sidelined. Following an unprecedented pardon of thousands of January 6 rioters,
apolitical DOJ staff were terminated for following normal enforcement policies,56 for
answering judges’ questions honestly about other policies,57 or for no stated reason at all.
A political appointee terminated an investigation of the mayor of New York City in return
for cooperating with the administration’s immigration policy, 58 effectively announcing
that “the President was prepared in the future to use criminal law enforcement as
leverage, in a direct quid pro quo, to force public officials to support his policy goals”
(Bauer 2025a).59
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
74
Having taken these steps, the new administration also has rewarded supporters with
offices and rents. President Trump pardoned a felon whose wife had donated nearly $2
million to the President’s campaign.69 The new administration created70 a new, extralegal “agency” not authorised or funded by Congress, in the form of the Division of
Government Efficiency (DOGE), with purported power to cut budgets, dismiss staff, and
centralise administration of the entire government. Thousands of career staff have been
terminated in violation71 of civil service protections72 and union contracts.73 Without
Congressional authorisation, thousands more were paid bonuses to resign,74 and, as
common with such buyout programmes, thousands have had to be rehired,75 some with
expertise on nuclear weapons76 and food safety,77 all at a net loss to the taxpayer. In all,
DOGE claims to have cut $150 billion, but generated transition costs nearly as large,78
while significantly disrupting government services.79 DOGE rapidly attempted to gain
access to multiple streams of confidential government data 80 (e.g., treasury data 81, tax
filings82, nuclear secrets83), with minimal oversight to prevent misuse for private gain.
Elon Musk, CEO of SpaceX and Tesla, was DOGE’s initial manager,84 but was formally
appointed only as a “special government employee,” exempting him from normal ethics
disclosures.85
More sweepingly, the new administration moved to reduce the autonomy of independent
agencies such as the Federal Reserve, the Federal Trade Commission and the National
Labor Relations Board, among other agencies (Gensler and Menand 2025, Calabresi and
Yoo 2008). The current administration took up the project with immediate attempts
to terminate officials in violation of clear statutory “for cause” job protection.86 While
many officials are still challenging the dismissals in multiple court cases, these efforts
to reshape the boundary between the executive and the legislature would dramatically
undermine the stability of federal policies of all kinds.
69 https://www.cnbc.com/2025/03/28/trump-pardons-nikola-trevor-milton-ceo-securities-fraud-electric-vehicle.html
70 https://www.whitehouse.gov/presidential-actions/2025/02/ensuring-lawful-governance-and-implementing-thepresidents-department-of-government-efficiency-regulatory-initiative/
71 https://www.govexec.com/workforce/2025/02/oversight-agency-finds-trumps-federal-worker-firings-unlawful-asks-someemployees-be-reinstated/403218/
72 https://beyer.house.gov/news/documentsingle.aspx?DocumentID=6397
73 https://minnesotareformer.com/2025/03/28/trump-moves-to-rescind-union-rights-of-over-1-million-federal-workers-andother-labor-news/
74 https://www.lawfaremedia.org/article/breaking-down-opm-s--fork-in-the-road--email-to-federal-workers
75 https://www.forbes.com/sites/saradorn/2025/04/04/trumps-great-rehiring-over-26000-fired-by-doge-likely-to-return-sofar/
76 https://www.cbsnews.com/news/doge-firings-us-nuclear-weapons-workers-reversing/https:/www.cbsnews.com/news/
doge-firings-us-nuclear-weapons-workers-reversing/
77 https://apnews.com/article/fda-layoffs-trump-doge-rehired-medical-devices-85d4743e4ce88dbe3b99c813bad4b702
78 https://www.nytimes.com/2025/04/24/us/politics/musk-cuts.html
79 https://www.reuters.com/world/us/us-farm-agency-require-doge-approval-some-loans-2025-04-30/
80 https://www.nytimes.com/2025/04/11/nyregion/doge-treasury-lawsuit.html
81 https://fortune.com/2025/02/08/elon-musk-doge-team-access-treasury-department-central-accounting-system/
82 https://apnews.com/article/doge-treasury-irs-taxpayer-data-musk-7d6b80e429106250afa6d02e55a981b1
83 https://www.npr.org/2025/04/28/nx-s1-5378684/doge-energy-department-nuclear-secrets-access
84 https://www.bloomberg.com/news/features/2025-04-29/elon-musk-s-wealth-drops-by-25-after-his-doge-work-for-donaldtrump?embedded-checkout=true
85 https://www.citizen.org/news/musk-just-one-of-many-special-government-employees-in-high-level-roles-posing-ethicsrisks/
86 https://www.npr.org/2025/01/28/nx-s1-5277103/nlrb-trump-wilcox-abruzzo-democrats-labor
A final threat to the rule of law was the President’s public musing that he may remain in
office after 2028.88 No prior president has even suggested staying beyond explicit limits
on their office, and many Republican officials say they do not take the idea seriously.89
With a clear bar in the US Constitution, and the near-impossible hurdle of a formal
amendment, the President nonetheless insisted he was “not joking”90 and alluded
vaguely to “methods” for remaining in office. This is consistent with treating law as if it
may be ignored if a lawyer can be found to ‘interpret’ law into non-existence. Further, in
February 2025, the President proclaimed: “He who saves his Country does not violate any
Law”,91 and the Vice President declared that “Judges aren’t allowed to control Trump’s
‘legitimate power’”,92 implying that the President, and not the courts, should have the last
word on what the law is. Elected leaders willing to say such things out loud, or tolerate
them being said, may be one of the biggest threats to the rule of law in the United States
since the Civil War.
4 ECONOMIC SIGNIFICANCE OF THE RULE OF LAW
A functioning democracy cannot long endure without the rule of law. Democracies entail
a legally defined process (elections) for the choice of agents, who in turn create, enforce,
and apply other laws. Elections cannot distribute power in the presence of arbitrary
government. Democracy depends on law to preserve the role of citizens in electing
representatives and directing government. Empirically, representative democracies have
generated more economic growth than other political systems (Acemoglu et al. 2019).
With or without the rule of law, economic policies in democracies are predictably
unpredictable. Contests among political agents produce oscillations in core policies,
such as trade, monetary, and labour policy. Rapid policy oscillations increase risk and
inhibit trade. With the rule of law, legislation can segment power by issue, and delegate
segmented power to specialised agents (e.g. central banks, antitrust agencies) who lack
plenary power and cannot as easily derive rents for personal ends. With the rule of law,
it takes more time and effort to change policy segmentation than it takes to change
87 https://executivefunctions.substack.com/p/the-trump-executive-orders-as-radical
88 https://www.nytimes.com/2025/04/06/us/politics/trump-third-term-constitution.html
89 https://www.nytimes.com/2025/04/06/us/politics/trump-third-term-constitution.html
90 https://www.nytimes.com/2025/03/30/us/trump-third-term.html
91 https://www.nytimes.com/2025/02/15/us/politics/trump-saves-country-quote.html
92 https://www.nytimes.com/2025/02/09/us/politics/vance-trump-federal-courts-executive-order.html
75
THE RULE OF LAW | COATES
If these efforts succeed, the United States could no longer have an independent central
bank. Sharp swings in many salient policies not specifically reflected in statutes would
replace the stability of multi-member, bi-partisan boards and commissions overseeing
regulation (and deregulation). Consistent with this reading of the President’s ‘policy’ on
the rule of law, a bipartisan and informed pair of observers have suggested that the new
administration “is seeking to effectuate radical constitutional change”.87
policy itself by a single executive. The rule of law helps create conditions for stable policy
through-lines in democracies, encouraging long-term investments that allow capitalist
economies to thrive.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
76
Rule of law supports growth by protecting property. The components of the rule of
law sketched above are key “institutions” that “provide the incentive structure of an
economy” (North 1997: 87). Payne et al. (2025) echo long-standing recognitions that
prosperity depends on such institutions. Capital markets, in particular, require security
of property over time. Credible commitments to secure property require the “shackling
of a ruler’s power to prevent arbitrary seizures” (North 1981). Seizures can consist simply
of confiscation (or ‘takings’, in US legal jargon), but can also be achieved economically
through arbitrary taxation, and by threats as well as by outright force. Historically,
seizures have been inhibited by giving lawmaking authority not to a single person but
to a legislature composed of multiple representatives of dispersed members of the polity,
and empowering independent courts to implement those laws. Rule of law limits taxes to
those that are general and prospective, preventing them from being used for confiscation.
“The rule of law – including stability in law and regulation – is essential to secure property
rights” (Murphy et al. 1993).
Effective enforcement of contracts lowers the cost of transacting, facilitating exchange,
division of labour, and specialisation. By enforcing contracts, legal institutions enable
investment at lower cost, and so expand trade, innovation, and growth. Long-term,
open-ended contracts that govern most investments cannot be reliably enforced without
independent courts and lawyers. Without contract enforcement, investors need to rely on
self-help and self-enforcing means to secure returns, which are riskier, more expensive,
and some of which (e.g. hostages, private repossession of collateral) can threaten civil
order.
Legally enforced contracts are particularly important for one-off (as opposed to repeat)
exchanges, for complex trades, trades characterised by imperfect information, and
exchanges among strangers across long distances and over longer periods of time – all
features of cities and globalisation (with constant trade among strangers) and of modern
capitalism (with large-scale, long-term capital investments). Better enforcement, in
North’s historical account, drove economic growth in the West from the early modern
period onwards. Conversely, degradation of legal institutions can cause the economy to
stagnate or decline. Without a stable rule of law, investment shrivels; with it, investment
expands.
Modern legal systems encourage competition by combatting monopolies through
disciplined (neutral) enforcement of competition or antitrust law, and limit the
reach of the state, and political struggle over the state, by protecting businesses from
secondary boycotts. Where states carry out significant economic functions, law deters
growth-inhibiting corruption (Johnson et al. 2011). Law inhibits rapid concentrations
of wealth through theft or fraud, and suppresses ‘kleptocracy’, wasteful rent-seeking,
and corruption by limiting bribery and its distortions on economic activity. Law can
stabilise the allocation of power to “groups with interests in broad-based property
rights enforcement”, constrain the powerful (who may seek to subvert democracy), and
minimise rents that can be pursued by the powerful (Acemoglu et al. 2005).
5 ECONOMIC EFFECTS OF THE NEW ADMINISTRATION’S SHIFT ON THE RULE
OF LAW
From the rule-of-law actions reviewed above under the current administration, economic
consequences are predictable. The risk of expropriation, policy shocks, failure to respect
property, and failure to enforce contracts has increased. This is most obvious with respect
to the parts of the private sector that directly or indirectly depends on government
contracts, which are now potentially less valuable. Over $750 billion of US government
spending flows annually through contracts, 94 split 60/40 between defence and civilian
agencies. Law firms are advertising their services to sue for breaches,95 in response to
widespread repudiation of contracts; whether lawsuits can vindicate contractor interests
depends on how the administration’s struggles with courts and the rule of law play out.
Contracts with investors – most basically, US Treasury bonds – will be riskier, even
than implied by threats to the independent inflation-moderating ability of the Federal
Reserve and an administration bent on cutting taxes more than spending.96 Credit
risk is on top of the 9% drop in the value of dollar-denominated assets through April
93 https://www.intellinews.com/russia-has-zero-fdi-in-1q20-180945/
94 https://www.gao.gov/blog/snapshot-government-wide-contracting-fy-2023-interactive-dashboard
95 https://www.pillsburylaw.com/en/news-and-insights/second-trump-administration-mass-contract-terminations.html
96 https://www.nytimes.com/2025/03/27/business/trump-debt-tax-us.html
77
THE RULE OF LAW | COATES
Evidence from a range of settings and studies using a range of methods supports these
ideas. Acemoglu et al. (2001) show the importance over centuries of property rights by
contrasting economic outcomes across different modes of colonisation and resulting legal
systems. Barro (2001: Table 1) finds expert judgements about law enforcement, sanctity of
contracts, and security of property correlate in the cross-section with growth. Acemoglu
and Johnson (2005) find variations in protection of property by legal institutions
across countries have a “first order effect on … long-run economic growth.” Djankov et
al. (2022) exploit relatively recent data from the World Bank and show that cities with
better protections of rights of possession and transfer are associated with better housing
outcomes. Even before illegally invading Ukraine, Russia suffered economically from
underinvestment,93 due to a weak rule of law, consistent with findings on law and foreign
direct investment (Busse and Hefkeker 2007, Zhang and Liu 2021).
2025.97 Similarly affected by a willingness to break commitments are research and
other activities dependent on government grants, such as in healthcare98 and with
universities99 more generally.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
78
Also at risk are businesses built around existing laws and regulations, which includes a
much bigger part of the overall economy. Examples include the media (now being sued
by the President personally),100 and shipping (whipsawed by tariffs,101 some of questioned
legality).102 Resource companies – even ones that might appear to benefit from the
administration’s energy policies – face commodity price uncertainty,103 partly due to
supply shocks affected by legal disputes. Equity returns for all of these sectors operating
in the United States likely will need to be higher to attract investors, as they reprice those
risks.
The risk and size of rent-seeking and stagnating economic growth have all increased,
attracting and wasting increasing amounts of social resources. Policies may be bent in
inefficient directions in a whole range of domains. Socially valuable regulations may go
unenforced. Trade and growth will be suppressed, below the lower level induced by a
tariff war with China and uncertainty about trade policy generally. And, of course, if the
challenges to the rule of law were to contribute to the end of the American democratic
experiment, that calamity would be accompanied by yet more destruction of social value.
All these effects are likely to endure longer than for ordinary economic policies. Those
kinds of policies – trade, monetary, fiscal – can be reversed relatively quickly. By contrast,
loss of credibility, loss of faith in courts, and constitutional conflicts can be reversed
much more slowly. Institutions take time to build, and after being degraded, take time
to rebuild. One should not expect political and legal risk to revert to low levels after the
next presidential election, if only because some of the same political forces leading the
administration to take the actions it is taking will persist in shaping the United States
and world economies.
6 CONCLUSION
President Trump’s second administration’s ‘policy’ on the rule of law may be among
the most consequential – politically and economically – elements of his first 100 days.
President Trump’s direct economic policies may be harmful, but could be reversed
relatively straightforwardly after his successor is chosen. His policies attacking the rule
of law will have a more lasting economic impact. They threaten to degrade institutions
97 https://www.nytimes.com/2025/05/01/business/dealbook/us-dollar-fall-reserve-currency-alternatives-euro.html
98 https://www.statnews.com/2025/04/24/trump-100-days-nih-new-grants-cut/
99 https://www.nature.com/articles/d41586-025-01289-4
100 https://www.reuters.com/business/media-telecom/paramount-board-settle-trumps-60-minutes-lawsuit-nytreports-2025-04-29/
101 https://fortune.com/article/trump-china-trade-war-tariff-loophole-de-minimis/
102 https://www.bloomberg.com/news/articles/2025-04-24/trump-tariffs-face-new-lawsuits-what-to-know
103 https://www.wired.com/story/trumps-policies-are-creating-uncertainty-for-fossil-fuel-companies/
that take time to rebuild, destroy the reputation of the United States as a location for
secure investment, and scar the world economy and US democracy long past the next
presidential election.
Acemoglu, D and S Johnson (2005), “Unbundling Institutions”, Journal of Political
Economy 113: 949-95.
Acemoglu, D, S Johnson and J A Robinson (2001), “The Colonial Origins of Comparative
Development: An Empirical Investigation”, Amercian Economic Review 91: 1369–1401
Acemoglu, D, S Johnson and J A Robinson (2005), “Institutions and Fundamental
Determinants of Long-Run Growth,” in P Aghion and S Durlauf (eds), Handbook of
Economic Growth.
Acemoglu, D, S Naidu, P Restrepo, and J A. Robinson (2019), “Democracy Does Cause
Growth”, Journal of Political Economy 127(1): 47-100.
Barro, R J (2001), Determinants of Economic Growth: A Cross-Country Empirical Study,
MIT Press.
Blackstone, W (1765), Commentaries on the Laws of England 4: 352.
Busse, M and C Hefeker (2007), “Political Risk, Institutions and Foreign Direct
Investment”, European Journal of Political Economy 23: 397–415.
Calabresi, S and C Yoo (2008), The Unitary Executive, Yale University Press.
Djankov, S (2022), “Property Rights and Urban Form”, Journal of Law, Economics &
Organization 65: 535-64.
Fuller, L L (1969), The Morality of Law, Yale University Press.
Grossman, S J and O D Hart (1986), “The costs and benefits of ownership: A theory of
vertical and lateral integration”, Journal of Political Economy 94: 691–719.
Hart, H L A (1983), Essays in Jurisprudence and Philosophy, Oxford University Press.
Hart, O (1995), Firms, Contracts, and Financial Structure, Oxford University Press.
Hart, O D and J Moore (1990), “Property Rights and the Nature of the Firm”, Journal of
Political Economy 98: 1119–58.
Johnson, N D, C L LaFountain and S Yamarik (2011), “Corruption is Bad for Growth
(Even in the United States)”, Public Choice 147: 377
Murphy, K M, A Shleifer and R W Vishny (1993), “Why Is Rent Seeking So Costly to
Growth?”, American Economic Review: Papers and Proceedings 83: 409
79
THE RULE OF LAW | COATES
REFERENCES
North, D C (1981), Structure and Change in Economic History, W W Norton & Co.
Parrillo, N R (2018), “The Endgame of Administrative Law: Governmental Disobedience
and the Judicial Contempt Power”, Harvard Law Review 131: 685-794.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
80
Payne, J E, J W Saunoris, S Nazlioglu and R S Sobel (2025), “What factors drive crosscountry economic freedom convergence?”, Public Choice.
Pennington, K (2003), “Innocent Until Proven Guilty: The Origins of a Legal Maxim”,
The Jurist: Studies in Church Law and Ministry 63: 106.
Radin, M J (1989), “Reconsidering the Rule of Law”, Boston University Law Review
69(781):787–88.
Whitman, J (2008), The Origins of Reasonable Doubt: Theological Roots of the Criminal
Trial, Yale University Press.
Zhang, X and W Liu (2021), “The Rule of Law and Foreign Direct Investment”, Advances
in Economics, Business and Management Research 203: 118-22.
ABOUT THE AUTHOR
John Coates is the John F. Cogan, Jr. Professor of Law and Economics at Harvard Law
School, where he also serves as Deputy Dean and Research Director of the Center on the
Legal Profession. Professor Coates served as General Counsel and as Acting Director
for the Division of Corporation Finance for the SEC. Before joining Harvard, he was
a partner at Wachtell, Lipton, Rosen & Katz, specializing in financial institutions and
M&A. At HLS and at HBS, he teaches corporate governance, M&A, finance, and related
topics. He has testified before Congress, advised the U.S. Department of Justice (DOJ),
the U.S. Department of Treasury, and the New York Stock Exchange, and served as the
Chair of the Investor-as-Owner Subcommittee of the Investor Advisory Committee of
the SEC.
CHAPTER 5
Josh Bivens
Economic Policy Institute
The attack on the federal workforce has been a surprising policy development in the first
100 days of the second Trump administration, as the presidential campaign certainly did
not emphasise any plan to radically downsize the civil service. Much of the activity aimed
at reducing the federal workforce so far has been led by the newly created Department
of Government Efficiency (DOGE). The effects of this effort on the US economy are hard
to forecast with any accuracy. This is partly because the dubious legality of the efforts
has led to dozens of legal challenges, but also because the process of DOGE has been so
chaotic (with multiple instances of cuts being quickly reversed) that it is hard to tell how
many federal layoffs have actually happened or are even scheduled to happen in coming
months.
Despite this, we can bracket some of the potential economic effects with data. The most
useful way to do so is to separate out short-run effects on aggregate demand and longerrun effects that stem from the federal workforce’s role in providing public goods and
services that complement private-sector actors in generating economic growth.
Federal layoffs are unambiguously a drag on short-run aggregate demand growth. The
magnitude of this drag, however, is likely quite limited by the simple fact that the federal
workforce and its payroll are quite small scaled against the larger economy. For example,
the US economy tends to create nearly as many new jobs as exist in the civilian federal
workforce in any given non-recessionary year. In the long run, though, the growth
effect of a smaller federal workforce (especially if the workforce reductions are poorly
considered) will run through eroded state capacity to collect revenue, administer large
government transfer programmes, and deliver key public goods and services. This eroded
state capacity could have profoundly negative effects on long-run growth.
81
THE ECONOMIC EFFECTS OF RAPID FEDERAL DOWNSIZING | BIVENS
The economic effects of rapid federal
downsizing
THE SHORT-RUN MACROECONOMIC EFFECTS OF FEDERAL LAYOFFS LIKELY
LIMITED BY SMALL SIZE OF THE FEDERAL WORKFORCE
If the only significant policy initiative undertaken by the Trump administration was the
DOGE effort to downsize the federal workforce, it would be highly unlikely to cause a
recession, though it could meaningfully affect the pace of aggregate job-growth over the
next year. The reason for this is straightforward: the federal civilian workforce and its
payroll are quite small relative to the overall economy. Figure 1 shows the share of the
civilian federal workforce as a share of overall employment. The post-pandemic years
saw a small uptick in this share, but it remains well under 2% of all workers.
FIGURE 1
FEDERAL CIVILIAN FULL-TIME EQUIVALENT EMPLOYEES (FTEs) AS A SHARE
OF ALL DOMESTIC FTEs, 1948-2023
4.0%
3.5%
3.0%
2.5%
2.0%
1.5%
2023
2017
2020
2011
2014
2008
2005
1999
2002
1996
1993
1987
1990
1981
1984
1975
1978
1972
1969
1966
1963
1957
1960
1951
1954
1.0%
1948
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
82
Source: Bureau of Economic Analysis (BEA), National Income and Products Accounts Tables 6.5.B-6.5.C
Figure 2 shows the total compensation of civilian federal workers expressed as a share
of total federal government expenditures (including transfer payments). This highlights
that the pay of civilian federal workers is an extremely modest share of the overall
flow of funds they are responsible for administering and managing (about 5% of total
federal government spending). It should be noted that because over a quarter of federal
employees live in the Washington, DC metropolitan area (likely a smaller share than
many think, but still high), even modest cuts to federal employment could surely spur a
regional recession (see EPI 2025 for estimates of federal employment by state and substate regions).
FIGURE 2
COMPENSATION OF CIVILIAN FEDERAL EMPLOYEES AS A PERCENT OF
FEDERAL GOVERNMENT EXPENDITURE, 1948-2023
16%
83
12%
10%
8%
6%
1948
1950
1952
1954
1956
1958
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020
2022
4%
Source: BEA, NIPA Tables 6.2.A-6.2.C and 3.2.
The upshot of these figures is clear: it would take a radical reduction in federal government
employment effectuated in an extremely compressed timeframe to make this a major
event for aggregate demand in the short run. Say that the DOGE effort resulted in a
25% cut to the federal workforce over the next year. This would be a historically large
and fast cut – driving the workforce to its lowest level since 1960 and its lowest share of
overall employment ever by a substantial amount. This cut would constitute 600,000 jobs
lost over the year. This would noticeably slow the pace of aggregate job growth, but the
US economy has seen average annual job growth in non-recessionary years of at least 2
million jobs for decades (including in every year since 2012, except for 2020). This federal
employment cutback alone would hence not necessarily be a recession-forcing event. If
payroll was cut in line with jobs, this would constitute a reduction to GDP of roughly
0.3%.
This modest fraction of GDP accounted for by even historically large cuts to the federal
payroll obviously points to how limited such cuts could be as a strategy for reducing the
federal budget deficit. In 2024, this deficit reached 6.4% of GDP – a radical 25% reduction
in the federal workforce would hence reduce the deficit by less than 5%. In fact, even
zeroing out the entire federal civilian payroll would only cut the federal budget deficit by
roughly 20%.
One potential amplifier to federal workforce cuts could be reduced contracting
employment. There are likely as many contractors working for the federal government
as direct employees.1 If each federal employee targeted for layoff was associated with a
1
Estimates of the number of Federal contractors vary widely. Shierholz and Zipperer (2021) estimated just under 2 million
federal contractors in 2021, based on aggregate dollar value of contracts and input-output data mapping the industries
these dollars flowed to and average dollars per employee.
THE ECONOMIC EFFECTS OF RAPID FEDERAL DOWNSIZING | BIVENS
14%
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
84
reduction of one federal contractor, then the effects noted above could double. This would
start to look closer to a recession-forcing event even without assessing other parts of the
Trump administration’s economic policy agenda. Historical experience with reductions
in federal civilian employment, however, have been associated with greater employment
of contractors, so it is not exactly a sure thing whether contractor employment would be
an amplifier or a buffer to the short-run macroeconomic effect of federal layoffs.2
Finally, we should note the extreme uncertainty about just what has even happened so
far in regards to cuts to the federal workforce. From February to April, federal workers
on payroll (as measured by the Current Employment Statistics, or CES) had fallen by a
combined 26,000 employees. This small number might be in part because workers on
administrative leave are still on payroll or because announced layoffs will be spread over
the rest of the year. Year-to-date spending on federal salaries as reported by the Daily
Treasury Statement (DTS) was trivially higher than in 2024 even as of mid-April.3 In
regards to contractors, total federal spending from the DTS shows year-to-date increases
from 2024, so widespread shedding of contracts so far seems unlikely (there are obvious
exceptions – DTS spending for the US Agency of International Development, or USAID,
is clearly down year-to-date in 2025).
All of this said, there are a few small data movements indicating the beginning of
potential ruptures in the federal workforce and its functions. For example, Pitts (2025)
cites a collection of media reports that indicate roughly 150,000 federal employees had
been laid off by the end of April. Shao and Wu (2025) have kept a running total for the New
York Times on confirmed cuts, employees accepting buyouts, and planned reductions. As
of early May, these totalled over 284,000. Some of these cuts might be filtering modestly
through to ‘hard’ labour market data – unemployment insurance (UI) claims by federal
workers noticeably spiked in February (see Figure 3). This spike was from a low base, so
‘excess’ UI claims by federal workers by the beginning of April was roughly 5,000.
Further, Worker Adjustment and Retraining Notification (WARN) Act notices – required
to be issued by employers planning layoffs of over 100 employees – have increased in
the DC metropolitan area. By April of 2025, there were roughly 8,000 excess affected
employees of WARN Act notices relative to previous year-to-date norms (see Figure 4).
2
3
See Verkuil (2017) on the historic trend of trying to replace Federal employees with contractors and why this often results
in less-effective government. See Friedman (2025) for early evidence that announced cuts by DOGE have been followed
up rapidly by calls to hire contractors in the Food and Drug Administration (FDA).
See the Hamilton Project’s Tracking Federal Expenditures in Real Time website for ongoing spending updates.
FIGURE 3
CHANGE IN FEDERAL WORKER UI CLAIMS FROM LAST YEAR, SELECTED
STATES
900%
DC
700%
MD
600%
VA
500%
US
85
400%
300%
200%
100%
0%
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan
Feb Mar
Apr
2024 2024 2024 2024 2024 2024 2024 2024 2025 2025 2025 2025
Note: Values are smoothed using the average value over the last four weeks.
Source: EPI analysis of US Employment and Training Administration Report 539 data from Department of Labor.
FIGURE 4
AFFECTED FEDERAL CONTRACTOR EMPLOYEES FROM WARN ACT NOTICES
12000
2025
10000
8000
6000
2024
2021
2023
2022
4000
2000
0
5
10
15
20
25
30
35
40
45
50
55
60
65
70
75
80
85
90
95
100
105
110
115
120
125
130
135
140
145
150
0
Days since 1 January
Source: EPI analysis of data obtained from layoffdata.com
All in all, the mechanical effects of lower federal employment seem unlikely by themselves
to be a recession-forcing event. This is because this workforce is quite modest relative to
the overall labour force and their pay is small as a share of GDP. And while the hard data
so far show little evidence that large federal workforce cuts have already occurred, there
are some indications that the first wave of these cuts may have begun.
THE ECONOMIC EFFECTS OF RAPID FEDERAL DOWNSIZING | BIVENS
800%
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
86
In the following section, we will note some of the crucial functions undertaken by federal
employees that would suffer due to cuts and downsizing. The economic effect of these
degraded functions would mostly show up as steady declines in economy-wide growth,
but some of these degradations could spark a short-term crisis through unconventional
means (say, if federal pandemic surveillance efforts failed to predict or contain a potential
virus outbreak in the United States).
THE LONG-RUN EFFECTS OF ERODED PUBLIC SECTOR CAPACITY COULD BE
PROFOUND
The relatively small size of the federal workforce was cited before as a reason for less
concern about the short-run macroeconomic effects of layoffs. However, the small size
of the federal government could well mean that large cuts going forward will do grave
damage to the federal government’s capacity to provide key public goods and services. To
put it simply, the federal workforce was likely already stretched too thin for optimal state
capacity; further cuts will just push it further away from this.
Economists have long considered state capacity – the ability of governments to
successfully implement the policies they devise and enact – a key input to long-run
growth. This capacity can be damaged if the public workforce is too small and/or
reliant on outsourced contractors. For example, in a study of state governments, Liscow
(2024) finds that a higher number of transportation department employees in a state
actually reduces construction costs for highways, yet departments of transportation have
shrunk across both state and federal governments in recent decades. Figure 2 showed
the economy-wide resources flowing to salaries for federal workers had reached historic
lows as a share of the overall economy even before the recent efforts of DOGE, providing
ample basis to think that the United States was already suffering from degraded state
capacity stemming from the size and pay of its federal workforce.
Below, we highlight a range of key state capacity functions that the federal government
provides and provide some analysis of what cuts to the workforce undertaking these
functions could mean for longer-run growth and other key economic variables.
Revenue collection
One universally agreed-upon criterion for assessing state capacity is revenue collection.
On this front, again, the federal government had significant challenges even before the
incoming Trump administration. The ‘tax gap’ – the amount of taxes legally owed but
not paid in a given year – had exceeded $600 billion in 2022.4 This gap was larger than
the country’s ‘fiscal gap’ – the amount by which tax revenue must rise or spending must
be cut to stabilise the country’s debt-to-GDP ratio going forward. This tax enforcement
challenge was addressed in the Inflation Reduction Act (IRA) of 2022, with nearly $80
4
See IRS (2025) for estimates of the 2022 tax gap.
Successive legislation had already trimmed this infusion of new resources substantially.
In recent months, the IRS has been the target of some of the largest announced cuts so
far in federal personnel.5 Some estimates indicate that revenue collection could fall by
$500 billion in 2025 alone due to these cuts.6 If this estimate is close to true, the loss to
the federal government from these cuts would be several times larger than any claimed
savings from cuts in other departments.7 This would also substantially increase the longrun deficit of the United States, leading to measurable increases in interest rates and
lower investment in coming years.
Administration of social insurance and income support programmes –
particularly health care
The majority of federal government spending constitutes transfer payments for social
insurance and income support programmes – like Social Security, Medicare, Medicaid,
and nutrition assistance. These programmes directly keep tens of millions of Americans
out of poverty and provide crucial resources for others.8 Much of the federal workforce
administers these programmes. Compared to private-sector analogues in terms of
retirement or health insurance plans, the administrative costs of federal programmes
are tiny.9 In fact, more resources to administer these programmes could both make them
more easily accessible to US residents who qualify for them and also find clear efficiencies
in provision. 10
The clearest example is in health care, which accounts for nearly a third of federal
government spending. Health care constitutes nearly a fifth of the entire US economy.
Further, the price of health care goods and services has often risen extraordinarily rapidly.
Thus, how well the federal government administers its spending in this market and how
its regulations condition this growth has profound impacts for US living standards. Take
one example: in 2009, the year before the Affordable Care Act (ACA) was passed into law,
the Congressional Budget Office (CBO) estimated that spending on Medicare would rise
5
See TIGTA (2025) for a review of the original IRA funding for increased IRS enforcement and subsequent clawbacks of
these resources.
6 See Bobage (2025) for these estimates.
7 See Farenthold and Singer-Vine (2025) for estimates of DOGE savings and how they remain likely quite over-inflated.
8 See Creamer (2022) for the various programmes and their effect in reducing poverty.
9 See CBO (2004) for a comparison of Social Security administrative costs with private retirement plans, and CBO (2020)
for a detailed comparison of administrative costs between private health insurers and Medicare.
10 Reich and Windham (2021) provide a detailed overview of how reduced spending on administration of Federal government
programs have directly worsened their performance over time. Cutler (2008) notes a trade-off in health sectors between
administrative costs and other ways of controlling use (and hence system-wide volumes and costs).
87
THE ECONOMIC EFFECTS OF RAPID FEDERAL DOWNSIZING | BIVENS
billion allocated in enhanced resources for the Internal Revenue Service (IRS) over
the next ten years – resources that the IRS planned to spend on enforcement efforts,
modernisation of infrastructure and processes, and taxpayer services. Summers and
Sarin (2019) had estimated that a significant infusion of IRS resources and a tighter
mission focus on revenue collection could close the tax gap by 15% annually. Over a decade
this would raise roughly $1.3 trillion, or well over ten times the amount appropriated for
improved IRS capacity.
to $824 billion by 2019. The years after the ACA’s passage saw health care price growth
slow dramatically, and by 2019 actual Medicare spending was $324 billion lower than
had been previously forecast.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
88
Further success in stemming the growth of Medicare costs is threatened by continued
overpayments to Medicare Advantage (MA) plans – plans administered by private health
insurers but paid for by the Department of Health and Human Services. The introduction
of private plans into a programme that guarantees coverage for all of the over-65
population has always raised the concern that these plans would simply ‘cream-skim’
healthier patients. There has been a running attempt to ensure payments to insurers for
MA take this into account. There is broad agreement that so far these attempts have not
been fully successful and payments to private insurers are excessive, perhaps by as much
as 20–30%.11 As more and more Medicare enrolees choose MA plans, this inflates the
cost of Medicare overall. The stakes of better administration and oversight of Medicare
and MA plans are enormous – in 2024, MA overpayments were estimated at roughly
$100 billion.12 Even small success in curbing these overpayments would have significant
payoffs to future federal budget deficits.
Provision of public goods that complement private-sector growth
Besides collecting revenue and administering key transfer programmes, the federal
government workforce also provides numerous invaluable public goods and services.
These public goods and services provide crucial complements to private-sector activity,
supporting economic growth.
1 Providing stable and transparently enforced rules for efficient functioning of private
markets
Many federal agencies are tasked with providing and enforcing transparent ‘rules of the
road’ for markets that channel economic competition into productivity improvements
instead of zero-sum opportunism. For example, the Securities and Exchange Commission
(SEC) and the Consumer Financial Protection Bureau (CFPB) provide protection to
investors by enforcing rules against fraud or misappropriation of their funds from
companies they invest in. This promotes trust and allows more liquid capital markets
that are able to provide finance for more prospective and ongoing businesses. The Federal
Trade Commission (FTC) and the Anti-Trust Division at the Department of Justice aim
to keep firms’ monopoly power from distorting markets. The Occupational Health and
Safety Administration (OSHA) and the Wage and Hour Division at the Department
of Labor protect employees from abusive workplaces, allowing them to choose among
prospective employers without having to factor in whether or not these employers will
provide unsafe or exploitative working conditions.
11 On the size of Medicare Advantage overpayments, see Johnson et al. (2024), MedPAC (2025), and CBO (2024).
12 Johnson et al. (2024) provide these estimates of potential budget savings from successful efforts to equalize payments
between MA and traditional Medicare.
In 2017, the federal government spent $2.3 billion on the 13 principal statistics agencies. If
the revenue of just the GDIS (a group of businesses accounting for just 1% of the economy)
was just 1% higher because of the existence of the public good of government data, this
would by itself pay for the entire statistical apparatus of the Federal government.
3 Financial, epidemiological, and weather surveillance
One broad set of public goods and services provided by the federal government concerns
surveillance and monitoring of potential shocks to the economy and society – including
financial, epidemiological, and weather shocks. This monitoring is extremely valuable.
Bisetti (2024), for example, finds that unexpected declines in bank surveillance intensity
by federal regulators leads to substantial losses in a bank’s value. He finds that banks
engage in more earnings management and substitute more costly internal auditing for
the lower regulatory surveillance. Hirtle et al. (2019) similarly find that “…banks that
receive more supervisory attention hold less risky loan portfolios, are less volatile, and
are less sensitive to industry downturns, but do not have slower growth or profitability”.
In regards to weather surveillance, Lazo (2008) has estimated that the monetised value of
the information provided by the federal government’s National Weather Service exceeded
$30 billion, as compared to a budget expenditure of roughly $1.5 billion. Lemoine and
Kapnich (2024) estimate that a 1% improvement in the accuracy of forecasts from the
United States National Oceanic and Atmospheric Administration’s “El Nino outlook” is
worth $18 billion to firms exposed to weather risk. That the data generated by the NWS
strongly complement private sector activity can be seen by Kumar and Rosenthal’s (2025)
reporting that hedge funds were hiring weather experts for over $1 million per year.
A similar public good is provided by pandemic surveillance. Laxminarayan (2024)
provides a useful overview of how improved pandemic surveillance systems could be
deployed and the potential value they could provide. He calls for $1 billion each year
to be invested in pandemic prevention. Given the $16 trillion economic loss estimated
89
THE ECONOMIC EFFECTS OF RAPID FEDERAL DOWNSIZING | BIVENS
2 Economic data
Another key example – most relevant to economists – is the extraordinarily valuable
public good of high-quality, open-access data. Hughes et al. (2019) note a survey of
private-sector members of the National Association of Business Economics (NABE)
from 2018, in which members were asked: “Are government data important to analyses
and forecasting that drive business decisions?”. Ninety-five percent answered “yes”.
The same survey asked respondents to evaluate the usefulness of government data as
inputs into business decision-making. On a scale of 1 to 5, with 5 being “very critical”,
half of respondents ranked government data as critical to capital spending decisions,
pricing decisions, financing decisions, and asset allocation. In 2014, the Economic and
Statistics Administration estimated that ‘government data-intensive sectors’ (GDISs) – a
group that included investment analysts, database aggregator firms, market researchers,
benchmarkers and others – had revenues of over $200 billion in 2012. Hughes et al. (2019)
estimate this had likely grown by well over 25% by 2019.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
90
for the Covid-19 pandemic, this surveillance investment would pay for itself even if (i)
another pandemic only occurred once every 100 years, and (ii) improved surveillance
only reduced the overall cost of the pandemic by 0.6%. This finding that pandemic
surveillance provides net monetised benefits even under assumptions that pandemics are
extremely rare is supported by Nascimento de Lima et al. (2024), who undertake a costbenefit analysis of extra investment in environmental sampling surveillance technologies
for monitoring disease.
4 Research and development
The federal government is a key funder of basic and applied science and medical research.
Both the National Institutes of Health (NIH) and the National Science Foundation
(NSF) have already seen staff reductions in recent months, and the newly released
White House budget calls for further cuts. The administration and selection of projects
that should receive funding is a key task performed by federal employees in these (and
other) agencies. Without high-quality staff making these selections, any given amount of
federal R&D spending is likely to be less effective. The stakes here are large: Fieldhouse
and Mertens (2023) estimated extraordinary returns to historical Federal R&D spending
– with implied rates of return as high as 150%. Even small reductions in the efficiency of
federal R&D stemming from poorly selected staff reductions in the granting agencies
could have large growth effects over time.
5 When long-run capacity erosion increases the probability of short-run shocks
These surveillance functions are meant to promote economic growth and decrease
the probability or damage from shocks – whether environmental, epidemiological,
or financial. The value of this surveillance is best measured over long periods of time
– in any single given year, the probability of shocks might be quite low and hence the
value of surveillance (particularly ex post) may seem low. But of, course, the damage
that these shocks inflict is felt acutely in the short run during which they hit. If rapid
federal government downsizing in the coming year increased the chances or the damages
stemming from a crisis, then the long-run/short-run distinction would no longer really
hold.
Further, the threatened downsizing of federal employment in recent months has come
about through an unexpected, chaotic, and largely extra-legal process that may itself
increase the probability of a crisis of some kind. Allowing inexperienced users who have
shown a lack of knowledge about the functions of the federal government access to the
Bureau of the Fiscal Service payments systems seems to boost the risk of some profound
failure (say, missing a debt service payment to Treasury holders).13 In a well-publicised
episode early in the DOGE layoffs at USAID, several pandemic experts were laid off and
then there was a rapid attempt to rehire them.14 Even the DOGE team, it seemed, had
13 See Baker (2025) for documentation of multiple incorrect statements and falsehoods about the functioning of the Federal
government made by people associated with DOGE.
14 See Diamond and Hudson (2025) for this episode and the unsuccessful attempts to rebuild pandemic prevention teams in
the wake of DOGE cuts.
recognised that their chaotic layoff process had exposed the United States and the rest of
the world to a higher risk of an unrecognised or less prepared-for disease outbreak. It’s
not hard to imagine dozens of such possibilities stemming from the process of downsizing
that the Trump administration seems to have embarked upon.
CONCLUSION
The civilian federal government workforce in the United States was quite small relative
to the surrounding economy and the scope of its responsibilities even before the second
Trump administration. This small size likely limits just how much macroeconomic
damage will be done mechanically in the short run from the downsizing, unless it reaches
extraordinary levels.
The small federal workforce, however, undertakes a wide range of valuable functions.
The state capacity provided by this high-quality workforce is a crucial complement to
much private sector activity, and it boosts economic growth in the long run. There is a
strong case to be made that this state capacity and the boost to growth it could provide
was already too weak before the second Trump administration. Sharp cuts to it could
have absolutely profound effects in the coming years on the pace of economic growth and
the welfare of US households.
REFERENCES
Baker, D (2025), “How Quickly Would Elon Musk Have Been Fired If He Worked in the
Private Sector”, Substack post (https://substack.com/home/post/p-159744204?utm_
campaign=post&utm_medium=web).
Bisetti, E (2024), “The Value of Regulators as Monitors: Evidence From Banking”,
Management Science 70 (https://pubsonline.informs.org/doi/10.1287/mnsc.2021.03083).
Bobage, J (2025), “Tax Revenue Could Drop 10% Amid Turmoil At IRS”, Washington Post,
25 March (https://www.washingtonpost.com/business/2025/03/22/irs-tax-revenue-lossfederal-budget/).
91
THE ECONOMIC EFFECTS OF RAPID FEDERAL DOWNSIZING | BIVENS
Do labour market data validate the value of federal workers?
Estimates of large value stemming from the public goods and services provided by today’s
federal workforce imply that federal employees are high-quality. Van Dam (2025) has
validated this implication with labour market data. Specifically, he uses the panel data
structure of the Current Population Survey (CPS) to assess the labour market outcomes
when federal employees move into private-sector employment. He finds that these
employees work fewer hours and yet earn higher pay in the private sector relative to their
federal employment.
Congressional Budget Office (2004), “Administrative Costs of Private Accounts in Social
Security” (https://www.cbo.gov/sites/default/files/108th-congress-2003-2004/reports/
report_1.pdf).
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
92
Congressional Budget Office (2009), “Budget and Economic Outlook, 2009 to 2019”.
Congressional Budget Office (2020), “How CBO Analyzes the Costs of Proposals for
Single-Payer Health Care Systems That Are Based On Medicare’s Fee-for-Service
Program” (https://www.cbo.gov/system/files/2020-12/56811-Single-Payer.pdf).
Congressional Budget Office (2024), “Budget Options (Modify Payments to Medicare
Advantage Plans for Health Risk)” (https://www.cbo.gov/budget-options/60907).
Congressional Budget Office (2025), “Budget and Economic Outlook, 2025 to 2034”.
Creamer, J (2022), “Supplemental Poverty measure That Accounts for Additional
Government Benefits Lowest on Record at 7.8%”, US Census Bureau (https://www.census.
gov/library/stories/2022/09/government-assistance-lifts-millions-out-of-poverty.html).
Diamond, D and J Hudson (2025), “Musk Says DOGE ‘Restored’ Ebola Prevention
Effort. Officials Say That’s Not True”, Washington Post, 27 February (https://www.
washingtonpost.com/politics/2025/02/26/elon-musk-ebola-prevention-usaid-doge/).
Economic Policy Institute (2025), “Federal Workforce Tracker” (https://www.epi.org/
research/federal-workers/).
Farenthold, D and J Singer-Vine (2025), “DOGE Is Far Short of its Goal and
Still Overstating Its Progress”, New York Times, 13 April (https://www.nytimes.
com/2025/04/13/us/politics/doge-contracts-savings.html).
Fieldhouse, A and K Mertens (2024), “The Returns to Government R&D: Evidence
from U.S. Appropriations Shocks”, working paper (https://andrewjfieldhouse.com/wpcontent/uploads/2024/11/The_Return_to_Government_R_D_revised_manuscript.
pdf).
Friedman, D (2025), “FDA Seeks Contractors to Replace Dozens of Feds Laid Off
Two Weeks Ago”, Federal News Network, 15 April (https://federalnewsnetwork.com/
workforce/2025/04/fda-seeks-contractors-to-replace-dozens-of-feds-laid-off-twoweeks-ago/).
Hamilton Project (2025), “Tracking Federal Expenditures in Real Time” (https://www.
hamiltonproject.org/data/tracking-federal-expenditures-in-real-time/).
Hirtle, B, A Kovner, and M Plosser (2019), The Impact of Supervision on Bank
Performance, Federal Reserve Bank of New York Staff Report (https://mfm.uchicago.
edu/wp-content/uploads/2020/07/Hirtle-Kovner-Plosser-The-Impact-of-Supervisionon-Bank-Performance.pdf).
Hughes-Cromwick, E and J Coronado (2019), “The Value of US Government Data to
US Business Decisions”, Journal of Economic Perspectives 33(1): 131–46 (https://www.
aeaweb.org/articles?id=10.1257/jep.33.1.131).
Johnson, M, D Berwick, and R Gilfillan (2024), Ending Overpayment in Medicare
Advantage: A Proposal to Improve the Value of the Medicare Program, Center for
American
Progress
Report
(https://www.americanprogress.org/article/endingoverpayment-in-medicare-advantage/).
Kumar, D and L Rosenthal (2025), “Hedge Funds Paying Up to $1 Million for Weather
Modelers”, Bloomberg, 11 March (https://www.bloomberg.com/news/articles/2025-03-11/
hedge-funds-paying-up-to-1-million-for-weather-modeling-experts).
Laxminarayan, R (2024), “The Value of Disease Surveillance”, The Milliken Review, 23
January (https://www.milkenreview.org/articles/the-value-of-disease-surveillance).
Lazo, J, RebecRca Morrs, and J Demuth (2008), “300 Billion Served: Sources, Perceptions,
Uses, and Values of Weather Forecasts”, Bulletin of the American Meteorological Society
90 (https://www.jstor.org/stable/26220993).
Lemoine, D and S Krapnick (2024), “Financial Markets Value Skillful Forecasts of
Seasonal Climate”, Nature Communications 15 (https://www.nature.com/articles/
s41467-024-48420-z).
Liscow, Z (2024), “State Capacity for Building Infrastructure”, Aspen Economic Strategy
Group Discussion Paper (https://www.economicstrategygroup.org/wp-content/
uploads/2024/12/Liscow-AESG-2024.pdf).
MedPAC (2025), March 2025 Report to the Congress: Chapter 11 – The Medicare Advantage
Program: Status report (https://www.medpac.gov/wp-content/uploads/2025/03/
Mar25_Ch11_MedPAC_Report_To_Congress_SEC.pdf).
Nascimento de Lima, P, S Karr, J Z Lim, R Vardavas, R Roberts, A Kessler, J Awan, L
Faherty, and H Willis (2024), “The Value of Environmental Surveillance for Pandemic
Response”, Scientific Reports 14 (https://www.nature.com/articles/s41598-024-79952-5).
Sarin, N and L Summers (2019), “Shrinking the Tax Gap: Approaches and Revenue
Potential”, NBER Working Paper 26475 (https://www.nber.org/papers/w26475).
Shao, E and A Wu (2025), “The Federal Work Force Cuts So Far, By Agency”, New York
Times
(https://www.nytimes.com/interactive/2025/03/28/us/politics/trump-dogefederal-job-cuts.html).
93
THE ECONOMIC EFFECTS OF RAPID FEDERAL DOWNSIZING | BIVENS
Internal Revenue Service (2025), “IRS: The Tax Gap” (https://www.irs.gov/statistics/irsthe-tax-gap).
Shierholz, H and B Zipperer (2021), “EPI Comments on Proposal to Increase the
Minimum Wage for Federal Contractors”, Public comment, 27 August (https://www.
epi.org/publication/epi-comments-on-proposal-to-increase-the-minimum-wage-forfederal-contractors/).
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
94
TIGTA – Treasury Inspector General for Tax Administration (2025), “Quarterly Snapshot:
The Inflation Reduction Act’s Internal Revenue Service Spending Through September
30, 2024” (https://www.tigta.gov/sites/default/files/reports/2025-03/2025ier014fr.pdf).
Van Dam, A (2025), “Are Federal Workers Lazy? Let’s Look at the Data”, Washington
Post, 21 February (https://www.washingtonpost.com/business/2025/02/21/are-federalworkers-lazy-lets-look-data/).
Verkuil, P (2017), Valuing Bureaucracy: The Case for Professional Government,
Cambridge University Press (https://www.cambridge.org/us/universitypress/subjects/
law/constitutional-and-administrative-law/valuing-bureaucracy-case-professionalgovernment).
ABOUT THE AUTHOR
Josh Bivens is the Chief Economist at the Economic Policy Institute (EPI) in Washington,
DC. His work focuses on macroeconomics, inequality, and public policy. He is the author
or co-author of three books and has published in both academic and public journals and
has testified numerous times before both Houses of Congress. He has been at EPI since
2002, first as an economist, then as Research Director, and then as Chief Economist.
CHAPTER 6
Anna Maria Mayda and Giovanni Peri
Georgetown University and CEPR; UC Davis
1 INTRODUCTION
Promises of deporting undocumented immigrants, reducing humanitarian immigration,
and preventing any crossing of the US–Mexico border were central messages of the
Trump electoral campaign, with the goal of significantly reducing immigration to the
United States. Since in power, instead of trying to realise this vision by working to pass
permanent policy changes in collaboration with the Republican-majority Congress, the
new Trump administration has opted for a series of Executive Orders on immigrationrelated issues. The consequence is that, while effective in the short run, these provisions
are vulnerable to challenges, more limited in scope than legislative changes, have not
been vetted by a discussion, and can be undone by future administrations.
Given how hard it has been to reach political consensus on migration policy reforms,
including during past administrations, the use of Executive Orders in immigration is not
new. What is new, however, is the frequency and scope with which Executive Orders have
been used during the first two and a half months of the current administration. In this
chapter, we summarise the Executive Orders (Section 2), assess their potential impact
on the number and type of immigrants (Section 3), and analyse the potential economic
consequences for the next few years (Section 4).
Our main findings are as follows. Using estimates of recent trends in yearly inflows of
immigrants, and considering the targeting of specific groups of immigrants by Executive
Orders, we assess that the current actions may reduce the net change in the number of
high school-educated immigrants in the United States by 400,000 per year and reduce
the net change in the number college educated immigrants by 200,000 per year, relative
to the level that would have prevailed without these policies. This represents a decline by
0.3% of the working age population and will reduce total employment by about 510,000
workers. Using estimates of the causal impact of immigration on the US economy, we
calculate that this decline will likely reduce US GDP by almost 0.7%, or $205 billion per
year. Correspondingly, per capita yearly income of US citizens will decline by $270 per
year and yearly wages of native workers by $200. These effects are due to a decline in
investment, fewer new firms, less efficient specialisation and lower productivity growth,
as well as loss in demand and in human capital. Local prices of non-tradable services will
increase by 0.3%, due to higher costs of local personal services and hospitality, while local
95
IMMIGRATION AND BORDER POLICIES | MAYDA AND PERI
Immigration and border policies
housing prices will decline by only 0.15%. The decline in GDP will directly generate a loss
of $29.8 billion in federal government tax revenues, per year and total revenues of local
governments will decrease by around $600 million per year.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
96
2 POLICIES BASED ON EXECUTIVE ORDERS AND ENFORCEMENT ACTIONS
The stated goal of the Executive Orders is to influence several aspects of US migration
policy, including the entry and composition of different types of immigrants. The
Executive Orders target both less-educated and highly educated immigrants arriving as
economic migrants, asylum seekers, resettled refugees, immigrants on temporary visas,
as well as permanent residents and citizens who gained status by birth. Some Executive
Orders have been blocked by the courts (e.g. on citizenship birthright), some may lack
the administrative personnel to be implemented (e.g. on identifying immigrants on
Temporary Status to revoke it), and some may require collaboration from states and
other entities which are not willing to provide it (e.g. on large-scale deportations and
arrests). Additionally, the Executive Orders might have unintended consequences that
may induce parts of the administration to push back on their full implementation.
With these limitations in mind, we first organise the many Executive Orders into three
groups depending on the type of immigrants that they target, separating them into
highly educated, less educated and second generation, as the economic impact of those
groups is likely to be different.
2.1 Executive Orders affecting mainly less-educated immigrants
Various Executive Orders in the Trump administration lay the groundwork for a
substantial reduction in the net inflow and stock of (documented and undocumented)
less-educated immigrants:
• Mass deportation campaigns of undocumented immigrants not only focused on
those with violent criminal records but, in principle, extended to all undocumented
immigrants. In particular, the administration has vowed to expand the application
of expedited removal to undocumented immigrants far from the border.1
• Strict policing of the border to prevent the arrival of new undocumented immigrants,
asylum seekers and immigrants asking for protected status, with the employment
of the US military2 and construction of additional parts of the US–Mexico border.3
Additionally, larger appropriation of funds for enforcement by the Immigration and
1
2
3
"Executive Order Protecting the American People Against Invasion" (https://www.whitehouse.gov/presidentialactions/2025/01/protecting-the-american-people-against-invasion/).
"Executive Order Declaring a National Emergency at the Southern Border" (https://www.whitehouse.gov/presidentialactions/2025/01/declaring-a-national-emergency-at-the-southern-border-of-the-united-states/).
"Executive Order Securing Our Border" (https://www.whitehouse.gov/presidential-actions/2025/01/securing-ourborders/).
Custom Enforcement (ICE) agency and cuts to federal funds for cities that do not
collaborate in the apprehension of undocumented immigrants (sanctuary cities)
were authorised.4
2.2 Executive Orders affecting college educated immigrants
Other immigration-related Executive Orders and policies by the Trump administration
are likely to have a big impact on current and future numbers of highly skilled immigrants:
• Restrictions on visa programmes and travel bans for some foreign students and
scholars.7
• Cuts in grants from the federal government to universities for scientific research
and other activities related to diversity, equity, and inclusion that, in part, fund
international graduate and undergraduate students and scholars.8
• Targeting foreign students in US colleges for their role in past protests,9 by revoking
student visas and expelling them.10 While receiving a lot of press attention, most
sources put the number of revoked student visas, so far, in the hundreds.11 However,
the chilling effect of those measure may discourage many students from coming to
the United States and some to leave.
4
“Executive Order Protecting the American People Against the Invasion” (https://www.whitehouse.gov/presidentialactions/2025/01/protecting-the-american-people-against-invasion/).
5 "Executive Order Realigning the United States Refugee Admissions Program" (https://www.whitehouse.gov/presidentialactions/2025/01/realigning-the-united-states-refugee-admissions-program/).
6 "Executive Order Securing Our Border" (https://www.whitehouse.gov/presidential-actions/2025/01/securing-our-borders/)
and "Executive Order Protecting the United States from Foreign Terrorists and Other National Security and Public Safety
Threats"
(https://www.whitehouse.gov/presidential-actions/2025/01/realigning-the-united-states-refugee-admissionsprogram/). For a full review of all executive orders related to immigration, which have been signed by President Trump
since taking office in January 2025, see “Summary of Executive Orders and Other Actions on Immigration - The Center for
Migration Studies of New York (CMS)”.
7 “Executive Order Protecting the United States from Foreign Terrorists and Other National Security and Public Safety
Threats” (https://www.whitehouse.gov/presidential-actions/2025/01/protecting-the-united-states-from-foreign-terroristsand-othernational-security-and-public-safety-threats/).
8 “Executive Order Ending Radical and Wasteful DEI programs and Preferencing” (https://www.whitehouse.gov/presidentialactions/2025/01/ending-radical-and-wasteful-government-dei-programs-and-preferencing/).
9 “Executive Order Additional Measures to Combat Anti-Semitism” (https://www.whitehouse.gov/presidentialactions/2025/01/additional-measures-to-combat-anti-semitism/).
10 “What we know about the foreign college students targeted for deportation” (https://abcnews.go.com/Politics/foreigncollege-students-targeted-deportation/story?id=120210587).
11 https://www.insidehighered.com/news/global/international-students-us/2025/04/07/where-students-have-had-theirvisas-revoked
97
IMMIGRATION AND BORDER POLICIES | MAYDA AND PERI
• Reduction in the size or elimination of programmes that allowed (mostly lowskilled) humanitarian immigrants to enter the United States legally, such as the
refugee resettlement programme,5 the asylum seekers programme, the Custom
Border Protection app, the human parole programme, and the TPS programme.6
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
98
• During the campaign in June 2024, there were also suggestions of expansionary
policies, such as Green Cards for US college graduates12 and a “Gold Card” for
wealthy individuals potentially investing $5 million in the United States.13 Those
measures may increase some categories of immigrants, but so far, action on those
measures has not materialised.
2.3 Executive Orders affecting second-generation immigrants
• End of the birthright citizenship law, which has so far granted US citizenship to
any individual born in the United States.14 This executive order could increase
the number of undocumented immigrants by adding, among their ranks, a large
fraction of second-generation immigrants,15 specifically those whose parents are
neither US citizens nor permanent residents.
3 EFFECTS ON THE NUMBERS AND TYPES OF IMMIGRANTS
3.1 Less-educated immigrants
The Executive Orders described in Section 2.1 will reduce the number of humanitarian
and undocumented immigrants in the United States, a group that tends to have lower
levels of education (a high school degree or less). The inflow of humanitarian immigrants
(asylum seekers, humanitarian parolees and temporary status immigrants) was quite
small between 2010 and 2021 (between 50 and 100,000 arrivals per year, mainly resettled
refugees). Then, after a further decrease during 2020 and 2021, recent Census estimates
show an ‘immigration surge’ of humanitarian immigrants in 2022, 2023 and early 2024.16
Possibly, a total of 3–3.5 million likely less-educated immigrants arrived over the period
2022-2024 as humanitarian immigrants.
These recent humanitarian immigrants are the most likely to be declared ‘irregular’ by
the Executive Orders of this administration and, possibly, will be pushed to leave the
country or removed. Those with some criminal record can be actively deported. The net
inflow of humanitarian immigrants will likely drop to zero and their number in the United
States may decrease in the next years if some of the 2022–2024 arrivals are deported/
pushed to leave. Additionally, if some of the pre-existing undocumented immigrants
(estimated at around 11 million) leave or go into hiding, millions of additional workers
may be removed from the US labour force. According to the Trump administration,
the deportation campaign has led to the removal of more than 100,000 undocumented
immigrants between 20 January and early April, although several observers are sceptical
12 https://www.reuters.com/world/us/trump-says-foreign-college-graduates-should-automatically-get-greencards-2024-06-20/
13 https://www.reuters.com/world/us/trump-says-foreign-college-graduates-should-automatically-get-greencards-2024-06-20/
14 "Executive Order Protecting the Meaning and Value of American Citizenship" (https://www.whitehouse.gov/presidentialactions/2025/01/protecting-the-meaning-and-value-of-american-citizenship/).
15 In general, second-generation immigrants are defined as US-born individuals with foreign-born parents.
16 https://www.census.gov/newsroom/blogs/random-samplings/2024/12/international-migration-population-estimates.html
about the stated extent of removals.17 In comparison, the Biden administration removed
around 271,000 undocumented immigrants in the fiscal year 2024 and the Obama
administration removed around 350,000 undocumented immigrants per year during the
2009-2016 period (Chisti et al. 2017).
3.2 College-educated immigrants
The measures described in Section 2.2 are most likely to affect foreign students and
scholars. This group experienced a net inflow of close to 250,000 per year over the
period 2010–2020. This inflow could drop significantly due to the measures targeting
universities, student visas, and students’ funding. By how much will depend on how
many students/scholars are discouraged and look for alternatives in other countries.
The drop in students and scholars will reduce the aggregate inflow of college-educated
people. Many of them work in STEM jobs, laboratories, hospitals and in the health sector,
and contribute to research and innovation (Kerr and Lincoln 2010, Hunt and GauthierLoiselle 2010, Peri et al. 2010). This will likely also result in a decline in entrepreneurs
and startups (Beine et al. 2024). Many students and scholars will redirect themselves
to study and do research in other countries (Canada, Australia, Europe) and this may
generate a long-lasting decline if people follow newly formed networks in other countries.
Similarly, other skilled immigrants, due to the uncertainty of the future of the H1B
visa programme, the unfriendly environment and continued uncertainty driven by the
Lottery (the H1B visa Lottery of April 2025 had 480,000 applicants for 85,000 visas), may
direct themselves to other countries (Glennon 2024, Brinatti and Guo 2023) depriving
the United States of innovative and research abilities.
Combining these factors, it is reasonable to expect a drop in net number of collegeeducated immigrants of about 200,000 per year if foreign students, scholars, and
scientists/researchers choose other destinations.
3.3 Effect on the overall working age population and labour force
Figure 1 shows that net foreign inflows in the first Trump administration (2015–2019)
only contributed a net growth to the US working age population of 150,000 per year,
down from more than 500,000 per year in the early 2000s. The figure also shows that the
US-born working age population has grown at slower rates since 2000, and since 2020
it has shrunk at the rate of more than 200,000 per year. The predicted net change in
foreign born net flows from the previous section of negative 600,000 (400,000 fewer less-
17 https://www.newsweek.com/mass-deportation-update-illegal-immigration-trump-administration-2053905
99
IMMIGRATION AND BORDER POLICIES | MAYDA AND PERI
It is therefore reasonable to expect that the combination of the decrease in net inflows to
zero and increased outflows/removal/return to the levels experienced during the Obama
administration or slightly higher may lead to a net reduction of less-educated immigrants
of up to 400,000 per year, relative to the level that would have prevailed without these
policies.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
100
educated and 200,000 fewer highly educated immigrants) implies that the US workingage population may shrink at a rate of more than 800,000 per year.18 The consequences of
the decline in foreign-origin workers will be particularly significant in a period in which
labour shortages/vacancies in the US economy are large (as we will discuss in the next
section) and the US-born labour force is likely to decline.
FIGURE 1
NET ANNUAL CHANGE IN US WORKING AGE (18-65) POPULATION (IN
MILLIONS)
2.00
1.50
1.00
0.50
0.00
2000-04
2005-09
2010-14
2015-19
2020-23
-0.50
US-born
Foreign-Born
Source: Author’s elaboration on Census, American Community Survey, data.
3.4 Effects on second-generation immigrants
The measures discussed in Section 2.3, if implemented, will affect second-generation
immigrants whose parents are neither US citizens nor permanent residents, since
they will lose automatic access to citizenship at birth, and may even end up being
undocumented. As a consequence, their ability to access education and skilled labour
market opportunities will decrease, which will in turn affect the extent of economic
integration and success of these individuals.
This would mark a sharp departure from the status quo, as the United States has
historically fostered a very successful second generation of immigrants. Several papers
(e.g. Abramitzky et al. 2021) have shown that second-generation immigrants in the United
States catch up to the income levels of ‘third-plus’ Americans19 and even outperform
them. Moreover, second-generation immigrants make a substantial positive contribution
to population growth.
18 The drop of net yearly immigration we are predicting for the second Trump term, relative to the status quo, is about twice
the drop experienced in the first Trump term relative to the Obama years.
19 Descendants of immigrants who are three or more generations removed from their original immigrant ancestors.
4 POTENTIAL ECONOMIC EFFECTS
4.1 Labour market: Vacancies, unemployment, employment, and wages
Existing research has extensively analysed changes in immigration across US labour
markets or across US skill groups to identify the wage impact of changes in the supply of
foreign workers. Most studies (e.g. Ottaviano and Peri 2012, Caiumi and Peri 2024b, Card
2009) find a small effect of immigration on native wages. This is because immigrants
combine a competition effect, which can reduce wages and employment of natives, with
demand expansion/complementarity effects, which would increase them. In a period
such as the present, where vacancies are higher than unemployment, immigration is even
less likely to crowd natives out of jobs.
Additionally, highly skilled immigrants are found to increase productivity and
investments (Peri 2012, International Monetary Fund 2020) and their decline can lead
to a decrease in labour productivity (and aggregate demand), especially in the medium
run. A loss of 600,000 immigrants per year, as hypothesised above due to the more
restrictive Executive Orders, corresponds to a negative contribution to the US working
age population (around 211 million in 2024) of about -0.3 percentage points. The effects
on relative native wages, using reasonable estimates of elasticity of native labour demand
in the short run (between -0.1 and -0.3) and assuming perfect substitution between
immigrants and natives, will be small (+0.03 to +0.09 percentage points). The potential
crowding-in of native workers’ employment (usually estimated to be non-significant) will
likely be zero in a situation of very tight labour markets and a higher number of vacancies
than unemployed workers.
4.2 GDP growth, productivity, investments, and new firms
The very modest relative wage gains for natives calculated above will be offset by the
likely decline in investments and productivity, which will also affect average wages. Using
the estimates in Peri (2012) of the elasticity of capital intensity to immigrants and the
drop by 0.3 percentage points of the working age population, capital per worker would
decrease by 0.3*0.3=0.09 percentage points due to lower demand and to complementarity
and specialisation effects. These effects will offset the potentially positive wage effects
on natives. Even more significant is the loss in productivity due to slower total factor
productivity (TFP) growth, which is stimulated by immigrants, and especially high-
101
IMMIGRATION AND BORDER POLICIES | MAYDA AND PERI
The decline in low-skilled immigration, at a time of demographic decline, high labour
shortages and tight labour markets, will likely reduce employment growth and overall
growth, while it may increase the relative wages of natives and prices somewhat.
Additionally, the loss of skilled immigrants will reduce investments, new firm creation,
and new ideas, as well as efficiency and productivity growth, with negative effects on
income per person and average wages. In this section, we will analyse the likely impact
on several economic outcomes, combining these channels.
skilled immigrants. Using the elasticity of TFP to immigration (estimated in Peri 2012) of
around 1, the decline in income per person (and average wages) would be 0.3 percentage
points, which will also be reflected in wages.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
102
In total, these effects will produce a decline in the number of workers of around 0.3
percentage points (similar to the decline in the working age population) and generate a
total loss of 0.69 percentage points of GDP (0.3+0.3+0.09). Evaluated at the 2024 level of
GDP, this is equal to a loss of $205 billion (0.0069*29.724 trillion) per year. The GDP per
person of US citizens, on the other hand, will decline by $270 per year and the average
wage of natives by about $200 per year.
Contributing to the loss of investments that we calculate, several studies (Azulay et al.
2022, Beine et al. 2024) show that the probability of a foreigner starting a company is
three times larger than that of a US-born citizen. Hence the loss of up to 200,000 skilled
immigrants per year would translate into fewer US firms and, according to the estimates
in Beine et al. (2024), to about 200 fewer successful startups per year. Similarly, patented
innovation in science and technology may decline (Kerr and Lincoln 2010), with lasting
effects on US innovation and productivity.
4.3 Effects on specific sectors
Sectors like construction (28% of its workers were immigrants in 2023), hospitality (20%
immigrants), personal services (22% immigrants), and farm labour (73% immigrants)
will be hit particularly hard by measures that reduce the availability of less-educated
foreign workers. As the number of less-educated natives declines, these sectors become
heavily reliant on immigrant workers. In recent years, construction and hospitality were
among the sectors with the largest numbers of unfilled vacancies: on average during the
period 2020-2024, 1.3 million unfilled vacancies existed every month in the hospitality
sector and 300,000 in construction (Caiumi and Peri 2024b). Personal services such
as home care, elderly and child care, and care of the disabled are already experiencing
large and increasing demand and many open vacancies, and 20-25% of their workers are
immigrants. An increase in the prices of services provided in these sectors is therefore
likely.
4.4 Prices
As discussed above, immigrants are heavily employed in several service sectors (personal
services, construction, hospitality and home production industry, etc.) and, importantly,
the prices in these sectors are very sensitive to local changes in supply and demand
(differently from manufactured goods, the prices of which are mostly driven by trade
dynamics). Seminal work by Cortes (2008) suggests that the 1980–2010 flow of low-skilled
immigrants into American cities reduced these prices by 15%. Our prediction is that a
drop in the low-skilled immigrant population of about 400,000 would imply an increase
in prices of low-skilled intensive services of 0.3%.
4.5 House prices
The impact of immigration on the housing market is also important as rent and house
prices contribute to inflation and, in many large cities, housing affordability is a critical
issue. The empirical evidence on these effects, based on US data, is mixed. The impact
depends on the level of geographical disaggregation analysed, the types of immigrants
considered (less-educated versus college-educated immigrants), and the restrictiveness
of regulations on new constructions. The estimated effects of more immigrants on
housing prices tend to be on average positive at the city level, consistent with an overall
increase in the demand for housing (Saiz 2007), and negative at the neighbourhood level
within metropolitan areas, due to reallocation of natives (Saiz and Wachter 2011). The
arrival of low-skilled immigrants results in relatively slower house price appreciation,
while the opposite is the case for high-skilled immigrants (Mayda et al. 2024, Cabral
and Steingress 2024). This can be explained by differences in the purchasing powers
of immigrants of different education and income levels, as well as by changes in the
willingness of natives to pay for housing in places where low-skilled versus high-skilled
immigrants settle.
Recent evidence also shows how adjustments in the supply of housing, in the form of
building restrictions, affect these estimates. No study that we know of properly accounts
for the effect of immigration on housing supply and building costs. In a situation like
the current one in which labour shortages in the construction sector are pervasive, the
increased costs of building may reduce new house supply as a consequence of lower
immigration (since immigrants are a large source of workers in the construction sector).
Based on the elasticities estimates in Cabral and Steingress (2024),20 we calculate that
the reduction in the number of immigrants predicted above (i.e., of 600,000 people, equal
to 0.2% of the population) would reduce house prices by 0.15% and rent prices by 0.06%
for the county with the median restrictiveness in terms of building permits.21
20 This study mainly focuses on the effects of immigrants as a source of increased demand for housing and differentiates
between immigrants with higher or lower levels of education and between locations with different building regulations.
21 We would like to thank Walter Steingress for providing these estimates.
103
IMMIGRATION AND BORDER POLICIES | MAYDA AND PERI
An additional consequence of the loss in less-educated immigrants who work in the socalled ‘household production sector’ (babysitting, housekeeping, gardening, cleaning, etc.)
is an increased burden on women in the family. Low-skilled immigration between 1980
and 2000, allowed women with professional degrees or PhDs to increase their working
time by 0.6 hours per week (Cortes and Tessada 2011). Since women tend to be underrepresented in some of the most remunerative jobs, which require long working hours
(Goldin 2014), low-skilled immigration has helped reduce the gender gap by affecting
the ability of female workers to work longer hours (Cortes and Pan 2019). Additionally,
by reducing the price of outside help for childcare, low-skilled immigration increases the
fertility of married native women with a graduate degree (Furtado 2016).
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
104
4.6 Effects on tax revenues and public expenditures and provision of local public
goods
Finally, public expenditures and provision of public goods at all levels of the US
government can be affected. The influential report on immigration by the National
Academy of Science (NAS) (2016) found that past immigration to the United States had
a range of fiscal effects, which tended to be somewhat positive at the federal government
level and more differentiated at local levels. Under reasonable assumptions, the impact
of an increase in immigrants was estimated to be positive at the level of the federal
government, which administers programmes such as Social Security and Medicare,
where the young average age of immigrants is an asset. The report found that the effects
are less positive, and at times negative, at the state and county levels, where redistribution
mostly takes place from the rich to the poor, as opposed to from the young to the old.
A recent reduced-form study by Mayda et al. (2024) focuses on local (county-level) US
governments, which provide very important public goods in the United States such as
K-12 education, fire and police protection, parks and recreation, public transportation,
and housing for low-income individuals. The paper estimates that, given the skill
composition of immigrants who arrived in the United States between 1990 and 2010,
they had on average a very small impact on per capita public expenditures (only -0.3%
per year).
Mayda et al. (2024) also show that local per capita public revenues and spending tend
to decrease when low-skilled immigrants arrive to a county and increase in response to
highly skilled immigrants. The effects work through changes in the tax base, specifically
the property tax base, and locally generated (per capita) revenues. Accounting for this
heterogeneity, and for the 400,000 fewer less-educated and 200,000 fewer highly educated
immigrants, we calculate that yearly per capita own revenues would increase by 0.13% at
the local (county) level in the United States, while per capita general expenditures would
increase by 0.05%. While per capita revenues and expenditures will increase, because
the population becomes relatively more skilled, we find that the overall effect on total
dollar revenues and expenditures at the local level is negative. This is because the overall
population will be smaller, due to the reduced number of immigrants.22 In dollar terms,
we calculate that own revenues of US counties will decrease by around $600 million per
year, which will reduce the total amount US counties can spend on general expenditures
by $2.6 billion per year.
22
d(Revenue) d(Revenue per capita)
d(Revenue)
Revenue per capita
*population +
d(immi)
d(immi) *
d(immi)
= 0.13%*$4,023*340M+$4,023*600,000=$1.8B-$2.4B. A similar calculation applies to expenditures (which were $5,986
in 2022). The gap between changes in own revenues versus general expenditures is due to the adjustment in
intergovernmental transfers.
5 SUMMARY AND CONCLUSIONS
Our current assessment is that the multitude of Executive Orders, the intensified
enforcement, and the more hostile environment towards skilled immigrants will likely
reduce the number of immigrants in the United States. Based on recent yearly inflows
of immigrants, on what happened during the first Trump administration, and on the
targeting of specific visas/groups of immigrants, we assess that the current actions will
reduce the net change of less-educated (high school or less) immigrants in the by 400,000
per year and reduce the net change in more educated (college or more) immigrants by
200,000 per year, relative to the level that would have prevailed without these policies.
Using estimates from recent studies, we expect that such a net decline of immigrants –
of 0.3% of the working-age population per year – will likely reduce US GDP by almost
0.7%, or $205 billion per year. Correspondingly, per capita average income for US citizens
will decline by $270 per year and average wages of natives will decline by $200. These
effects are due to a smaller economy, less investment, fewer new firms, less efficient
specialisation, and lower productivity growth. Local prices of non-tradable services will
increase by 0.3%, due to higher costs of local personal services and hospitality, while local
housing prices will decline by only 0.15%. Other prices will likely not be affected.
The decline in GDP will directly generate a loss of $29.8 billion in federal government
tax revenues per year. At the local level, total revenues will decrease by around $600
million per year, due to the combined effect of changes in the per capita tax base and
smaller numbers of tax payers. These changes are significant and mostly in the direction
of reducing real income of Americans, reducing the total fiscal revenues and making
services more expensive.
23 https://taxfoundation.org/data/all/federal/latest-federal-income-tax-data-2025/. The current corporate tax rate of 21% is
higher than the income tax rate.
105
IMMIGRATION AND BORDER POLICIES | MAYDA AND PERI
At the federal government level, the lower number of immigrants will also produce
significant losses due to a lower tax base and lower income per person. Using an
average federal income tax rate of 14.5% based on data for 2022,23 we calculate that the
reduction in total GDP calculated in Section 4.2 would reduce tax revenues of the federal
government by about $29.8 billion. Additionally, reducing immigrants who are younger
than natives, on average, will accelerate the increase of the ‘dependency ratio’ (which has
gone from ten working people per retiree in 1950 to only four currently) and will make it
more difficult to sustain the pay-as-you-go Social Security pension system. The burden of
per capita debt will also grow.
REFERENCES
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
106
Abramitzky, R, L Boustan, E Jacome, and S Perez (2021), “Intergenerational Mobility of
Immigrants in the United States over Two Centuries”, American Economic Review 111(2):
580–608.
Azoulay, P, B F Jones, J D Kim, and J Miranda (2022), “Immigration and Entrepreneurship
in the United States”, American Economic Review: Insights 4(1): 71–88.
Beine, M, G Peri and M Raux (2024), “The Contribution of Foreign Master’s Students to
US Start-Ups”, NBER Working Paper 33314.
Brinatti, A and X Guo (2023), “Third-Country Effects of U.S. Immigration Policy”, Staff
Working Paper 23-60, Bank of Canada.
Cabral, J and W Steingress (2024), “Immigration and US Shelter Prices: The Role of
Geographical and Immigrant Heterogeneity,” Staff Working Paper 24-40, Bank of
Canada.
Caiumi, A and G Peri (2024a), “Immigration’s Effect on Us Wages and Employment
Redux”, NBER Working Paper No. 32389 (https://ssrn.com/abstract=4810604).
Caiumi, A and G Peri (2024b), “Immigration and Waning US Labor Force Growth”,
EconoFact (https://econofact.org/immigration-and-waning-us-labor-force-growth).
Card, D (2009), “Immigration and Inequality”, American Economic Review 99(2): 1–21.
Chisti, M, S Pierce and J Bolter (2017), “The Obama Record on Deportations: Deporter in
Chief or Not?”, Migration Policy Institute, 26 January (https://www.migrationpolicy.org/
article/obama-record-deportations-deporter-chief-or-not).
Cortes, P (2008), “The Effect of Low‐Skilled Immigration on U.S. Prices: Evidence from
CPI Data”, Journal of Political Economy 116(3): 381–422.
Cortes, P and J Tessada (2011), “Low-Skilled Immigration and the Labor Supply of Highly
Skilled Women”, American Economic Journal: Applied Economics 3(3): 88–123.
Cortes, P and J Pan (2019), “When Time Binds: Substitutes for Household Production,
Returns to Working Long Hours, and the Skilled Gender Wage Gap”, Journal of Labor
Economics 37(2): 351-398.
Furtado, D (2016), “Fertility Responses of High-Skilled Native Women to Immigrant
Inflows”, Demography 53: 27–53.
Glennon, B (2024), “How do restrictions on high-skilled immigration affect offshoring?
Evidence from the H-1B program”, Management Science 70(2): 907-930.
Goldin, C (2014), “A Grand Gender Convergence: Its Last Chapter”, American Economic
Review 104(4): 1091–1119.
Hunt, J and M Gauthier-Loiselle (2010), “How Much Does Immigration Boost
Innovation?”, American Economic Journal: Macroeconomics 2(2): 31-56.
Kerr, W R and W F Lincoln (2010), “The Supply Side of Innovation: H-1B Visa Reforms
and U.S. Ethnic Invention”, Journal of Labor Economics 28(3): 473-508.
Mayda, A M, M Senses and W Steingress (2023), “Immigration and Local Public
Finances: Evidence from the US”, CEPR Discussion Paper No. 18054.
National Academies of Sciences, Engineering, and Medicine (2016), The Economic and
Fiscal Consequences of Immigration, National Academies Press.
Orrenius, P M (2017), “New Findings on the Fiscal Impact of Immigration in the United
States”, Working Paper 1704, Federal Reserve Bank of Dallas.
Ottaviano, G and G Peri (2012), “Rethinking the Effect of Immigration on Wages”,
Journal of the European Economic Association 10(1): 152-197.
Peri, G (2012), “The Effect of Immigration on Productivity: Evidence from U.S. States”,
The Review of Economics and Statistics 94(1): 348-358.
Peri, G, K Shih and C Sparber (2015), “STEM Workers, H-1B Visas, and Productivity in
US Cities”, Journal of Labor Economics 33(S1): 225-255.
Saiz, A (2007), “Immigration and housing rents in American cities”, Journal of Urban
Economics 61: 345–371.
Saiz, A and S Wachter (2011), “Immigration and the neighborhood,” American Economic
Journal: Economic Policy 3: 169–188.
ABOUT THE AUTHORS
Anna Maria Mayda is Professor of Economics at Georgetown University, with a joint
appointment in the Economics Department and School of Foreign Service. She studied
statistics and economics at University of Rome La Sapienza, and received a PhD in
Economics at Harvard University. She was a visiting scholar in several institutions
including the IMF and World Bank in Washington DC, CEPII in Paris, EIEF in Rome,
etc. More recently she was Senior Economist and Senior Adviser in the Office of the Chief
Economist at the U.S. State Department in the Obama administration. She is a Research
Affiliate at CEPR and CReAM. Her research mainly focuses on issues of immigration,
trade and political economy and has been published in journals such as the Quarterly
Journal of Economics, the Review of Economics and Statistics, American Economic
Journal: Applied, and the Journal of International Economics. She has also been
awarded two National Science Foundation (NSF) grants.
107
IMMIGRATION AND BORDER POLICIES | MAYDA AND PERI
International Monetary Fund (2020), “The Macroeconomic Effects of Global Migrations”,
Chapter 4 in IMF World Outlook 2020.
Giovanni Peri is C. Bryan Cameron Chair and Distinguished Professor of Economics
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
108
at UC Davis and Founder and Director of the Global Migration Center at UC Davis, a
multi-disciplinary research center focused on migrations and refugees. He is Research
Associate at the National Bureau of Economic Research, in Cambridge, Massachusetts
and has been Co-Editor of the Journal of European Economic Association between 2017
and 2022 and Chair of the UC Davis Economics Department between 2015 and 2019.
His research focuses on the economic determinants and consequences of international
migrations and immigration policies. He has published around 100 refereed articles in
academic Journals including the American Economic Review, The Review of Economic
Studies, Review of Economics and Statistics and the Journal of Economic Perspectives.
He has received research grants from the Mac Arthur Foundation, the Russel Sage
Foundation, the World Bank and the National Science Foundation. His research is often
featured in media outlets such as the Economist, the New York Times, The New Yorker,
the Wall Street Journal and NPR news. He has advised more than 60 Ph.D. students,
currently employed in academic, research and policy institution all over the world. He
has often provided his expertise on economics of migrations and refugees to government
and international agencies such as the Congressional Budget Office, the IMF and the
World Bank.
Restriction on birthright citizenship to children of
citizens or permanent residents
Secondgeneration
immigrants
-0.15%
-$0.6 billion
Hospitality,
personal services,
construction,
agriculture.
Local fiscal revenues
Most affected sectors:
Federal fiscal revenues -$29.8 billion
Housing prices
IMMIGRATION AND BORDER POLICIES | MAYDA AND PERI
Loss of citizenship status for
millions of people
Total immigrants -600,000
=
-0.3% population in working
age
=
-0.18% of population
-0.3%
TFP
Personal service prices +0.3%
-0.3%
(-510,000 workers)
-0.1%
Investments
Employment
-0.3% ($200)
Native wages
Highly skilled
-200,000
immigrants
=
(college or more) -0.1% of the population in
working age
=
-0.06% of population
-0.4% ($270)
GDP per capita
Restrictions on visa programs for foreign students
and scholars
Cuts to federal grants for universities
Revoking students’ visa
No increase in the H1B cap
-0.7%
(-$205 billion)
Less skilled
-400,000
immigrants (high =
school or less)
-0.2% of the population in
working age
=
-0.12% of population
Expedited Removal of Undocumented
Policing of the border with Military
Funding ICE, additional border security.
Elimination of Refugee Resettlement, Humanitarian
Parole, TPS programs.
GDP
Predicted changes in net flow of immigrants, Calculated changes in main economic
per year
outcomes, per year
MAIN ECONOMICS OUTCOMES
PREDICTED EFFECTS OF IMMIGRATION-RELATED EXECUTIVE ORDERS ON NUMBER OF IMMIGRANTS, TYPE OF IMMIGRANTS AND ON
Type of Executive Order
TABLE A1
APPENDIX
109
CHAPTER 7
Gary Gensler, Lev Menand and Joshua Younger
MIT Sloan; Columbia University; Columbia University
The second Trump administration’s approach to financial markets and institutions mixes
familiar deregulatory policies with a range of other policies (financial and non-financial)
that are largely without precedent and may lead to significant structural change in the
long term. Combined, these policies have the potential to affect the financial sector in
at least four ways. First, they could threaten the foundations of the global dollar system
– mutual cooperation, trust, and interdependency, both between the producers and
consumers of financial instruments and among the nations that constitute the dollar
bloc. Second, they may undermine financial stability by loosening prudential standards,
especially with respect to limits on leverage. Third, they can jeopardise consumer
and investor confidence by relaxing regulatory standards and lessening financial law
enforcement. Fourth, they could frustrate the financial crimes and sanctions regime,
notably by promoting stablecoins, which can be used beyond the reach of governments to
enable various forms of illicit activity.
These effects, in turn, could have a negative impact on the economy in the medium to
long term. They raise the risk of financial instability and a messy deleveraging. They also
may put upward pressure on interest rates for public and private dollar-denominated
debt. Although the global dollar system has proven robust to past disruptions, and
remains well entrenched, the administration’s new stance, if pursued to its logical end,
could increase financial fragility and impair capital formation. If that comes to pass, a
future exogenous shock to the economic or financial system would pose significant risk to
economic growth if policymakers are unable, in the face of such a shock, to come together
swiftly to avert a disorderly monetary contraction.
This chapter proceeds in two parts. First, it catalogues the relevant policy shifts that
are likely to affect the financial sector. Then it considers how these shifts may impact
financial stability, capital markets, and the global dollar system.
POLICY SHIFTS
In its first hundred days, the second Trump administration has taken a range of steps that
directly affect the financial sector. They also have taken other steps (not directly related to
finance), particularly in relation to international alliances and the administrative state,
111
THE FINANCIAL SECTOR AND GLOBAL DOLLAR SYSTEM | GENSLER, MENAND AND YOUNGER
The financial sector and global dollar
system
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
112
which may, in the long run, have significant effects on the financial sector. Some steps
are of the sort that often follows a change in party control in Washington. For example,
the administration has adopted deregulatory and de-supervisory approaches to banking
and markets frequently pursued by prior Republican administrations. Other steps,
however, are more dramatic. For instance, the administration has asserted presidential
supremacy over financial regulatory agencies, undermined central bank independence,
and disrupted US relations with historic allies, all in ways with little to no precedent.
Deregulation
Banking
The core framework for the prudential regulation of US banks is provided by an
international agreement known as the Basel Accord. Formed in the wake of a major
international banking crisis in 1974 (Braun et al. 2021),1 and championed by the United
States, Basel was created to level the playing field for dollar-denominated banking around
the world. That, it was hoped, would forestall a race to the bottom in regulatory standards
that could fuel dollar-based financial bubbles and ultimately precipitate acute monetary
contraction. Towards this end, the latest agreement, known as Basel III, was introduced
in 2010 in response to the Global Financial Crisis. It was designed to significantly reduce
leverage at global banks and tighten equity and liquidity requirements on the largest,
most systemically important institutions.
The new US administration is now considering stepping back from the Basel framework.
For the last several years, banking regulators have been working on the final round of
rule changes associated with the Basel III agreement known as ‘Basel III endgame’.
This April, Secretary of the Treasury Scott Bessent questioned whether it made sense
to continue with those changes. Instead, he told a group of bankers that “we could
borrow selectively from them” to the extent that “they can provide inspirations”. And
more generally, Bessent asserted that “[w]e should not outsource decision making for
the United States to international bodies.” “Instead, we should conduct our own analysis
from the ground up to determine a regulatory framework that is in the interests of the
United States” (Bessent 2025a).
The administration so far has suggested several changes to banking regulation that
deviate noticeably from current Basel standards. Most notably, it has questioned the
current calibration of the limit on bank leverage (the ‘leverage ratio’). Secretary Bessent
has criticised it as “too frequently binding” (when compared to risk-based capital
rules) (Bessent 2025a). He also has recently floated excluding Treasury securities from
consolidated measures of leverage, which would be at odds with current Basel standards
(Tarullo 2023). The Office of the Comptroller of the Currency (OCC) also has rolled
1
See also https://www.bloomberg.com/news/articles/2025-01-16/the-hidden-history-of-eurodollars-part-3-spinning-out-ofcontrol
back stricter merger review policies for national banks and federal savings associations
(rescinding a 2024 policy statement and amending, without notice or comment, a 2024
final rule).
Investor protection is also facing reversals. To date, the Securities and Exchange
Commission (SEC) has delayed implementation of new rules related to Treasury markets
mandating clearing for much of the Treasury market (SEC 2025; see also Yadav and
Younger 2025). The SEC also has indicated a desire to make it easier for retail investors to
invest in private funds (“Such higher-risk, higher reward investments can help complete
a diversified portfolio”) (Uyeda 2025).
The new administration also has rapidly embraced cryptocurrencies. In his first week in
office, President Trump signed an Executive Order designed to fashion the US into the
“crypto capital of the world”. In March, the White House announced a Strategic Bitcoin
Reserve and a US Digital Asset Stockpile. In April, the Department of Justice announced
that it would disband its National Cryptocurrency Enforcement Team.4 Also in April, the
new SEC Chair gave his first speech to a crypto roundtable, stating his view that the rise
of cryptocurrencies would help to “modernize aspects of our financial system” (Atkins
2025).
Presidential supremacy over regulators
The White House also has asserted unprecedented claims to control government agencies
including the financial regulators (see Chapter 3 by Gensler and Menand in this volume).
