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I saw her today at the reception
In her glass was a bleeding man
She was practiced at the art of deception
Well, I could tell by her blood-stained hands, sing it
You can’t always get what you want
But if you try sometimes, well, you just might find
You get what you need
- You Can’t Always Get What You Want, by The Rolling Stones
Tariffs: Great in Theory … Dumb in Practice
Apropos of what has been clearly driving markets over the past several weeks, in this month’s commentary I will discuss tariffs. Specifically, I will demonstrate that although they can, in theory, produce certain benefits, in reality, they are far more likely to cause more harm than good, both for economies and markets.
A Boon to Humanity
The entire world has benefitted immeasurably from global trade in the postwar era. Its expansion has vastly expanded the supply of most goods, leading to lower prices. In simple terms, globalization has led to more things at lower prices, which has made the world far wealthier and led to a phenomenal increase in standards of living.
Consumers and businesses in the U.S. and other developed nations have benefitted from the fact that most things can be made for less in other countries. To be sure, the windfall of cheaper goods has involved the dislocation of manufacturing jobs over the last several decades. However, the percentage of the American workforce in manufacturing currently stands at roughly 8%, and less than 14% in 2000.
Furthermore, most experts agree that technology and automation, as opposed to trade, have been primarily responsible for the decline in manufacturing employment in the U.S. Also, given that the U.S. is currently at full employment, it stands to reason that dislocated jobs have been replaced. Importantly, the net benefit of trade has been massive, enabling citizens of advanced economies to enjoy higher standards of living than if they were forced to buy only domestically produced goods.
The Theoretical Benefits of Tariffs
Although the benefits from free trade are undeniable, governments are periodically tempted to tweak trade relationships in their favour to maintain or augment globalization’s existing benefits while minimizing or eliminating its relatively minor drawbacks. These initiatives entail some degree of restrictions on trade. Today, the U.S. is pursuing such policies by imposing tariffs on imported goods.
The purported benefits of these particular tariffs are:
Benefit #1: Improved government finances: This argument contends that tariff revenues will afford the government some flexibility with respect to fiscal policy. Specifically, the revenue which is collected via tariffs will be used to reduce the ever-expanding U.S. deficit. Alternatively, these revenues could serve to increase government spending and/or reduce taxes without a deterioration of the government’s fiscal position.
Promise #2: A manufacturing renaissance: Another potential benefit involves the bolstering of certain industries via reduced competition from imports, with an associated boost to employment in these areas. The current U.S. administration has been particularly vocal about the ability of tariffs to revitalize manufacturing in states where it was once prominent.
Promise #3: A Better Deal: This argument holds that tariffs will force other countries to the negotiating table and put the U.S. in a strong position to secure better trade agreements and/or end unfair trade practices that hurt its economy.
Einstein’s Warning
Albert Einstein famously stated, “In theory, theory and practice are the same. In practice, they are not.” In theory, tariffs can deliver on the aforementioned promises, but the reality is that not only are they unlikely to do so but stand a very good chance of causing more harm than good.
Very little, if anything, in the modern global economy occurs in a vacuum. One specific policy or event can easily start a chain reaction of subsequent policies and events. Although some of these cascading effects can be anticipated, their magnitude is almost impossible to predict. More ominously, many of them are unforeseeable (the technical term used by economists for such developments is “unintended consequences”). As a result of such reverberations, few, if any of the purported benefits of tariffs are likely to materialize, should they remain in place. Moreover, their associated consequences could prove severe.
Improved Government Finances: Robbing Peter to Pay Paul
Escalating tensions and the prospect of long-lasting trade wars have resulted in a heightened state of uncertainty among both businesses and consumers, which may have a significant impact on their investment and spending.
Tariff-related uncertainty can cause businesses to curtail their activity, or at the very least to delay or cancel growth initiatives. Given the very real possibility of an about-face by the U.S. on tariffs, it would be imprudent for CEOs to commit capital to new projects. No sane person would ever make a material investment decision based on tariffs that may be subject to either renegotiation or outright cancellation. Such tactics can reduce growth and employment or even cause them to contract, thereby leading to a recession.
With respect to U.S. consumers, any anticipated or actual tariff-induced layoffs will cause them to curtail their spending. This could in turn create a negative feedback loop whereby lower demand causes companies to trim payrolls, thereby spurring a further reduction in spending, etc., with the endgame being a recession (which certainly wouldn’t be good for government finances).
A Manufacturing Renaissance: Don’t count on it
All else being equal, tariffs “should” spur domestic manufacturing by increasing the prices of products from abroad. The thinking is that higher prices for imported goods will reduce their competitiveness and shift demand towards domestically made products. To meet this increased demand, manufacturers (both domestic and foreign) will build new factories in the U.S. and/or hire Americans: a clear win for the “home team,” right?
