Podcast Summary: Thoughts on the Market Episode: The Downside Risks of Reciprocal Tariffs
Release Date: February 20, 2025
Host/Author: Morgan Stanley

Introduction

In this episode of Thoughts on the Market, Morgan Stanley’s Global Chief Economist, Seth Carpenter, delves into the potential adverse effects of reciprocal tariffs on the U.S. economy. Carpenter provides a comprehensive analysis of how increased tariffs, particularly those targeting China, could undermine economic growth, despite the market’s current focus on the inflationary impacts of such trade policies.

Downside Risks of Tariffs to the U.S. Economy

Seth Carpenter opens by addressing the predominant concern surrounding tariffs — their inflationary pressures. However, he emphasizes that the negative implications on economic growth are equally, if not more, significant yet often overlooked.

“The inflationary risk of tariffs gets its due attention in markets, but the adverse growth implications? That's an underappreciated risk.” [01:04]

Carpenter warns that the escalation of reciprocal tariffs could pose a substantial threat to the U.S. economic forecast for the year. He underscores that while markets have adjusted to some extent, the broader growth implications remain underestimated.

Surprising Growth Forecasts and Potential Upside Risks

Reflecting on prior economic forecasts, Carpenter admits that many analysts, including Morgan Stanley, were taken aback by the unexpected economic growth in 2023 and 2024. He questions whether there might be overlooked positive factors that could further bolster the economy.

“Maybe we should ask, are there some upside risks that we're missing?” [01:30]

One prominent upside he identifies is the surge in productivity driven by advancements in Artificial Intelligence (AI). Morgan Stanley remains optimistic about AI’s role in enhancing productivity beyond pre-COVID levels, potentially contributing an additional 0.1 percentage points to productivity growth within the year.

“We penciled in about a 10th percentage point of extra productivity growth this year from AI.” [02:30]

Additionally, Carpenter notes that AI-related capital expenditure (capex) spending could provide a modest boost to Gross Domestic Product (GDP), further supporting economic growth despite the headwinds from tariffs.

Impact of Reciprocal Tariffs on Industrial Production

Carpenter discusses the historical context of tariffs, specifically referencing the tariffs imposed on China. He highlights how these tariffs significantly dampened industrial production in the U.S., extending their adverse effects well into 2019.

“The tariffs imposed before on China led to a sharp deterioration in industrial production.” [03:20]

Moreover, the absence of a subsequent rebound in industrial output suggests that the expected benefits of producing more domestically were not realized to the extent projected. This points to the complexities and real-world challenges of reversing decades-long trade imbalances through tariff policies.

Global Implications of Reciprocal Tariffs

Expanding the scope beyond the U.S., Carpenter emphasizes that reciprocal tariffs could have far-reaching consequences globally, particularly affecting Latin America and Asia. He explains that many key economies have imposed higher tariffs on U.S. goods compared to the tariffs the U.S. has placed on theirs, exacerbating global trade tensions.

“Free trade has divided production functions around the world, but it's also driven large trade imbalances.” [03:50]

Carpenter warns that attempting to swiftly address these long-standing trade imbalances through reciprocal tariffs could lead to significant disruptions in international trade dynamics, further complicating economic recovery efforts.

Baseline Outlook and Future Prospects

Despite the rising risks, Carpenter maintains Morgan Stanley’s baseline outlook that only tariffs on China are likely to remain persistent. He suggests that any delayed implementation of reciprocal tariffs aligns with this perspective, although the potential for broader tariff implementations cannot be dismissed entirely.

“Ultimately, though, we are retaining our baseline view that only tariffs on China will prove to be durable.” [04:30]

Carpenter concludes by reiterating the importance of monitoring global trade policies and their implications, both domestically and internationally, as the U.S. navigates the complexities of reciprocal tariffs.

Conclusion

Seth Carpenter’s analysis provides a nuanced understanding of the multifaceted impacts of reciprocal tariffs on the U.S. economy. While acknowledging the potential for AI-driven productivity gains to offset some negative effects, he cautions against underestimating the significant risks tariffs pose to economic growth and global trade stability. This episode serves as a crucial reminder for policymakers and investors alike to consider both the immediate and long-term consequences of escalating trade tensions.

Notable Quotes Summary

• “The inflationary risk of tariffs gets its due attention in markets, but the adverse growth implications? That's an underappreciated risk.” — Seth Carpenter [01:04]
• “Maybe we should ask, are there some upside risks that we're missing?” — Seth Carpenter [01:30]
• “We penciled in about a 10th percentage point of extra productivity growth this year from AI.” — Seth Carpenter [02:30]
• “The tariffs imposed before on China led to a sharp deterioration in industrial production.” — Seth Carpenter [03:20]
• “Free trade has divided production functions around the world, but it's also driven large trade imbalances.” — Seth Carpenter [03:50]
• “Ultimately, though, we are retaining our baseline view that only tariffs on China will prove to be durable.” — Seth Carpenter [04:30]

Further Engagement

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Disclaimer: The content discussed in this podcast is for informational purposes only and does not constitute financial or legal advice. It does not take into account individual financial circumstances and objectives and may not be suitable for all listeners.