These regulators have long benefited from significant autonomy from White House staff,
2
3
4
https://www.npr.org/2025/02/10/nx-s1-5292123/the-trump-administration-has-stopped-work-at-the-cfpb-heres-what-theagency-does
https://apnews.com/article/donald-trump-doge-cfpb-elon-musk-456b747c367fccbcf3b74d2893cd1a35
https://www.whitecase.com/insight-alert/doj-announces-policy-ending-regulation-prosecution-digital-assets
113
THE FINANCIAL SECTOR AND GLOBAL DOLLAR SYSTEM | GENSLER, MENAND AND YOUNGER
Consumer and investor protection
A similar liberalising push is apparent in other areas of financial regulatory policy. Most
notably, the administration has nearly shuttered the Consumer Financial Protection
Bureau (CFPB). Established as an independent federal agency by Congress in response to
the 2008 financial crisis (as part of the Dodd–Frank Wall Street Reform and Consumer
Protection Act of 2010), the CFPB was intended to better protect American consumers
from fraudulent and deceptive practices in the offering of financial products. As Rohit
Chopra, who ran the agency under President Biden, recently put it: “At its core, [the
CFPB] is a law enforcement agency. It takes big financial institutions to court who
cheat consumers, whether it’s a credit reporting agency or a large bank or a credit card
giant”.2 Various lawmakers have been attempting to defund and disable the CFPB since
its founding (Sitaraman 2021), and the first Trump administration sharply curtailed
its enforcement actions (Peterson 2019). But the new administration has functionally
dismantled the organisation, slashing its funding, firing the vast majority of its staff and
leaving it without a dedicated leader (see Chapter 8 by Neale Mahoney).3
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
114
especially in formulating legislative rules such as capital and liquidity requirements
(Congressional Research Service 2023). Under the administration’s new policy, financial
regulators will have to submit all proposed rules for review to the Office of Information
and Regulatory Affairs (OIRA) in the White House, which can reject those proposals by
declining to pass them back to the agencies for promulgation.
President Trump also has claimed the power to remove financial regulators at will,
despite statutory language barring the president from removing them except for cause.
This change may result in partisan domination of previously balanced multimember
commissions such as the Federal Deposit Insurance Corporation (FDIC), the SEC, and
the Commodities Futures Trading Commission (CFTC). Further, the downsizing of
agencies along with changes to civil service protections are likely to reduce policymaking
capacity, lowering the expertise and experience of their staffs.
Central bank independence
In an even sharper break from recent administrations, the White House has attacked
the legal foundations of central bank independence in the United States. In a recent
Executive Order,5 the administration has asserted power to control the regulatory and
supervisory functions of the Federal Reserve. While the Executive Order disclaims the
power to control “monetary policy”, this distinction may not end up amounting to much.
After all, the regulation of financial institutions is monetary policy (see Chapter 3), and
a White House determined to relax monetary conditions could effectuate such a policy
through changes to the rules governing bank balance sheets.6
The administration also has shown little regard for monetary policy autonomy. On
multiple occasions, the President has publicly called for a more accommodative stance.
For example, in May he wrote: “With these costs trending so nicely downward, just what
I predicted they would do, there can almost be no inflation, but there can be a SLOWING
of the economy unless Mr. Too Late, a major loser, lowers interest rates, NOW.”7
By statute, the president is permitted to remove Federal Reserve governors only “for
cause”. The new administration has called this limit into question, however, at several
points. For example, in April, the President said8 that “Powell’s termination cannot come
fast enough!” The President also subsequently stated that “if I want him out, he’ll be out
of there real fast, believe me”. The President already has fired a half dozen officials on
multi-member commissions similar in structure to the Federal Reserve (see Chapter
3). Further, these statements about having the authority to remove Chair Powell are
consistent with legal positions the administration has already staked out in court.
5
6
7
8
https://www.whitehouse.gov/presidential-actions/2025/02/ensuring-accountability-for-all-agencies/
The administration has also failed to clarify its stance with respect to lender of last resort activities, which play a critical
role in preventing disorderly monetary contractions.
https://www.reuters.com/business/trump-warns-economic-slowdown-unless-fed-cuts-rates-2025-04-21/
https://apnews.com/article/trump-powell-federal-reserve-fed-termination-b6148c8048dda538a6ca3b5a270fd09e
Stablecoins
The administration’s stance toward stablecoin issuers is of relevance to the monetary
system. Stablecoins are digital assets designed to maintain a constant value relative to
more traditional currencies. By far the most common application has been to mimic a US
dollar. This is typically achieved by holding short-term, low-risk US dollar-denominated
securities and bank deposits in a ‘reserve fund’. Stablecoin tokens are ‘minted’ when
funds are deposited; they are ‘burned’ when holders ask for their fiat currency back
(subject to restrictions after being redeemed, either for currency or in kind) (Gorton and
Zhang 2023).
The stated goal of stablecoin issuers is to create ‘on-chain’ dollars which are imbued
with all the technological advantages of cryptocurrencies but maintain access to the
payments and economic networks used by more traditional monies. Practically, they
have offered people a way to move dollars outside of the banking system via transfers
on permissionless (i.e. open) blockchains. They initially were created because many
cryptocurrency intermediaries were unable to get bank accounts due to their inability
or unwillingness to sufficiently comply with anti-money laundering requirements.
Their primary use, by far, has been within the crypto trading and lending ecosystem. At
present, the size of the market is between $200 and $250 billion and is dominated by two
issuers, Tether and Circle.
An Executive Order released days into the new administration called on federal agencies
to “[take] actions to promote the development and growth of lawful and legitimate
dollar-backed stablecoins worldwide”.11 Congress is currently considering legislation that
would provide a legal framework for banks and nonbanks to issue stablecoins. In May
2025, the US Senate voted to debate a bill which, if enacted, would regulate stablecoin
issuers operating in the United States. It would require issuers to back reserves at least
one to one with highly liquid short-term assets (e.g. Federal Reserve liabilities, Treasury
9 https://thehill.com/homenews/administration/5254177-trump-if-i-ask-powell-to-leave-hell-be-out-of-there/
10 The president also has insinuated that Chair Powell is engaged in misfeasance, another recognised removal ground. (“Well,
he should lower [interest rates]. And at some point, he will. He’d rather not because he’s not a fan of mine. You know, he just
doesn’t like me because I think he’s a total stiff.”) It is hard to predict how courts would adjudicate a challenge following a
removal by the president for cause, given the lack of recent precedent.
11 Executive Order 14,178, “Strengthening American Leadership in Digital Financial Technology”, The White House, 23
January 2025.
115
THE FINANCIAL SECTOR AND GLOBAL DOLLAR SYSTEM | GENSLER, MENAND AND YOUNGER
Although legal observers have questioned whether the Supreme Court would accept an
attempt by the President to ignore “for cause” removal provisions in the Federal Reserve
Act (allowing the president to remove Federal Reserve governors at will), the President
also has made statements suggesting that he may have cause to remove Chair Powell. For
example, the President said: “I don’t think he’s doing the job. He’s too late. Always too late.
A little slow and I’m not happy with him. I let him know it.”9 Though the President has
subsequently said that he was not going to remove Chair Powell, these comments at the
time may have been in an effort to lay the ground for “neglect of duty” and “inefficiency” –
two recognised “for cause” removal grounds (Manners and Menand 2021).10
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
116
bills, repurchase agreements, and demand deposits at federally regulated commercial
banks), not pay interest, and confirms that such issuers are financial institutions under
the Bank Secrecy Act. These steps address a number of issues raised during the Biden
administration. (President’s Working Group Report on Stablecoins et al. 2021) As
the legislation would address stablecoins issued or sold only in the United States and
stablecoins could still be transferred on permissionless ledgers, it leaves open their
overseas use outside of the money laundering laws.
In a separate set of developments, the US Treasury Department announced that it
has removed the requirement that US firms comply with Congressionally mandated
beneficial ownership data collection.12 This had been an important initiative by Congress
and prior administrations to fill holes in entity ownership information to best enforce
anti-money laundering and sanctions laws.
International alliances
In its opening months, the new administration has taken an aggressive stance towards
historical allies. The White House has challenged the sovereignty of independent nation
states including Greenland, Panama, and even Canada. It has terminated longstanding
international programmes such as USAID. Through the imposition of tariffs that are in
many cases prohibitively high, it has upended a global trading system that has been in
place for generations.
In recent months, market observers have raised concerns that the administration’s
adversarial posture might affect the future reliability of Federal Reserve central bank
liquidity swap lines. Central bank liquidity swap lines are a key element of the existing
global dollar system. These swap lines, often referred to as simply FX swap lines, are
standing arrangements between the Fed and foreign central banks to lend dollars against
foreign currencies. They date back to 1962 when they were first used to stabilise offshore
dollar markets as well as for exchange rate management (McCauley and Shenck 2020).13
Large-scale provisioning of offshore dollar liquidity using the swap lines proved essential
in the Global Financial Crisis (Fleming and Klagge 2010) and Covid pandemic (Choi et
al. 2021).
FINANCIAL AND ECONOMIC CONSEQUENCES
The new administration’s policy direction may have a range of possible financial and
economic consequences including undermining the global dollar system, increasing
risks to financial stability, reducing consumer and investor protections, and weakening
controls on illicit financial activities.
12 https://www.fincen.gov/news/news-releases/fincen-removes-beneficial-ownership-reporting-requirements-us-companiesand-us
13 See also https://www.bloomberg.com/news/articles/2025-01-15/the-hidden-history-of-eurodollars-part-2-defending-thedollar-system
Many of the second Trump administration’s moves threaten to erode the trust that
undergirds the system (Rogoff 2025). The first and most consequential area of concern
is an uncertainty regarding the current administration’s willingness to backstop global
dollar liquidity.16 Although nothing concrete has been made public, the adversarial
posture of the administration toward historical allies has led some to question whether,
due to a combination of domestic political considerations and geopolitical brinksmanship,
the swap lines may not be available or not active in time to avoid damaging scenarios in a
future financial crisis (McCauley 2025).17
The FX swap lines are not just a crisis fighting tool, they are critical to confidence in
the global dollar itself. In the same way that federal deposit insurance and access to the
Federal Reserve’s discount window are critical to ensuring the safety and interoperability
of the $20 trillion bank deposits issued by the US banking and credit union systems, the
swap lines smooth out and lubricate the daily operations of dollar-issuing banks and the
over $12 trillion in Eurodollar deposits across the world.
In other words, the stability of the global dollar system as presently constituted rests
on the uninterrupted and mostly unconditional access to US dollar liquidity.18 This
element of the global dollar system is often overlooked, due to the perceived pre-existing
commitment of the Federal Reserve and the US government to offer it when needed. This
may be a reflection of military and political alliances that have themselves, until this
administration, also been considered as firm commitments. Without reliable and timely
access to emergency dollars, the next global crisis would be significantly more severe
14 The key currency view of international monetary systems is often attributed to Charles Kindleberger, its most prominent
advocate in the postwar years. This contrasts with a more multilateral approach championed by Robert Triffin and John
Maynard Keynes.
15 https://www.bis.org/speeches/sp210818.htm
16 https://www.reuters.com/markets/currencies/de-dollarisation-could-speed-up-with-us-isolationist-policies-analystssay-2025-03-27/
17 See also https://www.reuters.com/markets/after-tariff-shock-trump-may-weaponise-finance-against-allies-2025-04-04/
18 At $13 trillion, the overseas dollar market is too big to rely on the domestic banking system alone (which is at most twice
as large) (Gensler 2024).
117
THE FINANCIAL SECTOR AND GLOBAL DOLLAR SYSTEM | GENSLER, MENAND AND YOUNGER
The global dollar system
The global dollar system is an extensive and complex network. It is the product of a
political project begun after World War II to build an international economy centred
on the US dollar. This project, carried on by presidents of both parties, produced deep
and liquid global capital markets and bank-based payment systems run on dollars as the
international ‘key’ currency (Mehrling 2002).14 Its stability depends on the confidence of
a wide variety of participants. That confidence ultimately flows from governments, and
particularly the willingness of those governments to cooperate amongst each other and,
to some extent, sacrifice some of their own sovereignty in the interest of the collective
whole. As one former Secretary of the Basel Committee on Banking Supervision once put
it: “Global financial stability is a public good.”15 Governments cooperate not to check each
other but to provide this public good by checking the markets.
(Ricks 2016). Even if participants in the global dollar system were to come to believe
emergency liquidity might have political strings attached, it could potentially precipitate
a crisis in the first instance.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
118
Stepping back from the Basel Accord also could have negative repercussions for the
global dollar. The Accord may not always be popular with each of its participating
countries. International agreements rarely are. But they have proven effective at
fostering a congruent set of principles to safety and soundness regulation – a key element
of maintaining confidence in the global dollar system without requiring depositors to be
fully versed on the intricacies of each local banking system. Without it, the global dollar
system could come to resemble the ‘free banking era’ of the 19th century in the United
States, when substantial regional variation in bank regulation was a major impendent to
the free flow of capital and, ultimately, a material drag on economic growth (e.g. Sprague
1910, Jalil 2015).
In that vein, Secretary Bessent’s comments and the broader posture of the administration
represent a potentially worrisome departure from prior norms. While the United States,
under prior administrations, has not implemented all of the recommendations of the
various Basel Accords, it has generally made a good faith attempt to incorporate the spirit
of those standards.19 If the United States. were to deviate significantly from international
standards, it is plausible that other countries may feel both license and competitive
pressure to abandon them as well. The frequent panics and rampant instability of the
United States’ antebellum banking system still serves as a valuable lesson for those who
might consider going down that road.
That said, to date the administration has taken few concrete steps toward changing
regulatory standards. One exception of great relevance internationally is the potential
for changes to the implementation of Basel III in the United States. The devil will be
in the details. Modest deviations from international standards are commonplace. More
substantial changes, however, could contribute to the unravelling of international
economic and financial cooperation. Such an unravelling could, in turn, trigger a global
deregulatory unwinding that could be difficult to stop. Among other things, the global
system allows the US government to borrow at lower interest rates and supports robust
economic growth (Levine 2003); a shift to other currencies and away from dollars could
reverse these effects over time.
Financial stability
The administration’s relaxation of regulatory standards has the potential to increase
risks to financial stability by contributing to the buildup of additional leverage across the
financial system over time.
19 A notable exception is the decision to exempt Treasuries and reserves from the Supplementary Leverage Ratio at
both the bank holding and bank operating company levels in 2020. This was, however, done on a temporary basis and
was specifically issued “[i]n light of recent disruptions in economic conditions caused by the coronavirus disease 2019
(COVID–19) and current strains in U.S. financial markets” (85 FR 20578, 14 April 2020).
Presidential supremacy over financial regulators also could threaten financial stability
over the medium to long term. This is because greater White House control over
regulatory policy could favour financial actors seeking to arbitrage rules and, on the
margin, could hamstring regulators seeking to prevent evasion. Enforcement, especially
by markets regulators, could drop. More highly resourced and politically favoured actors
may benefit disproportionately. Further, the pace of rulemaking is likely to slow, with
White House deregulatory goals prioritised (see Chapter 3).
Consumer and investor protection
Relaxed regulatory standards, as well as the shrinking of policymaking and enforcement
capacity at financial regulators, is likely to put consumers and investors at greater risk.
What will happen to the enforcement authority the CFPB previously exercised is, as yet,
uncertain. Though the new administration has suggested that these authorities should
be transferred to other regulators, it is unclear if they will be and if so, how effectively or
efficiently they will be used.
Legal protections, whether they are provided by the CFPB, SEC, CFTC, or others, are
intended to provide investors and consumers with assurances that they can make
informed decisions free of fraud and misleading information about risks, investments,
and products. Although state regulators are primed to step into part of the breach,
history suggests that only rigorous federal enforcement can provide sufficient protection.
In the long run, the associated lack of confidence could harm risk appetite and capital
formation more generally.
Another key area of focus of changed policy has been regarding crypto assets. The new
administration has made clear that it intends to actively promote the development of
crypto assets. That may leave investors more exposed to the kind of fraud and abuse
revealed in these markets.
119
THE FINANCIAL SECTOR AND GLOBAL DOLLAR SYSTEM | GENSLER, MENAND AND YOUNGER
That large financial institutions do not internalise the costs of their failure on their
creditors and the economy at large can skew their incentives to adopt high leverage.
To the extent that leverage is a binding constraint on a given institution, loosening
those requirements without counterbalancing adjustments to equity requirements will
therefore lead to lower capital levels. De-supervision – policies that reduce the intensity
of stress tests and oversight by examiners – also may lead to increased regulatory
arbitrage, including actions geared toward achieving greater synthetic and on-balance
sheet leverage. A similar dynamic preceded the 2008 financial crisis, where a rollback
in discretionary supervision facilitated firm behaviour that undermined the efficacy of
bright-line rules (Menand 2018). Increased reliance on leverage has been associated with
fragility in Treasury markets (Kashyap et al. 2025). More recently, the bank runs in 2023
were associated with de-supervision and deregulation of mid-sized banks and significant
undercapitalisation (Hoenig 2023).
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
120
Financial crimes, illicit activities, and sanctions
The efficacy of guarding against illicit activities and enforcing sanctions depends
upon the use of the dollar as the international key currency. Businesses worldwide use
dollars for most large cross-border and domestic payments. That privileged position has
allowed the United States and its allies a degree of control over critical nodes in financial
payment networks (i.e. chokepoints) as well as an invaluable informational advantage
(i.e. a panopticon; Farrell and Newman 2019).
As a result, in recent decades, financial sanctions have emerged as a key tool for advancing
US interests through non-military means (Mulder 2021, Fishman 2025). National
security policymakers have used sanctions to bloc problematic transactions, individuals,
corporations, and even entire countries from parts of the global economy.
Stablecoins, however, can undermine the United States’ ability to guard against illicit
activities and promote national security policy (Massad 2024, Rauterberg and Younger
2024).20 As transactions involving these tokens settle outside of the banking system and
are pseudonymous, stablecoins are well designed to evade authorities. At the moment
they are relatively small – less than half of 1% of the more than $45 trillion in US dollar
monetary instruments circulating globally (Gensler 2024) – and, as mentioned, they are
mostly used within the crypto trading and lending ecosystem. Like many digital creations,
though, stablecoins have the potential to grow quickly. Already, some cryptocurrency
companies are offering a way to hold stablecoins while earning interest (among the
biggest competitive disadvantages at present with other monetary instruments).
Secretary Bessent recently cited expectations that stablecoins could grow to more than
$2 trillion in just a couple of years (Bessent 2025b). This figure presumably reflects
the anticipated effects of the administration’s advocacy, including “promot[ing] the
development and growth of lawful and legitimate dollar-backed stablecoins worldwide”.21
(A new stablecoin issued by World Liberty Financial, an organisation majority owned
by the President’s business interests, already exceeds $2 billion.) Previously there were
significant hurdles to stablecoins replacing bank deposits and other more traditional
forms of currency in international trade and finance.22 At the scale suggested by
Secretary Bessent, however, in any jurisdictions in which stablecoins (or their affiliates)
have the ability to pay interest, they could start to compete (although this introduces
additional legal considerations; Birdthistle et al. 2025). Were that to occur, the use of the
global dollar-based banking system for sanctions and guarding against illicit activities
could be degraded.
20 Stablecoins threaten to undermine the efficacy of this “economic weapon” (Massad 2023).
21 Executive Order 14,178
22 https://www.bloomberg.com/news/newsletters/2025-01-31/josh-younger-and-lev-menand-on-why-stablecoins-aren-t-thenew-eurodollars?embedded-checkout=true
To the extent that this lowers the effectiveness of sanctions, it risks a destabilising shift
towards more use of kinetic warfare rather than financial conflict.
CONCLUSION
The new administration is making policy changes that could pose long-term risks to
the US financial system, including the global dollar architecture. Some of these are
direct adjustments to financial policy, such as relaxing regulatory standards, reducing
enforcement activity, and promoting nonbank stablecoins. Others are facially unrelated
to the financial sector. Most notably, the new administration has called into question
traditional economic alliances and relationships and asserted unprecedented control
over regulatory agencies. Incidentally, it is these more general changes that may have the
biggest effects on the financial sector and by extension the economy.
Each of these shifts is still unfolding. None has yet done lasting damage to the dollar,
financial stability, capital markets, consumer protection, or national security. The
administration’s actual and proposed actions, however, could eventually have significant
impacts on each of these financial sector dimensions. Mark Sobel, a former senior
Treasury official, recently warned: “by weakening America’s economic and institutional
foundations, by not being a trusted partner, [the United States] is undermining the
underpinnings of what has given rise to dollar dominance”.23 While there is, at present,
no viable alternative to the US dollar, a transition away from key currencies to a more
multipolar monetary system is certainly plausible. By its actions and policy goals, the
second Trump administration is potentially pushing and accelerating that transition.
Similarly, degradation of our consumer and investor protections, our ability to combat
illicit finance, and checks on excessive leverage could contribute to future financial
instability and higher cost of capital in the economy.
REFERENCES
Atkins, P S (2025), “Remarks at the Crypto Task Force Roundtable”, Washington, DC,
25 April (https://www.sec.gov/newsroom/speeches-statements/atkins-remarks-cryptotask-force-roundtable-042525).
23 https://www.theguardian.com/business/2025/apr/11/the-damage-is-done-trumps-tariffs-put-the-dollars-global-reservestatus-at-risk
121
THE FINANCIAL SECTOR AND GLOBAL DOLLAR SYSTEM | GENSLER, MENAND AND YOUNGER
Even if the growth of stablecoins falls short of more enthusiastic projections, the
administration is taking other steps that reduce the efficacy of financial sanctions. The
US Treasury’s recent announcements dropping requirements for new Congressionally
mandated entity beneficial ownership reporting, for example, leaves a significant gap in
the current tools for financial crimes and sanctions enforcement.
Bessent, S (2025a), “Remarks at the American Bankers’ Association,” Washington, D.C.,
Apr. 9, 2025.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
122
Bessent, S (2025b), “Testimony before the House Financial Services Committee”, Hearing
on the International Financial System, 7 May.
Birdthistle, W, G Rauterberg, J Younger and J Zhang (2025), “Shadow Investment
Companies”, Columbia Business Law Review, forthcoming.
Braun, B, A Krampf and S Murau (2020), “Financial globalization as positive integration:
monetary technocrats and the Eurodollar market in the 1970s”, Review of International
Political Economy 28(4): 794-819.
Choi, M, L Goldberg, R Lerman and F Ravazzolo (2022), “The Fed’s Central Bank Swap
Lines and FIMA Repo Facility”, Economic Policy Review 28(1), Federal Reserve Bank of
New York.
Congressional Research Service (2023), Independence of Federal Financial Regulators:
Structure, Funding, and Other Issues, CRS Report prepared for Members and
Committees of Congress (https://www.congress.gov/crs-product/R43391).
Farrell, H and A Newman (2019), “Weaponized Interdependence: How Global Economic
Networks Shape State Coercion”, International Security 44(1): 42-79.
FinCEN – Financial Crimes Enforcement Network (2025), “FinCEN Removes Beneficial
Ownership Reporting Requirements for U.S. Companies and U.S. Persons, Sets New
Deadlines for Foreign Companies”, 21 March.
Fishman, E (2025), Chokepoints: American Power in the Age of Economic Warfare,
Portfolio.
Fleming, M J and N J Klagge (2010), “The Federal Reserve’s Foreign Exchange Swap
Lines”, Current Issues in Economics and Finance 16(4).
Gensler, G (2024), “A Feature, Not a Bug: The Important Role of Capital Markets in the
U.S.”, remarks at the Bloomberg Global Regulatory Forum, Washington, DC, 22 October.
Gorton, G and J Zhang (2023), “Taming Wildcat Stablecoins”, University of Chicago Law
Review 90(3): 909-971.
Jalil, A J (2015), “A New History of Banking Panics in the United States, 1825-1929:
Construction and Implications”, American Economic Journal: Macroeconomics 7(3):
295-330.
Kashyap, A K, J C Stein, J L Wallen, and J Younger (2025), “Treasury market dysfunction
and the role of the central bank”, Brookings Papers on Economic Activity, 26 March
(https://www.brookings.edu/articles/treasury-market-dysfunction-and-the-role-of-thecentral-bank).
Levine, R (2025), “Finance and growth: theory and evidence”, in Handbook of Economic
Growth, Vol. 1, pp. 865–934
Massad, T G (2024), “Stablecoins and national security: Learning the lessons of
Eurodollars”, Brookings, 17 April (https://www.brookings.edu/articles/stablecoins-andnational-security-learning-the-lessons-of-eurodollars/).
McCauley, R N (2025), “Avoiding Kindleberger’s trap: A dollar coalition of the willing”,
VoxEU.org, 5 May (https://cepr.org/voxeu/columns/avoiding-kindlebergers-trap-dollarcoalition-willing).
McCauley, R N and C R Schenk (2020), “Central bank swaps then and now: swaps and
dollar liquidity in the 1960s”, BIS Working Paper No. 851 (https://www.bis.org/publ/
work851.htm).
Mehrling, P (2002), Money and Empire: Charles P. Kindleberger and the Dollar System,
Cambridge University Press.
Menand, L (2018), “Too Big to Supervise: The Rise of Financial Conglomerates and the
Decline of Discretionary Oversight in Banking”, Cornell Law Review 103(6): 1527-1588.
Peterson, C (2019), “Dormant: The Consumer Financial Protection Bureau’s Law
Enforcement Program in Decline,” Consumer Federation of America, 12 March.
President’s Working Group on Financial Markets, the Federal Deposit Insurance
Corporation, and the Office of the Comptroller of the Currency (2021), Report on
Stablecoins.
Rauterberg, G and J Younger (2024), “The Hidden Monetary State”, Arizona State Law
Journal (https://arizonastatelawjournal.org/wp-content/uploads/2024/08/Rauterberg_
PUB.pdf).
Ricks, M (2016), The Money Problem: Rethinking Financial Regulation, University of
Chicago Press.
Rogoff, K (2025), Our Dollar, Your Problem: An Insider’s View of Seven Turbulent Decades
of Global Finance, and the Road Ahead, Yale University Press.
SEC (2025), “SEC Extends Compliance Dates and Provides Temporary Exemption for
Rule Related to Clearing of U.S. Treasury Securities”, Press Release 2025-43, 25 February.
Sitaraman, G (2021), “The Political Economy of the Removal Power”, 134 Harvard Law
Review 352 (https://harvardlawreview.org/print/vol-134/the-political-economy-of-theremoval-power/).
123
THE FINANCIAL SECTOR AND GLOBAL DOLLAR SYSTEM | GENSLER, MENAND AND YOUNGER
Manners, J and L Menand (2021), “The Three Permissions: Presidential Removal and the
Statutory Limits of Agency Independence”, Columbia Law Review 121(1): 1-79.
Sprague, O M W (1910), History of Crises Under the National Banking System, National
Monetary Commission.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
124
Tarullo, D (2023), “Capital Regulation and the Treasury Market”, Working Paper
Hutchins Center on Firscal and Monetary Policy at the Brookings Institution (https://
www.brookings.edu/wp-content/uploads/2023/03/Brookings-Tarullo-CapitalRegulation-and-Treasuries_3.17.23.pdf)
Uyeda, M (2025), “Remarks at the 44th Annual Small Business Forum”, Washington,
D.C., 20 April.
Yadav, Y and J Younger (2025), “Central Clearing the U.S. Treasury Market”, University
of Chicago Law Review 92(2), Article 5.
ABOUT THE AUTHORS
Gary Gensler is Professor of the Practice, Global Economics and Management, and
Professor of the Practice, Finance, at the MIT Sloan School of Management. Professor
Gensler previously served as Chair of the Securities and Exchange Commission (2021–
2025), Chair of the Commodity Futures Trading Commission (2009–2014), Under
Secretary of the Treasury for Domestic Finance (1999–2001), and Assistant Secretary
of the Treasury (1997–1999). He also was Chair of the Maryland Financial Consumer
Protection Commission (2017-2019) and Senior Advisor to Senator Paul Sarbanes (2002).
Earlier, Gensler worked at Goldman Sachs for 18 years, where he became a partner. His
research focuses on artificial intelligence, finance, and economic policy.
Lev Menand is Associate Professor of Law at Columbia Law School and Affiliated Faculty
at the Institute of Global Politics at the School for Public and International Affairs.
Joshua Younger is currently a Portfolio Manager at Tudor Investment Corporation as well
as a Lecturer and a Senior Fellow in the Program on Public Economic Law at Columbia
Law School. Prior to that he was a Senior Adviser at the Federal Reserve Bank of New
York after holding a variety of senior positions at J.P. Morgan Chase & Co. Josh holds an
AB from Princeton University and a PhD from Harvard University, both in Astrophysics.
CHAPTER 8
Neale Mahoney1
Stanford University
INTRODUCTION
On 7 February 2025, just days into Donald Trump’s second presidential term, Elon Musk
tweeted “CFPB RIP” along with an emoji of a tombstone. Hours earlier, members of
his team had entered the headquarters of the Consumer Financial Protection Bureau
(CFPB) with the goal of dismantling the nation’s only agency focused primarily on
protecting consumers from predatory financial practices. As some in the venture capital,
fintech, and cryptocurrency industries cheered on,2 consumer advocates pointed out the
devastation that the gutting of this agency would have on consumers and the economy.
The mission of the CFPB is to protect consumers from abusive financial practices by
implementing and enforcing laws passed by Congress. In its almost 14-year history, the
Bureau has developed deep expertise on the supervision of financial institutions, the
enforcement of consumer protection laws, and the analysis of consumer behaviour and
financial markets.
But the Trump administration has acted to shrink the CFPB to levels unseen in its
history, issuing reduction-in-force notices to almost 90% of Bureau employees, with
some reports referencing plans to reduce the bureau to as few as five employees.3
Working with Congress, the Trump administration has repealed a rule that would have
capped bank overdraft fees,4 and the Bureau has worked through the courts to reverse
rules that remove medical debt from credit reports and limit credit card late fees.5,6 The
Bureau has retroactively withdrawn many of its past policy statements, interpretive
rules, and advisory opinions,7 including protections for active-duty servicemembers
1
2
3
4
5
6
7
I am grateful to Adam Shaw for his assistance in preparing this essay. All errors are my own.
https://x.com/brian_armstrong/status/1888385895163953554 and https://x.com/tyler/status/1888461425703555209
among others
https://www.cnbc.com/2025/02/28/cfpb-leaders-and-elon-musk-doge-planned-to-fire-nearly-all-staff.html
https://www.consumerfinanceandfintechblog.com/2025/05/president-trump-signs-resolution-nullifying-cfpb-overdraftfee-rule/
https://www.consumerfinancemonitor.com/2025/05/07/cfpb-industry-groups-ask-federal-judge-to-kill-bureau-medicaldebt-rule/
https://www.reuters.com/business/finance/trump-administration-moves-scrap-biden-era-credit-card-late-feerule-2025-04-14/
https://public-inspection.federalregister.gov/2025-08286.pdf
125
CONSUMER FINANCIAL PROTECTION | MAHONEY
Consumer financial protection
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
126
and prohibitions on discrimination based on gender and sexual orientation.8,9 Beyond
this, the Bureau has indicated an intention to “deprioritise” issues such as student loans,
lending, and medical debt, effectively signalling an abandonment of many of the Bureau’s
core functions.10 Further, in firing the Director, then the Acting Director, and then
allowing the agency to be led by Treasury and then Office of Management and Budget
principals, the Trump administration has compromised the agency’s independence and
stability.11
Policymakers often disagree on where to set the dial between leniency and stringency
in consumer financial regulation. Typically, Democrats prefer more regulation,
and Republicans less. But what the Trump administration is doing is anything but
typical. Rather than turning the dial to the left or the right, they are dismantling the
government’s capacity to enforce its laws, degrading the very ability to set the dial to
any particular setting now or in the future. These actions will likely end up supporting
scammers, harming well-meaning financial institutions, and hurting the families who
rely on consumer financial markets in their everyday lives.
THE NEED FOR CONSUMER FINANCIAL PROTECTION
Federal consumer financial protection regulations have existed in the United States since
the early 20th century, but it was only after the 2008 financial crisis that these authorities
were centralised in a single agency.
In 2007, defaults in the subprime segment of the mortgage market sparked a global
financial crisis that put millions out of work and destroyed trillions in household wealth.
In its examination of its causes, the Financial Crisis Inquiry Commission highlighted
problematic practices in mortgage origination, enabled by scant regulation and amplified
by risky mortgage-backed securities. More broadly, in their post-mortem analysis,
policymakers identified two fundamental issues with the structure of consumer financial
regulation in the United States.12
First, regulatory authority was spread across too many agencies, none of which focused
exclusively on consumer protection issues. The Treasury Department’s now defunct
Office of Thrift Supervision, for example, shared oversight of mortgage servicing and
lending activities with the Office of the Comptroller of the Currency, the Federal Reserve,
the Federal Deposit Insurance Corporation, the Department of Housing and Urban
8
https://www.federalregister.gov/documents/2021/06/23/2021-13074/examinations-for-risks-to-active-dutyservicemembers-and-their-covered-dependents
9 https://www.federalregister.gov/documents/2021/03/16/2021-05233/equal-credit-opportunity-regulation-bdiscrimination-on-the-bases-of-sexual-orientation-and-gender
10 https://www.nytimes.com/2025/04/17/us/politics/consumer-financial-protection-bureau-layoffs.html
11 https://www.consumerfinancialserviceslawmonitor.com/2025/02/new-leadership-and-dramatic-changes-at-the-cfpbfuture-of-the-bureau-uncertain/
12 https://fcic-static.law.stanford.edu/cdn_media/fcic-reports/fcic_final_report_full.pdf
Development, and numerous state regulatory bodies. Since no single agency “owned” the
issue of consumer financial protection, practices such as risky mortgage lending were not
adequately monitored.
Competing mandates and a fragmented regulatory landscape made it difficult for the
government to implement and enforce laws in ways that benefited consumers. Following
the 2008 crisis, Congress decided that a new dedicated and centralised structure for
consumer financial protection regulation and enforcement was needed.
THE CFPB’S TRACK RECORD
In a 2007 article in Democracy, then-Harvard Law School Professor Elizabeth Warren
famously compared consumer financial products to toasters (Warren 2007). Consumers,
she wrote, could purchase toasters without fear of them “bursting into flames” thanks
to effective consumer product regulation. Obtain a consumer financial product on the
other hand, such as a mortgage or auto loan, and there was no such protection from the
product blowing up in your face.
One issue Warren identified was that financial products were regulated as contracts,
allowing financial institutions to engage in problematic practices as long as they were
disclosed in the fine print. Another was the problem of coordination between numerous
state and federal regulators. The result was a proliferation of hidden fees, complex rate
policies, and punitive billing methods that were aggressively marketed to consumers who
don’t always know what they’re buying. The solution she recommended was a “Financial
Product Safety Commission” that could “protect consumers who use credit cards, home
mortgages, car loans, and a host of other products…and advance efficient and more
dynamic markets”.
In 2010, this vision was made reality when the Dodd–Frank Wall Street Reform and
Consumer Protection Act established the Consumer Financial Protection Bureau,
centralising consumer protection in a single agency that would supervise institutions,
enforce laws, and undertake research.
Across these roles, perhaps the most tangible has been the CFPB’s role as a figurative cop
on the beat enforcing consumer financial protection laws. The CFPB played a central role
in the investigative and enforcement work that uncovered the Wells Fargo cross-selling
scandal, in which the bank was fined over $2 billion for opening millions of chequing
accounts, savings accounts, and credit cards for its customers without authorisation or
consent. In more recent years, the CFPB led successful actions against illegal practices
127
CONSUMER FINANCIAL PROTECTION | MAHONEY
Second, many of these agencies had “safety and soundness” missions that at times
operated in tension with their consumer protection objectives. For instance, if a proposal
to strengthen banks’ consumer protections might come at the expense of lowering profits
and as a result capital buffers, opponents might successfully oppose the regulation by
arguing that it could increase the likelihood of bank failure and create systemic risks.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
128
taken by Navient, a student loans servicer,13 and the Navy Federal Credit Union, which led
to $80 million returned to consumers, including military veterans and their families.14
As of early 2025, the CFPB has recovered almost $20 billion in consumer relief and $5
billion in civil money penalties.15
Economic principles teach us that enforcement has benefits that go well beyond the dollar
amounts recovered. Enforcement deters other financial institutions from engaging in
similar behaviour, reducing the prevalence of scams that harm consumers. Enforcement
also creates an even playing field and allows law-abiding firms to invest with the
confidence that they won’t be undercut by law-breaking rivals, increasing competition in
the market.
In addition to its enforcement role, the CFPB plays a central role in issuing and updating
consumer financial regulations, including those pertaining to bank fees and medical
debt. In 2024, the CFPB updated a rule to functionally cap credit card late fees at $8
per infraction, down from $30 or above.16 The rule was grounded in recent economic
research, including my own on fee regulations under the 2009 CARD Act (Agarwal et
al. 2015). In that study, we found that caps on late fees had no effect on the frequency of
late payments. That is, consumers were not late due to a rational cost-benefit calculation,
but because they simply forgot or did not have the money to pay. It follows that excess
late fees should not be seen as a tool for encouraging on-time payments, but rather as
a means to extract revenue from the most vulnerable customers. Capping late fees at
costs would, at a minimum, shift the credit card industry away from a fee-driven revenue
model, where a disproportionate share of revenue is earned from customers who have
difficulty managing their finances. Indeed, my research on the CARD Act shows that
banks did not offset lower fee revenue with new fees or higher interest rates, suggesting
broader consumer benefits from this type of fee regulation.
On medical debt, the CFPB’s highest profile action was a January 2025 rule that banned
listing medical debt on credit reports.17 More than any other type of debt, medical debt
results from bad luck, not bad financial behaviour. A basic economic tenet is that we
should provide social insurance against bad luck, so long as there are not too large
unintended consequences. To this end, CFPB analysis showed that medical debt has
relatively little power in predicting defaults, indicating that it could be removed from
credit reports without meaningfully diminishing the accuracy of credit scores.18 Instead,
the primary impact of a medical debt reporting ban would be on debt collectors, which
13 https://www.consumerfinance.gov/about-us/newsroom/cfpb-bans-navient-from-federal-student-loan-servicing-andorders-the-company-to-pay-120-million-for-wide-ranging-student-lending-failures/
14 https://www.consumerfinance.gov/about-us/newsroom/cfpb-bans-navient-from-federal-student-loan-servicing-andorders-the-company-to-pay-120-million-for-wide-ranging-student-lending-failures/
15 https://www.consumerfinance.gov/enforcement/enforcement-by-the-numbers/
16 https://www.federalregister.gov/documents/2024/03/15/2024-05011/credit-card-penalty-fees-regulation-z
17 https://www.consumerfinance.gov/about-us/newsroom/cfpb-finalizes-rule-to-remove-medical-bills-from-credit-reports/
18 https://www.consumerfinance.gov/about-us/newsroom/cfpb-study-finds-medical-debt-overly-penalizes-consumer-creditscores/
have historically used credit reporting as a form of leverage to scare consumers into
payment (Kluender et al. 2025). Credit reporting was not set up to provide debt collectors
with this type of leverage on medical bills, and the CFPB, through notice-and-comment
rule-making, effectively limited debt collectors from exercising this potential power.
Underpinning these enforcement, rulemaking, and bully pulpit accomplishments has
been the CFPB’s market monitoring and research capabilities. On the market monitoring
side, this includes a consumer complaint database that had logged over 4 million
complaints on various companies from consumers. On the research side, the CFPB’s
staff included economists and behavioural scientists who conducted and published
research on consumer financial markets. The CFPB research conference, which has been
occurring annually for seven years, has been one of the top research conferences in the
field. Each time I’ve presented at the CFPB, I’ve been impressed by the comments and
suggestions of the audience. It is difficult to understate the importance of the knowledge
base that the bureau has assembled – and what its significant downsizing would mean
for evidence-based consumer financial protection moving forward.
SIGNIFICANTLY SHRINKING THE CFPB
When there is a change in party control in Washington, there are natural efforts to
turn the dial on consumer financial protection policy in one direction or the other. For
instance, during the George W. Bush administration, the Treasury Department’s Office
of the Comptroller of the Currency took the view that federal regulations pre-empted
stronger state regulations of mortgage activities. As a result, states with stronger
consumer protection laws, such as New York and California, were functionally limited
in the degree to which they could regulate banks, leading to a less stringent regulatory
landscape (Cassady 2004).
19 https://www.consumerfinance.gov/about-us/newsroom/cfpb-study-finds-medical-debt-overly-penalizes-consumer-creditscores/
20 https://www.bauerfinancial.com/to-fee-or-not-to-fee-where-does-your-bank-stand/
21 https://www.consumerfinance.gov/about-us/newsroom/cfpb-closes-overdraft-loophole-to-save-americans-billions-infees/
129
CONSUMER FINANCIAL PROTECTION | MAHONEY
Beyond the levers of enforcement and rulemaking, the CFPB has used its bully pulpit to
shine a light on problematic consumer finance practices, sometimes leading to voluntary
industry responses. For instance, before issuing its medical debt rule, research reports
and other CFPB actions prompted the three major credit bureaus to stop listing certain
types of medical debt on credit reports.19 On bank overdraft fees, widely distributed
reports and public advocacy by the CFPB led over 100 banks to begin sunsetting their
practices,20 saving customers an estimated $6 billion annually in fee payments.21
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
130
The Trump administration’s approach is not a turning of the dial, but a radical effort
to largely dismantle the CFPB. By scrapping and delaying rules, detailing plans to
significantly reduce headcount, and deprioritising issues such as student loans, lending,
and medical debt, it appears that the administration intends to abandon the Bureau’s
core functions and consumer financial protection as we’ve known it.
Actions to dismantle the agency have been challenged in the courts, in the papers,
and on Capitol Hill. In late March, a federal judge on the D.C. District Court granted
a preliminary injunction22 to halt the dismantling of the Bureau.23 In April, a federal
appeals court ruled that the Trump administration could proceed with wide-scale
headcount reductions, and around 1,500 of the CFPB’s 1,700 employees were sent
reduction-in-force notices.24,25
Given the cutbacks, the number of consumer complaints the Bureau has been able to
process is down significantly.26 The agency has dropped active enforcement cases against
Zelle, Transunion, and Capital One, and suspend dozens more pending enforcement
actions.27 In the months to come, the potential harm to consumers is only likely to grow.
CONCLUSION
Regulatory bodies are created to make rules and enforce laws. When we cease to debate
the trade-offs between stringency and leniency, but instead question whether regulation
and enforcement should exist, we threaten the government’s very ability to enforce its
own laws.
Critics of the CFPB might argue that the Bureau has overstepped its legal mandate and
that the regulatory landscape should return to the pre-CFPB era when responsibility was
dispersed across many regulators. The lessons of history, though, show that the functions
of the CFPB were not appropriately conducted when spread across agencies where
consumer protection was just one of multiple priorities.
Beyond the direct impacts of scams on consumer and household finances, the significant
downsizing of the CFPB likely will reduce consumers’ confidence in the financial system
and harm the system’s overall capability. Wary of scam products and companies,
consumers may pull back to some degree from participating in consumer financial
markets, missing out on the real value provided by the sectors’ payment, borrowing, and
saving instruments. Law-abiding firms may hesitate to innovate and expand, concerned
that their investments could be undercut by companies that flout the rules. Newer
22 https://www.courtlistener.com/docket/69624423/87/national-treasury-employees-union-v-vought/
23 https://www.theverge.com/news/638987/cfpb-nteu-vought-preliminary-injunction-trump-doge
24 https://www.nytimes.com/2025/04/17/us/politics/consumer-financial-protection-bureau-layoffs.html
25 https://www.foxbusiness.com/politics/cfpb-make-sweeping-job-cuts-trump-admin-refocuses-agency
26 https://www.washingtonpost.com/business/2025/02/28/trump-cfpb-enforcement/
27 https://www.banking.senate.gov/newsroom/minority/ahead-of-speech-trump-abandons-cfpb-enforcement-cases-leavingamerican-consumers-high-and-dry
financial models and technologies, such as cryptocurrencies and ‘buy now, pay later’
(BNPL) platforms, will see less monitoring, supervision, and appropriate regulation,
raising the prospect of financial events with potential systemic implications.
REFERENCES
Agarwal, S, S Chomsisengphet, N Mahoney and J Stroebel (2015), “Regulating Consumer
Financial Products: Evidence from Credit Cards”, The Quarterly Journal of Economics
130(1): 111–164 (https://doi.org/10.1093/qje/qju037).
Cassady, A (2004), “Tying the Hands of the State: The Impact of Federal Preemption
on State Problem-Solvers”, State Public Interest Research Groups (https://
publicinterestnetwork.org/wp-content/uploads/2012/01/TyingtheHandsofStates.pdf).
Kluender, R, N Mahoney, F Wong and W Yin (2025), “The Effects of Medical Debt Relief:
Evidence from Two Randomized Experiments”, The Quarterly Journal of Economics
140(2): 1187–1241 (https://doi.org/10.1093/qje/qjae045).
Warren, E (2007), “Unsafe at Any Rate”, Democracy: A Journal of Ideas 5 (https://
democracyjournal.org/magazine/5/unsafe-at-any-rate/).
ABOUT THE AUTHOR
Neale Mahoney is the Director of the Stanford Institute for Economic Policy Research
(SIEPR) and a professor of economics at Stanford. He served as an advisor on the
National Economic Council in the Biden White House and was a member of the CFPB’s
Academic Research Council from 2023-2025.
131
CONSUMER FINANCIAL PROTECTION | MAHONEY
If the Trump administration is successful in dismantling the CFPB, in the years to come
the effort to effectively regulate for consumer protection will fall to the states. In the
long run, the lesson of the 2008 financial crisis is that underregulated consumer finance
raises the risks of a crisis, with the potential to harm millions of Americans. It is my hope
that the United States will not need to relearn those lessons yet again. Evidence-based
consumer financial protection is better for consumers and the economy.
CHAPTER 9
Jonathan B. Baker1
American University
The second Trump administration’s initial moves in competition policy suggested
continuity in many core areas of antitrust. The administration brought in new leadership
with substantial antitrust backgrounds, including Abigail Slater as the Assistant
Attorney General (AAG) for Antitrust at the Department of Justice (DOJ) and Mark
Meador as Commissioner to fill the vacant seat on the Federal Trade Commission (FTC).
These recent appointees come from the pro-antitrust wing of the Republican Party, not
the non-interventionist wing. Each has described vigorous antitrust enforcement as
necessary to protect individual liberty against private monopolies, particularly for AAG
Slater monopoly power in online platforms (Meador 2025, Slater 2025).
Slater and FTC Chairman Andrew Ferguson have supported many important Biden
administration antitrust initiatives. They continued to pursue monopolisation cases
against large digital platforms, some of which were instituted during the first Trump
administration. They also endorsed their Biden administration predecessors’ new focus
on labour antitrust, including its concern with the exercise of market power to lower
wages, harming workers. They preserved the 2023 Merger Guidelines and the 2024
premerger notification rules, both introduced during the Biden administration, despite
substantial criticism from antitrust conservatives and counsel for merging firms,
respectively.
The new agency heads did cut back on some Biden-era approaches, such as by reinstating
early termination of merger reviews when a preliminary investigation did not raise
concerns. FTC Chairman Ferguson prefers that his agency act through adjudication
rather than competition rulemaking, which the Biden-era FTC occasionally sought to
employ. The new heads also have indicated a greater willingness to accept settlements
as remedies in merger cases. But overall, the early policy shifts were no more significant
than the policy changes that followed past transitions of the executive branch from one
political party to another. In the US system, moreover, policy modifications by federal
enforcers are tempered by the agencies’ need to prove cases in court and the ability of
state antitrust enforcers and private plaintiffs to bring cases regardless of the views of
the DOJ and FTC.
1
Parts of this chapter were adapted from Baker (2025). The author is indebted to Bill Baer, Andy Gavil, and Gene
Kimmelman.
133
COMPETITION POLICY | BAKER
Competition policy
STEPS THAT MAY DRAMATICALLY AFFECT COMPETITION POLICY
The second Trump administration has taken other steps, however, that have the potential
to change competition policy dramatically.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
134
First, President Trump fired the two Democratic FTC commissioners.2 (The FTC has
slots for five commissioners, with no more than three from the same party. The three
other commissioners are all Republicans.) President Trump’s action is inconsistent with
statute and with constitutional precedent,3 but recent Supreme Court decisions have
raised questions about its constitutional basis. The Supreme Court will likely decide the
constitutional issue soon, perhaps in a case involving removals from other commissions
or boards.4
Removing two opposition party commissioners places the legality of agency action
under a cloud, particularly decisions that could have come out differently had the two
Democratic commissioners participated. If that action is upheld, moreover, it would
undermine the ability of the FTC to pursue its distinctive role as a bipartisan forum for
antitrust policymaking and adjudication (see the contribution by Gensler and Menand
in this volume). That, in turn, could encourage Congress to shift the FTC’s antitrust
enforcement role to the Justice Department’s Antitrust Division, as some congressional
Republicans have already proposed.5 Such a shift would harm antitrust enforcement in
several ways. It would end the FTC’s ability to develop the law through administrative
adjudication (subject to review in the appellate courts). It also would end the FTC’s
unique ability to use compulsory process to evaluate competitive concerns and propose
legislative remedies or identify targets for antitrust investigations. These aspects of the
FTC’s institutional design have contributed to the past success of antitrust enforcement
and policymaking. Shifting all antitrust activity to the Justice Department also would
preclude the possibility of competition rulemaking, a Biden-administration policy
initiative with substantial promise but an uncertain legal status.
Second, the new administration has proposed or begun to undertake institutional or
organisational changes that could cut back enforcement substantially. The administration
had placed both the FTC and DOJ under considerable budgetary pressure, potentially
affecting the staffing of even the most important and high-profile cases,6 even before Elon
Musk’s Department of Government Efficiency (DOGE) arrived at the FTC.7 (At other
agencies, DOGE-led task forces have overseen severe curtailment or near elimination of
agency functions.) The DOJ withdrew employment offers to honours law students,8 and
2
3
4
5
6
7
8
https://protectdemocracy.org/wp-content/uploads/2025/03/Slaughter-v-Trump-Complaint.pdf
https://supreme.justia.com/cases/federal/us/295/602/
https://media.cadc.uscourts.gov/orders/docs/2025/04/25-5037.25-5057.EN1.pdf
https://www.govtrack.us/congress/bills/119/s1059
https://apnews.com/article/amazon-ftc-doge-trial-delay-3265683227438a61503d2f6727cab5bb
https://www.theverge.com/news/643674/doge-members-spotted-ftc-elon-musk
https://www.nytimes.com/2025/01/23/us/politics/justice-honors-program-trump.html
Third, the new administration could act in antitrust enforcement the way it has
begun to act elsewhere: negotiating with individual firms to resolve law enforcement
matters affecting them. President Trump has taken this approach outside of antitrust
by repeatedly delaying the congressionally mandated sale of TikTok.11 Other examples
include the President’s willingness to work out firm-specific policy adjustments involving
Nvidia (with export controls)12 and certain firms13 and industries14 affected by tariffs. In
antitrust specifically, Meta’s CEO, Mark Zuckerberg, has reportedly sought to negotiate
directly with the President in an attempt to settle the FTC’s ongoing case seeking to
force the sale of Instagram and WhatsApp.15 Further, the new administration’s executive
orders that close agency doors (including the Antitrust Division and perhaps the FTC)
and the courts to law firms that the President dislikes,16 and the administration’s deals
with law firms17 requiring them to invest pro bono resources on causes the administration
supports may undermine antitrust enforcement. They suggest to private industry that
firms should attempt to buy off enforcement by hiring advisers that President Trump
considers friendly and, more generally, by showing in advance their support of the
administration policies.
This top-down approach to antitrust enforcement would allow settlements and prosecution
decisions to be influenced by President Trump’s political interests, his extensive personal
and familial financial interests, and the financial interests of close advisers like Elon
Musk. That would undermine the ability of the antitrust laws to prevent firm conduct
that harms competition. Presidential directives to the FTC that erode its independence
and autonomy also raise statutory and constitutional issues similar to those presented
by the removal of the Democratic FTC commissioners. In addition, if an agency resolves
a case or investigation according to presidential instructions, and the president reaches
his decision without considering input from agency staff and other interested parties and
9
10
11
12
13
14
15
16
17
https://www.theverge.com/news/623242/federal-trade-commission-terminations
https://static01.nyt.com/newsgraphics/documenttools/80043aa4cf197e0a/b99ad74a-full.pdf
https://www.nytimes.com/2025/04/07/technology/trump-tiktok-china-tariffs.html
https://www.npr.org/2025/04/09/nx-s1-5356480/nvidia-china-ai-h20-chips-trump
https://www.wsj.com/livecoverage/stock-market-trump-tariffs-trade-war-04-09-25/card/trump-says-he-will-considerexempting-some-u-s-companies-from-tariffs-BXfdUETG5o197ZivMbn0
https://www.nytimes.com/2025/03/10/business/economy/trump-tariffs-exceptions.html?smid=nytcore-ios-share&referri
ngSource=articleShare
https://www.wsj.com/politics/policy/meta-antitrust-trial-zuckerberg-lobbying-trump-67c8f3a5
https://www.whitehouse.gov/presidential-actions/2025/03/addressing-risks-from-perkins-coie-llp/
https://www.theguardian.com/us-news/2025/apr/02/trump-law-firm-executive-order
135
COMPETITION POLICY | BAKER
the FTC terminated probationary staffers.9 The Deputy Attorney General has proposed
closing the Antitrust Division’s field offices in charge of technology enforcement and
prosecuting agricultural cartels and shifting the personnel in the legal policy and expert
analysis sections (including its economists, who play a critical role in non-criminal
investigations and litigation) to a DOJ component outside the Division.10 (The Antitrust
Division leadership is reportedly resisting those proposals, however.) Anecdotally, many
experienced staff, concerned about their work environment, have left the agencies or are
planning to do so.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
136
without reviewing the detailed factual record developed by an agency investigation, that
resolution may violate the president’s constitutional obligation to “take care that the laws
be faithfully executed”18 (see the contribution by Gensler and Menand in this volume). A
direct presidential role also diminishes the authority and credibility of agency officials
with courts and firms, further harming antitrust enforcement.
Fourth, President Trump’s emerging economic war against the United States’ major
trading partners in North America, Europe, and Asia undermines the ability of the United
States to advance international economic norms that benefit domestic firms, including
the ‘big tech’ firms that find themselves targeted by enforcers abroad as well as at home.
Nations that are important trading partners for the United States are increasingly being
told to fend for themselves through President Trump’s foreign policy as well as his tariff
policies. As a result, they will likely become more resistant to US advocacy on behalf
of US firms to ensure that foreign competition authorities offer firms subject to their
investigations due process protections such as “nondiscrimination, transparency, timely
notice, meaningful engagement, timely resolution, confidentiality protections, avoidance
of conflicts of interest, access to information, opportunity to defend, access to counsel,
attorney-client privilege, written decisions, and judicial review” (Alford 2020: 1166).
Moreover, if the administration intervenes in antitrust enforcement matters in response
to corporate lobbying to protect domestic firms against competition from foreign rivals,
that would encourage other nations to respond in kind. Other nations also could reach
deals with the United States to go easy on favoured US firms in return for advantages
like reduced US tariffs or continued US security protections – to the benefit of US firms
in good graces with the administration but to the detriment of global competition.
POSSIBLE SCENARIOS FOR THE EVOLUTION OF COMPETITION POLICY
These developments from the first three months of the second Trump administration
suggest three possible scenarios for the future evolution of US competition policy. The
scenarios are not mutually exclusive, and it is difficult at this early juncture to say which
is more or less likely. Even if the path, or paths, chosen become evident quickly, their
economy-wide effects would not be rapidly apparent; those effects would likely take years
to be recognised.
The first scenario is the least dramatic: policy continuity with a Trumpian populist
spin. In this scenario, antitrust institutions would remain largely insulated from broader
administration trends. The agencies would fend off severe budget cuts and reorganisations,
the courts would uphold the FTC’s structure, and the President would focus his attention
on other policy arenas and stay away from antitrust enforcement. Relative to the Biden
administration, the federal enforcement agencies would likely be more willing to accept
settlements and may decline to pursue some close cases that their predecessors would
18 https://constitution.congress.gov/browse/article-2/section-3/
The economic consequences of such a broad continuity in antitrust policy depend on
whether current antitrust rules and enforcement levels are thought adequate to deter the
exercise of market power. While considerable economic evidence marshalled at the end of
the previous decade indicates that market power has been growing in the United States
for the past half-century, in part because of insufficient antitrust enforcement (Baker
2019: 13-25), there is now a debate about whether recent evidence suggests otherwise
(Shapiro and Yurukoglu forthcoming, Miller 2025, Baker and Scott Morton 2024). If
antitrust needs strengthening to address market power trends, policy continuity with a
Trumpian populist spin is unlikely to supply it.
The second scenario involves retrenchment. This could happen in more than one way.
First, even if the substantive antitrust norms pursued by the agencies do not change
much, administration initiatives such as large budget cuts, a DOGE-led downsizing
of the agencies, judicial neutering of the FTC through the removal of Commissioners
without cause, the possible transfer of the FTC’s antitrust functions to DOJ, and a major
reworking of the Antitrust Division’s organisational structure would be expected to lead
to a substantial cutback in federal antitrust enforcement. State government enforcement
and private plaintiffs may increase their efforts in response but would be unlikely to
come close to filling the gap. Second, advocates of big business could gain the upper
hand in the administration’s economic policymaking, perhaps, for example, if other
administration economic policies such as tariffs harm large firms materially. That could
prompt the agencies to take non-interventionist positions that advance big business
interests (Lancieri et al. 2023). Finally, the Supreme Court could implement an antitrust
retrenchment regardless of the substantive views of enforcement agency leadership
through antitrust decisions that take a non-interventionist view (Baker 2023a).
Antitrust retrenchment removes a critical check on the increased exercise of market power.
Regardless of how the evidence about past market power trends and the sufficiency of
antitrust enforcement is interpreted, there is little question that retrenchment of federal
enforcement would supercharge the exercise of market power. That happened during
historical episodes in which US antitrust enforcement was absent or lax (Baker 2003).
The predictable consequences of the exercise of market power within the affected markets
include wealth transfers away from the affected buyers or suppliers, allocative efficiency
137
COMPETITION POLICY | BAKER
have challenged through enforcement, while maintaining major antitrust norms. The
agencies also would continue to pursue their high-profile challenges to anticompetitive
conduct by big tech firms. Future enforcement, however, and perhaps the remedies sought
in some big tech cases now being litigated, could take a Trumpian populist tilt, focused
on the alleged suppression of conservative voices by ‘woke’ corporations rather than the
adverse economic effects of their unlawful monopolistic conduct. A Trumpian populist
spin on antitrust enforcement also might target for investigation agreements among
product market rivals to develop and implement environmental, social, and government
(ESG) policies. If the big tech cases do not change focus, though, enforcement in this
scenario would, in a general way, look similar to enforcement in the recent past.
losses, wasteful rent seeking, and slowed innovation and productivity improvements
(Baker 2019: 26-29). Economy-wide, greater market power can be expected over time to
slow economic growth and increase inequality (Baker 2019: 29-31).
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
138
The third scenario can be termed direct political influence. This scenario encompasses
several possibilities (Baker 2019: 53-57). The direct political influence scenario includes
special interest protectionism, by which firms or other narrow interest groups induce the
government – in this case, through presidential influence over antitrust enforcement – to
create or protect market power. It also includes straightforward corruption, by which
firms find ways to make financial or political payoffs to the president, possibly indirectly
through his family or political allies, in exchange for favourable regulatory treatment.
If such outcomes move from being transactional and episodic to becoming a systemic
and entrenched method of operation, then firms with political influence can invest the
rents from their exercise of market power to secure greater political power, allowing
them to preserve and extend their market power and thereby creating a vicious circle. In
the extreme, when the system is used to enrich firms’ political allies (their ‘cronies’) – in
this case, perhaps senior administration officials and their families – as well as to enrich
the firms, it is termed ‘crony capitalism’.
In addition to undermining the rule of law (see the contribution by Coates in this
volume), direct political influence would threaten economic prosperity. When firms
can evade antitrust proscriptions by negotiating deals, competition and prosperity are
harmed directly, as would also result from retrenchment. Direct political influence
also creates more insidious threats to productivity and growth. In this scenario, when
firms realise they must pay tribute to conduct their business – even if their mergers
or business conduct would ultimately be found not to violate the antitrust laws after a
long and expensive trial – they would be expected to channel their business activities to
navigate around the president’s political and financial interests. In President Trump’s
case, those financial interests extend from hotels and golf courses to social media (Truth
Social) and finance (brokerage19 and cryptocurrency20). Firms also would be expected
to navigate around the president’s political interests, which could, for example, possibly
discourage investment in pharmaceutical research (e.g. for vaccine development). The
uncertainty generated by this way of doing business will by itself make investment less
attractive, further inhibiting economic growth. These adverse effects may be amplified if
this approach to US competition policy is emulated by other nations, particularly major
trading partners.
The first scenario – policy continuity with a Trumpian populist spin – would tend to
preserve current antitrust norms. The retrenchment and direct political influence
scenarios, by contrast, risk imperiling those norms. That could endanger the “faith in
19 https://www.barrons.com/articles/djt-truth-social-trump-media-stock-price-investment-accounts-55722e5d; https://www.
dlnews.com/articles/people-culture/inside-the-trump-family-crypto-empire/
20 https://www.bbc.com/news/articles/c98y47vrv2jo
CONCLUSION
Antitrust enforcement during the first few months of the second Trump administration,
as implemented by the DOJ and FTC, has not deviated dramatically from the Biden
administration’s approaches, although the continuity in competition policy may
take a Trumpian populist tilt. In this respect, antitrust differs appreciably from early
second Trump administration policies in other areas influencing the economy, such as
international trade, immigration, and funding for scientific research.
Other steps taken by the new Trump administration from outside the antitrust
enforcement world could potentially lead to more substantial consequences for
competition policy. Some of those steps suggest an antitrust enforcement retrenchment.
Others suggest the possibility of direct political influence on antitrust enforcement
outcomes. It is too early to tell which scenario, or what mix of scenarios, is the most likely.
Regardless of the way competition policy evolves, the short-term economic consequences
likely would be limited. But the retrenchment and direct political influence scenarios
would give rise to substantial long-term threats to innovation, productivity, growth, and
prosperity economy-wide. Moreover, uncertainty about the evolution of competition
policy can itself discourage investment, compounding the potential for long-term
economic harms.
REFERENCES
Alford, R (2020), “Promoting International Procedural Norms in Competition Law
Enforcement”, Kansas Law Review 68: 1165-1180.
Baker, J (2003), “The Case for Antitrust Enforcement”, Journal of Economic Perspectives
17(4): 27–50.
Baker, J (2019), The Antitrust Paradigm: Restoring a Competitive Economy, Harvard
University Press.
Baker, J (2023a), “What About the Supreme Court? The Lurking Threat to U.S. Antitrust
Reform”, Journal of Antitrust Enforcement 11: 154–161.
21 National Society of Professional Engineers v. United States, 435 U.S. 679, 695 (1978) (quoting Standard Oil Co. v. Federal
Trade Commission, 340 U.S. 231, 248 (1951)).
139
COMPETITION POLICY | BAKER
the value of competition” that the Supreme Court has described as at “[t]he heart of our
national economic policy”.21 Together with other Trump administration policy initiatives,
these latter scenarios also could mark the decisive rejection of a central theme of postWorld War II domestic economic policy in the United States that transcends the 1980s
turn to neoliberalism, namely, the pursuit of inclusive economic growth (Baker 2023b).
Baker, J (2023b), “Not a Simple Story of Big Business Capture: An Essay on the Political
Economy of Antitrust”, Antitrust Law Journal 85(2): 521-538.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
140
Baker, J (2025), “Threats to Competition Policy in the Second Trump Administration: Is
Antitrust Enforcement Following Alice Down the Rabbit Hole?”, ProMarket, 12 April.
Baker, J and F Scott Morton (2024), “Market Power Has Grown and Antitrust Needs
Strengthening, Despite What Shapiro & Yurukoglu and Miller Suggest”, ProMarket, 1
October.
Lancieri, F, E A Posner and L Zingales (2023), “The Political Economy of the Decline of
Antitrust Enforcement in the United States”, Antitrust Law Journal 85(2): 441-519.
Meador, M R (2025), “Antitrust Policy for the Conservative,” Federal Trade Commission,
1
May
(https://www.ftc.gov/system/files/ftc_gov/pdf/antitrust-policy-for-theconservative-meador.pdf).
Miller, N (2025), “Industrial Organization and The Rise of Market Power”, International
Journal of Industrial Organization 95: 103131.
Shapiro C and A Yurukoglu (forthcoming), “Trends in Competition in the United States:
What Does the Evidence Show?”, Journal of Political Economy Microeconomics.
Slater, A (2025), “The Conservative Roots of America First Antitrust Enforcement”,
speech at University of Notre Dame, 28 April (https://www.justice.gov/opa/speech/
assistant-attorney-general-gail-slater-delivers-first-antitrust-address-university-notre).
ABOUT THE AUTHOR
Jonathan B. Baker is Professor of Law Emeritus at American University Washington
College of Law, and Fellow and Senior Academic Advisor of the Thurman Arnold Project
at Yale. He served as the Chief Economist of the Federal Communications Commission
from 2009 to 2011 and as the Director of the Bureau of Economics at the Federal Trade
Commission from 1995 to 1998. Previously, he worked as a Senior Economist at the
President’s Council of Economic Advisers, Special Assistant to the Deputy Assistant
Attorney General for Economics in the Antitrust Division of the Department of Justice,
an Assistant Professor at Dartmouth’s Amos Tuck School of Business Administration,
an Attorney Advisor to the Acting Chairman of the Federal Trade Commission, and
an antitrust lawyer in private practice. He has received the Jerry S. Cohen Award
for Antitrust Scholarship, American University’s Faculty Award for Outstanding
Scholarship, Research, and Other Professional Accomplishments, and the Federal Trade
Commission’s Award for Distinguished Service.
CHAPTER 10
Gary Gensler
MIT Sloan
Artificial intelligence (AI) is one of the most transformative technologies of our times.
As it further takes on pattern recognition, decision making, content generation, and
complex reasoning, it will continue to create efficiencies and innovations across the
economy, from health care, to science, to everyday life.
In this chapter, I explore how the second Trump administration’s policies may affect the
path of AI development and what this may mean for the economy.
First, I review the AI policy landscape prior to the current administration. I then review
the new administration’s AI-related policy shifts. It is important to note, though, that AI
policy is yet to be fully formed and that the administration’s policy changes not directly
related to AI may have a more significant effects on AI development than those from
direct AI-related policies.
To consider the economic consequences of the new administration’s policies, I next turn
to two brief sections on (a) the key characteristics of AI development and adoption, and
(b) the ongoing debates on the economic implications of AI.
Recognising the many uncertainties, I then explore the possible economic effects of the
new administration’s AI-related policies.
THE AI POLICY LANDSCAPE PRIOR TO THE NEW ADMINISTRATION
Since the OECD first conducted its 2017 conference entitled “AI: Intelligent Machines,
Smart Policies” (OECD 2018) and published its 2019 OECD “AI Principles”,1 hundreds
of AI-related policy conferences, guidelines, and principles have been conducted or
released.
Thus, a full review of the global AI policy landscape is beyond the scope of this chapter. I
will therefore attempt to summarise only those policy interventions most relevant to the
question at hand, namely, the effects that the evolving policies of the new administration
may have on the US economy.
1
https://oecd.ai/en/ai-principles, updated in May 2024.
141
ARTIFICIAL INTELLIGENCE DEVELOPMENT AND POLICY LANDSCAPE | GENSLER
Artificial intelligence development and
policy landscape
First, there are a broad array of policies characterised as AI ethics or, more recently, as
‘responsible AI’. This can cover policies related to explainability, bias, accuracy, reliability,
privacy, data rights, transparency, conflicts, safety, and security (Stanford Institute for
Human-Centered AI 2025).
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
142
For both consumer and commercial use, AI presents challenges regarding explainability,
bias, and accuracy. This is particularly relevant as AI models have been developed to
help make decisions about who gets jobs, loans, healthcare, entry to schools, and prison
sentences, to name just a few.
Such challenges are not new in the use of data analytics to allocate scarce resources.2
AI, though, heightens these challenges. Its math is nonlinear and can have many billions
of parameters, making it inherently challenging to explain in terms understandable to
humans. The outcomes also are based on data which may reflect historical biases and
latent features that inadvertently are proxies for protected characteristics. Further, as
users of generative AI models know, the impressive performance of these models does
not mean they are always accurate or reliable.
AI also has been used by bad actors to deceive people, whether it be for identify theft,
fraud, disinformation campaigns, fake news, market manipulation, or influencing
elections. There also has been a rise in AI intimate image deepfakes.
Further, given AI’s critical dependence on data, there have been significant debates about
privacy, copyright protection, and intellectual property rights. The long and growing list
of copyright lawsuits playing out in US courts is but one indication of the challenges in
this area (Knibbs 2024).
In addition, as AI facilitates efficient ‘narrowcasting’ – targeting communications,
product offerings, and pricing narrowly to each of us – producers are more able to find
each individual’s maximum willingness to pay a price to purchase a product. With such
narrowcasting, there is a greater chance of conflicts and shifting consumer welfare to
producers (Gensler 2024a). Further, the possibility of one or even a small number of AI
platforms or data aggregators dominating a field raises issues regarding economic rents
and financial stability (Gensler and Bailey 2020).3
The EU has adopted a series of laws related to these issues, including the EU AI Act.4
This act puts new requirements on a list of ‘high-risk’ AI applications, such as those used
for jobs, education, and health treatment, while banning certain other applications, such
as real-time biometric identification or those used for social scoring.
2
3
4
In the late 1960s and early 1970s, the Fair Housing Act, Fair Credit Reporting Act, and Equal Credit Opportunity Act were
enacted, in part, driven by similar issues.
Also see Gensler (2024b).
https://www.bloomberglaw.com/external/document/X89VQB00000000/tech-telecom-professional-perspective-gdpr-vai-act-other-eu-dat
Second, the US and other nations have used tax, competition, energy, trade, and industrial
policy to promote AI development within their countries. In 2022, the US enacted the
CHIPS and Science Act, providing $53 billion in funding to promote US semiconductor
manufacturing (US Department of Commerce 2024).
Further, starting with the 2019 restrictions on Chinese tech company Huawei,8 the
US has used an increasing scope of restrictions on China, including export controls
on AI-related technology, particularly for semiconductors and chip making. The Biden
administration added investment controls on China as well, on both outbound9 and
inbound10 investments. Towards its end, the administration adopted a rule placing
restrictions on AI diffusion, on other countries as well as China, based upon individual
countries’ positions within a new three-tier system (Horowitz 2025).
Prior to leaving office, though, Biden’s Secretary of Commerce, Gina Raimondo, said that
“[t]rying to hold China back is a fool’s errand”, suggesting that other than near-term costs
on China, they are likely to catch up. She added that promoting US tech investments
“matters more than export controls” (Ward and Fitch 2024).
5
Executive Order 14110 “Safe, Secure, and Trustworthy Development and Use of Artificial Intelligence”, 30 October 2023
(https://www.federalregister.gov/documents/2023/11/01/2023-24283/safe-secure-and-trustworthy-development-and-useof-artificial-intelligence), as well as Executive Order 14141 “Advancing United States Leadership in Artificial Intelligence
Infrastructure”, 17 January 2025 (https://www.federalregister.gov/documents/2025/01/17/2025-01395/advancing-unitedstates-leadership-in-artificial-intelligence-infrastructure).
6 “Memorandum on Advancing the United States’ Leadership in Artificial Intelligence; Harnessing Artificial Intelligence
to Fulfill National Security Objectives; and Fostering the Safety, Security, and Trustworthiness of Artificial Intelligence”,
24 October 2024 (https://bidenwhitehouse.archives.gov/briefing-room/presidential-actions/2024/10/24/memorandumon-advancing-the-united-states-leadership-in-artificial-intelligence-harnessing-artificial-intelligence-to-fulfill-nationalsecurity-objectives-and-fostering-the-safety-security/).
7 https://www.bclplaw.com/en-US/events-insights-news/us-state-by-state-artificial-intelligence-legislation-snapshot.html
8 See Commerce Department Bureau of Industry & Security Final Rule 15 CFR Part 744 (https://www.federalregister.gov/
documents/2019/05/21/2019-10616/addition-of-entities-to-the-entity-list).
9 https://home.treasury.gov/policy-issues/international/outbound-investment-program
10 Executive Order 14083 “Ensuring Robust Consideration of Evolving National Security Risks by the Committee on Foreign
Investment in the United States”, 15 September 15 (https://www.govinfo.gov/content/pkg/FR-2022-09-20/pdf/2022-20450.
pdf).
143
ARTIFICIAL INTELLIGENCE DEVELOPMENT AND POLICY LANDSCAPE | GENSLER
In the US, rather than passing a set of binding federal laws, President Biden issued several
Executive Orders5 and Memorandums6 addressing safety, security and US leadership in
AI. Further, his regulatory agencies took up rule-making projects on various aspects
of AI’s use (Stanford Institute for Human-Centered AI 2025: Chapter 6). Legislative
activity, though, has occurred in US states, with many having implemented or considered
laws related to privacy, data governance, intimate imagery, election fraud, and bias.7
EVOLVING POLICY UNDER THE NEW ADMINISTRATION
I now turn to explore the new administration’s AI-related policies – both direct and
indirect.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
144
Four overall observations to start:
1. In contrast to other policy areas (e.g. tariffs, immigration, science funding, or
foreign aid), AI-related policy shifts, to date, have been far less dramatic.
2. The new administration’s AI-related policy is yet to be fully formed and remains
uncertain, with public comment sought on 20 topics in the AI Action Plan Request
for Information.11
3. The direction of travel, though, is clearly to ease economic regulations, thus
effecting ‘responsible AI’, and to toughen restrictions with regard to China’s access
to technology.
4. Policy changes not directly related to AI likely have a more significant effect than
those from direct AI-related policies announced to date.
Let us now turn to some of the specific policy shifts.
First, the new administration’s numerous efforts to ease regulation in general12 are
the most relevant policy shifts effecting responsible AI to date. The President also has
issued an Executive Order calling for an action plan to be developed within 180 days to
“sustain and promote America’s global AI dominance.”13 The President revoked the prior
administration’s Executive Order on safe, secure, and transparent AI, though has yet to
rescind actions related to infrastructure or national security. The new administration
also has called for the EU to scale back its AI and digital-related laws and regulation
(Vance 2025).
Second, the new administration has taken steps to toughen restrictions on technology
flows to China, amongst other countries. The Commerce Department added 80 entities
from China, Iran, South Africa, Taiwan, and the UAE to the list of entities restricted
from purchasing various US manufactured technologies (Bureau of Industry and
Security 2025). They subsequently put restrictions on Nvidia’s ability to sell its H20 chips,
11
https://www.federalregister.gov/documents/2025/02/06/2025-02305/request-for-information-on-the-development-ofan-artificial-intelligence-ai-action-plan
12 Of particular relevance to AI development and use might include the easing of regulations at the Consumer Financial
Protection Bureau, Education Department, Environmental Protection Agency, Federal Trade Commission, Food & Drug
Administration, Health & Human Services Department, Housing & Urban Affairs Department, Labor Department, Securities
and Exchange Commission, Transportation Department, and Treasury Department, amongst others. See also Executive
Order 14151, “Ending Radical and Wasteful Government DEI Programs and Preferencing”, 20 January 2025 (https://www.
whitehouse.gov/presidential-actions/2025/01/ending-radical-and-wasteful-government-dei-programs-and-preferencing/).
13 Executive Order 14179, “Removing Barriers to American Leadership in Artificial Intelligence”, 23 January 2025 (https://
www.federalregister.gov/documents/2025/01/31/2025-02172/removing-barriers-to-american-leadership-in-artificialintelligence).
Lastly, as mentioned, policy changes not directly related to AI – particularly tariff,
environmental, anti-trust, immigration, and science funding policies – may have
significant effects on AI development.
To consider the economic consequences of the new administration’s policy, I now turn to
consider the key characteristics of AI development and adoption as well as some of the
debates on the economic implications of AI.
AI DEVELOPMENT AND ADOPTION
Though much of the recent buzz has been about generative AI, exemplified by the
commercials broadcast during the 2025 Super Bowl (Forristal 2025), AI is much broader
and isn’t at all new.17
We already have seen a lot of adoption of AI. Text prediction in our phones and emails
has been commonplace for years. AI surpassed human baseline performance for image
classification in 2015, and medium-level reading comprehension two years later.18 It is
being used for natural language processing, translation software, recommender systems,
radiology, robotics, drones, and our virtual assistants. It also is being used in scientific
research and medical devices to help save lives and by militaries in war. In his recent
annual letter to shareholders, Amazon CEO Andy Jassy wrote that Amazon currently
has over 1,000 generative AI applications being developed, stating that “Generative AI is
going to reinvent virtually every customer experience we know…”.19
AI performance gains are based on sustained advances in each of AI’s main building
blocks – computational power, math, and data. As a result, AI is experiencing three
exponential tech growth curves simultaneously – each amplifying the others.
14 https://www.nytimes.com/2025/04/16/technology/nvidia-deepseek-china-ai-trump.html; also see https://www.wsj.com/
economy/trade/nvidia-china-us-export-rules-0a3e9280
15 https://www.bloomberg.com/news/articles/2025-05-07/trump-to-rescind-global-chip-curbs-amid-ai-restrictions-debate.
See also https://www.bloomberg.com/news/articles/2025-03-25/tech-chiefs-foreign-leaders-urge-trump-to-rethink-aichip-curbs
16 “America First Investment Policy”, Presidential Memorandum, 21 February 2025 (https://www.whitehouse.gov/presidentialactions/2025/02/america-first-investment-policy/).
17 It was 1950 when Alan Turing wrote a seminal paper, opening with, “I propose to consider the question, ‘Can machines
think?’” (Turing 1950). In 1997, world chess champion Garry Kasparov was defeated by IBM’s Deep Blue (Krishnamurthy
2022). By 2016, AlphaGo, using AI, defeated a human world champion in the complex game of Go (Metz 2016).
18 See Figure 2.1.33 in Stanford University Institute for Human-Centered AI (2025).
19 https://www.aboutamazon.com/news/company-news/amazon-ceo-andy-jassy-2024-letter-to-shareholders
145
ARTIFICIAL INTELLIGENCE DEVELOPMENT AND POLICY LANDSCAPE | GENSLER
which had been released just last year to comply with Biden-era restrictions.14 After
many industry and international calls to do so, the new administration is planning to
revise Biden’s AI Diffusion Rule, though not change the restrictions on China.15 Further,
it issued the America First Investment Plan, which streamlines investment reviews for
allies, while tightening restrictions on China and certain other countries investing in US
companies with sensitive technology, data, or infrastructure.16
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
146
Many readers are familiar with Moore’s Law – the prediction in 1965 that computational
power would double every two years.20 Remarkably, this has been roughly true ever
since. Machine learning hardware performance has doubled every 2.2 years since 2008
(Rahman 2025). When also taking into consideration increased hardware spending, the
amount of compute used to train AI models has grown even faster, doubling every five
months (Rahman and Owen 2025).
There have been major advances in the math, computer science, and algorithms
underlying AI as well. AI has moved from deterministic models, to neural networks, to
deep learning, to transformer models, resulting in significant advances in its performance.
AI models’ parameters21 no longer number in the hundreds; they can be in the billions,
with some models now having passed a trillion.22 By one set of estimates (Brown et al.
2024), gains from algorithm innovation may be on a par with the computational gains via
Moore’s Law.
AI also can train on an exponentially growing set of data. Far beyond just using the
Common Crawl23 and Internet web scraping (Leffler 2023), data are being drawn from
many other sources, including our social media, shopping, and spending footprints. They
are being drawn from the explosion in sensors – cell phones, fitness devices, telematics
in cars, appliances, cameras, and other so-called Internet of Things (IoT) sensors (Biba
2023). Generative AI can be trained on user queries and data inputs. We also are seeing
advances in multimodal AI systems, which use multiple types of data sets – video, audio,
speech, images, and text – to make even more powerful systems.
Another relevant perspective worth mentioning is that AI is not one uniform sector nor set
of products. Rather, today’s AI relies on a complex set of ecosystems populated by a wide
variety of companies, markets, products, service providers, researchers, technologies, and
users. AI’s technology stack ranges from the hardware, software, and cloud providers, to
the hyperscalers building generative AI platforms, to the app developers and users in
nearly every economic sector. It includes multiple layers of companies providing data,
network security, and development operations.24
20 Moore’s Law was the prediction of Gordon Moore, co-founder of Intel, in 1965. He said computer power would double every
two years while computer costs would be cut in half (see https://www.intel.com/content/www/us/en/history/virtual-vault/
articles/moores-law.html).
21 Coefficients related to the connections between neural networks’ nodes or to transformer models’ weight matrixes.
22 https://ourworldindata.org/grapher/exponential-growth-of-parameters-in-notable-ai-systems#:~:text=More%20
parameters%20can%20help%20the,than%20learning%20their%20underlying%20patterns.
23 https://commoncrawl.org
24 https://www.leewayhertz.com/generative-ai-tech-stack/. Also see Hopkins et al. (2024).
ECONOMICS OF AI
Estimates of AI’s impact on US productivity vary widely (Hartmann and Maver
2025).25 My MIT colleague, Daron Acemoglu, projects that AI may add only 0.5–
0.6% to productivity over ten years (Acemoglu 2024). My former MIT colleague, Eric
Brynjolfsson, along with Martin Bailey and Anton Korinek, predict a more optimistic
future for productivity (Bailey et al. 2023). My former employer, Goldman Sachs, also has
a more optimistic forecast for productivity gains, predicting that AI will boost GDP by
7% over a decade (Briggs and Kodnani 2023).
Productivity gains from AI will depend on numerous factors. Of consequence will be
the rate at which AI is used to automate tasks versus augmenting them. Which tasks
and sectors will experience adoption and at what rate? The more AI spurs innovation,
leads to complementary inventions, and changes business models, the more significant
the productivity gains will be.
AI development, though, is experiencing exponential performance across the three main
inputs –the compute, algorithms, and data. I believe that AI performance will continue
to grow rapidly, enabling its use for an increasing number of tasks and innovations across
many sectors of the economy. As a result, I am more optimistic than others with regard
to AI’s likely contribution to US productivity and economic growth over the intermediate
and longer term.
As this chapter, though, is focused on the economic consequences of policy changes rather
than the current projected level of growth, we need not pick amongst the competing
views as a base case.
There are similar debates as to what AI’s effects will be on labour markets and income
inequality. Will AI act more as a labour substitute or complement? Acemoglu and his
MIT colleague Simon Johnson contend that while AI may boost average productivity, it
also may substitute for routine and middle-skill jobs, potentially displacing workers and
exacerbating wage disparities (Acemoglu and Johnson 2024).26 In contrast, David Autor
suggests that AI, if implemented thoughtfully, could augment capabilities of lowerskilled workers, potentially reducing inequality (Autor 2024).
25 Also see Chapter 7 of Council of Economic Advisers (2025) and Aldoroso et al. (2024).
26 Also see Acemoglu and Johnson (2023).
147
ARTIFICIAL INTELLIGENCE DEVELOPMENT AND POLICY LANDSCAPE | GENSLER
Though many economists recognise AI as a transformative general-purpose technology,
there are a wide range of views as to its potential economic implications. While AI raises
many interesting economic debates, three in particular are prominent. How much will
it boost productivity? What will its effects be on labour markets and income inequality?
What are its effects on market concentration?
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
148
As to market concentration, we have seen how one tech platform, or a small number of
platforms, can come to dominate a field. In the US, there is one leading search engine, one
leading ecommerce platform, and three leading cloud providers. Due to the economies
of scale and network effects at play, we are likely to see the same develop within the AI
ecosystem.27 We already have seen affiliations between the three largest cloud providers
and the leading generative AI companies. We also have seen concentration develop at the
infrastructure level. Nvidia, TSMC, ASML, and SK Hynix each dominate their respective
products of AI accelerators, advanced semiconductors, EUV lithography systems, and
high band-width memory chips (Bergen 2025). On the other hand, to the extent that
smaller firms can leverage AI to gain expertise, it may foster greater competition. Further,
open-source models may foster broader access to AI and lessen market concentration.
POSSIBLE ECONOMIC EFFECTS OF THE NEW ADMINISTRATION’S POLICIES
Recognising that while much is still unknown, what might be the possible economic
effects of the new administration’s evolving policy landscape? As Brynjolfsson and Unger
(2023) point out, the future economic effects of AI depend, in part, on policy choices.
First, what might be the effects of an eased overall regulatory landscape, including
enforcement, which might affect responsible AI?
I believe that the effects may be different in the near term versus the intermediate to
longer term.
In the near term, less oversight, related costs, and compliance risk may spur greater
product innovation, experimentation, and productivity gains. This, however, could come
with increased reputational risks for AI providers and risks for their users. In addition,
light enforcement of copyright and IP rights would likely diminish economic incentives
for content producers, affecting the quantity and availability of certain high-quality
data.28
In the intermediate to longer term, the history of consumer and investor protection laws
suggests that a balanced regulatory approach to responsible AI would create a public
good of trust, likely better promoting economic growth. Addressing explainability, bias,
accuracy, reliability, and privacy encourages more adoption of AI; guardrails against
fraud, conflicts, and deepfakes do the same. AI companies would benefit from greater
demand, uniform minimum compliance standards, potentially lower costs, and lower
brand risk. Car manufacturers – along with drivers, passengers, and pedestrians – have
long benefited from traffic lights, stop signs, and speed limits.
27 “’Issac Newton to AI’: Remarks before the National Press Club”, Gary Gensler, 17 July 2023 (https://www.sec.gov/news/
speech/gensler-isaac-newton-ai-remarks-07-17-2023).
28 On May 9, the President fired the head of the U.S. Copyright Office, after that office published a pre-publication report
(U.S. Copyright Office 2025). The report had indicated that some training of generative AI models may go “beyond fair use
boundaries”.
Second, what might be the effects of tightening export and investment controls along
with the effects of the trade war? Again, the near-term effects may be different than the
longer-term effects.
Tougher controls may support US AI companies’ competitive lead in the near term,
though even in the short run the trade war could significantly disrupt semiconductor
supply chains. In the intermediate and longer term, these policies could further encourage
China (and possibly other nations) to become self-sufficient and more competitive.29
Users, though, might benefit from the increased global competition, lowering market
concentration and economic rents. On the other hand, it may be negative for the growth
of US AI companies, particularly the hyperscalers and infrastructure providers. It also
may diminish the global market shares and profitability of such US companies.
There are increasing concerns amongst the tech and AI sectors about these very points.
Particularly in light of the dramatic increase in tariffs and the ongoing trade war, they
are concerned that US policy will constrain its AI development.30
China has shown its capabilities and ability to innovate in many fields while also building
self-sufficiency. It also has shown impressive advances in closing the AI performance gap
with the US, with competitive products by DeepSeek, Baidu, Alibaba, ByteDance, and
others.31
While restrictions on the best semiconductors may slow progress, China will likely find
workarounds and become more self-sufficient over time. Their computer scientists are
talented and generally have access to the latest algorithms. With its size, political system,
sensor-based economy, and social credit system (Daum 2024), China has greater access
to personal data than any other country.
29 https://www.nytimes.com/2025/04/18/technology/ai-chips-china-huawei.html
30 https://www.ft.com/content/7c1baaaf-eb58-4b9b-9abb-3cece7970afa
31 See Chapter 2 in Stanford Institute for Human-Centered AI (2025).
149
ARTIFICIAL INTELLIGENCE DEVELOPMENT AND POLICY LANDSCAPE | GENSLER
It is less clear what an eased ‘responsible AI’ regulatory environment might mean for
labour markets or the three underlying AI performance drivers. On the one hand, eased
regulations might lead to greater inequality. On the other hand, it is possible that lighter
regulation might spur innovative AI uses that serve as complements to labour rather than
just substitutes. As for the AI performance gains, as it is possible that less protection may
lead to lower demand for AI in the intermediate and longer term, this may lead to lower
investment in improving the compute, math, and data.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
150
Further, the trade war, along with curtailing access to semiconductors, has already
led China to put restrictions on exports of rare earth magnets, 32 which has affected
the production of robots. Though less likely, China also could put increasing pressure
on Taiwan (Collins and Erickson 2023), which produces over 90% of the world’s most
advanced chips, making it key to both nations’ economic growth and stability.33
Regarding other policies, an easing of environmental regulations and streamlining of
permitting may lead to more timely and less costly data centres. On the other hand, any
lighter enforcement of anti-trust laws may lead to greater market concentration and
related economic rents. Policies regarding the issuance of H1-B visas and immigration
restrictions could affect labour markets for data scientists and other AI-related jobs.
Lastly, changes in science and academic funding put real constraints on research and
will likely have effects on academic AI research as well.
In the current climate of heightened policy uncertainty, companies also may be reluctant
to make investments in AI (which are often very large) when they don’t know what
policies will be or what it will cost them. This could slow investments in AI and distort
the selection of use cases.
CONCLUSION
In this chapter, I have explored how evolving AI policies may affect the path of AI
development and what this may mean for the economy. I did so within the context of two
lenses: the drivers of AI development and adoption, as well as the ongoing debates on the
economic implications of AI.
The new administration’s AI-related policy, though, remains uncertain . In contrast to
other policy areas reviewed in this book, AI-related policy shifts, to date, have been far
less dramatic. The effect of policy changes not directly related to AI may have a more
significant effect on AI development than those from direct AI-related policies. The
direction of travel, though, is clearly towards eased economic regulations as well as
tougher restrictions with regard to China’s access to technology.
Recognising the many uncertainties in such a review, while suggesting there may be
some near-term gains in productivity from lighter-touch regulation, over the longer
term this could diminish user trust in AI, lowering associated demand and investment.