Even if tariffs did engender a material increase in demand for locally produced products, the reality is that it would be difficult to meet it. New factories take years to build, and executives need to be confident that the associated costs are justified by an expectation of sufficient profits over the long term. Given the very real possibility that U.S. trade policy may change materially over the next several years, it is hard to believe that any CEO has such confidence. Furthermore, the U.S. probably does not have enough skilled workers to take the place of their counterparts in other countries which currently produce exports for America.
Bullying can Backfire
There are instances where using tariffs as a proverbial “stick” to coerce other countries to adopt trade policies which are more advantageous for the stick-wielding country may prove effective. However, such tactics are by no means guaranteed to produce the desired results.
Granted, smaller countries which are largely dependent on the U.S. may have no choice but to acquiesce to whatever terms are imposed on them, regardless their fairness. However, as China has demonstrated (and as Eurozone countries may yet demonstrate), stronger countries have the viable option of retaliating with tariffs of their own.
In addition, one cannot underestimate the role of psychology in such matters. To the extent that tariffs are viewed as unfair by the citizens of countries on which they are imposed, people may be willing to endure hardship rather than acquiesce. While I am by no means an expert when it comes to trade negotiations, I suspect that referring to Canada as the 51st state doesn’t exactly provide a strong foundation for agreement!
The Bad and the Ugly
Putting aside how successful tariffs prove in terms of ultimately achieving their desired outcomes, there can be little doubt that they cause significant pain, both for economies and markets.
The one thing that tariffs are almost 100% certain to result in is higher prices. Tariffs are taxes on imports. As is the case with any tax, someone must pay it. In theory, the tax can be absorbed by foreign manufacturers or domestic importers to preserve their business. However, the reality is that they will resist sacrificing profits. Even if they are willing to bear the brunt of some or all of the tariffs, their profit margins may not be sufficient to enable them to do so.
Moreover, replacing imported goods with domestically produced substitutes is easier said than done. It would take years (at best) to build enough domestic capacity to satisfy U.S. demand, resulting in interim shortages and prices at previous levels plus the tariffs. As such, U.S. businesses and consumers will be the ones that take it on the proverbial chin and pay for tariffs.
One argument that does bear some sympathy is that tariffs should be used to support a handful of mission critical, strategic industries, particularly in a geopolitically uncertain world. In such cases, the economic loss from tariffs can be justified by concerns related to national security. However, these situations are limited and may justify a highly tailored approach as opposed to the broad-based tariffs.
At the end of the day, tariffs lead to higher prices, which in turn lead to lower standards of living. While this might not be the case if wages keep pace with prices, such an outcome runs the risk of igniting a toxic and inflationary price-wage spiral.
Playing Defense and Hoping that Level Heads Prevail
There can be little doubt that the U.S. has started down a very dangerous path and that tariffs are costly, both for the U.S. and the rest of the world.
Turning to markets, tariffs have clear implications. Higher prices result in lower sales volumes and corporate profit margins, which tend to be a leading indicator of recessions. When margins come under pressure, companies refrain from making new investments and shed people, which brings about economic downturns. Importantly, lower profits lead to lower equity prices unless multiples expand by a sufficient amount to offset the damage.
Unfortunately, given elevated levels of risk and uncertainty, multiples can be expected to contract rather than expand, resulting in a double whammy for markets. In addition to consternation about a tariff-induced recession, markets have recently been demonstrating additional concerns surrounding America’s long-standing reputation for good governance and stability, with both the U.S. dollar and Treasuries suffering significant setbacks since the beginning of April.
Nobody can predict how current trade frictions will play out, and I sincerely hope that level heads will prevail. However, as the expression goes, “Fool me once, shame on you; fool me twice, shame on me.” Even if the U.S. does an about face, my guess is that governments and companies will nonetheless take meaningful steps to reduce their dependence on a long-term continuation of benign U.S. trade policies, which has negative implications for global growth and inflation.
Given this dynamic, investors should remain flexible and lighten up on private and other less liquid investments. With respect to their liquid positions, they should favour companies that are less cyclically sensitive, less dependent on imported goods, and towards sectors and companies whose sales are domestically concentrated.
Noah Solomon is Chief Investment Officer for Outcome Metric Asset Management Limited Partnership. From 2008 to 2016, Noah was CEO and CIO of GenFund Management Inc. (formerly Genuity Fund Management), where he designed and managed data-driven, statistically-based equity funds. Between 2002 and 2008, Noah was a proprietary trader in the equities division of Goldman Sachs, where he deployed the firm’s capital in several quantitatively-driven investment strategies.
Prior to joining Goldman, Noah worked at Citibank and Lehman Brothers. Noah holds an MBA from the Wharton School of Business at the University of Pennsylvania, where he graduated as a Palmer Scholar (top 5% of graduating class). He also holds a BA from McGill University (magna cum laude). Noah is frequently featured in the media including a regular column in the Financial Post and appearances on BNN. This blog originally appeared in the April 2025 issue of the Outcome newsletter and is republished here with permission
