A Brief History of Tariffs and Their Function

Tariffs have shaped trade and politics for centuries. From the Roman Empire’s taxation on imports to Britain’s tariff-driven control of its colonies, these trade policies have played a crucial role in economic history. In the early days of the United States, Alexander Hamilton, the first Secretary of the Treasury, was a key advocate of protectionist tariffs. In his 1791 Report on Manufactures, he argued that young American industries needed tariff protections to grow strong enough to compete with European manufacturing. His vision helped shape early U.S. trade policy, laying the foundation for domestic industrialization. However, as the global economy evolved, tariffs had mixed results. By the 20th century, the 1930 Smoot-Hawley Tariff Act attempted to shield American businesses but backfired, worsening the Great Depression and leading to global retaliations. Recognizing these dangers, world leaders formed the General Agreement on Tariffs and Trade (GATT) in 1947, later evolving into the World Trade Organization (WTO) in 1995, which sought to reduce trade barriers globally.

How Tariffs Work and Their Economic Justification

Tariffs function as a means to make domestically produced goods more attractive by increasing the cost of competing foreign imports. By raising import prices, governments aim to create a price advantage for local industries, fostering job creation and economic growth.

The economic rationale behind tariffs is largely tied to the infant industry argument and domestic protectionism. The infant industry argument suggests that emerging sectors may struggle to compete against well-established foreign industries, justifying temporary tariffs to provide them with a competitive edge. Additionally, tariffs can protect domestic jobs by reducing reliance on foreign suppliers and maintaining local production. However, excessive reliance on tariffs can lead to market inefficiencies, encourage retaliation from trade partners, and result in higher consumer prices.

Trump’s Tariff Strategy: Protectionism, Negotiation, and Geopolitical Leverage

Trump’s tariff strategy has been a mix of economic protectionism, negotiation leverage, and geopolitical manoeuvring. His administration has justified tariffs as a means to reduce trade deficits, protect domestic industries, and pressure trading partners into new agreements. In early 2025, Trump imposed a 10% tariff on Chinese imports, reigniting trade tensions, while a 25% tariff on Canada and Mexico was delayed pending their cooperation on border security and drug trafficking. Tariffs on steel, aluminium, and critical imports like semiconductors and pharmaceuticals are also part of the broader effort to strengthen U.S. manufacturing and reduce reliance on foreign suppliers. The administration has hinted at new tariffs on European auto imports, framing them as leverage to encourage European countries to increase their defence spending under NATO commitments and to boost imports of U.S. energy products, particularly liquefied natural gas. While tariffs have benefited some domestic industries, they have also increased inflationary pressures, with estimates suggesting a 0.5 percentage point rise in core inflation. Additionally, economists project that these tariffs could shave off up to 0.3 percentage points from U.S. GDP growth, depending on the extent of trade disruptions and retaliatory measures from key trading partners. Thus, the question remains: Do these tariffs truly achieve their intended economic and geopolitical goals, or do they ultimately create more problems than they solve?

Evaluating the Success of the 2018 Tariffs: A Blueprint for Today’s Trade Policy 

The tariffs introduced by the Trump administration in 2018 serve as a case study for assessing whether protectionist trade policies achieve their intended objectives. The 2018 tariffs, which targeted over USD 283 billion in imports, primarily aimed to reduce trade deficits, protect domestic industries, and pressure China into ending unfair trade practices. However, economic research, including a study by Amiti, Redding, and Weinstein (2019), economists at the New York Fed and Princeton University, found that these tariffs had significant unintended consequences

Rather than compelling foreign exporters to lower prices, the tariffs were almost entirely passed on to U.S. consumers and businesses. By December 2018, these tariffs were costing U.S. consumers and importers an additional USD 3.2 billion per month in tax costs and another USD 1.4 billion per month in deadweight losses. Domestic producers, shielded from foreign competition, took advantage of the situation by raising prices, further contributing to inflationary pressures. The tariffs also disrupted global supply chains, leading to a reallocation of trade worth approximately USD 165 billion per year as companies sought to bypass the new trade barriers.

Additionally, retaliatory tariffs imposed by China, the European Union, and other key trading partners significantly harmed U.S. exporters, particularly in the agricultural and manufacturing sectors. The total redirected trade and lost export opportunities amounted to roughly USD 183 billion annually, underscoring the risks of escalating trade wars.

The 2018 tariffs ultimately raised questions about the effectiveness of unilateral protectionism. While they provided short-term revenue and some benefits to domestic producers, they also increased costs for consumers, triggered retaliatory actions, and disrupted long-term trade stability. These lessons are particularly relevant as Trump reintroduces tariffs in 2025. If the same patterns hold, the current wave of tariffs could once again lead to higher consumer prices, retaliation from trading partners, and economic distortions that outweigh any short-term gains.

The EU’s Hidden Ace: How Service Tariffs Could Reshape the U.S.-EU Trade Dispute 

The European Union is expected to react strategically to new U.S. tariffs, following a playbook similar to its 2018 response, but with a key difference: the introduction of the Anti-Coercion Instrument (ACI), which allows the EU to target U.S. service exports, particularly Big Tech. While the U.S. has traditionally focused on goods like autos and industrial materials, the EU runs a significant trade deficit in services, amounting to nearly EUR 150 billion annually as of 2024.

Exhibit 1: EU trade relations with the United States.

Source: Eurostat, Mbaer.

Under the ACI, the EU could impose severe restrictions, including revoking intellectual property protections for U.S. companies, limiting software downloads, and restricting market access for banking, insurance, and other financial services. Some officials argue that Trump's previous threats to use tariffs to coerce Denmark over Greenland and to pressure the EU into abandoning enforcement actions against U.S. tech firms provide clear grounds for retaliation. However, while the legal framework is in place, the political reality remains complex. Any EU countermeasures would require approval from at least 15 of the 27 member states, a process that could take months. Some nations remain wary of escalating tensions, especially given Europe’s fragile economic growth.

Despite these constraints, EU trade ministers have expressed broad support for responding firmly if necessary. The EU has learned from past trade disputes, when it took three months to adopt retaliatory measures on USD 2.8 billion of U.S. goods. This time, officials stress the need for a faster, more coordinated response. However, despite having this powerful tool at its disposal, the EU is likely to favor de-escalation over escalation. Historically, trade tensions between the U.S. and EU have been more manageable than those with China, and European policymakers recognize the economic interdependence between the two regions. By keeping its response measured and leveraging the ACI as a bargaining tool rather than an immediate weapon, the EU may avoid a full-scale trade war, ensuring that diplomatic channels remain open while signaling that it will not be a passive player in global trade disputes.

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