Tougher restrictions on exports, investments, and trade in the near term may give US AI
companies a competitive boost. In the intermediate to longer term, though, it may lead to
more robust competition from China and lower US AI leadership, while likely boosting
users’ alternatives.
32 https://www.reuters.com/business/autos-transportation/musk-says-teslas-optimus-humanoid-robots-affected-by-chinasexport-curbs-rare-2025-04-23/
33 https://www.nytimes.com/2025/04/16/business/china-taiwan-tariffs-chips.html
REFERENCES
Acemoglu, D (2024), “The simple macroeconomics of AI”, Economic Policy 40 (https://
academic.oup.com/economicpolicy/article/40/121/13/7728473).
Acemoglu, D and S Johnson (2024), “Learning from Ricardo and Thompson: Machinery
and Labor in the Early Industrial Revolution and in the Age of Artificial Intelligence”,
Annual Reviews of Economics 16: 597-621 (https://www.annualreviews.org/content/
journals/10.1146/annurev-economics-091823-025129).
Aldoroso, I, S Doerr, L Gambacorta and D Rees (2024), “The Impact of Artificial
Intelligence on Output and Inflation”, BIS Working Paper 1179 (https://www.bis.org/
publ/work1179.pdf).
Autor, D (2024), “AI Could Actually Help Rebuild the Middle Class”, NOEMA, 12 February
12 (https://www.noemamag.com/how-ai-could-help-rebuild-the-middle-class/).
Baily, M N, E Brynjolfsson and A Korinek (2023), “Machines of mind: The case for an AIpowered productivity boom”, Brookings, 10 May (https://www.brookings.edu/articles/
machines-of-mind-the-case-for-an-ai-powered-productivity-boom/).
Bergen, M (2025), “How the AI Boom Created the Most Valuable Monopolies in History”,
Bloomberg, 20 March (https://www.bloomberg.com/news/features/2025-03-20/
are-ai-monopolies-here-to-stay-nvidia-and-the-future-of-ai-chips?srnd=phxtechnology&embedded-checkout=true).
Biba, J (2023), “14 Types of IoT Sensors Available Today”, Built In, 21 February ( https://
builtin.com/internet-things/iot-sensors).
Briggs, J and D Kodnani (2023), “The Potential Large Effects of Artificial Intelligence
on Economic Growth”, Goldman Sachs Global Economics Analysis, 27 March (https://
www.gspublishing.com/content/research/en/reports/2023/03/27/d64e052b-0f6e-45d7967b-d7be35fabd16.html).
Brown, Z, P Slattery and H Lyu (2024), “What drives progress in AI? Trends in
Algorithms”, MIT FutureTech, 20 May (https://futuretech.mit.edu/news/what-drivesprogress-in-ai-trends-in-algorithms).
Brynjolfsson, E and G Unger (2023), “The Macroeconomics of Artificial Intelligence”, IMF
Finance & Development Magazine, December (https://www.imf.org/en/Publications/
fandd/issues/2023/12/Macroeconomics-of-artificial-intelligence-Brynjolfsson-Unger).
151
ARTIFICIAL INTELLIGENCE DEVELOPMENT AND POLICY LANDSCAPE | GENSLER
Acemoglu, D and S Johnson (2023), “Rebalancing AI”, IMF Finance & Development
Magazine, December (https://www.imf.org/en/Publications/fandd/issues/2023/12/
Rebalancing-AI-Acemoglu-Johnson).
Bureau of Industry and Security (2025) “Commerce Further Restricts China’s Artificial
Intelligence and Advanced Computing Capabilities”, press release, 25 March (https://
www.bis.gov/press-release/commerce-further-restricts-chinas-artificial-intelligenceadvanced-computing-capabilities).
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
152
Collins, G and A Erickson(2023), “Silicon Hegemon: Could China Take Over Taiwan’s
Semiconductor Industry Without Invading?”, Baker Institute, 27 September (https://
www.bakerinstitute.org/research/silicon-hegemon-could-china-take-over-taiwanssemiconductor-industry-without-invading#_edn5).
Council of Economic Advisers (2025), Economic Report of the President 2024.
Daum, J (2024), “Social Credit Action in 2025”, China Law Translate, 11 June(https://
www.chinalawtranslate.com/en/social-credit-action-in-2025/).
Forristal, L (2025), “AI-driven ads take the field during the 2025 Super Bowl”, TechCrunch,
10 February (https://techcrunch.com/2025/02/10/ai-driven-ads-take-the-field-during2025-super-bowl/).
Gazzani, A and F Natoli (2024), “The macroeconomic effects of AI innovation”, VoxEU.
org, 18 October (https://cepr.org/voxeu/columns/macroeconomic-effects-ai-innovation).
Gensler, G (2024a), “Conflicts of Interest in Artificial Intelligence”, Office Hours with
Gary Gensler, US Securities and Exchange Commission, 13 August (https://www.sec.
gov/newsroom/speeches-statements/gensler-transcript-artificial-intelligence-081324).
Gensler, G (2024b), “Systemic Risk in Artificial Intelligence”, Office Hours with Gary
Gensler, US Securities and Exchange Commission, 19 September (https://www.
sec.gov/newsroom/speeches-statements/gensler-transcript-systemic-risk-artificialintelligence-091924).
Gensler, G and L Bailey (2020), “Deep Leaning and Financial Stability” (https://papers.
ssrn.com/sol3/papers.cfm?abstract_id=3723132).
Hartmann, P and V Maver (2025), “Implications of Artificial Intelligence for Monetary
Policy”, SUERF Policy Brief No. 1080 (https://www.suerf.org/publications/suerf-policynotes-and-briefs/implications-of-artificial-intelligence-for-monetary-policy-a-firstconceptual-assessment/).
Hopkins, A, I Struckman, A Madry and L Videgaray (2024), “AI Supply Chains aren’t
AI Value Chains”, Thoughts on AI Policy, 19 January (https://aipolicy.substack.com/p/
supply-chains-6).
Horowitz, M (2025), “What to Know About AI Diffusion Policy and Export Controls”,
Council on Foreign Relations, 13 January (https://www.cfr.org/blog/what-know-aboutnew-us-ai-diffusion-policy-and-export-controls).
Knibbs K (2024), “Every AI Copyright Lawsuit in the US, Visualized”, WIRED, 19
December (https://www.wired.com/story/ai-copyright-case-tracker).
Leffler, L (2023), “Your Personal Information is Probably Being Used to Train Generative
AI Models”, Scientific American, 19 October (https://www.scientificamerican.com/
article/your-personal-information-is-probably-being-used-to-train-generative-aimodels/).
Metz, C (2016), “What the AI Behind AlphaGo Can Teach Us About Being Human”,
WIRED, 19 May (https://www.wired.com/2016/05/google-alpha-go-ai/).
OECD (2018), AI: Intelligent Machines, Smart Policies Conference Summary.
Rahman, R (2025), “The computational performance of machine learning hardware has
doubled every 2.2 years”, Epoch AI (https://epoch.ai/data-insights/peak-performancehardware-on-different-precisions).
Rahman, R and D Owen (2025), “The training compute of notable AI models is doubling
roughly every five months”, Epoch AI (https://epoch.ai/data-insights/compute-trendpost-2010).
Stanford Institute for Human-Centered AI (2025), Artificial Intelligence Index Report
2025.
Turing, A M (1950), “Computing Machinery and Intelligence” (https://phil415.pbworks.
com/f/TuringComputing.pdf).
U.S. Copyright Office (2025), Copyright and Artificial Intelligence (https://www.
copyright.gov/ai/Copyright-and-Artificial-Intelligence-Part-3-Generative-AI-TrainingReport-Pre-Publication-Version.pdf#page11.)
U.S. Department of Commerce (2024), “Two Years Later: Funding from CHIPS
and Science Act Creating Quality Jobs, Growing Local Economies, and Bringing
Semiconductor Manufacturing Back to America”, 9 August (https://www.commerce.gov/
news/blog/2024/08/two-years-later-funding-chips-and-science-act-creating-qualityjobs-growing-local).
Vance, J D (2025), “Remarks by the Vice President at the Artificial Intelligence Action
Summit in Paris, France”, 11 February (https://www.presidency.ucsb.edu/documents/
remarks-the-vice-president-the-artificial-intelligence-action-summit-paris-france).
Ward, A and A Fitch (2024), “Raimondo Says Holding Back China in Chips Race Is a
‘Fool’s Errand’”, Wall Street Journal, 22 December (https://www.wsj.com/politics/
national-security/china-biden-chip-manufacturing-gina-raimondo-b98c2606).
153
ARTIFICIAL INTELLIGENCE DEVELOPMENT AND POLICY LANDSCAPE | GENSLER
Krishnamurthy, B (2022), “The Evolution of Chess AI”, Built In, 22 October (https://
builtin.com/artificial-intelligence/chess-ai).
ABOUT THE AUTHOR
Gary Gensler is Professor of the Practice, Global Economics and Management, and
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
154
Professor of the Practice, Finance, at the MIT Sloan School of Management. Professor
Gensler previously served as Chair of the Securities and Exchange Commission (2021–
2025), Chair of the Commodity Futures Trading Commission (2009–2014), Under
Secretary of the Treasury for Domestic Finance (1999–2001), and Assistant Secretary
of the Treasury (1997–1999). He also was Chair of the Maryland Financial Consumer
Protection Commission (2017-2019) and Senior Advisor to Senator Paul Sarbanes (2002).
Earlier, Gensler worked at Goldman Sachs for 18 years, where he became a partner. His
research focuses on artificial intelligence, finance, and economic policy.
CHAPTER 11
David Baker and Simon Johnson
University of Washington; MIT Sloan
The United States has long maintained global scientific leadership through sustained,
bipartisan investment in research and talent. As China and other international
competitors expand their capabilities, the question today is whether the United States
will continue to lead or begin to fall behind. Calls for robust domestic innovation – in AI,
biomedicine, space exploration, and more – must be matched with reliable support for
the people and institutions that are fundamental to the discovery process.
Since January 2025, the Executive Branch has introduced significant uncertainty into
the US research landscape. Based on the administration’s FY2026 budget request, there
are proposals to cut funding for basic and applied science by 35–50% at the National
Institutes of Health (NIH) and the National Science Foundation (NSF). These proposals
follow ongoing shifts in policies affecting grants, international student visas, and
university research overhead.
According to the administration, the intent is to “refocus investments in the priority
areas that America must continue to lead in, securing our standing as a global tech leader
and ending woke science spending.”1 President Trump’s science advisor has described
the goal as “reinvigorating America’s scientific enterprise” to usher in a “Golden Age of
Innovation.”2
In practice, however, these changes constrict the entire US research pipeline – including
in fields the administration has identified as vital.3 In the face of unprecedented
uncertainty, American universities are already seeing steep declines in graduate student
admissions and visa availability for international researchers, who form a critical part
of the global scientific workforce. These disruptions have also prompted institutions
to scale back programmes, reduce hiring, and pause critical research initiatives.4
1
2
3
4
https://www.science.org/content/article/trump-s-proposed-budget-would-mean-disastrous-cuts-science
Michael Kratsios, speaking at the National Academies of Science, 19 May 2025 (https://www.whitehouse.gov/briefingsstatements/2025/05/remarks-by-director-kratsios-at-the-national-academy-of-sciences/).
In the assessment of Rob Atkinson of the Information Technology and Innovation Foundation: “If the administration has
any goal other than to significantly hurt the US science and research system, it will not achieve that” and “[t]his isn’t
about cutting a few projects that embraced radical DEI, or making some changes to get a little bit more efficiency. This is
actually cutting meat and bone from the entire research enterprise” (https://www.politico.com/newsletters/digital-futuredaily/2025/05/22/trump-science-nsf-funding-ostp-kratsios-00365938).
https://www.wsj.com/articles/bioscience-funding-confusion-threatens-u-s-innovation-ab0efc30.
155
WILL THE UNITED STATES CONTINUE TO LEAD IN SCIENCE? | BAKER AND JOHNSON
Will the United States continue to lead
in science?
Additional pressures – such as targeted restrictions on specific universities and broad
proposals for stiff new taxes on university endowments – have further contributed to a
chilling effect.5,6,7 Whether these significant changes will permanently weaken America’s
scientific enterprise now depends in part on the reaction of the courts and Congress.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
156
In this chapter, we explore what these changes may mean for the economy. First, we
review the US federal government research funding prior to the current administration.
We then turn to summarise the state of play for funding under the second Trump
administration at three of the main funding agencies: the National Institutes of Health,
the National Science Foundation, and Department of Energy (DoE).
Then we consider the economic consequences of these actions in three sections. First, we
consider possible effects on innovation in biosciences. We then turn to possible effects
that these actions might have to advantage China. Lastly, drawing from economic and
scientific history, we reflect on why federal government funding for science matters so
much to the overall economy and national security.
RESEARCH FUNDING: PRIOR TO THE SECOND TRUMP ADMINISTRATION
In FY2024, the US federal government spent about $195 billion on research and
development (R&D).8 Almost all of this money flowed through individual funding
agencies, following a precise allocation determined by Congress in the annual
appropriations process. Six agencies received about 95% of all federal R&D funding: the
Department of Defense (DoD, roughly 46% of the total); the Department of Health and
Human Services, within which R&D is almost entirely run by the NIH (25%); the DoE
(11%); the National Aeronautics and Space Administration (NASA, 6%); the NSF (4%);
and the US Department of Agriculture (USDA, 1.5%).9
Federal spending in the fiscal 2024 on R&D was categorised as $47 billion on basic
science, $48 billion on applied research, $95 billion on development, and $5.7 billion
on facilities and equipment. In terms of spending on just basic science, the key funding
5
6
7
8
9
In May 2025, much higher taxes on university endowment income, up to 23.1 percent in some cases, were included tax
legislation that passed the House.
The administration is currently withholding about $2.7bn in research funding from Harvard University, as well as over $2
billion from other universities (The Economist 2025, pp.67-68).
There are about 36,000 “foreign and domestic STEM PhD seekers”, of whom about 16 percent are Chinese nationals.
The Administration has indicated that it will become more difficult for such students to receive or renew visas, and some
existing visas may be revoked. https://www.nytimes.com/2025/05/28/us/politics/china-student-visas-revoke.html
FY2024 ended on 30 September 2024. The information in this paragraph is from Congressional Research Service (2024).
For details of the appropriations process and the relevant legislation, see Table 7 on p.13 of that report.
The Economist (2025: 69) reports “[r]esearch spending at government institutions and universities, 2023 or latest, $bn
at PPP” as around $180 billion, but this figure likely includes Department of Defense spending; much of the DoD activity
is classified, but presumably the vast majority is spent on weapons development (see the discussion in Congressional
Research Service 2024: 14-17).
agencies are NIH (roughly $22 billion in FY2024 was on basic research), the NSF ($6.3
billion in FY2024 on basic research), and the DoE ($6.1 billion in FY2024 on basic
research).10
RESEARCH FUNDING: SECOND TRUMP ADMINISTRATION FOR THE NATIONAL
INSTITUTES OF HEALTH, THE NATIONAL SCIENCE FOUNDATION, AND
DEPARTMENT OF ENERGY
The state of play for the three main funding agencies at the end of May 2025 includes the
following
National Institutes of Health
1. Effective 10 February, the administration limited reimbursement of indirect costs
at universities and medical centers to 15%, replacing all previously negotiated
rates (which averaged over 25%, although for some institutions the rate is over
50%). Implementation of these cuts is currently blocked by the courts.12
2. The precise funding flow from NIH in 2025 is not yet clear, but some grants have
been terminated and there has been an increase in the rejection rate for grants,
including for young scientists from varied backgrounds. As of 6 May, according
to one estimate, 777 NIH grants worth approximately $1.8 billion had been
terminated so far in 2025.13
10 Source: Table 3 in Congressional Research Service (2024). All figures are estimates for FY2024. The NIH number here is
approximated from the line item for Department of Health and Human Services, as NIH accounts for 97% of HHS R&D
spending (Congressional Research Service 2024: 17-18). NIH is comprised of the NIH Office of the Director and 27 institutes
and centers (p.18); the total NIH budget “with proposed mandatory amounts” was $48.8 billion (p.22). Part of the DoE
science spending is in its own labs, but “the Department provides over $2.5 billion annually to more than 300 colleges
and universities to support Department-sanctioned research” (https://www.energy.gov/articles/department-energyoverhauls-policy-college-and-university-research-saving-405-million).
11 The Economist (2025: 66) sees the math this way: “The federal government doles out around $120bn a year, $50bn or so
of which goes towards tens of thousands of grants and contracts for higher-education institutions, with the rest going to
public research bodies.” The New York Times calculates the flow to 650 colleges “in all 50 states” in 2023 as closer to $60
bilion and offers a very useful regional breakdown at https://www.nytimes.com/interactive/2025/04/30/us/universityfunding-research.html.
12 See https://www.statnews.com/2025/03/05/nih-indirect-costs-lawsuit-federal-judge-extends-order-blocking-trump-cuts/
and https://www.lathamreg.com/2025/03/the-nih-funding-cuts-implications-and-status-of-lawsuits/.
13 According to one informed assessment, “the NIH quietly closed around 100 funding categories in February and March,
according to documents seen by Nature. Many of these categories supported researchers from diverse backgrounds or
investigators early in their careers” (https://www.nature.com/articles/d41586-025-01539-5). On the funding cuts, see
https://www.aamc.org/media/83356/download.
157
WILL THE UNITED STATES CONTINUE TO LEAD IN SCIENCE? | BAKER AND JOHNSON
As a country, the United States spent $801 billion on R&D in 2021 (this the latest
available annual data, which also indicate that China spent $668 billion, Japan spent
$177 billion, and Germany spent $154 billion) (National Science Board 2024: 2). While
the federal government’s share of total national R&D hovers at around a quarter, it is
the most important funder of basic research in the United States with a 40% share; the
remainder is funded by business (37%), higher education (12%), and other sources (11%).11
3. The administration’s FY2026 budget proposes a cut of $18 billion to the NIH
budget, which would be a 37% decline from the $49 billion spent in FY2024.14
4. Hundreds of staff have been laid off, including some senior leadership.15
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
158
National Science Foundation
1. From 5 May, reimbursements of indirect costs are limited to 15%.16
2. Since January, the NSF has slowed its spending by roughly 50% – in 2015-24 it
awarded grants worth roughly $2 billion on average from January through May
21, but during the same period in 2025 it only spent $989 million.17
3. The administration has proposed to shrink the NSF FY2026 budget from $9
billion to $4 billion in FY2026.
4. A significant employment reduction is underway.18
Department of Energy
1. Reimbursements of indirect costs will be limited to 15%.19
2. The administration proposes cutting the Office of Science spending in FY2026 by
14% to $7.1 billion.20
3. Large employment cuts are reportedly under consideration, subject to determining
which employees are deemed “essential”.21
ECONOMIC EFFECTS: INNOVATION IN BIOMEDICINE
In this section, we focus on the case of biomedicine, which stands on the verge of
potential major breakthroughs, including by marrying the latest developments in AI
with cutting-edge lab research. Prior to 2025, the United States was in pole position
to create the next generation of technologies that save lives, improve productivity, and
protect against aggression.22 Given the actions of the second Trump administration,
there is a very real risk that American biomedicine (and science more broadly) will
now fall behind its international competitors, with profound negative implications for
industry, employment, and national security.
14 “President Donald Trump’s administration wants to cut nearly in half the $47 billion budget of the U.S. National Institutes
of Health (NIH) and reorganize the agency’s 27 institutes and centers into just eight institutes” (https://www.science.org/
content/article/trump-proposes-massive-nih-budget-cut-and-reorganization). See also https://www.science.org/content/
article/trump-s-proposed-budget-would-mean-disastrous-cuts-science.
15 https://www.statnews.com/2025/04/01/nih-rif-1200-layoffs-raise-concerns-health-medicine-biomedical-research
16 https://www.nsf.gov/policies/document/indirect-cost-rate.
17 https://www.nytimes.com/interactive/2025/05/22/upshot/nsf-grants-trump-cuts.html
18 https://www.science.org/content/article/exclusive-nsf-faces-radical-shake-officials-abolish-its-37-divisions
19 https://www.energy.gov/articles/department-energy-overhauls-policy-college-and-university-research-saving-405-million
20 https://www.science.org/content/article/trump-s-proposed-budget-would-mean-disastrous-cuts-science
21 https://www.eenews.net/articles/leaked-doc-56-of-doe-employees-essential
22 This broad assessment is based on Priority Technologies Group (2009), a working paper produced by MIT engineering,
science, and management faculty that focuses on biomanufacturing, critical minerals, advanced manufacturing,
semiconductors, and energy modernization.
For-profit firms are interested in innovation only to the extent that it improves their
bottom line – and not if creating new ideas and products primarily benefits someone
else. But the post-1945 experience confirms that spillover effects (‘externalities’) from
discovery are incredibly important, creating both the basic scientific knowledge and
the applied ideas that help determine how fast our economy can grow. For example, in
the 1980s, a former Nobel Prize winner led a private sector effort to map the human
genome, but it could not get funded. Instead, through NIH, the United States funded
a $3 billion human genome project. The returns from this investment have been
spectacular: economic activity from the genomics sector has generated at least $65 for
each $1 invested, while even as far back as 2012, the genomics sector paid $6 billion per
year in taxes – twice the initial investment returned to the public sector in one year alone.
In biomedicine, new discoveries made by graduate students and postdocs in academic
labs are further developed by biotechnology companies, and then – if sufficiently
promising – ultimately transferred to large pharmaceutical companies. Once their
training is complete, graduate students and postdocs become the workforce for
the biotech and pharma industries, and key partners for the medical profession.
Pharmaceutical companies specialise in bringing drug candidates through clinical trials
and then manufacturing, marketing and distributing these new medicines — but these
companies are not central hubs for new innovation.
For 80 years, the United States’ ace card in the race to invent the medical future has
been the NIH – the largest and most successful supporter of medical research in the
world. Research labs at universities compete intensely for funding and use the money
to support graduate students and postdocs to make scientific breakthroughs – and most
of our breakthroughs are powered by these brilliant young people. Universities provide
the facilities and infrastructure for this research, including programmes that bring
in graduate students. The economic returns to society on investing in this system are
substantial.24
23 Through FY2024, about 11% of the NIH budget supported “intramural research projects” conducted by federal scientists,
most of whom were employed at NIH in Bethesda, MD. Most of the remainder (83%) “supports research performed by
more than 300,000 nonfederal scientists and technical personnel who work at more than 2,500 universities, hospitals,
medical schools, and other research institutions” (Congressional Research Service 2024: 18).
24 This measure of returns includes all social benefits through potential ‘externalities’ – these are gains for society even if
an individual investor cannot capture them fully, for example because there are knowledge spillovers between activities.
Gruber and Johnson (2019) report “social returns to R&D of more than 50 percent – that is, each dollar invested in R&D
yields fifty cents return per year” (p. 107).
159
WILL THE UNITED STATES CONTINUE TO LEAD IN SCIENCE? | BAKER AND JOHNSON
A great deal of new biomedicine starts with grants from NIH. In recent decades, the basic
science carried out at NIH or funded by NIH was the basis for every new pharmaceutical
innovation.23 Research from colleagues at MIT shows that each $1 billion in NIH funding
creates $8 billion in private R&D funding, results in $4 billion in stock market value, and
creates about 40,000 jobs (Azoulay et al. 2018). Moreover, this same research shows that
NIH spending has a 43% social rate of return, while each $10 million in NIH funding
generates 2.7 more drug patents.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
160
The deal for any admitted PhD student is simple: you won’t get paid much, you will work
very hard, and you won’t have any time for employment outside the lab, but you will
get trained and earn a PhD – and have a real shot at inventing the next generation of
breakthrough science. Funding for university-based research labs is the linchpin of this
multi-year training programme.
Recent events highlight the vital importance – and unfortunate fragility – of this talent
development pipeline. Concern about what will happen to grant funding in the near
future is causing universities to drastically cut graduate admissions immediately or
even rescind offers that have already been made.25 This means that the flow of college
students into biomedicine and advanced STEM careers is already disrupted. Many young
Americans who always dreamed of pursuing a scientific career will now be disappointed.
For all aspiring Marie Curies who come from modest backgrounds, the hope of social
and geographic mobility may have been dashed. Graduate students and postdoctoral
fellows who seek to push the frontiers of science at universities are also seeing their job
prospects disappear, as universities are cancelling faculty searches due to the funding
uncertainties. These decreases in research and training at universities today will reduce
the number of innovations tomorrow that form the core of the biotech industry, while
also reducing the number of new scientists entering the workforce who are familiar with
the latest discoveries.
According to The Economist (2025: 70), if the projected budget cuts for NIH (and the
NSF) are put in place, “more than 80,000 researchers could lose their jobs. American
funding for academic science would fall significantly behind that of either China or the
European Union, after adjusting for costs”.
Presumably, any slowdown in the rate of invention would be matched by fewer technologybased startups, less commercialisation more broadly, and fewer new jobs being created.
The United States would also be less likely to lead the way in terms of new products and
services in biomedicine and more broadly. The implications for biosecurity and national
security are harder to evaluate, but should surely be a concern. History suggests that you
never know exactly what you need to invent when a crisis occurs – but deep scientific
expertise and the ability to come up with entirely new practical solutions is frequently a
great advantage.
ECONOMIC EFFECTS: ADVANTAGE CHINA
President Xi wants China to become “a science and technology great power”26 and on
11 March his government announced another major boost in spending on science and
technology (Burnham and Yang 2025). This increase comes on top of an impressive surge
25 For cuts in graduate admissions, see https://www.nature.com/articles/d41586-025-00608-z. For an example of rescinding
grad school offers, see https://www.thedp.com/article/2025/02/penn-graduate-student-class-size-cut-trump-funding.
26 https://www.nytimes.com/2025/03/11/world/asia/china-xi-trump.html.
Why is the Chinese government so intent on turbocharging high-quality scientific
research? Stronger basic science increases the odds of inventions that can be
commercialised, further increasing China’s productivity and exports. A bigger scientific
innovation ecosystem also creates more good jobs. China’s global prestige will rise in
tandem. And one major lesson of the past 150 years is that deeper national science often
also strengthens military capacity.
The United States has led the world in biomedicine in recent decades, and the output
of this sector now generates around $1.4 trillion per year and employs roughly 300,000
people (Reece et al. 2025). But China’s enormous investments in university-level
biomedicine over the past 15 years are starting to pay off.30 There is a very real possibility
that we may be about to experience a moment in biomedicine that strongly resembles the
launch of Sputnik in October 1957, when the Soviet Union elevated its prestige and role in
the world by pulling ahead in the race to space.31
The United States is already buying key pharmaceutical ingredients and products
from China, and China may soon supply America with advanced medicines and other
products that are developed based on deep scientific research. But it doesn’t have to end
this way. The bipartisan response to the launch of Sputnik was to increase American
investment in science, including through the 1958 National Defense Education Act,
which strengthened university STEM programmes and pulled more young people from
all parts of the country into math, engineering, and science.
One major Chinese advantage is population: 1.4 billion, compared with 340 million
Americans. The United States has led on science and technology in part because it has
historically (at least since the 1930s) been able to attract top talent from around the
world – because it is seen as a safe haven for brilliant people. National population is not
a limiting factor on scientific enterprise, if the United States can continue to attract the
27 Precise numbers cited above. The US share of global R&D in 2001 was 37% (https://cen.acs.org/articles/92/i7/Shifting-RDLandscape.html); this measure includes government, business, universities, and all other sources of funding.
28 The comparative number of discoveries is from https://www.nature.com/articles/d41586-023-02159-7; the second “close
to or exceeds” is from https://www.springernature.com/gp/researchers/the-source/blog/blogposts-for-editors/chinagrowing-influence-global-research-nature-index-2024/27731198.
29 On the hiring spree, see https://webofjobs.com/239-open-roles-in-westlake-university/. See also The Economist (2025:
69).
30 https://www.biopharmadive.com/news/biotech-us-china-competition-drug-deals/737543/
31 One sector in which this may happen is synthetic biology (Gruber and Johnson 2009: 200-204); see also National Science
Board (2024: 15-21).
161
WILL THE UNITED STATES CONTINUE TO LEAD IN SCIENCE? | BAKER AND JOHNSON
over the past two decades: in 2001, China accounted for just 4% of world R&D, but by
2023 total Chinese R&D comprised more than 26% of the world total, running just below
the US level (National Science Board 2024: 2).27 The number of high-impact discoveries
published by researchers in China per year is close to or exceeds that of US groups in
chemistry, biology, and medicine.28 And now China exudes enough confidence to launch
a credible international hiring spree; their flagship universities are on track to rival the
best in the world.29
global talent. But if visa restrictions on foreign students shut down or severely limit this
talent pipeline, it will in effect be allowing China to make the most of its population scale
advantage.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
162
In addition, as illustrated by the release of DeepSeek (in the AI space), China already has
advanced science-based efforts in all areas with advanced technology (see Chapter 10
by Gary Gensler). Attempting to deny China access to new ideas is very unlikely to slow
them down much – there are no effective borders when it comes to the flow of knowledge.
What the United States needs to do is invent more useful solutions in as many fields as
possible and put those into production quickly and effectively, while preferably creating
as many good jobs in the United States as possible. If anything, we should be scaling up
NIH, NSF, and DoE funding in face of competitive pressures from China.
Unfortunately, the administration’s current science policy trajectory – funding cuts, vias
restrictions, attacks on leading research universities, and so on – is more likely to help
China build and cement its lead in key sectors. This will have significant adverse effects
on job creation in the United States. New drugs and clinical trials will either slowdown
or take place elsewhere or never happen. History suggests that the net effects on our
national security will also not be positive.
WHY SCIENCE MATTERS FOR THE ECONOMY AND NATIONAL SECURITY
World War II demonstrated the profound national security value of scientific capability.
In an unprecedented mobilisation of talent, American physicists, chemists, biologists,
and other university-based scientists were put to work on priority projects that quickly
produced a wide range of useful products at scale, including radar, antibiotics, synthetic
rubber, and the atomic bomb. University-based science could no longer be seen as
something that was ‘nice to have’; it played an essential role in winning this war and
potential future wars. The key lesson was not just to have the most effective machines
at any moment in time; rather, it was to push the technological frontier further and
faster than all competitors. The goal became not just to build next-generation weapons,
but also to create a productive civilian economy that could continue to invent whatever
was needed for robust national security. And the right way to do this was to organise
fundamental science and technology development around universities, funded by the
federal government and with key partnerships for commercialisation and development
in the private sector.32
Before 1940, the United States had a strong engineering tradition, but it did not lead the
world in science. Prior to 1930, of the 90 Nobel Prizes awarded for physics, chemistry,
and medicine, Americans won only five. Young American scientists were advised to
finish their education in Western Europe, because it was there that the big new scientific
32 The history in this paragraph and the next is documented Chapters 1 and 2 in Johnson and Gruber (2019).
Nothing is perfect of course, and there are ways to alter the federal funding to encourage
more young investigators, greater focus on breakthrough science, and fewer silos within
academia (and between universities and the private sector). Still, according to the latest
assessment from the National Science Board (2024: 2), this decades-long investment in
technical knowhow and associated education has generated strong rewards in terms of
job creation.
“The U.S. science, technology, engineering, and mathematics (STEM) workforce
comprised 36.8 million people in diverse occupations that required STEM
knowledge and expertise in 2021, accounting for 24% of the total U.S. workforce.”
Universities play a key role in translating ideas from research labs to commerce, including
startups:
“In 2021, US universities executed about 8,800 new technology licenses or options;
17% of these licenses and options were executed with startup companies, and 61%
were executed with small companies (those with fewer than 500 employees). New
university-associated startups increased from nearly 400 in 2000 to over 1,000 in
2021.”
As for the private sector, there are 12 industries with high or medium-high R&D intensity
(nine in manufacturing and three in services). In terms of knowledge- and technologyintensive (KTI) services, the United States retains a leading position, accounting for $1.3
trillion of value-added output out of $3.3 trillion globally – an increase from 30% in 2012
to 39% in 2021.33 In contrast, the US share of global KTI manufacturing was 20% in
2010 and 19% in 2021 (roughly the same as the 27 EU countries combined). However,
during that same time, China increased its share of global KTI manufacturing value-
33 KTI manufacturing sectors include chemicals, computers, electrical equipment, vehicles, other transport, other machinery,
and medical instruments. KTI services are mostly information technology, but also “scientific R&D services” (National
Science Board 2024: 32).
163
WILL THE UNITED STATES CONTINUE TO LEAD IN SCIENCE? | BAKER AND JOHNSON
ideas originated. But from the 1940s, the geography of global scientific invention shifted
dramatically to the United States. Ideas created in American universities, hospitals, and
other federally funded research institutions became fundamental to the creation of new
products within existing industries. It also led to the emergence of entirely new sectors
with worldwide impact – such as pharmaceuticals, jet aircraft, computers, the Internet,
satellites, and mobile communications. These innovations had a significant impact on
productivity in the United States, as well as allowing American companies to sell highvalue products and services around the world (Gruber and Johnson 2019). In the postwar decades, the United States never won less than 49% of science Nobel Prizes, peaking
in the 1990s when Americans won 43 out of 60 total prizes awarded. American research
universities have become the most prestigious and productive in the world, attracting
talent from all corners of the globe.
added from 22% to 33%. China’s investments in science have boosted its industry in a
big way. The impending potential US retreat from science will only compound this rising
Chinese advantage.34
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
164
CONCLUSION: A MAJOR CONGRESSIONAL DECISION LIES AHEAD
In the 1940s, amid urgent national security concerns, the United States made a strategic
decision to invest in university-based science. World War II demonstrated – and the
Sputnik crisis reaffirmed – that American universities could attract and develop top
global talent. That talent, working in campus labs, launching companies, and supporting
emerging technology sectors, has driven breakthrough innovations for over 70 years.
From radar and antibiotics to biotechnology and computing, the US research ecosystem
has delivered lasting benefits in both prosperity and security. For decades, support for
science has united lawmakers across the aisle.
Today, that legacy faces a major test. As outlined above, proposals to reduce science
funding by up to 50% at major agencies, combined with restrictive policy changes,
have introduced deep uncertainty across the research enterprise. Budget cuts, visa
constraints, and institutional targeting risk weakening the infrastructure that underpins
US scientific leadership.
The impacts are already visible. Research initiatives are being paused, faculty searches
cancelled, and graduate admissions scaled back. These disruptions limit opportunities
for young scientists and slow the expansion of science-driven industries. At the same
time, nations like China are significantly expanding their R&D investments, positioning
themselves to lead in emerging technologies.
Congress now faces a pivotal choice. The decisions made in the coming appropriations
cycle will shape the future of American innovation for decades to come. Reaffirming the
bipartisan commitment to science will help ensure the United States continues to lead
in discovery, which in turn will power economic growth and protect national security..
REFERENCES
Azoulay, P, J S Graff Zivin, D Li and B N Sampat (2018), “Public R&D Investments and
Private-sector Patenting: Evidence from NIH Funding Rules”, Review of Economic
Studies 0: 1-36.
Burnham, J and J Yang (2025), “Aiming for Parity With U.S., China Announces Increase
in Science and Technology Spending”, FDD Policy Brief, 19 March (https://www.fdd.
org/analysis/policy_briefs/2025/03/19/aiming-for-parity-with-u-s-china-announcesincrease-in-science-and-technology-spending).
34 All the numbers in this paragraph are from the National Science Board (2024: 32).
Congressional Research Service (2024), “Federal Research and Development (R&D)
Funding: FY2025”, 9 December.
National Science Board (2024), The State of U.S. Science and Engineering 2024, March
(https://ncses.nsf.gov/pubs/nsb20243).
Priority Technologies Group (2025), “Priority Technologies: Recommendations to Ensure
U.S. Security, Competitiveness, and Prosperity”, working paper, MIT, February.
Reece, E A, J R Balser, K Bibbins-Domingo et al. (2025), “Four Opportunities To
Revitalize The US Biomedical Research Enterprise”, Health Affairs 44(2).
The Economist (2025), “The Assault on American Science”, 24-30 May.
ABOUT THE AUTHORS
David Baker is the Henrietta and Aubrey Davis Endowed Professor of Biochemistry and
Director of the Institute for Protein Design at the University of Washington. He is also a
Howard Hughes Medical Institute Investigator and a member of the National Academy
of Sciences. In 2024, Baker was awarded the Nobel Prize in Chemistry for computational
protein design. His lab develops software for protein design and uses it to create
molecules that address challenges in medicine, technology, and sustainability. Recent
work includes the development of machine learning methods for generating functional
proteins. Baker has published more than 650 scientific papers, been awarded over 100
patents, and co-founded 21 biotechnology companies. More than 100 of his trainees have
gone on to independent faculty positions.
Simon Johnson is the Ronald A. Kurtz (1954) Professor of Entrepreneurship at the MIT
Sloan School of Management, where he is head of the Global Economics and Management
group. At MIT, he is also co-director of the Shaping the Future of Work Initiative and a
Research Affiliate at Blueprint Labs. In 2024, Johnson received the Sveriges Riksbank
Prize in Economic Sciences in memory of Alfred Nobel, joint with Daron Acemoglu and
James A. Robinson, “for studies of how institutions are formed and affect prosperity.” In
2007-08, Johnson was Chief Economist and Director of the Research Department at the
International Monetary Fund. He currently co-chairs the CFA Institute Systemic Risk
Council with Erkki Liikanen. He is a Research Associate at the NBER and a Fellow at
CEPR.
165
WILL THE UNITED STATES CONTINUE TO LEAD IN SCIENCE? | BAKER AND JOHNSON
Gruber, J and S Johnson (2019), Jump-Starting America: How Breakthrough Science Can
Revive Economic Growth and the American Dream, Public Affairs (https://www.jumpstartingamerica.com).
CHAPTER 12
Jonathan Gruber
MIT
Health care is the single biggest sector in the US economy, consuming almost 18% of
the nation’s resources – by far the highest in the developed world.1 More than 22 million
people work in health care, and it is the largest and most rapidly rising element of both
state and federal spending.2 Moreover, while often viewed as a ‘private’ health care
system, in fact about half of US health care spending is done by the federal government.3
As such, any changes that the Trump administration make to this sector will reverberate
loudly through the nation’s health and economy.
BRIEF BACKGROUND ON US HEALTH CARE
The way that health care is consumed and delivered doesn’t differ significantly around
the developed world. Most spending is through inpatient hospitalisations, while most
interactions with the health care system occur through outpatient visits with doctors.
Prescription drugs are a rising part of the health care spend, but still a distant third
to physicians and doctors. And as nations around the world age rapidly, the long-term
health care needs of the elderly who are unable to care for themselves is a growing burden.
What differs more significantly is how these services are regulated and paid for. In every
other developed nation, there is a clear recognition that health care markets are classic
examples of ‘market failure’, and as such are heavily regulated: both the prices that are
charged for medical services and the supplies of those services as subject to rigorous
government oversight and regulation. In the United States, on the other hand, prices
for health care services for the majority of the population with private insurance are
determined by the market. As a result, the United States pays dramatically more for
its health care services than do other nations: both medical services such as surgeries
and medical products such as prescription drugs have costs that are multiples of the
developed country average (Gruber 2021).
1
2
3
“OECD Health Statistics”, Organization for Economic Co-operation and Development (https://www.oecd.org/en/data/
datasets/oecd-health-statistics.html).
“About Healthcare Workers”, U.S. Centers for Disease Control and Prevention (https://www.cdc.gov/niosh/healthcare/
about/index.html).
“National Health Expenditure Data”, Centers for Medicare & Medicaid Services (https://www.cms.gov/data-research/
statistics-trends-and-reports/national-health-expenditure-data/historical).
167
HEALTH CARE | GRUBER
Health care
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
168
Despite this high spending, the United States has poor average health outcomes and
enormous disparities in both access and outcomes. For example, it ranks 54th in infant
mortality worldwide, but this ranking is somewhat misleading due to disparities in this
outcome: a white child born in the United States today has roughly the same infant
mortality rate as one born in Europe, while a black child born in the United States today
has a lower chance of survival than one born in Serbia (Gruber 2021).
These health care disparities have many root causes, but one major one is lack of access
to affordable health care. The United States also has a very complicated multi-payer
health insurance system, in contrast to the single or more limited payer systems in
other nations. Roughly speaking, 55% of the population gets their insurance through
employers (either as employees or as dependents), 10% buy insurance on their own, 27%
have publicly provided insurance, and 8% are uninsured (U.S. Census Bureau 2024).But
there are many subtle distinctions within these categories. For example, the majority of
individuals covered by public insurance actually receive their care from private insurers
who are contracting with the government (Gruber 2017). And even those who are insured
from private sources often face high costs when they seek care.
The United States also has a large and active public health sector. This is headquartered
at the federal level by the Centers for Disease Control and Prevention (CDC), which
provide data and support to thousands of local public health departments. This was a
sector that largely flew beneath the radar of most Americans until Covid-19, when almost
all Americans interacted in some way or another with public health regulations and
support systems.
Finally, the country unambiguously leads the world in health care innovation. This is
most clearly illustrated in the pharmaceutical space, where most new innovations initiate
in the United States. But it is also evident in new and transformative treatments in other
aspects of health care as well. The lack of wait times and the early access to cutting edge
health techniques in the United States are enviable; indeed, roughly one million people
from around the world come to the country for their health care each year, while a much
smaller number leave for care elsewhere.
THE AFFORDABLE CARE ACT4
The most significant change to the US health care system in the last 50 years was the
Patient Protection and Affordable Care Act (ACA), which was passed in 2010 and largely
implemented in 2014. This law is primarily focused on expanding health insurance
coverage through what I describe as a ‘three-legged stool’. This approach was pioneered
through the successful health care reform in Massachusetts in 2006.
4
The ACA is described in more detail – and graphically! – in Gruber (2012).
Insurers were understandably concerned that such a mandate could lead to significant
adverse selection when individuals could delay purchase of insurance until they were
sick; indeed, this was the experience of the seven states that had mandated community
rating in their non-group insurance markets. The second leg of the stool was therefore
a mandate that all individuals buy insurance, so that insurers could be ensured of a
representative risk pool.
But such mandates raised a new challenge: insurance was unaffordable for low-income
families, given the high price of US health care. The third leg of the stool was therefore
subsidies to make insurance affordable, in two forms: an entitlement to free insurance
for those with incomes below 133% of the poverty line, and tax credits to offset the costs
of buying insurance in the non-group market through the new state ‘exchanges’ created
by the ACA.
The impacts of the ACA after its implementation in 2014 were almost immediately
positive; by 2016, about 20 million Americans had gained insurance coverage. But it
was also politically controversial, and disappointment with the process and substance
of the law was a contributing factor to the election of Donald Trump and a Republican
Congress in 2016. The ACA subsequently came within one vote of repeal in 2017 but
survived, albeit in a weakened form. It became more popular over time, and was bolstered
significantly under the Biden administration as part of its Covid response. Aboulafia et
al. (2025) provide empirical evidence on the impact of different administrations on the
effectiveness of the ACA. In particular, they show that they extension of ACA subsidies
under the Biden administration’s ARPA legislation led to millions gaining coverage.
The ACA also included a number of features designed to transform the delivery of health
care in the United States, ultimately with a vision towards bringing costs down. These
included a variety of experiments in health care delivery, with a focus on “value-based
care” that would pay based on health care improvements, not just based on health care
utilisation. The ultimate success of these initiatives has been limited, but it remains true
that health care costs in the years after the ACA grew at a historically slow rate.
WHAT WILL THE TRUMP ADMINISTRATION DO?
As I’m sure is true with many of the contributions in this volume, the ultimate policy
positions of the Trump administration are not yet clear. But there are clear directions of
emphasis
169
HEALTH CARE | GRUBER
To understand this model, it is important to highlight a key feature of the US health care
system before the ACA: the ability of insurers to discriminate against the sick in both the
availability and pricing of insurance. This led to a highly selected insurance market for
those not offered insurance by large groups such as employers, and was a major cause of
uninsurance. The first leg of the ACA stool was therefore to mandate community rating
in insurance so that pricing could only vary by age, location and smoking status.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
170
Perhaps the most profound early change has been in the dimension of public health.
The new Secretary of the Department of Health and Human Services (HHS), who is
the most powerful person in controlling national health care resources and priorities,
is a noted sceptic of the effectiveness of many scientifically uncontroversial treatments,
such as vaccination against communicable disease. This has already supercharged the
movement away from these treatments, with consequences such as a fully preventable but
deadly measles outbreak in Texas. But they also include a retrenchment from collecting
and reporting data on disease prevalence, which could lead to critical shortfalls in
combatting future public health crises.
Meanwhile, there has been an active attack on the health care infrastructure of the
US government. HHS has allowed layoffs of 10,000 employees, on top of a large set of
voluntary retirements. Expert advisory committees in areas such as epidemic surveillance
have disbanded, raising the risk of future pandemics.
The second immediate change has been a cut in funding for basic science research under
the National Institutes of Health. The administration has already cut $2.4 billion in
funding, and more may be coming. Moreover, dramatic cuts to university funding appear
to be in the works, with threatened large cuts to particular universities, reductions in the
supplements to federal grants that support university infrastructure, and a rise in the
tax on universities with large endowments. While the short-run costs of this action are
modest, the long-run effects will be devastating. Research has shown the incredible rate
of return to investing in basic biomedical research through NIH, with each $1 of NIH
funding generating approximately $2.46 of economic activity.5 These cuts in funding
will result in fewer newer medical treatments being developed, with resulting negative
consequences on health in the United States and in the rest of the world. The cuts in
tandem to university funding will have a multiplier effect, as universities are the source
of many of the innovations that drive our economy.
The third announced change is a significant reduction in the resources that the
government brings to bear on ensuring that individuals are insured through the ACA.
While there is no strong movement to repeal the ACA (after failures to do so during the
first Trump administration), the current administration has multiple tools at its disposal
that impact its effectiveness, such as funding outreach to uninsured individuals to sign
up for the insurance exchanges. My research shows that the effectiveness of the ACA
varied substantially across the first three administrations that ran these programmes,
with the effectiveness of subsidised coverage on the exchanges being 30% lower under the
first Trump administration than under either Obama or Biden.
But for the ACA, the most significant change will the end of the ARPA subsidies described
above. As noted, these subsidies expire at the end of 2025 and are unlikely to be renewed
by the Trump administration. Estimates from the Congressional Budget Office suggest
5
“Impact of NIH Research”, National Institutes of Health (https://www.nih.gov/about-nih/what-we-do/impact-nih-research).
that in the long run, this will lead to almost 4 million more uninsured individuals. Using
the estimates from research cited above, this implies at least 5,000 more deaths per year
in the United States.
MACROECONOMIC IMPACTS
The clearest impacts of the President’s actions on health care will be the negative
consequences for the nation’s health and wellbeing. The near-term macroeconomic
impacts are less clear and probably second order relative to other issues such as tax policy.
That said, there are clear implications for both employment and inflation. On the
employment side, health care has become a major jobs engine for the US economy.
Significant cuts to health care, and in particular to the extensive labour force serving the
nation’s elderly, will meaningfully reduce employment.
On the inflation front, roughly 15 years of historically slow health care cost growth
appears to be coming to an end. From 2008 to 2013, health care cost growth averaged
3.6%; but in 2023, health care costs grew by 7.5%.6 In the near term, the key actions
that the Trump administration may take revolve around prescription drug pricing.
The Biden administration included a key provision in the Inflation Reduction Act that
allowed the Medicare programme to negotiate lower drug prices, and it appears to have
had a significant short run impact. The Trump administration has sent mixed signals
about the future of drug price regulation, simultaneously opposing the IRA reforms
while suggesting that they might tie US drug prices to their much lower international
counterparts. In the longer run, future cost growth could be rapid if purging investments
in public health leads to more use of expensive downstream services, or if movements
away from the value-based approach of the ACA lead to higher utilization of health care.
6
“National Health Expenditure Data”, Centers for Medicare & Medicaid Services (https://www.cms.gov/data-research/
statistics-trends-and-reports/national-health-expenditure-data/historical).
171
HEALTH CARE | GRUBER
And this is modest relative to the potential cuts to Medicaid, the programme that provides
publicly financed free coverage for the poorest in the United States. The proposed budget
passed by House Republicans would cut this programme significantly, perhaps by as
much as $880 billion (Williams et al. 2025). In assessing these cuts, it is important to
emphasise the dual nature of the Medicaid programme. Most people on Medicaid are
non-disabled/non-elderly children and adults. This has been the focus of policy debates
and existing proposals to cut funding focus, in particular the non-elderly adults made
eligible for Medicaid by the ACA. But most spending on Medicaid is on the disabled
and elderly – these groups account for roughly three-quarters of programme spending.
Medicaid is the primary payer for long-term care in the United States, and there is no
way to achieve the proposed level of spending cuts without limiting services or eligibility
for this population as well.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
172
The most dramatic implications are likely for the long-term growth of the US economy.
Health care innovation has been a major contributor to the dynamic economic growth of
recent decades. This is largely driven by massive research and development investments;
indeed, pharmaceutical companies account for the majority of the top R&D spenders
across all industries. Importantly, a major driver of this innovation has been public R&D
investments. Spending on NIH research massively crowds in spending on private R&D;
each $1 of NIH spending leads to an additional $8.38 in industry R&D spending over
eight years.7 The proposed cutbacks in NIH will therefore jeopardise a major source of
long-term economic growth.
And perhaps even more significant is the long-run risk facing the United States. The most
significant sudden economic shock the nation faced since the Great Depression was the
Covid-19 epidemic. But this could have been even worse were it not for the rapid response
of its public health infrastructure, which put in place protective measures that reduced
the spread of disease; its disease surveillance infrastructure, which guided efforts to
manage the disease; and its government funding infrastructure, which provided the R&D
support and purchase guarantees that allowed for record-breaking developments of new
vaccines. All of these infrastructures are being weakened by the Trump administration,
significantly raising the long-run risk faced from future pandemics.
REFERENCES
Gruber, J (2012), Health Care Reform: What It Is, Why It’s Necessary, How It Works, Hill
and Wang.
Gruber, J (2017), “Delivering Public Health Insurance through Private Plan Choice in the
United States”, Journal of Economic Perspectives 31: 3–22.
Gruber, J (2021), Public Finance and Public Policy, 7th edition, Macmillan.
Williams, E, A Burns, and R Rudowitz (2025), “Putting $880 Billion in Potential Federal
Medicaid Cuts in Context of State Budgets and Coverage”, KFF, 24 March.
US Census Bureau (2024), Health Insurance Coverage in the US: 2023 (https://www.
census.gov/library/publications/2024/demo/p60-284.html)
ABOUT THE AUTHOR
Jonathan Gruber is the Ford Professor of Economics and the Chairman of the Economics
Department at the Massachusetts Institute of Technology, where he has taught since
1992. He is also the former Director of the Health Care Program at the National Bureau
of Economic Research, and the former President of the American Society of Health
7
“Impact of NIH Research”, National Institutes of Health (https://www.nih.gov/about-nih/what-we-do/impact-nih-research).
During the 1997-1998 academic year, Dr. Gruber was on leave as Deputy Assistant
Secretary for Economic Policy at the Treasury Department. From 2003-2006 he was
a key architect of Massachusetts’ ambitious health reform effort, and in 2006 became
an inaugural member of the Health Connector Board, the main implementing body
for that effort. During 2009-2010 he served as a technical consultant to the Obama
Administration and worked with both the Administration and Congress to help craft
the Patient Protection and Affordable Care Act. In 2011 he was named “One of the Top
25 Most Innovative and Practical Thinkers of Our Time” by Slate Magazine. In both
2006 and 2012 he was rated as one of the top 100 most powerful people in health care in
the United States by Modern Healthcare Magazine. In 2020 he received a Guggenheim
Fellowship.
173
HEALTH CARE | GRUBER
Economists. He is a member of the Institute of Medicine, the American Academy of Arts
and Sciences, the National Academy of Social Insurance, and the Econometric Society.
He has published more than 180 research articles, has edited six research volumes, and
is the author of Public Finance and Public Policy, a leading undergraduate text in its
7th edition, Health Care Reform, a graphic novel, and Jump-Starting America: How
Breakthrough Science Can Revive Economic Growth and the American Dream (with
Simon Johnson). In 2006 he received the American Society of Health Economists
Inaugural Medal for the best health economist in the nation aged 40 and under.
CHAPTER 13
Valerie J. Karplus and Costa Samaras
Carnegie Mellon University
The National Oceanic and Atmospheric Administration (NOAA) plays a vital role in
the United States’ ability to anticipate and respond to short- and long-term threats to
security, health, and resilience. NOAA is an agency within the Department of Commerce
that tracks and predicts changes in weather, climate, coastal lands, and oceans, enabling
actions that prevent damage to life and property. From avoiding deaths due to extreme
weather, to averting collisions of objects in space, to informing decisions of farmers and
fishers, NOAA offices constantly generate trusted, open information that has profound,
tangible benefits for people and businesses. NOAA is facing the potential of losing more
than 25% of its current $6 billion budget.1 Without NOAA, the US economy will be no
match for everyday events, and woefully unprepared for climate change.
As one of the world’s premier weather and climate change research agencies, NOAA
provides data, tools, and information to help advance the scientific understanding of
climate change and its impacts.2 Essential weather data used widely across both the
public and private sectors in the US originates with NOAA.3 Helping the public and
businesses understand how heat,4 drought,5 floods,6 sea level rise,7 and other hazards
are changing can allow communities to better prepare for climate change and manage
impacts. However, risk from climate impacts is a combination of how hazards change,
if people and infrastructure are in harm’s way of these hazards, and how vulnerable
these communities are to damages when extreme weather shows up. NOAA connects
these concepts and serves as a critical climate resilience agency, enabling communities
to assess climate risks and take action.8 NOAA provides on-the-ground resources for
communities to build up the local workforce and capacity9 to prepare for and respond
to climate change. The agency is also a scientific powerhouse. Former NOAA scientist
1
2
3
4
5
6
7
8
9
https://www.npr.org/2025/04/11/nx-s1-5361366/major-budget-cuts-proposed-for-the-national-oceanic-and-atmosphericadministration
https://www.climate.gov
https://theconversation.com/noaas-vast-public-weather-data-powers-the-local-forecasts-on-your-phone-and-tv-a-privatecompany-alone-couldnt-match-it-249451
https://www.heat.gov
https://www.drought.gov
https://tidesandcurrents.noaa.gov/high-tide-flooding/
https://coast.noaa.gov/slr/
https://toolkit.climate.gov
https://www.noaa.gov/news-releases/noaa-ira-framework-2023
175
DOWNSIZING THE NATIONAL OCEANIC AND ATMOSPHERIC ADMINISTRATION | KARPLUS AND SAMARAS
Downsizing the National Oceanic and
Atmospheric Administration
Syukuro Manabe shared the Nobel Prize in physics in 2021 for developing the first
3D models of the global atmosphere while working at the agency’s Geophysical Fluid
Dynamics Laboratory, which provided early evidence of how the climate responds to
changes in atmospheric greenhouse gas emissions.10
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
176
As a result of investments over decades, NOAA capabilities underpin the U.S. response
to extreme weather and climate change. In the last five years, there were 115 separate
major weather and climate events in the United States that resulted in more than $750
billion dollars in total damages.11 These are costs that are borne by taxpayers and the
private sector, as communities and livelihoods are destroyed by hurricanes, wildfires,
and extreme weather. Climate change impacts are driving up homeowner insurance
premiums, which can contribute to increased risk of home mortgage delinquency (Ge et
al. 2025). Climate impacts can reduce the value of real estate and other financial assets
(Giglio et al. 2021) as well as stress household budgets (U.S. Treasury 2023) and increase
energy cost burdens for low-income families (Jones et al. 2023). These are all physical
risks from climate change (TCFD 2017) that affect communities, governmental budgets,
firms, and the broader macroeconomy (National Academies 2024). Because the impacts
of some cuts are likely only to become clear in a moment of crisis, jettisoned capabilities
will be difficult or impossible to recover, and too late to avert acute and far-reaching
damage.
Most Americans might not be familiar with NOAA’s work or its far-reaching benefits to
their daily lives. Its ongoing success is evident in costs and disasters avoided and crises
averted. NOAA data provide essential information on which route a pilot should take to
avoid severe turbulence, which causes discomfort and incurs maintenance cost. NOAA’s
fire observation systems enabled tracking and prediction of the rapidly developing Los
Angeles wildfire in January 2025,12 supporting timely decisions to evacuate and saving
lives. NOAA’s information has great value to individual businesses, each of which
would be unable to afford to recreate the capabilities of NOAA or even access them
through a subscription, should it be priced to cover costs. Moreover, the existence and
open availability of the data spur the creation of new businesses, the benefits of which
are expected to be vast. Senator Maria Cantwell (D-Washington) noted that NOAA
“...provides products and services that support more than a third of the nation’s gross
domestic product”.13
NOAA’s world-leading capabilities, the result of billions in public investment over
decades, are too large and generate benefits so substantial that the private sector cannot
replicate it profitably and comprehensively. Cuts as of April 2025 have affected 10% of the
NOAA workforce14 and already undermine NOAA’s essential benefits to society. Proposed
10
11
12
13
14
https://www.nobelprize.org/prizes/physics/2021/manabe/biographical/
https://www.ncei.noaa.gov/access/billions/
https://datafoundation.org/news/blogs/570/570-How-NOAAs-Data-Powers-American-Lives-Economy-and-Innovation
https://thehill.com/policy/energy-environment/5170268-trump-noaa-staff-cuts-concerns/
https://www.breakthroughjournal.org/p/gutting-noaa-is-a-bad-idea
Specific actions affected by the NOAA cuts are only just now coming into focus. The
National Weather Service, part of NOAA that is a major target of cuts, is charged with
informing action to protect life and property from severe weather. Weather balloon
launches that provide essential data for weather and climate models have been cancelled.19
Nearly half NOAA’s National Weather Service offices are now critically understaffed.20
These conditions could delay or reduce the alerts that keep communities informed when
dangerous weather is approaching. The US Global Forecast system already lags the
European Union’s European Centre for Medium-Range Weather Forecasts in terms of
its accuracy (Mass 2023). The prospect of broader, systemic cuts raises the odds it will
continue to fall further behind. This will increase our dependence on forecast capabilities
outside of the US.
As of this writing, the cuts are expected to continue. Following a court ordering the
rehiring of probationary employees, many learned on 10 April that their positions were
once again eliminated.21 Many probationary employees had been with NOAA for many
years, but had recently moved positions. These dismissals represent the loss of deep
institutional knowledge that will be impossible to recover.
The resulting erosion of capabilities will put citizens, businesses, and the economy in
harm’s way (Aerts et al. 2024). For example, NOAA is currently in the middle of developing
neighbourhood-level flood inundation maps,22 with plans to have flood information
15 https://www.npr.org/2025/04/11/nx-s1-5361366/major-budget-cuts-proposed-for-the-national-oceanic-and-atmosphericadministration
16 https://www.nytimes.com/2025/04/11/climate/noaa-research-budget-cuts.html
17 https://www.nesdis.noaa.gov/news/billion-dollar-weather-and-climate-disasters
18 https://pallone.house.gov/media/press-releases/pallone-leads-nj-democrats-urging-trumps-commerce-secretary-stopnoaa-cuts
19 https://www.weather.gov/media/notification/pdf_2025/pns25-08_kotzebue_ak_upper_air_suspension.pdf
20 https://www.pbs.org/newshour/politics/nearly-half-of-national-weather-service-offices-are-critically-understaffedexperts-warn
21 https://www.theguardian.com/us-news/2025/apr/10/noaa-firings-trump
22 https://water.noaa.gov/#006EFF,true&q=
177
DOWNSIZING THE NATIONAL OCEANIC AND ATMOSPHERIC ADMINISTRATION | KARPLUS AND SAMARAS
additional cuts could destroy them entirely.15 On 11 April, the New York Times reported
that the Trump administration had recommended the elimination of the Oceanic and
Atmospheric Research office as part of a “reduction in force” that accompanies a 2026
budget allocation to NOAA of $4.4 billion, a reduction of $1.6 billion relative to 2025.16
The National Marine Fisheries Service would see its budget reduced by one-third, while
funding for the National Ocean Service would be cut in half. NOAA’s satellite and space
programmes, including programmes for managing traffic in outer space, may lose
funding entirely, while satellite programmes that feed data to weather models, essential
for forecasting, would be reduced, including the tracking of billion-dollar weather and
climate disasters.17 A “reduction in force” plan is slated to reduce the NOAA workforce
by a further 20%. In total, all cuts anticipated to date entail an estimated 27% cut to the
overall budget and 75% cut to NOAA’s research capabilities, according to a letter led by
Congressman Frank Pallone’s (D-New Jersey) office.18
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
178
for nearly all of the US population over the next few years. Taking away important
information like this from communities could be deadly, as climate change accelerates
flooding impacts. The impacts will take the form of direct hits to GDP (Bodenstein and
Scaramucci 2024), as well as increased risk of exposure for already vulnerable groups.
In 2022, the marine economy, which represents only a fraction of economic activity
that would directly suffer from the NOAA cuts, contributed $476 billion to GDP and
$777 billion in sales.23 Parts of the country that, prior to the development of modern
approaches, suffered from severe storms, such as Tornado Alley in the central US,
may quickly find themselves reliving the unpredictability and devastation. Even more
challenging will be planning for effects in areas now expected to experience more socalled one-in-1,000-year storms and flooding, as a dearth of NOAA data and analytics,
and reduced capabilities to update these estimates to include climate impacts (Wright
et al. 2021) and to provide guidance for adaptation planning (Webber et al. 2022), will
undermine community resilience.
NOAA ostensibly became a target of cuts by the administration because of its connection
to climate change. The Heritage Foundation’s Project 2025 indicated that the programme
should be “broken up and downsized”.24 This would materially harm the economic and
national security of the US, and ignores NOAA’s critical role in the everyday economic
function of many industries. NOAA was originally established during the Cold War by
an Act of Congress, the Maritime Resources and Engineering Development Act of 1966,
with the goal of supporting US maritime strategy. It cited wise use of ocean resources,
competition with the Soviet Union, and interest in deep sea mining of critical minerals
among its major aims. With renewed calls for US manufacturing and supply chain selfsufficiency and escalating global tensions, NOAA’s charter is strongly aligned with the
national interest, including many of the stated interests of the Trump administration.
A case in point is the impact cuts will have on US competitive advantage in artificial
intelligence (AI), an area in which the White House has indicated the country must
lead.25 NOAA has long invested in AI innovation to improve weather predictions, protect
communities, and manage natural resources.26 Undermining NOAA slows down this
innovation, but also destroys the lifeblood of AI algorithms for the private sector: data.
But data are only the tip of the iceberg – NOAA’s deep knowledge and capabilities inform
wise use of data and algorithm development and position the US at the forefront of
AI innovation. NOAA’s data are already used in advanced data science applications to
elucidate newly recognised relationships and improve predictive capabilities that provide
a competitive edge in many industries. Contract cancellations in early April sounded the
23 https://coast.noaa.gov/states/fast-facts/marine-economy.html
24 https://www.pbs.org/newshour/politics/fact-checking-what-project-2025-says-about-the-national-weather-service-andnoaa
25 https://www.whitehouse.gov/presidential-actions/2025/01/removing-barriers-to-american-leadership-in-artificialintelligence/
26 https://www.noaa.gov/ai
One thing is clear: if the present cuts continue, NOAA’s ability to provide essential
information and services to the US economy will be widely felt. As costs of obtaining
previously free information rise, so will inflation, while service quality will orient
towards customers with highest willingness-to-pay, excluding new entrants, trampling
entrepreneurs, and stifling competition. US capabilities relative to those of its allies
and adversaries will further atrophy. And, indeed, we will get worse at countering the
increasingly unpredictable and severe effects of climate change. The US will lose the
ability to make wise investment choices in adaptation and mitigation, putting millions
of people at risk.
NOAA is at a crossroads. Continuing the present uncertainty and chaos will only further
degrade the nation’s capabilities to understand and respond to extreme weather – a
resource that taxpayers invested in and benefit from every day. If cuts go further, if more
civil servant experts are forced out, if more facilities are closed, the US will lose a vital
asset that has taken decades to build – and workers, communities, and competitiveness
will suffer the most.
As of 1 June 2025, proposed cuts to NOAA funding were slated to be even more dire
than those foreseen earlier in the spring. The proposed FY2026 budget is around half of
the FY2024 budget (Office of Management and Budget 2025: 199) and would essentially
eliminate funding to NOAA’s Office of Oceanic and Atmospheric Research (OAR), the
agency’s climate science powerhouse. The changes severely undermine the agency’s major
scientific activities and sharply raise the chances that the worst outcomes discussed
above will be realised.
REFERENCES
Aerts, S, L Stracca and A Trzcinska (2024), “Measuring economic losses caused by climate
change”, VoxEU.org, 2 October (https://cepr.org/voxeu/columns/measuring-economiclosses-caused-climate-change).
27 https://www.bloomberg.com/news/articles/2025-04-04/us-weather-agency-websites-to-vanish-under-planned-contractcuts
28 https://www.washingtonpost.com/nation/2025/02/25/farmers-lawsuit-usda-trump-climate-change/
179
DOWNSIZING THE NATIONAL OCEANIC AND ATMOSPHERIC ADMINISTRATION | KARPLUS AND SAMARAS
alarm that datasets could disappear.27 Just as farmers are suing the government over
deletion of data they use to make agricultural decisions,28 so too can we expect users to
protest the loss of NOAA resources. Data deletions, which become more likely with the
recent staff cuts, will stymie advances across the broad range of economic activities that
NOAA supports, putting the US at a competitive disadvantage while China and Europe
pull further ahead.
Bodenstein, M and M Scaramucci (2024), “On the GDP Effects of Severe Physical
Hazards”, International Finance Discussion Paper 1386, Board of Governors of the
Federal Reserve System.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
180
Ge, S, S Johnson and N Tzur-Ilan (2025), “Climate Risk, Insurance Premiums and the
Effects on Mortgage and Credit Outcomes”, Federal Reserve Bank of Dallas (https://doi.
org/10.24149/wp2505).
Giglio, S, B Kelly and J Stroebel (2021), “Climate finance”, Annual Review of Financial
Economics 13(1): 15-36.
Jones, A, D Nock, C Samaras, Y L Qiu and B Xing (2023), “Climate change impacts on
future residential electricity consumption and energy burden: A case study in Phoenix,
Arizona”, Energy Policy 183, 113811.
Lopez-Cantu, T, M K Webber and C Samaras (2022), “Incorporating uncertainty
from downscaled rainfall projections into climate resilience planning in US cities”,
Environmental Research: Infrastructure and Sustainability 2(4), 045006.
Mass, C (2023), “The Uncoordinated Giant II: Why U.S. Operational Numerical Weather
Prediction Is Still Lagging and How to Fix It”, Bulletin of the American Meteorological
Society 104(4).
Office of Management and Budget (2025), “Technical Supplement to the 2026 Budget:
Appendix”
(https://www.whitehouse.gov/wp-content/uploads/2025/05/appendix_
fy2026.pdf).
National Academies (2024), Incorporating Climate Change and Climate Policy into
Macroeconomic Modeling, Proceedings of a Workshop.
TCFD – Task Force on Climate-Related Financial Disclosures (2017), Recommendations
of the Task Force on Climate-related Financial Disclosures, Final Report (https://assets.
bbhub.io/company/sites/60/2021/10/FINAL-2017-TCFD-Report.pdf).
Wright, D B, C Samaras and T Lopez-Cantu (2021), “Resilience to extreme rainfall starts
with science”, Bulletin of the American Meteorological Society 102(4): E808-E813.
ABOUT THE AUTHORS
Valerie J. Karplus is a Professor in the Department of Engineering and Public Policy
(and Heinz College, by courtesy) and Associate Director of the Scott Institute for Energy
Innovation at Carnegie Mellon University
Costa Samaras is a Professor in the Department of Civil and Environmental Engineering
(and Engineering and Public Policy, by courtesy) and Director of the Scott Institute for
Energy Innovation at Carnegie Mellon University
CHAPTER 14
John E.T. Bistline
EPRI
OVERVIEW OF POLICY ACTIONS
The re-election of President Donald Trump has prompted conversation about potential
changes to federal climate and energy policy, especially with majorities in the House and
Senate in the 119th Congress. While specific policy changes are still uncertain, we may
expect Executive Orders and proposals to have implications for investment, employment,
affordability, and trade. This chapter provides an overview of proposed policy
changes, summarises the literature on their potential economic effects, and highlights
uncertainties moving forward.
The US government issued a series of Executive Orders in early 2025 related to energy
and environmental policy. On Inauguration Day, orders were signed to withdraw the
United States from the Paris Agreement,1 increase oil and gas development in Alaska,2
freeze leases for wind projects,3 and declare an energy emergency4 to “facilitate the
identification, leasing, siting, production, transportation, refining, and generation of
domestic energy resources”. The National Energy Dominance Council5 was established
in February 2025 to “expand all forms of reliable and affordable energy production to
drive down inflation, grow our economy, create good-paying jobs, reestablish American
leadership in manufacturing, lead the world in artificial intelligence, and restore peace
through strength”. Bloomberg lists 82 environmental directives across 20 government
bodies in the first 52 days of the administration (Gongloff and He 2025).
Trade measures in early 2025 also may affect energy markets. In February 2025,
emergency economic powers were invoked to impose tariffs6 on key trading partners,
including 25% tariffs on many imports from Canada and Mexico (with a lower 10%
rate for energy resources from Canada) and a 10% tariff on imports from China. These
tariffs include energy resources such as fossil fuel imports as well as materials such as
1
2
3
4
5
6
https://www.whitehouse.gov/presidential-actions/2025/01/putting-america-first-in-international-environmentalagreements/
https://www.whitehouse.gov/presidential-actions/2025/01/unleashing-alaskas-extraordinary-resource-potential/
https://www.whitehouse.gov/presidential-actions/2025/01/temporary-withdrawal-of-all-areas-on-the-outer-continentalshelf-from-offshore-wind-leasing-and-review-of-the-federal-governments-leasing-and-permitting-practices-for-windprojects/
https://www.whitehouse.gov/presidential-actions/2025/01/declaring-a-national-energy-emergency/
https://www.whitehouse.gov/presidential-actions/2025/02/establishing-the-national-energy-dominance-council/
https://www.whitehouse.gov/fact-sheets/2025/02/fact-sheet-president-donald-j-trump-imposes-tariffs-on-imports-fromcanada-mexico-and-china/
181
CHANGES IN FEDERAL CLIMATE POLICY | BISTLINE
Changes in federal climate policy
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
182
aluminium and steel, which have the potential to disrupt energy flows and increase
costs (BloombergNEF 2025a, 2025b). Reciprocal tariffs7 announced on 2 April extend
the geographic scope and magnitudes of tariffs. These tariffs could affect energy
technologies, as higher import fees may increase costs and lower deployment of supplyand demand-side technologies, especially since global supply chains have historically led
to cost savings (Helveston et al. 2022).8
There are also questions about potential changes to the US Inflation Reduction Act
(IRA). The IRA has been described as the largest federal climate legislation to date and
uses tax credits, grants, and loans to encourage clean energy adoption (Bistline et al.
2023a). Although many of the IRA’s energy and climate provisions remain in place as
of May 2025, an early Executive Order9 pauses the “disbursement of funds appropriated
through the Inflation Reduction Act of 2022 (Public Law 117-169) or the Infrastructure
Investment and Jobs Act (Public Law 117-58)” pending review. The IRA’s Waste Emissions
Charge, which creates a fee on methane emissions for some facilities, was repealed in
February 2025 by a Congressional Review Act measure, before it went into effect. The
IRA’s energy and climate provisions could undergo more extensive changes through the
budget reconciliation process in Congress later in 2025. Many provisions of the 2017 Tax
Cuts and Jobs Act are scheduled to expire at the end of 2025, and since policymakers
have expressed support for extending these tax cuts, they may look to a fill revenue gap,
with some early analyses suggesting $4 trillion over the next decade (Clausing and Sarin
2023), including by repealing portions of the IRA.
In early 2025, the US government initiated rollbacks of regulations across multiple
agencies. The EPA, under Administrator Lee Zeldin, unveiled 31 rollback actions10 on
12 March to “unleash American energy, lower cost of living for Americans, revitalize
the American auto industry, restore the rule of law, and give power back to states to
make their own decisions”. These actions included the reconsideration of power plant
greenhouse gas (GHG) standards, Mercury and Air Toxics Standards for power plants,
vehicle emissions standards, National Ambient Air Quality Standards, and several
others. The EPA also announced that it would reconsider the 2009 GHG “endangerment
finding”, which declared that CO2 and five other heat-trapping gases pose a threat to
public health; however, this review faces several legal hurdles (Farber 2025). Officials
argue that these deregulatory steps will boost economic growth and US energy output,
but questions remain about legal challenges to these rollbacks under laws such as the
Clean Air Act (Carlson and Burtraw 2019).11
7
https://www.whitehouse.gov/presidential-actions/2025/04/regulating-imports-with-a-reciprocal-tariff-to-rectify-tradepractices-that-contribute-to-large-and-persistent-annual-united-states-goods-trade-deficits/
8 Wood Mackenzie (2025) estimates that broad-based tariffs would have the largest impacts on solar and battery storage,
given the current reliance on Southeast Asian manufacturers for solar panel supply chains and on Chinese battery imports,
though domestic production investment can lower cost escalation.
9 https://www.whitehouse.gov/presidential-actions/2025/01/unleashing-american-energy/
10 https://www.epa.gov/newsreleases/epa-launches-biggest-deregulatory-action-us-history
11 The Inflation Reduction Act amended the Clean Air Act to explicitly recognise that GHGs are air pollutants and that
reducing them is a core objective of the Act (Dotson and Maghamfar 2023).
ECONOMIC AND ENERGY IMPACTS
FIGURE 1
HISTORICAL AND PROJECTED ELECTRIC SECTOR CAPACITY ADDITIONS AND
RETIREMENTS BY TECHNOLOGY
Note: Projections come from Bistline et al. (2023b) and show the average annual low-emitting capacity investments
through 2035 under reference and IRA scenarios (where bars show the range and circles show individual model outputs).
Low-emitting capacity includes renewables, energy storage, nuclear, and carbon-capture-equipped capacity. Historical
additions of utility-scale capacity come from Form EIA-860 data and distributed solar from the US Energy Information
Administration’s Electric Power Monthly.
Beyond the power sector, announcements since the IRA was passed suggest increased
investment in emerging segments, including low-emitting hydrogen, sustainable aviation
fuels, and carbon management (Rhodium-MIT/CEEPR 2025), though it may be early to
observe changes specifically from the IRA, since many projects were planned earlier.
183
CHANGES IN FEDERAL CLIMATE POLICY | BISTLINE
Tax credits in IRA are expected to accelerate future electric sector investments,
according to modelling from several organisations (Bistline et al. 2023a). Long-running
cost declines have buoyed deployment of renewables and energy storage in recent years
(Figure 1), including record adoption levels of solar and battery storage in 2024. However,
analysis suggests that the IRA’s power sector production and investment tax credits could
roughly double the pace of investment by 2035 (Figure 1). Figure 1 also shows the steady
decline in coal power plant capacity over last decade. Recent analysis on the EPA’s power
plant rules indicates that these standards could amplify coal retirements and increase
the pace of natural gas capacity additions (Bistline et al. 2025a). Although the rules are
based in part on the application of carbon capture and storage, many models find limited
carbon capture deployment in the power sector under the rules.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
184
According to data from the Clean Investment Monitor, IRA incentives and pre-existing
trends boosted domestic manufacturing of low-emitting technologies in many US
regions (Figure 2). Low-emitting energy manufacturing investment quadrupled between
2022 and 2024, which was led by batteries (Rhodium-MIT/CEEPR 2025), though this
manufacturing is partially contingent on current incentives. For instance, analysis
suggests that between 29% and 72% of battery cell manufacturing could be uneconomic
if EPA tailpipe regulations and IRA tax credits are repealed (Jenkins 2025).12 The
“America First Investment Policy”,13 which constrains Chinese investments in the United
States, may impact planned US battery and solar production, where firms headquartered
in China or with Chinese ownership account for 11% and 14% of production, respectively
(BloombergNEF 2025c). Recent estimates indicate that repealing the IRA could lead
to a decline of 790,000 jobs by 2030 due to direct and indirect employment related to
energy projects (Energy Innovation 2025). Another study suggests that repealing the
IRA’s electric vehicle credits could lead to a net loss of 130,000 jobs by 2030 related to
battery pack manufacturing, vehicle assembly, parts manufacturing, and charging
infrastructure (Bui et al. 2025).
FIGURE 2
MANUFACTURING INVESTMENT ANNOUNCEMENTS BY TECHNOLOGY, 2022 Q3
THROUGH 2024 Q4
.S[JXYRJSY
9JHMSTQTL^
Note: Data come from the Rhodium Group-MIT/CEEPR Clean Investment Monitor available at https://www.
cleaninvestmentmonitor.org/. Bubble size is proportional to investment.
Effects of the IRA on interest rates, unemployment, and inflation are projected to be
small relative to other factors (Bistline et al. 2023c); however, the macroeconomic
environment, especially interest rates, can alter energy investments due to the capitalintensive nature of many low-emitting technologies.
12 Jenkins (2025) also suggests that large shares of existing and planned US EV assembly could be at risk of cancellation or
closure without EPA tailpipe regulations and IRA incentives.
13 https://www.whitehouse.gov/presidential-actions/2025/02/america-first-investment-policy/
CONSUMER AND AFFORDABILITY IMPACTS
Proposed changes to tax credits, regulations, and tariffs could impact consumer
purchases of energy-consuming goods. For instance, Executive Orders have suggested
changes that could alter electric vehicle adoption – reconsidering vehicle emissions
standards, repealing tax credits for electric vehicle purchases, and redirecting federal
programmes intended to expand chargers. Analysis of the IRA’s vehicle credits implies
that over two-thirds of credits could go to households that would have purchased an
electric vehicle without the credits and that the credits decrease foreign producer surplus
(Allcott et al. 2024). In addition, tariffs also could raise costs of operating and purchasing
vehicles, especially with 25% tariffs for imported vehicles, which could raise prices by
$5,000 to $15,000 per vehicle according to Goldman Sachs estimates (Sozzi 2025). Since
35% of electric vehicles sold in the United States in 2024 were manufactured elsewhere,
BloombergNEF estimates that the 25% tariffs on passenger vehicles, light trucks, and
parts could cut the US market for imported electric vehicles in half (Bloomberg 2025d).
EMISSIONS IMPACTS
The peer-reviewed modelling literature compares potential emissions impacts of the IRA,
EPA regulations, and other federal and state policies relative to counterfactual scenarios
without these policies (Bistline et al. 2025b, Bistline et al. 2023a, Iyer et al. 2025).
Modelled projections suggest that the IRA could amplify pre-existing decarbonisation
trends and approximately double emissions reductions by 2035 (Figure 3). Economy-wide
GHG emissions could decline by 34–49% by 2035 from 2005 with the IRA, compared
with 27–36% in the reference without the IRA (compared with 20% reductions in 2024).
These incentives could narrow the implementation gap to achieve near-term emissions
targets over the next decade, but even in hypothetical scenarios with additional federal
and state policy measures, most models and scenarios see national emissions above these
185
CHANGES IN FEDERAL CLIMATE POLICY | BISTLINE
The policy changes above could alter energy expenditures. The IRA’s tax credits
potentially can reduce costs for households and businesses. Analysis suggests that energy
costs could increase by $68 to $430 per household annually by 2035 if the IRA’s energy
credits were repealed (Bistline and Venkatesh 2025, King et al. 2025, Energy Innovation
2025). Repealing IRA tax credits also could increase industrial manufacturing costs by
$8-14 billion annually by 2035, largely due to higher electricity costs (King et al. 2025).
An analysis focusing on repealing the IRA’s power sector credits finds average annual
electricity bill increases of $100 to $160 nationally, but increases of $300 to $400 in some
regions (Bergman et al. 2025). Independent models show that the EPA’s power plant
rules could increase wholesale electricity prices by less than 2% in 2040 (Bistline et al.
2025a). Finally, the elimination of Low-Income Home Energy Assistance Program staff
in April 2025 could increase utility bills for the 6 million low-income households that use
this programme (Plumer 2025).
targets. The EPA’s power plant GHG rules could reduce power sector CO2 emissions and
narrow their range: 73–86% below 2005 levels in 2040 compared to 60–83% without the
rules (Bistline et al. 2025a).
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
186
Other policy changes mentioned above may also impact emissions, though there are
not yet estimates for their potential impacts. Some factors could lower emissions, such
as tariffs on imported oil (which could lower aggregate demand and substitute toward
lower carbon-intensity resources),14 while others have ambiguous impacts, including
tariffs on vehicles (which could lead to shifts in new vehicle sales, used vehicle markets,
and utilisation of existing vehicles; see Jacobsen and van Benthem 2015). If tariffs lower
economic activity and household income (The Budget Lab 2025, Amiti et al. 2019),15
these changes could lower emissions, as they have in previous economic crises (Bersalli
et al. 2023).
FIGURE 3
COMPARISON OF US ECONOMY-WIDE EMISSIONS REDUCTIONS ACROSS
SCENARIOS
Note: Projected emissions over time are shown under reference scenarios without IRA (blue), with IRA (orange), and
extended state and federal policies (red). Scenarios come from Bistline et al. (2025b), Bistline et al. (2023a), and Iyer et al.
(2025). Historical emissions are based on the US EPA’s “Inventory of U.S. Greenhouse Gas Emissions and Sinks”.
14 For instance, Canada has among the highest carbon intensity of crude oil production (Masnadi et al. 2018), so the 10%
tariff on Canadian crude oil could shift toward lower-emitting resources.
15 The Budget Lab at Yale (2025) modelled all tariffs in 2025 including the tariffs announced on 2 April and estimates that
tariffs will lower average disposable income by $3,800 annually in 2024 dollars, while real GDP is 0.6% lower in the long
run. Amiti et al. (2019) study impacts of the 2018 tariffs and find that prices of goods subject to the tariffs increased by
10-30% and that they were “passed on almost immediately to US importers and consumers”.
These changes to climate and energy policy also affect conventional air pollutants such
as NOx and SO2. Studies of the IRA’s impacts on improved local air quality suggest that
monetised benefits could be $20–49 billion per year by 2030 (Roy et al. 2022, Mahaan et
al. 2022, Jenkins et al. 2022).16
FISCAL IMPACTS
Estimates of the IRA’s fiscal costs to the government range from $430 billion to $1,370
billion through 2031 (Bistline et al. 2023a).17 Cumulative spending increases to $830–
1,840 billion by 2035, due to the longer eligibility of some credits, including the power
sector technology-neutral tax credits. The range over the 10-year budget window is 1.1
to 3.5 times the initial IRA score from the Congressional Budget Office (CBO) and Joint
Committee on Taxation (JCT). The updated score from February 2024 doubled the
earlier estimate, which included higher values for the transport and power sector credits
(CBO 2024).
FIGURE 4
CUMULATIVE FISCAL COSTS OF IRA’S ENERGY AND CLIMATE PROVISIONS
(BILLION NOMINAL DOLLARS)
Note: Left bars show CBO/JCT scores by IRA provision, where specified (CBO 2022, 2024). Right bars show other
projections of IRA’s fiscal costs (separated in power sector and total fiscal costs) with individual studies as circles and the
range as bars (Bistline et al. 2025b, Bistline et al. 2023a, Bistline et al. 2023c, Goldman Sachs 2023, Credit Suisse 2022).
PTC/ITC = power sector production and investment tax credits.
16 Such valuations omit several benefits categories in the empirical literature from improved air quality related to human
health, cognition, and productivity (Henneman et al. 2023; Alexander and Schwandt 2022, Wen and Burke 2022, Chang et
al. 2019).
17 See the contribution by Fatas and Panizza in this volume for broader discussions of the fiscal policy outlook.
CHANGES IN FEDERAL CLIMATE POLICY | BISTLINE
187
UNCERTAINTIES AND OPEN QUESTIONS
Many factors may shape the trajectory of US energy, environmental, and climate policy.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
188
• Data centres and load growth: Data centres, end-use electrification, and onshoring
manufacturing could supercharge electricity demand growth, after two decades of
relative stagnation. Stakeholders have been acutely focused on understanding data
centre growth with the use of artificial intelligence for commercial and consumer
use. In the United States, data centre electricity use is projected to double or triple
through 2030, from 4% of total electricity demand in 2023 to 5–12% by 2030 (EPRI
2024, Shehabi, et al. 2024, Blanford and Bistline 2024). These rapid changes raise
questions about regional grid impacts, load flexibility, and costs and are linked to
the pace of siting, permitting, and interconnection (Armstrong et al. 2024).
• Global fuel market dynamics: US energy trade is tied to global markets. The
United States became a net exporter of liquified natural gas (LNG) in 2017 and
exported 18% of natural gas production in 2023, becoming the world’s largest
exporter. Reversing the pause on LNG export permits in January 2025 may amplify
trends of increasing exports. Econometric analysis of domestic and international
fuel prices suggests that LNG exports have connected US gas prices to world
markets, which increases domestic prices similar to imposing a carbon tax on
natural gas of $20 per metric ton of CO2 (Stock and Zaragoza-Watkins 2024).
Ultimately, global substitution patterns determine emissions implications of
increased US LNG exports (Abuin 2025, Department of Energy 2024).
• Long-run effects of tariffs: The potential long-run implications of tariffs for
investment, international competitiveness, and responses from other countries are
still uncertain. The duration of tariffs is not the only factor in determining their
effects. For instance, one study finds that, although steel tariffs in 2002 only lasted a
year, those “tariffs did not boost local steel employment but substantially depressed
local employment in steel-consuming industries for many years” after they were
removed (Lake and Liu 2025). The uncertainty created by the tariffs specifically
for the oil and gas sector is reflected in the March 2025 Dallas Fed Energy Survey,
which saw the outlook uncertainty index jump from 24 to 41 from the previous
quarter (Federal Reserve Bank of Dallas 2025).18 In a survey of expert economists,
74% agreed that “disruptions to global supply chains from new tariffs and trade
wars will lead to measurably slower global growth over the next five years” (Chicago
Booth 2025), which would alter energy markets.
18 Over 60% of respondents from oil and gas support services firms expected steel import tariffs to decrease customer
demand in 2025 (Federal Reserve Bank of Dallas 2025).
SUMMARY
Recent Executive Orders, proposed regulatory rollbacks, new tariffs, and potential
revisions to the IRA’s climate provisions together signal a material, but uncertain, shift
in US climate and energy policy trajectories. If the IRA incentives are reduced, most
published models suggest notably slower growth in low-emitting energy adoption, higher
energy expenditures for businesses and households ($68 to $430 per household annually
by 2035), and smaller reductions in economy-wide emissions over time (Table 1). Fiscal
cost impacts span hundreds of billions of dollars, with budgetary estimates hinging on
how much of the IRA remains in force. Overall, modelling studies suggest that policy
adjustments are likely to alter investment signals, technology costs, and emissions
outcomes rather than reversing long-term decarbonisation trends entirely.
189
CHANGES IN FEDERAL CLIMATE POLICY | BISTLINE
• Subnational policy and company targets: Companies, cities, and states have
increasingly pledged to reduce their emissions, including many entities targeting
net-zero emissions (Davis et al. 2023). States have adopted a broad collection of
measures, policies, and incentives to encourage clean energy deployment and
emissions reductions. In addition, companies have set voluntary emissions
reduction targets, including growing interest of large electricity customers, electric
companies, and others in procuring and supplying ‘carbon-free’ energy 24 hours
a day, seven days per week (EPRI 2022). But it remains to be seen whether these
actions are contingent on federal efforts (e.g. if federal tax credits support action
by lowering costs of clean energy) or supplant federal action (e.g. if efforts from
businesses, cities, and states increase their goals as federal action recedes).
Lower than
full-IRA
baseline
Net decrease
Net increase
Clean Energy
Investment
Energy-Related
Employment
Household
Energy Costs
Reduced tax credits could raise costs; higher
tariffs could increase equipment prices; regulatory
uncertainty could slow project development
Qualitative Mechanisms
Lower federal IRA energy provisions:
outlays
$0.4-1.4 trillion through
2031
34-49% lower in 2035
with IRA from 2005 (2736% without IRA)
$68 to $430 per year by
2035
Tax credit repeal could reduce expenditures; lower
deployment due to other changes
Weaker incentives for low-emitting supply- and
demand-side technologies; fuel-mix shifts under
revised regulations; demand effects from tariffs
Loss of tax credits, modest price effects of regulatory
changes, and higher costs for vehicles and appliances
790,000 clean energy jobs Fewer projects and thinner domestic manufacturing
by 2030 (with 130,000
margins could offset gains in fossil-fuel-related jobs
electric vehicle jobs)
26-48% lower power
sector capacity additions
Quantitative Range
Note: Qualitative and quantitative changes are summarised based on recent analysis.
Fiscal Costs
GHG Reductions Slower
decline
Potential
Direction of
Impact
CBO (2024); Bistline et al.
(2023a); Credit Suisse (2022)
Bistline et al. (2023a); Iyer et
al. (2025)
Bistline and Venkatesh (2025);
King et al. (2025); Energy
Innovation (2025)
Energy Innovation (2025); Bui
et al. (2025)
Bistline, et al. (2023a, 2023b);
Rhodium-MIT/CEEPR (2025)
Sources
SUMMARY OF POTENTIAL IMPACTS OF RECENTLY PROPOSED CHANGES TO FEDERAL CLIMATE AND ENERGY POLICIES
Channel
TABLE 1
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
190
REFERENCES
Alexander, D and H Schwandt (2022), “The Impact of Car Pollution on Infant and Child
Health: Evidence from Emissions Cheating”, The Review of Economic Studies 89(6):
2872-2910.
