America’s policy turn towards higher tariffs was widely expected to derail the world economy. Instead, 2025 turned out alright. According to the latest (January 2026) update to its global economic outlook, the International Monetary Fund (IMF) reckons that world trade in goods and services grew by 4.1% in 2025, a tad better than 2024’s 3.6%. World GDP growth held steady at 3.3% and the financial markets had a field day.

After initially being badly rattled by Donald Trump’s ‘liberation day’ (2 April 2025) tariff plans, the (Morgan Stanley Capital International) MSCI World Index finished the year up 19.5% in US dollar terms. Shares in the ‘emerging markets’ – normally the sorts of countries most vulnerable to trade shocks – rose by a stonking 30.5% (going by the MSCI Emerging Market Index, again in US dollars).

Swings and roundabouts

You’d be tempted to think that the alarm calls from economists and others about the damage tariffs would do were mightily overblown. Maybe protectionism isn’t so bad after all? Certainly the US Government is pleased: it’s currently taking in around US$30 billion a month in tariff income, roughly three times its pre-‘liberation’ haul.

But you’d be wrong to relax. For now, the impact may well have been hard to see. That’s because monetary policy has eased pretty much everywhere as the COVID-era inflation has come back under control, and there’s been a growth-supporting surge in investment in the likes of AI and data centres. And, while on average US tariffs have gone up significantly, the US has also back-pedalled on some of its initial plans, so the impact hasn’t been as bad as originally feared.

All that said, higher tariffs lurk in the background as a terrible idea and will go on doing harm for years to come. Every time economists are polled, they prefer free trade.

When US economists were asked, for example, whether they agreed with the statement that ‘freer trade improves productive efficiency and offers consumers better choices and, in the long run, these gains are much larger than any effects on employment’, 85% agreed or strongly agreed. When asked if ‘adding new or higher import duties on products such as air conditioners, cars and cookies to encourage producers to make them in the US would be a good idea’, 93% disagreed or strongly disagreed.

Does anyone seriously believe that we’d be better off if we drew a line down the middle of Australia or across Cook Strait and charged folks a tariff to move goods across it?

The case for free trade

Why do economists like free trade and dislike import duties?

For a start, economists reject the notion that trade is a win-lose game. Rather, we observe that people willingly trade to their mutual advantage all the time. When I sell my motorbike second hand and use the cash to buy a new laptop, at least three parties are better off: the new bike owner, the laptop seller and me. We’ve all got what we would prefer. It makes no difference what nationalities we all are.

Unlike the US administration, we don’t see imports as a bad thing. Quite the reverse: the more cancer drugs, cases of Veuve Clicquot and tickets to Ed Sheeran concerts we buy, the better off we are. Exporting is the chore we’ve got to do to buy the nice things we’d like.

Plus, free trade is efficient. Things tend to be made by the folks best able to make them which boosts our living standards by increasing world output, while using up the least resources to do it.

Protectionism, on the other hand, is inefficient by design. The second or third (or worse) best gets to produce more expensive stuff behind the tariff walls. It’s inherently implausible as a good policy. Does anyone seriously believe that we’d be better off if we drew a line down the middle of Australia or across Cook Strait and charged folks a tariff to move goods across it?

Who pays?

In the US, tariffs have been portrayed as an easy way to snaffle some of overseas exporters’ cash flow. That’s wrong, too. It’s become clear that it’s US consumers who are actually paying the tariffs.

It’s true that who pays is not immediately evident. If a US supermarket previously imported a bottle of wine at wholesale for $10 and sold it at retail for $15, what price will it charge when, say, a $2.50 tariff raises the wholesale cost to $12.50?

$17.50? Something less?

Is there a chance that the wine supplier will swallow the tariff and supply the US supermarket at $7.50, and the bottle on the shelf will still cost $15, leaving the retail customer unaffected?

Figuring out how much of a cost increase sellers pass on to buyers is a surprisingly complex calculation. However, as researchers have turned their minds to it, they keep coming up with the same answer. US consumers are very largely wearing the cost. As one example, researchers at the Kiel Institute for the World Economy, a German think tank, found that “The 2025 US tariffs are an own goal: American importers and consumers bear nearly the entire cost. Foreign exporters absorb only about 4% of the tariff burden – the remaining 96% is passed through to US buyers.”

The knock-on effects

A final flaw is the downward spiral that tariffs can set off. An example: we export wine to Japan, they export cars to us. If we put tariffs on their cars, we buy fewer of them. That reduces the carmakers’ income, so they buy less wine. As our wine exporters lose sales their incomes go down, so they buy fewer cars again and the carmakers buy even less wine. Throw in retaliatory tariffs on wine and it gets worse again.

The Great Depression of the 1930s saw exactly this spiral play out. It wasn’t the only thing that went wrong – dumb fiscal and monetary policy played a large part, too – but it helped create an unprecedented economic calamity.

You’d have thought, when it comes to trade policy, that we had learned from that folly, just as we have learned to run better fiscal and monetary regimes. Apparently not. Karl Marx said in 1852 that “History repeats itself, first as tragedy, then as farce.” He wasn’t wrong.