Inside Economics: Trump’s trade war – What are tariffs? Who pays them and why they’ll hit you in the back pocket

US President Donald Trump has thrown the rulebook on international trade out the window.

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Making sense of Trump’s war tactics

There’s no getting around US politics this week – much as I’d like to avoid it. There’s a big yellow-haired elephant in the room for anyone writing about economics.

US President Donald Trump has put his tariff policy into action and the reaction has been dramatic.

Plans over the weekend for the rapid implementation of 25% tariffs on goods from Mexico and Canada – and 10% tariffs on Chinese goods – immediately rattled markets and put trading nations around the world on edge.

Here in this tiny trading nation, those of us following economics and trade have known nothing but a steady and prosperous march towards free trade for decades.

Even though Trump has been talking about big tariffs for months, it still felt like a shock to see 40 years of progress on trade liberalisation upended so rapidly and seemingly recklessly.

As of Monday (when I foolishly started drafting this column), we were braced for a massive market meltdown. Investors sold on fears a trade war would lower global growth and bring higher US inflation, putting paid to rate cuts from the US Federal Reserve this year.

Then it didn’t happen.

Mexico cut a deal and gained a one-month reprieve, Canada followed suit and (as of Tuesday evening) markets more or less returned to pretending all of this isn’t really happening.

In the Trump-era US, policy moves fast, to the point you can’t be sure where it is from hour to hour.

One suspects that is all part of the plan – to upend normal diplomatic convention and use aggressive trade policy for US advantage.

It certainly seems like the economic rationale for tariffs is playing second fiddle.

But despite so much being still unclear about US trade policy, it will have enormous implications for the global and local economy, however it lands.

At the time of writing, the US was yet to pause tariff plans on China and the prospect of tariffs on European Union goods has been raised.

So it seems like a good time to step back (take a breath) and remind ourselves how tariffs work and what they might mean for us here in New Zealand.

What are tariffs?

Put simply, tariffs are taxes applied to imported goods. They are almost as old as trade itself.

The earliest examples date back to ancient Mesopotamia, around 2800-2600BCE. These early tariffs were essentially customs duties collected at city gates on traded goods.

That’s more or less exactly what the Trump tariffs will be, although these days, the tariffs are paid electronically.

Who pays them?

Trump has repeatedly stated it will be foreign companies that pay the tariffs, not US consumers.

That, as numerous critics have pointed out, is absolutely not correct.

If you want to import goods into the US, you must register with US Customs and Border Protection to become an importer of record.

It’s no mystery. The US already has tariffs in place on most imported goods (although the average level is about 2.5%), so the systems are in place.

That’s one of the reasons Trump can act so quickly to increase the tariffs.

Who bears the real cost?

This is a different proposition from who actually pays the tariff. You’d have to assume it’s what Trump is talking about when he claims foreign companies will pay.

Faced with a tariff (which they have to pay), US importers have three choices.

They can bear the cost themselves and take a hit to their margins and profits.

If they have enough leverage, they can try to demand the foreign companies drop their prices to cover the cost of the tariff.

Or they can pass the cost through to the retailers and consumers they sell to.

Trump’s confidence suggests he believes tariffed exporters in Canada, Mexico and China will be so desperate to get their goods into the US, they will cut their prices.

If they have no markets that can match the US price (including the new tariff), then that might be the case.

But where they can find other markets that will take their goods at a better price, they’ll go there.

It’s been suggested by economists there could be an upside for New Zealand in this.

If goods that are no longer economical to sell into the US increase supply to tariff-free nations like New Zealand, we may actually see some lower prices.

Are tariffs inflationary?

Ultimately, the pass-through of higher costs to consumers is the whole point of tariffs.

If there is any economic logic for introducing them, it is that they impart a pricing advantage to local producers by making imported goods more expensive.

So, of course that is inflationary.

US consumers will pay more for imported goods, and there is no reason for locally produced goods to get cheaper because the tariffs remove the competitive pressure to produce them more efficiently.

Why do we care about US inflation?

Unfortunately, the prospect of Trump’s tariff policies boosting US inflation is one of the most pressing issues for the New Zealand economy.

Before we even get to the trade fallout, Kiwis are already being hit in the back pocket.

That’s because US inflation – or assumptions about the prospect of it – have pushed up US interest rates.

Expectations that the US Federal Reserve would keep cutting the Official Cash Rate (OCR) this year have gone up in smoke.

Federal Reserve chairman Jerome Powell speaks during a news conference. Photo / AFP

So wholesale bond yields are rising in anticipation of higher long-term rates.

That has three flow-on effects for Kiwis, none of them good.

Your mortgage rate

The first is that higher US borrowing costs push up the cost of debt for our banks – which still fund a sizeable portion of their mortgage lending from international markets.

So the extent to which local banks can pass on OCR cuts made by the Reserve Bank is potentially lower than it might have been.

The Reserve Bank of New Zealand (RBNZ) could compensate by cutting more aggressively but may bump up against its own inflation woes (see below).

The Kiwi dollar effect

A second effect of higher US inflation is that it can be exported our way via the currency.

Higher US interest rates push the US dollar higher and the Kiwi dollar lower in relative terms.