Allcott, H, R Kane, M S Maydanchik, J S Shapiro and F Tintelnot (2024), “The Effects
of “Buy American: Electric Vehicles and the Inflation Reduction Act”, NBER Working
Paper 33032.
Amiti, M, S J Redding and D E Weinstein (2019), “The Impact of the 2018 Tariffs on
Prices and Welfare”, Journal of Economics Perspectives 33(4): 187-2010.
Armstrong, L, A Canaan, C Knittel, G Metcalf and T Schittekatte (2024), “Can Federal
Grid Reforms Solve the Interconnection Problem?”, Science 385(6704): 31-33.
Bergman, A, M Peplinski, K Rennert and N Roy (2025), “Projected Impacts of Repealing
the Section 45Y and 48E Technology-Neutral Clean Electricity Tax Credits”, Resources
for the Future Issue Brief 25-06.
Bersalli, G, T Trondle and J Lilliestam (2023), “Most Industrialised Countries Have
Peaked Carbon Dioxide Emissions During Economic Crises Through Strengthened
Structural Change”, Communications Earth & Environment 4: 44.
Bistline, J and A Venkatesh (2025), Impacts of the U.S. Inflation Reduction Act on Energy
System Investments and Emissions, EPRI Report 3002031650.
Bistline, J, G Blandford, M Brown et al. (2023a), “Emissions and Energy Impacts of the
Inflation Reduction Act”, Science 380(6652): 1324-1327.
Bistline, J, M Brown, M Domeshek et al. (2023b), “Power Sector Impacts of the Inflation
Reduction Act of 2022”, Environmental Research Letters 19(1): 014013.
Bistline, J, N R Mehrotra and C Wolfram (2023c), “Economic Implications of the Climate
Provisions of the Inflation Reduction Act”, Brookings Papers on Economic Activity,
Spring: 77-157.
Bistline, J, A Bergman, G Blandford et al. (2025a), “Impacts of EPA’s Finalized Power
Plant Greenhouse Gas Standards”, Science 387(6730): 140-143.
Bistline, J, K A Clausing, N R Malhotra, J H Stock and C Wolfram (2025b), “Climate
Policy Reform Options in 2025”, Environmental and Energy Policy and the Economy
6(1): 101-139.
191
CHANGES IN FEDERAL CLIMATE POLICY | BISTLINE
Abuin, C (2025), “Power Decarbonization in a Global Energy Market: The Climate Effect
of U.S. LNG Exports”, Job Market Paper (https://constanzaabuin.github.io/assets/pdf/
Abuin-GlobalPowerDecarbonization.pdf).
Blanford, G and J Bistline (2024), Powering Data Centers: U.S. Energy System and
Emissions Impacts of Growing Loads, EPRI Report 3002031198.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
192
BloombergNEF (2025a), “What Trump’s Metal Tariffs Mean for Imports, Prices, and
Jobs” (https://www.bnef.com/insights/35879).
BloombergNEF (2025b), “U.S. Battery Storage Cost Jumps 6% With Trump’s New Tariffs”
(https://www.bnef.com/insights/35999).
BloombergNEF (2025c), “Trump’s Investment Rules Hold Back Made-in-U.S. Clean
Tech” (https://www.bnef.com/insights/36067).
BloombergNEF (2025d), “Auto Tariffs Could Cut US Market for Imported EVs in Half:
React” (https://www.bnef.com/analyst-reactions/su7dr6t0g1kw00).
The Budget Lab (2025), “Where We Stand: The Fiscal, Economic, and Distributional
Effects of All U.S. Tariffs Enacted in 2025 Through April 2” (https://budgetlab.yale.
edu/research/where-we-stand-fiscal-economic-and-distributional-effects-all-us-tariffsenacted-2025-through-april).
Bui, A, L Pierce, P Slowik, S Searle and R Orvis (2025), “How the Inflation Reduction Act
Is Driving U.S. Job Growth Across the Electric Vehicle Industry”, International Council
on Clean Transportation.
Carlson, A and D Burtraw (eds) (2019), Lessons from the Clean Air Act: Building
Durability and Adaptability into U.S. Climate and Energy Policy, Cambridge University
Press.
CBO – Congressional Budget Office (2022), “Summary: Estimated Budgetary Effects of
Public Law 117-169, to Provide for Reconciliation Pursuant to Title II of S. Con. Res. 14.
Congressional Budget Office” (https://www.cbo.gov/system/files/2022-09/PL117-169_97-22.pdf).
CBO (2024), “The Budget and Economic Outlook: 2024 to 2034” (https://www.cbo.gov/
publication/59710).
Chang, T Y, J Graff Zivin, T Gross and M Neidell (2019), “The Effect of Pollution on
Worker Productivity: Evidence from Call Center Workers in China”, American Economic
Journal: Applied Economics 11(1): 151-172.
Chicago Booth (2025), “Tariffs, Technology, and Growth. Kent A. Clark Center for Global
Markets” (https://www.kentclarkcenter.org/surveys/tariffs-technology-and-growth/).
Clausing, K and N Sarin (2023), “The Coming Fiscal Cliff: A Blueprint for Tax Reform in
2025”, The Hamilton Project.
Credit Suisse (2022), “U.S. Inflation Reduction Act: A Tipping Point in Climate Action”.
Davis, S J et al. (2023), “Mitigation”, in A R Crimmins, C W Avery, D R Easterling et
al. (eds), Fifth National Climate Assessment, U.S. Global Change Research Program
(https://nca2023.globalchange.gov/chapter/32/).
Dotson, G and D Maghamfar (2023), “The Clean Air Act Amendments of 2022: Clean
Air, Climate Change, and the Inflation Reduction Act”, Environmental Law Reporter 53:
10017.
Energy Innovation (2025), “Repealing Federal Energy Tax Credits Would Cost American
Jobs and Increase Household Energy Bills”.
EPRI – Electric Power Research Institute (2022), 24/7 Carbon-free Energy: Matching
Carbon-free Energy Procurement to Hourly Electric Load, EPRI Report 300202520.
EPRI (2024), Powering Intelligence: Analyzing Artificial Intelligence and Data Center
Energy Consumption, EPRI Report 3002028905.
Farber, D (2025), “Dissecting the Attacks on the Endangerment Finding”, LegalPlanet,
17
March
(https://legal-planet.org/2025/03/17/dissecting-the-attacks-on-theendangerment-finding/).
Federal Reserve Bank of Dallas (2025), “Oil and Gas Activity Edges Higher; Uncertainty
Rising, Costs Increase” (https://www.dallasfed.org/research/surveys/des/2025/2501).
Goldman Sachs (2023), Carbonomics: The Third American Energy Revolution (https://
www.goldmansachs.com/insights/goldman-sachs-research/carbonomics-the-thirdamerican-energy-revolution).
Gongloff, M and E He (2025), “Years of Climate Action Demolished in Days: A Timeline”,
Bloomberg
(https://www.bloomberg.com/opinion/features/2025-03-26/years-ofclimate-action-are-being-demolished-in-days-by-trump-a-timeline).
Helveston, J P, G He and M R Davidson (2022), “Quantifying the Cost Savings of Global
Solar Photovoltaic Supply Chains”, Nature 612: 83-87.
Henneman, L, C Choirat, I Dedoussi, F Dominici, J Roberts and C Zigler (2023),
“Mortality Risk from United States Coal Electricity Generation”, Science 382(6673): 941946.
Jenkins, J (2025), “Potential Impacts of Electric Vehicle Tax Credit Repeal on U.S. Vehicle
Market and Manufacturing”, REPEAT Project (https://zenodo.org/records/15001499).
Iyer, G, A Zhao, A Bryant et al. (2025), “A Multi-Model Study to Inform the United States’
2035 NDC”, Nature Communications 16: 643.
193
CHANGES IN FEDERAL CLIMATE POLICY | BISTLINE
Department of Energy (2024), “Energy, Economic, and Environmental Assessment of
U.S. LNG Exports”, U.S. Department of Energy, Office of Fossil Energy and Carbon
Management.
Jacobsen, M R and A A van Benthem (2015), “Vehicle Scrappage and Gasoline Policy”,
American Economic Review 105(3): 1312-1338.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
194
Jenkins, J D, E N Mayfield, J Farbes, R Jones, N Patankar, Q Xu, and G Schivley (2022a),
Preliminary Report: The Climate and Energy Impacts of the Inflation Reduction Act of
2022, REPEAT Project.
King, B, H Kolus, M Gaffney, A van Brummen and J Larsen (2025), “The Stakes for
Energy Costs in Budget Reconciliation”, Rhodium Group.
Lake, J and D Liu (2025), “Local Labor Market Effects of the 2002 Bush Steel Tariffs”,
American Economic Journal: Economic Policy (forthcoming).
Masnadi, M S, H M El-Houjeiri, D Schunack et al. (2018), “Global Carbon Intensity of
Crude Oil Production”, Science 361(6405): 851-853.
Mahaan, M, O Ashmoore, J Rissman, R Orvis and A Gopal (2022), Modeling the Inflation
Reduction Act Using the Energy Policy Simulator, Energy Innovation.
Plumer, B (2025), “Entire Staff Is Fired at Office That Helps Poorer Americans Pay for
Heating”, New York Times, 2 April.
Rhodium-MIT/CEEPR (2025), “Clean Investment Monitor”, Rhodium Group and
Massachusetts Institute of Technology Center for Energy and Environmental Policy
Research (https://www.cleaninvestmentmonitor.org/).
Roy, N, M Domeshek, D Burtraw, K Palmer, K Rennert, J-S Shih and S Villanueva
(2022), Beyond Clean Energy: The Financial Incidence and Health Effects of the IRA,
RFF Report 22-11.
Shehabi, S J Smith, A Hubbard et al. (2024), 2024 United States Data Center Energy
Usage Report, Lawrence Berkeley National Laboratory LBNL-2001637.
Sozzi, B (2025), “Trump’s 25% Auto Tariffs May Send Car Prices Surging Up to $15,000
Higher, Goldman Warns”, Yahoo Finance, 28 March.
Stock, J H and M Zaragoza-Watkins (2024), “The Market and Climate Implications of
U.S. LNG Exports”, NBER Working Paper 32228.
Wen, J and M Burke (2022), “Lower Test Scores from Wildfire Smoke Exposure”, Nature
Sustainability 5: 947–955.
Wood Mackenzie (2025), Impact of Tariff Scenarios on U.S. Renewable Energy Costs:
Analysis of Onshore Wind, Solar, and Battery Storage Cost Trends and Competitiveness
Under Various Tariff Policies.
ABOUT THE AUTHOR
John Bistline is a Senior Program Manager in EPRI’s Energy Systems and Climate
195
CHANGES IN FEDERAL CLIMATE POLICY | BISTLINE
Analysis group. His research analyses the economic and environmental effects of policy
and technological change with a focus on energy systems. Dr. Bistline’s current research
activities examine the impacts of federal and state energy and environmental policies,
power systems modelling, and the economics of emerging technologies. Dr. Bistline was
an author for the Intergovernmental Panel on Climate Change Sixth Assessment Report
and for the mitigation chapter of the Fifth U.S. National Climate Assessment. He is an
Associate Editor for The Electricity Journal. Dr. Bistline earned a Bachelor of Science
degree in Mechanical Engineering and Engineering and Public Policy from Carnegie
Mellon University, a Master of Science degree in Mechanical Engineering from Stanford
University, and a doctorate in Management Science and Engineering from Stanford
University.
CHAPTER 15
Mary K. Hendrickson and David J. Peters
University of Missouri; Iowa State University
A stark rural-urban economic divide has developed over the past 20 years in the United
States. The decade of the 2000s was bookended by two recessions. Both urban and rural
areas slowly recovered job losses from the short 2001 recession, only to lose those gains
during the severe Great Recession in 2007-2009. The decade of the 2010s saw a job
creation boom in urban areas, while rural America struggled to create jobs. For example,
urban jobs during the 2010s grew by 24.9% compared to only 4.8% for rural jobs (BEA
2024). Then the COVID-19 pandemic hit and triggered another recession in 2020, wiping
out a decade of job gains in rural America. Post-pandemic, urban jobs have rebounded
fast, while rural jobs have been slow to recover. Over the past two decades of booms and
busts, urban economies have managed to grow employment by 32%, four times faster
than the rural job growth rate of only 7.8%. All of this suggests a widening rural-urban
economic divide, where urban areas have been much more resilient to economic shocks,
while more vulnerable rural areas have lagged behind. Prior recessions and global trade
have hit traditional rural sectors like manufacturing and agriculture hard, leading to
business closures and farm concentration (Constance et al. 2014, Partridge 2020). Rural
economic vulnerabilities have been reinforced by other vulnerabilities that include outmigration of young adults, farm consolidation, drug addiction and mental health crises,
and falling rural quality of life (MacDonald 2020, MacDonald et al. 2023, Peters 2020,
Peters et al. 2020).
In this chapter, we discuss potential economic and social impacts on an already
vulnerable rural America from proposed policies during the first months of President
Trump’s second term in office. We say ‘potential’ impacts for two reasons. First, most
of the administration’s policies have yet to be fully implemented by Executive Order or
by Congress. Second, there are no available data on how proposed changes may have
already affected rural America, if at all. As a result, we use existing data to identify
rural vulnerabilities that may be exacerbated by policies currently in force or under
consideration by the executive and legislative branches of the US government. In our
analysis, urban areas are defined as counties that belong to a federally designated
metropolitan statistical area, whereas rural areas are counties that fall outside a metro
197
RURAL ECONOMIES AND COMMUNITIES | HENDRICKSON AND PETERS
Rural economies and communities
area.1 We examine key economic indicators for both the private and public sectors,
including the farm economy. We also examine a few social issues related to population
loss, labour shortages, and healthcare.
198
As shown in Figure 1, the rural economy is dominated by goods-producing and resourceextracting industries (including agriculture), while urban America is primarily a
services-based economy.2,3 Nearly 42% of rural GDP, 36% of rural earnings, and 28% of
rural jobs are tied to the farm or the factory. Rural shares in GDP, jobs, and earnings are
1.5 to 2 times higher than in urban economies.
FIGURE 1
SHARES OF EMPLOYMENT, EARNINGS, AND GDP BY INDUSTRY 2023
100
90
Percent in 2023
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
RURAL AMERICA’S ECONOMY IS MORE VULNERABLE TO TRADE WARS
80
Natural Resources & Mining
Professional-Related Services
Trade, Leisure, Hospitality
10.8
14.3
10.5
21.7
15.2
17.0
10.4
19.5
70
60
17.7
30
31.6
39.3
19.0
22.6
15.5
32.8
16.9
19.2
Jobs
Earnings
Metro
18.9
9.2
GDP
15.9
14.7
20.4
20.8
7.0
0
12.5
15.2
20.2
20
10
14.5
14.6
50
40
Goods Producing & Related
Real Estate & Other Services
Government/Public Sector
Jobs
27.9
8.1
27.5
14.2
Earnings GDP
Non-Metro
Data Source: Regional Economic Accounts, U.S. Bureau of Economic Analysis.
The Trump administration’s goal to restart American manufacturing by imposing
high tariffs on foreign imports, even on key US trading partners in Canada and Mexico
who have been part of the NAFTA/USMCA trading block for the past 30 years, has the
1
2
3
Metropolitan is defined using 2012 Core Based Statistical Areas. Metropolitan counties contain a central city of 50,000 or
more people, plus surrounding counties that are linked to the central city by commuting patterns. Counties not falling into
a metro area are classified as non-metropolitan. In 2012, non-metropolitan areas contained 63% of counties, but only held
15% of the population.
Natural Resources and Mining includes: agriculture, forestry, fishing, and mining. Goods Producing and Related includes:
construction, manufacturing, transportation and warehousing, and utilities. Professional-Related Services includes:
information, finance and insurance, professional, management, educational, health care, and social assistance services.
Real Estate and Other Services includes: real estate, rental and leasing, administrative and support services, waste
management, and other services. Trade, Leisure, and Hospitality includes: wholesale and retail trade, arts, entertainment,
and recreation, and accommodation and food services. Government and Public Sector includes: public education, public
healthcare, and state and local government.
Employment, earnings, and GDP is for private and public establishments, including farm proprietors and self-employed.
Jobs include full-time and part-time positions. Source: Regional Economic Accounts, U.S. Bureau of Economic Analysis.
In short, prolonged tariffs will disproportionately harm rural workers and businesses
because the rural economy is more specialised in export-dependent sectors like
agriculture and manufacturing. By contrast, urban workers and businesses will be
less impacted as the urban economy is a services-based one, though urban as well as
rural populations will all be affected by higher consumer prices reflecting the potential
pass-through costs of increased tariffs. In particular, tariff-related price increases will
reduce rural incomes in a few key areas, according to data from the US Bureau of Labor
Statistics.4 Rural households pay more for transportation than their urban counterparts,
especially for gasoline and diesel fuel (27% more), and for both used cars and trucks
(31.8% more) and new vehicles (7.7% more). Rural people also pay 13.4% more for major
appliances than people living in large cities.
TRADE WARS MAY SLOW ALREADY SLUGGISH JOB GROWTH IN MOST OF
RURAL AMERICA
In the last two decades, one can summarise the rural economy as a tale of ‘the west
and the rest’, as shown in Figure 2. The rural mountain and western states have the
fastest growing economies and populations, far outpacing other rural regions in the
United States.5 Most of these gains are attributable to high natural amenities that link
population gains with economic growth (Watson and Deller 2022). On the other hand,
the rest of rural America is facing slow job creation and losses in population, especially
in northern and northeastern states. For example, the rural Northeast only managed to
grow jobs by 4.4% since 2002; and the rural Midwest–Great Lakes region only has 5.1%
more jobs today than two decades ago. Most of rural America is unable to create enough
new jobs to stimulate population growth, is unable to pay higher wages to attract or
retain workers, and is vulnerable to recessions that wipe away prior job and wage gains.
4
5
Consumer Expenditure Survey for 2023, US Bureau of Labor Statistics.
For a map of US Bureau of Economic Analysis regions, refer to https://www.icip.iastate.edu/maps/refmaps/bea. For more
information on the data, refer to footnote 3
199
RURAL ECONOMIES AND COMMUNITIES | HENDRICKSON AND PETERS
potential to severely harm rural workers and businesses. Other nations would almost
certainly respond by imposing retaliatory tariffs on American manufactured products
and agricultural goods, making them more expensive and less competitive on the global
market. Major trading partners may also see the United States as an unreliable supplier
and start looking to other nations to supply their import needs. Rural businesses also rely
on foreign imports of raw materials and other inputs for their supply chain. US-imposed
tariffs will raise production costs and may even limit the supply of needed inputs if
other nations ban exports of certain goods to the United States. Both the loss or export
markets and limited supply chains may result in job losses and business closures in rural
communities.
FIGURE 2
PERCENT CHANGE IN NON-METROPOLITAN EMPLOYMENT BY REGION, 2002-
28
26
24
22
20
18
16
14
12
10
8
6
4
2
0
-2
-4
Non-Metro Employment
2002-2008 2009-2015
2016-2023
Mountain &
Far West
Southwest
Midwest &
Great Lakes
4.4
5.1
10.2
12.4
Percent change since 2002
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
200
27.6
2023
Southeast
Northeast
Data Source: Regional Economic Accounts, U.S. Bureau of Economic Analysis.
Tariffs and continued trade wars would have a devasting impact on manufacturing and
farming economies in the rural Midwest–Great Lakes and Northeast, which are heavily
dependent on these sectors and which have had very slow job gains over the past two
decades. In short, prolonged trade wars have the potential to stop rural job creation as
the economy recovers from COVID-19 losses.
SOYBEAN FARMERS IN THE CORN BELT ARE MOST AT RISK FROM
RETALIATORY TRADE SANCTIONS
As already discussed, agriculture is an important part of rural employment, earnings,
and GDP. The 2018-2019 trade war with the People’s Republic of China during President
Trump’s first term offers insights into how the current trade war may affect farmers. Figure
3 presents the losses in total exports and net farm income, excluding government trade
loss payments under the Market Facilitation Program, on three commodities targeted by
China.6 We find that soybean farmers bore the brunt of China’s retaliatory actions, as net
farm incomes fell by nearly 60% in 2019, with smaller losses in 2020 as soybean prices
recovered. Corn farmers experienced a 35% loss in net incomes, but strong domestic
demand covered export losses by 2020. For both soybeans and corn, global exports still
remained low as the trade war ended in 2020, indicating a shift by importing nations to
6
Net farm income taken from ARMS, US Department of Agriculture. Income is adjusted for inflation using BEA PCE price
indices. Exports taken from the Foreign Agricultural Service, US Department of Agriculture. The Corn Belt region is
counties in the Midwest identified by USDA.
FIGURE 3
PERCENT CHANGE IN NET FARM INCOME AND EXPORTS TO CHINA BY
20
Net Income 2017-18
China Exports 2017-18
10
5.6
Net Income 2017-19
China Exports 2017-19
12.4
-23.4
0
-20
-60
-70
-35.4
-57.6
-75.1
-50
-63.0
-40
-23.5 -21.7
-23.7
-63.8
-30
-52.8
-10
-50.2
Percent change from 2017
PRODUCTION COMMODITY IN THE US CORN BELT, 2017-2019
Soybeans
Hogs
-34.2
-80
Corn
Poultry
Data Source: ARMS and FAS, U.S. Dept. of Agriculture. Note: No export data is available for poultry.
In a prolonged trade war, other nations will likely target tariffs and boycotts on American
farmers to apply maximum political pressure on the US government. During the 2018-19
trade war, the federal government issued emergency payments to protect farm incomes
and prevent farmers from falling into bankruptcy. However, the cost of this support over
time is likely to become a political issue as the Republican Party seeks to reduce federal
spending and deficits, calling into question the future of these emergency payments.
Corn and soybean farmers face an uncertain future if trade disputes continue. Loss
of market share and farm income has the potential to drive smaller family farms out
of business, leading to greater farm concentration and possible corporatisation of the
nation’s farming system.
IMMIGRATION RESTRICTIONS WILL LIKELY SHRINK RURAL POPULATIONS
AND WORSEN RURAL LABOUR SHORTAGES
Immigration reform is a central policy priority for President Trump in his second term,
as it was in his first. While there are sound arguments for better enforcement of existing
immigration laws, the reality is that much of the rural economy depends on immigrant
201
RURAL ECONOMIES AND COMMUNITIES | HENDRICKSON AND PETERS
source from other exporting nations like Argentina and Brazil (Wesz et al. 2023). The
trade war strengthened the South America–China soy nexus developed over the last two
decades through increased Chinese investments in South American soy production and
expanded crushing capacity within China (Wesz et al. 2023). Hog producers took a 34%
income loss during the first year of the trade war, but exports remained strong as China
experienced devastating losses in pork production due to an outbreak of African swine
fever. As Chinese pork production recovered, US exports declined (Gale et al. 2023).
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
202
workers, whether legal or not, and whether first-generation or later. In rural America,
the White non-Hispanic population is falling rapidly due to slower birth rates and high
out-migration to metropolitan cities (Johnson 2023). This population gap is being filled
by immigrants. Diversification of rural communities is occurring exceptionally fast
in the Midwest–Great Lakes region, as shown in Figure 4.7 In many states, the White
population is shrinking sizably and the only growing segment is people of colour, many
of whom are immigrants, their children, or grandchildren. For example, rural Nebraska’s
population would have fallen by 5.5% during the past decade instead of shrinking by only
1.7% due to gains in people of colour. The American Heartland is both shrinking and
diversifying at the same time.
Immigration policies that slow or halt in-migration of people into rural communities
could have major impacts. Rural businesses would lose workers in all sectors, but
especially in agriculture, meatpacking, construction, and manufacturing. For instance,
in the past 35 years, agriculture has rapidly consolidated, especially in the livestock
sector (Hendrickson et al. 2020, MacDonald et al. 2023), leading to a heavy reliance on
immigrant labour in dairy and hog operations, as well as in meat processing plants.8
Thirty-five percent of manual livestock workers were foreign-born in 2022, according
to USDA’s Economic Research Service.9 Anecdotally, many farmers report feeling
concerned about new immigration crackdowns and the potential impact on their
operations.10 Rural schools would close as the number of students would fall, leading to
school consolidation, fewer school resources, and longer busing times (Hausermann et
al. 2021, Lay 2017). Rural quality of life would worsen as local stores, hospitals, daycares,
and entertainment venues close due to lack of customers (Peters 2019). Most immigrants,
even second-generation, tend to have larger families with younger children, and thus
spend more of their income on local services and shops (Das and Das 2019). Local
government services would also be hit as loss of families would decrease sales taxes and
property taxes (Das and Skidmore 2018).
Immigrants have been essential to keeping the rural economy functioning, as they fill
major workforce shortages. Lack of workers is especially acute in the Midwest–Great
Lakes region, and particularly in agriculture, manufacturing, and healthcare. Labour
force participation rates, presented in Figure 5, show that nearly everyone in the rural
Midwest–Great Lakes region is employed:11 over 85% of people aged 16 to 64 have a job in
Iowa, Kansas, Minnesota, Nebraska, North Dakota, and South Dakota. This situation will
7
8
Population by race taken from Population Estimates Program, U.S. Census Bureau.
Between 1987 and 2017, the median dairy herd size in the United States increased from 80 to 1,300 cows (MacDonald 2020).
Larger herd sizes require more time on milking chores, even with automation, and labour needs have been filled with
immigrants. A University of Wisconsin survey estimates that 70% of labor on the state’s dairy farms are undocumented
workers (Ibarra et al. 2023).
9 https://www.ers.usda.gov/topics/farm-economy/farm-labor#links
10 See https://investigatemidwest.org/2025/04/28/trump-deportations-have-dairy-farmers-on-edge/, https://spectrumnews1
.com/wi/milwaukee/news/2025/03/07/wisconsin-farmers--immigration and https://www.theguardian.com/us-news/2025/
may/28/farmworkers-h-2a-trump-agriculture. See also https://www.agweb.com/news/policy/politics/true-cost-whatfarmers-argue-broken-immigration-system-u-s.
11 Labour force participation is the percentage of the population aged 16-64 that is employed or unemployed but actively
seeking work. Data taken from Local Area Unemployment Statistics, US Bureau of Labor Statistics.
FIGURE 4
PERCENT CHANGE IN NON-METROPOLITAN POPULATION BY RACE AND
Non-Metro
6 Population
Hispanic
African Amer.
Asian or Other
Growth Rate
2+ Races
White
4
2
0
-2
-4
WI
SD
OH
ND
NE
MO
MN
MI
KS
IA
-8
IN
-6
IL
Percent change from 2013-2023
ETHNICITY IN MIDWEST AND GREAT LAKES STATES, 2013-2023
Data Source: Population Estimates Program, U.S. Census.
FIGURE 5
LABOUR FORCE PARTICIPATION RATES (AGES 16-64) IN MIDWEST AND GREAT
Data Source: LAUS, U.S. Bureau of Labor Statistics.
83.1
WI
SD
77.0
OH
ND
NE
MO 71.7
MN
MI
KS
IA
IN
74.3
79.1
85.1
85.7
89.5
89.7
90.5
84.7
Labour Force Participation
Metro
Non-Metro
76.7
96
94
92
90
88
86
84
82
80
78
76
74
72
70
IL
Percent in 2023
LAKES STATES, 2023
203
RURAL ECONOMIES AND COMMUNITIES | HENDRICKSON AND PETERS
only tighten as rural populations get older and many begin to retire from the workforce.
Persistent out-migration over the last four decades means there is no future pipeline of
rural workers. Labour shortages can only be addressed by in-migration of people seeking
economic opportunities, which in most circumstances will be immigrants. Lack of
workers means rural business will not be able to expand and grow, and prevents the rural
economy from attracting new businesses. In short, immigrants and their families play a
vital role in the rural economy.
MEDICAID REFORMS WILL HURT RURAL CHILDREN AND RURAL HOSPITALS
FIGURE 6
PERCENT POPULATION WITH MEDICAID COVERAGE (CIVILIAN NONINSTITUTIONALISED) BY REGION, 2023
54.8
55
41.9
Metro Children
Non-Metro Children
Metro Adults
Non-Metro Adults
39.7
45.2
40
49.2
50
45
35
30
Southwest
Midwest &
Great Lakes
19.8
16.5
10
16.5
15
19.9
25
20
19.3
Percent in 2023
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
204
Proposed Trump administration cuts to Medicaid could have large detrimental impacts
on rural communities. Higher percentages of the non-metro population, especially
children, rely on Medicaid coverage (see Figure 6).12 In all regions of the country, 40%
or more of non-metro children rely on Medicaid. Rural people in Southeast states are
heavily dependent on Medicaid, where the programme covers a stunning 55% of children
and 20% of adults.
Southeast
Northeast
5
0
Mountain &
Far West
Data Source: ACS 2023, U.S. Census.
Substantial cuts to Medicaid would likely mean much reduced access to healthcare for
rural populations, increasing morbidity and mortality to diseases and worsening health
outcomes overall (Peters 2020). Loss of Medicaid reimbursements could further worsen
the financial viability of many rural hospitals and clinics, exacerbating already limited
availability of rural healthcare. Federal data show that rural households pay far more
for healthcare than urban households.13 For example, rural people pay 30.6% more for
pharmaceuticals, 28.5% more for medical services, and 18% more for health insurance
premiums. Medicaid is an important programme that helps rural households offset
some of these costs, especially for vulnerable households with low incomes or that have a
person with a disability.
12 Medicaid enrollment taken from American Community Survey (one-year estimates), US Census Bureau.
13 Consumer Expenditure Survey for 2023, US Bureau of Labor Statistics.
CONCLUSION
In conclusion, we find that newly announced policies by the second Trump administration
may negatively impact already struggling rural economies and communities. Prior
national economic development policies have only widened the rural-urban divide, as
they have tended to benefit urban economies (Leigh and Blakely 2013, Moretti 2012,
Parker et al. 2022). Over the past two decades, the US government has attempted to
promote rural development by either reducing government intervention in the economy,
as during the Bush and first Trump administrations, or through national economic
planning to reindustrialise the nation in key sectors, as during the Obama and Biden
administrations. However, these approaches have done little to address the rural-urban
gap.
For example, during the Biden administration, tax incentives and government financing
to promote advanced manufacturing, renewables or ‘green’ technology, and advanced
computing technologies largely flowed to urban counties. Most rural counties did
not have the skilled labour, supporting industries, educational institutions, or local
government capacity to capitalise on these programmes. In fact, such policies may have
exacerbated rural out-migration of skilled workers (Parker et al. 2022). More concerning
today are proposals to restart American manufacturing by imposing high tariffs on
foreign imports, even on key US trading partners in Canada and Mexico. Tariffs would
have a devasting impact on manufacturing and farming economies in the rural Midwest,
Great Lakes, and the Southeast.
Rural America needs a different approach than what we have seen in 2025. Current
policies will hinder rural development, worsening an already wide rural-urban divide.
The approach taken by the second Trump administration is to use tariffs, immigration
reforms, and reduced federal spending in an effort to stimulate the rural economy
through increases in domestic production, consumption, and investment. This approach
may succeed if trade, immigration, and budget policies work as promoted, but only over
the long term. However, we have shown in this chapter that this approach has many
short-terms risks for rural America. It is imperative that federal policy be designed to
account for rural vulnerabilities related to the economy and population. Doing so will
205
RURAL ECONOMIES AND COMMUNITIES | HENDRICKSON AND PETERS
In addition, supporting rural healthcare through Medicaid also means supporting rural
economies. Healthcare is often of one the largest employers in many rural counties,
employing many skilled professionals with postsecondary degrees (Mullens et al. 2023).
Medicaid expansion under the Affordable Care Act improved the financial performance
of hospitals and lowered the risk of closure, particularly in rural areas (Lindrooth et
al. 2018). Rural hospital closures have negative impacts on income, population, and
community economic growth, and can lead to increased poverty and increase the time
and distance to healthcare (Mills et al. 2024). Further, loss of rural clinics and hospitals
reduces quality of life in small towns, exacerbating out-migration and population loss.
avoid unnecessary harm to rural economies and communities that strongly supported
President Trump in the most recent election, and would better advance an agenda of
promoting rural resiliency and vitality.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
206
REFERENCES
BEA – Bureau of Economic Analysis (2024), “Regional Economic Accounts”, U.S.
Department of Commerce (https://www.bea.gov/data/economic-accounts/regional,
accessed 5 April 2025).
Constance, D, M Hendrickson, P Howard, and W Heffernan (2014), “Economic
Concentration in the Agrifood System: Impacts on Rural Communities and Emerging
Responses”, in C Bailey, L Jensen, and E Ransom (eds), Rural America in a Globalizing
World: Problems and Prospects for the 2010s, West Virginia University Press.
Das, A and B Das (2019), “Economic and Fiscal Impacts of Refugees in Central Iowa:
Opportunities for University Extension”, Journal of Extension 57(2):1-17 (https://open.
clemson.edu/joe/vol57/iss2/17).
Das, B and M Skidmore (2018), “Asymmetry in Municipal Government Responses
in Growing versus Shrinking Counties with Focus on Capital Spending”, Journal of
Regional Analysis and Policy 48(4):62-75 (http://dx.doi.org/10.22004/ag.econ.339920).
Gale, F, J Kee and J Huang (2023), How China’s African Swine Fever Outbreaks Affected
Global Pork Markets, USDA Economic Research Service ERR-326 (https://www.ers.
usda.gov/publications/pub-details?pubid=107924).
Hausermann, H, M Lundy, J Mitchell, A Ipsen, Q Zorn, K Vasquez-Romero, and R
DeMorrow Lynch (2021), “Unsettled Belonging in Complex Geopolitics: Refugees, NGOs,
and Rural Communities in Northern Colorado”, Sustainability 13(1344): 1-18 (https://
doi.org/10.3390/su13031344).
Hendrickson, M K, P H Howard, E M Miller, and D C Constance (2020), The Food System:
Concentration and Its Impacts, Report to Family Farm Action (https://farmaction.us/
concentrationreport/).
Ibarra, A, A Kulwiec, and G Austin-Nichols (2023), “Dairy Workers Study: Legal and
Community Assessment”, Working Paper, School for Workers, University of WisconsinMadison
(https://schoolforworkers.wisc.edu/wp-content/uploads/sites/795/2023/06/
Dairy-Workers-Study-Legal-and-Community-Needs-Assessment.pdf).
Johnson, K (2023), “Population Redistribution Trends in Nonmetropolitan America,
2010 to 2021”, Rural Sociology 88(1): 193-219 (https://doi.org/10.1111/ruso.12473).
Lay, J C (2017), “Adjusting to Immigrants in Two Midwestern Communities: Same
Outcome, Different Process”, Social Science Quarterly 98(5): 1731-1748 (https://doi.
org/10.1111/ssqu.12349).
Leigh, N G and E Blakely (2013), Planning Local Economic Development: Theory and
Practice, Sage.
MacDonald, J M (2020), “Tracking the Consolidation of U.S. Agriculture”, Applied
Economic Perspectives and Policy 42(3): 361-79 (https://10.1002/aepp.13056).
MacDonald, J M, X Dong, and K O Fuglie (2023), Concentration and Competition in
U.S. Agribusiness, USDA Economic Research Service, EIB 246.
Moretti, E (2012), The New Geography of Jobs, Houghton, Mifflin, Harcourt.
Mullens, C L, J A Hernandez, J Murthy, S Hendren, and W Zahnd (2023), “Understanding
the Impacts of Rural Hospital Closures: A Scoping Review”, Journal of Rural Health
40(2): 227-237 (https://doi.org/10.1111/jrh.12801).
Mills, C A, V A Yeager, K T Unroe, A Holmes, and J Blackbur (2024), “The Impact of Rural
General Hospital Closures on Communities—A Systematic Review of the Literature”,
Journal of Rural Health 40(2): 238-48 (https://10.1111/jrh.12810).
Parker, E, L Tach, and C Robertson (2022), “Do Federal Place-Based Policies Improve
Economic Opportunity in Rural Communities”, RSF Journal of Social Sciences 8(4): 125154 (https://doi.org/10.7758/RSF.2022.8.4.06).
Partridge, M (2020), Rural America’s Stagnant Economic Performance: The Role of
Declining Dynamism, American Enterprise Institute (https://www.aei.org/researchproducts/report/rural-americas-stagnant-economic-performance-what-is-the-role-ofdeclining-dynamism/).
Peters, D (2019), “Community Resiliency in Declining Small Towns: Impact of Population
Loss on Quality of Life Over 20 Years”, Rural Sociology 84(4): 635-668 (https://doi.
org/10.1111/ruso.12261
Peters, D (2020), “Community Susceptibility and Resiliency to COVID-19 Across the
Rural-Urban Continuum in the U.S.”, Journal of Rural Health 36(3): 446-456 (https://
doi.org/10.1111/jrh.12477).
Peters, D, S Monnat, A Hochstetler, and M Berg (2020), “The Opioid Hydra: Understanding
Mortality Epidemics and Syndemics Across the Rural-Urban Continuum”, Rural
Sociology 85(3): 589-622 (https://doi.org/10.1111/ruso.12307).
Watson, P and S Deller (2022), “Tourism and Economic Resilience”, Tourism Economics
28(5): 1193-1215 (https://doi.org/10.1177/1354816621990943).
207
RURAL ECONOMIES AND COMMUNITIES | HENDRICKSON AND PETERS
Lindrooth, R C, M C Perraillon, R Y Hardy, and G J Tung (2018), “Understanding the
Relationship between Medicaid Expansions and Hospital Closures”, Health Affairs 37(1):
111-20 (https://10.1377/hlthaff.2017.0976).
Wesz, V J, F Escher, and T Mefano Fares (2023), “Why and How Is China Reordering the
Food Regime? The Brazil-China Soy-Meat Complex and COFCO’s Global Strategy in the
Southern Cone”, Journal of Peasant Studies 50(4): 1376–1404 (https://10.1080/03066150.
2021.1986012).
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
208
ABOUT THE AUTHORS
Mary Hendrickson is Professor of Rural Sociology at the University of Missouri and serves
as Director of the Interdisciplinary Center for Food Security. Hendrickson has been a
leading scholar on consolidation and concentration in the food and agriculture system,
the impacts of such a system on farmers, workers and communities, and new ways of
conceptualizing policy responses around anti-trust. Through research and teaching, she
seeks to build resilient, food secure communities across Missouri and beyond. In 2020,
she taught sustainable agriculture at the Agricultural University of Iceland as a Fulbright
Scholar. Early in her career, she spent 15 years working to create local food systems in
Missouri as an extension sociologist, gaining valuable experience in transforming food
systems.
David J. Peters is a Professor of Agricultural and Rural Policy and Extension Rural
Sociologist at Iowa State University. His work broadly encompasses social and economic
change in rural communities. Specific research areas include rural population and the
economy, rural quality of life, rural health, and public perceptions of genome edited
foods. At ISU, he leads the Iowa Small Towns Project; and has research appointments at
the Center for Agricultural and Rural Development and the Crop Bioengineering Center.
Previously, he was an Assistant Professor of Agricultural Economics at the University of
Nebraska. He has worked as a policy advisor for the Missouri Department of Economic
Development; and as a researcher for the Rural Policy Research Institute (RUPRI). He
holds a BS cum laude from the University of Minnesota, and an MS and PhD from the
University of Missouri.
CHAPTER 16
Michael R. Strain1
American Enterprise Institute, Georgetown University, and IZA
INTRODUCTION
President Trump has stated many goals to justify his trade war. He has argued that
tariffs on imports produce leverage that the US can use to reduce inflows of fentanyl and
illegal immigrants and to negotiate better trade deals. He has also argued that tariffs will
advance US national security and economic resilience, and be a source of revenue for the
federal treasury.
But the two most prominent arguments the President has advanced – both during the
early months of his second term, and for decades prior – are that protectionism will
reduce the trade deficit and increase manufacturing employment. This chapter will focus
on the latter claim.
On “Liberation Day” – 2nd April 2025, when the administration announced increases
in US tariff rates that would take the average rate higher than under the Smoot Hawley
Tariff Act of 1930 – President Trump said: “Jobs and factories will come roaring back
into our country, and you see it happening already. We will supercharge our domestic
industrial base.”2 The President said the following on 7th January 2025: “We’ll impose
new tariffs so that the products on our stores will once again be stamped with those
beautiful words, made in the USA.”3
Other prominent members of Trump’s administration have made similar assertions. US
Trade Representative Jamieson Greer, for example, testified before the Senate Finance
Committee in April: “The President wants to see factories back here.”4
1
2
3
4
I thank Duncan Hobbs for excellent research assistance.
Donald Trump, “Speech Announcing Tariffs at the Rose Garden”, 2 April 2025 (https://www.npr.org/2025/04/05/nx-s15351708/u-s-business-owner-is-cautiously-optimistic-in-the-face-of-sweeping-tariffs).
Donald Trump, “Press Conference at Mar-a-Lago”, 7 January 2025 (https://rollcall.com/factbase/trump/transcript/donaldtrump-press-conference-mar-a-lago-january-7-2025/#61).
“The President’s 2025 Trade Policy Agenda: U.S. Senate Committee on Finance”, Full Committee Hearing, 119th Congress
(2025), Testimony of U.S. Trade Representative Jamieson Greer, 8 April 2025 (https://www.finance.senate.gov/imo/media/
doc/040825_greer_testimony.pdf).
209
THE (NON) EFFECT OF TARIFFS ON MANUFACTURING EMPLOYMENT | STRAIN
The (non) effect of tariffs on
manufacturing employment
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
210
The President and his advisors are going to be disappointed. This chapter will argue that
the tariff increases imposed by the current administration will not substantially increase
US manufacturing employment. Indeed, the trade war will likely decrease the number
of manufacturing jobs in the US. I will also argue that increasing US manufacturing
employment is not a particularly important or desirable goal, and that the protectionist
impulse is predicated on incorrect judgements of economic trends for typical workers
and households.
TARIFFS WON’T INCREASE MANUFACTURING EMPLOYMENT
Protectionists can appeal to intuitive economic logic. Tariffs are a tax on imported goods,
but not on domestically produced goods. By increasing the relative price of imported
goods, price-sensitive consumers will substitute away from imports. This will increase
the competitiveness of domestic producers, in turn boosting the market demand for
manufacturing labour services. Manufacturing employment and wages will therefore
increase.
Protecting domestic manufacturers from competing with imported goods is, indeed, a
major part of the economic story. But two other factors are of first-order importance.
Because US manufacturers import a good deal of what they need to produce final goods,
tariffs are not just a tax on consumption – they are also a tax on business investment.
Taxing investment should reduce the competitiveness of domestic manufacturers, putting
downward pressure on the demand for manufacturing labour services. In addition,
though they are often discussed as static events, tariff increases should be thought of in
a dynamic context. Other nations will retaliate, which will hurt domestic exporters and
reduce the demand for manufacturing workers.
Because of these competing effects, the impact of the Trump administration’s trade war
on manufacturing employment is ultimately an empirical question.
A look at the import statistics should give protectionists immediate pause. In each
quarter of the years 2023 and 2024, between 54% and 56% of US imports consisted of
industrial supplies and materials, capital goods, and automotive engines and parts.
Or consider the case of steel. The administration’s steel tariffs might help US steel
producers. But for every one job in steel production, there are 80 jobs in US industries that
use steel. Among others, US manufacturers of household appliances, farm machinery,
mining machinery, batteries, and hardware are steel intensive, and will face higher
production costs due to steel tariffs (Russ and Cox 2018).
Beyond summary statistics and industry anecdotes, scientific evidence comes from
rigorous studies of President Trump’s first-term trade war. A comprehensive literature
review is beyond the scope of this short chapter. Instead, I will highlight three papers
that I find of particular relevance to current policy issues. Each takes a different lens to
study the manufacturing employment effects of the first trade war. Flaaen and Pierce
(forthcoming) conduct an industry analysis of manufacturing employment, Autor et al.
(2024) analyse local labour markets (i.e., commuting zones), and Javorcik et al. (2022)
study labour demand.
Autor et al. (2024) study the effect of the 2018-2019 tariffs on local labour markets. Their
analytical design separately considers the employment effect of US import tariffs and
foreign retaliatory tariffs. They do not find a positive employment effect from US import
tariffs, but they consistently find negative employment effects in response to foreign
retaliatory tariffs. They also find that the agricultural subsidies the administration
put in place to counteract retaliatory tariffs did little to compensate for the damage to
agricultural employment.5
Javorcik et al. (2022) study the effect of the 2018 tariff increases on online job postings,
which are a measure of labour demand. They do not find that exposure to import
protection increased labour demand. They do find that a local labour market’s exposure
to tariff-driven higher intermediate-input costs and foreign-export tariffs both led to
declines in labour demand. In addition, they find that relative labour demand declines
were larger for vacancies aimed at workers with relatively lower skill levels.
There are two other reasons why this specific trade war will not lead to a revival of US
manufacturing employment. The first comes down to time. The President may be able
to enact tariffs with the stroke of a pen, but building factories – whether for cars, drugs,
clean energy, or semiconductors – takes several years.
The second – and more important – reason is policy uncertainty. Businesses are unlikely
to commit to an expensive, multiyear manufacturing investment in the current policy
environment, which is characterised by unclear policy goals, incompetent execution,
sudden policy reversals and changes, and a chaotic atmosphere. As I wrote in a recent
5
In the current trade war, President Trump is clearly worried about foreign nations retaliating against U.S. agriculture
exporters. On 15 April 2025, the President posted this on social media: “Our farmers are GREAT, but because of their
GREATNESS, they are always put on the Front Line with our adversaries, such as China, whenever there is a Trade
negotiation or, in this case, a Trade War. The same thing happened in my First Term. China was brutal to our Farmers, I these
Patriots to just hold on, and a great trade deal was made. I rewarded our farmers with a payment of $28 Billion Dollars, all
through the China deal.” (https://x.com/TruthTrumpPosts/status/1912171986719236496)
211
THE (NON) EFFECT OF TARIFFS ON MANUFACTURING EMPLOYMENT | STRAIN
Flaaen and Pierce (forthcoming) estimate the effect of the US tariff increases of 20182019 on manufacturing employment. The authors decompose the overall effect into the
three components described above: import protection, higher input costs, and retaliation.
They find that shifting a detailed (four-digit NAICS) industry from the 25th to the 75th
percentile of tariff exposure was associated with a 0.4% increase in employment due
to import protection, a 2.0% decrease in employment due to higher input costs, and a
1.1% decrease in employment due to retaliation. On net, they find that moving from the
25th to the 75th percentile of exposure reduced employment by 2.7%. They also provide
evidence that lower rates of job creation is the main mechanism by which manufacturing
employment fell in response to the 2018-2019 tariffs.
commentary: “Given that US producers rely heavily on imported intermediary goods,
wild swings in tariffs are hugely destabilizing. When firms can’t forecast their costs, they
can’t determine which investments are likely to generate profits” (Strain 2025b).
WHY THE FOCUS ON MANUFACTURING JOBS?
Tariffs are unlikely to increase manufacturing employment as an empirical matter. But
more fundamentally, invoking manufacturing employment declines as a justification for
protectionism fundamentally misunderstands the root causes of employment dynamics.
Manufacturing employment as a share of total nonfarm employment has been declining
since the end of World War II because manufacturing productivity has been increasing
over that period. The main driver of manufacturing employment declines has been
technological progress, not international trade.
Figure 1 clearly illustrates declining manufacturing employment well before China’s
accession to the WTO in 2001 or the North American Free Trade Agreement (NAFTA)
coming into effect in 1994. If protectionists really wish to boost manufacturing
employment, then they should be arguing for reducing manufacturing productivity, not
imports.
FIGURE 1
MANUFACTURING EMPLOYMENT SHARE
0.40
Manufacturing Employment Share of
Total Employment
0.35
0.30
0.25
0.20
0.15
0.10
0.05
1939
1941
1943
1945
1947
1949
1951
1953
1955
1957
1959
1961
1963
1965
1967
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
2019
2021
2023
2025
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
212
Note: Total employment in manufacturing divided by total nonfarm employment, from the Current Employment Statistics
programme.
Source: Bureau of Labor Statistics; author’s calculations.
Why should manufacturing employment receive so much attention? Protectionists
often cite the quality of manufacturing jobs relative to service sector jobs, the need for
strong domestic manufacturing capacity, and resilience and security concerns. But these
concerns are either misplaced or will be aggravated, not ameliorated, by the current
trade war.
Some supporters of protectionism seem to think that because manufacturing
employment has been declining for decades, the US’s ability to produce has also been
declining. Indeed, the assertion that “the United States doesn’t make things anymore” is
as common as it is incorrect. The US does not need to adopt protectionist policies – to say
nothing of starting a severe global trade war – to create the capacity to produce goods; it
already has that capacity.
US industrial output reached its post-World War II high in February 2025. It is true that
the growth of industrial output substantially slowed following the 2008 global financial
crisis. But the level of industrial output today is higher than it was prior to China’s 2001
accession to the WTO. Industrial output was higher in 2001 than in 1994, when NAFTA
came into effect. And as shown in Figure 2, industrial output was higher in 1994 than in
any earlier year.
FIGURE 2
US INDUSTRIAL OUTPUT
110
Index (2017=100)
90
70
50
30
-10
1919
1922
1925
1928
1931
1934
1937
1940
1943
1946
1949
1952
1955
1958
1961
1964
1967
1970
1973
1976
1979
1982
1985
1988
1991
1994
1997
2000
2003
2006
2009
2012
2015
2018
2021
2024
10
Note: Industrial production: total index, from the Federal Reserve Board’s Industrial Production and Capacity Utilization
(G.17) statistical release.
Source: Federal Reserve Board; author’s chart.
The US is not just producing more than ever before; relative to other nations, it is a global
manufacturing powerhouse. As shown in Figure 3, the US produces more manufacturing
output than any nation except China – and third place is a distant third. It is important
to note that China overtook the US because it ramped up its production, not because the
US began producing less.
213
THE (NON) EFFECT OF TARIFFS ON MANUFACTURING EMPLOYMENT | STRAIN
Supporters of protectionism often tout the quality of manufacturing jobs. But the average
wage of a manufacturing job has been lower than the average wage in a services sector
job since 2018. Manufacturing jobs are often more dangerous and less pleasant than
services jobs. And if the current administration succeeds in transferring low-wage, lowvalue-added manufacturing jobs from other countries to the US, then the average US
manufacturing wage will decrease.
It may or may not be important for the US to have a robust manufacturing sector. One
could reasonably argue that all that matters for the US is to have strong alliances with
trading partners in which the goods Americans wish to consume are produced.
But even economists who hold that view might grant exceptions for a small number of
critical goods, like semiconductors or certain pharmaceuticals. The disruptions during
the Covid-19 pandemic arguably exposed the need for greater resilience in supply chains.
And escalating geopolitical tensions highlight the relationship between imports and
national security.
FIGURE 3
THE US IS A GLOBAL MANUFACTURING POWERHOUSE
5,000
4,500
Billions (2015 constant dollars)
4,000
3,500
3,000
2,500
2,000
1,500
1,000
France
Mexico
UK
Italy
India
South Korea
Germany
Japan
USA
China (mainland)
2020
2022
2016
2018
2012
2014
2008
2010
2004
2006
2000
2002
1996
1998
500
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
214
Note: Total value added from manufacturing from 1970 to 2023 for the top 10 countries in terms of total manufacturing
value added in 2023, measured in 2015 constant dollars, published by the United Nations Statistics Division.
Source: United Nations Statistics Division; author’s calculations.
The right way to address these resilience and security considerations is to take a judicious
approach in targeting a narrow set of products and technologies that clearly warrant
intervention, and to pursue that intervention in concert with a broad coalition of allies.
If done properly, policymakers would take great care not to conflate economic security
goals with domestic economic or political considerations, like trends in manufacturing
employment (Strain 2024a).
Contrast that approach with the Trump administration’s. It is hard to think of a better
way to exacerbate supply chain disruptions than a sudden, severe global trade war. And
America is clearly less safe because of the President’s trade war.
TRADE DEFICITS AND TAX REVENUE
In addition to concern about manufacturing and the trade deficit, the President and
some of his advisors sometimes argue that tariffs will increase tax revenue. The President
is right that the government should increase revenue. But tariffs are in part a tax on
business investment, which will result in lower productivity and lower wages. An actual
consumption tax would be far superior.6
In addition, raising tax revenue through tariffs is constitutionally improper. As I wrote
in a recent commentary: “For the President to attempt to unilaterally raise taxes by
hundreds of billions of dollars per year is an aggressive and egregious assault on our
constitutional system of government. In the Constitution, it is Congress’s role to raise
revenue, not the president’s. I am an economist, not a constitutional scholar. I don’t know
whether Trump is violating the Constitution in a technical legal sense. But I am a citizen
of the United States, and I know that Trump is violating the spirit of the Constitution.
The President raising this much revenue through import taxes without authorization
from Congress is an obvious and extreme abuse of power” (Strain 2025a).
As for extracting concessions from other nations around a host of issues (fentanyl, illegal
immigration, export conditions), the President’s tariffs may in some cases prove somewhat
effective. But at such a high cost, and with no success on his two main objectives, this will
be small consolation.
FALSE PREMISES
The twin foundations of today’s protectionist impulse seem to be the view that economic
outcomes for typical workers and households have been stagnant or deteriorating for
decades and, relatedly, that the US’s 2000 decision to grant China permanent normal
trade relations (PNTR) and China’s 2001 accession to the WTO were major policy errors
that devastated the working class. Both of these views are mistaken.
6
For a discussion of the merits of a consumption tax, see Sawhill et al. (2024), Caroll and Viard (2012), and Auerbach (2017).
215
THE (NON) EFFECT OF TARIFFS ON MANUFACTURING EMPLOYMENT | STRAIN
The subject of this chapter is manufacturing, but permit me a few sentences to discuss
some of the other ways in which tariffs are justified. In addition to manufacturing
considerations, the other major justification for the trade war is concern about the trade
deficit. But the President is wrong to assert that the trade deficit is a problem. The trade
deficit offers consumers greater product variety and gives US businesses a competitive
edge by allowing workers to focus on more productive tasks. Moreover, the President is
wrong to conclude that large tariff increases will narrow the trade deficit (Strain 2024a).
The trade deficit is determined by aggregate savings and investment. Because the US
invests more than it saves, it runs a trade deficit. Tariffs will do little to address that.
Figure 4 clearly shows that real wages for production and nonsupervisory workers were
stagnant or declining during the 1970s and 1980s. But the US left that period behind
over three decades ago. Since the early 1990s, real wages for typical workers have been
steadily rising.
This has not been a period of uninterrupted progress – see, for example, the stagnation
following the 2008 global financial crisis7 and the Covid-19 pandemic – and this pace of
wage growth should not lead to complacency.
But from July 1990 to February 2025 (the latest data available at the time of this writing),
the purchasing power of the average wage of workers – specifically, production workers
in the manufacturing sector, construction workers in the construction sector, and
nonsupervisory workers in the service sector – has increased by 44%. This is a substantial
increase in average real wages.
FIGURE 4
REAL WAGES FOR PRODUCTION AND NONSUPERVISORY WORKERS
26
25
2019 dollars
24
23
22
21
20
19
18
17
16
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020
2022
2024
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
216
The first crack-ridden foundation of this trade war is the mistaken view that economic
outcomes for typical workers and households have stagnated or deteriorated for the past
several decades. As I argue in my book, The American Dream Is Not Dead: (But Populism
Could Kill It), this view is at odds with the best reading of the economic evidence (Strain
2020).
Note: Average hourly earnings of production and nonsupervisory workers, from the Current Employment Statistics
program, deflated by the price index on personal consumption expenditures, from the Bureau of Economic Analysis. Wage
data are presented in December 2019 constant dollars.
Source: Bureau of Labor Statistics; Bureau of Economic Analysis; author’s calculations.
7
For more on the economics and economic policy of the Great Recession and subsequent recovery, see Shambaugh and
Strain (2021).
There is no doubt that the middle of the labour market was ‘hollowed out’ in recent
decades, with employment growth concentrated among low- and high-wage jobs. But
this disruption has been driven mostly by technological progress, not by trade. And the
disruption of these decades has mostly been a story of upward economic mobility.
In addition, a ‘new middle’ is forming in the labour market. Manufacturing jobs and
clerical jobs may be shrinking as a share of total employment, but a new middle is rising,
with occupations including sales representatives, truck drivers, managers of personal
service workers, heating and air conditioning mechanics and installers, computer support
specialists, self-enrichment education teachers, event planners, and health technologists
and technicians (Strain 2020).
The second argument serving as a faulty foundation for the trade war – that China’s
2000 PNTR status and 2001 WTO entry were major US policy errors with devastating
consequences – misunderstands both history and economics. China had most-favoured
nation (MFN) status renewed annually with the US since 1980, which meant that it faced
similar US trade barriers to other nations during the two decades prior to its WTO entry.
While the elimination of trade policy uncertainty that accompanied the developments
of 2000 and 2001 did play a role in increasing Chinese exports to the US, that role is
overstated in the policy debate and ignores the huge increase in imports from China
during the 1980s and 1990s (Handley and Limão 2017, Amiti et al. 2020). Indeed, in
the decade prior to China receiving PNTR, US imports from China (in current dollars)
increased by nearly a factor of seven. China’s booming export capacity had much to do
with its own internal economic reforms, not changes in US policy.
On the economics, it is of course true that trade liberalisation – including the ‘China
shock’ – contributed to manufacturing jobs losses. Autor et al. (2013) find an average
reduction in manufacturing employment of 90,000 jobs per year from 1990 to 2007,
while Acemoglu et al. (2016) find an average reduction in manufacturing employment of
200,000 per year from 1999 to 2011.
But there are two important considerations in interpreting those estimates and applying
them to real-world policy issues. First, they must be placed in the context of broader
economic dynamism. Second, they fail to account for export-driven manufacturing job
gains. The following five paragraphs and associated footnotes discuss those issues, and
most of the text in those paragraphs is directly taken from Strain (2024a).
217
THE (NON) EFFECT OF TARIFFS ON MANUFACTURING EMPLOYMENT | STRAIN
The share of households earning real incomes (measured in 2023 dollars) between
$35,000 and $100,000 – a proxy for middle-income – fell by 16.4% from 1967 to 2023.
But this was not accompanied by an increase in the share of households earning less
than $35,000, which fell by 10.3%. Instead, the share of households earning real incomes
above $100,000 grew by 26.5% over this period (Strain 2020, Strain 2024b).
In a typical month, five million workers separate from their employers. In the
manufacturing sector, typical monthly separations are 351,000.8 Two hundred thousand
jobs per year sounds like a lot, but in the context of US labour market dynamism it feels
less apocalyptic than today’s political rhetoric implies.9
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
218
Moreover, Autor et al. and Acemoglu et al. focus on half the story of increased trade
openness. Trade liberalisation is associated with increased imports and exports.
Economic theory suggests that employment reductions in sectors exposed to import
competition should be roughly balanced by employment increases in export-intensive
sectors and in other sectors.10
Feenstra et al. (2019) note that the literature on the China shock has focused on the
impact that surging imports from China have had on job losses, with little attention paid
to the job gains from growing exports.11 They expand Acemoglu et al.’s framework to
incorporate not only US imports from China but also imports from the rest of the world,
exports to China, and exports to the rest of the world.
In their preferred specification, Feenstra et al. estimate that, at the industry level, a one
percentage point rise in import penetration from China reduces industry employment
by 0.81 percentage points. This estimate is very similar in magnitude to the findings of
Acemoglu et al. But when they study the effects of trade more broadly, Feenstra et al.
find that the job losses identified by Acemoglu et al. and Autor et al. are fully offset by job
gains due to US exports.
8
These calculations exclude March 2020 and April 2020, when total and manufacturing separations spiked due to the
Covid-19 pandemic. Separations include voluntary quits, involuntary layoffs and discharges, and separations due to
retirement, disability, and other reasons. Bureau of Labor Statistics data on separations begin in December 2000, later
than the starting years in the Autor et al. (2013) and Acemoglu et al. (2016) studies. Through 2007, average monthly
manufacturing separations were 425,000; through 2011, they were 381,000.
9 The evidence suggests that the same qualitative conclusion holds for NAFTA. In their review paper, Burfisher et al. (2001)
note that “perhaps the worst fear” in the US regarding NAFTA was that it would place US workers at a competitive
disadvantage, making them compete against a flood of imports from Mexico. “Ross Perot memorably spoke of a ‘giant
sucking sound south’ of jobs moving to Mexico because of NAFTA,” the authors note. They conclude: “The broad
consensus from research in the early 1990s suggested that these fears were overstated.” More importantly, they conclude:
“The evidence on labor markets post-NAFTA indicates that, while NAFTA has had some effect, the effects in the US
economy are indeed small and are overwhelmed by other U.S. macroeconomic trends such as a rapidly growing economy.”
10 While Autor et al. present some results using net imports, they focus on import competition – one side of the ledger.
Acemoglu et al. attempt to estimate general equilibrium effects in (and, importantly, not across) local labour markets, but
the focus of their study is also employment reductions due to import competition.
11 Feenstra and Sasahara (2018) note the same. Using global input-output analysis, they study the impact of imports and
exports on labor demand in the US from 1995 to 2011. They find that US imports from China led to reduced demand of 1.4
million jobs in manufacturing and 0.6 million in services – findings quite similar to those of Acemoglu et al. (2016). Over
the same period, they find that the growth of US exports led to increased labour demand of 2 million manufacturing jobs,
0.5 million jobs in resource industries, and 4.1 million jobs in services. Focusing only on goods exports, labour demand
increased by 3.7 million jobs in total, for an increase in net labour demand of 1.7 million jobs. Factoring in imports from the
rest of the world and services exports, they conclude that labour demand increased on net over this period.
Specifically, in their preferred specification, they find job losses of 533,000 due to import
competition between 1999 and 2011. These losses were offset by job gains of 411,000 due
to exports. Since export-driven gains were greater than import-driven losses during the
1990s, over the entire 1991–2011 period they find a net gain of 379,000 jobs.12
First, the labour market is less fluid than many economists had thought, and it is
harder for workers specialised in one sector with declining opportunities – in the case
of trade, in import-competing sectors – to reallocate to other sectors with expanding
opportunities. The second lesson is that workers may be less willing to relocate from
regions with declining opportunities to regions with expanding opportunities than many
economists had thought.
These are generalisable lessons that apply to labour market disruptions broadly,
regardless of the source of the disruption. For example, the development of generative
artificial intelligence raced forward in 2023 and portends substantial labour market
disruption (Strain 2024c). The energy transition away from fossil fuels could create a
situation similar in kind to the China shock, given the geographic concentration of that
industry. These lessons from the China shock will apply to AI and the energy transition.
Other lessons from the China shock are important for understanding that episode but
may be of limited generalisability. China’s export growth was rapid, with its share of
world manufacturing exports rising from 3% in 1995 to 18% in 2014, to 21% in 2020.14
And the reallocation of workers across sectors was likely severely adversely affected by
the 2008 global financial crisis and Great Recession, in which the US unemployment
rate peaked at 10% and there were as many as six unemployed workers for every one job
12 Feenstra et al. (2019) also provide estimates of job changes driven by trade between the US and China. Exports to China
are substantially smaller than imports from China. Over the full 1991–2011 period, they find that trading with China led to
322,000 job losses. As robustness checks, the authors examine specifications using only Autor et al.-style instruments
and ending their time period in 2007. They find job losses from Chinese import competition totaling 671,000 alongside
export-driven job gains of 1.2 million. Feenstra et al.’s industry-level results use variation in exposure to import penetration
and export expansion to predict changes in manufacturing-sector employment. This methodology does not address the
geographic effects of trade liberalisation. To study the effects of both import competition and export expansion on local
labour markets, they follow Autor et al. and Acemoglu et al. in examining 722 commuting zones. Feenstra et al. confirm
the result that import competition at the commuting-zone level caused employment losses. Over the 1991–2011 period,
they estimate 1.9 million job losses due to import penetration. These losses are balanced out by export-driven gains.
They estimate an additional 830,000 jobs lost due to competition with imports from the rest of the world (on top of
the 1.9 million jobs lost from Chinese imports) and 2.6 million job gains due to export expansion. Moreover, they find
some evidence that commuting zone with higher percentage losses are relatively more likely to also experience higher
percentage gains.
13 This chapter has largely focused on people, but the thrust of my argument applies to places, as well. Of the counties with
a disproportionately large share of manufacturing jobs in 1970, 62% have successfully transitioned to new industries, and
23% exhibit solid economic performance while still having a large manufacturing sector (Strain 2020).
14 These statistics are based on my calculations using data from the OECD. Baldwin (2024) has similar calculations.
219
THE (NON) EFFECT OF TARIFFS ON MANUFACTURING EMPLOYMENT | STRAIN
What lessons, then, should economists and policymakers take away from the China
shock? It is the case that the domestic economic effects of trade with China intensified
around the turn of the century, leaving some people and places behind.13 The following
three paragraphs, taken from Strain (2024a), discuss two important lessons.
opening in the labour market. To the extent that adverse effects on import-competing
workers created Keynesian aggregate-demand reductions, post-2007 economic slack
was a major contributor.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
220
CONCLUSION
Regarding the trade war and manufacturing, the two most important conclusions are
as follows. First, the current administration’s trade war is founded on a deeply flawed
analysis of the US’s economic challenges. American manufacturing is not in crisis,
and open trade has not been the most important driver of declining manufacturing
employment. From an economic perspective, manufacturing jobs do not deserve special
attention.
Second – and, from a political perspective, perhaps most importantly – the trade war will
not substantially increase manufacturing employment. Indeed, it is likely to decrease
manufacturing employment. It will fail to achieve its wrongheaded goal.
Protectionists are motivated by misplaced nostalgia for an imagined past. They are trying
to turn back the clock. They will not succeed. A better and achievable goal would be to
create more on-ramps to the economic opportunities of the present – and the future.
REFERENCES
Acemoglu, D, D Autor, D Dorn, G H Hanson, and B Price (2016), “Import Competition
and the Great US Employment Sag of the 2000s”, Journal of Labor Economics 34(S1):
S141–98.
Amiti, M, M Dai, R C Feenstra, and J Romalis (2020), “How did China’s WTO entry
affect US prices?”, Journal of International Economics 126: 103339.
Auerbach, A J (2017), “Demystifying the destination-based cash-flow tax,” Brookings
Papers on Economic Activity, Fall.
Autor, D H, D Dorn, and G H Hanson (2013), “The China Syndrome: Local Labor Market
Effects of Import Competition in the United States”, American Economic Review 103(6):
2121–68.
Autor, D, A Beck, D Dorn, and G H Hanson (2024), “Help for the Heartland? The
Employment and Electoral Effects of the Trump Tariffs in the United States”, NBER
Working Paper No. 32082.
Baldwin, R (2024), “China Is the World’s Sole Manufacturing Superpower: A Line Sketch
of the Rise”, VoxEU.org, 17 January (https://cepr.org/voxeu/columns/china-worlds-solemanufacturing-superpower-line-sketch-rise).
Burfisher, M E, S Robinson, and K Thierfelder (2001), “The impact of NAFTA on the
United States”, Journal of Economic Perspectives 15(1): 125-144.
Feenstra, R C, H Ma, and Y Xu (2019), “US Exports and Employment”, Journal of
International Economics 120: 46–58.
Feenstra, R C and A Sasahara (2018), “The ‘China Shock,’ Exports and U.S. Employment:
A Global Input–Output Analysis”, Review of International Economics 26(5): 1053–83.
Flaaen, A and J Pierce (forthcoming) “Disentangling the Effects of the 2018-2019 Tariffs
on a Globally Connected U.S. Manufacturing Sector”, Review of Economics and Statistics.
Handley, K and N Limão (2017), “Policy uncertainty, trade, and welfare: Theory and
evidence for China and the United States”, American Economic Review 107(9): 2731-2783.
Javorcik, B K S, K Stapleton, B Kett, and L O’Kane (2022), “Did the 2018 Trade War
Improve Job Opportunities for U.S. Workers?”, World Bank Policy Research Working
Paper No. 10249.
Russ, K and L Cox (2018), “Will Steel Tariffs Put US Jobs at Risk?”, Econofact, 26
February.
Sawhill, I V and M R Strain, et al. (2024), “Toward a Potential Grand Bargain for the
Nation”, Bipartisan Policy Center, July.
Shambaugh, J C and M R Strain (2021), “The recovery from the Great Recession: A long,
evolving expansion”, The ANNALS of the American Academy of Political and Social
Science 695 (1): 28-48.
Strain, M R (2020), The American Dream Is Not Dead: (But Populism Could Kill It),
Templeton Press.
Strain, M R (2024a), “Protectionism is Failing and Wrongheaded: An Evaluation of the
Post-2017 Shift toward Trade Wars and Industrial Policy”, in M S Kearney and L Pardue
(eds), Strengthening America’s Economic Dynamism, The Aspen Institute.
Strain, M R (2024b), “The American Dream Is Alive and Well (and the Problem of US
Inequality Greatly Exaggerated)”, Journal of Applied Corporate Finance 36(2), 36-39.
Strain, M R (2024c), “The Case for AI Optimism”, National Affairs 60 (Summer).
Strain, M R (2025a), “Trump’s tariffs are a historic tax hike”, National Review, 3 April.
Strain, M R (2025b), “Trump’s Tariffs Won’t Bring Back Manufacturing Jobs,” Project
Syndicate, 21 April.
221
THE (NON) EFFECT OF TARIFFS ON MANUFACTURING EMPLOYMENT | STRAIN
Carroll, R and A D Viard (2012), Progressive consumption taxation: The X tax revisited,
Rowman & Littlefield.
ABOUT THE AUTHOR
Michael R. Strain is the Arthur F. Burns Scholar in Political Economy at the American
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
222
Enterprise Institute. He is also a professor of practice at Georgetown University and a
research fellow with the Institute of Labor Economics (IZA).
PART II
RESHAPING THE
INTERNATIONAL ECONOMIC
SYSTEM
CHAPTER 17
Barry Eichengreen
University of California, Berkeley and CEPR
On 7 April 2025, a scant 125 hours after “Liberation Day,” when President Donald Trump
unfurled his reciprocal tariffs, and just 48 hours before President Trump announced
a 90-day pause in implementation, Stephen Miran, Chair of the Council of Economic
Advisors, delivered a speech at the Hudson Institute laying out the rationale for the
administration’s international economic policies (Miran 2025).
At its core, Miran’s argument had three elements. First, the United States provides a
pair of valuable public goods to the world economy: global military security, which has
delivered 75 pacific years free of war between the major powers; and global financial
security, in the form of dollar reserve assets which have supported the expansion of
the international economy, again for the better part of 75 years. Together these global
public goods have created “the greatest era of peace” and “the greatest era of prosperity
mankind has ever known”.
Second, providing these global public goods is costly to the United States. US servicemen
and women are exposed to disproportionate risks, and American taxpayers bear a
disproportionate burden in providing a security umbrella to the rest of the world.
Analogously, Miran contends that the reserve currency function of the dollar imposes
significant costs on the country. It has led to unsustainable trade deficits, decimated
American manufacturing, and caused grave harm to working-class families and
communities.
Third, tariffs are a way of rectifying these imbalances. They are a source of revenue for the
US Treasury. Since they are levied on foreign goods, they are paid by foreign producers,
which works to shift part of the cost of global public good provision toward the rest of the
world. They are a bargaining chip, insofar as they will be removed only if and when other
countries stop free riding on the military and financial security services of the United
States. And they are a way of narrowing the trade deficit if other countries continue to
free ride.
The notion that the burden of providing global public goods falls disproportionately on
the leading economic power traces back to the influential work of Charles Kindleberger
(1973). In Kindleberger’s view, only a dominant economic power possesses the resources
and capacity to supply global public goods on a worldwide basis. Relatedly, Kindleberger
225
THE GLOBAL PUBLIC GOOD | EICHENGREEN
The global public good
also observed that only the dominant economic power has an incentive to provide these
public goods on a global basis, since only it is large enough to internalise a significant
share of the benefits.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
226
No one disputes the contribution of the United States to the NATO alliance, or the
singular role of the dollar in the global monetary and financial system – though some will
question whether the country has always deployed its military resources judiciously and
whether global dependence on the dollar has always been a stabilising financial force. To
cite two 21st century examples, can you say Second Iraq/Gulf War and Subprime/Global
Financial Crisis?
More fundamentally, critics of Mr. Miran’s argument will dispute that the cost to the
United States of its contribution to the provision of these global public goods exceeds the
benefits. Being an economist, I leave the cost/benefit calculus of the US contribution to
global military security to others, as does Miran. But some simple economic observations
suffice to establish that the benefits to the United States of the dollar’s international
currency role in fact dominate the costs.
Those benefits fall under four headings. First, and most prosaically, US banks and
firms have the convenience value of being able to do cross-border business in their own
currency. This limits the transactions costs and financial uncertainty they face when
doing international business. Concretely, US banks and firms are relieved of the need to
purchase hedges against exchange rate fluctuations.
Second, the US government can fund its fiscal deficits at lower cost as a result of the
additional demand by foreign central banks and governments for US treasury securities
associated with the dollar’s reserve currency status. Estimates of the magnitude of this
cost advantage vary. One study (Szoke et al. 2024) compares the difference in yields of
safe (AAA) corporate bonds and of 10-year US treasuries. The authors take this as a
measure of impact of foreign official demand for the US treasuries, since foreign central
banks hold treasury securities but not US corporate bonds. In fact, the corporate–
Treasury spread reflects in addition other attractions of treasuries, such as the credit risk
advantage of treasuries over corporates, a more liquid market, and the wider market of
real money account holders of sovereign versus corporate debt. Hence the 120 basis point
differential between AAA corporate and Treasury yields as of early May 2025 (time of
writing) should be taken as an upper bound on the impact of the dollar’s reserve currency
status.
Third, the dollar’s international and reserve currency status means that the currency is
regarded as a safe haven – or at least has been so regarded historically. Hence the dollar
tends to strengthen in periods of heightened economic and financial volatility. Financial
capital flows into rather than out of the dollar and the United States in response to
shocks, which works to stabilise the US economy and the US financial system in the face
of disturbances. Historically, capital has flowed into rather than out of the dollar even
when the United States itself is the source of those shocks, as in the case of the Lehman
Brothers crisis in September 2008.
As for the costs, it is doubtful that any additional strength enjoyed by the dollar as a
result of its international and reserve currency has much of an impact on the US trade or
current account balance. In a world of international capital mobility, it is not the case that
the United States has to run trade deficits in order to provide foreign reserves to the rest
of the world. These can be supplied instead through the capital account of the balance of
payments – that is to say, through financial flows. Foreigners can acquire financial claims
on the United States by selling the US financial claims on their economies. The Swiss
franc also functions as an international and reserve currency – albeit on a smaller scale
than the dollar, reflecting the very different size of the two economies. That Switzerland
regularly runs a trade surplus does not preclude it from serving in this international and
reserve currency role.
A country’s current account is, arithmetically, the difference between its investment
and saving. America’s deficit thus indicates that US saving is inadequate to finance US
investment, pure and simple. This suggests a very different perspective on US current
account and trade balances than that of Mr. Miran. The US current account deficit means
that foreigners are doing the country a favour, from the viewpoint of capital formation
and growth, by funding investment that Americans would be incapable of funding on
their own.
As for the role of the dollar’s exorbitant privilege, it is hard to believe that treasury bond
yields 120 basis points higher (the upper bound on the simple counterfactual associated
with assuming away the currency’s international role) would significantly raise US
household and corporate savings rates. It is hard to imagine that marginally higher yields
would magically produce a consensus in the Congress about how to eliminate the budget
deficit that is the source of public-sector dissaving.
This accounting perspective also speaks to the question of whether across-the-board
tariffs will narrow the trade deficit. Again, it is hard to see why tariffs should boost
household or corporate saving. The revenue they generate is unlikely to close the budget
deficit (Clausing and Obstfeld 2024), especially when they are raised to prohibitive levels
of 145% (as they have been on imports from China), in which case they raise no revenue
227
THE GLOBAL PUBLIC GOOD | EICHENGREEN
Fourth and finally, the United States derives geopolitical leverage from the dollar’s
international and reserve currency role. The dependence of other countries on the dollar,
the US banking system, and SWIFT for a majority of their cross-border transactions gives
it a powerful financial weapon, as illustrated by the decision to freeze the dollar assets
of the Bank of Russia and bar Russian entities from the US banking system and SWIFT
following the Putin government’s attack on Ukraine in February 2022. This is another
instance of the close connections between global public goods of military security and
financial security – though not one mentioned by Mr. Miran.
at all. Of course, tariffs would narrow the trade deficit if they caused investment to
collapse. This scenario can’t be ruled out, insofar as tariffs are levied on imported inputs
and intermediate goods, disrupt global supply chains, and heighten uncertainty. But this
would mean reducing the trade deficit at a very high cost to the economy.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
228
US exports, as well as the competitiveness of US goods competing with imports, are not
entirely immune to changes in the level of the exchange rate. But the fact that so many
of America’s imports and exports are invoiced and settled in dollars, at prices that are
sticky, limits the impact of such fluctuations on the profitability of US firms and thus on
their incentive to produce (Gopinath et al. 2020). In the longer run, when import prices
finally do adjust to exchange rate movements, so too will the rate of inflation, neutralising
the impact of the former. Fundamentally, the competitiveness and profitability of US
manufacturing depend on innovation, on the quality of capital and labour inputs, and on
improvements in efficiency (what economists call total factor productivity growth) much
more directly and powerfully than they depend on the level of the exchange rate.
This conclusion that the benefits to the United States of the dollar’s international and
reserve currency role exceed the costs goes back it least six decades, to when French
Finance Minister Valery Giscard d’Estaing referred to America’s “exorbitant privilege”.
President Trump would appear to agree, in that he responded to suggestions that the
BRICS countries would develop a currency or mechanism enabling them to trade and
settle payments amongst themselves without going through the dollar and the US
banking system by threatening them with a 100% tariff (Shakil 2025).
Kindleberger’s dire conclusion, grounded in 1930s history, was that when the hegemon
is in decline or is otherwise unprepared to provide global public goods, the world is
consigned to crisis and instability. But there is also another view, most prominently
associated with Robert Keohane (1984), that a group of like-minded countries can
cooperate in the provision of global public goods. To be sure, multilateral cooperation
in the provision of global public goods may be easiest to arrange with leadership from a
hegemon, if that leader is prepared to organise what is known as hegemonic cooperation.
But Keohane argued that provision was still possible even in the absence of a dominant
power. Countries could be encouraged to contribute to the provision of global public
goods and deterred from free riding through repeated interactions, transparency
and monitoring. Their interaction and monitoring could be systematised by creating
international organisations, formal international agreements, and informal norms
of acceptable international behaviour (what is known in political science literature as
international regimes). Put simply, international cooperation may still be possible in the
absence of a hegemonic power if countries are able to converge on a common set of norms
and understandings, and if they give those norms and institutions a formal institutional
basis.
This perspective, and even Miran’s own emphasis on the problem of free riding in the
provision of global public goods, points to the importance of durable and effective
multilateral economic institutions. The IMF is an institutional mechanism to discourage
countries from running unsustainable external imbalances and manipulating their
exchange rates. The WTO is an institutional mechanism for preventing countries from
imposing beggar-thy-neighbour trade restrictions and otherwise pursuing unfair trade
policies. US policymakers could argue, not without justification, that these institutions
should be more forceful in pursuing these objectives. But withdrawing from such
organisations, as President Trump has threatened in the case of the WTO and Project
2025 has recommended in the case of the IMF, or simply undermining their operation by
violating the norms and understandings on which membership is based, are not examples
of hegemonic cooperation. Rather, they are symptomatic of a hegemon in decline.
Maybe Kindleberger was right after all, that a hegemon in decline opens the door to
a dangerous period of instability. Or maybe other countries can redouble their efforts
to ensure the adequate provision of global public goods and strengthen the institutions
through which they are provided, even without the participation of the United States.
229
THE GLOBAL PUBLIC GOOD | EICHENGREEN
Eichengreen (1989) was an early attempt to apply these insights to the history of the
international monetary and financial system. My analysis juxtaposed the immediate postWorld War II period, when cooperation was organised with hegemonic leadership by the
United States, with the final decades of the classical gold standard era and the 1960s and
1970s. In the immediate post-World War II period, the United States was the undisputed
international monetary and financial leader, and it unilaterally took steps, such as the
Marshall Plan, to stabilise the international monetary and financial system. Under the
gold standard, the pound sterling was first among international monetary equals. Where
the Bank of England led, other central banks followed; the Bank was “conductor of the
international orchestra” (Keynes 1930). But the Bank of England nonetheless lacked the
capacity to stabilise the international monetary system unilaterally. In practice, it was
repeatedly the international borrower of last resort rather than the international lender.
It thus cooperated with the Bank of France and German Reichsbank in stabilising the
international system (Eichengreen 1992). Similarly, come the 1960s, the United States
was no longer sufficiently dominant to stabilise the international monetary and financial
system on its own. Rather, it had to organise the cooperation of other advanced countries
in arrangements such as the Gold Pool (Bordo et al. 2019).
REFERENCES
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
230
Bordo, M, E Monnet and A Naef (2019), “The Gold Pool (1961-1968) and the Fall of the
Bretton woods System: Lessons for Central Bank Cooperation”, Journal of Economic
History 79: 1027-1059.
Clausing, K and M Obstfeld (2024), “Can Trump Replace Income Taxes with Tariffs?”,
Peterson Institute for International Economics, 20 June (https://www.piie.com/blogs/
realtime-economics/2024/can-trump-replace-income-taxes-tariffs).
Eichengreen, B (1989), “Hegemonic Stability Theories of the International Monetary
System”, in R Cooper, B Eichengreen, G Holtham, R Putnam and R Henning (eds), Can
Nations Agree? Issues in International Economic Cooperation, Brookings Institution,
pp.255-298.
Eichengreen, B (1992), Golden Fetters: The Gold Standard and the Great Depression,
1919-1939, Oxford University Press.
Gopinath, G, E Boz, C Casas, F Diez, P-O Gourinchas and M Plagborg-Moller (2020),
“Dominant Currency Paradigm”, American Economic Review 110: 677-719.
Keohane, R (1984), After Hegemony: Cooperation and Discord in the World Political
Economy, Princeton University Press.
Keynes, J M (1930), A Treatise on Money, Macmillan.
Kindleberger, C (1973), The World in Depression, 1929-39, University of California Press.
Miran, S (2025), “CEA Chairman Steve Miran Hudson Institute Event Remarks”, The
White House, 7 April (https://www.whitehouse.gov/briefings-statements/2025/04/ceachairman-steve-miran-hudson-institute-event-remarks/).
Shakil, I (2025), “Trump Repeats Tariffs Threat to Dissuade BRICS Nations from Replacing
US Dollar”, Reuters, 30 January (https://www.reuters.com/markets/currencies/trumprepeats-tariffs-threat-dissuade-brics-nations-replacing-us-dollar-2025-01-31/)
Szoke, B, I Xavier and F Vazquez-Grande (2024), “Convenience Yield as a Driver of r*”,
FEDS Notes, 3 September (https://www.federalreserve.gov/econres/notes/feds-notes/
convenience-yield-as-a-driver-of-r-20240903.html).
ABOUT THE AUTHOR
Barry Eichengreen is George C. Pardee and Helen N. Pardee Chair and Distinguished
Professor of Economics and Professor of Political Science at the University of California,
Berkeley. He is an NBER Research Associate and a CEPR Research Fellow. In 1997-98 he
was Senior Policy Advisor at the International Monetary Fund. Professor Eichengreen is a
fellow of the American Academy of Arts and Sciences (class of 1997). He is a distinguished
231
THE GLOBAL PUBLIC GOOD | EICHENGREEN
fellow of the American Economic Association (class of 2022), a corresponding fellow of
the British Academy (class of 2022), and a Life Fellow of the Cliometric Society (class
of 2013). He has held Guggenheim and Fulbright Fellowships and been a fellow of the
Center for Advanced Study in the Behavioral Sciences (Palo Alto) and the Institute for
Advanced Study (Berlin). For 15 years from 2004 he served as convener of the Bellagio
Group of academics and officials. He is a regular monthly columnist for Project Syndicate.
Professor Eichengreen has been awarded the Economic History Association’s Jonathan
R.T. Hughes Prize for Excellence in Teaching and the University of California at Berkeley
Social Science Division’s Distinguished Teaching Award. He is the recipient of a doctor
honoris causa from the American University in Paris, and was the 2010 recipient of the
Schumpeter Prize from the International Schumpeter Society and the 2022 recipient of
the Nessim Habif Prize for Contributions to Science and Industry. He was named one of
Foreign Policy Magazine’s 100 Leading Global Thinkers in 2011. He is a past president of
the Economic History Association (2010-11).
CHAPTER 18
Kevin Hjortshøj O’Rourke
CNRS, Sciences Po and CEPR
It is much too soon to speculate about the long-run impact of the second Trump
administration’s trade policy, since we don’t know what it will be next week, let alone
four years from now. But what we do know is that 2 April 2025 marked a brutal rupture
with 90 years of American foreign economic policy that have shaped the world we live in.
The symbolism was stark. By awarding each trading partner its own “reciprocal” tariff,
the government of the US was tearing up the central foundational principle of the GATT
and its successor organisation, the WTO, namely, the principle of non-discrimination
enshrined in Article 1 of the GATT. Since it was the US itself that had been the great
promoter of non-discrimination in trade – a position it had held since the 1930s – the
events of 2 April marked the end of an era.
It is worth remembering why it was that the US became such a firm supporter of nondiscrimination in the first place, since this had not always been the case. Treaties
incorporating the most-favoured nation (MFN) principle can be found as far back as
the 17th century; indeed, Davis (1942: 1) finds an “embryo of the clause” in a 1226 treaty
between Emperor Frederick II and the city of Marseilles. Nonetheless, it is the Anglo–
French Cobden–Chevalier treaty of 1860 that is typically taken to have established the
principle’s centrality in modern international trade. Britain and France accorded each
other unconditional MFN status, implying that whatever tariff concessions France might
in the future make to other trade partners would be automatically extended to the UK,
and vice versa. In this manner, both parties could be confident that they would not see
third parties undercutting them in the other’s market as a result of even more favourable
treatment being subsequently accorded to them.
There followed a wave of bilateral treaties between the major European countries, each of
them incorporating the unconditional MFN clause. The US stood aloof from the process,
only granting its partners conditional MFN status when negotiating treaties. What this
meant was that if it, in the future, were to make a trade concession to another country in
return for some “compensation”, it would only be obliged to extend the same concession
to its treaty partners if they offered the US equivalent compensation. In this manner,
it would not find itself granting countries something in return for nothing. Indeed, by
sitting back it could hope to free ride off the web of bilateral deals being struck by others.
233
FROM MFN TO “RECIPROCAL TARIFFS” | O’ROURKE
From MFN to “reciprocal tariffs”
Since these involved the unconditional clause, they would lead to some of its own treaty
partners giving concessions to others in return for nothing, in which case the US could
then claim those same concessions, again in return for nothing.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
234
In practice, however, the US: “obtained only meagre results from her bargaining.
Many of the concessions she received were merely nominal, or consisted of the removal
of discriminations to which she would not have been subject in any case if she had
been following the unconditional practice herself. With the exception of some exclusive
concessions extracted from Brazil by strong-arm diplomacy, for which episode two later
presidents of the United States offered apologies, none of the concessions received by
her from any country were exclusive or even special in character. The discriminations
in her treatment of imports coming from different countries led also to repeated and
acrimonious diplomatic protests, and were in part responsible for the fact that the export
trade of the United States was, before the war, subjected to more open discriminations in
foreign tariffs than the exports of any other important country” (Viner 1936: 93).
The US thus adopted the unconditional form of the MFN clause in 1923, but as we know,
this did not make it a free trader. The Hawley-Smoot tariff of June 1930 represented a
sharp increase in protection, at a time when the world was already sinking into what
would become the Great Depression. Not surprisingly, this led to a wave of anti-American
hostility, accompanied by retaliatory tariffs and consumer boycotts. High-profile and
technologically advanced American exports such as cars were a particular target. Recent
research using quarterly data on bilateral trade for 99 economies between 1925 and 1938
suggests that retaliation was effective, lowering US exports to the countries concerned by
roughly 30% (Mitchener et al. 2022).
Sometimes retaliation was de jure non-discriminatory, and thus consistent with the
unconditional MFN principle, while de facto singling out the US for special treatment. For
example, the French government changed its automobile tariffs from a value to a weight
basis, which in practice hit moderately priced but heavy American cars. But sometimes
retaliation was explicitly discriminatory. Canada not only levied (non-discriminatory)
tariffs on prominent US exports to the country, but also imposed anti-dumping duties on
imports from America, and lowered tariffs on goods coming from the UK. The Canadian
response to Hawley-Smoot was all the more muscular as a result of the general election
victory of the Conservatives in July 1930, who had traditionally been more protectionist,
and more in favour of imperial preference, than their Liberal opponents, and whose
appeal was boosted by American protectionism (Irwin 2017: 402). Ottawa had been
discriminating in favour of British imports since the turn of the century, so this was
merely a ramping up of previous policies, but in 1931 the traditionally free-trading UK
also adopted imperial preference, and in the summer of 1932 a conference in Ottawa
saw the adoption of wholesale tariff discrimination vis-à-vis the rest of the world by the
British Empire. This discrimination was successful in increasing trade flows within the
Empire, at the expense of foreign countries such as the US (de Bromhead et al. 2019,
Arthi et al. 2024, Lampe et al. 2025). And the British Empire was not an exception: the
1930s saw a general unwinding of the multilateral trade flows of the pre-war world in
favour of greater bilateralism centred around imperial trade blocs (de Zwart et al. 2024).
