While addressing steel workers in the U.S. state of Pennsylvania, Mr. Trump threatened to increase the import tariffs on steel and aluminium from the current 25% to 50% from June 4, upset by the slow progress of a trade deal between the U.S. and the EU.
Steel and aluminium are used as basic inputs in a host of industries and sectors ranging from transportation (rail, road, sea and air), defence and aerospace, household appliances, engineering machinery of all kinds, agricultural tools and implements, civil engineering and construction, power generation and transmission and a whole lot of others.
Now that the tariffs have come into effect, they would further increase the domestic prices of goods and services in the U.S. where steel and aluminium are used, either as intermediate products and inputs or as fully finished products, lower the consumer and industrial demand for such products and slow down the overall growth of the economy, as steel and aluminium happen to be key basic inputs used in a wide variety of industries and economic activities. The U.S. economy had contracted by 0.2% in the first quarter of 2025 as compared to the previous quarter, while inflation had declined to 2.31% at the end of April 2025, still higher than the threshold level of 2% for the Federal Reserve to start cutting interest rates again.
Impact on GDP
With the economic and trade disruption caused by uncertain trade policies and the widening U.S. Budget deficit, there is a fear that U.S. inflation may go up again, forcing the Federal Reserve to postpone its interest rate cuts to September, and in a worst-case scenario, towards the end of the year.
The Paris-based Organization for Economic Cooperation and Development (OECD) has forecast a slowing down of the U.S. GDP growth rate to 1.6% in 2025 from 2.8% in 2024 and a fall in World GDP growth rate to 2.9% for 2025 as compared to 3.3% in the previous year. In April 2025, the U.S. economy added 1,77,000 new jobs, exceeding previous expectations, though falling short of the 2,56,000 new jobs generated in December 2024, the last month of the Biden administration, before Mr. Trump assumed office. The unemployment rate, however, remained steady at 4.2% April 2025.
Loss of consumer’s surplus
Economic theory tells us that when an import tariff is imposed on a commodity in a free-market economy following free international trade, the higher tariff-inclusive price will become the new domestic price. It reduces the consumer’s surplus, which is calculated as the notional difference between what consumers are prepared to pay for a product or service and what they actually end up paying – the lower the actual price the higher the consumer’s surplus and vice versa. It transfers some of this lost consumer’s surplus to the domestic producers of the import competing industry as producer’s surplus, while the rest (of the lost consumer’s surplus) is treated as a deadweight loss to society as a whole.
Still, Governments all over the world use import tariffs as measures to increase Government revenue (ultimately paid for by the domestic consumers) and to support domestic manufacturers of the import competing products for generating local employment, incomes and economic growth. Rarely are tariffs used as measures to promote national security which Mr. Trump is signalling in justification of his new 50% levies on steel and aluminium imports.
Nominal vs. effective rate
The rate of effective protection provided by an import tariff to domestic producers of an import competing product is perceived to be high, if the tariff on the imported input used in the manufacture of that product is lower than the tariff on the imported finished product. Otherwise, the domestic producers suffer the consequences of negative protection and the anomalies of an inverted duty structure, which arises when the tax rate on inputs used to produce goods or services is greater than the tax rate on the finished output.
Impact on U.S. auto units
Let us consider the impact of Mr. Trump’s new tariff levies on steel and aluminium imports on the American automobile producers. Currently automobile imports into the U.S. from the EU attract an import tariff of 25%. With the new 50% import tariffs on steel and aluminium imports from the EU and other countries (excepting U.K.), American producers of automobiles who use steel and aluminium as inputs in their manufacturing process, will not only see a sharp rise in their manufacturing costs, but will also see the 25% import tariff on automobiles not providing the protection that it is intended to provide. Far from providing a positive rate of effective protection, the proposed higher tariffs of 50% on steel and aluminium imports, will end up as disincentives to ramping up domestic production of automobiles in the US.
Domestic firms
Let us illustrate this with a hypothetical example. Assume the basic starting price of a Ford Mustang car in the U.S. is $30,000. The cost of steel and aluminium parts used in the Mustang car is $20,000. The U.S. is taxing a comparable car model of the EU imported into the U.S. (Volkswagen Jetta), an import tariff of 25%, but the imported steel and aluminium metals and components, an import tariff of 50%. The rate of effective protection provided to Ford to ramp up the domestic production of Mustang car can be estimated using the following formula:
g = {(t-a¡t¡) / (1-a¡)}
where,
g= rate of effective protection to domestic producers of the final product,
t= nominal tariff rate on consumers of the final product,
a¡= ratio of the cost of the imported input to the price of the final product in the absence of tariffs,
t¡= the nominal tariff rate on the imported input.
In the above example:
t= 25%
t¡= 50%
price of final product = $30,000
cost of steel input = $20,000
Negative vs. positive rate
Using the above formula for estimating the rate of effective protection, g can be calculated as -0.25 or -25%, which is a negative rate and acts as a disincentive for ramping up the domestic production of Ford Mustang cars. On the other hand, if the import tariff on steel and aluminium metals and parts is fixed at 10%, like the basic import tariff on all other imports announced by Mr. Trump, then the rate of effective protection, g, will be 0.55 or 55%, which will be a sufficient incentive for Ford to ramp up the domestic production of its Mustang cars.
(The writer is former associate professor of economics, Loyola College, Chennai)
Published – June 05, 2025 06:00 am IST
