Individual product tariffs like this can damage productivity in many ways.

Economists argue that productivity is not everything, but it is nearly everything. This saying is usually applied to the scope for living standards to rise over time. But there is an argument for applying it to currencies as well, as those who struggle with poor productivity growth often tend to experience currency weakness and vice versa. The US – and hence the dollar – has been a leader here for some time, but tariffs could cause this to change.

To see this, we need to start in the UK. Q2 productivity data was recently released and, like most before it, the numbers were poor. Productivity was down 0.6% in the quarter in terms of output-per-hour and that leaves it 0.8% lower than a year ago. The Office for National Statistics (ONS) likes to compare current levels with the pre-Covid period. On this score productivity has risen by just 1.5% since 2019. The ONS presumably makes the comparison with the pre-Covid period because the pandemic is thought to have weighed on productivity. However, this is also a period through which the UK has experienced the agony of Brexit and it may be difficult to disentangle the adverse effects of Brexit from the pandemic on productivity.

If we compare the UK to the US, for instance, we find that the US has seemingly been able to shrug off any pandemic-related weakness and post good productivity growth again with output-per-hour some 10% higher than end-2019 levels. Now we would certainly not ascribe all the difference to the Brexit effect, but we do think it has had a role.

The independent Office for Budget Responsibility (OBR) believes that Brexit has left productivity 4% points below the level that would have existed had the UK remained in the EU. The damage to productivity from Brexit could be an important template going forward as we think about the impact of tariffs on the US’s productivity advantage. And, if strong US productivity performance in the past has been a key to US dollar strength, then tariffs could cut this down.

Of course, there will be some debate about whether tariffs are harmful for US productivity. But we do have an example we can use, which are the steel tariffs that were introduced back in 2018. Individual product tariffs like this can damage productivity in many ways. One is that it shields domestic firms from foreign competition, allowing them to become lazy in terms of things like productivity-enhancing investment and collaboration with more efficient foreign producers.

The upshot is that companies that might have otherwise fallen by the wayside in a more competitive environment (in the absence of tariffs) are allowed to soldier on, and this brings down productivity within the sector. If we look at the data we see that it is quite striking that productivity in the US steel sector has, indeed, fallen off a cliff since the 2018 tariffs were introduced; something that has not been seen across the manufacturing sector in general.

If we fast-forward to today, steel tariffs are still in play but other, much bigger. Sectors are seeing product-specific tariffs as well. Here we’d include the likes of autos and lumber with threats hanging over other products as well such as pharmaceuticals, critical minerals and semiconductors. The more sectors that are impacted, the bigger the risk that productivity is held back on a more general level. This, of course, is in addition to any productivity-depleting properties of country-wide tariffs.

In contrast, foreign firms that have, in general, underperformed their US counterparts in terms of productivity for some years will have an incentive to try to work harder and smarter in order to reclaim the hit to competitiveness that results from the tariffs. In theory, at least, this could lift their productivity and so close the productivity gap with the US even more.

Steven Barrow, Head of Standard Bank G10 Strategy, said productivity would certainly not be everything when it comes to longer-term trends in exchange rates, but even if it is regarded as a moderately influential factor, especially when we look at currencies in real (inflation-adjusted) terms, then it opens up another route through which US tariffs may weigh on the US dollar.