I embraced the philosophy I carried throughout my twelve years as Secretary
of State, into the Trade Agreements, into numerous speeches and statements
addressed to this country and to the world. From then on, to me, unhampered
trade dovetailed with peace; high tariffs, trade barriers, and unfair economic
competition, with war. Though realizing that many other factors were involved,
I reasoned that, if we could get a freer flow of trade – freer in the sense of fewer
discriminations and obstructions – so that one country would not be deadly
jealous of another and the living standards of all countries might rise, thereby
eliminating the economic dissatisfaction that breeds war, we might have a
reasonable chance for lasting peace. (Hull 1948: 81).
Hull embraced the principle of non-discrimination in trade, advocating the unconditional
MFN principle and opposing imperial preferences. According to Irwin (2017), Hull’s
vision, which promoted freer and less discriminatory trade on geopolitical as much as
on economic grounds, was a key driver of subsequent developments in American trade
policy. A major turning point was the passage of the Reciprocal Trade Agreements
Act (RTAA) in 1934. This not only allowed Congress to give the president permission
to negotiate trade agreements with foreign countries, but also required that any tariff
reductions that were agreed would be applied to all countries on an unconditional MFN
basis. While Republicans were initially strongly opposed to the RTAA, by the late 1940s
they had come around to accepting it, subject to various safeguards. This was in part
because of public support for freer trade, and the dominant role of the United States in
the world economy, and partly because of the need to support democracy and economic
recovery in Europe, in the context of the Cold War (Irwin 1998).
In August 1941, Churchill and Roosevelt met off the coast of Newfoundland and drafted
the Atlantic Charter, setting out their hopes for the postwar world. The fourth of these
stated that:
they will endeavor, with due respect for their existing obligations, to further the
enjoyment by all States, great or small, victor or vanquished, of access, on equal
terms, to the trade and to the raw materials of the world which are needed for their
economic prosperity
235
FROM MFN TO “RECIPROCAL TARIFFS” | O’ROURKE
The US thus had every economic reason to oppose discriminatory trade policies, which
left it at a relative disadvantage in many key markets. But by the 1930s, a powerful
additional motivation was beginning to influence American policy. Roosevelt’s Secretary
of State, Cordell Hull, was a Southern Democrat who had been brought up to favour free
trade on economic grounds. Before 1916, he later wrote, he had opposed tariffs because
they raised consumer prices, facilitated monopolies and trusts, and lowered US exports.
But he writes that from 1916:
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
236
While Hull was disappointed with the mention of “existing obligations”, since this let
the British off the hook as regards imperial preferences, the general thrust of the
commitment to non-discrimination was unmistakable, and this commitment was once
again manifest in Article 1 of the GATT with its requirement that signatories grant each
other unconditional MFN status (although once again European imperial preferences
were grandfathered into the agreement). The GATT also permitted the establishment
of free trade areas and customs unions, and the US was a strong supporter of European
integration in general, and the European Economic Community (EEC) in particular.
While this left it at a relative disadvantage in EEC markets, the geopolitical imperative
to strengthen political ties between its (Western) European allies trumped any economic
concerns it might have had (Camps 1964: 237).
The US commitment to non-discriminatory international trade thus stemmed from
two main sources. First, the country had discovered through bitter experience that
aggressive trade policy invited retaliation, and in the long run left it at a disadvantage in
its major export markets. Some of those trade policy consequences that Hull and others
found themselves trying to dismantle after 1934 proved extremely durable – preferential
trade ties with the Commonwealth were still important to the UK as late as the 1960s,
and were one of the main hurdles to be overcome when negotiating its entry into the
EEC. And second, the experience of two World Wars, and the decades leading up to each,
convinced American policymakers that discriminatory trade policy was a dangerous
source of international tension.
As regards the first motivation, it would not be surprising to find the US becoming, once
again, the most discriminated against major economy on the world scene. As regards the
second, it is regrettable that Washington has forgotten the lessons of the past at a time
when, by ripping up the post-Cold War international security architecture, Putin and
Trump are making the world a more dangerous place.
REFERENCES
Arthi, V, M Lampe, A Nair and K H O’Rourke (2024), “Deliberate Surrender? The Impact
of Interwar Indian Protection”, Economic Journal 134: 23-47 (https://doi.org/10.1093/ej/
uead073).
Camps, M (1964), Britain and the European Community, 1955-1963, Princeton University
Press.
Davis, H O (1942), America’s trade equality policy, American Council on Public Affairs.
de Bromhead, A, A Fernihough, M Lampe and K H O’Rourke (2019), “When Britain
Turned Inward: The Impact of Interwar British Protection”, American Economic Review
109: 325-352. See also the Vox column at https://cepr.org/voxeu/columns/when-britainturned-inward.
Hull, C (1948), The Memoirs of Cordell Hull, Vol. I, Macmillan.
Irwin, D A (1998), “From Smoot-Hawley to Reciprocal Trade Agreements: Changing
the Course of U.S. Trade Policy in the 1930s”, in M D Bordo, C Goldin, and E N White
(eds), The Defining Moment: The Great Depression and the American Economy in the
Twentieth Century, University of Chicago Press.
Irwin, D A (2017), Clashing over commerce: A history of US trade policy, The University
of Chicago Press.
Lampe, M, K H O’Rourke, L Reiter and Y V Yotov (2025), “The Empire project: Trade
policy in interwar Canada”, Journal of International Economics 153: 104024 (https://
www.sciencedirect.com/science/article/pii/S002219962400151X).
Mitchener, K J, K H O’Rourke and K Wandschneider (2022), “The Smoot-Hawley Trade
War”, Economic Journal 132: 2500-2533. See also the Vox column at https://cepr.org/
voxeu/columns/ghost-smoot-hawley-tells-why-america-isnt-too-big-avoid-retaliation.
Viner, J.(1936), “Comments on the Improvement of Commercial Relations between
Nations”, in Joint Committee Carnegie Endowment-International Chamber of
Commerce, Separate memoranda from the economists consulted by the Joint Committee
on the improvement of commercial relations between nations and the problems of
monetary stabilization (88-100), International Chamber of Commerce.
ABOUT THE AUTHOR
Kevin Hjortshøj O’Rourke is a Directeur de Recherche at the CNRS, and a Professor of
Economics at Sciences Po, Paris. He was previously the Chichele Professor of Economic
History at All Souls College, Oxford and the Research Director of CEPR. He is a Fellow
of the British Academy and a Member of the Royal Irish Academy. He received his PhD
from Harvard in 1989, and has taught at Columbia, Harvard, University College Dublin,
Trinity College Dublin, and NYU Abu Dhabi. He is a Fellow of the Cliometric Society and
holds an honorary doctorate from the University of Southern Denmark.
He has served inter alia as Trustee and President of the European Historical Economics
Society, Editor of the European Review of Economic History, Vice President of the
Economic History Association, Programme Director of the CEPR’s Economic History
programme, and Senior Editor of Economic Policy. Kevin’s research lies at the
intersection of economic history and international economics, particularly international
trade. He has written extensively on the history of globalisation and deglobalisation, and
237
FROM MFN TO “RECIPROCAL TARIFFS” | O’ROURKE
de Zwart, P, M Lampe and K H O’Rourke (2024), “The last free traders? Interwar trade
policy in the Netherlands and Netherlands East Indies”, Economic History Review 77:
1057-1085 (https://onlinelibrary.wiley.com/doi/10.1111/ehr.13308). See also the Vox column
at https://cepr.org/voxeu/columns/interwar-trade-policy-netherlands-and-netherlandseast-indies.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
238
his Globalization and History (co-authored with Jeffrey G. Williamson) won the 1999
American Association of Publishers/PSP Award for the best scholarly book in economics.
Power and Plenty: Trade, War and the World Economy in the Second Millennium, coauthored with Ronald Findlay, was published by Princeton University Press in 2007.
Une Brève Histoire du Brexit was published by Odile Jacob in 2018, and appeared in
English as A Short History of Brexit (Penguin, 2019). In his spare time, Kevin serves as a
municipal counsellor in St Pierre d’Entremont, a small mountain village in France.
CHAPTER 19
Richard Baldwin
IMD and CEPR
To understand America’s aggressive shift on trade, you must first grasp the silent, slowbuilding, decades-long erosion of American middle-class prosperity. This shift began
well before President Trump and will outlive him. It is rooted in the collision between
failed social policies and economics shocks.
Since President Reagan’s presidency, US governments – Democratic and Republican
alike – have steadily dismantled the New Deal safety nets, financing tax cuts with weaker
social protection and adjustment policies.
Into this vulnerable environment crashed the ‘globotics shock’ – the potent of automation
and offshoring that ravaged traditional manufacturing jobs (Baldwin 2019). Middleskilled workers lost stability and income as high-education workers prospered.
But America’s economic distress wasn’t just financial; it was a crisis of pride and hope.
The ‘American Dream’ – the idea that hard work ensures a better life for your children –
was disrupted. Home ownership, secure jobs, affordable healthcare, and upward mobility
became unattainable dreams for many (Kochahr 2024). After electing traditional
Democrats and traditional Republicans who failed to address the problem, middle-class
fury eventually brought a protectionist populist to the White House (twice).
TARIFFS: A FALSE SOLUTION
The Trump administration’s tariffs might seem logical – if globalisation was part of
the cause, perhaps tariffs should be part of the solution. Unfortunately, tariffs are
economically ineffective. Here’s why tariffs do not, indeed cannot, help the US middle
class:
• Tariffs can only protect workers in goods-producing sectors, since service imports
cannot be tariffed.
• Few middle-class workers work in goods-producing sectors; most have servicesector jobs (see Figure 1).
• For service workers, tariffs only mean a higher cost of living, not higher wages.
239
US MIDDLE-CLASS MALAISE AND THE WORLD TRADE SYSTEM | BALDWIN
US middle-class malaise and the world
trade system
Thus, tariffs actively hurt most US middle-class workers.
FIGURE 1
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
240
MUCH OF THE US MIDDLE CLASS WORK IN NON-GOODS-PRODUCING SECTORS
Much of the US
middle class
work in nongoods
producing
sectors.
% of U.S. workers in each income tier, by industry, 2022
Lower income
Middle income
Finance, insurance
and real estate
14 %
53
33
Information
15
52
33
Professional services
Public administration
31
50
19
27
61
13
Upper income
Wholesale trade
20
58
22
Education
17
61
22
Manufacturing
19
59
21
Health care
and social assistance
22
56
21
Arts, entertainment
and recreation
25
56
19
Agriculture, forestry,
fishing and mining
28
55
17
Transportation,
warehousing and utilities
25
59
16
Construction
26
59
15
Retail trade
30
56
14
Other services
30
57
14
Military
Accommodation and
food services
38
Note that they are rather
evenly distributed across all
sectors as can be seen by
noting that the share in each
sector isn’t too far from their
total share in the population,
namely 51%
13
65
21
The share of Americans who
are in the middle class fell
from 61% in 1971 to 51% in
2023, while their share of US
GDP fell from 61% to 43%.
52
11
Note: People are assigned to income tiers based on their household incomes, after incomes
have been adjusted for the number of people living in each household and the local area
cost of living. Shares may not total 100% due to rounding. Estimates are for p eople ages 16
and older who had worked in the previous five years.
Source: Pew Research Center analysis of the American Community Survey (IPUMS), 2022.
PEW RESEARCH CENTER
Source: Kochhar (2024) and author.
While tariffs cannot, on net, help the middle class, they are appealing to US politicians
across the political spectrum. Policies that might actually lift up the left-behind – like
Canadian-style health, education, pension, and active labour market policies – would
require higher taxes and bigger government. For reasons that are hard to pinpoint, this
route is politically infeasible in today’s America. With economically effective policies
blocked, US politicians blamed foreigners – especially China – and immigrants.
The upshot is clear: because no US policy is economically effective and politically
feasible, both middle-class malaise and America’s anti-trade stance are here to stay for
the foreseeable future.
While the tariffs will not help the middle class, they are already damaging the US
economy. The mechanism is easy to understand. Volatility leads to uncertainty, which
leads to postponed spending, which hits aggregate demand which results in slower GDP
growth.
In particular, the erratic nature of recent tariff announcements undermines the
predictability that is essential for investment in plants, equipment, and technology
As Goldman Sachs CEO David Solomon puts it, the current administration’s tariffs
are “forcing CEOs to tighten their belts”. resulting in hiring freezes and postponed
investments. In the first quarter of 2025, US business investment growth slowed to 3.4%,
down from 3.7% in 2024. Uncertainty also leads consumers to hesitate, especially when it
comes to big-ticket items like cars, appliances, and housing upgrades.
When millions of households delay major purchases, aggregate demand shifts backward.
The result isn’t just slower growth; it can become contraction. Indeed, the US economy
shrank by 0.4% in Q1 2025 – the first quarterly GDP contraction in three years – raising
concerns that tariff-driven instability could tip the economy into recession.
THE END OF US TRADE LEADERSHIP? THE ARCHITECT TURNS ARSONIST
Historically, the United States was the architect of the global trade system, championing
principles like non-discrimination. From the bipartisan enthusiasm of Presidents
Clinton and Bush Jr. to Obama’s cautious hesitancy, America gradually retreated from its
leadership role. Under President Trump, the architect has turned arsonist.
His administration’s new tariffs are a direct and purposeful rejection of the rules-based,
multilateral trade system, and specifically of two core WTO principles.
• By slapping different tariffs on different partners, the administration violated the
trade system’s non-discrimination principle (most-favoured nation, or MFN, in
WTO jargon). This principle is so important that it is, literally, Article 1 in the WTO
rulebook.
Why is non-discrimination important? If you have different tariffs on every country,
you must prove where every import actually originates to avoid tariff cheating. But
establishing origin requires rules and procedures that are a red-tape headache for
exporters and importers alike.
This is not a small thing. The United States defines tariffs for something like 15,000
distinct products. Each will need more stringent checking to avoid, for example, Chinese
sports socks being transhipped through Singapore to pay a 10% tariff (the administration’s
tariff on goods from Singapore) instead of 57% (the tariff on goods from China). Since the
rules proving origin for sports socks cannot be the same as the rule for, say, marine diesel
engines, each of the 15,000 tariff lines requires its own rule. US customs will have to hire
many more people to handle the complexity.
• The second violation concerns the foundational principle that WTO members
should respect the commitments they made to one another. Specifically, WTO
members should not raise tariffs above the levels they agreed to in past multilateral
trade negotiations. These agreed tariff levels are known as ‘tariff bindings’ in WTO
terminology.
Why are bindings important? Tariff bindings create commercial certainty that is critical
to international trade and investment. Whatever the tariff levels, bindings assure
companies that they will stay there. President Trump’s tariffs shattered the bindings –
and the commercial certainty along with it. Among other things, the absence of bindings
will discourage firms from investing in US-based manufacturing.
US MIDDLE-CLASS MALAISE AND THE WORLD TRADE SYSTEM | BALDWIN
241
The President’s tariffs dismantle US leadership of the global trade system, and this
creates a leadership vacuum. History teaches us that vacuums rarely remain unfilled, but
the United States is not thinking about who will take up the reins of trade-system leader,
or where they will take it.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
242
HOW THE WORLD SHOULD RESPOND
The rest of the world faces a critical juncture. How should it react strategically to
America’s aggressive unilateralism?
In the short term, global trading nations must:
• stay calm and avoid retaliatory escalation outside WTO rules;
• file clear and consistent WTO complaints to uphold international legality and
legitimacy;
• publicly reinforce the mutual benefits of trade, clarifying how tariffs harm all,
including American middle-class voters themselves;
• strengthen financial and political support for the WTO Secretariat to resist
undermining by US actions.
In the longer run, the world must:
• prepare for a more protectionist and isolated United States that may persist beyond
the Trump presidency;
• strategically explore new leadership coalitions to uphold and modernise the WTO
system;
• develop contingency plans against broader threats, such as destabilising
financial interventions hinted at by Trump’s team, including aggressive currency
manipulation or disruptions to global financial markets.
CONCLUDING REMARKS
President Trump’s tariffs are not anomalies; they are symptoms of deeply rooted
structural problems in American society and politics. America’s withdrawal from global
trade leadership is neither temporary nor trivial. Tariffs won’t solve the underlying
malaise, but instead deepen the crisis.
To safeguard global prosperity, other nations must actively defend and sustain the
WTO’s principles. The current moment resembles less a Bretton Woods reset and more
the dangerous precedent of 1929, when unilateral American trade barriers sparked
widespread protectionist spirals. It is imperative to ensure that history does not repeat
itself.
REFERENCES
Baldwin, R (2019), The Globotics Upheaval: Globalisation, Robotics and the Future of
Work, Oxford University Press.
ABOUT THE AUTHOR
Richard Baldwin is a Professor of International Economics at IMD Business School in
Lausanne, the Editor-in-Chief of VoxEU.org, which he founded in June 2007, and a NonResident Fellow at the Peterson Institute for International Economics in Washington.
Baldwin served as the President of CEPR (2016-2019), Director (2014–2016), Policy
Director (2006–2014), and International Trade Programme Director (1991–2001). He has
been a Research Fellow since 1988. He was a visiting professor at Oxford (2012-2015),
the University of Adelaide (2013), and MIT (2003), and previously was a professor at the
Graduate Institute in Geneva and Columbia Business School in New York (1986-1992).
Before relocating to Europe, Baldwin was a Senior Staff Economist for the President’s
Council of Economic Advisors during the Bush (the Elder) Administration (1990-1991),
where he was involved in trade negotiations, including the Uruguay Round, NAFTA, and
numerous US-Japan trade disputes. His research interests include international trade,
globalisation, regionalism, and European integration. He wrote his PhD at MIT under
the guidance of Paul Krugman, with whom he has co-authored a half dozen articles. His
MSc in Economics is from the London School of Economics, his BA in Economics from
the University of Wisconsin-Madison. He was awarded honorary doctorates from the
Turku School of Economics and Business in Finland (2005), the University of St. Gallen
in Switzerland (2012), and the Pontifica Universidad Católica del Perú (2014). Baldwin
has served as an Elected Member on the Council of the European Economic Association
(1999-2004, 2006-2011) and as Vice Chair of the Academic Advisory Committee of the
Peterson Institute for International Economics in Washington (2008-2012)
243
US MIDDLE-CLASS MALAISE AND THE WORLD TRADE SYSTEM | BALDWIN
Kochahr, R (2024), The State of the American Middle Class, Pew Research Report
(https://www.pewresearch.org/race-and-ethnicity/2024/05/31/the-state-of-theamerican-middle-class/).
CHAPTER 20
Kimberly A. Clausing
University of California, Los Angeles
The tariff spree during the first 100 days of the second Trump administration created
a bewildering economic policy chaos, disrupting the path of the US macroeconomy,
challenging longstanding international trade norms, and threatening the prosperity
of consumers, workers, and firms in the United States and beyond. Further, for US
taxpayers, Trump’s first 100 days mark the largest tax increase in more than a generation.
In this chapter, I will briefly recap the current state of affairs (as of May 1 2025)1 and
then discuss the consequences of the current administration’s tariffs for the US economy
(considering consumers, producers, and the macroeconomy) and the larger world
community (considering detrimental effects as well as possible policy responses).
TRUMP’S TARIFFS
In the first 100 days of the second Trump administration, there have been so many tariff
policy announcements that it is difficult to even keep track; one excellent timeline is
provided by Chad Bown at PIIE.2 Several of the tariff actions have evoked the president’s
emergency authority under the International Emergency Economic Powers Act
(IEEPA) to impose tariffs with respect to Canada, Mexico, and China (citing supposed
emergencies surrounding migration, crime, and drugs) and with respect to every country
in the world (citing supposed emergencies surrounding bilateral trade deficits and trade
practices abroad). The latter – so-called “reciprocal tariffs” – include both a countryspecific component (now paused in most cases) and an across-the-board 10% tariff.3 In
this analysis, I will focus on the tariffs in place as of 1 May 2025 , noting that the evolution
of future tariff policy is still subject to a substantial level of uncertainty.
1
2
3
As this piece was going to press, President Trump “paused” the higher tariffs on China for 90 days on 12 May. According to
the Budget Lab analysis (https://budgetlab.yale.edu/research/state-us-tariffs-may-12-2025), that still leaves damage to the
US economy from higher tariffs at about 60% of the level before the China pause. Future harms from the US tariffs may
be higher or lower than those discussed here if tariff pauses expire (including those affecting Canada and Mexico paused
3 February, reinstated 4 March, and then selectively paused again 6 March; those affecting most other countries paused 9
April; and these higher Chinese tariffs paused 12 May), or if tariffs are negotiated downward.
https://www.piie.com/blogs/realtime-economics/2025/trumps-trade-war-timeline-20-date-guide (last accessed 9 May
2025).
The country-specific component was based on the US bilateral trade deficit with each country; this formulaic approach
was widely criticised by economists as lacking any coherent rationale.
245
THE AFTERMATH OF TARIFFS | CLAUSING
The aftermath of tariffs
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
246
Many of these policy changes have been subject to reversals, pauses, exceptions, and new
threats, layering chaotic policy uncertainty on top of the serious disruption caused by
such a large economic shock. Further, some countries have retaliated, some have paused
retaliation, and the US government has also responded to retaliation. In the case of
China, a tit-for-tat retaliatory spiral has ensued, such that there are now sky-high (125–
145%) tariffs in both directions, threatening the possibility of an effective embargo of
trade between the world’s two largest economies.4 Beyond these actions, there have also
been sector-specific tariffs announced in the automobile, automobile parts, and steel
and aluminium sectors; in addition, there have been announcements that tariffs may
be coming in several other sectors, including semiconductors, pharmaceuticals, lumber,
copper, critical minerals, cranes, seafood, and trucks.
At present, effective tariff rates (average tariffs on all imports) are an order of magnitude
higher than they were at the beginning of the second Trump administration, standing
at about 25%. US effective tariff rates were below 4% for most of the last 50 years, stood
at about 1.5% prior to the first Trump administration, rose to nearly 3% by the end of
that administration, and declined to about 2.3% by the end of the Biden administration.
Consumer substitution will eventually lower today’s high effective tariff rates, but there
is no question that the new tariffs are a very large economic shock for the US economy;
they will also have large impacts on countries that trade large amounts with the United
States (Irwin 2025).5
How tariff policies will play out in the coming months remains a matter of some
mystery as of this writing. The end goals of the current administration are unclear, and
the governments that have attempted to negotiate with the United States have often
expressed dismay at the lack of clarity regarding US objectives. To some extent, this state
of affairs is a consequence of President Trump’s contradictory set of goals for the tariffs,
which are seen as instrumental for extracting concessions from foreign governments
(implying that tariffs might be negotiated down, thus reducing their revenue yield),
raising enough revenue to finance large income tax cuts (which implies large, persistent
tariffs), and revitalising the US production base (which implies a continued price signal
in favour of domestic production as well as a model of the economy that ignores the
negative effects of tariffs on production).
4
5
Tariffs have been “paused” since this was drafted; see footnote 1.
The numbers in the text consider effective tax rates relative to total imports, and they do not account for consumer
substitution that is likely to occur toward lower-tariffed or domestic goods in the face of such high tariffs, particularly
in the Chinese case. Both the Budget Lab (https://budgetlab.yale.edu/research/state-us-tariffs-april-15-2025) and a Tax
Foundation analysis York and Durante (2025) note that effective tariff rates are above 25% (estimates are 28% and
25.5%, respectively), but will fall due to behavioral response, to 18% and 11%, respectively.
CONSEQUENCES FOR THE US ECONOMY: CONSUMERS AND TAXPAYERS
For most families, these tariff tax increases will also dwarf any forthcoming tax cuts
that are contemplated due to Tax Cuts and Jobs Act (TCJA) extensions. The tax cut from
extending the TCJA provisions (that would otherwise expire at the end of 2025) amounts
to only about $1,000 for a median family, and even that would not be experienced as a
tax cut since it merely continues current policy, avoiding a counterfactual tax increase
of $1,000 under current law, under which many TCJA provisions expire. Thus, the net
effect of the tariffs and the tax cut extensions is likely to be negative for a majority of US
households.
Further, the combination of income tax cuts and tariff increases is a regressive fiscal
switch that moves the tax burden down the income distribution, away from the welloff and towards poorer members of society. The income tax is a very progressive tax,
and TCJA extensions are forecast to disproportionately benefit the well-off. In contrast,
tariffs are a consumption tax that disproportionately burdens those lower in the income
distribution, especially in the short run, for the simple reason that savings (which are not
6
7
8
9
https://budgetlab.yale.edu/research/state-us-tariffs-april-15-2025
https://taxpolicycenter.org/features/tracking-trump-tariffs
https://taxpolicycenter.org/statistics/historical-average-federal-tax-rates-all-households. I use data for 2019 to avoid
pandemic-induced distortions in the 2020 data; subsequent years are not available from this source.
Tax Policy Center estimates of TCJA extensions are from July 2024 (https://taxpolicycenter.org/model-estimates/makecertain-provisions-2017-tax-act-permanent-july-2024/t24-0023-make-certain). A few factors could potentially mediate
price increases for consumers. First, when countries with large market size implement tariffs, that can drive down prices
of their import goods on world markets. However, while the United States is a large country, it only accounts for 13% of
world merchandise imports, and a large body of careful empirical work found no such effects for the tariffs implemented
during the first Trump administration. See Clausing and Lovely (2024) for a review of those studies, which include Amiti
et al. (2019), Cavallo et al. (2021), Fajgelbaum et al. (2020), Fajgelbaum and Khandelwal (2022), Flaaen et al. (2020),
and Houde and Wang (2023). Second, in theory, tariffs should lead to dollar appreciation, due to excess demand for USproduced goods. However, so far the early experience in the second Trump administration has been that the US dollar has
depreciated alongside these chaotic tariff announcements, perhaps due to reduced confidence in US financial stability.
Third, firms may reduce their profit margins in order to cushion consumers from price increases. This effect is likely to be
modest, however, as many firms that sell tariffed goods operate in highly competitive markets, and the tariffs in question
are quite large, so few firms will be able to absorb the tariff increases.
247
THE AFTERMATH OF TARIFFS | CLAUSING
As noted above, Trump’s first 100 days mark the largest tax increase in more than a
generation for US taxpayers. As of mid-April (when tariffs were at similar levels as of
this writing), estimates of the cost for a typical household are in the thousands of dollars.
The Budget Lab places short-run costs (including effects on domestic price increases) for
typical households at $4,900, declining to $2,600 after consumer substitution effects.6
A Tax Policy Center analysis indicates a cost of about $3,100 from the tariffs.7 The Penn
Wharton Budget Model (2025) implies reduced consumption of about 3%. To put these
estimates into context, these are enormous tax increases relative to current federal tax
payments. For the median taxpayer, federal tax rates (all in) were about 13% in 2019, 9%
of which was due to the payroll tax (which funds social security and Medicare) and only
2.5% of which was due to the federal income tax.8 Thus, these tariffs have the potential
to amount to a larger tax burden that the federal income tax for a median taxpayer , and
even more so for lower-income taxpayers!9
burdened by tariffs) increase steadily with income. Lower-income people save little, if
any, of their income, whereas higher-income people often save substantial shares of their
income.10
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
248
As one illustration, consider a situation where tariffs eventually settle at 10% for most of
the world and 60% for China, and TCJA tax extensions are passed by Congress and take
effect. The net effect of the combined policies is illustrated in Figure 1. For the lowest
quintile, tariffs cost more than 5% of their after-tax income, and tax cuts generate little
benefit. For the top quintile, tax cuts and increases nearly balance; only those at the top
of the distribution are net beneficiaries of this policy combination. Further, the spending
cuts envisioned by Congress would also have regressive effects if enacted, exasperating
this pattern.11
Beyond the impact of these historically large tax increases, the way they were
implemented is likely to exacerbate the harm for consumers by generating shortages
and supply chain disruption, similar or worse that that experienced during the Covid-19
pandemic (operating with a lag).12 For example, at the time of this writing (early May
2025), West Coast ports were reporting large drop-offs in shipping volume, which could
certainly lead to shortages and empty shelves in American stores.
FIGURE 1
AN ILLUSTRATIVE TRUMP FISCAL POLICY SWITCH FROM INCOME TAXES TO
TARIFFS (PERCENT CHANGE IN AFTER-TAX INCOME)
6.0
4.0
2.0
0.0
-2.0
-4.0
-6.0
Lowest
Quintile
Second
Quintile
Middle Quintile
TCJA Extension
Fourth
Quintile
Tariffs
Top Quintile Top 1 Percent
Net Effect
Notes: The tariff estimates consider a 10 % US tariff for most goods from the rest of the world and an incremental 50%
tariff on Chinese imports. The net effect bars show the combined net effect of the loss from proposed tariffs and the gain
from TCJA extensions. The method follows Clausing and Lovely (2024), using updated data. Tariff burden calculations
use data from the Consumer Expenditure Survey on consumption patterns and data on incomes from the US Treasury.
TCJA extension estimates are from Tax Policy Center (2024); these do not include the full suite of tax cuts that have been
proposed.
10 There is also research that indicates that poorer household consume more imports in their consumption bundle than
richer households, although the literature in this area is more mixed in its findings. See Clausing and Lovely (2024) for a
discussion.
11 One analysis of the tax and spending cuts proposed in the budget process so far is from the Urban Institute, in Banthin et
al. (2025), but that analysis does not include the effects of tariffs.
12 Even though these policies are misguided, the damage would have been lessened if the policies were announced ahead of
time, and phased in slowly and gradually, with due consideration for bottlenecks and other collateral damage.
CONSEQUENCES FOR THE US ECONOMY: FIRMS AND WORKERS
There are several basic reasons for these findings. First, tariffs create new shocks
and supply disruptions that are harmful for businesses. A majority of US imports are
intermediate goods; raising their costs makes US producers less competitive relative to
peer firms abroad. For example, studies of steel tariffs have found that, while they may
have preserved some steel jobs, those jobs came at the expense of a far larger loss of jobs
in industries that use steel, which face higher input costs and lower competitiveness as a
result.
Second, tariffs generate multiple sources of disruption for exporters, who often import
key intermediate inputs; indeed, the largest exporting firms are frequently the largest
importing firms (Jensen 2016). In addition to higher costs, tariffs often beget retaliation,
and foreign tariffs reduce market opportunities for US exporters. Concerns along these
lines have been raised by many producers, from farmers in Iowa to large manufacturers
like Boeing, which has seen previously ordered planes returned.13
Finally, there are also ‘general equilibrium’ problems; in particular, the first consequence
of tariffs is not their only effect. Tariffs attempt to encourage production, true, but in
order to increase production of goods that were formerly imported, labour and capital
must be freed from other sectors. Thus, expansion of the import-competing sector
comes, in part, at the expense of contraction in the export sector (as well as the nontraded
sector). This reorients the economy away from the goods where comparative advantage
lies and toward goods that the economy is less suited to producing, reducing efficiency
and diminishing innovation and growth.
THE US MACROECONOMIC CONTEXT
The experience so far from the tariffs of Trump’s first 100 days provides early evidence
of the disruption such large tariffs can cause. Consumer confidence has fallen, measures
of investor uncertainty and economic policy uncertainty have risen, economic growth
13 For news stories on these developments, see https://www.nytimes.com/2025/05/05/business/soy-farmers-struggle-withtrade-war.html and https://www.bbc.com/news/articles/c3evw059x04o
249
THE AFTERMATH OF TARIFFS | CLAUSING
Many tariff advocates note that tariffs could increase costs somewhat for consumers,
but the increased costs will ultimately be worth the sacrifice, since the resurgence of
American productive activity will create better US manufacturing jobs, improving
(over time) workers’ standards of living. While this hopeful scenario sounds plausible, it
runs into large problems when confronted with basic logic or the data from prior tariff
episodes. Many studies of the first Trump administration tariffs concluded that they
were, on net, harmful for job creation (e.g. Flaaen and Pierce 2024, Russ 2019, Russ and
Cox 2020a, 2020b, Autor et al. 2024, Handley et al. 2025).
expectations have been revised downward, and forecasters have raised the probability
of a US recession substantially. Tariffs are cited as a key determinative factor in all
instances.14
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
250
The tariffs have also worsened the problem of macroeconomic management, as noted
by Chairman Powell and other Federal Reserve officials. Tariffs risk stagflationary
pressures, due to the simultaneous occurrence of upward price pressures and recessionary
headwinds. This makes the job of the central bank particularly vexing, since there will
be conflicts between the ‘loose’ monetary policies that might address recessionary
headwinds (which would worsen inflationary pressures) and the ‘tight’ monetary policy
that would address upward prices pressures (but worsen recessionary forces). Further,
this occurs alongside threats from the President of the United States regarding Federal
Reserve independence. President Trump has even mused that he might remove Chairman
Powell on several occasions, even if he ultimately backed down, arguably due to market
pressures.
Casual attacks on Federal Reserve independence have occurred in a particularly
challenging larger context, characterised by significant erosion in US institutional
strength and respect for rule of law. On multiple occasions, the Trump administration
has refuted the authority of the courts, and on myriad occasions, the administration has
engaged in unlawful behaviour, as a host of ongoing lawsuits is slowly establishing.15
There have also been important erosions in the US fiscal stance. Beginning from a
period of very high deficits and debt, despite a strong economy going into the Trump
administration, the US Congress and the administration are working on a package of tax
cuts (and more modest spending measures) that could end up adding nearly $6 trillion to
US deficits over the coming decade.16
Beyond the large new deficits, Republicans in Congress have also suggested accounting
gimmicks that would disappear trillions in debt (for budgeting purposes) by adopting
a ‘current policy’ baseline. Such a baseline simply assumes that there are no costs
associated with extending policies that would otherwise expire under current law,
leaving the cost of those extensions completely unaccounted for. (It would be akin to a
person attending an expensive college for one semester, and then announcing all future
14 The University of Michigan surveys consumers; data are available at https://www.sca.isr.umich.edu/charts.html. One
measure of policy uncertainty is discussed at https://www.marketwatch.com/story/not-even-the-co-creator-of-thiseconomic-uncertainty-index-can-tell-when-the-worst-will-be-over-9ec655dd. The stock market volatility index (VIX),
sometimes referred to as the ‘fear index’, increased sharply around the April tariff announcements and remains elevated
although it has fallen since the peak (https://www.stl.news/cboe-volatility-index-vix-drops-markets-stabilize/),. Goldman
Sachs, the IMF, and the OECD have all reduced their estimates of likely US GDP growth, noting the important role of
tariffs. See Nathan et al. (2025), J.P. Morgan (2025), Gourinchas (2025), OECD (2025), and https://www.wsj.com/economy/
trade/us-economic-outlook-trump-b4e3469a?mod=article_inline. The probability of a recession has also increased; for
example, Reuters notes that several investment banks have raised recession probability forecasts (https://www.reuters.
com/markets/us/goldman-sachs-raises-odds-us-recession-45-2025-04-07/).
15 One tracker of the lawsuits is available at https://www.justsecurity.org/107087/tracker-litigation-legal-challenges-trumpadministration/
16 The Congressional Budget Office issues periodic reports on the long-term US budget outlook (CBO 2025). On possible
deficit impact of the coming tax legislation, see Committee for a Responsible Federal Budget (2025).
semesters are costless, since it is simply an ‘extension’ of current spending patterns.)
While the Senate Parliamentarian may ultimately reject such a baseline, if the Senate
pursues it nonetheless (which they can do by bypassing or firing the parliamentarian),
that would mark a further deterioration in budgeting norms.
Markets have calmed somewhat since the volatility of April, but key questions about the
path of the administration’s economic policies are unanswered. If tariffs remain at very
high levels, outcomes will be significantly worse than if they fall substantially. However,
even if some tariffs are paused or negotiated downwards, it is quite likely that they will
remain substantially higher than at any point in the last 50 years. For example, the Trump
administration has shown very little willingness to reconsider the ten percent acrossthe-board tariff. In the first ‘trade deal’ with the United Kingdom – arguably an easier
deal to reach than many, due to the two countries’ longstanding partnership – there was
remarkably little liberalisation. The new 10% tariff on UK exports to the United States
will remain intact, and other trade liberation under the deal (which itself affects less than
3% percent of US goods trade in 2024) is minimal.17
IMPLICATIONS FOR THE REST OF THE WORLD
While the current administration’s trade stance clearly harms the economic interests
of the United States, it also damages economies abroad as well as international norms.
Canada and Mexico are particularly vulnerable; in 2024, trade with the United States
accounted for 63% of Canadian trade and 61% of Mexican trade, with higher ratios for
those countries’ exports.18 Canada and Mexico are also relatively open economies, with
high trade to GDP ratios, so exports to the United States comprise a sizeable share of
GDP: about a fifth for Canada, and about a quarter in the case of Mexico.
China has far less dependence on the United States in relative terms; US exports amount
to about 2.5% of Chinese GDP. Still, in 2024, the United States was the largest purchaser
of Chinese exports, and the sky-high tariffs risk damaging both economies. That said,
17 For one explainer, see https://www.bbc.com/news/articles/c15ng4g5g0eo.
18 Data are from the International Monetary Fund (https://data.imf.org/en/Data-Explorer?datasetUrn=IMF.STA:IMTS(1.0.0))
and include both imports and exports. Canada and Mexico have 76% and 83% of their exports, respectively, destined for
the US market.
251
THE AFTERMATH OF TARIFFS | CLAUSING
Financial markets have taken note of this combination of macroeconomic risks. Indeed,
movements in the bond market and the currency markets indicate some possibility that
the US government may be soon (if not already) facing a risk premium associated with
US debt, which raises borrowing costs and increases macroeconomic fragility in the
United States, making the already troubling high deficits and debt even more worrisome.
Indeed, when tariff announcements were associated with dollar depreciation, instead of
the expected appreciation, many attributed these trends to declining confidence in the
US macroeconomic policy regime (e.g. Butts 2025 and Lubin 2025).
damage to China may be reduced by the fact that China is simultaneously expanding
trade with the rest of the world, and in many respects is less vulnerable to bilateral trade
disruption than the United States.19
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
252
In addition, the tariffs pose a larger macroeconomic risk to the world economy,
particularly given the fragile US macroeconomic context discussed above. And, if US
policy errors generate a US recession, that creates negative macroeconomic spillovers,
and recessionary headwinds, for the entire world economy.
Perhaps even more important than the above factors is the risk that ascendant nationalism
and transactional deal-making supplant longstanding international cooperative efforts.
The United States is supposedly attempting to negotiate a rapid succession of ‘trade deals’
with many US trading partners; these efforts are at times characterised by US officials as
an attempt to reset the terms of bilateral economic relationships. The list of US desires
appears only weakly related to trade protection, and includes other tax policy, economic
policy, and foreign policy desiderata.20
Should other countries take these negotiations seriously – or worse, follow the Trumpian
lead and conduct more of their own trade policies on a bilaterally negotiated basis – that
would bode quite poorly for the norms of the world trading system, administered by
the WTO. The WTO counts 166 jurisdictions as members, including the United States.
Under WTO norms, member countries agree to adhere to prior tariff commitments
as well as the notion of most-favoured nation (MFN) status, whereby WTO members
commit to treat their partners on similarly favourable terms.21 The President’s tariff
approach is antithetical to these principles. And, while of course the WTO is not perfect,
the governments that join the WTO value a rules-based trading system, recognising that
such a system is far superior to either isolationism or transactional deal-making.
In the coming period, an ideal approach for other governments would be to form
‘coalitions of the willing’ to continue to solve collective action problems, with or without
the United States. This could include efforts to maintain world trading system norms,
and even to enhance trade liberalisation on a plurilateral basis when feasible. Such
an approach would also be useful with respect to other issues, such as climate change
mitigation, public health, and tax competition.
The world has much to gain from continued economic collaboration. A free and open
trading system provides opportunities for prosperity and economic growth. Continued
climate action creates a more habitable planet and reduces the serious harms to vulnerable
populations and ecosystems that stem from climate change (Clausing and Wolfram
19 See Posen (2025) on the asymmetric vulnerabilities of the US-China war. Rising Chinese exports to other countries are
chronicled in news stories (e.g. https://www.cnbc.com/2025/05/09/chinas-exports-jump-us-tariffs-imports-tumble.html).
20 For a discussion of some of these arguments, see Clausing (2025).
21 World trade system norms allow exceptions for closer ties between free trade area or custom unions partner countries, so
long as trade is substantially liberalized between the partners, and barriers are not simultaneously raised with respect to
other WTO members. US free trade area partners are likewise bewildered by the lack of US commitment to the terms of
their prior agreements.
2023, Clausing et al. 2025). Future pandemics require both scientific collaboration and
information sharing across borders. And international collective action helps overcome
the free-rider problems that plague the development of fair and efficient tax systems, in
part due to the difficulty of taxing internationally mobile income.22
Finally, there is the question of how the Trump administration responds to the verdict
that markets are already delivering on their economic agenda. If the folly of the trade
wars is swiftly reversed, and something more like the first Trump administration is the
end outcome, both the United States (and the world) may avoid the worst. As of this
writing (1 May 1 2025), the economic outlook is highly uncertain.
REFERENCES
Amiti, M, S J Redding, and D E Weinstein (2019), “The Impact of the 2018 Tariffs on
Prices and Welfare”, Journal of Economic Perspectives 33(4): 187–210 (https://doi.
org/10.1257/jep.33.4.187).
Amiti, M, S J Redding, and D E Weinstein (2020), “Who’s Paying for the US Tariffs?
A Longer-Term Perspective”, AEA Papers and Proceedings 110: 541–46 (https://doi.
org/10.1257/pandp.20201018).
Autor, D, A Beck, D Dorn, and G Hanson (2024), “Help for the Heartland? The
Employment and Electoral Effects of the Trump Tariffs in the United States”, NBER
Working Paper 32082 (https://doi.org/10.3386/w32082).
Banthin, J, M Buettgens, J Carter and G B Mermin (2025), “Who Gains and Who Loses
under a Tax Cut Extension with Medicaid and SNAP Spending Reductions”, Urban
Institute
(https://www.urban.org/research/publication/who-gains-and-who-losesunder-tax-cut-extension-medicaid-and-snap-spending).
Butts, M (2025), “Trump’s Tariffs Lead Investors to Question the Future of the Dollar”,
Insights by Stanford Business, 5 May (https://www.gsb.stanford.edu/insights/trumpstariffs-lead-investors-question-future-dollar).
22 For more on the problems of corporate tax base erosion, profit shifting, and tax competition, and the role of the
international tax agreement of 2021 in addressing these problems, see Clausing (2023).
253
THE AFTERMATH OF TARIFFS | CLAUSING
If other leaders work to address these important international collective action problems,
future US governments may ‘rejoin’ down the road, should future US voters reject the
isolationism and protectionism that are at the heart of the Trump agenda. However, if
the rest of the world follows the lead of the present Trump administration, one can easily
imagine a scenario more akin to the 1930s, where countries’ inward turns exasperate
economic downturns, ultimately fueling animosity and war.
Cavallo, A, G Gopinath, B Neiman, and J Tang (2021), “Tariff Pass-Through at the Border
and at the Store: Evidence from US Trade Policy”, American Economic Review: Insights
3(1): 19–34.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
254
CBO – Congressional Budget Office (2025), “The Long-Term Budget Outlook: 2025 to
2055”, March (https://www.cbo.gov/publication/61270).
Clausing, K, J Aldy, D Tingley, and C Wolfram (2025), “Global Climate Cooperation After
2024: A Proposal for a Heavy-Industry Climate Coalition”, forthcoming CEPR/Bruegel
volume.
Clausing, K A (2025), “Reciprocity and discrimination: When are tariffs useful remedies?”,
PIIE blog, 3 March (https://www.piie.com/blogs/realtime-economics/2025/reciprocityand-discrimination-when-are-tariffs-useful-remedies).
Clausing, K A and M E Lovely (2024), “Why Trump’s Tariff Proposals Would Harm
Working Americans”, PIIE Policy Brief 24-1, Peterson Institute for International
Economics.
Clausing, K A and C Wolfram (2023), “Carbon Border Adjustments, Climate Clubs, and
Subsidy Races When Climate Policies Vary”, Journal of Economic Perspectives 37(3):
137–62.
Clausing, K A (2023), “The International Tax Agreement of 2021: Why It’s Needed, What
It Does, and What Comes next?”, PIIE Policy Brief (https://www.piie.com/publications/
policy-briefs/2023/international-tax-agreement-2021-why-its-needed-what-it-doesand).
Committee for a Responsible Federal Budget (2025), “Comparing the House vs. Senate
on FY 2025 Reconciliation”, 17 April (https://www.crfb.org/blogs/comparing-house-vssenate-fy-2025-reconciliation).
Fajgelbaum, P D and A K Khandelwal (2022), “The Economic Impacts of the US–China
Trade War”, Annual Review of Economics 14(1): 205–28.
Fajgelbaum, P D, P K Goldberg, P J Kennedy, and A K Khandelwal (2020), “The Return
to Protectionism”, Quarterly Journal of Economics 135(1): 1–55 (see also the update at
http://www.econ.ucla.edu/pfajgelbaum/rtp_update.pdf).
Flaaen, A and J Pierce (2024), “Disentangling the Effects of the 2018-2019 Tariffs on a
Globally Connected US Manufacturing Sector”, Finance and Economics Discussion
Series 2019-086, Board of Governors of the Federal Reserve System (http://www.
justinrpierce.com/index_files/flaaen_pierce_tariffs_manufacturing.pdf).
Flaaen, A, A Hortaçsu, and F Tintelnot (2020), “The Production Relocation and Price
Effects of US Trade Policy: The Case of Washing Machines”, American Economic Review
110(7): 2103–27.
Gourinchas, P-O (2025), “The Global Economy Enters a New Era”, International
Monetary
Fund
(https://www.imf.org/en/Blogs/Articles/2025/04/22/the-globaleconomy-enters-a-new-era).
Houde, S and W Wang (2023), “The Incidence of the U.S.-China Solar Trade War”,
available at SSRN.
Irwin, D (2025), “The historic significance of Trump’s tariff actions”, PIIE Realtime
Economics
Blog
(https://www.piie.com/blogs/realtime-economics/2025/historicsignificance-trumps-tariff-actions).
Jensen, J B (2016), “Importers are Exporters: Tariffs Would Hurt Our Most Competitive
Firms”, PIIE Trade and Investment Policy Watch, 7 December (https://www.piie.com/
blogs/trade-and-investment-policy-watch/2016/importers-are-exporters-tariffs-wouldhurt-our-most).
Lubin, D (2025), “The U.S. Dollar’s Role in the International Monetary System is Now
Dangerously in Flux”, Chatham House, 16 April (https://www.​chathamhouse.org/​2025/​
04/​us-dollars-role-international-monetary-system-now-dangerously-flux).
JP Morgan (2025), “The Probability of a Recession Remains At 60”, 15 April (https://
www.jpmorgan.com/insights/global-research/economy/recession-probability).
Nathan, A, J Grimberg and A Rhodes (2025), “Tariff-Induced Recession Risk”, Goldman
Sachs Research, 7 April (https://www.goldmansachs.com/pdfs/insights/goldman-sachsresearch/tariff-induced-recession-risk/tariff-induced-recession-risk.pdf).
OECD (2025), “Steering Through Uncertainty”, OECD Economic Outlook, 17 March
(https://doi.org/10.1787/89af4857-en).
Penn Wharton Budget Model (2025), “The Economic Effects of President Trump’s
Tariffs”, 10 April (https://budgetmodel.wharton.upenn.edu/issues/2025/4/10/economiceffects-of-president-trumps-tariffs).
Posen, A (2025), “Trade Wars Are Easy to Lose”, Foreign Affairs, 9 April (https://www.
foreignaffairs.com/united-states/tariffs-trade-wars-are-easy-lose).
Russ, K N (2019), “The Costs of US Tariffs Imposed Since 2018”, EconoFact, 10 October
(https://econofact.org/the-costs-of-u-s-tariffs-imposed-since-2018).
Russ, K N and L Cox (2020a), “The Trade War Has Cost 175,000 Manufacturing Jobs
and Counting”, Econbrowser, 19 September (https://econbrowser.com/archives/2020/09/
guest-contribution-the-trade-war-has-cost-175000-manufacturing-jobs-and-counting).
255
THE AFTERMATH OF TARIFFS | CLAUSING
Handley, K, F Kamal, and R Monarch (2025), “Rising Import Tariffs, Falling Exports:
When Modern Supply Chains Meet Old-Style Protectionism”, American Economic
Journal: Applied Economics.
Russ, K N and L Cox (2020b), “Steel Tariffs and US Jobs Revisited”, EconoFact, 6
February (https://econofact.org/steel-tariffs-and-u-s-jobs-revisited).
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
256
Tax Policy Center (2025), “Tracking Trump’s Tariffs”, 4 April (https://taxpolicycenter.org/
features/tracking-trump-tariffs).
York, E and A Durante (2025), “Trump Tariffs: The Economic Impact of the Trump Trade
War”, Tax Foundation, 5 May (https://taxfoundation.org/research/all/federal/trumptariffs-trade-war/).
ABOUT THE AUTHOR
Kimberly A. Clausing is the Eric M. Zolt Professor of Tax Law and Policy at UCLA
School of Law and a nonresident senior fellow at the Peterson Institute for International
Economics, a research associate at the National Bureau of Economic Research, and
a member of the Council on Foreign Relations. From 2021 to 2022, she served as the
Deputy Assistant Secretary for Tax Analysis at the US Department of the Treasury. She
is the author of Open: The Progressive Case for Free Trade, Immigration, and Global
Capital (Harvard U Press) and dozens of articles on taxation.
CHAPTER 21
Antoine Bouët
CEPII
This chapter provides an estimation of the economic and trade consequences of the
“reciprocal tariffs” announced by Donald Trump on 2 April 2025. These “reciprocal
tariffs” are part of a protectionist plan initiated shortly after the inauguration of the
new US administration on 20 January 2025. The announcement immediately provoked
a swift reaction from key partners, notably Canada and China, in the form of effective
retaliation. The European Union also responded with a retaliatory announcement. On
9 April 2025, just one week after the press conference, the President announced that for
three months, “reciprocal tariffs” would not be applied and instead an increase of tariffs
by 10 percentage points would be put in place on US imports from all US partners, with
a few exceptions (four countries – Belarus, Cuba, North Korea, and Russia – and specific
products, such as pharmaceuticals).
The so-called “reciprocal tariffs” comprise a list of tariffs applied to the 57 countries
listed in Annex 1 of the Executive Order issued by the White House on 2 April 2025 (see
Table 1). The United States has a deficit on merchandise trade with these countries, and
these tariffs are supposed to restore equilibrium to these bilateral trade balances. In this
Executive Order, the US administration definitively states that the “unfair” practices of
these countries (higher tariffs on US products than the US tariffs on their products, nontariff measures, discriminatory taxes, exchange rate manipulation) explain these deficits.
In this chapter, I estimate the impact of protectionist decisions taken worldwide
during the first five months of 2025 on key economic indicators. I postulate that the US
administration will not entirely retract the tariffs that were proclaimed on 2 April 2025,
leaving it with a binary decision: either implement “reciprocal tariffs” with effect from
9 July 2025 and and a surcharge of tariffs by 10 percentage points on other partners,
or refrain from doing so and instead impose a permanent additional across-the-board
tariff of 10 percentage points. The results are as follows. First, I estimate that an impact
of between -1.5% and -1.4% on US GDP, between -1.7% and -1.5% for China, and between
257
FIRST ESTIMATIONS OF THE EFFECTS OF RECIPROCAL TARIFFS | BOUËT
First estimations of the effects of
reciprocal tariffs
-0.5% and -0.2% for the European Union. Second, I estimate that the impact on US
inflation will range between +1.8% and +2.8%. Third, the increase in US tariff revenues is
muted, ranging between $152.1 billion and $244.7 billion.1
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
258
METHODOLOGY
I estimate the economic impact of three packages of measures adopted by the United
States and its partners. The “reciprocal tariffs” were announced after other measures
adopted since 20 January 2025, and were followed by a significant change in the direction
of US trade policy. These three packages are:
• US decisions taken after 20 January 2025 and before 2 April 2025: a 25% tariff
on products from Canada and Mexico, with a 10% tariff on energy products from
Canada and a tax exemption for products complying with USMCA rules of origin;
a 25 percentage point tariff surcharge on imports of steel, aluminium and related
products from all sources; a 25 percentage point tariff surcharge for imports of
vehicles and auto parts from all sources; two 10 percentage point tariff increases
on all imports from China. This package of US protectionist decisions is included
in Scenario 1.
• US decisions announced on 2 April 2025: a 10 percentage point tariff surcharge
for all US trading partners, except for the 57 countries whose exports to the US are
penalised by a tariff surcharge shown in Table 1, with four countries exempted from
any tariff surcharge (Belarus, North Korea, Cuba, and Russia). Some products are
exempt from these tariff increases (those already subject to an increase in Scenario
1, and others such as pharmaceuticals). This package of US protectionist decisions
is included in Scenario 2.
• A package of measures characterised by a relative retreat on the part of the
US authorities: the application of reciprocal tariffs is suspended and US imports
from these 57 countries are subject to a 10 percentage point tariff surcharge. The
US tariff regime for other countries remains unchanged (including an additional
tariff of +10 percentage points compared to the situation before 2 April 2025), with
the exception of China, for which the tariff rises from 84% to 125%. The productspecific increases (S1) are maintained (for aluminium, steel, vehicles), as are the
exemptions introduced in S2. This package of US protectionist decisions is included
in Scenario 3.
1
These results are from Scenarios 2 and 3 (see below).
RECIPROCAL TARIFFS ANNOUNCED ON 2 APRIL 2025
Country
Tariff
Country
Tariff
Country
Tariff
Algeria
30%
Iraq
39%
Nigeria
14%
Angola
32%
Israel
17%
North Macedonia
33%
Bangladesh
37%
Japan
24%
Norway
15%
Bosnia & Herzegovina
35%
Jordan
20%
Pakistan
29%
Botswana
37%
Kazakhstan
27%
Philippines
17%
Brunei
24%
Laos
48%
Serbia
37%
Cambodia
49%
Lesotho
50%
South Africa
30%
Cameroon
11%
Libya
31%
South Korea
25%
Chad
13%
Liechtenstein
37%
Sri Lanka
44%
China
34%
Madagascar
47%
Switzerland
31%
Côte d`Ivoire
21%
Malawi
17%
Syria
41%
DR Congo
11%
Malaysia
24%
Taiwan
32%
Equatorial Guinea
13%
Mauritius
40%
Thailand
36%
European Union
20%
Moldova
31%
Tunisia
28%
Falkland Islands
41%
Mozambique
16%
Vanuatu
22%
Fiji
32%
Myanmar
44%
Venezuela
15%
Guyana
38%
Namibia
21%
Vietnam
46%
India
26%
Nauru
30%
Zambia
17%
Indonesia
32%
Nicaragua
18%
Zimbabwe
18%
Source: Office of the USTR (https://ustr.gov/issue-areas/presidential-tariff-actions).
For each package of US protectionist decisions, I include the retaliation they provoked.
When estimating the impact of a decision, it is important not to dissociate its
implementation from the retaliation it implies. In the first package (Scenario 1), I include
the Canadian retaliation announced on 1 February 2025 and the two sets of Chinese
retaliation announced on 4 February and 4 March. In the second package (Scenario 2),
I include China’s retaliation against the United States on 4 April 2025 (a 34% tariff),
US counter-retaliation on 8 April 2025 (+50 percentage points), and Chinese countercounter-retaliation on 9 April 2025 (+50 percentage points). Finally, in the third package
(Scenario 3), I include China’s decision to impose a 125% tariff in place of the two previous
decisions on US products (decision on 11 April 2025).
259
FIRST ESTIMATIONS OF THE EFFECTS OF RECIPROCAL TARIFFS | BOUËT
TABLE 1
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
260
A number of trade policy decisions taken since 20 January 2025 have not been taken
into account in this estimate: (i) China’s export restrictions on certain rare earths and
other strategic minerals, as the model used does not have sufficient granularity to take
them into account; (ii) the US exemption from tariffs on smartphones, computers,
semiconductors and other electronic goods, announced on 11 April 2025 (I will soon be
including this exemption in Scenario 3); and (iii) the “secondary tariffs” imposed on US
imports from countries buying oil from Venezuela, as there has been no confirmation
that this tariff will be implemented.
To make this estimate, I use a database and a model of the world economy. The database
I use is MAcMaps-HS6 (Guimbard et al. 2012), which it provides tariffs, expressed as a
percentage, for each importing country and 5,600 products, applied to each exporting
country, taking into account all regional trade agreements and trade preferences.
The world economy model I use is MIRAGE-Power (Decreux and Valin 2007),2 which
is a dynamic, multi-sector, multi-country computable general equilibrium model.
The model is used here in a version with 24 countries (or regions) and 38 sectors. The
model is calibrated on the most recent GTAP network database, describing the global
economy for 2017. I build a baseline (2018-2040) whose dynamics are determined by the
evolution of exogenous variables (evolution of population, labour supply, growth in total
factor productivity, natural resources, etc.) and by endogenous capital accumulation (the
extension of agricultural land is also endogenous). Certain variables, such as savings
rates and current account balances, are provided by the MAGE macroeconometric
model (Fontagné et al. 2022). The model calculates a medium- to long-term path for the
global economy, based on explicitly specified microeconomic behaviours (of consumers,
producers and investors). I integrate into this path the trade policies pursued over the
2018-2024 period: Brexit, Western sanctions against Russia, the implementation of the
Comprehensive Economic Trade Agreement between Canada and the EU, and the first
Sino-American trade war.
The three scenarios are successively implemented in 2025. By comparing these scenarios
with the baseline, one can measure the effects of these trade measures in 2040. In
modelling terms, this allows us to consider a situation in which the adjustment of
production factors has been completed, and in which the effects of the implemented
measures become virtually constant (in deviation from the baseline).3
MIRAGE-Power does not take into account uncertainty and its effects on investment
decisions. Uncertainty over trade policy in April 2025 is historically high, and increased
uncertainty over future tariffs has been shown to reduce investment and activity (Caldara
et al. 2020).
2
3
See also the MIRAGE wiki at https://mirage-model.eu/.
This work has been conducted in collaboration with Houssein Guimbard, Cristina Mitaritonna, Balthazar de Vaulchier and
Yu Zheng.
IMPACT ON AVERAGE CUSTOMS DUTIES
FIGURE 1
AVERAGE TARIFF US IMPOSES TO OTHER REGIONS, IN PERCENTAGE
United Kingdom
Sub-Saharan Africa
Spain
South-East Asia
South Korea
Rest of the World
Rest of Latin America
Rest of Europe
Rest of EU27
North Africa
Middle East
Mexico
Japan
Italy
India
Germany
France
EFTA
Community of Inpendant States
China
Canada
Brazil
Bangladesh
Australia-NZ
0%
20%
Scenario 3
40%
60%
Scenario 2
80%
Scenario 1
100%
120%
140%
Before 01/20/2025
Source: MAcMAps-HS6 and author’s calculation
Before 20 January 2025, exports from European countries were subject to low tariffs on
the American market – for example, an average tariff of 3% on imports from France and
3.5% from Germany (the product composition explains the differences in average tariffs
applied to European countries). By 1 April 2025, tariff increases on steel, aluminium and
related products, automobiles and spare parts had already significantly raised the average
tariff for European countries – for example, to 7% on average for French exports and
8.2% for Germany (which has higher car exports). The “Liberation Day” announcements
further increased customs duties on European products, raising the average customs
duty for European countries to close to 20%. After 9 April, the average tariff fell to just
over 13%.
261
FIRST ESTIMATIONS OF THE EFFECTS OF RECIPROCAL TARIFFS | BOUËT
US customs duties varied significantly between 20 January and 9 April 2025. The average
tariff faced by Chinese exports to the US market rose from 21.5% on 20 January to 44.4%
on 1 April, 99% on 2 April, and 140% on 9 April (Figure 1).
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
262
Interestingly, Bangladesh – a less-developed country that has based its development
strategy on exports of textiles and clothing to developed countries, particularly the
United States – has seen the average tariff on its exports more than quadruple with the
announcement of “reciprocal tariffs”, from 11.9% before 20 January to 48.8% on 2 April,
before falling to 21.9% on 9 April.
Finally, it should be remembered that the importance of export flows between two
countries does not depend on the absolute level of tariffs, but on their relative level. With
the rounds of retaliation launched between the United States and China, the latter faces
a much higher average tariff on its exports to the United States than other countries.
This should help to reduce the magnitude of the negative impact of “reciprocal tariffs” on
other countries exporting to the US market.
WORLD IMPACT
At the global level (Figure 2), the imposition of new barriers to international trade
reduces real trade in goods by -1.6% (Scenario 1), -3.9% (Scenario 2) and -3.1% (Scenario
3). All three scenarios have a downward effect on world GDP, particularly Scenario 2
(-0.75%) and Scenario 3 (-0.65%).
FIGURE 2
PERCENTAGE DEVIATION IN 2040 BETWEEN LEVELS OF WORLD WELFARE,
WORLD GDP AND EXPORTS OF GOODS IN VOLUME IN SCENARIOS 1, 2, AND 3
AND THE BASELINE
World Welfare
World GDP (vol)
Exports goods(vol)
-5.00
-4.00
-3.00
-2.00
-1.00
Scenario 3
Scenario 2
Scenario 1
0.00
Source: MIRAGE-Power
The main losers in this trade tariff war are the United States and China (Table 2).
Scenario 2 shows a similar loss for both economies (-1.5%), while Scenario 3 implies
a greater loss for China (-1.7% versus -1.5%). In Scenario 3, not only are US tariffs on
Chinese products higher, but countries other than China are less affected by US tariffs
than in Scenario 2. This implies greater export losses for China in Scenario 3. For the
TABLE 2
PERCENTAGE DEVIATION IN 2040 IN REAL TERMS BETWEEN LEVELS OF GDP
BY COUNTRY OR REGION IN SCENARIOS 1, 2, AND 3 AND THE BASELINE
Country/region
Scenario 1
Scenario 2
Scenario 3
Australia and New Zealand
0.0
-0.1
-0.1
Bangladesh
0.2
-0.6
0.2
Brazil
0.1
-0.1
-0.3
Canada
-0.4
1.0
0.5
China
-0.6
-1.5
-1.7
CIS
0.0
0.0
0.0
EFTA
-0.1
-0.9
-0.4
France
0.1
-0.3
-0.1
Germany
-0.2
-0.7
-0.3
India
0.2
-0.5
0.0
Italy
0.0
-0.3
-0.1
Japan
-0.4
-0.6
-0.4
Korea
0.2
-0.1
0.5
Mexico
-5.5
-0.8
-2.2
Middle East
0.0
0.0
0.0
North Africa
0.1
0.1
0.1
Rest of EU27
-0.1
-0.6
-0.3
Rest of Latin America
0.2
0.4
0.0
Rest of World
0.1
-0.5
-0.3
Southeast Asia and Hong Kong Taiwan
1.4
1.2
2.4
Spain
0.0
-0.2
-0.1
Sub-Saharan Africa
-0.1
-0.3
-0.1
United Kingdom
-0.1
-0.2
-0.3
United States
-0.7
-1.5
-1.4
Source: MIRAGE-Power
263
FIRST ESTIMATIONS OF THE EFFECTS OF RECIPROCAL TARIFFS | BOUËT
United States, the difference in terms of GDP loss between Scenario 2 and Scenario 3 is
not significant. The four countries/regions that export the most to the United States are
Canada, China, Mexico and the European Union. Moving from Scenario 2 to Scenario 3
implies less US protection for the European Union (and other exporters), the same level
for Canada and Mexico, and more protection for China.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
264
Scenarios 2 and 3 also imply reductions in real GDP for European countries, but these
are relatively small compared to those for the United States and China. For France, for
example, the macroeconomic shock is limited (-0.3% in Scenario 2 and -0.1% in Scenario
3). Indeed, less than 8% of its goods exports are destined for the United States. However,
variations in activity in certain goods sectors may be significant (see below). Among
European countries, Germany is more affected (-0.7% of GDP in volume in Scenario
2; -0.3% in Scenario 3), notably due to a significant drop in its exports of vehicles and
automotive parts to the United States.
All three scenarios involve reductions in exports of goods from China to the United States.
Scenario 3 sees the greatest reduction in this flow (-92.6%; see Figure 3), as not only are
these exports taxed more heavily in this scenario, but exports from other countries to the
United States are taxed less heavily than in Scenario 2. Reallocations of Chinese goods
flows to other destinations are low, with the exception of those to Canada. There are
two possible reasons for these low reallocations. First, economic activity declines in most
countries in all three scenarios, implying, all other things being equal, less demand for
imports from all countries. Second, the sectoral structure of non-US import demand may
differ significantly from that of the United States.
FIGURE 3
PERCENTAGE DEVIATION IN 2040 IN REAL TERMS BETWEEN LEVELS OF
CHINA’S EXPORTS OF GOODS AT CIF PRICE BY DESTINATION IN SCENARIOS 1,
2, AND 3 AND THE BASELINE
USA
UK
Mexico
Japan
India
Germany
France
Canada
Brazil
Bangladesh
Australia and New Zealand
EU27
-100
-80
-60
-40
-20
0
S3
Source: MIRAGE-Power
S2
20
S1
40
Table 3 shows the changes in value added by volume in the three scenarios for the three
biggest trading powers (China, the United States, and the European Union) in four large
(aggregate) sectors (agriculture and food, energy and mining, industry, services), and
then in eight sectors explicitly included in the modelling.
TABLE 3
PERCENTAGE DEVIATION IN 2040 IN REAL TERMS BETWEEN LEVELS OF
VALUE ADDED BY COUNTRY AND SECTOR IN SCENARIOS 1, 2, AND 3 AND THE
BASELINE
Scenario 1
Scenario 2
Scenario 3
Sector
EU27 China
US
EU27 China
US
EU27 China
US
Agriculture
0.1
0.3
-2.2
0.2
1.1
-6.1
0.2
1.1
-6.0
Energy and Mining
0.1
0.2
-0.2
-0.4
0.3
-0.8
-0.2
0.4
-0.7
Industry
-0.3
-0.7
1.1
-1.0
-1.4
4.6
-0.4
-1.6
4.0
Services
0.0
-0.1
-0.6
-0.1
-0.3
-1.3
0.0
-0.4
-1.3
Beverages and tobacco
0.1
-0.3
-0.7
-0.8
-1.0
-0.6
-0.4
-1.0
-1.0
Chemistry
1.9
1.0
-4.8
0.6
2.2
-2.4
1.4
2.7
-4.8
Electrical equipment
-0.1
-2.1
4.2
-0.3
-4.7
12.3
0.5
-5.4
13.9
Electronic and optical prod.
3.7
-5.8
8.0
3.2
-13.5
11.9
6.1
-15.1
16.2
Pharmacy
2.0
0.4
-6.0
4.6
1.4
-20.2
3.4
1.6
-14.8
Textile
0.5
-1.8
-4.7
3.2
-2.7
46.7
1.2
-3.8
21.4
Transportation equipement
4.5
0.6
-5.5
-6.1
1.6
6.3
-0.9
1.7
3.3
Vehicles and parts
-7.3
1.5
-0.2
-6.9
2.2
-8.1
-7.2
2.4
-6.1
Source: MIRAGE-Power
MIRAGE-Power is a neoclassical model. In this sense, it does not capture monetary
dynamics, but it can provide an indication of the consumer price variation implied by
tariff changes. All three scenarios are inflationary for the United States, particularly
Scenario 2, which implies a growth of the consumer price index by 2.8% (Table 4). This
265
FIRST ESTIMATIONS OF THE EFFECTS OF RECIPROCAL TARIFFS | BOUËT
In Scenarios 2 and 3, the United States experiences reindustrialisation (+4.6% in Scenario
2; +4% in Scenario 3), with a significant increase in activity in the electrical equipment,
electronic and optical products, and textile and clothing sectors, but at the cost of a loss
of activity in agriculture and services – two major sectors in which the United States
has traditionally had a surplus vis-à-vis the rest of the world. In China, activity losses
are high in the electronics and optical products sector, especially in Scenarios 2 and 3.
For European countries, in the case of Scenarios 2 and 3, activity losses are high in the
transport equipment sector (aeronautics, rail, etc.), particularly in France, and in the
automotive vehicles and parts sector (Germany).
means that the tariffs imposed by the US administration are not paid in full by foreign
producers and that the pass-through of tariffs is positive, which is confirmed by other
studies, including the contribution by Santander and Olarreaga in this volume.
266
TABLE 4
DEVIATION IN 2040 BETWEEN LEVELS OF CONSUMPTION PRICE INDEX (IN
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
%), COMPENSATION OF PRODUCTIVE FACTORS (IN % AND REAL TERMS) AND
TARIFF REVENUES (IN $ BILLIONS) IN THE US IN SCENARIOS 1, 2, AND 3 AND
THE BASELINE
Variable
Scenario 1
Scenario 2
Scenario 3
Consumption Price index (%)
1.0
2.8
1.8
Real return to capital (%)
0.4
0.7
0.8
Skilled real wages (%)
-1.1
-2.5
-2.4
Unskilled real wages (%)
-0.5
-0.9
-1.0
Tariff revenue (US$ billion)
121.7
244.7
152.1
Source: MIRAGE-Power
For the United States, tariff revenues increase in all three scenarios, notably in Scenario
2 with a revenue gain of $244.7 billion. However, these are small increases compared
with the revenues involved in the federal individual income tax ($2,632 billion in 2022;
$2,176 billion in 2023) or payroll taxes ($1,483 billion in 2022; $1,614 billion in 2023).
There is no variation in the level of employment in MIRAGE-Power. The impact of a
policy reform on the labour market can be seen in the variation in real wages. All three
scenarios have a negative impact on real wages, particularly for skilled workers. On the
other hand, the impact is positive on the real remuneration of capital. This may be related
to the above-mentioned result on increased activity in industry.
In conclusion, with the implementation of the “reciprocal tariffs” announced on 2 April
2025, the United States would have to pay a significant economic cost (loss of GDP,
inflation, lower real wages) to achieve only moderate reindustrialisation and a modest
increase in federal government revenues. The cost to the global economy in terms of lost
trade and GDP is also likely to be significant.
REFERENCES
Caldara, D, M Iacoviello, P Molligo et al. (2020), “The economic effects of trade policy
uncertainty”, Journal of Monetary Economics 109: 38-59.
Decreux, Y and H Valin (2007), “MIRAGE, Updated Version of the Model for Trade
Policy Analysis with a Focus on Agriculture and Dynamics”, CEPII Working Paper 200715 (http://www.cepii.fr/CEPII/fr/publications/wp/abstract.asp?NoDoc=958).
Fontagné, L, E Perego and G Santoni (2022), “MaGE 3.1 : Long-term Macroeconometric
Projections of the World Economy”, International Economics 172: 168-189.
ABOUT THE AUTHOR
Antoine Bouët is Director of CEPII as of October 1, 2022. He is also Professor of
Economics at the University of Bordeaux. Previously, he joined the International Food
Policy Research Institute (Washington DC) in February 2005 as a senior researcher
to conduct research on global trade modeling, trade policies, regional agreements,
multilateral trade negotiations and informal cross-border trade in Africa. He was
previously a scientific advisor at CEPII, where he participated in the development of
the MIRAGE model of the world economy and the MAcMAP-HS6 database on market
access. He has also conducted research on improving trade and trade policy data, the
modeling of support for the biofuels industry, the economics of exports restrictions,
world agricultural markets, African agricultural trade, multilateral and regional trade
agreements, the economics of trade retaliation and the world trading system.
267
FIRST ESTIMATIONS OF THE EFFECTS OF RECIPROCAL TARIFFS | BOUËT
Guimbard, H, S Jean, M Mimouni and X Pichot (2012), “MacMap-HS6 2007, an exhaustive
and consistent measure of applied protection in 2007”, International Economics 130: 99121 (https://www.sciencedirect.com/science/article/pii/S2110701713600463).
CHAPTER 22
Marcelo Olarreaga and Sara Santander1
University of Geneva, CEPR and FERDI; University of Geneva
China will now pay a big number to our treasury. This is all taxes. And don’t let
them keep telling you that this is a tax on our people. I hate that. You know, they
say it’s a tax. No.
President Donald Trump at the National Republican Congressional Dinner,
8 April 2025.
1 INTRODUCTION
In April 2025, the Trump administration declared a national emergency, resulting in the
imposition of a 10% base tariff on all imports (with few exceptions such as pharmaceuticals
and bullion) and higher reciprocal tariffs targeted on specific countries: China (34%), the
EU (20%), and Japan (24%). Five days after their introduction, “reciprocal” tariffs were
suspended for 90 days. Within days, more exceptions were granted to goods satisfying
USMCA origin requirements, chips, and so on. China was the first to retaliate, explaining
the rapid increase in US tariffs on Chinese imports from the initial 34% to 145%. The
EU announced retaliatory tariffs that are temporarily suspended, giving a chance for
bilateral negotiations during the 90-day suspension to reach a mutually beneficial deal.
President Trump has repeatedly argued that these tariffs are not a tax on US importers
and consumers, but a tax on foreign exporters (see the quote above). Interestingly, this
directly contradicts his own administration’s calculation for reciprocal tariffs, which
assumed that US importers supported 25% of the cost of the tariffs. USTR (2025) uses a
pass-through elasticity of φ = 0.25 when explaining the calculation for reciprocal tariffs.
It justifies this value citing Cavallo et al. (2021), who in reality estimate φ = 0.94 (see
column 1 of Table 1 in their paper), suggesting that US importers paid most of the cost
associated with tariffs during the first Trump administration’s tariffs on China. Using
the estimates of Cavallo et al. (2021) would have resulted in reciprocal tariffs that would
have been a quarter of the values announced on 2 April 2025.2
1
2
Authors appear in reverse alphabetical order. We are grateful to Simon Evenett for numerous discussions and Ugo Panizza
for comments on a previous version.
We take the calculations of retaliatory tariffs as given without engaging with their economic rationale.
269
WHO PAYS FOR US TARIFFS? | OLARREAGA AND SANTANDER
Who pays for US tariffs?
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
270
This chapter aims to estimate pass-through elasticities from tariffs to domestic prices and
argues that they are unlikely to be identical across goods – they will vary with variations
in export supply and import demand elasticities across goods. Using a simple supply and
demand framework, we use trade elasticities to compute the share of the tariff paid by US
importers. Results suggest that there is indeed an important heterogeneity across goods.
The pass-through elasticities vary from 0% to 100% in the US, with a median of 53%.
There is even a higher pass-through elasticity for intermediate goods and raw materials,
suggesting that the burden of the tariffs is higher for producers importing inputs, leading
to higher production costs in the US.
A similar exercise for the US’ main trading partners shows that if retaliatory tariffs are
applied on a most-favoured nation (MFN) basis, importers bear between 66% and 84%
of the cost. Importers in smaller countries with little market power in international
markets bear higher shares of the costs associated with retaliatory tariffs. If retaliation
targets only the US, the burden decreases to around 30–35%.
These results are important for at least three reasons. First, they show that the cost for
importers vary across countries, and as expected, larger countries tend to bear a lower
burden. While everyone loses when imposing a tariff, smaller countries lose more. Second,
the results show that a single pass-through elasticity hides a lot of heterogeneity across
goods and importers. Consumers of certain goods in certain countries will be hit much
harder than others. And last but not least, they suggest that broad retaliatory tariffs
are not the right strategy for the US’ trading partners. Not only are they more likely to
result in a global trade war but, as shown here, they are likely to hurt the importing
countries imposing the retaliatory tariffs more than US exporters. A more targeted
strategy targeting only US imports and a few goods with small pass-through elasticities
should be preferred.
The main challenge we face when computing pass-through elasticities at the product
level is obtaining import demand elasticities and export supply elasticities for the rest
of the world. We borrow these elasticities from Nicita et al. (2018) and Soderberry (2018).
Nicita et al. (2018) provide import demand elasticities and export supply elasticities for
the rest of the world at the six-digit level of the Harmonised System (HS). Soderberry
(2018) provides bilateral elasticities for exporter-importer pairs at the four-digit level of
the HS.
This chapter falls short of estimating the impact of reciprocal tariffs on exports, imports,
wages, or real income. In his contribution to this volume, Antoine Bouët addresses
these important questions using a computable general equilibrium model of the world
economy. His results suggest that not only will consumers in the US pay a significant
share of the tariffs, but also the real wages of unskilled and skilled workers, as well as real
income, will decline.
Section 2 presents the simple supply and demand framework we used to compute the
pass-through elasticity and derives the formula to calculate the pass-through elasticity φ.
Section 3 presents the results, and Section 4 concludes.
We model each HS 6-digit product as an independent market. Import demand mc(pc)
in country c depends on the price paid by importers pc, while rest of the world export
supply xc(p) to country c depends on the price received by exporters p. Without other
trade costs, pc = p(1+ t), and in the absence of tariffs pc = p. Without loss of generality,
let us choose units so that all world prices p = 1 after tariffs are imposed, so that in the
presence of tariffs the difference between the price paid by importers in the US (pc) and
the price received by exporters to the US (p) is given by the ad-valorem tariff t.
Figure 1 illustrates the impact of imposing a tariff t on importer and exporter prices.
Starting from the initial equilibrium without tariffs, where p = pc, it is clear that importers
and exporters share the burden of the tariff. The price paid by importers increases from
p = pc to 1 + tc, and the price received by exporters declines to 1 (because of the choice of
units).
FIGURE 1
MEASURING THE PASS-THROUGH FROM TARIFFS TO IMPORTER PRICES
prices
tc
pc = 1 + tc
p = pc
p=1
mc
xc
mc (t = tc ) mc (t = 0)
quantities
It is also clear from Figure 1 that the more elastic the import demand (i.e. the lower the
slope of mc in absolute value), the lower the share of the tariff that importers pay, as
importers can substitute for other goods or sources of imports. Similarly, the more elastic
the export supply of the rest of the world (i.e. the lower the slope of xc), the higher the
share of the tariff that importers pay, as exporters in the rest of the world can substitute
to other destinations or other goods.
WHO PAYS FOR US TARIFFS? | OLARREAGA AND SANTANDER
271
2 METHODOLOGY AND DATA
It can easily be shown (see Appendix A) that the share of tariff that is paid by importers
rather than exporters to the US, i.e. the pass-through elasticity from tariffs to importer
prices, is given by:
φc =
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
272
εxc
x
εc – εmc
(1)
where ε cx is the rest of the world’s export supply to the country c and ε cm is the import
demand elasticity of country c (which is negative). We can then compute φc using equation
(1) and the import demand elasticities and the rest of the world’s export supply elasticities
estimated in Nicita et al. (2018). Importantly, the import demand elasticity is for aggregate
imports from the world, and the export supply elasticities are for the rest of the world
aggregate. This implies that this will provide us with pass-through elasticities for MFN
tariffs imposed on all importers, i.e. the 10% across the board. Similarly, computing φc
for the US’ trading partners retaliatory tariffs using these aggregate elasticities assumes
that they will impose retaliatory tariffs on all trading partners, not only on US imports.
This is unlikely.
To move away from this assumption, we need to estimate φc at the bilateral level. This
implies that when using equation (1), we need bilateral export supply elasticities from the
US to each of its trading partners, as well as import demand elasticities of the US’ trading
partners for imports from the US. Soderberry (2018) provides estimates of these bilateral
elasticities that we use to estimate φc while assuming that trading partners’ retaliatory
tariffs are only imposed on US imports.
We expect φc to be smaller when computing tariffs using bilateral elasticities and assuming
that retaliatory tariffs are only imposed on US imports because the US’ trading partners
will be able to substitute their US imports with other trading partners, decreasing the
share of the retaliatory tariffs that importers pay.3
3 RESULTS
Figure 2 reports the results of the estimation of φc for the US across all HS six-digit goods
(last boxplot to the right of Figure 2), but also for the group of goods that are classified as
raw materials (first boxplot), intermediate goods (second boxplot), and final goods (third
boxplot). The estimated pass-throughs reported in Figure 2 use the aggregate import
demand and export supply elasticities in Nicita et al. (2018). This assumes that tariffs
are imposed across the board on all importers in an MFN manner and therefore better
describes the pass-through of the 10% base tariff. Each boxplot provides the interquartile
range. with the bottom of the box providing the 25th percentile and the top of the box
3
Note that Soderberry (2018) bilateral trade elasticities are estimated at the four-digit of the HS, whereas those of Nicita et
al. (2018) are estimated at the six-digit of the HS. More aggregated elasticities are likely to be smaller (in absolute value)
as it is easier to substitute similar goods (a t-shirt and a shirt) than goods that are further apart (a t-shirt and a pair of
shoes). That said, while elasticities are smaller when estimated at a more aggregate level, if we assume that the effect of
aggregation is equal and proportional for import demand and export supply elasticities, this will have no impact on the
passthrough elasticity φ.
FIGURE 2
MEASURING THE PASS-THROUGH OF US TARIFFS
1
.8
.6
.4
.2
0
Raw materials
Intermediate goods
Final goods
273
WHO PAYS FOR US TARIFFS? | OLARREAGA AND SANTANDER
providing the 75th percentile of φc. The horizontal line in the middle of the box gives the
median φc. The top whiskers provide the minimum between the maximum φc and 1.5
times the interquartile range, and the bottom whiskers provide the maximum between
the minimum φc and 1.5 times the interquartile range. The values that are beyond the
whiskers are outliers that are beyond 1.5 times the interquartile range.
All goods
The median pass-through across all goods is 53%, suggesting than more than half of
US tariffs are paid by US importers. The pass-through can be as high as 1 (i.e. the entire
burden falls on US importers) and 25% of products have a pass-through elasticity above
80%, suggesting that less than one-fifth of the costs are paid by exporters to the US.
However, the pass-through elasticity can also be as small as zero (i.e. the entire burden
falls on exporters to the US). Around 25% of products have a pass-through elasticity
below 27%, suggesting that more than 73% of the cost of the tariffs falls on exporters to
the US.
Interestingly, the pass-through to US importers is higher for raw materials and
intermediate goods, with median elasticities of 66% and 61%, respectively. For final
goods, the median pass-through to US importers is 46%. This suggests that the cost to the
US’ importers of intermediate goods and raw materials may be higher than for importers
of final goods. This implies that US producers using imported intermediates are more
likely to see their costs increase, making them less competitive, not more competitive.
Figure 3 provides the distribution of estimates of φ for the US’ trading partners. All
trading partners have pass-through elasticities that vary between 0 and 1, so targeting
products with low φc for retaliatory tariffs makes sense as it avoids imposing a large share
of the cost of the tariff on their importers.
274
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
FIGURE 3
MEASURING THE PASS-THROUGH OF THE US’ TRADING PARTNERS’
RETALIATORY TARIFFS
1
.8
.6
.4
.2
0
CAN
CHN
EUN
JPN
MEX
USA
However, all trading partners have a higher median pass-through elasticity than the US,
suggesting that trading partners’ importers will pay a higher share of the retaliatory tariffs,
not US exporters. At the median, Canadian importers will foot 82% of the retaliatory
tariffs cost, Chinese importers 79%, European importers 66%, Japanese importers 76%,
and Mexican importers 84%. So, smaller countries with weak market power in world
markets will support a higher share of the costs associated with retaliatory tariffs. This
is because they tend to face a higher export supply elasticity from the rest of the world,
increasing the pass-through elasticity in equation (2).
An important assumption behind the pass-through elasticities reported in Figure 3 is that
retaliatory tariffs are imposed on an MFN basis. If retaliatory tariffs are discriminatory
and only imposed on imports from the US, the pass-through elasticities will likely be
smaller. Figure 4 provides the results of the estimation of equation (2) for the US’ trading
partners using bilateral trade elasticities provided by Soderberry (2018) and allowing us
to estimate the share of the retaliatory tariff cost that importers will pay if retaliatory
tariffs are only imposed on imports from the US.
FIGURE 4
MEASURING THE PASS-THROUGH OF TRADING PARTNERS’ BILATERAL
RETALIATORY TARIFFS
1
275
.6
.4
.2
0
CAN
CHN
EUN
JPN
MEX
As expected, estimates of φc for the US’ trading partners when assuming retaliatory tariffs
discriminate against the US. Importers in trading partners pay an import-weighted
median cost of 30 to 35% instead of 66 to 79%.4 US exporters pay the largest share of the
cost when retaliatory tariffs discriminate between imports from the US and the rest of
the world, as trading partners’ importers shift to alternative importing sources.
Another claim the US administration often made in the build-up to the announcement
of reciprocal tariffs on 2 April 2025 is that they will contribute to raising tariff revenue.
A quick back-of-the-envelope calculation suggests that this is unlikely. As shown in
Appendix B, the elasticity of tariff revenue with respect to tariffs is given by (1 + ε mφ). The
average import demand elasticity (ε m) of the US estimated by Nicita et al. (2018) is equal
to -4.4. We have estimated in this chapter the average pass-through elasticity (φ) for the
US to be 0.53. Replacing these values in the equation above yields an elasticity of the
tariff revenue with respect to tariffs in the US equal to -1.3.
This implies that, on average, a 1% increase in tariffs results in a 1.3% decline in tariff
revenue. This is clearly based on linear approximations that work well for small changes
in tariffs, and not the large increases currently envisaged in the US. Nevertheless, it
suggests that tariff revenue will decline as the US increases tariffs.
4
Note, however, that in all countries the bilateral passthrough elasticities span from 0 to 100%, illustrating some important
variation across products.
WHO PAYS FOR US TARIFFS? | OLARREAGA AND SANTANDER
.8
Of course, the impact on tariff revenue will likely vary across products as both the passthrough and the import demand elasticity differ across goods. A more detailed analysis
is warranted. Nevertheless, our back-of-the-envelope analysis shows that, on average, the
US’s tariff increases will likely result in a decline in tariff revenue.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
276
4 CONCLUDING REMARKS
We estimate the share of tariffs paid by importers rather than exporters to the tariffimposing country across products and countries. We find much larger variation within
countries than across countries, with the share paid by importers varying from 0% to
100% within all countries, depending on the product. Across countries, US importers
face a median burden of 53% and exporters to the US will pay the remaining 47% of the
costs associated with the Trump administration’s reciprocal tariffs.
If the US’ trading partners were to impose retaliatory tariffs without discriminating
across importers, 66% of the cost would be paid by Europe’s importers, while importers
in China, Canada, Japan, and Mexico would pay more than three-quarters of the costs
associated with their retaliatory tariffs. The share of the costs of retaliatory tariffs falls to
30–35% if applied only to US imports, as importers can circumvent the tariff by sourcing
from other countries.
These results suggest that, contrary to President Trump’s quote at the start of this
chapter, more than half of the recent increase in tariffs is paid by US importers. They also
imply that retaliatory tariffs by the US’ trading partners are likely very costly for their
importers, particularly if applied indiscriminately. If they are to be implemented, they
should be imposed only on US imports and on goods for which the share of the tariff cost
imposed on importers is low.
Finally, a back-of-the-envelope calculation of the impact of the US tariffs on its tariff
revenue shows that for each 1% increase in tariffs, tariff revenue declines by 1.3% due to a
large decline in import volumes. This implies that the Trump administration’s reciprocal
tariffs will result in a decline in tariff revenue.
REFERENCES
Cavallo, A, G Gopinath, B Neiman, and J Tang (2021), “Tariff Pass-Through at the Border
and at the Store: Evidence from US Trade Policy”, AER Insights 3(1): 19-34.
Nicita, A, M Olarreaga and P Silva (2018), “Cooperation in WTO’s Tariff Waters?”,
Journal of Political Economy 126(3): 1302-1338.
Soderberry, A (2018), “Trade elasticities, heterogeneity, and optimal tariffs”, Journal of
International Economics 114: 44-62.
USTR (2025), “Reciprocal tariff calculations”.
APPENDIX A: DERIVING THE PASS-THROUGH ELASTICITY OF IMPORTER
PRICES WITH RESPECT TO TARIFFS
dpc
dmc
= εmc •
pc
mc
dp
dxc
= εxc •
p
xc
Noting that the percentage change in imported quantities needs to be equal to the
percentage change in exported quantities, we then have:
dpc
dp
dmc dxc
εmc
=
= εxc •
p
xc
mc
pc
dpc
Solving the above equation for φc = pc , noting that initially pc = p and t = dpc −dp
tc
we obtain the pass-through elasticity φ, which gives us the share of the tariff paid by
importers:
dpc
φc = pc
εxc
= x m
t c εc – ε c
APPENDIX B: DERIVING THE ELASTICITY OF TARIFF REVENUE WITH
RESPECT TO TARIFFS
Let us define tariff revenue as TR = t m. Take logs on both sides and then take the derivative
with respect to the natural log of tariffs. A linear approximation to the percentage change
in tariff revenue is given by:
dt dm
dt
dTR
dt
m dt
=
=
=
+
+ε φ
(1 +εm φ)
t
m
t
TR
t
t
The elasticity of tariff revenue with respect to tariffs is then given by:
dTR
TR dt = (1 +εm φ)
t
277
WHO PAYS FOR US TARIFFS? | OLARREAGA AND SANTANDER
Using the definition of elasticities of import demand and export supply elasticities, we
have that the percentage change in imported quantities by country c and the exported
quantities to country c are given by:
ABOUT THE AUTHORS
Marcelo Olarreaga is Professor of Economics at the University of Geneva, Research
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
278
Fellow at the Centre for Economic Policy Research (CEPR) in London and the FERDI in
Clermont-Ferrand. He is currently directing a research project on the political economy
of trade policy funded by the Swiss National Science Foundation (SNSF). Before joining
the University of Geneva he worked in the Research Department of the World Bank, as
well as in the Economics Research Division of the World Trade Organization.
