The Heart of the Deal

Why the US-UK trade deal might make both countries poorer

Photo by Kristina Gadeikyte on Unsplash

The proposed US-UK trade agreement provides preferential access to each other’s markets. But the highly restricted scope of the agreement and explicit quantity restrictions on the volume of trade eligible for reduced tariffs suggest that the agreement will not realize the potential benefits possible from increased trade. Instead, it more closely resembles an agreement by each government to subsidize the other’s politically influential sectors by sharing the implicit subsidies provided by their ongoing tariffs on imports from the rest of the world.

Free trade agreements need not deliver the same benefits as free trade

Trade liberalization has been advocated by economists for over 200 years as a policy likely to raise national income. Those persuaded by the case for free trade might be expected, therefore, enthusiastically to welcome the proposed new US-UK trade agreement, which offers reduced tariffs and other trade barriers on the flow of steel, cars, beef, ethanol, and pharmaceutical products. Unfortunately, far from being a panacea, this deal may leave both countries poorer than the current status quo.

It has long been understood that badly constructed bilateral free trade agreements (FTAs) can make one or both partners poorer, even if truly free trade would actually raise their incomes. Unlike a full-hearted embrace of free trade, an FTA delivers preferential liberalization for its members only, while leaving existing tariff barriers in place against non-partners. This inherently discriminatory trade policy can backfire because preferential trade policy sends the wrong signals to market participants about the true costs of the goods they might buy.

Consider U.S. imports of British steel as an illustrative example. Prior to the Trump Administration, steel imports to the U.S. were governed by a patchwork of tariffs and quotas. The effective tariff rate on imported steel was 5.3%. In 2024, the US imported 26.2 million metric tons of steel for a value of $32.99 billion. Exports were 8 million metric tons in comparison. Imports from the UK were 240,000 metric tons, less than one percent of imports by volume. Imports from Brazil and South Korea, two major producers not covered by NAFTA and subject to stronger quota and tariff regimes, made up 10 and 15 percent of total US imports, respectively. The UK’s current small share of US steel imports is no surprise. The UK’s steel industry has been in decline for decades, and is currently in an existential crisis caused in part by the UK having the highest electricity costs in Europe, almost five times higher than the cost of electricity in the US. The last site operating blast furnaces in the UK is heavily loss-making, and was slated for closure by its Chinese owner until the UK government rushed through emergency legislation to take over its operations in April 2025. Facing similar trade barriers on steel from the UK, Brazil, and South Korea, most US companies clearly did not opt for UK imports, strong evidence of their relative cost. The same argument holds for British imports of U.S. beef.¹

Trade diversion can leave the importer poorer

The proposed reduction of the tariff on steel from the UK could be seen as unimportant from the perspective of Americans. The UK is unlikely to supply much of the US market. For this very reason, the proposed expansion in the UK’s tariff-free quota will not change the price for US importers, thereby neither benefiting US consumers nor hurting US steel producers. All the deal will do is allow UK exporters to expand their market share in the US at the expense of Canadian, Brazilian, and other exporters who must still face the full cost of the latest 25% tariffs on imported steel.

However, this trade diversion is only half the story. Substitution from taxed Brazilian to duty-free UK imports will cost the US government forgone tariff revenue. With no offsetting gain from lower prices for steel-using industries or higher overall steel consumption, the US stands to lose from the trade diversion that will arise from its discriminatory trade policy. A similar policy exists for British automobiles, which have steadily lost market share to Japanese and South Korean alternatives, with an additional twist. To make sure that British auto exports to the US do not take off as a result of their preferential access, exports will be limited by a quota to 100,000, almost exactly equal to their 2024 volume. This deal all but ensures that imports from the UK will remain at around the same level while not benefiting American consumers and costing the American government tariff revenue that instead will flow to UK car firms and workers as higher profits and wages.

In this scenario, where the volume of preferential exports is limited either by the high relative costs of the favored exporter or by explicit quotas to limit the volume of exports, the gains to the exporters are less than the importer’s forgone tariff revenue. When both countries exchange this highly trade-diverting preferential market access, they make themselves both worse off.

When politics trumps economics, governments might implement policies that lower national income

Why would policymakers agree to a deal that leaves both sides poorer? In a series of papers from the 1990s, Gene Grossman and Elhanan Helpman suggested an explanation. In their seminal “Protection for Sale” article, they first propose an explanation for why tariffs are so widespread, even in environments in which free trade across the board would maximise national income. Political interests, perhaps channeled through lobbyists and political contributions, can influence policymakers to protect some favored special interest groups. Tariffs force foreign suppliers to charge higher prices, allowing local producers to raise their prices, and profits, too. This subsidy for domestic producers is a transfer from domestic consumers who end up paying higher market prices.

In their follow-up paper, “The Politics of Free Trade Agreements,” Grossman and Helpman analyze when policymakers subject to domestic political pressures might agree to an FTA. They characterize small, high-cost sectors that benefit from trade diversion to sell into their trade partner’s protected market as enjoying “enhanced protection”. These exporters now effectively benefit from the protective tariffs that their trade partner maintains on imports from the rest of the world, and their high market prices. In a scenario of enhanced protection, it’s foreign consumers who subsidize their preferred trade partner’s exporters.

But one side’s gains are another side’s losses. Why would policymakers agree to an arrangement that cost them revenue? Conceivably, they might be willing to, if the revenue losses from their importing sectors were balanced by higher profits for their exporters in other sectors. Policymakers who prioritize exporters’ interests might be persuaded to agree to FTAs that benefit their own exporters, even if those benefits are less than the costs to the general taxpayer from giving up tariff revenue to effectively subsidize their partner’s exporters.