That means the cost of international goods rises for New Zealanders and adds inflationary pressure to the economy.

The most obvious example is the costs of petrol, which we’ve been paying more for this summer as the value of the Kiwi has fallen.

It is off 11% since late September – from US63c to US56c yesterday.

While the RBNZ still looks set to cut the OCR by another 50 basis points at its next meeting on February 19, the higher cost of imports and higher inflation could limit the ability to cut rates as far as they might otherwise have.

That is a potential headwind for our economic recovery.

Although, it is important to mention the lower currency will boost NZ dollar returns for our exporters, which are looking good for the current season.

The lower Kiwi will also make us more attractive to US tourists – although bad luck if you were planning a US holiday this year.

KiwiSaver fallout

Finally, higher interest rates are typically bad news for stock markets, as investors can get relatively better returns from less risky investments in cash.

We’ve already seen Wall Street rattled by Trump’s tariff threats. If he follows through on the scale he is threatening, then it could spark a sizeable sell-off. Some analysts fear it might even cause a correction or crash.

That would hit our KiwiSaver balances hard and probably flow through to the local NZX 50, putting more economic pressure on our listed companies.

How else are tariffs bad for New Zealand?

I don’t even want to speculate regarding the economic impact we’d feel if Trump decided to significantly lift tariffs on New Zealand goods.

It’s not clear that we are in the gun yet so it might be too soon to worry.

The US became New Zealand’s second-largest export market last year, according to new Stats NZ data released last week.

The growth was driven largely by demand for our cheap beef and edible offal (heading into US burgers and processed meat).

Because they need the beef, we get a fairly sizeable quota of exports set at a low tariff rate.

If that were reduced or tariffs were increased, our export earnings could take a big hit.

Our core dairy exports such as cheese and milk powder are already subject to significant tariffs in the US (outside of tight quotas).

However, the US is a significant market for Fonterra due to trade in specialist dairy protein ingredients that are used by US companies in the manufacture of nutritional products for US and global consumers.

In fact, the US was Fonterra’s second-largest market by value for exports from NZ in the year ending September 2024.

The technology sector could also be vulnerable.

A lot of Kiwi tech companies – like Rocket Lab – have been largely bought out by US firms so wouldn’t be affected.

But others, like the NZX-listed F&P Healthcare, have already found themselves in the gun because they have moved manufacturing to Mexico.

The Herald’s Jamie Gray took a deeper dive into the risks for specific sectors in this article: Trump trade wars: NZ caught in downdraft as US imposes trade tariffs.

The China syndrome

At this stage, a more immediate problem for New Zealand exporters will be the dampening effect new tariffs could have on our largest trading partner – China.

China’s economy has already been growing more slowly than hoped since Covid.

The slowdown there has already hit tourist numbers here and forestry exports. Thankfully, dairy prices have remained solid.

Chinese economic fortunes influence demand for forestry exports. Photo / NZ Herald

But our economic recovery hopes are closely tied to China’s economy, and the prospects of it taking another hit this year are ominous.

Why do economists hate tariffs so much?

Economists love efficiency and like policies that maximise wealth creation and minimise cost. On aggregate protectionism makes the world a poorer place.

There are few, if any, economists of note who support the widespread use of tariffs and subsidies across the global economy.

There are some – usually on the left – who make the case for targeted use to support struggling or developing industry sectors or developing economies.

The argument for tariffs and protecting local industries is that it will create jobs (or retain them) and increased local production and economic activity will boost GDP growth.

But in the same way printing money or artificially lowering interest rates can give an economy a short-term boost (as it did through Covid), it doesn’t generate real wealth in the long run.

When local businesses are protected with tariffs, the incentive to produce goods more efficiently is removed.

They are effectively being paid to produce more expensive goods than their foreign competitors.

The competitive drive to improve products is also removed.

We saw it in New Zealand in the 1950s, 60s and 70s. And we saw it in the Soviet Union.

Market economists consider protectionism and the distortion of market competition to be among the key failings of last century’s socialist policies.

It’s odd to see the great capitalist champion Trump and the Republicans (the party of Ronald Reagan) pursuing a failed socialist policy.

Since the 1980s, a large consensus of economists has argued freer trade has resulted in greater global economic growth.

Many felt policymakers had learned a lesson from the failures of the 20th century.

Trump, in his defence, prefers to look through the protectionist failures of the 20th century and cited the success of US tariff policies in the Gilded Age of the late 19th century.

While free trade might boost global growth, he is only interested in America.

He seems to believe in American exceptionalism and the idea it can grow its economy better in isolation.

Perhaps he’ll have some short-term success wielding US political might in this fashion.

History (and classical economics) suggests it won’t work in the long run.

Either way, it’s an extremely high-stakes experiment that doesn’t look good for the rest of the world.

Liam Dann is business editor-at-large for the New Zealand Herald. He is a senior writer and columnist, and also presents and produces videos and podcasts. He joined the Herald in 2003. To sign up to his weekly newsletter, click on your user profile at nzherald.co.nz and select “My newsletters”. For a step-by-step guide, click here. If you have a burning question about the quirks or intricacies of economics, send it to liam.dann@nzherald.co.nz or leave a message in the comments section.