Sara Santander is a Bolivian economist and Master’s student at the University of Geneva.
She has worked on research projects with the Inter-American Development Bank and
academic centers in Bolivia, mainly focused on data analysis and development policy.
Before starting her master’s, she was involved in projects related to taxation, labor
markets, and firm surveys. She enjoys working with data and learning how economic
tools can help better understand real-world problems, especially in developing countries.
CHAPTER 23
Arnaud Costinot and Andrés Rodríguez-Clare
MIT and CEPR; UC Berkeley and CEPR
US protectionism is back, again. Or maybe not.
We have no idea what US tariffs will look like in a few months, or even in a few weeks
from now. We suspect few people do.
But we believe that there are many questions about tariffs that can be answered through
a combination of theory and data. In this chapter, we discuss seven that everyone should
know the answers to.
1) WHAT IS (ALWAYS) BAD ABOUT TARIFFS?
A tariff is a tax. It creates a wedge between the price paid by the domestic buyer of a
foreign good and the price received by its foreign supplier. If the United States imposes
a 50% tariff on a $20 doll from China, then this wedge is $10: US buyers of Chinese dolls
must pay $10 more than Chinese producers receive, with the US government collecting
the difference.
The basic case against tariffs is the same one as against any tax. If the US government
creates a $10 wedge between the prices paid by US buyers and received by Chinese
producers, then some mutually beneficial transactions will no longer take place. A US
buyer who would have been willing to buy a doll for up to $25 will stop buying it if the
price goes to $30. The welfare loss for this hypothetical buyer is $5 – this is the difference
between her willingness to pay ($25) and the price of a doll in the absence of a tariff ($20).
Tariffs distort production too. If the US price of a doll goes up to $30, a domestic firm that
can produce it for $25 will now be willing to sell it too. It will pocket a profit of $5. From
an efficiency perspective, the problem is that there was a better technology that could
have been used to produce the same doll and generate profits of $10 instead, namely, by
importing it from China for $20. The difference between the maximum profit of $10 and
the realised profit of $5 measures the associated welfare loss for the United States.
In the aggregate, the total welfare loss from these consumption and production
distortions can be computed by adding up the previous monetary amounts across all US
consumers (with different marginal willingness to pay) and all US firms (with different
marginal costs of production). Graphically, this corresponds to the areas of Harberger’s
famous triangles.
279
SEVEN QUESTIONS ABOUT TARIFFS | COSTINOT AND RODRÍGUEZ-CLARE
Seven questions about tariffs
2) WHAT IS (POTENTIALLY) GOOD ABOUT TARIFFS?
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
280
The current US administration has put forward multiple rationales for its tariffs. One
of the most prominent ones is its desire to reduce trade imbalances between the United
States and its trading partners. It is hard not to interpret this goal as pure mercantilism,
arising from a mistaken belief that exports are good, imports are bad, and so trade
deficits should be reduced. This is nonsensical. Exports are the price countries must pay
to gain access to imports – not the other way around. “Liberation day” tariffs, motivated
by the magnitude of bilateral trade imbalances between the United States and other
countries, are textbook policy lunacy.
There are, however, other reasons why a tariff may help.
Tariffs as a tool for efficiency
Imperfect competition, unemployment, pollution. These are classical sources of
distortions. If the US economy is socially efficient to start with, then a tariff can only
create distortions. But if other distortions are already present, then a tariff could
potentially help correct them.
It is certainly not obvious why taxing dolls from China may improve aggregate efficiency
in the United States. But what about high-tech sectors? Are incentives for innovation
optimal to start with? Could the US government foster productivity in some sectors
by expanding their size, above and beyond what markets participants may be able to
internalise? Likewise, are US high-tech firms taking into account the impact of their
import decisions on geopolitical risk and the rise of China as a new hegemon? If not,
there is an efficiency rationale for tariffs in the United States.
The same general logic applies to global carbon emissions and climate change. Buyers
of beef from Brazil or palm oil from Indonesia may not internalise that imports of such
goods contribute to deforestation and increase carbon emissions. In that case, there is
again an efficiency rationale for taxing these imports.
Tariffs as a tool for redistribution
Another reason why a tariff may help is because it offers an opportunity to offer bigger
‘slices of the pie’ to some preferred constituents in society. The US government may
decide to raise tariffs because it wants to redistribute gains from international trade
away from, say, college-educated workers and towards high-school graduates. If this is
the goal, raising the US price of Chinese dolls may again not matter much, but if the
prices of all manufacturing products in the US were to go up because of across-the-board
tariffs, could these price increases be passed through to the wages of US manufacturing
workers? If so, this opens up the possibility of trade protection as redistribution.
The US government may also decide to raise tariffs because it wants to redistribute gains
from international trade towards the United States and away from foreigners, even if this
lowers the size of the global pie. This can be viewed as another form of trade protection as
3) SHOULD A COUNTRY (SOMETIMES) USE TARIFFS?
In the presence of distortions, tariffs might improve aggregate efficiency. They might also
help achieve a country’s preferred redistributional objectives. Does it follow that, in such
situations, tariffs should be used?
Targeting principle, and its limits
The conventional wisdom among many trade economists is that the answer to the
previous question is no. One key reason is that better, more targeted instruments are
always preferable. Even if tariffs can help lower global carbon emissions, a carbon tax that
directly targets the level of these emissions should be preferred. Likewise, even if tariffs
can help raise wages for manufacturing workers, it is a blunt instrument to provide such
a boost. According to this conventional wisdom, trade protection is acupuncture with a
fork. The Targeting Principle calls for using needles instead.
This is a fundamental observation. It ties to some of the most influential results
in economics, from the Second Welfare Theorem to Diamond and Mirrlees’ (1971)
Production Efficiency Theorem. But it should also be clear that the needles called upon
by the Targeting Principle may be much finer than whatever tools are available to
policymakers in practice. We therefore do not think that ‘free trade forever and always’ is
the only message about trade policy that economists are meant to convey to the outside
world.
A global carbon tax should be preferred to green tariffs, but can such a tax be enforced
in Amazonia? Does a country have access to labour taxes that can vary across workers
depending on their education, sector, or region of employment? If not, tariffs may be part
of an optimal second-best toolkit, both in order to correct distortions and to redistribute,
as discussed in Costinot and Werning (2023).1
Trade wars
Another key reason why trade economists worry about one country unilaterally imposing
tariffs, especially when they are massive and implemented with complete disregard
for the rules of the world trading system, is that such tariffs are likely to be retaliated
against. It is true, in theory, that a country may improve its terms of trade by imposing
tariffs if the rest of the world does not. But in practice, does anybody still expect China
1
The general idea in Costinot and Werning (2023) is that even in the presence of income taxation, tariffs may be used as a
form of predistribution. Crucially, optimal tariffs are not necessarily zero, but depend instead on the estimated impact of
imports on earnings across the income distribution.
281
SEVEN QUESTIONS ABOUT TARIFFS | COSTINOT AND RODRÍGUEZ-CLARE
redistribution, now operating between rather than within countries. This is the basis for
the classical optimal tariff argument. By imposing a tariff on Chinese dolls, the United
States may lower demand for these products and, in turn, cause a decline in the price it
pays to Chinese producers. This may, in turn, allow the United States to lower the price of
what it buys relative to what it sells, improving its terms of trade.
or the European Union to sit idle and simply let the United States get a bigger share of
the global pie? Trade wars happen. And when they do, one can expect all countries to be
worse off, as we further discuss below.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
282
4) HOW DO WE KNOW WHETHER (A PARTICULAR SET OF) TARIFFS ARE GOOD
OR BAD?
Before turning to data and what tariffs actually do, it is useful to ask where one should
look for smoking guns of whether a tariff is good or bad. The answer, not surprisingly,
depends on what issues tariffs were meant to remedy in the first place. For instance,
if production externalities make some sectors too small, then success is about whether
tariffs can make them bigger. Of course, the more difficult questions in such situations
are: How big are these externalities? And in turn, how far should one go in promoting
particular sectors? Likewise, in the case of geopolitical considerations, it is not obvious
how one would systematically assess the success of US tariffs, or export controls in
strategic industries, in affecting the behaviour of another hegemon.
When it comes to tariffs as redistribution, the data to look at in order to evaluate success
are more straightforward, but differ depending on whether the goal of US tariffs is
redistribution within the United States, aimed at helping manufacturing workers, or
redistribution between the United States and the rest of the world, aimed at extracting a
bigger slice of the overall gains from international trade.
If the goal of US tariffs is to affect redistribution within the United States, then tariffs
should affect the prices paid by US consumers and US firms. Without such a price signal,
why would US manufacturing firms be willing to expand and bid up US wages? In
contrast, if the goal of US tariffs is to affect redistribution between the United States and
the rest of the world, then tariffs should affect the prices received by foreigners. If foreign
exporters continue to sell their products in the United States at the same price, how is the
United States supposed to get richer?
Consider again the example of a 50% US tariff on a $20 Chinese doll, creating a $10
wedge. Do US buyers now pay $30 instead of $20, while Chinese sellers still receive $20?
Or do US buyers continue to pay $20, while Chinese producers now receive $10? Under
the first scenario, redistribution is a purely domestic affair, with US consumers and US
retailers on the losing end. Under the second scenario, redistribution occurs at the global
level, with foreigners paying for the tariffs. The sharp tariff hikes during the first Trump
administration offers an opportunity to find out where, between these two extremes, the
real-world incidence of tariffs lies.
5) WHAT WAS THE IMPACT OF THE 2018 TRUMP TARIFFS?
This is a striking result. It is important, however, to remember the limitations of this
empirical analysis. In particular, it does not settle whether the tariffs made the United
States richer at the expense of making its trading partners poorer. This analysis focuses
on the variation in US import prices across different products and foreign countries. But
whether the United States actually gained, and whether foreigners ultimately paid for the
tariffs, depends on how US import prices moved relative to its own export prices – that
is, the evolution of the US’ terms of trade – a question this analysis leaves unanswered.
This is the standard ‘missing intercept’ problem. The tariffs might have caused the
average level of US import prices to go up or down relative to the average level of US
export prices, for instance because it caused the US dollar to fluctuate and, in turn, US
wages to adjust relative to those in the rest of the world. Unfortunately, there is simply not
enough variation to estimate this type of general-equilibrium response econometrically.
Small aggregate welfare losses
Using estimates of the direct impact of tariffs on prices and quantities, and ignoring
indirect general-equilibrium effects, one can compute the area of Harberger triangles
associated with consumption and production distortions. When doing so, Fajgelbaum
et al. (2020) conclude that the welfare loss for the United States was 0.06% of US GDP.
When using a quantitative model to evaluate the full general-equilibrium response of the
US’ terms of trade, they find that this small welfare loss is turned into a tiny welfare gain
if foreign retaliation is ignored, and a 0.04% welfare loss when it is taken into account.
Using a different quantitative model, Caliendo and Parro (2022) reach a broadly similar
conclusion, with a welfare loss of 0.1% of GDP.
No evidence that US manufacturing benefited
Another common justification for higher US tariffs has been to bring back manufacturing
jobs. One may think that this is a reasonable response to the sharp decline in US
manufacturing employment during the 1990s and 2000s, a decline partly attributed to the
so-called China Shock, as documented by Autor et al. (2013) and Acemoglu et al. (2016). If
tariffs bring back manufacturing jobs, one would imagine that this extra demand for US
manufacturing workers would further boost their wages and, ultimately, benefit them.
There is, however, no evidence indicating that the 2018 tariffs were successful in bringing
back manufacturing jobs.
283
SEVEN QUESTIONS ABOUT TARIFFS | COSTINOT AND RODRÍGUEZ-CLARE
No evidence that foreigners paid for the tariffs
One might have expected foreigners, and China in particular, to pay for the 2018 tariffs by
receiving lower prices for their exports. Research by Amiti et al. (2019) and Fajgelbaum et
al. (2020) gives no support to that idea. For the few months following the implementation
of the tariffs, the authors find no significant difference in the evolution of prices received
by foreign exporters, regardless of whether or not they were directly targeted by tariffs.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
284
Autor et al. (2024) find that commuting zones specialising in newly protected sectors
did not experience any measurable change in employment, while regions exposed to
retaliatory tariffs – particularly those tied to agriculture – suffered clear employment
losses. At the sectoral level, manufacturing employment did not increase in response
to protection, while agriculture employment declined in response to foreign retaliatory
tariffs. Although protected manufacturing sectors saw increases in output per worker
and domestic prices, these gains did not translate into job growth. A key reason is that
tariffs raised the cost of imported intermediate inputs, undermining competitiveness.
This mechanism is consistent with the findings of Flaaen and Pierce (2024), who estimate
that the small positive employment effects of import protection were more than offset by
larger negative effects from higher input costs and retaliatory tariffs.
6) ARE GLOBAL TARIFFS UNFAIR TO THE UNITED STATES?
A prominent narrative from the Trump administration is that the world trading system
is fundamentally biased against the United States. Stephen Miran, who chairs the
Council of Economic Advisers, has declared that he wants to “reconfigure the global
trading and financial systems to America’s benefit” (Miran 2024). In a recent op-ed in
the Financial Times, Peter Navarro, a senior counsellor for trade and manufacturing,
wrote: “The international trade system is broken — and Donald Trump’s reciprocal tariff
doctrine will fix it. This long-overdue restructuring will make both the US and global
economies more resilient and prosperous by restoring fairness and balance to a system
rigged against America”.2 But is it?
If the narrow question is whether the average tariff imposed by the United States is lower
than the average tariff imposed by its trading partners, there is an element of truth to
the previous claims. In 2017, before the tariffs were imposed, the average US tariff was
around 1.5%, whereas the average foreign tariff on US exports was 3.5%.
We find, however, the overall magnitudes more striking than the direction of the bias –
3.5% versus 1.5% is a small difference in a world of small tariffs. Perhaps the world could
be slightly better off, on average, if US and foreign tariffs were both zero. Perhaps the
United States could be slightly better off if it were to impose a 3.5% average tariff, while
foreign tariffs were 1.5% on average. But we suspect that few economists would look at
these numbers and imagine that there are potentially huge benefits for the United States
from blowing up the world trading system.
As part of the same narrative, it is argued that non-tariff barriers make the issue even
worse. We do not deny that some product standards, like the European Union’s decision
to ban imports of hormone growth beef, might not only serve legitimate objectives in
terms of public policy, but also protectionist ones. Quantitatively, though, it is hard again
2
“Donald Trump's Tariffs Will Fix a Broken System”, Financial Times, 23 May 2025 (https://www.ft.com/content/f313eea9bd4f-4866-8123-a850938163be).
7) WHAT IS (REALLY) BAD ABOUT TRADE WARS?
We have already mentioned estimates of the welfare costs from the 2018 US-China trade
war that range from 0.04% to 0.1% of US GDP. These small numbers reflect, to a large
extent, the fact that the United States is less open than many other countries. The ratio
of US imports to US GDP is only about 15% because a significant fraction of trade occurs
between US states rather than with the rest of the world. This basic observation implies
that the welfare gains from trade in the United States are smaller than in most other
countries and, in turn, that the welfare costs from a trade war are not as high.
Looking ahead, would shutting down all trade between the United States and the rest of
the world be much more costly? In Costinot and Rodriguez-Clare (2018), we discussed
model-based estimates of the overall gains from trade that range from 2% to 8% of GDP.
There is, of course, considerable uncertainty around all these numbers. Trade models
used to compute them rely, like any other quantitative model in economics, on strong
assumptions. What may be true today about US imports, when they sit at 15% of US GDP,
may no longer be true as this share starts shrinking dangerously close to zero. Critical
inputs from abroad, like rare earth minerals, may make the magnitude of gains from
trade much larger than these models predict, at least in the short run before domestic
substitutes are developed or, in the case of rare earth minerals, before they are extracted
again in the United States.
Although it is important to recognise that the economic gains from trade may be much
larger than what quantitative models predict, we also do not expect a trade war to bring
the United States all the way back to autarky. With this in mind, welfare losses that are
of the order of a few points of GDP may provide a useful benchmark for the US economy.
While this is definitely nothing to spit at, it is not an existential threat either. The end of
international cooperation on the big issues of the day – war, poverty, climate change –
could be.
3
While US exports to the European Union face VAT and EU exports to the United States do not, implying an import tariff and
export subsidy respectively, this border adjustment is not protectionist. A tariff-export subsidy pair of equal size is neutral:
it raises EU price levels but does not distort relative demand between domestic and US goods – an application of Lerner
Symmetry (Costinot and Werning 2019).
285
SEVEN QUESTIONS ABOUT TARIFFS | COSTINOT AND RODRÍGUEZ-CLARE
to imagine large potential gains from removing such barriers for the United States, and
for its manufacturing sector in particular. One also often hears that the European Union
has a value-added tax (VAT) of around 20%. This sounds like a bigger deal, but is such
a tax protectionist? The answer is a clear no. Unlike an import tariff that discriminates
between domestic and foreign producers selling in the EU, a VAT uniformly affects all
producers and does not create incentives for European buyers to buy European rather
than American.3
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
286
The 1930s are often given as the poster child for a great trade policy disaster. This is not
because US tariffs, and the retaliatory response from US trading partners, raised the cost
of living for US consumers – though they certainly did. The reason why the trade war
from the 1930s has remained in the history books is because by eroding international
cooperation, it might have contributed, albeit indirectly, to the onset of World War II.
This cost is much larger than a few points of GDP.
As recently as 23 May, President Trump declared “the European Union [...] was formed
for the primary purpose of taking advantage of the United States on TRADE.” It was not.
As Martin et al. (2008) remind us: “the main objective of the European trade integration
process was to prevent the killing and destruction of the two World Wars from ever
happening again”. This is a lesson worth remembering.
REFERENCES
Amiti, M, S J Redding and D E Weinstein (2019), “The Impact of the 2018 Tariffs on
Prices and Welfare”, Journal of Economic Perspectives 33(4): 187–210.
Autor, D, A Beck, D Dorn and G Hanson (2024), “Help for the Heartland? The
Employment and Electoral Effects of the Trump Tariffs in the United States”, NBER
Working Paper No. 32082.
Caliendo, L and F Parro (2022), “Trade Policy”, in Handbook of International Economics,
Vol. 5, 219–295.
Costinot, A and A Rodríguez-Clare (2018), “The US Gains from Trade: Valuation using
the Demand for Foreign Factor Services”, Journal of Economic Perspectives 33(2): 3–24.
Costinot, A and I Werning (2019), “Lerner Symmetry: A Modern Treatment”, American
Economic Review: Insights 1(1): 13–26.
Costinot, A and I Werning (2023), “Robots, Trade, and Luddism: A Sufficient Statistic
Approach to Optimal Technology Regulation”, The Review of Economic Studies 90(5):
2261–2291.
Diamond, P A and J A Mirrlees (1971), “Optimal Taxation and Public Production I:
Production Efficiency”, American Economic Review 61(1): 8–27.
Fajgelbaum, P D, P K Goldberg, P J Kennedy and A K Khandelwal (2020), “The Return to
Protectionism”, The Quarterly Journal of Economics 135(1): 1–55.
Flaaen, A and J R Pierce (2024), “Disentangling the Effects of the 2018–2019 Tariffs on
a Globally Connected U.S. Manufacturing Sector”, Review of Economics and Statistics
106(1): 1–15.
Martin, P, T Mayer and M Thoenig (2008), “Make Trade Not War?”, The Review of
Economic Studies 75(3): 865–900.
Miran, S (2024), A User’s Guide to Restructuring the Global Trading System, Hudson Bay
Capital.
ABOUT THE AUTHORS
287
Technology. He specialises in international trade. His research includes work on the
theory of comparative advantage, the welfare gains from trade, and trade policy. He
earned his PhD in Economics from Princeton University in 2005. He is a CEPR Research
Fellow and a NBER Faculty Research Associate. He was elected a member of the
Econometric Society in 2021 and of the American Academy of Arts and Sciences in 2023.
Andrés Rodríguez-Clare is Professor of Economics at the University of California,
Berkeley, a Research Associate at the NBER, and a Research Fellow at the CEPR. He
is also Visiting Professor at the University of Nottingham and Visiting Scholar at the
Federal Reserve Bank of San Francisco. He received his PhD at Stanford in 1993. He
was Associate Professor at the University of Chicago, served as Chairman of the Council
of Presidential Advisors in Costa Rica (1998–2002), worked at the Inter-American
Development Bank (2002–2005), and was Professor at Penn State before joining Berkeley
in 2010. His research focuses on trade, industrial policy, and multinational production.
SEVEN QUESTIONS ABOUT TARIFFS | COSTINOT AND RODRÍGUEZ-CLARE
Arnaud Costinot is the Ford Professor of Economics at the Massachusetts Institute of
CHAPTER 24
Keith Head,a Thierry Mayer,bd Vincent Vicardc and Pauline Wibauxc
aUniversity of British Columbia; bSciences Po; cCEPII; d CEPR
INTRODUCTION
Analysing the waves of tariff proclamations and Executive Orders in early 2025 has been
challenging, in part because the motivations behind these tariffs are actively debated.
Are they attempts to change behaviour of foreign governments (e.g. to lower fentanyl
smuggling into the United States), address trade imbalances, set the stage for future
negotiations, or raise revenue as an offset for other tax reductions? Statements by the
President or his allies offer support for all these theories. The absence of definitive
evidence comes in part from the shifting policies and rhetoric by the President himself.
By way of contrast, in one particular industry, President Trump has been remarkably
consistent: the auto industry should have higher tariffs to move more car production
into the United States.
Prior to his first inauguration in 2017, President-elect Trump tweeted on 3 January
that General Motors should not export the Chevy Cruze to the United States from
Mexico. Two days later, he demanded that Toyota abandon plans to use a new plant to
be constructed in Mexico to export Corollas to the United States. In November 2018,
he suggested that the 25% “chicken tax” applied to pick-up trucks since 1964 should be
emulated for cars. By the following spring, his proposal for a 25% import tariff on cars
had evolved to Proclamation 9888 of 17 May 2019.1 Invoking Section 232 of a 1962 trade
act, the President announced a plan to monitor imports of automobiles and their parts
and “adjust imports” if necessary for the sake of national security. As it turned out, the
Section 232 tariffs did not get implemented in the first term. The mere threat of them
appears to have been used to extract concessions from Canada and Mexico in negotiating
the 2020 United States–Mexico–Canada Agreement (USMCA), a replacement deal for
the North American Free Trade Agreement (NAFTA).
1
https://www.federalregister.gov/documents/2019/05/21/2019-10774/adjusting-imports-of-automobiles-and-automobileparts-into-the-united-states
289
NATIONAL SECURITY TARIFFS ON THE AUTO INDUSTRY | HEAD, MAYER, VICARD AND WIBAUX
National security tariffs on the auto
industry
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
290
The long-promised tariffs on cars finally arrived in a 26 March 2025 proclamation,2 which
cited as its legal basis the Section 232 investigation from the 2019 proclamation. As of 3
April, a 25% tariff will apply to imported automobiles. The same rate will be imposed “no
later than May 3” on “certain automobile parts articles.”3 For automobiles that qualify
for USMCA preferences, the car tariff applies only to the non-US content (“calculated
by subtracting the value of the US content in an automobile from the total value of the
automobile”). It appears that all Canadian cars will be deemed to be USMCA-compliant
(97.5% of Canadian cars were imported into the United States in 2024 using the USMCA
zero tariff). Their non-US content will be deemed to be 50%. The bottom line (based on
current indications) is that cars from Canada pay a 12.5% Section 232 tariff. As far as we
can determine, cars from Mexico receive the same treatment. Automotive parts listed in
the proclamation annex that do not comply with USMCA should be subject to the 25%
plus the standard most-favoured nation (MFN) tariffs (which tend to be 2.5% or less).
For USMCA-compliant auto parts, the executive order envisions that they would also pay
tariff on their non-US content, but this provision is to be delayed until the Department
of Commerce establishes a process to apply the tariffs exclusively to the value of non-US
content in these parts.
In addition to the automotive tariffs, two other trade actions were initially relevant for
the auto industry. The first is the tariffs imposed on Canada and Mexico based on the
complaint that neither country has taken sufficient action to halt cross-border flows of
fentanyl. Imported products were exempted from these ‘fentanyl tariffs’ if they were
USMCA compliant. Thus, automotive parts that do not comply with USMCA would
face the combined auto + fentanyl tariff of 50% plus the MFN relevant for that part. The
second set of auto-related tariffs are the earlier national security (Section 232) tariffs
on steel and aluminium, which are both important inputs into car manufacturing. Both
of those tariffs were set a 25%. On 29 April 2025, the White House announced that the
fentanyl and metal tariffs would not “stack”, by which they meant that cars and parts
already paying the automotive tariffs would not also pay tariffs due to those other actions.
On 3 April, Canada announced countermeasures copying US tariffs and imposing a 25%
tariff on auto-imports that are not USMCA compliant.4 We should stress at this point
that the final duties imposed by the United States, Canada, and Mexico could differ from
the ones described above, but this is what our investigations suggest is the most likely
scenario as of early May.
What seems clear is that, after 60 years of tariff-free trade in the auto industry, North
America will now have large tariffs. How big an impact will these new tariffs, taken
individually and as a package, have on the auto industry? We report here on the results
2
3
4
https://www.whitehouse.gov/presidential-actions/2025/03/adjusting-imports-of-automobiles-and-autombile-parts-intothe-united-states/
The annex to the proclamation lists 130 US classifications comprising mainly “engines and engine parts, transmissions and
powertrain parts, and electrical components.”
https://www.reuters.com/world/americas/canada-impose-25-tariffs-us-autos-that-are-non-compliant-with-usmca-sayscarney-2025-04-03/
OVERVIEW OF THE QUANTITATIVE FRAMEWORK
Predictions for the impact of the recent sets of tariffs announced by the Trump
administration have come from several different sources, including the European Central
Bank, Bloomberg, CEPII, the Kiel Institute, and the UCSD Globalization Prosperity Lab.
The computation models underlying these predictions come from large-scale general
equilibrium models of the economy. Our approach (described in detail in our online
Appendix) differs from other work in that the model and data we use are dedicated to
worldwide auto assembly. We use estimates specific to the selection of assembly sites for
cars and the related decision of which set of car models to offer in each market. A crucial
distinction our model maintains is that car makers source assembly exclusively from
the set of plants that manufacture a specific brand. Thus, a Volkswagen ID.4 cannot be
sourced from Canada because Volkswagen lacks an operational factory there in 2024.
Taking into account the brand-level global structure of assembly plants yields more
realistic predictions of medium-run responses since adding new factories is rare and
involves years of preparation.
About 85% of the cost of a finished vehicles comes from parts. Our framework incorporates
changes in vehicle costs caused by tariffs on inputs through two mechanisms: (1) the
aluminium and steel (hereafter referred to as ‘metals’ for brevity) tariffs imposed by the
United States, and (2) tariffs on core parts (engine, transmission, etc.). The tricky aspect
of this is that metals are used in most core parts so potentially the same part could be
subject to one or both tariffs. We make the simplifying assumption that all metal use
is via the core parts. With the recent move by the United States to ‘unstack’ tariffs, this
means that imported core parts pay a 25% duty, except those that qualify for USMCA
preferential treatment. Core parts tend to be imported from the headquarter country.
Thus, foreign brands made in the United States have larger shares for imported parts.
Head and Mayer (2019) incorporate external economies of scale based on national car
output. Our revised estimate of the industry scale elasticity, -0.049, implies that each
time a country doubles the size of its car industry, its marginal costs fall by 3.3%.6 We
5
6
The structural parameters governing substitution on the sourcing and demand side are similar to the original paper, with
current estimates of 7 for the sourcing elasticity and 3 for demand elasticity. Other coefficients (mainly friction estimates)
are similar as well. The full set of new estimates are available in the online appendix.
The formula is 2^(-0.049) -1 = -0.033. The 0.049 scale elasticity (expressed in terms of productivity rather than costs) is
larger than the Head and Mayer (2019) estimate, but much smaller than the 0.19 scale elasticity for motor vehicles found
by Bartelme et al. (2025). The data underlying the revised estimate have eight extra years and include pick-up trucks. This
estimate can be interpreted as a national agglomeration elasticity so we find it reassuring that it falls within the 0.04 to
0.07 range for agglomeration elasticities given in the review article of Combes and Gobillon (2015: Section 5.5.1).
291
NATIONAL SECURITY TARIFFS ON THE AUTO INDUSTRY | HEAD, MAYER, VICARD AND WIBAUX
from our quantitative analysis of the prospective impact on producers and on consumers.
The model of the auto industry we employ comes from a previous paper focused on
impacts of trade policy in the auto industry (Head and Mayer 2019). However, we have
re-estimated the model developed in that paper, extending the data set to 20245 and
using 2024 data as part of the calibration.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
292
see these estimates as capturing (in highly reduced-form way) the linkages between
upstream input suppliers. More car production leads to a larger and more specialised
set of suppliers. This mechanism allows for a cost-reducing impact of tariffs. These
effects probably take time to manifest themselves and depend on firms making longrun adjustments in a stable environment. For this reason, the results that exclude this
channel of adjustment may be more trustworthy, especially over shorter time horizons.
THE SIMULATION SCENARIOS
Our simulations are based on the flows observed in 2024 for passenger cars (excluding
delivery vans but including pick-up trucks). Data are from S&P Global and provide
detailed information on sales (local and exports) by origin, destination, and model. The
nationality of the brand is time-invariant and attributed at the time of its creation.
Including pick-up trucks alongside passenger vehicles is particularly relevant for the US
market. Pick-up trucks represent 18% of vehicle sales in the United States, compared to
7% globally and close to 1% in markets like China or the European Union. Even before
the Trump-era trade policies, US tariffs on imported pick-up trucks stood at 25% –
substantially higher than the 2.5% imposed on passenger cars, highlighting their distinct
treatment. Figure 1 shows that the production and sourcing patterns of pick-up trucks
differ significantly from those of passenger vehicles: three quarters of pick-up trucks
sold in the United States are domestically manufactured (with most of the remainder
assembled in Mexico), compared to just half of the passenger vehicles.
FIGURE 1
ORIGIN OF PASSENGER CARS AND PICK-UPS SOLD IN THE UNITED STATES
Passenger cars
Pick-up trucks
0
20
40
60
Sales in USA (2024, %)
Countries of production:
USA
MEX
CAN
JPN
KOR
80
DEU
100
ROW
Core auto parts constitute 40% of costs. The United States accounts for 50% of those
parts, Canada and Mexico together provide 25%, and the remainder are provided by ‘rest
of world’ (RoW). For the 75.5% of parts sourced from Canada and Mexico in compliance
with USMCA rules of origin, we set the tariff to zero. The remaining quarter of Mexico
and Canada inputs that do not comply with USMCA face a 26.6% duty (the sum of the
auto input tariff and the average MFN rate on core parts). Inputs from the ‘rest of world’
obviously do not comply with USMCA; therefore, they all face the 26.6% auto duty. The
amount of rest of world inputs in US-assembled cars depends on the headquarters of the
brand. Domestic brands (Ford, etc.) manufactured in the United States have 70% US
input shares and 5% RoW shares, whereas foreign brands have 50% US share and 25%
RoW.7
The second scenario introduces a retaliatory dimension, in which US trading partners
impose reciprocal 25% tariffs on US car exports. We assume the retaliators refrain from
matching the US tariffs on car parts following the fact that Canada’s retaliation, the only
one yet implemented, excludes car parts. This tit-for-tat response mirrors the scale and
scope of the initial US tariffs and is intended to capture the potential escalation of global
trade tensions. Comparing both scenarios enables us to evaluate not only the direct
effects of US protectionist measures but also the broader economic consequences of a
retaliatory trade environment.
IMPACT ON PRODUCTION BY COUNTRY
The 25% tariffs are projected to have a substantial impact on global automotive
production patterns. As expected, Canadian and Mexican automotive industries are
particularly affected, with estimated declines in production of 22% and 19%, respectively
(see Table 1). The most affected country would, however be South Korea (-25%), with
Japan also experiencing a significant drop in automotive production (-11%). Finally,
European industries would also experience adverse effects, with production in Sweden,
Italy, and Germany projected to decline by 13%, 7%, and 6%, respectively. Other
European countries, including Slovakia and the United Kingdom, are expected to face
smaller production contractions. Finally, China’s production is almost not affected, an
unsurprising prediction given the lower current US market penetration by Chinese
models.
7
The online appendix provides the rationale for each of the above cost share and sourcing share assumptions.
293
NATIONAL SECURITY TARIFFS ON THE AUTO INDUSTRY | HEAD, MAYER, VICARD AND WIBAUX
We model two distinct trade policy scenarios to assess the potential impacts of increased
tariffs on the global automotive sector. The primary scenario assumes the implementation
of a 25% tariff on all US imports of automobiles and related parts and components. This
scenario adjusts the US tariff on imports from Mexico and Canada to 12.5% based on
US-content exemptions granted to vehicles that meet USMCA rules of origin.
TABLE 1
COUNTRY-LEVEL IMPACTS OF TRUMP AUTO TARIFFS AND RETALIATION
Change in quantity produced (in %)
Country
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
294
Cars
assembled
in 2024
(millions)
Constant marginal
costs
External scale
economies
US only
Retaliation
US only
Retaliation
%
change in
consumer
surplus*
South Korea
3.6
-24.6
-22.9
-29.4
-27.0
-1.5
Canada
1.3
-22.1
-18.2
-34.3
-27.8
-4.1
Mexico
3.5
-19.1
-15.2
-29.9
-23.5
-1.2
Sweden
0.3
-13.3
-12.1
-17.6
-15.8
-0.4
Japan
6.9
-11.5
-10.6
-13.0
-11.9
-0.6
Italy
0.4
-7.4
-6.2
-9.2
-7.7
-0.2
Germany
4.0
-5.9
-3.3
-7.2
-3.6
-0.4
United
Kingdom
0.8
-4.1
-3.6
-4.2
-3.9
-0.2
Slovakia
0.9
-4.0
-3.5
-3.2
-3.1
-0.4
China
25.0
-0.3
0.2
-0.2
0.4
0.0
United States
9.8
32.4
25.5
40.0
31.1
-5.8
Note: *Consumer surplus computed for the retaliation scenario with external scale economies.
Conversely, US automotive production is forecast to rise by approximately 32%, as
domestic output substitutes for reduced imports.8 However, this gain is anticipated to
come at a significant cost to US consumers, who would face higher vehicle prices due
to reduced market competition and elevated import costs. The final column of Table 1
reports a 6% reduction in consumer surplus for the car buyer. This would rise to 6.5% if
we excluded the external scale economies. This is because increasing returns offset the
tariff-based price increases with domestic cost reductions: the 40% increase in output
(column 4) lowers production costs for cars made in the United States by 1.6%.
Allowing for external scale economies magnifies the expected impact of the tariffs,
both on the negative and positive sides. The impact is particularly large for Mexico and
Canada, while larger producing countries such as Japan and Germany are less affected.
Finally, should the targeted countries implement retaliatory tariff measures, our second
scenario shows non-trivial impacts for a number of countries. The results show that
retaliation always helps production in the retaliating countries. This is because it reduces
8
The model assumes constant aggregate quantities sold in each market. Any reduction in US sales following the 6-7% rise
in vehicle prices would dampen the positive effect on US production.
IMPACT ON PRODUCTION BY CAR MAKER
For car makers, the +25% tariffs on US imports will have both a direct impact on their
shipments from their home country to the United states and an indirect impact through
their car production in other countries, in particular in Canada and Mexico for the US
market. The automotive industry is characterised by high trade costs – beyond just tariffs
– which encourages companies to establish their operations locally or regionally. As a
result, manufacturers often choose to invest in production facilities near their consumer
markets. To cater to American consumers, most companies rely at least partially on
factories located in the United States or North America.
Of the 15.5 million passenger cars or pick-ups sold in the United States in 2024,
approximately half were produced domestically, yet only 40% originated from US
brands. Japanese automakers command a dominant 38% share of the market, though
vehicles imported directly from Japan account for just 9% of total US sales. A similar
pattern is observed with German brands, which hold an 9% market share, while imports
from Germany make up only 3% of the total. Volkswagen illustrates this continental
integration particularly well: it has a relatively limited manufacturing footprint within
the United States (20% of its sales) but supplies 44% of its US sales from Mexican
facilities – including Audi’s plant in San José Chiapa and Volkswagen’s operations in
Puebla (Mexico) and Chattanooga (US). The remainder of Volkswagen’s vehicles sold in
the United States are sourced mainly from Germany.
The direct and indirect exposures vary significantly from one company to another (Figure
2). General Motors, Ford, Toyota, and Hyundai stand out as the top four car makers by
volume in the US market, yet their reliance on domestic and regional production differs
markedly. Ford, and to a lesser extent General Motors, benefits from a more regionally
integrated supply chain, with significant production based in the United States and
some in Mexico. By contrast, Toyota combines substantial US production with notable
imports from Japan and Canada, while Hyundai is heavily exposed to Korean exports
despite a sizable American footprint. Firms like Tesla exhibit minimal vulnerability to
foreign trade barriers, as its entire US sales volume is produced domestically. In contrast,
295
NATIONAL SECURITY TARIFFS ON THE AUTO INDUSTRY | HEAD, MAYER, VICARD AND WIBAUX
competition from US-based plants. Germany, in particular, would diminish its car
production loss from -6% to -3% (this comes primarily from the fall in German imports
from US plants of BMW and Mercedes-Benz, which are currently used as platforms
for supplying SUVs to the world). Retaliation would also dampen the negative impact
on Mexico and Canada, reducing their production losses by close to a fifth (Table 1
columns (1) and (2)). However, such gains in car production would come at the cost of
higher domestic prices for consumers. The gains in terms of production from imposing
retaliatory tariffs appear limited for South Korea or Japan. Conversely, retaliatory
measures would substantially attenuate the projected increase in US automotive output,
reducing the expected gain from 33% to 26%.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
296
Volkswagen depends heavily on imports from Mexico and to a lesser extent Germany,
while manufacturers such as BMW and Mercedes-Benz rely on imports from Germany,
underscoring a higher sensitivity to trade frictions. These differences in production
localisation reflect both historical investment patterns and strategic responses to existing
trade regimes, making some firms more insulated from tariff risks than others.
FIGURE 2
EXPOSURE OF THE MAJOR CAR MAKERS TO US TARIFFS
General Motors
Toyota
Ford
Hyundai
Honda
Stellantis
Nissan-Mitsubishi
Subaru
Volkswagen
Tesla
Countries of production:
USA
CAN
MEX
JPN
KOR
DEU
ROW
Mazda
BMW
Mercedes-Benz
Other
0
.5
1
1.5
2
Sales in USA (2024, mn units)
2.5
Our simulations confirm the stark divergences in outcomes across automakers, depending
on their production footprints (Table 2). Firms with a strong US manufacturing presence
– such as Ford, General Motors, Tesla, Stellantis, and Honda – are positioned to benefit
from the import duties. Ford, for example, is projected to increase its sales by over 290,000
units, while General Motors, Tesla and Stellantis follow closely with gains of around
100,000 units each. What do those changes mean in terms of plants and employment
(in the assembly stage)? In 2024, the median assembly plant worldwide produced 65,000
cars, while the figure for the average plant was 115,000, and 180,000 for the third quartile.
The top gainers therefore increase output by the equivalent of what is currently one
average-sized plant. The Marysville plant of Honda in Ohio produced a little less than
203,000 cars with 4,200 employees9 in 2024.
9
https://en.wikipedia.org/wiki/Marysville_Auto_Plant
6.5
8.3
1.3
2.1
1.0
9.7
5.6
0.9
2.5
3.7
4.7
1.8
4.2
3.3
Volkswagen
Mazda
Mercedes-Benz
Tata
Toyota
Nissan-Mits.
Subaru
BMW
Honda
Stellantis
Tesla
General Motors
Ford
78.0
57.2
100.0
60.8
60.5
48.2
54.8
49.0
50.2
0.0
33.8
19.2
20.0
34.0
USA
20.6
25.2
0.0
35.4
39.0
10.0
0.0
27.8
25.3
0.0
4.6
25.8
43.7
7.8
CAN/MEX
0.0
0.0
0.0
3.8
0.0
41.8
0.0
0.0
0.1
100.0
55.1
0.0
36.3
0.5
Europe
Percent US sales produced in
1.4
17.6
0.0
0.0
0.5
0.0
45.2
23.2
24.4
0.0
6.5
55.0
0.0
57.6
RoW
292.5
105.7
99.3
96.5
79.6
-23.0
-26.7
-28.4
-29.0
-38.6
-45.0
-76.9
-97.2
-267.4
US only
274.6
122.2
106.0
83.0
81.1
-73.3
-28.0
-13.8
-29.8
-36.8
-97.1
-67.7
-68.7
-237.3
Retaliation
Change in quantity produced
(000s)
NATIONAL SECURITY TARIFFS ON THE AUTO INDUSTRY | HEAD, MAYER, VICARD AND WIBAUX
Cars assembled
in 2024
(millions)
FIRM-LEVEL IMPACTS OF TRUMP AUTO TARIFFS AND RETALIATION
Hyundai
Firm
TABLE 2
297
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
298
In contrast, automakers heavily reliant on foreign production are projected to suffer
considerable declines. Hyundai faces the most substantial contraction, with production
falling by more than 260,000 units, reflecting its dependence on Korean exports to the
US market. Other global automakers like Volkswagen, Mazda, Mercedes-Benz, and
Tata (owner of the Jaguar and Land-Rover brands) also record sizeable declines.10 These
figures point to a reallocation of production toward firms with existing US capacity and
underscore the strategic advantage held by firms that have localised their supply chains,
not only mitigating exposure to trade frictions but also enhancing their capacity to
capture displaced demand from import-dependent rivals.
It is worth noting that some brands are particularly affected. Buick, which belongs to
General Motors and produces in China and South Korea and exports to the US market,
would experience a 58,000-unit drop in its sales (13% of its total sales). Chrysler (a brand
of Stellantis) and Genesis (Hyundai) would similarly lose 13% and 11% of their total sales.
By contrast, Ford and Chevrolet pick-ups would particularly benefit from tariffs, with a
179,000 (+13%) and 98,000 (+12%) unit increase, respectively.
Finally, retaliations have contrasting impacts across automakers. They amplify losses for
some – particularly Mercedes-Benz and BMW, which experience significantly sharper
declines under the retaliation scenario. Their US plants export to the rest of the world
and would be particularly hit by retaliations by other countries on their US imports. On
the contrary, retaliations reduce the negative impact of tariffs compared to the unilateral
scenario for firms like Hyundai or Volkswagen.
CONCLUSION
On 25 April, the Washington Post released the results of a poll that shed light on public
opinions on the Trump administration’s tariff policies.11 The poll revealed that 59% of
Americans expect the tariffs to boost US manufacturing jobs, but only one third of those
polled support the tariffs. The view held by 71% that the tariffs will increase inflation
probably explains why the majority of Americans oppose the tariffs. Our simulation
results are surprisingly aligned with popular views: the model predicts a 26% to 40%
increase in US car production, depending on the assumptions and policy scenarios. The
success of these policies as protectionist devices comes at the cost of 6-7% price index
increases for vehicles. It is worth noting that our model takes into account two effects
that mitigate the price-increasing impact of tariffs. First, the framework allows firms that
have production facilities in the United States to costlessly reallocate production for the
US market. Second, in the simulations with scale economies, we build in the argument
10 JLR makes around 400,000 cars with nearly 40,000 employees (https://en.wikipedia.org/wiki/Jaguar_Land_Rover). The
predicted loss of 39,000 units, being about 10%, would imply a loss of about 4,000 employees.
11 https://www.washingtonpost.com/business/2025/04/25/trump-tariffs-poll-approval/)
of tariff advocates who see protectionist policies as cost reducing. However, when we
put realistic numbers on these effects, we see that they are not sufficient to overcome the
basic problem tariffs cause for consumers, namely, that taxing imports raises prices.
Our results at the country level show that retaliating to the US-imposed automotive tariffs
would mitigate production losses in the other car-producing countries. It is somewhat
puzzling that so far only Canada and China have put in place retaliatory tariffs on cars.
One explanation that fits the European case is that German manufacturers have lobbied
against retaliation. Our quantitative results suggest that they have good reasons for this:
retaliation lowers combined production of the three major German car-making firms.
Another explanation for not retaliating is that our results predict that retaliation would
raise prices, something that many governments would like to avoid, having observed
the negative voter reactions to inflation in both recent elections and polls. The fact that
Europe has so far declined to retaliate against any of the new tariffs the US has imposed
suggests European negotiators see the car industry as one piece of a larger bargaining
process.
REFERENCES
Bartelme, D, A Costinot, D Donaldson, and A Rodríguez-Clare (2025), “The Textbook
Case for Industrial Policy: Theory Meets Data”, Journal of Political Economy 133(5).
Bown, C P (2025), “Trump’s trade war timeline 2.0: An up-to-date guide”, PIIE blog
(https://www.piie.com/blogs/realtime-economics/2025/trumps-trade-war-timeline-20date-guide).
Combes, P-P and L Gobillon (2015), “The empirics of agglomeration economies”, in
G Duranton, V Henderson and W Strange (eds), Handbook of Urban and Regional
Economics, Vol. 5, Elsevier-North Holland.
Evenett, S J and M-A Muendler (2025), “’These Are Your People’. Canada and Mexico
have retaliation options that shrink American take-home pay”, cBrief 5.
Head, K and T Mayer (2019), “Brands in Motion”, American Economic Review 109(9):
3073–3124.
299
NATIONAL SECURITY TARIFFS ON THE AUTO INDUSTRY | HEAD, MAYER, VICARD AND WIBAUX
Moreover, the variation in production adjustments to the Trump administration’s
tariffs across individual firms is considerably narrower – ranging from -6% to +9%
– than the disparities observed at the national level, which range from a 25% decline
in South Korea to a 32% increase in the United States. This highlights how the global
footprint of multinational automakers cushions their worldwide sales against countryspecific shocks. As a result, the impact of tariffs on a given firm’s operations may diverge
considerably from the broader effects on its home country’s industrial base. An advantage
of the detailed firm-level data used here is that they permit us to evaluate the alignment
of the interests of multinational firms with national outcomes.
Head, K, T Mayer, and M Melitz (2024), “The Laffer curve for rules of origin”, Journal of
International Economics 150, 103911.
300
ABOUT THE AUTHORS
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
Keith Head is a professor at the Sauder School of Business of the University of British
Columbia, where he holds the HSBC Professorship in Asian Commerce. After earning a
Bachelor of Arts at Swarthmore College in 1986, he completed a Ph.D. in Economics at the
Massachusetts Institute of Technology in 1991 under the supervision of Paul Krugman.
Dr. Head’s research focuses on barriers to international trade and the decisions of
multinational corporations.
Thierry Mayer is currently Professor of Economics at Sciences-Po. He also is a Scientific
Adviser in CEPII, and a Research Fellow in the International Trade/Regional Economics
programme at CEPR. He is an elected fellow of the Econometric Society. His research
is primarily focused on economic geography, trade theory and empirics as well as on
foreign direct investment determinants. His research was rewarded by a number of
distinctions, including the bronze medal of the CNRS. He published his work in several
of the leading journals of the discipline, including the American Economic Review, the
Quarterly Journal of Economics and the Review of Economic Studies, among others.
Vincent Vicard is Deputy Director of CEPII and the head of the International Trade
scientific programme. His current research focuses on the organisation and taxation
of multinational companies, European integration, industrial policies and the geoeconomic dimensions of globalisation. He holds a PhD in Economics from the University
of Paris I Panthéon-Sorbonne and has previously worked as a senior researcher at the
Banque de France and as an economist at the French Embassy in Poland. His academic
work has been published in several leading international journals, including the Review
of Economics and Statistics, Journal of International Economics, European Economic
Review and the IMF Economic Review. He is also a regular contributor to the French
media and teaches international trade at Sciences Po, Paris.
Pauline Wibaux is an Economist in the International Trade Analysis division at CEPII.
Her research focuses on strategic relations between countries, and her work focuses on
the use of (non-)cooperative trade policies, as well as on the implications of the strategic
autonomy for the European economy. She holds a PhD from the Université Paris
1 - Panthéon Sorbonne. She worked at the IMF as a Research officer in the Research
Department.
PART III
SPILLOVERS TO ADVANCED
ECONOMIES
CHAPTER 25
Luis Garicano
London School of Economics and CEPR
The return of Donald Trump to the White House confronts Europe with an existential
challenge. His administration’s willingness to weaponise trade – treating even NAFTA
partners as adversaries – makes clear that transatlantic economic relations have
become entirely transactional. The same is true for all the other aspects of the US–EU
relationship, including the critical security dimension. Europe faces this challenge from
a position of weakness, after two decades of relative decline. Hence this shock demands
a fundamental economic renewal. Without addressing the structural causes of this
weakness, Europe cannot achieve the strategic autonomy it desperately seeks.
The actions of the European institutions – the Commission, the Council and the
Parliament – must respond to the Trump shock along three dimensions:
1. Growth: Europe’s stagnation undermines the continent’s ability to respond to
external shocks. Europe must grow again.
2. Trade: The best response to the increasing world fragmentation and difficulty of
trading outside the EU is to deepen the Single Market and eliminate the many
remaining barriers to trade between member states.
3. Defence: While there is a role in defence for the EU and its institutions, the EU
must concede that main action here must take place at a broader level.
THE TRUMP SHOCK MEETS EUROPEAN ECONOMIC WEAKNESS
In May 2025, President Trump proposed a 50% tariff on EU imports. Whether this ends
up being imposed or not, his administration’s economic attack has arrived at Europe’s
most vulnerable moment. As Draghi (2024) points out, the EU–US gap in GDP per capita
widened from 15% in 2002 to 30% in 2023, and 70% of the shortfall reflects weaker
European labour productivity. Italy’s performance is an extreme example: its 2023 real
GDP per head remained at 2000 levels.1
1
Source: “Italy – GDP per capita (constant prices)", OECD Data.
303
STRATEGIC AUTONOMY FOR EUROPE REQUIRES ECONOMIC GROWTH | GARICANO
Strategic autonomy for Europe requires
economic growth
This dismal performance has multiple origins, but four merit special attention: energy
costs, innovation, regulation, and the Single Market. I discuss the first three in this
section.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
304
Energy
In 2024, EU firms faced industrial electricity prices 2.5 times higher than the US
and natural gas prices five times higher (Heusaff 2024). While this gap partly reflects
Europe’s lack of natural resources and Russia’s weaponisation of gas flows after the 2022
invasion of Ukraine, fundamental market design and regulatory choices exacerbate the
problem. The April 2025 Spanish blackout – when the country lost all electricity for hours
– demonstrated how renewable integration without adequate grid stability can create
catastrophic vulnerabilities (Garicano 2025b). The Europe-wide Dunkelflaute (the winter
doldrums with no sun, no wind, and lots of heating demand) is likely to become a feature
of the transition. High and unpredictable energy costs have contributed to the loss of over
500,000 European manufacturing jobs since 2022, accelerating deindustrialisation in
sectors that once formed Europe’s industrial backbone. According to a Financial Times
article,2 German energy-intensive firms are producing 20% less than before the Covid-19
pandemic and corporate distress is at levels last seen during the height of the pandemic.
Europe must deal with its energy problem. Approving the 25,000 km of pending crossborder transmission lines would cut wholesale prices by double digits and harden the
grid against blackouts. Moreover, Europe must adopt a much more pragmatic posture
concerning nuclear energy and gas. Both will be necessary for stability.
Innovation
Europe’s innovation deficit further weakens its position. Only four of the world’s 50 largest
tech companies are European. No firm founded in Europe in the past half-century has
reached a €100 billion valuation. EU startups attract just 6% of global AI funding, versus
61% for the US (Draghi 2024). This innovation gap means Europe increasingly depends
on foreign technology for its digital transformation, creating new vulnerabilities.
The response to this problem has two main axes. We must improve our innovation
system, and we must facilitate creative destruction. I focus here on one useful solution to
the innovation finance gap proposed by both Draghi and by Enrico Letta (Letta 2024): a
single ‘28th regime’ corporate statute covering venture financing, stock-option taxation,
and insolvency would allow start-ups to scale across the continent.
Regulation and compliance
As Draghi (2024) documented, Europe’s weakness is in part the result of the increasingly
complex regulatory environment. These regulations, often well-intentioned, serve some
potentially important purposes from privacy protection to environmental standards. But
it is increasingly recognised that they impose large cumulative costs on EU companies
2
https://www.ft.com/content/bdba0fc4-f651-41fa-9706-acaa4dc15bd0
No one who has read the Draghi Report can have any doubt that Europe must significantly
reduce its regulation. At a minimum, the Omnibus proposal now in Council would trim
mandatory CSRD data points and defer low-materiality disclosures. But Europe must
go much further. The entire regulatory apparatus must be examined and pruned –
particularly to facilitate competition inside the Single Market, as I discuss next.
Europe’s interconnected weaknesses – high energy costs, innovation deficits, and
regulatory complexity – make it particularly vulnerable to Trump’s economic coercion.
Europe’s response to the Trump shock must begin with economic renewal. Without
internal economic strength, Europe cannot credibly pursue strategic autonomy or
maintain its social model. But there is one more critical element to the response: the
Single Market.
THE TRADE SHOCK AND THE SINGLE MARKET CRISIS
The best response to the sudden increase in external barriers and the consequent
external trade fragmentation would be to reduce internal barriers. Yet the EU’s crowning
achievement – the Single Market – is deeply flawed. The IMF calculates that hidden
barriers within the EU are equal to a 45% tariff on goods and a 110% tariff on services,
exceeding the Trump administration’s most aggressive China tariffs.
FIGURE 1
BARRIERS TO EU INTERNAL TRADE: 2020 TARIFF EQUIVALENT
120
Percent
100
80
60
40
20
0
Source: IMF (2024).
Manufacturing
between US states
Manufacturing
between EU states
Services
between EU states
305
STRATEGIC AUTONOMY FOR EUROPE REQUIRES ECONOMIC GROWTH | GARICANO
and make market entry and exit, as well as firm growth, extremely hard. The Corporate
Sustainability Reporting Directive (CSRD) alone requires companies to track 1,052 data
points, with compliance costs estimated at 12.5% of mid-cap firms’ annual investment
budgets. During 2019-2024, the EU passed approximately 13,000 Acts compared to
3,500 pieces of legislation at the US federal level. This regulatory density, combined with
national variations in implementation, creates a complex operating environment that
particularly burdens smaller firms.
FIGURE 2
INTRA- AND EXTRA-EU TRADE IN THE EUROPEAN UNION
Average of exports and imports as share of total EU GDP
Goods (intra–European Union)
Goods (extra–European Union)
30
EU12
EU15
Services (intra–European Union)
Services (extra–European Union)
EU25
EU27
EU-28
EU27
25
20
15
10
5
23
22
21
20
19
18
17
16
15
14
13
12
11
10
09
08
07
06
05
04
03
02
01
99
2000
98
97
96
95
94
0
1993
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
306
Also according to the IMF, since the mid-1990s, trade costs for goods have dropped
16% for non-EU imports but only 11% for trade within the EU. Intra-EU trade intensity
remains 50% lower than that between US states (IMF 2024). This means European
companies often find it easier to expand in America than in neighbouring EU countries.
As a result, according to the IMF, the EU’s internal services trade and its external
services trade are roughly the same size as a share of the EU economy. In a true single
market, internal trade should be much larger. In a world where scale is ever more vital
(services include such scale-intensive business as AI, finance and IT), this fragmentation
of the Single Market is very damaging.
Source: IMF (2004).
The harmonisation trap
EU legislation frequently worsens rather than solves market fragmentation. New
directives pile atop existing national rules rather than replacing them. Research on
capital market regulation shows countries actually diverge more after EU harmonisation
attempts (Ewens and Farre-Mensa 2020) – stronger regulatory countries maintain their
standards while weaker ones add EU requirements without removing national ones.
Banking illustrates this layering problem. The Single Supervisory Mechanism oversees
banks, but national central banks impose additional capital and liquidity requirements.
French banks operating in Belgium, for example, face French, Belgian, and European
regulators simultaneously, eliminating cross-border synergies.
Data protection creates similar absurdities. Despite the General Data Protection
Regulation (GDPR) being an EU regulation, Austria banned Google Analytics while
neighbouring countries permit it. Italian authorities threatened US data transfers that
remain legal elsewhere. Publishers operating EU-wide must maintain separate systems
for different countries.
Enforcement collapse
The European Commission has abandoned its treaty duty to police the Single Market.
Infringement cases dropped to 658 in December 2024, down 21% since 2020. New cases
fell to 173 yearly, one-quarter the volume from a decade ago. At the same time, case
duration stretched to 46 months, up 31% since 2019.
FIGURE 3
TOTAL INFRINGEMENT ACTIONS OF THE EUROPEAN COMMISSION, BY YEAR
450
400
NUmber of actions
350
300
250
200
150
100
50
23
22
20
21
20
20
20
19
20
17
18
20
20
16
20
15
20
13
14
20
20
12
20
11
20
20
20
10
0
Source: European Commission Single Market Scoreboard (https://single-market-scoreboard.ec.europa.eu/_en).
This decline reflects the Commission’s evolution. Styling itself as “geopolitical” (von der
Leyen 2019), it seeks influence in defence, housing, and foreign policy while neglecting
core obligations. Confronting member states over market violations undermines the
political cooperation needed for these expanded ambitions.
Without enforcement, the Single Market erodes. Small companies in particular cannot
afford legal battles against national authorities claiming health or safety exceptions. The
original mutual recognition principle – that products legal in one member state should
circulate everywhere – has become meaningless without credible enforcement.
Europe must restore mutual recognition as the default rule and dramatically increase
enforcement actions. Products and services legal anywhere in the EU should face no
additional barriers elsewhere unless governments prove concrete risks. The Commission
must choose between political expansion and its constitutional duty to maintain Europe’s
economic foundation.
307
STRATEGIC AUTONOMY FOR EUROPE REQUIRES ECONOMIC GROWTH | GARICANO
Professional mobility remains constrained despite decades of EU directives. Portuguese
engineers with EU-recognised qualifications face lengthy German equivalency checks.
Architects and other professionals navigate regional requirements within single member
states. Small firms often abandon cross-border expansion rather than fight bureaucratic
battles.
DEFENCE AND STRATEGIC AUTONOMY: FINDING THE RIGHT DIVISION OF
LABOUR
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
308
As with trade, the Trump administration has made clear that its approach to defence is
transactional. This shock demands European strategic autonomy, including in defence.
The question this raises is how to organise this effort most effectively.
Arguments for greater EU involvement in defence rest on solid economic logic made
in this book, for instance, in the chapter by Armin Steinbach, Guntram Wolff, and
Jeromin Zettelmeyer and in the chapter by Ethan Ilzetzki. Defence procurement shows
significant economies of scale, and defence R&D generates substantial spillovers to
civilian technology. The current fragmentation – Europe operates 12 different main
battle tanks compared with America’s one – creates inefficiencies that weaken collective
defence while raising costs. Coordinated procurement could deliver better capabilities at
lower cost.
However, effective European defence faces structural challenges that EU institutions
cannot easily overcome. First, the EU is a diverse bloc with very different security and
defence postures among its members. It includes traditionally neutral states (such as
Ireland, Austria, and Malta) that have not been in NATO or any other military alliance.
Member states also hold varied threat perceptions and foreign policy leanings, sometimes
influenced by historical or economic ties that can complicate unified action, particularly
concerning large powers like Russia. With respect to this crucial player, the EU members’
attitudes run the gamut from slavish submission (Hungary) to bold defiance (Poland and
Estonia). Foreign policy and defence decisions typically require unanimity – a high bar
that often leads to slow or lowest common denominator outcomes, ill-suited to the pace
of geopolitical events
Second, a successful defence posture requires including NATO and non-EU actors. Key
European security actors, including the UK (a major military power), Norway (critical for
North Atlantic security), and Turkey (a large NATO ally in a strategic region), are outside
the EU. Canada, another G7 nation, is also a vital NATO partner currently with one
foot outside of the US defence umbrella. An EU-centric defence policy risks duplicating
efforts and alienating these crucial allies.
Third, the EU treaties offer a limited basis for a common defence policy in the traditional
sense. While initiatives like the European Defence Fund, the Permanent Structured
Cooperation (PESCO), and the European Peace Facility represent important steps in
bolstering defence industrial cooperation and supporting partners, they do not equate
to a centralised EU defence command or foreign policy execution power vested in the
Commission.
A more effective approach to European security involves ‘coalitions of the willing’ within
NATO or through ad-hoc groupings. Guntram Wolff, Armin Steinbach, and Jeromin
Zettelmayer (2025) have recently proposed a groundbreaking European Defence
The proposal addresses both fiscal and operational realities. It provides a framework to
integrate national and EU defence policy through flexible interpretation of fiscal rules,
collective arms procurement, and centralised investments. By allowing non-EU states
like the UK, Norway, and potentially Switzerland to participate, it acknowledges that
European security transcends EU membership.
The key insight is that European security requires flexible geometries. The EU can
contribute significantly through defence industrial policy, research coordination, and
single market benefits for defence firms. The European Defence Fund and PESCO
represent important steps. But operational defence coordination must include all
European security stakeholders, not just EU members. Forcing defence into EU
structures risks excluding key allies and creating inefficient parallel organisations.
CONCLUSION: ECONOMIC POWER OR STRATEGIC IRRELEVANCE
Trump’s return makes European strategic autonomy not just desirable but necessary.
Yet, autonomy without economic strength is an illusion. A Europe that cannot compete
economically cannot defend its interests or values globally. The mathematics are simple:
declining GDP and innovation ability equals strategic irrelevance.
The Trump administration’s tariffs target weakness. Europe can answer only with
economic strength: faster productivity growth, cheaper energy, a genuine continental
market, and tech leadership. Every hidden barrier, every reporting burden, and every
fragmented defence project hands leverage to Washington. Completing the tasks above
would add at least 8% to EU GDP within five years and narrow the strategic gap with the
United States.
Europe has the talent, resources, and institutional framework to compete globally. Its
universities produce excellent graduates, its companies hold leading positions in many
industries, its legal framework provides stability and predictability. What it lacks is the
political will to dismantle internal barriers and create the conditions for growth. Given
the external pressures Europe now faces, it is, truly, now or never.
309
STRATEGIC AUTONOMY FOR EUROPE REQUIRES ECONOMIC GROWTH | GARICANO
Mechanism (EDM) that exemplifies this approach (Wolff et al. 2025). Their proposal
envisions an intergovernmental institution open to all European democracies – both EU
and non-EU members – where participants would pool resources to collectively procure
defence equipment and services. The EDM would issue bonds to finance joint defence
procurement and common defence assets, with members paying for their shares of jointly
procured defence goods when delivered.
REFERENCES
Draghi, M (2024), The future of European competitiveness, European Commission.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
310
Ewens, M and J Farre-Mensa (2020) “The deregulation of the private equity markets and
the decline in IPOs”, The Review of Financial Studies 33(12): 5463-5509.
Garicano, L (2024), “The Compliance Doom Loop”, Silicon Continent, November.
Garicano, L (2025a), “The Myth of the Single Market: Why Europe’s internal barriers are
higher than Trump’s tariffs”, Silicon Continent, May.
Garicano, L (2025b), “Anatomy of an Error: On Spain’s Blackout and EU Energy Policy”,
Silicon Continent, April.
Heussaff, C (2024), “Decarbonising for competitiveness: four ways to reduce European
energy prices”, Policy Brief 32/2024, Bruegel
IMF (2024), A Recovery Short of Europe’s Full Potential, Regional Economic Outlook,
Europe
2024
(https://www.imf.org/en/Publications/REO/EU/Issues/2024/10/24/
regional-economic-outlook-Europe-october-2024).
Letta, E (2024), Much more than a market: Empowering the Single Market to deliver
Europe’s future and prosperity, Report to the European Council.
Von der Leyen, U (2019), “Speech by President-elect Ursula von der Leyen at the 2019
Paris Peace Forum”, 12 November (https://ec.europa.eu/commission/presscorner/detail/
en/speech_19_6270).
Wolff, G, A Steinbach and J Zettelmeyer (2025), “The governance and funding of
European rearmament”, Bruegel Policy Brief (https://www.bruegel.org/policy-brief/
governance-and-funding-european-rearmament).
ABOUT THE AUTHOR
Luis Garicano is a Professor of Public Policy at the London School of Economic and a
CEPR Research Fellow. Between 2019 and 2022, he was a Member of the European
Parliament, where he was Vice-President in charge of economic affairs for the Renew
Europe parliamentary group. Before entering elective politics, he was a Professor in
Economics and Strategy at the London School of Economics and at the University of
Chicago, where he received his PhD. As a Member of the European Parliament, during
the pandemic he led the development and negotiations on NextGenerationEU (the
European recovery plan) and on Russian sanctions.
CHAPTER 26
Paul Bergin and Giancarlo Corsetti
University of California at Davis; European University Institute and CEPR
A flurry of tariffs and tariff threats by the US are hitting the euro area. The euro area has
been targeted for “reciprocal tariffs”, directed at regions that tend to run trade surpluses
with the United States in goods trade (excluding services). Other tariffs single out goods
that are important exports for some EA members, such as automobiles and auto parts.
By some measures, the euro area and the United States have the largest bilateral trade
and investment relationship in the world, and the United States represents the largest
single market for EA exports.1 Tariffs dampening demand for EA exports would likely
lower GDP growth in Europe, and if the euro area retaliates with tariffs on imports from
the United States, this can be expected to put upward pressure on EA inflation. The
stagflationary consequences of a trade war are now becoming the dominant concern for
stabilisation policies.
Given the considerable uncertainty surrounding developments in trade policy, it is too
early to have a precise quantitative assessment of its implication for monetary stabilisation
in the euro area and elsewhere. It is, however, possible to analyse which factors will
shape the policy trade-offs that will weigh on the response by monetary authorities. In
this chapter we will do so drawing on a simple quantitative (DSGE) model, usable for
simulating simple tariff scenarios and for computing Ramsey-optimal monetary policy
responses. While quantitative predictions must be interpreted cautiously, the result are
useful for reconsidering monetary stabilisation of tariff shocks and retaliation in light of
the current policy debate.
WHY AND HOW DO TARIFFS CHALLENGE MONETARY POLICY?
Trade wars present policymakers with a choice between moderating headline inflation
or sustaining output and employment with a monetary expansion. How to manage
this complex trade-off is far from obvious. Following somewhat different approaches,
a number of recent contributions have nonetheless converged on a specific conclusion:
the main challenge for monetary authorities will be moderating the fall in output and
employment by taking an expansionary stance, while at the same time explaining to the
1
https://www.consilium.europa.eu/en/infographics/eu-us-trade/
311
TRADE WARS AND EUROPEAN MONETARY POLICY | BERGIN AND CORSETTI
Trade wars and European monetary
policy
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
312
public that some consumer price inflation will be the unavoidable but the least price to
pay to reduce the disruptive negative consequences of tariffs.2 Several leading central
banks shared this view. ECB President Lagarde has indeed stated that tariffs will likely
be “more disinflationary than inflationary”, while Bank of England Governor Andrew
Bailey refers to tariffs as a potential growth shock.3
While the exact configuration of tariffs across countries and regions is far from settled,
much is on the plate of central banks already. Anticipation of the macroeconomic
impact of tariffs is making households and firms more prudent in their consumption
and investment decisions. In some countries, this early recessionary impulse is to
some degree offset by an extraordinary surge in imports by US firms trying to beat the
anticipated tariff charge – in March 2025, the US trade deficits widened to $162 billion,
from US $92.8 billion twelve months earlier. Part of this reflects the negative reaction of
consumers abroad to the aggressive political statements of President Trump, motivating
a switching from US to local brands out of national pride. To complicate the picture,
uncertainty about the inflationary effects of the tariff challenges current pricing decisions
by firms. If inflation expectations worsen, firms may raise prices even if the demand for
their product is already falling.
To sum up our main message, the appropriate monetary response to tariff shocks and
uncertainty must balance at least three key factors: (i) the likelihood that the tariffs
are reciprocated in a trade war, determining the global recessionary implications of the
shock; (ii) the degree of reliance of domestic production on imported intermediates,
determining the cost push effects of tariffs on producer prices; (iii) and the special role
of the US dollar as the dominant currency for invoicing international trade, creating
a fundamental asymmetry in the conduct of monetary stabilisation, to the advantage
of the United States.4 We show how our main conclusion – the need for monetary
support of economic activity in Europe – follows from different scenarios combining
these elements. Underlying all our results, a key question concerns the implication of
tariffs on productivity and potential output. In the model we use in our simulations,
this is negative primarily because tariffs reduce the set of inputs firms may employ in
production, reducing their efficiency.
2
3
4
The analysis of the optimal policy response to tariffs has been first analysed in extensive detail by Bergin and Corsetti
(2023) using a global two-country model. Recently, studies based on small open economy models have been conducted
by Bianchi and Coulibaly (2025) and Monacelli (2025) among others. The conclusions of academic studies resonate
with policy papers (see Alcidi et al. 2025 and Bottazzi et al. 2025). Before these studies, much of the analysis of the
macroeconomic implications of tariffs and tariff wars was conducted in the context of real trade models, and in empirical
exercises that either abstracted from monetary policy, or model monetary policy positing exogenously given rules (e.g.
Born et al. 2019, Caliendo et al. 2017, Dhingra et al. 2017, Sampson 2017, Steinberg 2019, and Van Reenen 2016). Leading
examples of studies assuming standard monetary policy rules include Linde and Pescatori (2019), Erceg et al. (2018) and
Caldara et al. (2020), as well as Barattieri et al. (2021), who consider two alternative monetary regimes of a zero lower
bound and a fixed exchange rate. Auray et al. (2024) address the question of how alternative monetary policies affect
an endogenous, strategic tariff policy. This runs in the opposite direction of our question, the choice of optimal monetary
policy in the face of an exogenous tariff policy shock. Jeanne (2021) considers a broad set of policy instruments set
optimally by a government, including monetary policy and tariffs.
“Lagarde says that tariffs likely more disinflationary than inflationary”, Bloomberg, 23 April 2025; “UK economy faces
growth shock from Trump tariffs, says Bank governor”, The Guardian, 24 April 2025.
In Bergin and Corsetti (2025) we also examine the sectoral reallocation implied by tariffs, which may also raise political and
distributive issues challenging fiscal and monetary authorities
A MODEL-BASED ANALYSIS
While the model is not fully calibrated to represent the US and EA macro aggregates in
a detailed quantitative sense, its symmetric two-country structure is well suited to study
the relationship of these two large trading partners in more general terms, and certain
key parameters are chosen to enhance its quantitative relevance to the European case.6
In our analysis, we will refer to the United States as the ‘foreign’ economy. To keep focus,
we will refer to the euro area, instead of the European Union, as the ‘home’ economy, so
as to be able to discuss the implications of tariffs for the common monetary policy and
the euro-dollar exchange rate. As a caveat, the analysis abstracts from implications for
either EU countries outside the euro area, or the rest of the world outside the euro area.
We will consider unilateral tariffs vs. symmetric tariff wars. Our scenarios simulate
tariffs on imports raised 10 percentage points (from a pre-existing level of 2 percentage
points). While there is significant uncertainty regarding the eventual size of tariffs, this
value reflects the average level of US tariffs on EU goods at the time of writing.7 Shocks
have moderate persistence, based on the evidence from Barattieri et al. (2021).8 We
contrast the effects of these shocks on the economy conditional on two monetary policy
regimes. In one, central banks optimally trade off employment and inflation (this will be
marked by a solid line in our figures). In the other, they stabilise headline CPI inflation
(a dashed line). We will start positing a high degree of exchange rate pass through – so
5
6
7
8
We actually assume global monetary cooperation. This set up may not be an accurate description of cross-border monetary
interactions, but we know from previous work that we can obtain broadly similar results using a model specification in
which central banks pursue their own mandate of low inflation---see our specification of Taylor rule targeting PPI inflation
(Bergin and Corsetti 2023), reconsidered in Monacelli (2025). In addition, our approach allows us to derive the best
combination of monetary policies from a global perspective.
Model and calibration are from the two-country global economy in Bergin and Corsetti (2023), modified to reflect EA-US
bilateral trade. We calibrate the share of exports in GDP to match data for EA exports to the United States in 2023, which
was 2.9% of EA GDP (implying a calibration of trade cost equal to 2.1).
In the wake of Trumps’s 9 April announcement of a 90-day pause on full implementation of the reciprocal tariffs, most
tariffs on EA goods stand at around 10% (Barata de Rocha et al. 2025). Note that simulation of larger tariffs may push
bounds of accuracy in our linearised stochastic model.
Based on historical data, these authors estimate an autoregressive parameter equal to 0.56.
313
TRADE WARS AND EUROPEAN MONETARY POLICY | BERGIN AND CORSETTI
Below we will discuss monetary stabilisation of tariff shocks using an open-economy
New Keynesian (sticky price) model, appropriately extended to account for international
value chains in production, i.e. imported goods are used in the production of domestic
goods and exports. Throughout our analysis we model a share of imported inputs in
production in line with the US input-output tables for 2011. This share plays a crucial
role in shaping monetary stabilisation (we will discuss how). Quantitatively, the
implications for monetary policy are sensitive to the degree of passthrough of tariffs to
consumer prices. While we do not report results here for space consideration, we verify
that our main results remain qualitatively unaffected when we enrich the model with a
distribution sector that limits tariff passthrough to final prices. Finally, we assume that
monetary authorities do not take advantage of cross-border spillovers to pursue beggarthy-neighbour policies, i.e. we rule out opportunistic manipulation of the exchange rate.5
that a dollar appreciation will reduce imported inflation in the United States. But we will
also discuss how the dollar as a dominant currency in trade may provide a stabilisation
advantage to the United States.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
314
THE STRAIGHTFORWARD CASE FOR MONETARY SUPPORT OF ECONOMIC
ACTIVITY: US TARIFFS WITHOUT RETALIATORY MEASURES
In our first exercise, we focus on a scenario in which the United States unilaterally
implements tariffs on domestic purchases of European goods (to boost demand for US
goods), but there is no retaliatory tariff action by Europeans. In the euro area, US tariffs
translate into a negative demand shock lowering output and inflation. Under a Taylor
rule responding to CPI inflation (dashed line in Figure 1), the EA monetary stance would
indeed be expansionary, to prevent falling prices, but only moderately so. As shown in
Figure 1, output would contract by 0.37%, a prediction within the range of recent estimates
in the literature of 0.3% to 0.6% (see McKibbin and Noland 2025 and Felbermayr et al.
2024).9 EA inflation would be close to zero but remain somewhat negative.
FIGURE 1 UNILATERAL US TARIFF (EA VARIABLES)
Note: Vertical axis is percent deviation (1 = 1%) from steady-state levels. Trade balance in percent of GDP. Interest rates in
percentage points (1 = 1 percentage point). Horizontal axis is time (in quarters).
Monetary policy can do better. As also shown in Figure 1 (solid line), the optimal monetary
stance is more expansionary than prescribed by the CPI Taylor rule, up to halving the
drop in output, at a cost of some marginal inflation on impact. Note that over time the
dynamic of inflation is similar under our two alternative monetary strategies, mainly
reflecting the temporary nature of the tariff shocks modelled in our exercise.
9
McKibbin and Noland (2025) estimate a fall in fall EA GDP 0.3% for a unilateral 25% tariff; 0.6% with retaliation.
Felbermayer et al. (2024) predict a fall in EA GDP by 0.5% for a 10% tariff.
A STRONGER CASE FOR AN EXPANSIONARY MONETARY STANCE: TRADE
WARS
The negative impact of tariffs is shared across both countries in a trade war with
retaliation, unavoidably causing a significant contraction in the international demand
for goods and thus cross-border trade. To fix ideas, we consider a ‘symmetric war’, in
which tariff rates are set identical in retaliation by two countries with symmetric
economic structure – in Figure 2, ‘home’ and ‘foreign’ are identical. As shown by this
figure, during a symmetric tariff war, under the optimal policy output falls (by 0.17%)
while inflation spikes worldwide. The exchange rate plays no role in this scenario, as
there is no difference in tariff and policy rates.
As shown by our analysis, it is desirable for central banks around the world to maintain
an expansionary monetary stance and stabilise output (solid line), despite the hike in CPI
inflation hitting the consumers. Intuitively, much of the CPI hike reflects the fact that the
tariff is levied on top of the border price set by exporters, distorting the relative price of
imports at consumer level.15 Without the help of the exchange rate, the only way central
banks can reduce CPI inflation consists of engaging in a strong recessionary contraction,
10 In response to a tariff, to the extent that US production substitutes for imports, US firms experience a rise in demand.
This effect is strong under the relatively high trade elasticity we use in our calibration: the optimal policy turns out to be
contractionary relative to the natural rate allocation (targeting producers’ price stability). Under a lower trade elasticity,
the effect is weaker, and the optimal policy response turns expansionary (also relative to the natural rate). Similarly, the
optimal response tends to be relatively expansionary in response to persistent tariff shocks. All these results are available
on request. Recall that tariffs tend to raise marginal costs both via the cost of imported inputs and changes in wages
(driven by the CPI). Finally, US firms may experience a decline in productivity if they substitute away from imported inputs.
11 The euro-dollar response has the same sign independently of whether the US response is contractionary or expansionary
relative to the natural rate, depending on trade elasticities and shock persistence. This is because in either case the
monetary stance in the United States remains tighter (or less expansionary) than in the euro area.
12 It is worth recalling here that the post 2022 inflation surge has also been characterized by significant relative prices
movements; see Guerrieri et al (2024) for an analysis of the implied policy trade-offs.
13 Note, however, that, while correcting somewhat the relative price distortion, monetary policy can only imperfectly redress
the effects of the tariff on the broader set of macroeconomic aggregates shown in the figure.
14 Our baseline analysis assumes a high degree of exchange rate pass through on the import border prices. Allowing for a low
degree of pass through cannot but reinforce our conclusion. If prices are sticky in the currency of the export destination
country, currency fluctuations do not change much international relative prices: a depreciation does not improve much
the price competitiveness for the home exports. Hence monetary policy cannot rely on currency depreciation to redirect
global demand towards own traded goods in the short run. It will have to sustain activity by expanding domestic demand.
Unsurprisingly, in response to a unilateral foreign tariff, the optimal stance in the euro area is still expansionary.
15 See Bergin and Corsetti (2023) for a detailed discussion of this distortion.
315
TRADE WARS AND EUROPEAN MONETARY POLICY | BERGIN AND CORSETTI
Tariffs have different effects in the United States, the country imposing the tariff (shown
in a more detailed version of Figure 1 in the Appendix). In the United States, the effects of
the tariff on inflation and GDP call for a monetary stance that is relatively contractionary
vis-à-vis the euro area.10 Thus, the policy stances diverge across the Atlantic, causing a
depreciation of the euro vis-à-vis the dollar.11 To the extent that prices in the local currency
respond to the exchange rate in both regions, a weaker euro lowers the effective (beforetariff) price of US imports from the euro area, while raises the price of EA imports from
the United States.12 The exchange rate thus partly offsets the distortionary effect of the
tariffs on relative prices and global demand.13 A weaker euro also contains the effects of
the tariff shocks on the European trade surplus vis-à-vis the United States.14
forcing domestic firms to reduce their product prices. Relative to the optimal policy
response, indeed, if both central banks target the CPI, the contraction in output would be
three times larger (0.55%).16
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
316
FIGURE 2
SYMMETRIC TARIFF WAR
Note: Vertical axis is percent deviation (1 = 1%) from steady-state levels. Trade balance in percent of GDP. Interest rates in
percentage points (1 = 1 percentage point). Horizontal axis is time (in quarters).
We should note here that, to the extent that tariffs are levied on intermediate inputs, the
cost pressure may more than offset the adverse demand effect. Our model is calibrated
to the share of imported intermediate inputs in production in the United States and
euro area. If we consider higher and higher shares, at some point the production costs
will amplify the supply-side implications of the tariff, up to overcoming the demand
implications. In our model, the optimal response to a trade war indeed becomes
contractionary at a share of intermediate inputs in production as high as 57%. Our main
16 Comparing Figure 1 and 2, note that activity in the euro area falls by less in a trade-war scenario. This is because the tariff
retaliation protects domestic firms from foreign competition. In a unilateral tariff scenario, indeed, the larger loss in output
in the euro area corresponds to a US gain.
conclusion (prescribing an expansionary monetary stance) is the relevant one empirically,
at least for relatively large, moderately open economies like the United States and the
euro area.17
THE US ‘PRIVILEGE’ OF ISSUING THE DOMINANT CURRENCY IN
INTERNATIONAL TRADE
The US dollar retains a special role as the dominant currency used in international trade
of goods. It is well known that, if the prices of (a large share of) imports in all countries
are sticky in dollar units, the US (the dominant currency country) can rely to a much
larger extent on monetary policy as a stabilisation tool. That is, even in a symmetric trade
war, the United States should be in a better position to redress the distortionary effects
of the tariff shock on own output and employment. This has stark implications for EA
policy and, crucially, for the euro–dollar exchange rate.
In response to a symmetric trade war (see Figure A3 in the Appendix), the optimal
monetary stance is no longer identical in the two regions. The optimal policy is relatively
more expansionary in the United States. This is so because a dollar depreciation would
not produce significant imported inflation in goods and inputs – import prices in dollars
move very little with the exchange rate, at least in the short run – improving the trade-off
faced by the US central bank. An asymmetric expansion in the United States, in turn,
is somewhat good news for the euro area – it sustains the demand for the EA product.
Moreover, since a dollar depreciation means that the euro prices of imports from the
United Sattes falls at the border, it reduces EA imported inflation.
On the euro area side, even if the tariff hikes are perfectly symmetric, matching the US
expansion will not be a good course of action. A weaker euro will have limited effects on
EA firms’ competitiveness, since their international prices are sticky in dollars, while it
will increase imported inflation. Because of this, at the margin the euro area will have an
incentive to be more conservative and contain inflation, at the cost of some output losses.
So, while the optimal policy prevents a fall in GDP in the United States, it only moderates
17 Note that even if the tariff impact raises PPI and turns the optimal policy response contractionary, it will still be true that
monetary authorities should focus on PPI rather than CPI inflation, to calibrate their response.
317
TRADE WARS AND EUROPEAN MONETARY POLICY | BERGIN AND CORSETTI
Remarkably, in our simulations, if the central bank targets producer price (PPI) inflation
(as opposed to consumer price (CPI) inflation), the macroeconomic dynamic is close to
that under the optimal policy. This is because tariff shocks present policymakers with a
particular combination of supply and demand effects. A tariff is a shock to the relative
price of imports that tend to raise the average price of all consumption goods – via the
rising costs of goods and intermediate inputs imported from abroad. At the same time,
it is a shock to demand, that may put downward pressure on the price set by domestic
firms. While tariffs raise CPI inflation, PPI inflation is a better indicator of the balance
between cost pressures and demand conditions faced by domestic firms.
the GDP contraction in the euro area. The EA GDP falls by 0.13% under optimal policy
versus 0.17% under a Taylor rule. The asymmetry in monetary stance means that the
euro will appreciate vis-à-vis the dollar in a trade war.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
318
The dollar as dominant currency is of course consequential also in the unilateral tariff
scenario (see Figure A4 in the Appendix). Relative to the trade war scenario above,
inflation will be a more pressing concern for the US monetary authorities. Recall
that, to the extent that internationally traded goods are all priced in dollars, a dollar
appreciation would only have moderate crowding out effects on the demand for US goods
in the international market. As in Figure 1, under our calibration the optimal monetary
stance is contractionary.18
Global repercussions are apparent. The demand spillovers from the US contractionary
stance amplify the fall in EA GDP in our simulations, both under a Taylor rule (EA GDP
falls by 0.48%) and under the optimal policy (0.23%). In Europe, the optimal stance needs
to prompt domestic demand vis-à-vis falling exports to the United States – tolerating
inflation and exacerbating the euro depreciation. The dollar appreciates by more than in
Figure 1 in this scenario.
In concluding this section, it is worth stressing that, in light of our model, the euro-dollar
exchange rate may move in different directions in response to US tariff shocks: the dollar
weakens in a tariff war with retaliation, strengthens if tariffs are imposed unilaterally
by the United States. It follows that, considering retaliatory measures, the dollar
depreciation in the first month of 2025 in the wake of US tariff announcement is not, per
se, an empirical pattern at odds with state-of-the-art models of the transmission of tariff
shocks. Nonetheless, the magnitude of currency and yield movements prompted by the
sequence of tariff announcements and threats in 2025 may also reflect evolving market
expectations about the macroeconomic and fiscal outlook on both sides of the Atlantic.
CONCLUSIONS
Tariff shocks may present policymakers with a particularly difficult choice between
moderating inflation and stabilising the output gap. Several factors in the current
situation suggest that, even while tariffs are likely to be inflationary, it might be optimal
for policy to focus more on the inefficient fall in output. These factors include the
likelihood that US tariffs could be reciprocated in a tariff war, the fact that current tariff
threats seem centred on final consumption goods rather than intermediate inputs in
domestic production, and the fact that the US dollar has an asymmetric position in world
trade as a dominant currency.
18 As already mentioned in footnote 10, the monetary stance is sensitive to the persistence of the shock and the trade
elasticity, both impinging on the output and demand impact of tariff distortions. Also in the case of Dollar Currency Pricing,
it is possible that the monetary stance in the US accommodates some PPI inflation, i.e., is expansionary relative to the
natural rate. However, the dollar would still appreciate, as the stance will remain relatively contractionary vis-à-vis the
United States.
We close with some important caveats. When we started to work on the optimal monetary
policy response to a trade war, we drew on the experience from the early trade measures
of the first Trump administration. It is fair to say that virtually nobody anticipated the
scale and scope of the new round of tariffs rattling the world economy. Some of the
assumptions we use in our model simulations may not be reliable in exercises where tariff
rates are above 20% on average, with peaks above 100% in some countries. While our
results should be qualitatively unchanged, the dynamics may be different. If firms adjust
prices more flexibly, monetary policy may become less effective in sustaining output.
There are also serious concerns about the possibility that the trade war causes instability
in government bond markets. In the United States, there is no clear debt reduction plan
(see the contribution by Fatás and Panizza in this volume), and in Europe, fiscal policy
must account for increased defence spending – partly in response to the United States
withdrawing its security guarantees for Ukraine. To keep the bond market stable, central
banks may need to step in to prevent further financial market disruptions.
On a deeper level, if a full-blown tariff war breaks out in a highly polarised global
environment, can we expect central banks to be able to carry on as independent
institutions, focused on macroeconomic stability, according to the current best practice
and standards? If the answer is positive, under what conditions? The debate on how to
manage fiscal and monetary policy – revived during the Global Financial Crisis and
Covid-19 pandemic – remains unresolved, and finding a balanced solution may now be
even harder.
REFERENCES
Alcidi, C, I Angeloni and C Tille (2025), “Unpredictable Tariffs by the US: Implications
for the euro area and its monetary policy”, study requested by the ECON committee of
the European Parliament, Monetary Dialogue Papers, March.
19 One distinctive feature of the tariffs of the second Trump administration (Trump 2.0 tariffs), is that they impact a wider
cross-section of goods than was true in the previous tariff round, targeting a broad range of final consumption goods in
addition to materials such as aluminum and steel. Reallocation between different sectors of the economy typically is front
and center of analysis of tariffs in the trade literature; in fact, tariff policies often are motivated by the goal of favouring
such reallocation – say, promoting domestic manufacturing. In Bergin and Corsetti (2025), we reconsider the monetary
stabilisation of tariffs enriching New Keynesian model with comparative advantage between multiple sectors producing
tradables, hence potentially subject to tariffs, that differ in terms of market structure and price rigidity. We reach two main
results. At the aggregate level, our overall conclusion is in line with the standard model. The optimal response to a trade
war is expansionary, supporting activity and producer prices at the expense of generating short-run headline inflation.
This prescription of monetary expansion applies broadly, both for tariffs aimed at differentiated and non-differentiated
goods. Yet the dynamic of the model, and the motivation for such policy prescription are quite different across cases.
319
TRADE WARS AND EUROPEAN MONETARY POLICY | BERGIN AND CORSETTI
Computation of optimal monetary policy in a model (from Bergin and Corsetti 2023)
suggests it may be useful to focus on the effects of the shocks on producer prices, as the
response of these prices better reflect the balance between the demand and cost effects
of tariffs on production, hence economic activity and employment. Consumer prices will
have to adjust to the change in the relative price induced by the tariff, very similar to the
effect of a consumer tax, but selective on imports.19
Auray, S, M B Devereux, and A Eyquem (2024), “Trade Wars, Nominal Rigidities, and
Monetary Policy”, The Review of Economic Studies 10, 1093.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
320
Barata da Rocha, M, N Boivin and N Poitiers (2025), “The Economic Impact of Trump’s
Tariffs on Europe: an Initial Assessment”, Breugel Working Paper (https://www.bruegel.
org/analysis/economic-impact-trumps-tariffs-europe-initial-assessment).
Barattieri, A, M Cacciatore, and F Ghironi (2021), “Protectionism and the Business
Cycle”, Journal of International Economics 129, 103417.
Bergin, P R and G Corsetti (2023), “The Macroeconomic Stabilization of Tariff Shocks:
What is the Optimal Monetary Response?”, Journal of International Economics 143,
103758.
Bergin, P R and G Corsetti (2025), “Monetary Stabilization of Sectoral Tariffs”, CEPR
Discussion Paper No. 20257.
Bianchi, J and L Coulibaly (2025), “The Optimal Monetary Policy Response to Tariffs”,
NBER Working Paper 33560.