Prospects for an agreement are more likely when trade between the prospective partners is balanced, so that each side has some exporters who could expect to benefit from enhanced protection, and when country B has limited supply capacity in the industries in which country A has high tariffs (and vice versa). If country B were globally competitive in A’s highly protected industries, the same political lobbies that had successfully persuaded policymakers in A to protect them with high tariffs in the first place would likely also be able to persuade A’s policymakers not to sign an FTA. It’s precisely when B’s industry has high costs, and therefore poses no threat to A’s domestic producers, that firms in A will not bother to lobby to block the deal. Unfortunately, in these circumstances, there are also no benefits for consumers in A from preferring imports from B over imports that pay the full tariffs, and national income in A declines as a result of the trade deal.

Commerce Secretary Lutnick, in his remarks heralding the deal in the Oval Office on May 8^th, laid this logic out impeccably: “So the idea was, ‘How do they keep their jobs, protect their economy, and do the best for their people, while opening the market for us?’ And the way is they studied it, their team was exceptional, and they tried to figure out the markets that they are importing from other people, and tried to send them over to America.” If one of our students had written this as a description of trade diversion, we would give them an A.

Why would the UK consider such a potentially harmful arrangement? Commerce Secretary Lutnick laid out the logic clearly. “So we did a deal with them in automobiles, and you know, if you’re not building here, we charge you a 25% tariff. … [T]hey could send 100,000 cars into America, and only pay a 10% tariff, and that protects their car industry. And remember, we do 16 million cars a year, so this is only like 0.6%. But for the UK auto people, this is tens of thousands of jobs that the President agreed that he would protect for them.” As eloquently described by Secretary Lutnick, the expected volume of imports of high-cost cars from the UK will be low, and the price in the US market will hardly be affected, resulting in little to no benefits to US consumers or costs to US producers. But by incentivizing US households to switch their purchases from Japanese to UK car imports at the margin, the US will forgo the extra 15% tariff revenue that it would have collected had all car imports faced the same uniform tariff rate.

The proposed US-UK agreement may be good politics, but it’s bad economics

What would a good FTA look like? Partners’ total trade would rise by stimulating additional trade between them in sectors where they are truly world-class, rather than simply grabbing non-partners’ markets. When you give a globally competitive industry tariff-free access, prices fall for consumers, raising their real incomes and allowing them to increase consumption. While some domestic producers may be hurt, the losers tend to have high costs and be economically inefficient. Encouraging the reallocation of the productive inputs originally employed in those inefficient sectors into more efficient sectors is another potential benefit.

Unfortunately, when political lobbies are strong, concentrated producer interests that would bear the brunt of any losses from efficient growth in trade will lobby hard to block this kind of deal. The rules of global trade have long recognized the risks surrounding discriminatory trade policy in general and FTAs in particular. Under both the GATT and the WTO, countries were only allowed to sign agreements that discriminated against other members if those agreements liberated “substantially all the trade” between members.

An agreement that covers all trade is much more likely to include countries’ globally competitive sectors and to deliver the associated benefits. This proposed agreement, with its focus on a handful of sectors seemingly cherry-picked for enhanced protection, falls woefully short of that standard. There are precedents for similarly narrow liberalizations. The 1951 European Coal and Steel Community and the 1965 US-Canada Auto Pact are examples of initially narrow agreements that subsequently evolved into genuinely liberalizing trade agreements. But they are the exception. Most other narrow preferential trade agreements never bore fruit.

While it would be too sweeping to conclude that an FTA is necessarily harmful, Grossman and Helpman’s analysis suggests that governments are most likely to agree on one “when there is relative balance in the potential trade between the partner countries and when the agreement affords enhanced protection rather than reduced protection to most sectors … Thus, the conditions that enhance viability of a potential agreement also raise the likelihood that the agreement would reduce aggregate social welfare.”

The agreement in principle sketched out for the US-UK trade agreement resembles the scenario cautioned against by Grossman and Helpman almost perfectly. While there are FTAs that can be beneficial—by lowering prices, increasing trade, increasing consumption, and reducing inefficiently high-cost domestic production—it is striking that none of these potential benefits have been championed by policymakers advocating for this agreement. Instead, they have emphasized the potential benefits to a small group of producer interests: in the UK in cars and steel, and in the US in agriculture. These potential exporters are almost certainly higher-cost than the firms currently supplying the US and UK with those products, and this agreement is likely nothing more than a complex shell game under which American taxpayers and consumers subsidize high-cost British car and steel production, while British taxpayers and consumers return the favor to American farmers, leaving both countries poorer overall. It’s unclear whether British taxpayers would be willing to pay the subsidies directly to keep steel production going in the UK, or whether US taxpayers would be happy to increase already generous subsidies to US farmers. By shrouding these subsidies in the form of enhanced protection under the cover of a trade agreement, they may end up paying for them anyway.

1. In 2024 the UK imported almost £1.4 bn of beef (and exported less than £0.6 bn). Imports from the US, which were allowed a quota of 1000 metric tons at a tariff of “only” 20% (and faced the full rate of much higher tariffs on imports over the quota), were only £440,000. Imports from Argentina and Brazil, two major beef producers that both faced the full regime of import restrictions, were £8.5 million and £29 million respectively. The UK imported £47 million of beef from Australia (which enjoyed a tariff-free quota of 43,333 metric tons in 2024). The proposed expansion in the US’s tariff-free quota to 13,000 metric tons will allow US exporters to profit from selling at the British price of beef (higher relative to the price in the US) without materially lowering the price for British consumers.