The global economy has demonstrated a surprising degree of resilience in the face of rising trade barriers, but underlying vulnerabilities suggest this robustness may not be sustainable. While initial forecasts predicted a significant drag on growth and shifts in inflation following the implementation of tariffs, the actual impact has been less severe than anticipated, prompting analysts to dub it the “global resilience puzzle.” However, this apparent strength is underpinned by factors that may prove temporary, leaving the global outlook fragile.
At the beginning of , the National Institute of Economic and Social Research (NIESR) projected US economic growth of 2.4 per cent
and global growth of 3.2 per cent
. Following the announcement of tariffs, these forecasts were revised downwards to 1.6 per cent
and 3 per cent
, respectively. Inflation was expected to rise to 2.7 per cent
in the US and fall to 6.6 per cent
globally.
The divergence in inflation expectations – a rise in the US and a fall globally – stems from the differing nature of the impact. For the US, tariffs represent a supply shock, increasing domestic prices and dampening economic activity. Conversely, for the global economy, they act as a demand shock, reducing US demand for imports and creating a surplus of goods on the international market, thereby lowering global inflation.
While the direction of these effects proved accurate, the magnitude was somewhat off. Inflation forecasts aligned closely with actual outcomes, but the predicted declines in GDP were larger than what materialized. This suggests an underlying adaptability within the global economy that wasn’t fully captured in initial models.
Beyond Headline Rates: The Role of Effective Tariffs
One key factor explaining this resilience is that the actual impact of tariffs was less than initially feared. While headline tariff rates attracted considerable attention, the effective rate – the tariff implied by actual import duties collected – was roughly half the announced figure. As of , the US average headline tariff rate stands at 18 per cent
, while the effective rate is 9.2 per cent
. This discrepancy highlights the importance of focusing on the actual economic impact rather than solely on announced policies.
Trade Diversion: Re-Routing Global Commerce
Another significant contributor to the unexpected resilience is trade diversion. Unlike previous periods of trade disruption, such as and , global export volumes did not experience a substantial dip in . Instead, evidence suggests that trade flows were re-routed. For example, Chinese exports to the US fell by 20 per cent
in , but this decline was offset by increased exports to Africa, Latin America, and Southeast Asia. This suggests that tariffs, rather than directly suppressing activity, are primarily altering the geography of trade.
However, the sustainability of these new trade flows remains uncertain.
Fiscal Policy as a Cushion
The third factor cushioning the impact of tariffs is loose fiscal policy. Governments globally have maintained supportive fiscal stances since the pandemic, with both the US and China running historically large budget deficits – around 10 per cent
and 6 per cent
of GDP, respectively – in the previous year. Similar trends were observed in the Eurozone and the UK, exceeding earlier expectations. This increased government spending has helped to absorb some of the negative effects of tariffs, but it has also led to elevated borrowing costs and raised concerns about long-term fiscal sustainability.
A Fragile Outlook
Despite the apparent robustness of growth, the global outlook remains fragile. The positive effects observed are largely due to offsetting forces – tariffs absorbed by accommodative fiscal policy, trade diversion, and dollar devaluation. The extent to which these factors can be sustained is unclear. The costs of tariffs are not immediately visible in headline growth figures but are manifesting as a higher risk premium and a weaker dollar.
This creates a situation where the global economy has limited room for maneuver in the event of a future shock. For instance, a correction in the market for artificial intelligence equities – which has had spillover effects on employment and investment – could quickly expose underlying vulnerabilities. The current state of affairs can be described as everything looks fine for now, until it isn’t
.
The interplay of these factors suggests that the global economy is operating on borrowed time, with the potential for a more significant downturn looming if the supporting mechanisms begin to unravel. While resilience has been demonstrated, it is a resilience built on foundations that may not withstand further strain.