Born, B, G J Müller, M Schularick and P Sedláček (2019), “The Costs of Economic
Nationalism: Evidence from the Brexit Experiment”, The Economic Journal 129: 27222744.
Bottazzi, L, C Favero, F Fernandez-Fuertes, F Giavazzi, V Guerrieri, G Lorenzoni and T
Monacelli (2024), “Area Risks Amid US Protectionism”, study Requested by the ECON
committee of the European Parliament, Monetary Dialogue Papers, March.
Caldara, D, M Iacoviello, P Molligo, A Prestipino and A Raffo (2020), “The Economic
Effects of Trade Policy Uncertainty”, Journal of Monetary Economics 109: 38-59.
Caliendo, L, R C Feenstra, J Romalis, and A M Taylor (2017), “Tariff Reductions, Entry,
and Welfare: Theory and Evidence for the Last Two Decades”, working paper.
Dhingra, S, H Huang, G Ottaviano, J P Pessoa, T Sampson, and J Van Reenen (2017),
“The Consequences of Brexit for UK Trade and Living Standards”, Economic Policy
32(92): 651-705.
Erceg, C, A Prestipino, and A Raffo (2018), “The Macroeconomic Effects of Trade Policy,”
Board of Governors of the Federal Reserve System International Finance Discussion
Paper No. 1242.
Felbermayr, G, J Hinz and R J Langhammer (2024), “US Trade Policy After 2024:
What Is at Stake for Europe”, Policy Brief 178, Kiel Institute for the World Economy
(https://www.ifw-kiel.de/publications/us-trade-policy-after-2024-what-is-at-stake-foreurope-33388/).
Guerrieri, V, M Marcussen, L Reichlin, and S Tenreyro (2023), The Art and Science of
Patience: Relative Prices and Inflation, 26th Geneva Report on the World Economy,
ICMB and CEPR.
Lindé, J and A Pescatori (2019), “The Macroeconomic Effects of Trade Tariffs: Revisiting
the Lerner Symmetry Result”, Journal of International Money and Finance 95(C): 5269.
McKibbin, W J and M Noland (2025), “Modeling a US-EA trade war: Tariffs won’t improve
US global trade balance’, Realtime Economics, Peterson Institute for International
Economics, 24 March (https://www.piie.com/blogs/realtime-economics/2025/modelingus-eu-trade-war-tariffs-wont-improve-us-global-trade-balance).
Monacelli, T (2025), “Tariffs and Monetary Policy”, CEPR Discussion Paper No. 20142.
Sampson, T (2017), “Brexit: The Economics of International Disintegration”, Journal of
Economic Perspectives 31(4): 163-184.
Steinberg, J B (2019), “Brexit and the Macroeconomic Impact of Trade Policy Uncertainty”,
Journal of International Economics 117, 175-195.
Van Reenen, J (2016), “Brexit’s Long-Run Effects on the UK Economy”, Brookings Papers
on Economic Activity 47(2): 367-383.
ABOUT THE AUTHORS
Paul Bergin (Ph.D. Yale, 1996), is Professor in the Department of Economics at the
University of California at Davis. He is also a Research Associate at the National Bureau
of Economic Research. He publishes on topics of monetary policy in open economies,
as well as exchange rate and current account behaviour. He has served as editor of
the Review of World Economics, area editor of the Oxford Research Encyclopedia of
Economics and Finance, and associate editor of the Journal of International Economics.
Giancarlo Corsetti (Ph.D. Yale, 1992), is Pierre Werner Chair and joint Professor,
Department of Economics and Robert Schuman Centre for Advanced Studies of the
European University Institute. He is affiliated with CEPR and the Cambridge Janeway
Institute. He has been Academic Adviser at the Bank of England, the European Central
Bank and other national and international monetary institutions. He is a leading scholar
in international economics and open macro with pioneering contributions on currency,
financial and sovereign crises, monetary and fiscal policy in open economy, and the
international transmission and global imbalances, published in top academic journals.
321
TRADE WARS AND EUROPEAN MONETARY POLICY | BERGIN AND CORSETTI
Jeanne, O (2021), “Currency Wars, Trade Wars, and Global Demand”, Johns Hopkins
University Working Paper.
He served as co-editor of the Journal of International Economics between 2005 and
2016. In 2015 he gave the Schumpeter Lecture at the Meetings of the European Economic
Association in Manheim. In 2020, he was elected fellow of the British Academy.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
322
APPENDIX: SUPPLEMENTARY FIGURES
FIGURE A1
UNILATERAL US TARIFF
Note: Vertical axis is percent deviation (1=1%) from steady state levels. Trade balance in percent of GDP. Interest rates in
percentage points (1 = 1 percentage point). Horizontal axis is time (in quarters).
FIGURE A2 SYMMETRIC TARIFF WAR
Note: Vertical axis is percent deviation (1=1%) from steady state levels. Trade balance in percent of GDP. Interest rates in
percentage points (1 = 1 percentage point). Horizontal axis is time (in quarters).
TRADE WARS AND EUROPEAN MONETARY POLICY | BERGIN AND CORSETTI
323
FIGURE A3 SYMMETRIC TARIFF WAR, US DOMINANT CURRENCY
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
324
Note: Vertical axis is percent deviation (1=1%) from steady state levels. Trade balance in percent of GDP. Interest rates in
percentage points (1 = 1 percentage point). Horizontal axis is time (in quarters).
FIGURE A4 UNILATERAL US TARIFF WAR, US DOMINANT CURRENCY
TRADE WARS AND EUROPEAN MONETARY POLICY | BERGIN AND CORSETTI
325
Note: Vertical axis is percent deviation (1=1%) from steady state levels. Trade balance in percent of GDP. Interest rates in
percentage points (1 = 1 percentage point). Horizontal axis is time (in quarters).
CHAPTER 27
Armin Steinbach,ac Guntram Wolff,bc and Jeromin Zettelmeyercd
a
HEC Paris; bUniversité libre de Bruxelles; cBruegel; dCEPR
1 INTRODUCTION
Europe faces a grave security threat, created by Russia’s aggression in Ukraine and
exacerbated by changes in US policy on Ukraine and European defence. Since the
inauguration of President Trump, Europe can no longer rely on the United States
as a friendly hegemon backstopping its security.2 The result has been a watershed for
European attitudes towards defence. European leaders have called for greater defence
autonomy and far greater defence efforts.3 Germany has changed its constitution to allow
unlimited debt-financing of security spending. The European Commission has offered a
relaxation of EU fiscal rules and a new lending programme – Security Action for Europe,
or SAFE – in support of higher defence spending.
At the same time, Europe’s rearmament faces problems that cannot be solved even
by much greater willingness to spend on defence. Europe’s defence industrial base is
nationally fragmented. Europe’s defence production lacks scale, and home bias in
procurement shields national defence champions from competition. Several modern
arms technologies are missing (Burilkov et al. 2025). Fiscal space for rearmament is
unevenly distributed, making it difficult to fund expensive defence assets that would
benefit Europe as a whole. Unless these problems can be overcome, Europe’s rearmament
effort is likely to be expensive and slow, and some weapons systems may be unaffordable.
The purpose of this chapter, a shorter and revised version of Wolff et al. (2025), is to
analyse the shortcomings of the current EU defence industrial base and procurement
policies and present ideas for improving the governance and financing of European
rearmament. Section 2 presents Europe’s main challenge: to undertake large-scale,
accelerated rearmament in the face of an overstretched and nationally fragmented
1
2
3
This chapter is based on Wolff et al (2025). Research assistance by Juan Mejino-Lopez is gratefully acknowledged. the
authors are grateful to Rebecca Christie, Zsolt Darvas, Hans Gerooms, Heather Grabbe, Jacob Funk Kirkegaard, Pawel
Karbownik, Petros Mavroidis, Lucio Pench, Niclas Poitiers, Beatrice Weder di Mauro, Georg Zachman, and seminar
participants at Bruegel and the CEPR Research and Policy Network on European Economic Policy for comments on an
earlier draft.
The US position is now that “European allies [must] take ownership of conventional security on the continent” (speech by
US defence secretary Pete Hegseth to the NATO Ukraine Defence Contact Group, 12 February 2025).
European Council conclusion on European defence, 6. March 2025.
327
RETHINKING THE GOVERNANCE AND FUNDING OF EUROPEAN REARMAMENT | STEINBACH, WOLFF AND ZETTELMEYER
Rethinking the governance and funding
of European rearmament1
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
328
European defence industry. Section 3 discusses incremental efforts to increase defence
capacity based on existing EU mechanisms and financing instruments. Section 4
presents a proposal that would go further: a new institution based on intergovernmental
treaty that could plan, fund, and own expensive common European defence assets and
create a defence single market within its membership. The latter should be open to both
EU members and non-EU European democracies.
2 EUROPE’S REARMAMENT CONUNDRUM
Following the end of the Cold War, European countries slashed military budgets much
more than the United States. As their arsenals shrank, domestic defence suppliers became
niche, resulting in low volumes and high unit costs. This reinforced dependency on the
United States and further increased the scale advantage of the US defence industry.
Europe’s military capabilities are fragmented along national lines. The continent’s
defence relies on NATO and US leadership within NATO. Apart from boots on the
ground, the United States has provided Europe with ‘strategic enablers’, without
which national European armies would be far less effective: joint command and control
capabilities, satellite-based intelligence and communication, and other systems whose
benefits spread widely across countries.4
To reduce its dependence on the United States, Europe must thus close a large gap. This
means both acquiring strategic enablers that could potentially be put under European
operational control and better equipping its troops with military equipment such as
tanks, artillery, ammunition, drones, and aircraft (Burilkov and Wolff 2025, IISS 2019).5
Europe’s conundrum is that these ambitious rearmament goals must be reached with
limited fiscal space and in the face of a nationally fragmented defence industry, which
is already overstretched because of its limited capacity and the provision of military
support to Ukraine. European defence procurement is characterised by strong home
bias,6 implying that national suppliers have significant market power. European defence
companies and the scale of European weapons production are relatively small, and
some modern arms technologies – such as fifth generation fighters and HIMAR-style
rocket artillery systems – are missing altogether. With this market structure, a European
rearmament push risks sharply raise prices and/or perpetuating European dependence
on US suppliers.
4
5
6
The European Commission’s “White paper” speaks of critical capability gaps. We prefer, however, the term strategic
enablers as it is about enabling capacities that cannot be easily provided at the national level alone. Many missing national
capabilities, such as for example ammunition, are also critical but they do not have a cross-country enabling function.
IISS (2019) estimated that Europe would have to invest between US$288 billion and US$357 billion to fill the capability
gaps in a specific scenario. This would be for a scenario in which Europe would need to reassure the Baltics and Poland
after a Russian incursion into Lithuania. By now, prices have increased while Russia has greater capabilities, suggesting
that the number could be larger. Burilkov and Wolff (2025) estimate that Europe will need to invest into equipping up to
300,000 additional soldiers. Burilkov et al (forthcoming) estimate that building air defence capabilities along could cost
Europe some €300 billion. NATO aims to increase defence spending to 3.5% of GDP.
For example, Germany buys almost half of its equipment from domestic producers and around an additional 30% from
domestic joint ventures (Wolff et al. 2024, Mejino-Lopez and Wolff 2024).
The main elements of a solution are easy to describe in principle. First and foremost,
Europe must create a common European defence market, both to increase competition
among existing major defence players and to encourage entry by increasing the scale
of the potential market. Second, European countries should procure jointly, both for
monopsony power – to compress markups where competition remains limited – and to
raise scale. Higher production scale is associated with lower unit costs (Figure 1). Third,
Europe needs a structure for common ownership and funding of expensive strategic
enablers to spread the fiscal costs of common defence assets over many shoulders and
over time.
FIGURE 1
SELF-PROPELLED HOWITZERS: COST PER UNIT AND PRODUCTION SCALE
Cost per unit in millions of euros
18
Panzerhaubitze
2000
(Germany); 17.0
16
14
RCH-155 self
propelled
howitzer
(Germany); 11.1
12
10
8
Zuzana-2
CAESAR artillery
howitzer
howitzer
(Slovakia); 5.9 (France); 5.9
K9 Thunder
2S19 Msta-S
(South Korea);
(Russia); 3.0
3.0
M109 (US); 1.6
6
4
2
2S22 Bohdana
(Ukraine); 2.3
0
0
50
100
150
200
Annual production capacity (number of units)
Source: Wolff et al. (2025).
At the same time, moving in this direction requires overcoming or offsetting the incentives
and concerns that are the explanation of Europe’s defence and fiscal fragmentation.
These include longstanding national defence traditions and standards, which imply that
coordinating on common weapons systems might create high switching costs; industrial
nationalism and special interests; and concerns about fiscal transfers and moral hazard.
In the remainder of this chapter, we first examine whether it might be possible to
create solutions by expanding and modifying existing EU mechanisms, building on
institutions such as the European Defence Agency, as well as efforts to increase EU
329
RETHINKING THE GOVERNANCE AND FUNDING OF EUROPEAN REARMAMENT | STEINBACH, WOLFF AND ZETTELMEYER
A further problem is the uneven distribution of fiscal space across European countries
While some countries, including Germany, Scandinavian countries and the Netherlands,
have significant fiscal space to raise expenditures, others do not (Boivin and Darvas
2025). This imbalance makes common rearmament – including investment in shared
European strategic enablers – very difficult.
defence capabilities since the Russian invasion of Ukraine. We then sketch a solution that
would go further: the creation of a new international institution, a ‘European Defence
Mechanism’, through intergovernmental agreement.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
330
3 IMPROVING EUROPEAN DEFENCE CAPABILITIES THROUGH INCREMENTAL
EU-LEVEL EFFORTS
Since the first Trump administration first underlined the need for greater EU defence
autonomy, and particularly since Russia’s invasion of Ukraine, significant EU-level
efforts have been made to improve European defence (Table 1).
On the supply side, several EU instruments aim to develop the EU defence industry.
The current (2021-27) EU budget includes a European Defence Fund for defence-related
research and development. A 2023 Act in Support of Ammunition Production seeks to
expand capacity specifically for ammunition production. A proposed European Defence
Industry Programme (EDIP) would expand this to all defence industries. The European
Investment Bank has recently changed its eligibility rules to allow it to lend to defence
companies.
There have also been attempts to strengthen the demand side of the defence market.
A 2023 European Defence Industry Reinforcement through Common Procurement Act
(EDIRPA) offered a subsidy for common procurement, which has by now been used up.
EDIP seeks to create a legal framework that makes common procurement easier. Most
recently, the European Commission announced SAFE, which offers up to €150 billion in
loans to members states to finance joint procurement projects. The Commission has also
proposed a relaxation of EU fiscal rules by activating the escape clause in the rules to
allow for higher defence spending.
While helpful, these changes fall well short of creating a defence single market or
establishing common funding mechanisms. Incentives for common procurement remain
modest. Borrowing through SAFE offers a financial advantage only to a few countries
with above-average borrowing costs or infrequent access to the bond market, and is
immediately reflected in higher national debt.
Funding of cross-border infrastructure, including Infrastructure
dual use
Fund industrial policy supporting ammunition
production
Create a financial incentive for procurement
coordination
Fund industrial policy supporting the European
Defence Technology Industrial Based (EDTIB)
and incentivise common procurement under
a new legal framework, the "Structure for
European Armament Programme” (SEAP)
Funding of defence sector SMEs and startups,
infrastructure funding
Connecting Europe Facility
(CEF)
Act in Support of
Ammunition Production
(ASAP)
European Defence Industry
Reinforcement through
Common Procurement Act
(EDIRPA)
European Defence Industry
Programme (EDIP)
European Investment Bank
(EIB)
Supply side and
infrastructure
Supply and
demand (but
funding is for
supply side only)
Demand side
Supply side
Supply side
Not yet
passed
(proposal
dated 5/3/
2024)
October
2023
July 2023
July 2021
April 2021
March 2021
Passed on
2025
2025-2027
2024-2025
2024
2021-2027
2021-2027
2021-2027
Time frame
12.0
31.0
2.0
1.5
0.3
0.5
1.7
8.0
17.0
Amount
(€ bn)
RETHINKING THE GOVERNANCE AND FUNDING OF EUROPEAN REARMAMENT | STEINBACH, WOLFF AND ZETTELMEYER
Source: Wolff et al (2025).
of which: supply side measures
Total
Fund industrial policy and R&D on defence
sector, particularly benefitting SMEs
European Defence Fund
(EDF)
Crisis operations
Funding of EU military aid to partner countries
and EU military missions abroad (off-budget
instrument)
European Peace Facility
(EPF)
Focus
Purpose
OVERVIEW OF EU DEFENCE FUNDING MECHANISMS
Instrument
TABLE 1
331
3.9
6.9
2.0
0.5
0.3
0.5
0.3
1.1
2.4
Annual
(€ bn)
But perhaps these efforts could be pushed further within the framework of existing EU
institutions and cooperation frameworks. For example:
• Member states could commit to centralised procurement via the European
Defence Agency (EDA) in areas specified in the EDA statutes, and to refrain from
discriminating against the defence companies of other EDA members in their
national procurement.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
332
• Financial incentives through instruments such as SAFE could be extended to
not only promote joint procurements but to promote procurement from several
European suppliers (‘dual sourcing’).7 Apart from reducing procurement risks, this
could help increase competition over time, by giving new entrants a greater chance
of being considered in procurement alongside incumbents (Ilzetzki 2025).
• The EU framework for defence cooperation, PESCO, could be used to develop
strategic enablers, in collaboration with the UK and other non-EU European
democracies that might want to share defence assets.
• Building on precedents such as the EU’s 2020-22 “Support to mitigate Unemployment
Risks in an Emergency” (SURE) lending instrument, financial support for common
procurement could be expanded further, with participation from the UK and other
non-EU countries, which could contribute “externally assigned revenues” to the EU
budget for this purpose (see Wolff et al. 2025 for details).
But apart from their complexity – expanding and connecting institutional mechanisms
that were created for narrower purposes – these solutions would fall short in four main
ways.
The first is the lack of a legal commitment device. As argued above, overcoming home
bias in procurement involves leaning against national traditions, switching costs, and
potentially the capture of procurement agencies by national contractors. But under
Article 346 of the Treaty on the Functioning of the European Union (TFEU) – the national
security exception from the Single Market – commitments to non-discrimination of
suppliers from other countries and joint procurement are not legally enforceable.8
Second, the back-to-back lending structure of SURE and other financial instruments
based on on-lending of EU bond issuance would immediately be reflected in higher
government debt, a significant obstacle to the creation of strategic enablers with high
upfront costs. To avoid this, EU funds would need to be passed on to national governments
7
8
See, for example, https://breakingdefense.com/2023/07/to-help-supply-chain-challenge-dod-should-revive-secondsourcing-in-defense-acquisition/
Article 346(b) TFEU states that “any Member State may take such measures as it considers necessary for the protection
of the essential interests of its security which are connected with the production of or trade in arms, munitions and war
material; such measures shall not adversely affect the conditions of competition in the internal market regarding products
which are not intended for specifically military purposes”.
as grants or heavily subsidised loans, along the lines of the grants disbursed through
the 2021-26 Recovery and Resilience Facility. Creating such a scheme would require
unanimity in the European Council.
The fourth shortcoming is the fact that, although non-EU European countries could
selectively benefit from EU cooperation and financial support instruments, they could
not do so on an equal footing.
4 A NEW INTER-GOVERNMENTAL ORGANISATION: THE EUROPEAN DEFENCE
MECHANISM (EDM)
A solution to these problems could be a new, ESM-like intergovernmental institution – a
European Defence Mechanism (EDM). This would serve as an exclusive procurement
agency in specified areas, as planner, funder and potentially owner of strategic enablers,
and as a legal commitment to observe defence single market rules within the jurisdictions
of its members. Unlike the EDA, failure of members to live up to their obligations could
trigger sanctions, including suspension from the defence single market.
Such an institution could be structured as follows (see also Zettelmeyer et al. 2025):
Membership should include the largest European countries, including the UK, and
any other European democracy that wishes to join. Universal European membership
is desirable but not critical. The EU could join as a separate shareholder, similar to its
membership in the European Bank of Reconstruction and Development (EBRD). As a
European democracy with a very strong defence industrial sector, Ukraine could and
should join the EDM (Kirkegaard 2025). Since the country may not be able to afford
to contribute its paid-in capital immediately, a transition arrangement and/or initial
funding of Ukraine’s capital share by the EU or other EDM members would be required.
Governance: Members would pay a subscription (quota), consisting of paid-in capital
and callable capital, based on economic size and other structural features relevant to
the EDM’s mandate, such as the level of military spending and/or the military assets of
the member. Decisions would be taken based on subscription share-weighted simple or
qualified majorities, depending on the issue.
Mandate: To expand European defence capabilities and foster defence cooperation
through:
333
RETHINKING THE GOVERNANCE AND FUNDING OF EUROPEAN REARMAMENT | STEINBACH, WOLFF AND ZETTELMEYER
Third, the financial incentives associated with the on-lending of EU bond issuance are
typically small (or indeed non-existent for countries such as Germany, which can issue
debt a lower cost than the EU). For example, on 10 March 2025, the yield on a 10-year
EU bond was 3.41%, 60 basis points above the 10-year German bund and 11, 18 and 45
basis points, respectively, below the Spanish, French and Italian 10-year bond yields on
the same day. Hence, the interest rate subsidy is equivalent to a ‘discount’ of just 0.18% of
procurement costs for France and 0.45% for Italy.
1. Planning, funding, and ownership of European strategic enablers, with a
minimum list enshrined in the EDM treaty. Examples include a satellite system for
military intelligence and communication, and the development and deployment of
expensive air defence systems and new missile technology.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
334
2. The creation of a defence industry single market, through (1) prohibition of
discrimination in procurement based on nationality, with a much narrower scope
for any exceptions than under Article 346 TFEU; and (2) prohibition of state aid
for defence companies.
3. Joint procurement in critical areas (with a minimum list of such areas defined in
the EDM treaty).
4. Defence-related lending to all members.
5. Support for frontline members through subsidised (e.g. interest-free) lending and/
or by allocating greater shares of procured gear to frontline members than those
members pay for, with the cost split between all members based on quota shares.
Membership obligations would include:
1. Adherence to defence industry single market rules.
2. Refraining from procuring nationally in areas for which joint procurement has
been agreed in the EDM treaty.
3. Undertaking join procurement through competitive tenders (rather than
negotiations between national procurement authorities).
4. Paying for their shares of defence assets procured or planned through the EDM
either when those assets are delivered or when the services of those assets are
delivered. The share of assets would be determined:
a. in the case of joint procurement, by the offtake-share agreed at the beginning
of procurement projects (with commitment to a particular level of offtake
being voluntary on the part of each member);
b. in the case of strategic enablers: by the capital key of the EDM members.
5. Repaying any EDM loans.
Operations and instruments
1. The EDM would act as a procurement planner, defence planner, and procurement
agent in areas specified by the EDM treaty.
2. Procurement would be done according to a set of principles anchored in the EDM
treaty, including competitive tenders and defining the asset to be procured by a set
of desired capabilities rather than specific technical characteristics.
3. The EDM would borrow on capital markets, with the aim of financing (1) joint
procurement (with the EDM acting as the procurement authority) until the
ownership of procured gear is transferred to members, (2) strategic enablers, and
(3) lending to members.
benefits to all members, as well as retain property of procured defence goods until
they are needed (rather than transferring ownership to members upon purchase).
When defence assets remain EDM property, the debt issued to fund these assets
would remain on the books of the EDM and thus not show up in the national debts
of EDM members. While EDM members would need to pay a ‘service fee’ to cover
the cost of providing these European public goods – the interest cost of financing
the assets, plus a small markup – the cost of the acquisition itself would be funded
by issuing EDM bonds.
5. Lending to members could occur through two windows: a standard window, open
to all members; and a subsidised window accessible only to ‘frontline states’.
Scope of procurement: In general, only defence goods produced by defence contractors
headquartered in EDM countries – or by consortia with a defined minimum degree of
participation by contractors headquartered in EDM countries – could be procured by the
EDM. This principle could be overridden by a (possibly, qualified) majority of the EDM
board to accommodate circumstances in which the desired military capability cannot be
procured (or only at much higher cost) without the participation of a defence contractor
headquartered in a non-member state.
Relationships with PESCO, EDA and NATO: The EDM mandate would overlap with
some PESCO and EDA functions – coordination on procurement and development of
strategic enablers. Modalities for cooperation and sharing of expertise would need to
be developed in these areas. However, both PESCO and EDA have roles that go beyond
and would be complementary to the EDM, such as operational cooperation (PESCO)
and research and training support (EDA). In addition, the EDM could draw on the
procurement expertise of both the EDA and the NATO support and procurement agency.
5 CONCLUSION
Europe needs to rearm rapidly and acquire its own strategic enablers. To that end, it
needs scale, a functioning single market for defence, and coordinated demand. A new
European Defence Mechanism (EDM), based on intergovernmental treaty, would help
achieve this.
An EDM is preferable to an extension of existing EU mechanisms and financial
instruments, for three reasons.
335
RETHINKING THE GOVERNANCE AND FUNDING OF EUROPEAN REARMAMENT | STEINBACH, WOLFF AND ZETTELMEYER
4. The EDM could own military assets used at the European level that provide
1. It would address the fundamental legal constraint that currently precludes an
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
336
EU defence goods single market, namely, Article 346 of the TFEU, which allows
EU governments to ignore internal market rules by claiming a national security
interest. The EDM would allow European democracies to opt into a legal structure
that requires its members to follow such rules. This is much easier than changing
the TFEU.
2. It would loosen a critical fiscal constraint by allowing certain defence assets,
including both shared strategic enablers and procured materiel that is not
immediately needed by the armed forces of EDM members, to remain in EDM
ownership. Debt incurred to acquire those assets would remain on the EDM’s
books.
3. It would allow non-EU members to join on an equal footing.
Creating the EDM would be an ambitious undertaking. Although it would provide for far
greater fiscal benefits than any of the feasible alternatives, it would require substantial
paid-in capital. It would require competent staff, including a first-rate treasury. The setup costs would be substantial. But the set-up need not take long – the EBRD, for example,
went from signing to start of operations in less than a year.
REFERENCES
Boivin, N E and Z Darvas (2025), “The European Union’s new fiscal framework: a good
start, but challenges loom”, Bruegel Policy Brief 06/2025 (https://www.bruegel.org/sites/
default/files/2025-02/PB%2006%202025_0.pdf).
Burilkov, A and G Wolff (2025), “Defending Europe without the US - first estimates of
what is needed”,, Bruegel Analysis/Kiel Policy Brief, 21 February (https://www.bruegel.
org/analysis/defending-europe-without-us-first-estimates-what-needed).
Burilkov, A, J Mejino-Lopez, T Morgan, and G Wolff et al (2025), A forensic assessment of
European rearmament efforts, Bruegel/Kiel report, forthcoming.
IISS – International Institute for Strategic Studies (2019), “Defending Europe: scenariobased capability requirements for NATO’s European members’, Research Paper, 10 May
(https://www.iiss.org/research-paper/2019/05/defending-europe).
Ilzetzki, E (2025), Guns and growth: The economic consequences of defense buildups, Kiel
Report 2, Kiel Institute for the World Economy (https://www.ifw-kiel.de/publications/
guns-and-growth-the-economic-consequences-of-defense-buildups-33747/).
Kirkegaard, J F (2025), “Ukraine: European democracy’s affordable arsenal”, Bruegel
Policy
Brief
10/2025
(https://www.bruegel.org/policy-brief/ukraine-europeandemocracys-affordable-arsenal).
Mejino-Lopez, J and G Wolff (2024), “A European defence industrial strategy in a hostile
world”, Bruegel Policy Brief 29/2024 (https://www.bruegel.org/policy-brief/europeandefence-industrial-strategy-hostile-world).
Wolff, G, A Steinbach and J Zettelmeyer (2025), “The governance and funding of
European rearmament”, Bruegel Policy Brief 15/2025 (https://www.bruegel.org/policybrief/governance-and-funding-european-rearmament).
Zettelmeyer, J, A Steinbach and G Wolff (2025), “The proposed European Defence
Mechanism: questions and answers”, Bruegel Analysis, 16 April (https://www.bruegel.
org/sites/default/files/2025-04/the-proposed-european-defence-mechanism%3Aquestions-and-answers-10844_2.pdf
ABOUT THE AUTHORS
Armin Steinbach holds the Jean Monnet Chair and the HEC Foundation Chair of Law
and Economics, European Law and International Law at HEC Paris. He is also Affiliate
at the Max Planck Institute for Research on Collective Goods in Bonn and non-resident
Fellow at Brussels-based think tank Bruegel. Previously, Armin held academic posts
as Gwilym Gibbon Fellow at Oxford University’s Nuffield College, Jean Monnet Fellow
at the European University Institute in Florence, visiting professor at University of St.
Gallen, and Harvard University’s Center for European Studies.
Guntram Wolff is a Professor of Economics at the Solvay Brussels School of ULB. He
is a Senior Fellow at Bruegel, which he directed from 2013-22. From 2022-24, he was
director of the German Council on Foreign Relations. His research focuses on European
integration, climate policy, geo- and defence economics and macroeconomics. He
regularly advises EU finance ministers and national parliaments and has published in
leading journals such as Nature, Energy Policy, Climate Policy, Journal for European
Public Policy, and Foreign Affairs. .
Jeromin Zettelmeyer is Director of Bruegel and a CEPR Research Fellow. He was
previously Deputy Director of the IMF’s Strategy and Policy Review Department (20192022), Senior Fellow at the Peterson Institute for International Economics (2016-19),
Director-General for Economic Policy at the German Federal Ministry for Economic
Affairs and Energy (2014-16); Director of Research and Deputy Chief Economist at the
European Bank for Reconstruction and Development (2008-2014), and an IMF staff
member, where he worked in the Research, Western Hemisphere, and European II
Departments (1994-2008). His research interests include EMU governance, financial
crises, and sovereign debt.
337
RETHINKING THE GOVERNANCE AND FUNDING OF EUROPEAN REARMAMENT | STEINBACH, WOLFF AND ZETTELMEYER
Wolff, G, A Burilkov, K Bushnell and I Kharitonov (2024), Fit for war in decades: Europe’s
and Germany’s slow rearmament vis-a-vis Russia, Kiel Report 1, Kiel Institute for the
World Economy (https://www.ifw-kiel.de/publications/fit-for-war-in-decades-europesand-germanys-slow-rearmament-vis-a-vis-russia-33234/).
CHAPTER 28
Tom Enders, Jeannette zu Fürstenberg, René Obermann and Moritz Schularick
German Council on Foreign Relations; General Catalyst; Airbus SE; Kiel Institute for the
World Economy, Sciences Po and CEPR
The notable shift in US foreign and security policy, the uncertain commitment of the
United States to NATO, and the apparent lack of American support for the Ukrainian
cause have triggered a comprehensive rethink of European and German security
strategies. By bringing together the perspectives from industry, technology and
economics, we outline the priorities for a German and European defence policy strategy
for the coming decades.
1 CONTEXT AND PRIORITIES
Europe and Germany face a fundamentally altered security landscape, driven by Russia’s
war of aggression against Ukraine and the diminishing confidence in transatlantic
security guarantees (Irto et al. 2025). Simultaneously, the global competition for
technological dominance is accelerating.
At this critical juncture, we argue that Germany must initiate a ‘SPARTA’ project
(Strategic Protection and Advanced Resilience Technology Alliance) for European
defence. This necessitates the immediate launch of large-scale armaments programmes,
prioritising cutting-edge technologies and intra-European procurement for strategic
autonomy.
Eleven priority programmes should be central to this project. Each must create an
asymmetric advantage and be feasible in the short term (1-3 years) or medium term (3-5
years), if not immediately (6-12 months). The focus cannot be exclusively on long-term
development projects.
The focus of these efforts should be the ‘sharp end’ of defence to urgently reinforce
deterrence today – that is, they must primarily deliver combat superiority on the modern
battlefield, rather than prioritising the support or logistical aspects of defence.
1
An earlier version of this chapter was published in German as a Kiel Focus Paper and in the Wirtschaftsdienst journal.
339
ADVANCED TECHNOLOGY AS EUROPE’S STRATEGIC IMPERATIVE | ENDERS, ZU FÜRSTENBERG, OBERMANN AND SCHULARICK
Advanced technology as Europe’s
strategic imperative1
1. Immediate to short term: Reconnaissance and operational superiority across all
domains
a. Establish a comprehensive drone defence network along NATO’s Eastern Flank
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
340
for effective deterrence through sheer numbers (several tens of thousands of
combat drones for asymmetric capability that can be procured rapidly)
b. Modernise existing platforms to enable more effective reconnaissance and
combat – both by employing drones and countering enemy drones – as required
on the modern battlefield
c. Establish a ‘sovereign’ European satellite constellation and real-time analysis
for military applications, particularly for monitoring NATO’s Eastern Flank
d. Establish comprehensive underwater surveillance in the Baltic region, in
cooperation with countries bordering the Baltic Sea, to prevent Russia’s hybrid
warfare targeting critical undersea infrastructure
e. Ensure effective protection and deterrence against hybrid warfare by Russia –
both cyber and physical – such as supply chain security to guard sabotage
2. Short to medium term: Leadership in asymmetric digital superiority
a. Rapid implementation of a European Multi-Domain Combat Cloud to enable
decentralised, networked use of data on the battlefield accelerating command
and control, and ultimately improving combat effectiveness
b. Develop sovereign systems for electromagnetic warfare (EW) to degrade
enemy command and control capabilities
3. Medium term: Strategic air superiority and nuclear deterrence
a. Adopt uncrewed and autonomous combat drone systems (known in the
United States as Collaborative Combat Air) for qualitative and quantitative air
superiority
b. Develop a European missile and drone defence system (‘European Sky Shield’)
c. Develop a European hypersonic programme with a focus on mobile systems
for strategic deterrence
d. Cooperate with France and the United Kingdom to expand deterrence
capabilities, including in the area of strategic and tactical nuclear weapons
This list must not be exhaustive, but deliberately emphasises deterrence through
asymmetric technological advantage. Instead of gradually compensating for numerical
disadvantages in legacy platforms, we should focus on establishing clear technological
superiority in conjunction with affordable mass production and retrofitting of existing
systems.
2 STRATEGIC ANALYSIS: THE NEW EUROPEAN SECURITY ARCHITECTURE
The war in Ukraine demonstrates that military superiority arises from a blend of mass
deployment and technological excellence. Ukraine is holding the line for Europe, so it
is fighting for all of us. The economic and security policy consequences of a Ukrainian
defeat show, unmistakably, that it would cause a fundamental rupture in our societies.
The Kiel Institute for the World Economy calculates that this negative scenario would
cost hundreds of billions of euros over five years through additional refugee flows, higher
reactive military spending due to Russia’s strengthening, and losses from reductions in
trade and direct investment (Binder and Schularick 2024).
While Europe is not officially at war, it can no longer be considered at peace. Russia is
actively waging hybrid warfare against Europe, targeting critical infrastructure such as
Baltic Sea underwater cables, spreading disinformation, launching cyberattacks, and
engaging in acts of sabotage that threaten the stability of European societies. Accepting
these incursions would drive apart societies and a currently united Europe. Yet, tolerance
of such violations is growing. We must defend ourselves against both, hybrid warfare and
the growing tolerance of such violations.
Simultaneously, the global competition for technological dominance is accelerating.
Artificial intelligence (AI), autonomous systems, hypersonic weapons, and military space
operations are no longer visions of the future, but decisive factors for geopolitical power.
Europe can no longer afford to miss out on key military technologies. Incidentally, this is
also because the synergies with the civilian sector are considerable. Entire industries and
value chains are at risk of collapsing or relocating if Germany and Europe miss out on
this military technological change – as is the case in other industries and technologies,
such as semiconductors (Ilzetzki 2025). Based on a conservative estimate of the effects on
German potential growth from dependence on non-European military technology, the
growth losses would amount to €200-300 billion over the next decade, according to The
Kiel Institute for the World Economy.
3 EUROPEAN TECHNOLOGICAL SOVEREIGNTY FOR DEFENCE AND SECURITY
We are, therefore, convinced that Germany and Europe must pursue a technology-driven
defence strategy that combines military innovation with economic competitiveness. This
is possible at the same time and is actually mutually dependent. History shows that the
pressure from crises can drive technological innovation and excellence. The emergence
341
ADVANCED TECHNOLOGY AS EUROPE’S STRATEGIC IMPERATIVE | ENDERS, ZU FÜRSTENBERG, OBERMANN AND SCHULARICK
Europe and Germany are undergoing a historic transformation. The transatlantic
alliance with its historic security guarantees can no longer be taken for granted war
(Burilkov and Wolff 2025). Russia’s ongoing war of aggression in Ukraine makes it clear
that Europe’s security is based not only on diplomatic will, but also on military deterrence
and the ability to wage war. Europe’s capacity for independence, resilience, technological
sovereignty, and defence determines its strategic ability to act.
of Silicon Valley innovations and Israel’s high-tech cluster are examples of how targeted
public and private investment in security technologies promotes economic growth and
technological leadership.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
342
If Germany is now investing hundreds of billions in its security, these funds must be
directed towards defence, technological progress, and economic growth. In view of the
threat facing Germany and the need to quickly free itself of dependence on the United
States, national defence spending of 3.5% of GDP seems a reasonable figure. With
realistic assumptions about the speed of redeployment in the federal budget over the next
decade, an additional 1.5% of GDP could flow into the development of defence capacities
to reach 3.5% of GDP. However, ultimately the budgets should be determined by specific
requirements planning (Irto et al. 2025).
The first special fund was allocated to technologies of the 2000s and 2010s, and largely
non-European systems, due to the significant time pressures. The German and European
share went primarily into the land and sea domains. Future investments must focus more
strongly on strategic capabilities (deep strike and air defence) and modern technology
fields (networked and autonomous systems, and space), while at the same time expanding
and upgrading existing capabilities with modern technology. This includes artillery,
which is being made more effective with drones and software; equipping European
forces with medium-range missiles and precision weapons such as Taurus; retrofitting
Eurofighters with electromagnetic warfare capabilities; as well as A400M and C-295 for
transportation and MRTTs for aerial refuelling (Wolff et al. 2024).
A new procurement strategy must combine military and economic benefits:
3.1 Technological advantage in speed and precision is decisive for war
Ukraine demonstrates that combat effectiveness today is significantly improved through
speed, automation, and networked sensor technology. A debate focused solely on
numbers of tanks and aircraft is not productive; the decisive factors are speed of data
flows, precision, and digital integration on the battlefield. Germany has already spent
considerable sums on F-35 fighter jets. These aircraft have a highly encrypted and closed
software architecture, which makes it difficult to integrate them directly into European
systems. Their operation requires regular software updates and maintenance, which are
controlled by the United States, leading to continued dependency.
The experience from Ukraine shows that the battlefield reality is no longer that of the
Cold War. Ukraine has been holding its own against the numerically superior enemy for
three years thanks to the mass and cost-effective use of new technologies – above all,
reconnaissance and strike drones – as well as ongoing innovation. Complex, large weapon
systems, which take a long time to develop and produce but do not ensure technological
superiority or constant further development, cannot be the only solution. Procurement
has been predominantly based on these systems for years, as well as in the first special
fund, and at a ratio of no less than 99:1.
In addition to the positive macroeconomic effects, state-of-the-art technologies can
achieve tangible improvements to armed forces capabilities in the short term. Newly
deployed military equipment can be utilised more quickly and effectively through
greater system integration with other capabilities. To this end, military decision-making
processes at all levels are networked and supported by AI. This is another reason why
German military equipment has often proven its worth in the Ukraine war (Wolff et al.
2024).
Such modernisation is cost-effective compared to the procurement of new complex
hardware and the associated logistical follow-up costs, while the gain in capability in
the armed forces would be noticeable in a timely manner. In addition, state-of-the-art
technology can partially compensate for the quantitative deficit – being ‘outgunned’
and ‘outnumbered’ – against a potential Russian opponent. The area of electromagnetic
warfare is of particular importance here (Wolff et al. 2024).
To maximise the efficiency of the new funds, Germany needs to simplify its procurement.
The current procurement processes are still bureaucratically complex, involve
considerable delays, and in some cases also put European suppliers at a disadvantage
compared to US suppliers. A separate fast-track procurement procedure could be
established for European partners, particularly in the area of critical technologies, to
enable projects with urgency for security policy (Wolff et al. 2024).
4 FOCUS ON FIVE CENTRAL TECHNOLOGY AREAS
Additional funds for Germany’s and Europe’s defence and security must be invested in
five technology areas, through projects such as the following.
1. Scaling the production of autonomous systems and robotics
Autonomous systems are transforming the modern battlefield through the synthesis
of advanced technology, software, and AI. They bring mass to the battlefield while
augmenting the scarce manpower of the armed forces. Technological leadership can
overcompensate for other capability gaps and thus create advantages.
343
ADVANCED TECHNOLOGY AS EUROPE’S STRATEGIC IMPERATIVE | ENDERS, ZU FÜRSTENBERG, OBERMANN AND SCHULARICK
3.2 Technology-based defence investments are growth drivers
Analyses by the Kiel Institute for the World Economy show that investments in stateof-the-art defence technologies have higher economic multipliers than the replication of
outdated systems. The macroeconomic multipliers of defence investments range from 0.6
to 1.5, i.e. if the state invests €100 billion in defence, GDP increases by €60-150 billion.
The upper end of these effects becomes more realistic if investments are made primarily
in German and European development and production of high technology. So, the more
we invest in advanced areas with opportunities for real technological leaps, the more we
benefit economically and achieve European added value (Ilzetzki 2025).
• Autonomous systems and robots combine AI, sensor technology and control
software to take on important offensive and defensive tasks. Examples include
drone systems in the air, in water, and on land.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
344
• The development of these systems’ capabilities is largely driven by software.
Extensive capabilities that used to be ‘hard-wired’ into hardware are increasingly
shifting to software. It also enables consumer electronics (e.g. camera systems or
data links) for military use. These components can be mass-produced inexpensively
using civilian production resources.
• Success in air combat, particularly through combining crewed and uncrewed
systems that work together in close coordination, is crucial to overall military
success.
• Russia, Ukraine, China, and others are already producing military drones and
robot-assisted systems in large numbers.
• The United States has been translating this insight into concrete procurement
projects in the land and air sectors for some time. In particular, investments in
uncrewed combat aircraft, for which value is primarily driven by AI-supported
control software, point the way for future developments.
• Germany and Europe must not fall any further behind technologically in this area.
Both new and established companies in the German defence industry must be
positioned to become world leaders.
2. Broad use of applied AI and advanced software
The strategic importance of AI and software in modern defence technology is growing
rapidly – it increasingly determines military superiority and national security.
• Algorithms, machine learning, and data-driven systems for automation, analysis,
and decision support are of great importance on the battlefield. In combination
with electromagnetic warfare and crewed and uncrewed systems, they enable a
networked system for modern warfare.
• The United States is trying to expand its leading position in a targeted manner.
Software companies such as Palantir are set to become key players in the global
defence industry through large-scale procurement contracts. AI providers such
as OpenAI are beginning to make their models available to the defence industry.
China is rapidly closing the gap in this field, driven partly by extensive governmentbacked AI initiatives.
3. Sovereign access to space, protective shields, and secure communication
Sovereign access to space, a missile defence shield, and Europe’s own satellite-based
communication capabilities are indispensable components of national security and
strategic autonomy for increasingly digital warfare.
• The Ukraine conflict shows that success in military operations today depends
largely on broadband satellite communication and real-time earth observation,
but this is also indispensable for protecting the civilian population and critical
infrastructure during troop movements.
• With Starlink, the United States has created the first global, high-performance
constellation (Irto et al. 2025). China is currently following suit with its own
capability.
• European countries are far behind in terms of launch capacities and satellite
constellations. With OneWeb, consisting of 600+ satellites, Europe already has an
operational system that should offer similar communication capabilities to Starlink,
but it needs to be modernised and further expanded. In parallel, IRIS2 is to be setup, which should be state of the art for security and encryption of communication
signals, but is not expected to be fully operational until 2030.2
• Secure access to space is to be ensured by launchers such as Ariane 6, medium
and (new) micro launchers. Germany alone already has three micro-launchers
under development (RFA, Isar Aerospace, Hyimpulse), which are in competition
with other European countries via the European Launcher Challenge 2025. A joint
European approach would now be advisable in order to pool all resources.
• Given the appropriate incentives, the private sector could establish a robust satellite
constellation within the next three to four years. A dedicated focus on military
applications is urgently needed.
• As things stand today, Europe’s armed forces are, while not necessarily
acknowledged by all defensc ministries, also strategically dependent on Starlink
during large-scale warfighting scenarios – particularly if existing space assets were
targeted. In such emergencies, Europe would have to ask Elon Musk for critical
support – effectively placing our security in the hands of a single entrepreneur.
2
See https://defence-industry-space.ec.europa.eu/eu-space/iris2-secure-connectivity_en
345
ADVANCED TECHNOLOGY AS EUROPE’S STRATEGIC IMPERATIVE | ENDERS, ZU FÜRSTENBERG, OBERMANN AND SCHULARICK
Despite having excellent research institutions, numerous AI companies and cuttingedge international research, Germany’s defence sector is falling short of its full
potential. There is a lack of ambitious, large-scale procurement programmes that
effectively integrate these cutting-edge technologies into the Bundeswehr and allow
their transformative power to unfold. Furthermore, universities should remove their
civilian-use clauses that currently hinder collaboration with the military sector.
4. Expansion and modernisation of nuclear deterrence capabilities
Nuclear deterrence remains a central pillar of strategic stability and must counter
the very real nuclear threat from Russia. The further development of European
capabilities in this area can prevent Europe becoming subject to geopolitical coercion.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
346
• The Russian stationing of tactical nuclear weapons in Kaliningrad and the
preparation of launch bases in Belarus for ballistic missiles, which are also to be
equipped with nuclear weapons, represent significant potential for blackmail
against Europe.
• Europe must be equipped with similar capabilities in order to provide an effective
deterrent. Close cooperation between Germany and France and the United
Kingdom to expand capacities and integrate them into their specific protective
umbrellas appears to be the best option. Other European countries should also
participate in this programme as part of a coalition of ‘freedom defenders’.
• Germany’s current participation in NATO’s nuclear programme must remain
in place in the hope that the United States will continue to stand by NATO and
help to protect Europe if called upon in the future. However, it should be quickly
examined whether, in addition to the F35, European fighter aircraft in succession to
the Tornado could also meet requirements.
5. Development and integration of modern missiles and hypersonic weapon
systems
Hypersonic technology is defining the next generation of strategic weapon systems
and changing the balance of power in modern warfare. Their extreme speed and
manoeuvrability make them a relevant factor in deterrence and defence capabilities.
• Hypersonic weapons are elementary components of a new strategic defence
portfolio. Thanks to their combination of manoeuvrability and extreme speed,
they can overcome existing defensive systems and are therefore superior to ballistic
missiles.
• This specifically concerns weapons systems that are manoeuvrable (e.g. the Chinese
DF-17) and therefore far exceed the capabilities of those systems currently used in
the war in Ukraine.
• Hypersonic systems can also be equipped with nuclear and conventional warheads,
guaranteeing appropriate military performance depending on the situation.
Conventionally armed, they offer the highest level of sub-nuclear deterrence.
• Russia, China, and the United States have recognised the strategic potential and
are already investing billions in this area. Europe and Germany are dangerously
far behind. In order to have a future-proof strategic deterrence strategy, Germany
must develop this capability with confidence. This is the only way to keep up with
the rapid leapfrog innovation in the field of missile technology.
5 CONCLUSION
Germany must spearhead a ‘SPARTA’ project (Strategic Protection and Advanced
Resilience Technology Alliance) for European defence. Investments in autonomous
systems, AI technologies, sovereign space travel, and so on are not only imperative in
terms of security policy, they are also important catalysts for growth and technological
sovereignty.
REFERENCES
Binder, J and M Schularick (2024), “The costs of not supporting Ukraine”, Kiel Policy
Brief No. 179.
Burilkov, A and G Wolff (2025), “Defending Europe Without the US: First Estimates of
What is Needed”, Kiel Policy Brief No. 183.
Ilzetzki, E. (2025), Guns and Growth: The Economic Consequences of Defense Buildups,
Kiel Report No. 2.
Irto, G, I Kharitonov, T Nishikawa and C Trebesch (2025), “Ukraine Aid: How Europe
Can Replace US Support,” Kiel Policy Brief No. 168.
Wolff, G B, A Burilkov, K Bushnell and I Kharitonov (2024), Fit for war in decades:
Europe’s and Germany’s slow rearmament vis-à-vis Russia, Kiel Report No. 1.
ABOUT THE AUTHORS
Thomas (“Tom”) Enders studied Economics, Political Science and History at universities
in Bonn und Los Angeles (UCLA). He worked at various think tanks and in the Planning
Staff of the Federal Minister of Defense, before joining the aerospace industry in 1991.
He held various management positions at Messerschmitt-Bölkow-Blohm, DASA and
Airbus/EADS between 1991 and 2019. He was Chief Executive of Airbus/EADS between
2005 and 2019. Since 2019 he is President of the German Council on Foreign Relations
DGAP. He currently serves on the Boards of Linde Plc, GE Aerospace and Helsing SE.
347
ADVANCED TECHNOLOGY AS EUROPE’S STRATEGIC IMPERATIVE | ENDERS, ZU FÜRSTENBERG, OBERMANN AND SCHULARICK
As entrepreneurs and academics, we are convinced that our security is ultimately
determined by technological superiority and the willingness to invest heavily in it.
Those who scale and deploy the right technologies can better protect themselves against
aggressors. As a core component of a strong Europe, Germany must now implement
this in its defence policy. We stand at a historic crossroads. Will we assert ourselves as
a sovereign, defensible continent and protect our freedom and prosperity? Or will we
become dependent and gradually lose everything that has become dear to us?
Jeannette zu Fürstenberg is Managing Director of the global VC firm General Catalyst
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
348
(GC) and in charge of its European business. Jeannette is also Founding Partner of La
Famiglia VC, one of Europe’s most distinguished early-stage venture capital platforms.
Jeannette embodies the role of a passionate generalist with a founder-led approach.
Her investments are driven by her vision of a resilient, more prosperous Europe, with
technology as a key driver of transformation which is also reflected in her areas of
expertise which include AI, climate, industrial transformation, defense and traditional
software-centric opportunities. Jeannette’s early investment wins are companies such
as Deel, Forto, Groq Helsing, Mistral, and Personio. Having supported their journey
from the earliest stages, she also serves on the board of the unicorn companies Helsing
and Mistral. Beyond her investment activities, Jeannette is an active member of several
advisory boards, including the Board of Governors of the Kiel Institute for the World
Economy (If W). She is a driving force behind the EU AI Champions Initiative (EU AICI),
which brings together leading European companies to accelerate AI adoption in critical
industries. In her book, Europe’s New Renaissance, she explores how Europe can reinvent
itself by drawing on its enduring strengths in science, innovation, and industry.
René Obermann has been Chairman of the Board of Directors at Airbus SE since 2020
Alongside his role at Airbus, René works as Chairman of Warburg Pincus Europe, a
leading global private equity firm that he joined in 2015. He is also Deputy Chairman
of the Supervisory Board at IONOS SE, a publicly listed web productivity and cloud
company. René worked at Deutsche Telekom Group (DT) from 1998 until 2013. After
running DT’s mobile division (T-Mobile International), he was appointed as CEO of DT
in November 2006, where he remained until December 2013. René began his career with
a business traineeship at BMW AG. He then founded his own business in 1986: ABC
Telekom, a distribution and services company in the telecommunications sector. After
Hutchison Whampoa acquired ABC Telekom in 1991, René was appointed Managing
Partner of the resulting entity, Hutchison Mobilfunk GmbH and was CEO of that
company between 1993 and 1998. From 2007 to 2013, René also served as Vice President
of the German Association for Information Technology, Telecommunications and New
Media (BITKOM). In 2013 he was awarded the rank of Officer of the French Legion of
Honour.
Moritz Schularick is President of the Kiel Institute for the World Economy and
Professor of Economics at Sciences Po. He is one of the recipients of the 2022 LeibnizPrize, Germany’s most prestigious research prize awarded by the German Research
Foundation (DFG). In 2018, he received the Gossen-Prize of the German Economic
Association that is awarded every year to honor a German-speaking economist whose
work has gained international renown. His research spans macroeconomics, finance,
international economics and economic history and has been published in the American
Economic Review, the Quarterly Journal of Economics, the Review of Economic Studies,
the Journal of Political Economy, the Journal of Monetary Economics, the Journal of
International Economics, and several other journals.
CHAPTER 29
Ethan Ilzetzki
London School of Economics and CEPR
Russia’s full-scale invasion of Ukraine, mounting instability in the Middle East, and rising
tensions in the Indo-Pacific have prompted a sharp re-evaluation of defence policy across
advanced economies. US administrations of both parties have bemoaned European
dependence on American military deterrence, but President Trump has expressed these
frustrations with unprecedented force.
The message has been heard loud and clear in European capitals. European countries,
having long underinvested in defence relative to their official commitments, are now
contemplating large-scale military buildups, reversing a long downward trend in defence
spending since the Cold War. This is most notable in Germany, whose Bundestag went as
far as amending the constitution to borrow funds for the purpose of rearmament.
While the motivation for rearmament is fundamentally strategic, its economic
consequences are too significant to ignore. Large shifts in defence spending are
macroeconomic events, with implications for economic growth, productivity, and
technological innovation. This chapter examines those effects, drawing on historical
experience and an existing literature. The interested reader can refer to Ilzetzki (2025)
for a lengthier review of this literature. In this chapter, I argue that economies are
generally resilient to defence buildups and these may even have positive long-run effects,
depending on their design.
MACROECONOMIC EFFECTS OF DEFENCE SPENDING IN THE SHORT RUN
Evidence from the United States (Ramey 2011, 2016, 2019; Ramey and Zubairy 2018;
Antolin-Diaz and Surico 2024) shows that the economy is generally resilient in response
to defence buildups and expands to accommodate this heightened demand. Historically,
the multiplier on defence spending has been moderate, in the range of 0.6 to 1. This
implies an economic expansion of $0.6 to $1 for every $1 increase in defence spending.
Under ideal circumstances, specifically when monetary policy is accommodative and the
buildup is debt-financed, the multiplier may be as high as 1.5 (Nakamura and Steinsson
2014), implying an economic expansion of $1.5 per each dollar spent.
349
THE ECONOMICS OF THE EUROPEAN DEFENCE BUILDUP | ILZETZKI
The economics of the European defence
buildup
The short-run effects of defence expenditure depend on several factors:
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
350
• Monetary stance: Accommodative monetary policy reinforces the stimulative
effect of a fiscal expansion (Ilzetzki et al. 2013, Nakamura and Steinsson 2014,
2018); a strongly active monetary response counteracts it.
• Financing method: Borrowing enhances multipliers, whereas tax-financed
spending can crowd out private demand and labour supply (Baxter and King
1993, Nakamura and Steinsson 2014, Chodorow Reich 2019, Angeletos et al. 2024,
Valtaitis and Villa 2025). However, increased public debt can increase borrowing
rates, default risk, and inflation (Angeletos et al. 2023, Bianchi et al. 2023a, Bianchi
et al. 2023b) so that public borrowing should be accompanied with a framework that
ensures long-run debt sustainability. These concerns notwithstanding, European
bond yields declined after the President’s “liberation day” tariff announcement,
possibly suggesting these bonds are now treated as a ‘safe haven’ from global
volatility. Fiscal multipliers are larger in countries with good foreign market access
for their debt (Broner et al. 2021).
• Economic slack: Keynesian theories would predict that military expansions
have a greater stimulative effect when unemployment is high and resources
are underutilised, but the evidence for this is mixed (Ramey and Zubairy 2018
find no difference depending on the state of the business cycle; Auerbach and
Gorodnichenko 2012, 2013, Nakamura and Steinsson 2014, and Born et al. 2024
find larger multipliers when unemployment is high).
• Domestic procurement: Defence spending that stays within the domestic economy
can be expected to have greater output effects.
THE PEACE DIVIDEND RECONSIDERED
Following the Cold War, many advanced economies significantly reduced their defence
budgets. This was expected to yield a ‘peace dividend’, freeing up resources for productive
or welfare-enhancing uses. In practice, evidence of growth effects due to a peace dividend
is limited. Figure 1 shows that GDP growth declined alongside the share of GDP devoted
to military spending, indicating that other factors outweighed any economic dividend
proffered by the end of the Cold War.
Empirical studies find little evidence that reductions in military spending lead to
improved macroeconomic performance (Benoit 1973, 1978, Ram 1995, Alptekin and
Levine 2012, Yesilyurt and Yesilyurt 2019, Dunne and Smith 2020). In fact, the post-Cold
War period coincided with a slowdown in productivity and GDP growth. This suggests
that defence drawdowns may have less economic upside than was expected at the end of
the Cold War.
FIGURE 1 DEFENCE SPENDING (% OF GDP) AND GDP GROWTH: US AND EU
a) United States
10
9
8
Percentage
7
6
5
4
3
2
1
0
1965
1970
1975
1980
1985
1990
Military expenditure (% of GDP)
1995 2000 2005 2010
2015
GDP Growth (5-year moving average)
b) European Union
6
5
Percentage
4
3
2
1
0
-1
1965
1970
1975
1980
1985
Military expenditure (% of GDP)
Source: Ilzetzki (2025).
1990
1995 2000 2005 2010
2015
GDP Growth (5-year moving average)
351
THE ECONOMICS OF THE EUROPEAN DEFENCE BUILDUP | ILZETZKI
From a fiscal perspective, the decline in defence expenditures created fiscal space to the
tune of 2% of GDP in the European Union, but this fiscal space was more than fully
exhausted, as evidenced by historically high public debt since the global financial crisis.
A long-run trend of increased transfers to households accounts for this most of this debt
accumulation, alongside cyclical responses to the global financial crisis, the euro area
crisis, and the Covid-19 pandemic.
PRODUCTIVITY GROWTH, LEARNING EFFECTS AND INDUCED INNOVATION
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
352
How do economies expand in response to large increases in government employment
and purchases? Multipliers close to one imply a relatively elastic economy, and Fujita
et al. (2024) show how this elasticity played out in practice in the United States during
World War II, a period in which real GDP doubled due to the military expansion. The
authors show that employment increased dramatically with the military buildup, despite
the low unemployment rate that prevailed by 1941, and then declined at the end of the war
without the mass unemployment that many had predicted. The increase in labour supply
was due to large entry of women and youth into the workforce, demonstrating that a low
unemployment rate is not a sufficient statistic for an economy operating at ‘full capacity’.
But despite the massive increase in the labour force and an unprecedented increase in
public investment, a large increase in total factor productivity is needed to explain the
economic expansion. The traditional explanation for this phenomenon is ‘learning by
doing’ (see Thompson 2010, 2012 for reviews of the literature) whereby firms improve
their productivity with experience. This was the common post-war explanation for the
US production ‘miracle’ of World War II. Although learning curves don’t appear to be any
larger in wartime, the massive wartime demand surge implied that plants accumulated
experience at a faster pace during wartime.
A few caveats are necessary. First, it is unclear how long-lived productivity gains from
learning are, with Bahk and Gort (1993) showing that knowledge dissipates with each new
vintage of capital, and Field (2022) claiming that these didn’t spill over to private-sector
production in the post-World War II era. Second, Bean (1990) warns that investments in
defence production may crowd out investments in human capital, thus harming long-run
productivity through a different channel. Third, learning isn’t necessarily a ‘free lunch’
because ‘learning’ may in fact reflect real investments in R&D (Sinclair et al. 2000) or
changes to production processes. By this view, public demand induces innovation because
of the liquidity or advance market guarantee it provides to firms.
In Ilzetzki (2024), I provide evidence for this mechanism in what I term ‘learning by
necessity’. Firms show greater productivity growth when demand confronts capacity
constraints. This incentivises firms to make costly, one-off investments in new production
techniques that they would avoid under normal market conditions. Benigno and Fornaro
(2018) and Anzoategui et al. (2019) demonstrate that such demand-induced investments
can lead to medium- to long-run productivity gains. I find that a one percent increase
government procurement leads to a third of a percent increase in total factor productivity
within a year, and this is even larger for production lines facing tight capacity constraints.
LONG-RUN GROWTH, R&D, AND INNOVATION SPILLOVERS
Defence R&D also tends to stimulate private-sector R&D, encouraging firms to invest
by providing upstream research, stable demand, and de-risked early-stage technology
development. Moretti et al. (2025) show that a 10% increase in public R&D stimulates
5-6% in private R&D. Dyevre (2023) also shows that firms more exposed to spillovers
from public R&D saw productivity gains. Beraja et al. (2025) document that the Chinese
government has been able to leverage public R&D to gain leadership in artificial
intelligence technologies.
Countries with the highest per capita R&D spending – South Korea, Israel, the United
States – tend to also have the largest public investments in defence R&D. Mowery (2010)
and Ilzetzki (2025) show that mission-oriented R&D tends to be the largest and most
durable forms of public support for R&D. While Mazzucato (2021) has called for nondefence-focused mission-oriented R&D, this may understate the political economy
dynamics underlying defence R&D. The arms race motivations for defence innovation
creates powerful incentives for governments to invest in speculative, frontier technologies.
In defence matters, there is a clear strategic benefit to reaching the technological frontier
faster than one’s adversaries. In contrast, in other domains – such as cancer research and
green technologies – there are weaker first-mover advantages. Instead, governments may
have incentives to free ride on speculative research conducted elsewhere.
Despite its importance for growth and innovation, the share of defence budgets devoted
to R&D has declined in many countries. In the United States, it remains around 16%;
in Europe, it is closer to 4.5%. And while US defence R&D doubled in dollar terms from
2000 to 2019, defence R&D in EU countries remained roughly constant. (Non-defence
mission-oriented R&D roughly doubled in both cases.)
‘Public’ R&D is often procured from the private sector rather than reflecting in-house
research. Trajtenberg (2025) points to the counterexample of Israel, where much of the
military R&D – particularly intelligence related – is done by the military itself. This
model may rely on the universal draft; it isn’t obvious that the military would be able
to compete with high-tech private-sector wages. Nonetheless, frontier R&D requires a
353
THE ECONOMICS OF THE EUROPEAN DEFENCE BUILDUP | ILZETZKI
Public investments can have even longer-run effects through another channel: public
R&D. Defence-related R&D has been a major driver of technological change. The
internet, GPS, semiconductors, jet propulsion, and nuclear energy all emerged from
military research. Investigating 125 years of data, Antolin-Diaz and Surico (2024) show
that temporary increases in military spending can have echoes years later when they
involve public R&D. They find that a 1% increase in R&D-intensive military spending
leads to a 0.3% long-run increase in TFP and to a spurt of patenting activity. (See Jones
and Summers (2022) and Fieldhouse and Mertens (2023) for additional estimates of the
economic effects of public R&D.)
skilled workforce, whether it is produced or procured by the military. A defence buildup
should therefore come hand in hand with a medium-term plan for human capital
development.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
354
STRATEGIC PROCUREMENT POLICY
Defence procurement can be used strategically to increase the long-run economic
benefits of defence expenditures. The US government has been more active in using its
power as a large buyer and uses military procurement strategically for broader economic
aims. The EU military procurement landscape, on the other hand, is fragmented and
uncoordinated. Poorly designed procurement can concentrate benefits among a few
incumbents and limit innovation. Well-designed procurement can support competition,
innovation, and long-term growth.
Several best practices in procurement have emerged to maximise the economic benefits
of defence spending:
• Dual-use firms: Procuring from dual-use firms – firms that produce both for
civilian and military purposes – allows for greater spillovers from publicly funded
R&D to private R&D. It also allows the military to benefit from ‘spin-ons’ – civilian
technologies used for defence applications – that have been as important as ‘spinoffs’ in the 21st century (Feiglin 2020).
• Dual-sourcing: Awarding similar contracts to multiple firms promotes resilience
in supply chains and induces knowledge-sharing across competitors. This
knowledge sharing can spread the economic benefits of defence-related innovation
more broadly.
• Support for SMEs: Relative to European procurement, US defence procurement
tends to rely on a wider set of suppliers. A large body of empirical work shows that
young firms are engines of innovation. However, smaller firms are often financially
constrained and government contracts can benefit them disproportionately.
Further, Carril and Duggan (2020) show that market concentration leads to less
competition for contracts.
• ‘Open’ procurement competitions: Procurement that specifies strategic needs,
rather than rigid specifications, leads to better results and greater innovation and
spillovers to the private sector (Howell et al. 2023).
Due to its exposure to the war in Ukraine and its common border with Belarus, Poland
has been ahead of the curve in the European defence expansion. It also provides a
preliminary case study on how to use procurement strategically to onshore production,
knowledge, and innovation.
Poland increased military spending to 3.1% of GDP in 2024 and 4.8% in 2025. The
majority of spending is focused on imported equipment. This includes substantial
imports of Apache helicopters, HIMARS rocket systems and precision strike units, M1A1
Abrams tanks, and integrated air and anti-missile defence command systems.
In military procurement, the buyers’ leverage comes not only from its purchasing power;
the procuring military gains important operational experience that helps with product
improvement that is invaluable to the defence corporation.
A final consideration is the importance of coordination among European countries.
European defence efforts are currently fragmented and inefficient, with countries
duplicating projects, producing incompatible equipment, failing to achieve economies of
scale, and relying heavily on foreign suppliers. Without coordinated procurement and
standard-setting, European rearmament will fall short of its potential both militarily
and economically. Greater collaboration – through joint procurement initiatives, shared
R&D programmes, and harmonised equipment standards – would not only strengthen
collective security but also maximise the economic benefits of defence investment by
creating a more integrated and competitive European defence-industrial base.
The European Union puts defence squarely within national competencies, but joint
ventures already exist and should be encouraged. A dual-sourcing doctrine could be
coupled with a requirement that supply chains cross borders to maximise spillovers
not only between defence and civilian applications, but also across borders. It is hard
to imagine any substantial procurement power being concentrated in Brussels, but
ad hoc temporary institutions (modelled on the US War Production Board during
World War II, for example) could be assembled to coordinate efforts in the impending
European defence buildup. There is a precedent in the European Commission’s Health
Emergency Preparedness and Response Authority, a body created for centralised vaccine
procurement during the Covid-19 pandemic.1
1
I thank Helene Rey for pointing out this precedent.
355
THE ECONOMICS OF THE EUROPEAN DEFENCE BUILDUP | ILZETZKI
Poland has also procured 1,000 K2 Black Panther and K9 Thunder tanks from South
Korea at a cost of more than $6 billion. This gave the buyer substantial bargaining
power, which it used to enhance the potential for knowledge transfer. While the first
batch of tanks was produced in and delivered from South Korea, the second batch will
be assembled locally. It is speculated that the next generation of K2 tanks will be a joint
Polish–South Korean design. Similarly, the Polish WB Group and the South Korean
defence firm Hanwha Aerospace created a joint venture to manufacture missiles.
SPENDING TARGETS AND STRATEGIC TARGETS
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
356
The objective of procurement is to obtain the highest quality public goods or assets at
the lowest cost. Many NATO members have instead adopted or aspire to meet defence
spending targets expressed as a percentage of GDP. Current NATO targets require
expenditures of 2% of GDP and several governments have set their sights on higher
targets. While such targets provide a minimum benchmark and help monitor free-riding,
they are economically problematic. Spending targets incentivise ‘getting the money out
of the door’, which neither ensures the procurement of appropriate armaments nor
incentivises cost savings.
A percent-of-GDP target has several disadvantages. First, it may lead to procyclical
public spending, which is suboptimal from a macroeconomic perspective. When GDP
declines, military spending also declines in euro terms, rather than remaining constant
or increasing to boost the economy or smooth spending over time.
Second, targets ignore the fact that armaments are durable. The lifecycle of durables is
such that there may be some larger up-front procurement costs with lower maintenance,
replenishment, replacement, and upgrade costs later in the cycle. A percent-of-GDP
that is constant over time leads to under-spending in the early armament stages and
incentivises wasteful spending later in the cycle.
Third, productivity gains due to learning-by-doing can lead to long-run cost savings that
imply lower costs for the same quality of materiel over time.
Finally, targeting expenditure rather than the quantity and quality of armaments may
create incentives for ministries to rush to spend at year-end to meet targets or prioritize
short-term procurement over strategic investment.
CONCLUSIONS AND RECOMMENDATIONS
Geostrategic considerations should be in the forefront of the European defence buildup.
Yet, economic costs and benefits should also form an integral part of the calculus. These
costs and benefits aren’t merely fiscal and cannot be merely considered at their budgetary
price tag. Alongside fiscal and other economic costs there are also potential benefits in
terms of long-run productivity gains and support for industrial sectors. To harness these
gains, the key is to structure defence policy strategically:
• Recognise that technology is central to modern warfare; investing in frontier R&D
will maximise both security and social returns.
• Prioritise on-shoring of defence procurement over the medium term.
• Leverage short-run reliance on imported equipment to maximise long-run
spillovers to domestic industry.
• Broaden procurement to include smaller, dual-use firms, and favour open contracts
to spread benefits across the private sector.
• Replace rigid GDP-based spending targets with flexible, long-term strategic
procurement frameworks.
The return of rearmament is an opportunity to revisit the role of defence in economic
policy. With foresight and coordination, it is possible to align national security goals with
long-run economic growth.
REFERENCES
Alptekin, A and P Levine (2012), “Military expenditure and economic growth: A metaanalysis”, European Journal of Political Economy 28(4): 636-650.
Angeletos, G‐M, C Lian, and C K Wolf (2024), “Can Deficits Finance Themselves?”,
Econometrica 92(5): 1351-1390.
Angeletos, G-M, F Collard, and H Dellas (2023), “Public debt as private liquidity: Optimal
policy”, Journal of Political Economy 131(11): 3233-3264.
Antolin-Diaz, J and P Surico (2022), “The Long-Run Effects of Government Spending”,
CEPR Discussion Paper 17433.
Auerbach, A J and Y Gorodnichenko (2012), “Measuring the Output Responses to Fiscal
Policy”, American Economic Journal: Economic Policy 4(2): 1–27.
Auerbach, A J and Y Gorodnichenko (2013), “Fiscal multipliers in recession and
expansion”, in Fiscal policy after the financial crisis, University of Chicago Press, pp.
63–98.
Anzoategui, D, D Comin, M Gertler, and J Martinez (2019), “Endogenous technology
adoption and R&D as sources of business cycle persistence”, American Economic
Journal: Macroeconomics 11(3): 67-110.
Bahk, B-H, and M Gort (1993), “Decomposing learning by doing in new plants”, Journal
of Political Economy 101(4): 561-583.
Baxter, M and R G King (1993), “Fiscal Policy in General Equilibrium”, The American
Economic Review 83(3): 315–334.
Bean, C R (1990), “Endogenous growth and the procyclical behaviour of productivity”,
European Economic Review 34(2-3): 355-363.
Benigno, G and L Fornaro (2018), “Stagnation traps”, The Review of Economic Studies
85(3): 1425-1470.
357
THE ECONOMICS OF THE EUROPEAN DEFENCE BUILDUP | ILZETZKI
• Strengthen European-level coordination and collaboration in defence procurement
and innovation.
Benoit, E (1973), Defense and Economic Growth in Developing Countries, Lexington
Books.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
358
Benoit, E (1978), “Growth and defense in developing countries”, Economic Development
and Cultural Change 26(2): 271-280.
Beraja, M, W Peng, D Y Yang, and N Yuchtman (2025), “Government as Venture
Capitalists in Artificial Intelligence”, Entrepreneurship and Innovation Policy and the
Economy 4(1): 81-102.
Bianchi, F, R Faccini, and L Melosi (2023a), “A fiscal theory of persistent inflation”, The
Quarterly Journal of Economics 138(4): 2127-2179.
Bianchi, J, P Ottonello, and I Presno (2023b), “Fiscal stimulus under sovereign risk”,
Journal of Political Economy 131(9): 2328-2369.
Born, B, F D’Ascanio, G Mueller, and J Pfeifer (2024), “Mr. Keynes meets the Classics:
Government Spending and the Real Exchange Rate”, Journal of Political Economy
132(5).
Broner, F, D Clancy, A Erce, and A Martin (2022), “Fiscal Multipliers and Foreign
Holdings of Public Debt”, Review of Economic Studies 89(3).
Carril, R and M Duggan (2020), “The impact of industry consolidation on government
procurement: Evidence from Department of Defense contracting”, Journal of Public
Economics 184, 104141.
Chodorow-Reich, G (2019), “Geographic Cross-Sectional Fiscal Spending Multipliers:
What Have We Learned?”, American Economic Journal: Economic Policy 11(2): 1–34.
Dunne, J P and R P Smith (2020), “Military expenditure, investment and growth”,
Defence and Peace Economics 31(6): 601-614.
Dyevre, A (2023), “Public R&D spillovers and productivity growth”, mimeo.
Feiglin, G (2020), “New developments affecting military industries”, in The Israeli Defense
Industry and US Assistance, INSS, University of Tel Aviv, pp. 89–104.
Field, A J (2022), The economic consequences of US mobilization for the Second World
War, Yale University Press.
Fieldhouse, A J and K Mertens (2023), “The Returns to Government R&D: Evidence
from US Appropriations Shocks”, Federal Reserve Bank of Dallas, Research Department.
Fujita, S, V A Ramey, and T Roded (2024), “Why Didn’t the US Unemployment Rate Rise
at the End of WWII?”, NBER Working Paper No. 33041.
Howell, S T, J Rathje, J Van Reenen and J Wong (2023), “Opening up Military Innovation:
Causal Effects of Reforms to U.S. Defense Research”, NBER Working paper No. 28700.
Ilzetzki, E (2024), “Learning by Necessity: Government Demand, Capacity Constraints,
and Productivity Growth”, American Economic Review 114(8): 2436–71.
Ilzetzki, E, E G Mendoza, and C A Végh (2013), “How big (small?) are fiscal multipliers?”,
Journal of Monetary Economics 60(2): 239–254.
Jones, B F and L H Summers (2022), “A Calculation of the Social Returns to Innovation”,
in A Goolsbee and B Jones (eds), Innovation and Public Policy, University of Chicago
Press, pp. 13–59.
Sinclair, G, S Klepper, and W Cohen (2000), “What’s experience got to do with it? Sources
of cost reduction in a large specialty chemicals producer”, Management Science 46(1):
28-45.
Mazzucato, M (2021), Mission Economy: A Moonshot Guide to Changing Capitalism,
Allen Lane.
Moretti, E, C Steinwender, and J Van Reenen (2019), “The Intellectual Spoils of War?
Defense RD, Productivity and International Spillovers”, NBER Working Paper 26483.
Mowery, D C (2010), “Military R&D and innovation”, in Handbook of the Economics of
Innovation, Vol. 2, North-Holland, pp. 1219-1256.
Nakamura, E and J Steinsson (2014), “Fiscal Stimulus in a Monetary Union: Evidence
from US Regions”, American Economic Review 104(3):753–792.
Nakamura, E, and J Steinsson (2018), “Identification in Macroeconomics”, Journal of
Economic Perspectives 32(3): 59–86.
Ram, R (1995), “Defense expenditure and economic growth”, in Handbook of Defense
Economics, Vol. 1, North-Holland, pp. 251-274.
Ramey, V A (2011), “Identifying government spending shocks: It’s all in the timing”, The
Quarterly Journal of Economics 126(1): 1–50.
Ramey, V A (2016), “Macroeconomic shocks and their propagation”, in Handbook of
Macroeconomics, Vol. 2, pp. 71-162.
Ramey, V A (2019), “Ten Years after the Financial Crisis: What Have We Learned from
the Renaissance in Fiscal Research?”, Journal of Economic Perspectives 33(2): 89–114.
Ramey, V A and S Zubairy (2018), “Government spending multipliers in good times and
in bad: evidence from US historical data”, Journal of Political Economy 126(2): 850–901.
Thompson, P (2010), “Learning by Doing”, in B H Hall and N Rosenberg (eds), Handbook
of the Economics of Innovation, Vol. 1, Elsevier, pp. 429–476.
359
THE ECONOMICS OF THE EUROPEAN DEFENCE BUILDUP | ILZETZKI
Ilzetzki, E (2025), Guns and growth: The economic consequences of defense buildups, Kiel
Report No. 2, Kiel Institute for the World Economy (If W Kiel).
Thompson, P (2012), “The relationship between unit cost and cumulative quantity and
the evidence for organizational learning-by-doing”, Journal of Economic Perspectives
26(3): 203-224.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
360
Trajtenberg, M (2025), “(Re)building Europe’s defense – human capital is key”, Policy
Brief.
Valaitis, V and A T Villa (2025), “Optimal Fiscal Policy under Endogenous Disaster Risk:
How to Avoid Wars?”, mimeo.
Yesilyurt, F and M E Yesilyurt (2019), “Meta-analysis, military expenditures and growth”,
Journal of Peace Research 56(3): 352-363.
ABOUT THE AUTHOR
Ethan Ilzetzki is an Associate Professor in Economics at the London School of Economics.
He is a Fellow in the Centre for Economic Policy Research and an Affiliate of the
Centre for Macroeconomics. His research focuses on macroeconomics, international
economics, and fiscal policy. Ethan heads the CfM-CEPR panel of experts on the UK
and EU economies. He serves on the editorial boards of the IMF Economic Review
and the Journal of Monetary Economics. He holds a BSc in Electrical Engineering
from the Technion: Israel Institute of Technology, an MA in International Affairs from
Johns Hopkins University’s School of Advanced International Studies, and a PhD in
Economics from the University of Maryland. He has held policy and research positions
at the International Monetary Fund and the U.S. Department of Treasury and visiting
positions at the Federal Reserve Board, the World Bank, and the Bank of England.
CHAPTER 30
Ralph Luetticke and Gernot Müller
University of Tübingen and CEPR
In the realm of foreign policy, a major consequence of the Trump administration is
increased uncertainty about mutual defence commitments. Even before taking office,
President Trump suggested that American military support could no longer be taken for
granted. Since then, he has emboldened adversaries such as Russia and reduced support
for Ukraine. As a result, there is an urgent need for Europe to rapidly and effectively
strengthen its military capabilities. Figure 1 shows military expenditures across European
countries for the year 2023. All countries except Poland and Greece spend less than 3%
on defence. There is an emerging consensus that spending targets will be substantially
revised upwards, perhaps to up to 3.5% – a major increase for most countries.
FIGURE 1
MILITARY EXPENDITURE AS A PERCENTAGE OF GDP IN 2023
4
2
1
0
POL
GRC
EST
LTU
FIN
WLD
LVA
GBR
HUN
FRA
SVK
DNK
BGR
CYP
HRV
EUU
ROU
EMU
ITA
NLD
CZE
DEU
PRT
ESP
SWE
SVN
BEL
AUT
LUX
MLT
IRL
% of GDP
3
361
SPENDING TARGETS VERSUS MILITARY CAPACITY | LUETTICKE AND MÜLLER
Spending targets versus military
capacity
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
362
However, increased spending does not automatically translate into greater military
capability, as expanding productive capacity may absorb a substantial portion of the
additional funds. Ultimately, the key issue is not merely meeting nominal spending
targets but ensuring that increased expenditures translate into tangible improvements
in military readiness and capacity.
HOW TO MEASURE THE EFFECTIVENESS OF DEFENCE SPENDING: THE
MILITARY MULTIPLIER
What determines the effectiveness of military buildups? In recent work, we present a
systematic analysis based on new time-series evidence from the US and a calibrated
multi-sector model tailored to study economic adjustment in the face of large military
buildups (Antonova et al. 2025). We start from the observation that government spending
– particularly military spending – is biased toward specific sectors of the economy. For
instance, in the United States, the manufacturing sector accounts for about 40% of
Department of Defense spending, even though it makes up only 12% of overall value
added (Cox et al. 2024). Hence, a large military buildup requires certain sectors of the
economy to expand, necessitating the reallocation of resources between sectors – a
process that is both costly and time-consuming, as emphasised in early work by Ramey
and Shapiro (1998).
Depending on exactly how costly, as well as on the time horizon, the amount of military
equipment that an additional dollar of government spending can procure will generally
vary. Against this background, we define the military multiplier as the percentage
increase in military equipment that can be purchased with an additional unit of output.
In the short run, the military multiplier will be smaller than 1 because raising spending
will push up the price of military equipment and, as we show below, quite strongly so. As
such, the military multiplier provides a measure for the effectiveness of military buildups.
THE MILITARY MULTIPLIER DIFFERS FROM THE FISCAL MULTIPLIER
The military multiplier differs from the fiscal multiplier, which has been the focus of
a large literature in macroeconomics since Keynes (1936). It measures the percentage
increase of output in response to an additional unit of government spending. The
fundamental concern of the literature on the fiscal multiplier is how private expenditure
(consumption, investment, and, in an open economy, net exports) responds to an
increase in government spending, as this determines its effectiveness in stabilising the
business cycle – particularly when monetary policy is constrained by the zero lower
bound. If private expenditure rises in response to additional government spending (i.e.
it is ‘crowded in’), the fiscal multiplier is greater than one; if it is crowded out, the fiscal
multiplier is less than one.
EVIDENCE FROM MILITARY BUILDUPS IN THE US
In practice, this means that doubling military spending may raise military capacity
not by 100%, but for example, if the military multiplier is 0.5, by 50% only. This is not
an implausible scenario, given the new evidence that we establish based on US timeseries data. Specifically, we rely on military ‘news shocks’ compiled by Ramey (2011) and
estimate the response of the relative prices of US manufacturing goods which proxies the
price of military goods, in turn, a sufficient statistic for the military multiplier. We do so
based on two samples: the first covers the period from after World War II until the end of
the Cold War; the second period covers the period since then.
MILITARY MULTIPLIER (CUMULATIVE): DATA VERSUS MODEL
1.2
1.2
1
1
0.8
0.8
M-multiplier
M-multiplier
FIGURE 2
0.6
0.4
0.2
0
0
2
3
years
4
0.4
0.2
Data
Model
1
0.6
5
0
0
Data
Model
1
2
3
4
5
years
Figure 2 shows our estimates for the military multiplier in cumulative terms: the
cumulative change in real military spending over time, divided by the cumulative change
in output spent on military goods. The left panel shows results for the Cold War period,
the right panel results for the post-Cold War period, with solid lines indicating our point
estimates and shaded areas indicating 68% and 90% confidence intervals. The difference
across sample periods is large. In the Cold War sample, the multiplier is already quite
363
SPENDING TARGETS VERSUS MILITARY CAPACITY | LUETTICKE AND MÜLLER
In contrast, the response of private consumption and investment are irrelevant for the
military multiplier. It is fully determined by the response of prices for military equipment,
which, in turn, reflects the costs of adjusting factors of production across sectors. To see
this, consider the limiting case of perfectly elastic supply – say, because there is excess
capacity in the military sector – such that any increase in demand for military equipment
is met without a change in its price. In this case, the military multiplier is simply 1.
However, in the case of large military buildups, the sector that produces military
equipment will sooner or later encounter capacity constraints. As a result, prices will
rise, pushing down the military multiplier.
high initially and increases to about 1 over time. In the second sample, the multiplier is
initially only 0.4 and increases to 0.8 only after two years. Hence, military spending is
much less effective in raising military capacity in the post-Cold War period.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
364
HOW THE INDUSTRY STRUCTURE DETERMINES THE MILITARY MULTIPLIER
We interpret these differences through the lens of a structural multi-sector model. In the
model, the response of prices to a surge of sector-specific demand, and eventually, the
military multiplier, depends on how easy it is to expand a sector’s capacity, which in turn
depends on the factors of production – labour and capital. For the baseline, we assume
that labour is mobile across sectors and that production is Leontieff (meaning sectors
must use fixed proportions of inputs, limiting flexibility in expanding production).
Hence, how easily capital – the limiting factor – can expand within a sector is key. There
are two possibilities, both of which give rise to trade-offs that in turn determine the costs
of expanding the productive capacity of a sector and, hence, the effectiveness of military
buildups.
First, it is possible to build new capital, but this takes time and is costly. To capture this,
we explicitly model the investment network as in Vom Lehn and Winberry (2022). The
investment network is central to the dynamics of the model, as it governs how sectoral
outputs are combined to produce investment goods. For the baseline, we assume that
each sector relies exclusively on its own goods to produce investment goods. This makes
expanding a sector in the face of higher demand more costly than if the production of
investment goods sources inputs from other sectors as well.
Second, capital can be reallocated across sectors, a process that, while typically faster
than building new capacity, entails additional adjustment costs. These costs reflect the
challenges of repurposing existing productive assets, such as machinery and industrial
facilities, and they vary depending on the specific sectors involved. For example,
converting an automobile manufacturing plant to produce tanks is considerably less
costly than converting a restaurant for the same purpose. Consequently, given a certain
level of adjustment costs, the size of the military sector and the characteristics of the
sectors from which capital can be reallocated play a critical role in determining the
overall economic cost of military expansion.
To better understand how industry structure shapes the military multiplier, we calibrate
a simple three-sector model to capture key features of the US economy during two
periods for which we estimate the military multiplier: the Cold War and the post-Cold
War era. For the Cold War calibration, we assume that industry accounts for about 25%
of total economic output, services for 45%, and the military sector for 10% – consistent
with an ‘industrial economy’. For the post-Cold War calibration, industry’s share shrinks
to 10%, services expand to 75%, and the military sector declines to 5% – illustrating the
transition to a ‘service economy’.
LESSONS FOR EUROPEAN DEFENCE POLICY
Our analysis shows that merely increasing spending targets will not automatically
translate into enhanced military capacity and offers insights that are directly relevant
for European defence policy. Two lessons for effective military spending are key. First,
facilitating capital reallocation across sectors is critical to ensure cost efficiency. Second,
strategic coordination across European countries can significantly enhance military
capacity by pooling industrial resources and mitigating bottlenecks. We elaborate on
both points in what follows.
First, as the evidence from the post-Cold War US economy shows, a diminished
industrial base significantly reduces the military multiplier, meaning that substantial
portions of additional defence funds will be absorbed by rising prices rather than
effectively augmenting military capacity. Consequently, European policymakers face a
strategic choice: they can either boost their domestic production capacities, accepting a
potentially low military multiplier given the relatively small size of their industrial sector,
or rely increasingly on foreign suppliers, particularly the US, where the multiplier is
substantially higher. However, increased dependence on foreign military suppliers risks
undermining the goal of strategic autonomy. There is a fundamental geoeconomic tradeoff: the same amount of spending may yield little increase in military capacity if spent
domestically, whereas it can result in greater gains when spent abroad – albeit at the
expense of increased external dependence.
Second, the military multiplier, being determined by sectoral structure and reallocation
frictions, offers a useful lens for comparing countries’ readiness to scale up military
production – not in terms of economic size, but in terms of industry structure. This
opens the possibility of strategically coordinating production across Europe to leverage
comparative advantages and mitigate bottlenecks. Figure 3 offers suggestive evidence for
the potential gains of coordinating defence buildups in Europe, as it highlights differences
in the industry structure. Specifically, it shows the size of the manufacturing sector and
its import reliance across EU countries – two key drivers of the military multiplier in
our model. Countries like the Ireland or Poland combine large industrial sectors with
365
SPENDING TARGETS VERSUS MILITARY CAPACITY | LUETTICKE AND MÜLLER
We then use the model to match the empirical estimates of the military multiplier shown
in the figure above. Specifically, we calibrate the costs of reallocating capital across
sectors so that the model’s predictions align with the evidence. Quite plausibly, the
calibration implies that moving capital from industry to military production is relatively
easy and inexpensive, while reallocating capital from the service sector is much harder
and costlier. As the industrial base is much smaller in the service economy, expanding
military capacity is increasingly difficult, pushing up costs of an expansion and lowering
the multiplier. These findings highlight two critical determinants of an effective military
buildup: the size of the industrial sector and the frictions involved in reallocating
resources.
FIGURE 3
MANUFACTURING SHARE IN GDP (BLUE) AND IMPORT SHARE OF GOODS IN
MANUFACTURING (RED)
30
20
Value (%)
10
L
PR
T
RO
U
SW
E
PO
LD
N
IT
A
IR
L
C
A
UN
H
GR
FR
FI
N
BE
L
CZ
E
DE
U
DN
K
ES
P
0
AU
T
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
366
moderate import shares, making them structurally well-positioned to scale up military
production. Based on their combined manufacturing and military shares, our model
implies military multipliers of aroud 0.8 – levels comparable to those observed in the
United States during the Cold War. In contrast, countries such as Belgium, Spain, and
Greece, with smaller industrial bases, face much lower multipliers, in the range of 0.25
to 0.35. In some instances, such as the Netherlands and Belgium, the share of imports in
manufacturing is relatively high, suggesting that capacity constraints may be mitigated
through external sourcing, although our data do not allow us to determine the fraction
of goods imported from within Europe and the fraction imported from outside Europe.
Country
Finally, our study also identifies a critical role of the persistence in military spending
for achieving a high military multiplier. Persistent military spending signals sustained
future demand, encouraging firms to undertake investments and capital reallocations
that might otherwise seem too costly in the short term. In other words, persistent
commitments significantly mitigate price pressures in the medium run and enable
smoother and more efficient resource adjustments. Consequently, European countries
aiming to increase their military multiplier should adopt clear, credible, and long-term
defence budget strategies rather than sporadic or short-term increases in military
spending. This approach would substantially improve the effectiveness of military
expenditures, better aligning the effective use of economic resources with strategic
defence objectives.
REFERENCES
Antolin-Diaz, J and P Surio (2024), “The Long-Run Effects of Government Spending”,
American Economic Review, forthcoming.
Antonova, A, R Luetticke, and G Müller (2025), “The Military Multiplier”, CEPR
Discussion Paper DP20220..
Cox, L, G Müller, E Pastén, R Schoenle, and M Weber (2024), “Big G”, Journal of Political
Economy 132(10): 3260-3297.
Ilzetzki, E (2024), “Learning by Necessity: Government Demand, Capacity Constraints,
and Productivity Growth”, American Economic Review 114(8): 2436–71.
Keynes, J (1936), The General Theory of Employment, Interest and Money, Macmillan.
Vom Lehn, C and T Winberry (2022), “The investment network, sectoral comovement,
and the changing US business cycle”, The Quarterly Journal of Economics 137(1):387–433.
Ramey, V and M Shapiro (1998), “Costly capital reallocation and the effects of government
spending”, Carnegie-Rochester Conference Series on Public Policy 48(1): 145-194.
367
SPENDING TARGETS VERSUS MILITARY CAPACITY | LUETTICKE AND MÜLLER
Our analysis has focused primarily on the short- to medium-run economic consequences
(1–5 years) of military buildups, highlighting the significant costs associated with
resource reallocation. However, other recent research suggests that military spending
may also bring longer-run productivity benefits. Ilzetzki (2024), for instance, documents
productivity gains at the plant level triggered by capacity constraints and intensified
government demand, a phenomenon termed ‘learning by necessity’. Similarly, AntolinDiaz and Surico (2024) demonstrate that sustained military expenditures can shift public
spending composition towards R&D, thereby fostering innovation, raising productivity,
and boosting long-term GDP growth. Our framework also suggests that countries such
as Germany, France, and Italy, which retain a relatively larger industrial base, may find
it easier to scale up military production compared to more service-oriented economies.
For Europe, this implies that while short- to medium-term military buildups entail
substantial economic trade-offs, careful management and strategic persistence in defence
spending may eventually yield positive productivity spillovers, partially offsetting initial
economic costs.
ABOUT THE AUTHORS
Ralph Luetticke is a Professor of Economics at the University of Tübingen and a
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
368
Research Affiliate at CEPR and the Stone Centre on Wealth Concentration, Inequality,
and the Economy at UCL. His research focuses on macroeconomics, with an emphasis
on household heterogeneity. He earned his PhD from the University of Bonn and has
held academic positions at UCL and visiting roles at Stanford University. He has also
taught and consulted on heterogeneous agent macroeconomics at the Central Bank of
Colombia, the ECB, the IMF, and the Inter-American Development Bank.
Gernot Müller is a Professor of Economics at the University of Tübingen and a Research
Fellow at CEPR. His research focuses on international macroeconomics. He obtained
his PhD from the European University Institute in Florence and has previously held
positions as a Professor at the University of Bonn and as a postdoctoral researcher
at Goethe University Frankfurt. He has also been a visiting researcher at the Federal
Reserve Bank of New York and Columbia University, and has served as a consultant to
the ECB.
CHAPTER 31
Yuriy Gorodnichenko
University of California, Berkeley and CEPR
The barbaric Russian full-scale invasion of Ukraine has an additional unknown: the new
Trump administration. Besides sowing global economic chaos, the new administration
has not only frozen economic and military aid to Ukraine, thus giving Russia a lifeline
in the war, but has also undermined NATO and other security pacts. What are the
implications of the current team in the White House for Ukraine and its allies? In short,
Ukraine is largely insulated from the stress in the global economy, but Europe and others
have to step up in giving more aid – especially military aid – to replace the US’ support
for Ukraine’s defence effort and to minimise their own security risks.
UKRAINE’S EXPOSURE TO THE 2ND TRUMP ADMINISTRATION
The enormous stress from Russian attacks manifest in many forms, some of which are
captured by macroeconomic statistics. Ukraine has a large fiscal deficit (around 22% of
GDP in 2024) and a large trade deficit (around $45 billion in 2024) (see Figure 1). These
holes have been largely plugged by foreign aid – which is a first-best solution (Becker et
al. 2022) – and mobilisation of internal resources. For example, Ukraine has been trying
to raise more tax revenue and control non-defence spending (e.g. no inflation indexation
of safety net payments). Gradual depreciation of the hryvnia has helped to close some
part of the trade deficit. Despite Russia’s incessant missile strikes on Ukraine’s energy
infrastructure, the economy has gradually recovered and, although elevated, inflation
is largely in check. At the same time, output is roughly at its potential and therefore
further, non-inflationary growth can only be achieved by expanding supply – for
example, attracting refugees back to Ukraine via subsidies, housing support, and jobs
(Dombrovskis et al. 2024, Gorodnichenko and Gros 2025) – rather than additional fiscal
or monetary stimulus (Becker et al. 2022). In short, before the current administration,
Ukraine was in a difficult but manageable position.
369
UKRAINE AND EUROPE | GORODNICHENKO
Ukraine and Europe
FIGURE 1
MACROECONOMIC INDICATORS
Real GDP
Actual
25
20
15
10
5
0
1400
1300
1200
1100
1000
Potential GDP
900
Actual GDP
Forecast
800
2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027
2011
2013
Fiscal deficit
40
2015
2017
2019
2021
2023
2025
2027
Foreign aid
20
Actual fiscal deficit
Forecast
15
US$ bn
% of GDP
30
20
10
10
5
0
0
2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025
2022
Foreign reserves
2023
2024
2025
2026
2027
External trade balance
50
0
45
40
-2
US$ bn
35
US$ bn
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
370
inflation, %
Forecast
GDP, UAH bn, 2011 prices
Inflation
30
25
20
-4
-6
15
-8
10
5
-10
0
2018 2019 2020 2021 2022 2023 2024 2025 2026 2027
2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027
Notes: The vertical dashed lines show the timing of the Russian full-scale invasion. Data are from the National Statistical
Office and the National Bank of Ukraine. Forecasts are from the National Bank of Ukraine.
The extreme uncertainty created by the new US administration poses many challenges
for small open economies like Ukraine, but because of the war Ukraine has smaller
exposure than would normally be the case. First, US–Ukraine bilateral trade flows are
small and exports to the US account for a small share of international trade for Ukraine
(around 2% in 2024). Ukraine runs a goods trade deficit ($2.6 billion in 2024) vis-à-vis
the US, thus minimising the ire of the White House (consistent with the ‘tariff formula’,
Ukraine got the base tariff of 10%). Second, IT services (a key export of Ukraine to the
While the current financial commitments of its allies are sufficient to carry Ukraine
for the rest of 2025, the outlook for longer horizons is uncertain. Europe and other
supporters of Ukraine will need to replace US financial aid provided and locked in by the
Biden administration. According to the Kiel Institute’s Ukraine Tracker (Trebesch et al.
2023), this amounts to approximately $20 billion per year, a manageable sum. A much
more difficult challenge is how to substitute military kit, where the US has a (near)
monopoly. Indeed, as the Czech initiative demonstrated, Europe can locate, pay for,
and transfer large quantities of NATO-calibre artillery shells (Murray 2025) but there is
virtually no alternative to Patriots, a US-made anti-missile system, to protect Ukraine’s
sky from Russian ballistic missiles (Irto et al. 2025). In a similar spirit, the US has unique
capabilities to collect intelligence on Russian plans and movements, including missile
launches.
In short, a key vulnerability of Ukraine to the whims of President Trump is in military
supplies rather than economic exposure. The President and his allies have already
exploited this weakness on multiple occasions (recall that Mike Johnson, the Speaker
of US House, delayed aid for six months in 2023-2024) to constrain Ukraine’s military
operations (e.g., forcing Ukraine to accept a ‘ceasefire’ while Russia continues to attack
Ukrainian cities; using a ‘kill switch’ to disable or deny access to US intelligence and
371
UKRAINE AND EUROPE | GORODNICHENKO
US, worth around $1 billion in 2024) are not subject to the tariff. Third, some Ukrainian
products such as steel pipes have perennially faced antidumping tariffs in the US, but
these have been largely passed onto US consumers. Fourth, while some of Ukraine’s
exports, such as iron ore and steel (around 15% of Ukraine’s goods exports in 2024), are
sensitive to the global business cycle, prices and volumes of agriproduct exports (around
60% of goods exports in 2024) are more robust to the cycle, thus providing a more reliable
source of hard currency revenue. Fifth, the whopping tariffs imposed by the US on China
(which could redirect US-bound goods to other markets and therefore lower prices in
those markets), falling oil prices, and the weakening of the dollar will likely amount
to a favourable terms-of-trade shock for Ukraine and hence could help alleviate
inflationary pressures in the country. Finally, because of war risks, capital controls, and
reliance on official bilateral and multilateral capital inflows, Ukraine’s financial system
is effectively decoupled from the global financial system and therefore capital flights and
panics similar to those in 1998 (Russia’s default and the Long-Term Capital Management
crisis) and 2008-2009 (the Global Financial Crisis) are highly unlikely. Given Ukraine’s
generally healthy and resilient banking sector and the abundant international reserves
of the National Bank of Ukraine, one can expect a minimal fallout from turbulence in the
global markets.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
372
weapons) and to extract concessions (e.g., the infamous ‘minerals deal’).1 This of course
undermines Ukraine’s defences and the prospects of post-war reconstruction as well
as its aspirations to join the EU. At this point, one can hardly expect that the Trump
administration will reverse this policy and, if anything, the US could align more closely
with Russia than with Europe and Ukraine. Hence, the urgent task for Ukraine and its
supporters is to find or build capacity to replace the US in this arena.
SCENARIOS AND OUTLOOK
Nobody wants a durable and just peace more than Ukrainians, but the probability of a
peace in 24 hours (as promised by the President during his election campaign) or 100
days (a revised deadline once he came to the White House) is remote. Russia has not
toned down its pre-invasion demands or reduced the intensity of its attacks. Instead,
the Kremlin pushes maximal wants: demilitarisation, denazification, etc. of Ukraine;
annexation of the four Ukrainian oblasts that were added after 24 February 2022 to
the Russian constitution but that are not currently controlled by Russia. In addition,
Putin believes that he is winning the war and is betting on a large offensive in the
spring/summer of 2025. Consistent with this view and a lack of interest in a diplomatic
resolution, Putin is playing for time in ‘negotiations’, backed by President Trump, while
stepping up attacks on Ukraine.
On the other hand, Ukraine is fighting for its survival and, according to the polls, the
nation is overwhelmingly determined to continue to fight the Russian aggression even
if the US drops out (Kyiv International Institution of Sociology 2025, Economist 2025).
If anything, the humiliation of Ukraine’s President Zelenskyy in the White House Oval
Office on 28 February 2025 boosted his public support and thus gave him stronger cards
to protect Ukraine’s interests and freedom. Furthermore, in contrast to the Trump
administration, which wants to achieve ‘peace’ at any price for Ukraine, European
governments appreciate the dangers of having a failed state or a collapsing frontline in
Ukraine. As a result, they have pledged to support Ukraine economically and militarily.
This is helping Ukraine to partially close the imbalance in resources relative to Russia.
In short, there is little common ground between Russia and Ukraine, and both countries
have the will and resources to continue the fight. Therefore, the war of attrition will likely
grind on for the foreseeable future.
However, unexpected developments are possible. Perhaps, the greatest danger for Europe
and Ukraine is that the Kremlin and the White House might agree on a deal that is
deeply detrimental to Europe and Ukraine. Indeed, US demands for Ukraine’s mineral
1
Initial US proposals for joint Ukrainian-American projects to mine Ukraine’s mineral resources effectively amounted to
reparation payments for a country that has lost a war. Furthermore, these proposals were incompatible with Ukraine’s
aspiration to join the EU and violated Ukraine’s Constitution. After volatile negotiations, the agreement signed on 17 April
2025 is a vague memorandum of understanding between the countries. This gives Ukraine more time to develop a legal
basis in line with national interests, but the Trump administration can come up with new ideas on how to extract ‘payments’
from Ukraine.
resources and for Greenland indicate the appetite of the Trump administration as well
as potential alignment of Russia and the US in dividing the spheres of influence in the
Artic, Europe, and elsewhere.
There is also a remote possibility that diplomatic efforts will have a breakthrough, and
Ukraine and Russia can have a ceasefire. However, the current proposals for a ceasefire
appear to have at least two fatal problems. First, it remains unclear who is going to
monitor and enforce the ceasefire. For example, plans to put 10,000 or 20,000 soldiers
from the UK or France in Western Ukraine are inadequate when compared to 600,000
Russian soldiers currently fighting in Ukraine. Given that Russia has violated every
agreement and ceasefire with Ukraine, any pact with Russia is not credible unless there
are serious consequences for Russia. Second, Russia is a nuclear power and Ukraine is
not (recall that Ukraine gave up its huge nuclear arsenal in 1994 to help world peace and
denuclearisation). At this point, a nuclear deterrent or NATO membership for Ukraine
are not on the table. Hence, Russia can attack Ukraine again without impunity. In short,
a ceasefire would not address short- or long-term security concerns, which all but assures
another round of Russian aggression in the future.
WHATEVER IT TAKES?
With the ‘long war’ scenario being the baseline, one can anticipate that Ukraine will
have to make more sacrifices (loss of lives, more intensive conscription, higher taxes, etc.)
to maintain the war effort (Becker et al. 2024) while Europe and other members of the
coalition of the willing (perhaps Canada, Japan, Australia, etc.) will have to shoulder a
larger economic cost (around $40 billion per year in financial aid and around $50 billion
per year in military aid). However, these resources will likely suffice to only maintain the
status quo where Ukraine is in strategic defence.
Changing the tide of the war would likely require larger military commitments (for
comparison, Russia’s military spending was $140 billion in 2024 while Ukraine spent $64
billion, which is most of its entire state budget), seizing frozen Russian assets (to at least
373
UKRAINE AND EUROPE | GORODNICHENKO
Another key risk is whether Europe can present a united front while facing a historic
challenge. One may have thought that there is nothing more uniting than a common
enemy, and thus the Russian full-scale invasion should have brought Europe together
more than ever. The reality has turned out to be sobering: Hungary’s Viktor Orban
and Slovakia’s Robert Fico apparently depend on the Kremlin; Spain and Italy barely
increased their defence budgets; Germany’s AfD wants to be friends with Putin. Russia’s
occupation of the Zaporizhzhya nuclear power plant and its attack on the Chornobyl
plant should have sent shivers to Europe, but there has been no material response to
the prospect of a nuclear catastrophe. A squeeze between Presidents Trump and Putin
seems to present a final call for European unity.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
374
partially cover the cost),2 and more proactive and stronger sanctions (especially on the oil
sector) on Russia. The latter is important because the Russian economy shows signs of
overheating and slowdown (Gorodnichenko et al. 2024, Korsunskaya 2025). Importantly,
Europe should refuse to lift sanctions if the Trump administration decides to reward
Putin for making a deal at the expense of Europe and Ukraine. Limiting the economic
capacity of the Kremlin reduces the ability of Russia to wage the war.
More generally, Russia would engage in genuine peace negotiations only when Russia
is convinced that it cannot win the war or extract more concessions (i.e. when the costs
outweigh the benefits). In my view, the piecemeal, reactive response to the war has
proven ineffective and therefore the only viable strategy is ‘peace through strength’.
Specifically, firm commitments to support Ukraine for as long as needed would send a
strong signal to Russia that the cost of the war is too high. In a similar vein, extending
Ukraine’s access to European markets would make the country more resilient and thus
its survival more credible. Clearly, Europe has to dedicate significant resources to re-arm
– and re-arm fast – to guarantee Europe’s security and sovereignty. An ambitious defence
programme would create jobs, reduce strategic dependencies, forge links with other
European nations, and fund innovation. Importantly, these objectives are consistent
with the Draghi Report (European Commission 2024), which calls for reinvigoration of
the European economy.
Given the delays in, and high costs of, military procurement in Europe and other advanced
economies, some funding from allies has to flow directly into military production in
Ukraine. To appreciate the importance of this point, note that the life of a drone model
in frontline battles is estimated to be 2-3 weeks, and as Russia finds countermeasures
a new model must be developed. European weapons procurement is patently unable
to keep up such a tempo. On the other hand, the Danish model of funding Ukraine’s
military tech has proved to be highly successful: Ukraine now produces more howitzers
per month than the whole of Europe combined (Ministry of Defense of Ukraine 2025,
Gutiérrez 2025). Ukraine has capacity to produce 5 million drones per year (Fornusek
2025), but it lacks resources to contract such output. Obviously, Europe can pour money
into solving this problem. This would also make clear to the Kremlin that Ukraine is a
part of Europe’s defence perimeter.
CONCLUDING REMARKS
The second Trump administration has created stress and anxiety in many corners of
the world, but Ukraine is again at the epicentre of geopolitical developments that will
likely shape the future of global trade, international finance, and the world’s security for
decades to come. Perhaps surprisingly, Ukraine is more prepared to weather the current
2
This is also an opportune moment as capital is apparently fleeing the US (the euro has appreciated by nearly 15% since
Trump’s inauguration on 20 January 2025) and thus risks to the euro as a reserve currency are minimal.
Fortunately, the fundamental calculus has not changed. The Russian economy is onetenth of the that of the European Union. Various reports suggest that Russia is running
out of money, people, and tanks (Economist 2024). Ukraine has crossed so many ‘red
lines’ (e.g., strikes on the Kerch bridge and deep inside Russia, the sinking of the flagship
Moskva, incursion into the Kursk region) that Putin’s bluffs are patently clear. Prigozhyn’s
march on Moscow was met with little resistance, demonstrating the fragility of Putin’s
regime. With Ukraine’s resolve to repel Russian aggression and Europe’s huge economic
base, Moscow’s prospects prospects of winning the war are dim.
However, who prevails in this war is a choice rather than a destiny, and uncertainty is
extreme. Should Europe make a determined economic and military push to make war
unacceptable to Russia, a just and durable peace may be in sight. If Europe hesitates, it
would not only prolong the bloodbath in Ukraine but it would also invite aggression on
its own soil. Which of these scenarios will play out remains to be seen.
REFERENCES
Becker, T, B Eichengreen, Y Gorodnichenko, S Guriev, S Johnson, T Mylovanov, M
Obstfeld, K Rogoff, and B Weder di Mauro (2022), Macroeconomic policies for wartime
Ukraine, CEPR Rapid Policy Response #2 (https://cepr.org/publications/books-andreports/macroeconomic-policies-wartime-ukraine)
Becker, T, B Eichengreen, Y Gorodnichenko, S Guriev, S Johnson, T Mylovanov, M
Obstfeld, K Rogoff, I Sologoub, and B Weder di Mauro (2025), “Replacing foreign aid: A
macroeconomic plan B for Ukraine (and Europe),” CEPR Policy Insight No 140 (https://
cepr.org/publications/policy-insight-140-replacing-foreign-aid-macroeconomic-plan-bukraine-and-europe).
Dombrovskis, V, M Obstfeld, I Sologoub, Y Gorodnichenko, T Becker, A Fedyk, G Roland
and B. Weder di Mauro (2024), “Stimulating growth in Ukraine and policies for migrants’
return,” CEPR Policy Insight No 132 (https://cepr.org/publications/policy-insight-132stimulating-growth-ukraine-and-policies-migrants-return)..
Economist (2024), “Russia’s vast stocks of Soviet-era weaponry are running out,” 16 June
(https://www.economist.com/europe/2024/07/16/russias-vast-stocks-of-soviet-eraweaponry-are-running-out).
375
UKRAINE AND EUROPE | GORODNICHENKO
incarnation of Trump’s presidency than one could have expected given the ferocity and
scale of the Russian onslaught. However, the survival of Ukraine depends on Europe’s
ability to close ranks, stand up to the current US administration, and unite in supporting
Ukraine at this critical moment. In a remarkable twist of history, the futures of Ukraine
and Europe are closely tied as both may be thrown under Russian tanks.
Economist (2025), “Is Zelensky a disliked dictator or a popular hero?”, 12 March (https://
www.economist.com/europe/2025/03/12/is-zelensky-a-disliked-dictator-or-a-popularhero).
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
376
European Commission (2024), “The future of European competitiveness: Report by
Mario
Draghi”
(https://commission.europa.eu/topics/eu-competitiveness/draghireport_en).
Fornusek, M (2025), “Ukraine has capacity to produce 5 million FPV drones per year,
advisor says,” Kyiv Independent, 29 March (https://kyivindependent.com/ukraine-canproduce-5-million-drones-per-year-advisor-says).
Gorodnichenko, Y and D Gros (2025), “Ukraine Refugees: From Temporary Protection
to Encouraging Return to Support the Ukrainian Economy,” EconPol Forum 26(01):
38-40
(https://www.econpol.eu/sites/default/files/2025-01/econpol-forum-2025-1gorodnichenko-gros-ukraine-refugees.pdf).
Gorodnichenko, Y, I Korhonen, and E Ribakova (2024), “Russian economy on war footing:
A new reality financed by commodity exports,” CEPR Policy Insight No 131 (https://cepr.
org/publications/policy-insight-131-russian-economy-war-footing-new-reality-financedcommodity-exports).
Gutiérrez, Ó (2025), “Ukraine accelerates weapons production: ‘We produce more
howitzers than all of Europe combined’,” El Pais, 8 April (https://english.elpais.com/
international/2025-04-08/ukraine-accelerates-weapons-production-we-produce-morehowitzers-than-all-of-europe-combined.html).
Irto, G, I Kharitonov, T Nishikawa, and C Trebesch (2025), “Ukraine Aid: How Europe
Can Replace US Support,” Kiel Policy Brief 186 (https://www.ifw-kiel.de/publications/
ukraine-aid-how-europe-can-replace-us-support-33907/).
Korsunskaya, D (2025), “Russian economy slows sharply, with more turmoil on horizon,”
Reuters, 8 April (https://www.reuters.com/markets/europe/russian-economy-slowssharply-with-more-turmoil-horizon-2025-04-08/).
Kyiv International Institution of Sociology (2025), “Acceptance of the Proposal of
Ukraine and the Usa for a 30-day temporary ceasefire,” 25 March (https://www.kiis.com.
ua/?lang=eng&cat=reports&id=1509&page=1 ).
Ministry of Defense of Ukraine (2025), “EUR 597 million in investment: How the ‘Danish
model’ is strengthening Ukraine’s defense industry,” 6 February (https://mod.gov.ua/en/
news/eur-597-million-in-investment-how-the-danish-model-is-strengthening-ukraines-defense-industry).
Murray, W (2025), “Ukraine war briefing: Another 1.5m artillery shells for Ukraine under
Czech scheme,” The Guardian, 27 March (https://www.theguardian.com/world/2025/
mar/28/ukraine-war-briefing-another-15m-artillery-shells-for-ukraine-under-czechscheme).
ABOUT THE AUTHOR
Yuriy Gorodnichenko, a native of Ukraine, is Quantedge Presidential professor at the
Department of Economics, University of California – Berkeley. He received his BA and
MA at EERC/Kyiv-Mohyla Academy (Kyiv, Ukraine) and his PhD at the University of
Michigan. A significant part of his research has been about monetary and fiscal policy,
economic growth, and business cycles. Yuriy serves on many editorial boards, including
American Economic Review and VoxUkraine. He is the leader of CEPR’s Ukraine
Initiative. Yuriy is a prolific researcher. His work was published in leading economics
journals and was cited in policy discussions and media. Yuriy has received numerous
awards for his research.
377
UKRAINE AND EUROPE | GORODNICHENKO
Trebesch, C, A Antezza, K Bushnell, A Frank, P Frank, L Franz, I Kharitonov, B Kumar,
E Rebinskaya, and S Schramm (2023), “The Ukraine Support Tracker: Which countries
help Ukraine and how?”, Kiel Working Paper No. 2218(https://www.ifw-kiel.de/topics/
war-against-ukraine/ukraine-support-tracker).
CHAPTER 32
Mark Manger
University of Toronto
US President Donald Trump first floated the idea of acquiring Canada at a Mar-a-Lago
press conference on 7 January 2025 before taking office, proposing to use not military
but “economic force” because “… Canada and the United States, that would really be
something”.
For all its absurdity, the idea underscored that Canada and the United States are
already “really something”. No two sovereign states outside the European Union share
as much commercially, financially, or culturally. More than 800,000 Canadians live in
the United States, while over 600,000 hold dual citizenship within Canada. Each day,
around 400,000 people cross the 8,900km (5,500 mile) border. Trade flows are equally
dense: Canada is the United States’ top export destination, though the trade relationship
is, inevitably, asymmetrical. In 2024, 76% of Canada’s exports and 62% of its imports
were with its southern neighbour, according to Statistics Canada’s figures.1 Conversely,
the US$750 billion commercial exchange represents only 8% of US foreign trade.
Almost a third of Canadian exports to the United States (US$124 billion) are energy
products – mostly oil, gas, and bitumen. Without them, Canada would not have
the bilateral trade surplus of US$75 billion dollars that arouses the ire of the US
administration. The second-most important category, trade in motor vehicles and parts,
is nearly balanced with US$57 billion in exports and US$59 billion of imports.
Inevitably, then, the imposition of tariffs by the United States – first 10% on energy and
25% on all other products on 4 March 2025, then lifted two days later, then paused
for products compliant with the US-Mexico-Canada free trade agreement (USMCA) –
presents a major challenge for Canadian policymakers.
Canada swiftly retaliated with tariffs of its own – the only country apart from China
to do so. The stage seemed set for an economic standoff between two highly integrated
economies. Politically, the move also shifted the domestic landscape. A Liberal Party
that had been teetering on the brink of irrelevance found unexpected traction under its
new leader, Mark Carney. Despite failing to secure a majority, the Liberals reclaimed
ground from a Conservative Party whose leader, Pierre Poilievre, had taken a distinctly
1
https://www150.statcan.gc.ca/n1/pub/71-607-x/71-607-x2020001-eng.htm?c=USA
379
CANADA | MANGER
Canada
Trumpian tone. Older voters and those in Ontario and Quebec flocked back to the
Liberals, while younger voters, many immigrants, and those in the west of the country
favoured the Conservatives.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
380
Although Canadians reappraised their lopsided economic relationship with the United
States, the federal government also reminded voters (and Americans) that some parts
of the United States are far more dependent on Canada than others. For instance, the
Brookings “USMCA tracker” estimates that US exports to Canada directly support
71,000 jobs in Michigan.2 The close integration is most evident in the energy industry.
In the Midwest, oil refineries are specifically geared to using Canadian heavy crude. As
a result, in several states, between 60% and 80% of oil and gas is imported from Canada
(Figure 1). Given the specifications of the refinery process, the only alternative sources
would be Venezuelan crude pumped from the Gulf of Mexico (or, Gulf of America).
FIGURE 1
CANADIAN OIL AND GAS IMPORTS AS SHARE OF TOTAL OIL AND GAS
IMPORTS, 2024
% from Canada
60
40
20
Source: US Census Bureau.
Source: U.S. Census Bureau
What does this integration imply in the case of a renewed confrontation between the
United States and Canada involving tariff threats? Clearly, given the different sizes of
the two economies, Canada is asymmetrically dependent on the US market, but as the
principal supplier of natural resources for which there is no obvious alternative and the
source of over 60% of US imports of oil and gas, Canada has surprising leverage. The most
important tool in such a conflict would be an increase in the price of Canadian energy
exports that could be generated via an export tax. Without easily available alternative
suppliers and low demand elasticity, such an export tax would be borne by US consumers.
2
https://www.brookings.edu/articles/usmca-trade-tracker/#/goods
TABLE 1
ENERGY EXPORT TAX REVENUE SIMULATIONS
Oil
Gas
Electricity
Total
Value of exports
$97.9bn
$8.1bn
$2.1bn
$108.1bn
Price increase
35%
35%
35%
Short-term elasticity
-0.29
-0.18
-0.13
Expected reduction in demand
-10.3%
-6.3%
-4.4%
-9.8%
Expected revenue loss
$10bn
$510mn
$98mn
$10.7bn
Canadian government revenue
from export tax
$22bn
$1.8bn
$523mn
$24.4bn
Similar leverage exists in uranium, potash, aluminium, and nickel – all sectors where
Canada is the supplier of 60–80% of American consumption. Yet such tools are unlikely
to be used. Export taxes, while legal under Canada’s 1985 Export Act, would strain the
federation. Alberta and Saskatchewan would bear the brunt of lost energy revenue;
Quebec, a key electricity exporter, would balk. Both provinces already harbour separatist
leanings, albeit for diametrically opposed reasons. Albertans resent that part of their
taxes are redistributed to the francophone province and the Maritimes, leading the
provincial premier Danielle Smith to call into question the commitment to equalization
payments across the federation. Quebeckers, for their part, worry about preserving their
linguistic identity but also look askance at the Prairie Provinces, who vote for a brand
of political conservatism that attracts few followers in Canada’s east. Neither province
would want to engage in a trade war with the United States to protect the interests of
Ontario, the province whose manufacturing sector is most at risk. Maintaining political
unity in this situation would challenge any Canadian government, let alone one that is
two votes short of a parliamentary majority. All of this is before considering that export
taxes would be seen as an extreme escalation by Washington, judging by the threats
of even higher tariffs issued by the US President in reaction to then-Prime Minister
Trudeau’s retaliatory tariffs.
381
CANADA | MANGER
The evidence suggests that a Canadian export tax on energy could have a significant
impact on the United States at next to no economic cost for Canada in the short term.
Cabral et al. (2025) simulate a retaliatory export tariff of 25% (in addition to the 10%
import tariff imposed by the United States) using demand elasticities calculated by
Labandeira et al. (2017). Given the highly inelastic demand for energy products, US
consumers are unlikely to reduce demand much and would bear nearly all the cost. The
resulting revenue could more than offset the losses to Canadian exporters, as Table 1
shows.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
382
What then are likely scenarios? Let us begin with a pessimistic outlook: the Canadian and
American governments fail to agree – although it is unclear what the long-term objective
of pressure on Canada would be that falls short of complete accession. We could expect
prohibitive US tariffs on Canadian manufacturing exports that would create a severe
shock, economic output would likely fall several percentage points, and the Canadian
dollar would depreciate. Decompositions indicate that growth expectations and the oil
price drive the Canadian dollar’s exchange value (Feunou et al. 2022), so a weakening below
1.50 Canadian dollars to the US dollar is likely. For Canadian consumers, this would cause
a painful income shock, not least because for much of the year, nearly all fresh produce is
imported from the United States or Mexico. While the federal government could cushion
this blow, its fiscal space is limited after providing generous income support during the
Covid-19 pandemic combined with stagnating per-capita income over the last decade.
An excessive fall in the Canadian dollar’s value could also cause currency mismatches on
the balance sheets of Canadian companies and financial institutions, including two of
the country’s largest banks – Royal Bank of Canada and Toronto-Dominion – with their
significant presence in the US market. In the extreme case, the US Administration might
even limit the Federal Reserve’s provision of bilateral currency swaps that has existed
since 1994 under the North American Framework Agreement.
Nor can Canada easily pivot away. Pipeline infrastructure to export oil and gas to Asia
remains limited, and Quebec continues to block eastward pipeline proposals. The
alternative is a plan to build a deepwater port in Hudson Bay to supply icebreaking oil
tankers, as climate change opens up an Arctic route for most of the year. This requires
building a pipeline and risks oil spills in a highly sensitive natural environment. Even if
a political consensus could be found, the labyrinthine Canadian infrastructure approval
process privileges local interests over the government’s eminent domain and gives
indigenous groups a veto over any construction on their land. Proposing such a project in
a country that has been working on a cross-rail link in Toronto for longer than it took to
build the Coliseum in Rome is optimistic.
Trade diversification sounds attractive in theory, but Canada has already inked deals
with all major partners. Outside of China, where geopolitical tensions loom large,
further access is constrained by Canada’s own protectionist barriers: restrictions on
majority foreign investment in telecommunications, airlines, or banking; and the ‘supply
management’ system in its dairy industry that resembles a New York City taxi medallion
policy (farmers have the right to sell milk at a fixed price to the government, and any
imports are subject to a quota and trade restrictions that equate to a 200% tariff).
In an optimistic scenario, these domestic protectionist interests can be overcome,
opening up two negotiating avenues. The first is an enhanced Canada–EU trade
agreement. Investment in Canadian infrastructure – including telecommunications
– would be key to improving productivity and would make Canada less dependent
on the US market. The second is a renegotiation of the Canada-US-Mexico free trade
agreement concluded during President Trump’s first term in office. In this case, being
REFERENCES
Cabral, M, E Chong, C Lajoie, and M S Manger (2025), “Canada’s Leverage in a Trade
War – Energy as a Strategic Asset”, GEPL Economic Policy Brief, Global Economic Policy
Lab at the Munk School of Global Affairs and Public Policy.
Cameron, M A and B W Tomlin (2000), The Making of NAFTA: How the Deal Was Done,
Cornell University Press.
Feunou, B, J-S Fontaine, and I Krohn (2022), “Real Exchange Rate Decompositions”,
Staff Discussion Paper 2022–6, Bank of Canada.
Labandeira, X, J M Labeaga, and X López-Otero (2017), “A Meta-Analysis on the Price
Elasticity of Energy Demand”, Energy Policy 102: 549–68.
ABOUT THE AUTHOR
Mark Manger is a Professor of Political Economy and Global Affairs at the Munk School,
and Director of the Global Economic Policy Lab. His work investigates the political
economy of sovereign debt, exchange rate policy, and trade agreements. He is the author
of Investing in Protection: The Politics Preferential Trade Agreements between North and
South (Cambridge University Press, 2009). Professor Manger received his PhD from the
University of British Columbia (Vancouver).
383
CANADA | MANGER
able to make the same concessions to the United States – in particular on dairy, as a
concession to farmers in Wisconsin, a swing state in presidential elections – will be
crucial. Given the focus on the automotive industry, we could expect a replay of the
successive negotiations between Canada and the United States since the 1988 CanadaUS Free Trade Agreement (CUSFTA) that centre on the ‘rules of origin’ for the auto
industry. These rules stipulate the minimum value-added of a car and its parts that
need to be sourced from Canada, the United States, or Mexico to qualify for tariff-free
trade between the three countries. CUSFTA contained a 50% regional content provision,
tightened to 62.5% under NAFTA (splitting the difference between the 60% proposed
by Canada and the 65% demanded by the United States; Cameron and Tomlin 2000),
to 75% under the USMCA. Raising this regional value content to 100% would force
any auto manufacturer that wanted to avoid possibly punitive US tariffs to locate the
complete value in North America, coming close to President Trump’s stated goals.
The tariff standoff may have reignited Canadian patriotism, but it has also exposed the
country’s strategic fragilities. The question facing Prime Minister Carney is not simply
how to preserve economic independence, but how to navigate an unpredictable American
agenda. In a relationship where economic threats masquerade as policy, the balance
between sovereignty and survival grows ever more delicate.
CHAPTER 33
Bo Lidegaard,ab Mira Kleistac and Nick Bæk Heilmannac
aKaya Partners; bformerly Danish Government; cformerly Naalakkersuisut (Greenland
Government)
Since late 2024, President Trump has repeatedly said that the United States would
assume control over Greenland “one way or another”.1 Facing mounting pressure from
the Trump administration, politicians from Greenland and Denmark have repeatedly
rejected the idea. Meanwhile, the administration is pushing ahead with its plans both
by seeking to drive a wedge between Greenland and the rest of the Danish realm and
by communicating to the US public that Greenland is needed for national security and
critical minerals, and that the Greenlanders want US control and the United States
would make it a profitable deal.
This chapter will provide an overview of the historical relations between the United
States, Greenland, and Denmark and dive into the factors that seem to drive the
President’s interest in Greenland. It will also provide insights to the dilemmas that exists
in the possible solutions to overcome the historical crisis between friends and allies.
A BRIEF HISTORY OF THE GREENLAND–DENMARK–US TRIANGLE
Historical relations between Greenland, Europe, and the Americas go back a thousand
years. The Norse settler Erik the Red, born in Norway and settler to Iceland in 982,
founded the first permanent European settlements in Greenland.
His son, Leif Erikson, continued the Westward expansion by exploring parts of North
America, including an area he named Vinland in what is now Newfoundland, Canada,
around the year 1000 AD – roughly 500 years before Christopher Columbus.2
Subsequently, the Inuit people slowly began to populate the west coast of Greenland from
the north (Canada), while the Norsemen settlements became extinct in South Greenland.
Danish–Norwegian settlement of Greenland picked up again 1721 with the arrival of
Hans Egede, a priest who went on a quest to find the lost descendants of the Norse settlers
in Greenland. Danish and Norwegian missionaries and tradesmen began to settle along
the west coast, eager to assert the interests of the Danish-Norwegian Kingdom and push
back European whalers active on the coast (Heinrich et al 2025).
1
2
https://www.cnbc.com/2025/03/04/trump-says-the-us-will-take-greenland-one-way-or-the-other.html
Source: https://www.britannica.com/biography/Leif-Erikson
385
GREENLAND | LIDEGAARD, KLEIST AND HEILMANN
Greenland
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
386
A Danish–US friendship treaty dated 1826 referred to Greenland as the “possession” of
the King of Denmark.3 In 1867, soon after the United States had purchased Alaska from
Russia, there was a growing interest in expanding American influence and territory,
especially in the Arctic and North Atlantic. The United States suggested the acquisition
of Greenland and Iceland, and in 1868 US officials formally but unsuccessfully inquired
with the Danish government about the possibility of purchasing the two.4
American-led polar expeditions around the turn of the 19th century, including by Admiral
Peary, created growing interest and some doubt in Copenhagen as to the intentions of the
United States – and not without reason. In 1916, as it became clear the United States was
about the enter World War I, Denmark entered into negotiations with the United States
on the purchase of the Danish West Indies (now the US Virgin Islands). In Washington,
Robert Lansing, Secretary of State, argued that the United States should make the
purchase dependent on a Danish commitment to an open door policy in Greenland, but
President Wilson accepted the Danish demand for an American declaration, issued on 4
August 1916, stating that “the Government of the United States of America will not object
to the Danish Government extending their political and economic interests to the whole
of Greenland” (US Department of State 1917).
This can be seen as a rare qualification of the Monroe Doctrine, which was declared by
US President James Monroe in 1823. This doctrine stated that the Americas were no
longer open to colonisation by European powers and warned European nations against
interfering in the political affairs of the Western Hemisphere, asserting that any such
intervention would be viewed as a hostile act against the United States. Yet, the 1916 US
declaration did not open the door for wider European engagement on the island besides
that of the Danish. Rather, it signalled that the question of sovereignty over Greenland
was a bilateral issue between the United States and Denmark and not up for negotiation
with other interested parties in Europe such as Norway or Great Britain, which asked
for a right of first refusal but were rejected.5 The declaration therefore should be seen as
much as an instrument to deny all other powers access to any part of Greenland – and to
make this denial explicit, even if it was not obvious that Greenland fell within the Monroe
Doctrine. It is also worth noting that the declaration does not explicitly recognise Danish
sovereignty, only the more vague “political and economic interests”.
During World War II, the United States became the de facto protector of Greenland
following Denmark’s occupation by Nazi Germany on 9 April 1940. To prevent potential
German control of Greenland, the United States established diplomatic relations and a
US Coast Guard patrol on the West Coast. This was also to protect the open pit cryolite
mine at Ivittuut, on the southwest coast of Greenland. The mine provided the United
States with access to the critical mineral for the production of aluminium, which was
3
4
5
United Nations Treaty Series No. 6056 (https://treaties.un.org/doc/publication/unts/volume%20421/volume-421-i-6056english.pdf).
https://www.nationalgeographic.com/history/article/greenland-us-purchase-history-wwii
https://rosenbaum.org.uk/no-britain-doesnt-have-first-dibs-on-greenland
During World War II, the US Airforce established a number of facilities on the Atlantic
parts of Greenland, including a handful of airfields and crucial weather stations on the
east coast. After the war, a liberated Denmark sought to reassert full control of the island,
but despite several high-level démarches, the Truman administration made it clear to
Copenhagen that the United States leaving Greenland was out of the question. When
Denmark pressed the issue, in 1946 the US Secretary of State, James Byrnes, proposed
to his stunned Danish colleague that the United States buy Greenland for $100 million
in gold. While Denmark stopped pursuing the issue, the United States developed the
thinking around the North Atlantic Treaty, including Greenland and Denmark which, in
April 1949, became a founding party to the Alliance (now NATO).
This did not cause the United States to leave Greenland, but as the American strategic
focus shifted from the European theatre towards nuclear strategies and ballistic missiles,
in 1951 the United States began the construction of the Thule Air Base in the high polar
northwest of Greenland, a midway point between the industrial centres of the United
States and the Soviet Union, and at the same time requested a renegotiation of the 1941
Agreement. This led to the signing in April 1951 of a new bilateral agreement for the
defence of Greenland under the auspices of NATO. Under this agreement, the United
States rapidly expanded its military presence in Greenland with close to 20 “joint
defence areas”, including radar stations across the icecap. At the individual bases, the
United States gained extensive rights including exclusive jurisdiction (including to take
unilateral action), illustrated by the deployment in the 1950s of nuclear weapons at the
Thule Air Base with the tacid consent of the Danish government– despite Denmark’s
387
GREENLAND | LIDEGAARD, KLEIST AND HEILMANN
used for ramping up production of aircraft that were crucial for the Allied battle against
Nazi Germany. (The mine no longer plays a role as the resource has been exhausted and
cryolite has been replaced by other methods and inputs in the production of war material.)
As the Battle of Britain intensified over the winter of 1940-41 and an alarming number
of US fighter planes shipped by convoy to the United Kingdom were sunk by German
submarines in the North Atlantic, President Roosevelt decided to establish airstrips in
the southern part of Greenland to create a first ever hub for aircraft to fly over the Atlantic.
To overcome the challenge of a neutral United Sates getting permission from a formally
neutral Denmark, occupied by Germany, to establish such bases, the United States
entered into an agreement with the Danish envoy to Washington, Henrik Kauffmann,
who, without consultation with his government in occupied Copenhagen, negotiated and
signed the 9 April 1941 “Agreement between Denmark and the United States of America
for the Defense of Greenland”. He signed on behalf of the Danish King in “his capacity as
Sovereign over Greenland” and was accused by his government in occupied Denmark of
high treason for effectively giving the United States a free military hand in Greenland on
terms Denmark could not revoke even after the end of the war. The envoy, on his part,
argued that had he not done so, under the circumstances the United States would have
taken Greenland anyway and never returned it (Lidegaard 2003).
declared policy of not receiving nuclear arms “under the present circumstances”. This
agreement gives the United States large discretion in military affairs in Greenland and
has established a de facto irrevocable US military and security presence in the territory.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
388
Today, only the Thule Air Base, now known as the Pituffik Space Base, remains
operational as US military facilities. The base operates, among other things, a Ballistic
Missile Early Warning System and is equipped with sensors for space surveillance. It is
considered a cornerstone of the defence and security of the North American continent.
In 1953, Greenland changed its status from a Danish colony to become an integral part of
the Kingdom, largely administered from Copenhagen. Following years of modernisation,
the newly established Greenlandic political parties came together to create the Home
Rule Act of 1979, which granted Greenland some autonomy from Denmark, establishing
the first government and parliament of Greenland and over time took control over areas
such as healthcare and education. In 2009, Greenland took the next steps towards more
autonomy by introducing the Self Rule Act that paves the way to take home control of
more policy areas and, if the Greenlandic people choose it, independence (Heinrich et al.
2025: 16-34 and 157-209).
The Itilleq Declaration from 2003, a joint agreement between the Danish government
and the Greenland home rule government (Naalakkersuisut), formalised Greenland’s
involvement in foreign and security policy matters affecting its interests.6
The subsequent Igaliku Agreement in 2004, a trilateral accord between the United
States, Denmark, and Greenland, amends the 1951 defence agreement related to the
US military presence in Greenland. The agreement focuses on the modernisation of the
Thule Air Base (now the Pituffik Space Base) and it largely permits the United States to
upgrade the base for missile defence purposes, enshrines Greenland’s involvement and
participation in decisions regarding US military activities on its territory, and commits
to broader collaboration between the United States and Greenland beyond military
aspects (US Department of State 2011).
As the United States over the decades since 1941 has adjusted its military presense in
Greenland in accordance with evolving military doctrines and threat perceptions in the
Arctic region, these reconfigurations have generally been executed with consent from
the authorities of the Kingdom. Since the 1941 agreement, at no point has the Kingdom
appeared to refuse the United States the possibility of pursuing its evolving military and
strategic interests in Greenland. This is despite growing awareness in Greenland of the
strategic importance of its territory and natural resources and ever stronger requests by
the population to be part of decision making also with regards to international affairs.
6
Source: https://english.stm.dk/the-prime-ministers-office/the-unity-of-the-realm/greenland
Though Greenland in 1973 joined the then European Community with Denmark, it
voted to leave in 1982 and in 1985 left replacing membership with a status as an Overseas
Countries and Territories (OCT) affiliation with the EU.
Today, Greenland’s economy is primarily based on fisheries (mainly shrimp and halibut),
which accounts for about 90% of its export revenues and public sector activity. In 2023,
Greenland’s total GDP was around $2.5 billion, the population was roughly 56,000, and
the labour force just below 30,000 (Statistics Greenland 2024).
About half of the public sector is funded by an annual block grant from Denmark to the
amount of roughly $0.6 billion (in 2023; Statistics Greenland 2024), which helps finance
Greenland’s welfare expenditures such as healthcare and education. Total Danish direct
spending on Greenland, however, is higher than this as Denmark administers, for
example, the judicial area in Greenland, including the police. Depending on the method
of calculating financial streams and services within the different parts of the Danish
realm, total direct spending can roughly be estimated around $0.7 billion a year.
The growing US interest in strengthening its presence and influence in the Arctic region
continued into the Biden administration, though in more subtle and diplomatic ways.
TRUMP 2.0 AND GREENLAND
President Trump has, since before his second inauguration and as early as December
2024, repeatedly stated various iterations of needing Greenland for “national and
international security”. The potential for greater Greenlandic independence has created
uncertainty among some over how future relations between Denmark and Greenland
might develop. In the eyes of some Trump supporters, this opens up the prospect of
presenting Greenland with an offer it cannot refuse.
Three overarching ideas are quoted to sustain the Trump administration’s current,
insistent claims on Greenland:
1. National security and shipping lanes. As described above, the United States
has long-standing security interests in Greenland and has for years expressed
the need for an increased maritime presence and surveillance capabilities in the
territory. This reflects a desire for enhanced military and strategic oversight in
389
GREENLAND | LIDEGAARD, KLEIST AND HEILMANN
Jumping to 2019, the first Trump administration surprisingly expressed a desire
to purchase Greenland. The offer was quickly rejected by the governments in both
Greenland and Denmark. The government of Greenland underlined that the country
is not “for sale but open for business”. While the proposal to buy Greenland was not
pursued, the United States re-opened its consulate in Greenland in 2020, underscoring
a commitment to enhancing military, diplomatic, and economic ties, particularly as
Greenland’s geopolitical importance has grown due to its location in the Arctic and its
natural resources.
the region, driven by the geopolitical importance of the Arctic, its importance for
future shipping routes, and the need to counterbalance other global powers, such
as Russia’s rearmament of its own Arctic region.
Chinese interest in Greenland on a wide range of matters, including mining, peaked
in the mid-2010s with a number of Chinese licenses in minerals, bids to build
new infrastructure including airports, requests to build research stations and to
place a satellite receiver station in the territory, and an interest in purchasing the
abandoned Kangilinnguit naval base. The Chinese pivot to Greenland has largely
been abandoned following Covid-19 and the renewed US focus on Greenland, with
the United States directly or indirectly asking Greenland and/or Denmark not to
proceed with these Chinese development projects.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
390
Greenland’s official strategic interest in China is restricted to fisheries exports
(especially of shrimp and halibut), accounting for roughly 20% of total exports,
and tourism, which is a small but growing market. Yet, the Trump administration
appears to now imply that Greenland’s and Denmark’s actions to keep China out
of Greenland are inadequate.
In January 2025, and most likely as a result of the US administration’s statements
on Greenland, Denmark announced a 14.6 billion Danish krone ($2.05 billion)
investment to bolster its military presence in the Arctic and an investment
package 2.0 of twice the size is expected to be announced in the summer of 2025,
which is aimed at increasing awareness and surveillance capabilities in and
around Greenland.7
The 1951 defence agreement grants the United States vast legal authority to
expand its military presence if deemed necessary for national security reasons.
The security argument could thus be argued to potentially be mitigated by a larger
US military presence in Greenland under the current constitutional framework
without the US acquisition of Greenland.
2. Raw materials. Most critical raw materials (CRMs) deemed strategic by the United
States and under the EU Critical Raw Materials Act occur, or are believed to occur,
in Greenland (Rosa et al. 2023), either as primary resources or by-products. The
United States has expressed interest in accessing these potentially rich mineral
resources, which include most of the minerals crucial for advanced technologies
and renewable energy. Greenland has for decades been asking for investments in
these sectors, but few have been forthcoming and none from the United States.
There have been attempts to place a value on Greenland’s natural resources over
the last few decades, all of which are highly uncertain due to the uncertainty over
the deposit sizes and the fluctuations in the value of these resources on the world
7
https://www.fmn.dk/en/news/2025/new-agreement-strengthens-the-presence-of-the-danish-defence-in-the-arctic-andnorth-atlantic-region
Despite decades of oil exploration, there have been no significant oil or gas
discoveries in Greenland, and in 2021 the Government of Greenland banned any
further oil exploration.8
There has been very limited private business development by US companies in
Greenland in the past years. However, recent developments point to the fact that
key billionaires who have contributed to the Trump campaign are involved in a
number of companies that are exploring investments in Greenland – be it mining,
real estate development, or a potential hub for data centres utilising Greenland’s
vast hydropower potential. A recent analysis of campaign finance records and
corporate filings reveals that US tech moguls who have invested in mining
companies operating in Greenland, fossil fuel executives, and crypto tycoons
with their own plans for the country collectively gave at least $243 million to the
President’s 2024 campaign.9
Regardless of the current pivot by these named billionaires, Greenland is open to
investments and the United States can exploit these minerals under the current
legal structure, provided they live up to the standards set out in the Greenlandic
legislation.
3. This leaves the last, and most likely and most realistic, intention and interest,
which the United States cannot fulfil unless it does actually acquire Greenland:
a manifest destiny narrative that involves expanding American territory to
potentially create an exotic refuge for tech billionaires to live and to develop
new industries. On top of the stated ambitions in Greenland relating to national
security and critical raw materials, the President and supporters close to him
seem to share a more amorphous vision of “owning and controlling” Greenland,
possibly to use the country as an open space for investment and development
or even simply to expand American territory – an ambition that also made it
into Trump’s inauguration speech and which has been repeated countlessly in
subsequent interviews and speeches.
8
9
https://naalakkersuisut.gl/Nyheder/2021/07/1507_oliestop?sc_lang=da
https://www.theguardian.com/us-news/2025/apr/15/trump-greenland-donors-investors-finance
391
GREENLAND | LIDEGAARD, KLEIST AND HEILMANN
market, not to mention the initial high costs of building the infrastructure for
construction of extraction facilities in Greenland. The Greenland Parliament Act
on Mineral Activities (‘Mining Act’) entered into force at the beginning of 2024
and mandates that all exploited minerals in Greenland must, to the highest degree
possible, be processed in Greenland. Yet Greenland has a limited labour force,
and in particular a limited skilled labour force in mining, which means that the
government will have to enter into negotiations with a potential mining company
in order to set the minimum processing requirement in Greenland.
CURRENT US STRATEGY TOWARDS GREENLAND
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
392
Recent developments seem to indicate that the overall US strategy for reaching its goal of
“acquiring” Greenland is to attempt to drive a wedge between Greenland and Denmark
by utilising the colonial past and current sensitive issues between the two. Furthermore,
the US has criticised the “failed attempts to keep Greenland and Greenlanders safe”,10 for
example from alleged threats from Russia and China.
Domestically, the Trump administration is actively working to create a narrative that
Greenland wants to become a part of the United States, that Greenland is necessary
for national security, and that it would be a good deal for both the United States and
Greenland as minerals under US control will result in handouts to Greenland.
The Greenlandic and Danish rejection of the US ‘offer’ is clear and unequivocal. An
opinion poll from January 2025 shows that 85% of Greenlanders do not want to leave the
Kingdom of Denmark to become American.11 The parliamentary elections in Greenland
on March 11 manifested the stated view across Greenland’s political parties that
Greenland wishes to be neither American nor Danish, but Greenlandic. A statement from
all five parties in parliament following the elections stated that there is no way forward
for the United States to acquire Greenland under the current political setup: “We – all
party leaders – cannot accept the repeated statements about annexation and control over
Greenland. As party leaders, we find this behaviour unacceptable toward friends and
allies in a defence alliance”.12 However, Greenland is keen to strengthen cooperation with
the United States, primarily to benefit from civil use of American military presence and
industrial development, especially in critical raw materials. This stance reflects a desire
to maintain Greenland’s distinct identity while leveraging international partnerships to
enhance economic resilience.
The most likely path for the United States to absorb Greenland would be if Greenland
were to move rapidly towards independence and the United States offers or imposes
an alternative under the pretext of defence and security concerns. But as stated clearly
in the new four-party coalition agreement, there will be no Greenlandic independence
within the next four years. Even the most pro-independent party in Greenland seems to
have toned down its rhetoric on this issue, stating that a potential de facto independence
from Denmark will take many years to negotiate. Still, all parties – with varying nuances
and pressures – call for significant steps towards increased independence. This gradual
approach aims to balance the wish for increased autonomy with the practical conditions
of economic and military security.
10 https://www.cnbc.com/2025/03/29/jd-vance-accuses-denmark-of-failing-to-keep-greenland-secure.html
11 https://www.theguardian.com/world/2025/jan/28/85-of-greenlanders-do-not-want-to-join-us-says-new-poll
12 https://naalakkersuisut.gl/Nyheder/2025/03/1403_udtalelse?sc_lang=da
Meanwhile, the United States continues to build pressure by seeking to dive in wedge
between Greenland and Denmark by suggesting a ‘better deal’ for Greenland. As stated
above, the US administration seeks to build a public perception that the United States
needs Greenland for security, and that Greenland wants this and that it would also be
a good deal for the United States due to the richness of critical minerals. The last point
seems to imply an American vision to invest massively in building a mining industry and
other industries in Greenland by way of selling land/resources to investors, viewing the
fact that currently there is no private ownership of land anywhere in Greenland as an
opportunity to acquire huge virgin land masses. The US administration seems to want to
present the idea of sharing parts of the proceeds with Greenland as a major offer, while
ignoring that the land is presently owned collectively by the inhabitants of the island.
Denmark is left with several dilemmas in refusing formal concessions to the United States
while avoiding grandstanding and provocations and maintaining close transatlantic
ties in security and trade. The key line remains supporting the stance taken by the
Greenlandic parties. While Denmark and Greenland seek support and backing from
EU and Nordic partners in Greenland, at the same time they may have to realise that
stronger European engagement could complicate matters further with Washington, also
because in 1985 Greenland decided to leave the European Union and hence, in contrast to
Denmark, it is not presently a member of the Union.
Conversely, a trilateral engagement between Greenland, the United States, and Denmark
may also prove delicate as the United States is likely to want to set terms and conditions
for investments, and indeed for mineral offtake from Greenland, that are incompatible
with present legislation in Greenland and within the Kingdom.
Barring a secnario where the United States attempts to acquire or annex Greenland
without the explicit consent of Greenland and the Kingdom of Denmark, a more
amenable solution may be privately driven investments into Greenland infrastructure/
mining/energy development programmes, which could be a workable landing zone for all
parties and provide a win for the current US administration in cooperation between the
Greenlandic, Danish and US governments and the private sector.
393
GREENLAND | LIDEGAARD, KLEIST AND HEILMANN
The Danish and Greenlandic governments agree to work towards becoming more equal,
with concessions from the Danish side on Greenlandic wishes, and we expect new
legal and/or political frameworks for collaboration within the parts of the Kingdom of
Denmark to emerge. In this process, Greenland will seek to move towards a more equal
partnership with Denmark that respects Greenland’s sovereignty while maintaining
some form of collaboration, including on trade and defence. The details will be negotiated
in the coming months and perhaps years, as all parties need to agree internally in the
respective countries before entering into negotiations on a new legal framework.
REFERENCES
Heinrich, J, M M J Kleist and B Lidegaard (2025), Grønland. En rejse fra de tidligste
tider til et moderne samfund, Copenhagen.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
394
Lidegaard, B (2003), Defiant Diplomacy. Henrik Kauffmann, Denmark, and the United
States in World War II and the Cold War, 1939–1958, Peter Lang.
Rosa, D, P Kalvig, H Stendal and J K Keiding (2023), Review of the Critical Raw Material
Resource Potential in Greenland, Geological Survey of Denmark and Greenland (GEUS),
Copenhagen (https://pub.geus.dk/en/publications/review-of-the-critical-raw-materialresource-potential-in-greenla).
Statistics Greenland (2024), Greenland in Figures: 2024 (https://stat.gl/publ/en/
GF/2024/pdf/Greenland%20in%20Figures%202024.pdf).
US Department of State (1917), “Foreign Relations of the United States, 1917, Supplement
2” (https://history.state.gov/historicaldocuments/frus1917/d881); see also Lidegaard, B
(2003), “Overleveren 1914–1945”, Danmarks Nationalleksikon, pp. 79–87.
US Department of State (2011), “Denmark and Greenland: Self Rule Arrangement”
(https://2009-2017.state.gov/documents/organization/170358.pdf).
ABOUT THE AUTHORS
Bo Lidegaard is a historian with three decades of experience as a geo-political and climate
advisor, top-level diplomat and G20 sherpa, climate change negotiator, newspaper editor,
and writer on contemporary history. He served as a top diplomatic and national security
advisor for six years at the Office of the Danish Prime Minister and lead the political
negotiations in the lead up to the Climate Summit in Copenhagen 2009. In 2021, he cofounded Kaya Partners, providing high-level, business-oriented advice where geopolitics
intersect with climate transition, industrial policy, and European efforts to harness
competitiveness.
Mira Kleist is a Greenland native, based in Nuuk, and is a former diplomat with a decade
of expertise in global Arctic affairs, Greenland–EU relations, indigenous peoples’ rights,
and security policy. Her diverse experience spans government, the European Union, and
the United Nations. Mira’s background includes roles as a civil servant at the Ministry
of Foreign Affairs of Greenland, a posting to the Greenlandic EU Representation in
Brussels, a Social Affairs Associate at the UN headquarters in New York, and a Senior
Advisor at the Danish Ministry of Defence.
Nick Bæk Heilmann is a Greenland native and former diplomat. Nick is specialised in
Greenland/Arctic affairs, with a special focus on export promotion as well as inbound
investments. He also has extensive experience in Chinese domestic and foreign policy
from studies in China and being a caseworker on China in both the Greenland and
Danish foreign ministries. He has a background in Greenland’s Ministry of Foreign
Affairs, Denmark’s Ministry of Foreign Affairs, and the Danish Embassy in London.
GREENLAND | LIDEGAARD, KLEIST AND HEILMANN
395
CHAPTER 34
Kenichi Ueda
University of Tokyo
INTRODUCTION
Contrary to his intentions, President Trump has inadvertently reminded the world of
the importance of free and open international markets and reaffirmed the validity of
mainstream economic theory. Recent GDP figures, forecasts, and reactions in stock
and bond markets clearly show that protectionism harms both domestic and global
economies.
In principle, reducing tariffs brings prosperity to all trading partners. In this sense, there
should be no need for negotiations to lower tariffs. Yet domestic producers sometimes
seek protection to survive without sufficient innovation or effort, and occasionally these
demands are mistakenly heeded by politicians. This is how protectionism arises.
If only one country turns to protectionism, others should focus on persuading it to return
to the global free market system. In such a case, negotiations would not be necessary –
only persuasion. Unfortunately, Japan itself still protects several sectors to some extent,
making negotiations with the United States inevitable.
There is a glimmer of hope. If Japan wishes to protest high US tariffs, it must reduce its
protectionist policies. Here, regardless of President Trump’s true motivations, his push to
reduce Japan’s tariffs and non-tariff barriers could lead to even freer trade between the
two countries.
JAPAN’S TRADE BALANCE
Due to Japan’s historical trade surplus with the United States, President Trump
frequently groups Japan with China – and occasionally others – as a primary source of
the US trade deficit, which he appears to equate with manufacturing job losses. Thus,
it is noteworthy that Japan no longer runs a trade surplus against the rest of the world
(though it still has a current account surplus), as shown in Figure 1.
397
JAPAN | UEDA
Japan
FIGURE 1
JAPAN’S CURRENT ACCOUNT AND TRADE BALANCE (% GDP)
6.00
5.00
4.00
3.00
2.00
1.00
0.00
-1.00
-2.00
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
398
In 2024, the Balance-of-Payment (BOP) Statistics from Japan’s Ministry of Finance1
recorded a merchandise trade deficit of about 3.6 trillion yen (US$24 billion), about 0.6%
of GDP. This near-zero or slightly negative merchandise trade balance has persisted since
2011, following the Great East Japan Earthquake, the Fukushima nuclear accident, and
the nationwide shutdown of nuclear power plants, which had previously supplied onethird of the country’s electricity. Japan’s increased dependence on imported oil and gas
has offset its manufacturing trade surplus.
-3.00
-4.00
-5.00
Current account
Trade balance
Merchandise trade
Source: Balance-of-Payment Statistics, Ministry of Finance.
Moreover, Japan has been running deficits in service trades, which is the difference
between the trade balance and the merchandise trade in Figure 1, of about 3 trillion yen
($20 billion) in 2024. In particular, digital services trade has skyrocketed recently, with
few barriers. While not always captured in traditional trade categories, the balance-ofpayment statistics indicate Japan ran a digital services trade deficit of about 7 trillion
yen ($45 billion) in 2024, according to the report by Mitsubishi Research Institute on
10 February 2025. The United States is one of Japan’s primary sources of digital service
imports.
However, the Trump administration’s focus is on the bilateral merchandise trade deficit,
and thus it has treated Japan similarly to Europe, imposing a 25% global tariff on steel
and aluminium starting 12 March, as well as on autos and auto parts from 3 April and 3
May, respectively. A 10% “reciprocal” bilateral tariff on all other goods was introduced on
1
https://www.mof.go.jp/english/policy/international_policy/reference/balance_of_payments/index.htm
5 April and is expected to increase to 24% for Japan by 10 July unless a “deal” is reached.
Two other major categories reportedly under consideration are semiconductors and
pharmaceuticals. For Japan, semiconductors and the machines that produce them are
also key export items.
According to Trade Statistics by the Ministry of Finance,3 in 2024 Japan’s main exports
to the United States were automobiles (28%), auto parts (6%), engines (5%), and various
machinery and equipment (20%). Japanese negotiators have focused on auto-related
tariffs.
Japan’s top imports from the United States in 2024 included oil, gas, and coal (12% of
total merchandise imports from the United States ), all of which are essentially tariff-free.
Around 17% of imports from the United States were manufactured goods (e.g. aircraft,
engines, electronics), which also face essentially zero tariffs – autos included – although
very few American cars are imported. Japan traditionally imports large volumes of food,
especially from the United States. In 2024, grains, meat, and processed foods accounted
for 9% of Japan’s merchandise imports from the United States.
PROTECTIONISM IN JAPAN
Japan’s agricultural sector remains heavily protected. The Trade Statistics show that
regular imports from the United States are rice, wheat, soybeans, corn, and beef –
most of which are subject to high tariffs (data available on the Japan Tariff Association
webpage).4 Tariffs and distribution mechanisms, particularly for agricultural goods, are
often complex.
Rice is a particularly sensitive and complex case. Japan maintained administered prices
for domestic rice for decades. Although reforms have been underway since 1995, the
government had production limits until 2018 and still now offers subsidies to reduce rice
production in response to declining demand, due to changing preferences and population
decline. As a result, domestic rice prices have remained well above international levels,
with minimal imports. This rigid, quasi-socialist system dates back to wartime controls
around 1940 and still lingers. Similar systems exist, though to a lesser extent, for wheat,
sugar, and some fishery products.
2
3
4
https://www.census.gov/foreign-trade/statistics/highlights/top/top2412yr.html
https://www.customs.go.jp/toukei/info/index_e.htm
https://www.kanzei.or.jp/statistical/tariff/top/index/e
399
JAPAN | UEDA
According to US Census data for 2024, Japan was the fifth largest source of US
merchandise imports (approximately $150 billion) and the sixth largest destination
for US exports (around $80 billion).2 The resulting bilateral trade deficit of about $70
billion is similar to those with Taiwan and Korea, ranking seventh after China, Mexico,
Vietnam, Ireland, Germany, and Taiwan.
Notably, 1995 marked the first year that rice imports were permitted under the “minimum
access” arrangement. The government itself imported all the rice under this scheme. The
private sector imports were finally allowed in 1999, but with a substantially high tariff.
This scheme has remained essentially the same until now.
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
400
Each year, the Japanese government imports up to 770,000 tonnes of rice with no tariff,
of which up to 100,000 tonnes are for direct consumption (as opposed to industrial use).
These government-imported quantities are sold to domestic wholesalers at a markup
determined by an auction. In late 2024, the markup reached the legal ceiling of 292 yen
per kilogramme.5
Beyond the government’s imports, private-sector importers face a tariff of 341 yen per
kilogramme of rice, no matter what the original price is. Therefore, the estimated tariff
rate depends on the original rice price in foreign currency and the exchange rate.
The same Yomiuri article reports that Calrose, a US rice brand, could be imported at
150 yen per kilogramme, then added a 341 yen tariff. From this, the tariff rate for private
importers of Calrose is estimated at 230% (=341/150). In the end, the imported Calrose
was reportedly sold in supermarkets for under 700 yen/kg, compared to 900 yen for
domestic rice.
President Trump, when he announced the reciprocal tariffs at the White House, criticised
Japan for maintaining a high tariff of 700% for rice imports.6 This figure is not accurate
for American rice as described above. Yet, the statement has some basis – a 2009 report
by Japan’s Ministry of Agriculture, Forestry, and Fisheries estimated that the rice tariff
rate was 778%. However, this figure included rice imports from all countries, especially
from Asian countries, which usually sell rice cheaper than the United States. Also, the
international rice price and exchange rate were quite different then. In any case, my
estimation of the current rate of 230% cannot be categorised as a low rate.
The Japanese government claims that the average tariff across all rice imports has
been relatively low – around 2% in 2024 in my estimation, even assuming all imports
are relatively high-priced Calrose. This is because tariff-free government imports have
the dominant share in total rice imports. In other words, due to the high tariff rate for
private sector rice importers, import volumes by the private sector have not picked up.
Pharmaceuticals, another major import from the US (9% share), are even more tightly
regulated. Under Japan’s universal health system, the government sets drug prices and
determines which medications are covered. It also controls physician fees and service
prices. A report by the Ministry of Health, Labour and Welfare dated 27 February 2025,
notes that Japanese drug prices are roughly one-third of those in the United States,
though they are 20% higher than in the United Kingdom, Germany, and France.
5
6
https://www.yomiuri.co.jp/economy/20250315-OYT1T50048 (in Japanese).
https://www.nikkei.com/article/DGXZQOUA0326C0T00C25A4000000 (in Japanese).
At least in agriculture, US concerns about Japanese tariffs and non-tariff barriers are
well-founded. Japan should reduce the protection of agricultural products and perhaps
pharmaceuticals, even if this does not substantially eliminate the bilateral trade
imbalance.
APPROACHING NEGOTIATIONS
Prime Minister Ishiba may be particularly willing to engage in trade negotiations. He
is a vocal supporter of rural revitalisation and agriculture. During a visit to the United
States in February,7 he compared Japan’s rural population to the “forgotten” Americans
described in Vice President Vance’s book (Vance 2016). President Trump and Vice
President Vance reportedly welcomed him as a kindred spirit. Japanese voters appear
to accept the President’s rhetoric without surprise, as it echoes familiar political themes.
Prime Minister Ishiba was selected by Liberal Democratic Party (LDP) members last
November, reflecting these sentiments.
Given Japan’s reliance on the United States for defence, most citizens are focused on
trade talks without vocal opposition. Many consumers even welcome tariff reductions,
particularly on rice. It is Japan’s main staple, and recently rice prices have doubled,
reaching record highs after a decade of stability. All of this has led the Japanese
government to focus immediately on negotiations rather than resisting the US tariff
hikes.
The Edgeworth box
As noted, tariffs harm the public. But when both sides are protectionist, negotiations
become inevitable. Here, Japan and the United States – under like-minded leadership –
may find common ground.
President Trump favours negotiation, and the Edgeworth box shows that mutually
beneficial (Pareto optimal) outcomes can be reached through bargaining. If countries
avoid exploiting each other, a series of bilateral deals could potentially improve global
efficiency for the negotiators.
The sticking point is the ‘initial endowment’ – the starting point for negotiation. In
textbooks, this is given. However, the US administration unilaterally shifted it by raising
tariffs before talks began. Many countries reject this and contest its legitimacy. The
President justifies it by claiming the United States has been treated unfairly and needs
corrective action – effectively demanding ‘affirmative action’ from others.
In practice, two battles are being fought: (1) to restore the original starting point; and (2)
to negotiate reductions in tariffs and non-tariff barriers once that point is agreed upon.
7
https://japannews.yomiuri.co.jp/politics/politics-government/20250210-237840/
JAPAN | UEDA
401
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
402
Japan’s priority is restoring the starting point. Currently, the United States is willing to
discuss reciprocal tariffs, but not the 25% tariffs on autos, steel, and aluminium, which
were imposed under a separate legal basis. Japan’s first objective is to include those tariffs
in the talks. If successful, it seems ready to negotiate reductions in its own tariffs and
barriers, especially in agriculture.
Another way to improve its bargaining position is to raise its ‘reservation utility’ – for
example, by strengthening trade ties elsewhere. Japan is leading in expanding the
Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP),
pursuing regional deals like the Regional Comprehensive Economic Partnership (RCEP),
and negotiating new bilateral free-trade agreements, often with higher standards on
labour and the environment. These moves reduce dependence on the United States and
promote freer global trade.
Once the starting point is set, substantive negotiations can begin. Japan’s protectionist
measures – particularly in agriculture – will be central. Pharmaceuticals may also be
discussed. Industrial subsidies, often seen as hidden trade barriers, are another likely
topic. While Japan dismantled most industrial policies decades ago, some have reemerged – such as subsidies for Rapidus, a government-backed semiconductor firm, and
incentives for the Taiwanese firm, TSMC, to set up a factory in Japan. The government has
also been supporting small and medium-sized enterprises, some of which intentionally
stay small to retain access to this support (e.g. Japan Display). Although some of them
are welcomed by the United States for security reasons (e.g. semiconductors), generous
subsidies for many firms can be seen as hidden tariffs or non-tariff barriers.
CURRENT ACCOUNT AND STRUCTURAL ISSUES
Trade talks may ease short-term tensions but will not resolve deeper structural issues –
chiefly, the US current account deficit, which includes trade, income from investments,
and remittances. The latter two are persistently negative, with much of the United States’
outbound profits flowing to Japan and China due to the United States’ net external
liabilities. Indeed, the United States’ external liability seems unsustainably growing over
time (see Figure 2), while Japan, China, and Germany keep high external asset positions.
This large external liability, together with high fiscal debt, puts the United States in a
precarious position. In a typical emerging market, such imbalances would risk a balanceof-payments or debt crisis. It’s understandable that President Trump feels compelled to
act.
However, tariffs are the wrong remedy. They damage global growth and destroy jobs –
even in the United States. This fundamental economic reality must be communicated
by allies – especially Japan, which has long benefited from free trade and open capital
markets.
FIGURE 2
NET INTERNATIONAL INVESTMENT POSITION, 1970-2023 (CONSTANT 198284 AVERAGE USD BILLION)
2000
1000
-2000
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020
2022
-1000
-3000
-4000
-5000
-6000
-7000
-8000
France
Germany
Japan
UK
US
China
Source: External Wealth of Nations Database (https://www.brookings.edu/articles/the-external-wealth-of-nationsdatabase/). US CPI is from the Federal Reserve Bank of St Louis.
Even if global trade liberalisation resumes, the United States will likely maintain its
current account deficit, driven by internal imbalances – particularly its large fiscal
deficit. Some argue this persists because the US dollar is the world’s reserve currency,
creating strong demand for safe dollar assets.
Yet discipline is still possible. As financial technologies evolve, the ‘hard currency’
constraint may ease. Reforming the global monetary and payments system is a task for
all major economies.
REFERENCES
Mitsubishi Research Institute (2025), “MRI Daily Economic Points: Digital Kanren
Shusi (Digital services trade balance)”, 10 February (https://www.mri.co.jp/knowledge/
insight/dep/2025/i5inlu000001h7kf-att/dep20250210.pdf, in Japanese).
Ministry of Agriculture, Forestry and Fisheries (2009), Minimum Access Mai ni Kansuru
Houkokusho [Report on Rice Imports under Minimum Access] (https://www.maff.
go.jp/j/council/seisaku/syokuryo/0903/pdf/ref_data2.pdf, in Japanese).
Ministry of Health, Labour and Welfare (025), Shinyaku no Yakka ni okeru Oushu
tono Hikaku [New Drug Prices: Comparison with Europe], report to the Central Social
Insurance Medical Council (https://www.mhlw.go.jp/stf/shingi/2r9852000002w6r3att/2r9852000002w6uj.pdf, in Japanese).
Vance, J D (2016), Hillbilly Elegy: A Memoir of a Family and Culture in Crisis, Harper.
JAPAN | UEDA
403
0
ABOUT THE AUTHOR
Kenichi Ueda is Director of Center for Advanced Research in Finance (CARF) and
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
404
Professor at the Graduate School of Economics and the Graduate School of Public
Policy, The University of Tokyo. He serves as Representative Director of Tokyo Center
for Economic Research (TCER), Fellow at the Asian Bureau of Finance and Economic
Research (ABFER), and Associate Fellow at the Centre for Economic Policy Research
(CEPR). Since March 2015, he is a member of Council on Customs, Tariff, Foreign
Exchange, and other Transactions for the Japanese Ministry of Finance. His research
focuses on linkages between financial systems and macroeconomic activities. His
research papers have been published in top academic journals including the Review of
Economic Studies and the Journal of Economic Theory. Until 2014, he worked for the IMF
for fourteen years, mostly in the Research Department. He also held a visiting position
at the Economics Department of the Massachusetts Institute of Technology in 2011-2012.
He obtained his PhD in Economics from the University of Chicago in 2000. Prior to that,
he worked for the Ministry of Finance, Japan, after receiving a BA in Economics from the
University of Tokyo.
PART IV
SPILLOVERS TO EMERGING AND
DEVELOPING ECONOMIES
CHAPTER 35
Robin Brooks
Brookings Institution
THE TRUMP 2.0 TARIFF SHOCK TO EMERGING MARKETS
During the first Trump administration, it took well over a year for meaningful tariffs
to be imposed, all of which were directed at China. The second Trump administration
began very differently. Shortly after its inauguration, substantial tariffs were threatened
on Canada and Mexico, only for those to be paused shortly thereafter. Only a 10% acrossthe-board tariff hike on China went ahead at the time, followed by another 10% hike one
month later. Reciprocal tariffs, announced on 2 April, never went into effect for most
countries, leaving only the 10% universal tariff for most, and extremely high tariffs on US
imports from China (Figure 1).
While the imposition of a universal tariff is certainly a negative shock for emerging
markets, it is a manageable one. The direct hit to growth in 2025 is around half a
percentage point of GDP, as estimated by the IMF in its most recent World Economic
Outlook (2025). This downgrade is similar in size to that for China, though growth in
2026 is expected to recover somewhat in non-China emerging markets, unlike China
(Figure 2).
Instead, risks to emerging markets stem primarily from three sources that could sharply
tighten financial conditions via capital outflows, thereby weighing on growth: (i) an
escalation of the US–China trade conflict, in particular if China resorts to devaluation
of the yuan; (ii) mounting instability around the reserve currency status of the dollar,
which is seen as increasingly embattled in markets; and (iii) idiosyncratic trouble spots
in emerging markets – primarily Turkey and Argentina – where blow-ups could cause
contagion to the other emerging markets.
407
EMERGING MARKETS | BROOKS
Emerging markets
FIGURE 1
US TARIFF RATES ON CHINA
AND NON-CHINA EMERGING
MARKETS (%)
160
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
408
IMF ANNUAL GROWTH
FORECASTS, APRIL 2025
VERSUS OCTOBER 2024 (%)
6
140
Apr. '25
China
5
Non-China EM
120
100
FIGURE 2
Feb. '20: Phase I agreement – $101 bn
from 15% to 7.5% (List 4A)
4
Sep. '19: $101 bn at
80 15% (List 4A)
3
May '19: $200 bn
60 from 10% to 25%
(List 3)
Sep. '18: $200 bn
40at 10% (List 3)
Aug. '18: $16 bn
at 25% (List 2)
China (Apr. '25)
Mar. '25
Feb. '25
1
20
Jul. '18: $34 bn
at 25% (List 1)
Jan. '25
17
China (Oct. '24)
Non-China EM (Apr. '25)
Non-China EM (Oct. '24)
0
0
16
Forecast
2
18
19
20
21
22
23
24
25
2022
2023
2024
2025
2026
Source: Haver Analytics
This chapter discusses each of these risks in turn. As the US last imposed meaningful
tariffs in 2018, for much of the discussion it compares the evolution of financial markets
along each dimension for year-to-date so far in 2025 with 2018, to gauge the magnitude
of each of these risks.
RISK OF ESCALATION IN THE US–CHINA TARIFF WAR
Emerging market currencies have so far been relatively stable, even with the imposition
of universal tariffs. In aggregate, the currencies have been broadly stable year-to-date,
which parallels 2018. There are two important caveats to this picture, however. First,
non-resident investors in emerging market stocks and bonds – classified as portfolio
flows in the balance of payments – are extremely negative so far this year, based on daily
and weekly flows data from Bloomberg (Figure 3). This outflow is broad-based, with
Turkey seeing especially large outflows given ongoing anti-government protests. There
is also evidence that lower-income countries are being hit harder than middle-income
countries, given that their sovereign bond spreads are widening more. The stability in
exchange rates is thus likely a product of considerable official intervention, i.e. that stable
exchange rates hide underlying vulnerability. Second, China has so far not resorted to
depreciation of the yuan in response to US tariffs. When China did allow depreciation in
2018, from the middle of the year onwards (Figure 4), this set in motion a chain reaction
that saw emerging market currencies sell-off on a broad basis (as Figure 2 highlights).
Such contagion effects are very likely again now, especially factoring in how large capital
outflows already are, even without a yuan depreciation.
FIGURE 3
NON-RESIDENT INFLOWS INTO
EMERGING MARKETS, EXCL.
CHINA ($ MILLION)
FIGURE 4VALUE OF THE YUAN, YEARTO-DATE 2025 VERSUS
2018 (INDEXED TO 100 ON 1
JANUARY)
108
1000
409
2018
104
2025
0
102
-500
100
Bigger EM
capital outflows
-1000
98
April 18,
2025
Weaker yuan
against dollar
96
2018
-1500
April 18,
2025
-2000
94
2025
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
92
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Source: Bloomberg
RISK OF MOUNTING INSTABILITY AROUND US RESERVE CURRENCY STATUS
No two crises are ever the same. A major discrepancy with 2018 is how much the dollar has
fallen against its peer currencies in other advanced economies. Figure 5 shows a tradeweighted index measuring the strength of the G10 currencies – short-hand for advanced
economies – against the dollar through all of 2018 and in 2025 year-to-date. The rise
of G10 currencies against the dollar so far this year is highly unusual and completely at
odds with the 2018 experience. While much of this rise no doubt reflects an unwinding of
US ‘exceptionalism’ trades, which were predicated on the belief that the United States is
likely to outgrow its G10 peers for many years to come, there is certainly a lot of debate in
markets over mounting damage to the reserve currency status of the dollar and a waning
exorbitant privilege.
It is far too early to say whether the US reserve currency status is being compromised.
That said, a simple look at interest rate differentials – especially at longer tenors – does
not point to this as the dominant driver behind recent dollar declines. Figure 6 shows the
10-year interest rate differential of the US vis-à-vis its G10 trading partners, using the
same trade weights underlying the currency indices used earlier. There does not appear
to be a rising rate differential, which would point to a mounting US risk premium. In fact,
the opposite is true: the 10-year rate differential has fallen sharply since early this year,
consistent with the dollar fall being largely about markets re-rating US growth lower.
EMERGING MARKETS | BROOKS
106
500
FIGURE 5
410
US DOLLAR AGAINST G10
CURRENCIES, YEAR-TO-DATE
2025 VERSUS 2018 (INDEXED
TO 100 ON 1 JANUARY)
April 18,
2025
108
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
106
2018
2025
FIGURE 6
TEN-YEAR YIELD
DIFFERENTIAL OF THE US
VERSUS THE G10, YEAR-TODATE 2025 VERSUS 2018 (%)
1.7
1.6
1.5
104
Weaker G10
against dollar
102
1.4
1.3
100
1.2
98
2018
April, 18
2025
1.1
96
1.0
94
2025
Rate differential moves
against the US
0.9
92
0.8
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Source: Bloomberg
All this said, if the reserve currency status of the US did come under serious pressure, this
could very well be a risk-negative shock, which would again tighten financial conditions
in emerging markets via capital outflows. This is because such a loss of reserve currency
status would undoubtedly be the result of substantial policy uncertainty in the United
States – there is growing mention of capital controls, for example – or steps by China and
other countries to divest themselves of their US Treasury holdings. These things would
be extremely unsettling to global markets, and emerging markets would undoubtedly
suffer collateral damage.
RISK FROM FEAR OF FLOATING IN EMERGING MARKETS
Over twenty years ago, Calvo and Reinhart (2002) coined the term ‘fear of floating’ to
describe reluctance in emerging markets to embrace freely floating exchange rates. Their
work came in the wake of the Asian financial crisis, when many currency pegs collapsed
in explosive fashion, with large devaluations and financial turmoil weighing on growth in
the years that followed. Since then, many emerging markets have embraced fully flexible
exchange rates, alongside adopting independent, inflation-targeting central banks.
However, significant holdouts remain, even as they continue to suffer periodic currency
crises and volatility (there are also many dirty floats, i.e. countries who intervene
periodically, especially in Asia). Two of the most important holdouts are Argentina (Figure
7) and Turkey (Figure 8), which periodically devalue, only to then repeg their currencies
to the dollar, which inevitably sews the seeds for the next crisis. This is because inflation
passthrough in the wake of depreciation is large, which causes the real exchange rate to
rise quickly after devaluation. For example, Argentina’s real exchange rate has risen back
above where it was before devaluation in December 2023, entirely due to repegging amid
high inflation. Turkey’s real exchange rate is also at its highest in many years. In both
cases, reflexive repegging has given rise to large currency overvaluation in real terms,
which could give rise to depreciation episodes in both cases, as happened in 2018.
ARGENTINIAN PESO VERSUS
THE US DOLLAR AND AGAINST
ALL CURRENCIES
150
Apr.
2025
140
0
200
130
120
FIGURE 8
TURKISH LIRA VERSUS THE
US DOLLAR AND AGAINST ALL
CURRENCIES
150
0
140
5
130
10
120
400
110
100
600
90
80
800
70
15
110
100
20
90
25
80
30
70
60
Real effective Argentinian Peso
$/ARS (rhs, inverted)
50
40
10
12
14
16
18
20
22
1000
60
1200
40
Real effective Turkish Lira
$/TRY (rhs, inverted)
50
24
26
Apr. 35
2025
40
10
12
14
16
18
20
45
22
24
26
Source: Bloomberg
Of course, the circumstances in both countries are highly idiosyncratic. That said, the
combination of idiosyncratic problems in Argentina and Turkey in 2018, coupled with
mounting trade tensions between the United States and China, ultimately led to a broadbased emerging market sell-off from the middle of that year, not to mention the fact that
‘fear of floating’ encompasses many other emerging markets, including other extreme
examples like Egypt and Pakistan. The combination of idiosyncratic devaluations and a
US–China trade war is thus another risk that could tighten emerging market financial
conditions and weigh on growth. This risk is exacerbated by the preponderance of
external borrowing in foreign currency across emerging markets, as documented by
Eichengreen et al. (2023), with ‘original sin’ remaining a pervasive problem.
CONCLUSION
The universal US tariff of 10% has hit emerging markets EM alongside most other
countries. However, while this is certainly an adverse growth shock, it is manageable.
Bigger risks stem from emerging markets becoming collateral damage in an escalating
US–China trade war or from instability around a loss of the US reserve currency status.
Idiosyncratic imbalances in countries with dollar pegs could also metastasise into
broader capital flight, which could pose material downside risk to growth.
411
EMERGING MARKETS | BROOKS
FIGURE 7
REFERENCES
Calvo, G and C Reinhart (2002), “Fear of Floating”, The Quarterly Journal of Economics
117(2): 379-408
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
412
Eichengreen, B, R Hausmann and U Panizza (2023), “Yet It Endures: The Persistence of
Original Sin”, Open Economies Review 34: 1-42.
IMF (2025), “Policy Uncertainty Tests Global Resilience”, in A Critical Juncture Amid
Policy Shifts, World Economic Outlook, April 2025.
ABOUT THE AUTHOR
Robin Brooks is a senior fellow in the Global Economy and Development program at the
Brookings Institution. His research focuses on global growth and inflation dynamics,
capital flows to emerging and frontier markets, as well as Western sanctions policy
and the G7 oil price cap on Russia. He is frequently cited in popular media such as the
Financial Times, Wall Street Journal, and New York Times among others. He appears
regularly on CNBC and Bloomberg broadcasts.Prior to Brookings, he was managing
director and chief economist at the Institute of International Finance. In that role, he
oversaw macroeconomic analysis and served as part of the senior management team.
Prior to that, he was the chief FX strategist at Goldman Sachs based in New York, where
he was responsible for the firm’s foreign exchange forecasts and publishing international
macro research. Prior to Goldman Sachs, he was the FX strategist at Brevan Howard.
Before joining the private sector, Brooks spent eight years as an economist at the IMF,
where he worked on the IMF’s fair value models for FX, published academic research,
and participated in missions to IMF programme countries. Brooks earned his Doctoral
degree in Economics from Yale University in 1998. He earned a Bachelor of Science in
Monetary Economics from the London School of Economics in 1993.
CHAPTER 36
Yasheng Huang
Massachusetts Institute of Technology
Citing the negative effect of tariffs, Goldman Sachs1 projected China’s GDP growth to be
4% in 2025 and 3.5% in 2026, down from its previous estimates of 4.5% and 4%. These
forecasts already take into account the Chinese government’s expected policy support
and are based on an estimate that some 10–20 million workers in China are exposed to
exports to the United States.
In this chapter, I will not make specific forecasts about China’s GDP performance, in
part because of the uncertainty of the trajectory of the trade war but also because GDP
performance is not the only effect of the trade war. The focus of this chapter is on the
channels and mechanisms through which a trade war, if severe and prolonged, can
negatively impact Chinese economy. Media and business analysts2 focus on the trade
patterns such as China having run a consistent trade surplus with the United States
and China having diversified away from the United States, as indicated by the fact that
China’s share3 of US imports has fallen from 23% before the Covid pandemic to 13% now.
Trade patterns are only a partial indicator to gauge the potential impact of the trade
war. China’s exposure to the Trump administration’s trade shocks is twofold. First, the
trade shocks may induce a recession in the United States and likely a global economic
slowdown.4 China, like other countries, will be negatively impacted. The second channel
works through China’s total exposure to the world market, not just to the American
market. At the time of this writing, the statutory tariffs on Chinese goods stand at 145%,
although there are exemptions and exceptions. At that level, the United States effectively
has a trade embargo against China on most goods. According to Gene Seroka,5 executive
director of the Port of Los Angeles, arrivals at the port would drop by 35% as “essentially
all shipments out of China for major retailers and manufacturers has ceased”. This is a
real trade war, not just an escalation of costs of doing trade with China.
1
2
3
4
5
https://www.wsj.com/livecoverage/stock-market-trump-tariffs-trade-war-04-10-25/card/goldman-lowers-china-gdpforecast-citing-tariffs-B5FLWMKl0kVoGdl0syxY
https://abcnews.go.com/Business/country-leverage-us-china-trade-war-experts-weigh/story?id=120713403
https://www.wsj.com/economy/trade/how-u-s-and-china-are-breaking-up-in-charts-282bd878
https://www.reuters.com/business/imf-cuts-growth-forecasts-most-countries-wake-century-high-us-tariffs-2025-04-22/
https://www.pbs.org/newshour/nation/shipments-from-china-fall-as-trumps-tariffs-loom-over-economy
413
CHINA | HUANG
China
THE ECONOMIC CONSEQUENCES OF THE SECOND TRUMP ADMINISTRATION: A PRELIMINARY ASSESSMENT
414
In 2024, China’s overall trade surplus6 was nearly one trillion dollars, a historical high.
Its trade surplus with the United States was US$295.4 billion.7 A loss of that magnitude
is unlikely to be offset elsewhere. The European Union, for example, already runs a
massive trade deficit of US$349 billion8 with China, limiting its capacity to absorb much
of the trade diversion from the United States. The relevant question is whether China’s
domestic economy can absorb a substantial part of the production that will be lost
due to the Trump administration’s trade shocks. In the short run, the answer to that
question is likely to be negative; in the long run, the answer depends on drastic changes
in the configurations of the Chinese economic structure, which in turn depend on the
adjustments of China’s growth model.
The degree of China’s vulnerability depends on the degree of the trade shocks, but a
prolonged trade war will definitely have a substantial impact on the Chinese economy.