Protectionism, Policy Shifts, and the New Economic Reality

Considering the announced acceleration of capital expenditure (capex) spending by all major hyperscalers, there is little reason to expect AI-related infrastructure to feature less prominently in U.S. GDP growth in the second half of 2025.

Meanwhile, the U.S. consumer faces ongoing challenges as tariff-induced inflation eats into consumers’ purchasing power. Seven months after the current U.S. administration raised tariffs on “Liberation Day,” the overall consumer price inflation is up modestly: annual inflation accelerated from a low of 2.3% in April to just over 3% in September, thanks largely to continued (and belated) housing disinflation.

Just below the headline level, things look less rosy. Goods prices are moving up sequentially at an accelerating rate. This is in sharp contrast to two decades of persistent declines. According to the Harvard Business School Pricing Lab, imported goods prices are up approximately 6% from pre-tariff trends, while domestic goods prices are up some 4.3%.

Goods Prices Break From Trend Following New Tariffs

After years of gradual price declines, both domestic and imported goods have seen abrupt increases once new tariff measures took effect. Imported goods prices have climbed the most, rising around 6 percentage points relative to trend, while domestic goods are up more than 4 points.

Sources: Harvard Business School Pricing Lab and William Blair, as of October 11, 2025.

U.S. consumer spending has not remained unscathed: retail sales adjusted for inflation are barely growing and consumer discretionary stocks within the S&P 500 Index have lagged the overall index by about 12% through the end of November 2025.

Tariff-related disruption is also eating into corporate profits more broadly. According to aggregate corporate profits data tracked by the U.S. Bureau of Economic Analysis, manufacturing, wholesale trade, and transport profits are down sequentially by 10% to 20% in the first half of 2025 from 2024. Outside of AI-related investment and financials, U.S. companies are feeling squeezed.

Year-Over-Year Change in U.S. Corporate Profits (In Billions)

Tariff-related disruptions have weighed on corporate profitability, and most industries outside AI investment and financials have experienced noticeable strain.

Sources: U.S. Bureau of Economic Analysis (BEA) and William Blair, as of June 30, 2025.

Facing midterm elections in November 2026, the current U.S. administration is likely to focus on supporting the domestic economy. The One Big Beautiful Bill Act aims to catalyze greater investment into domestic production by reducing or eliminating tax on structures, research and development, and other activities. The Tax Foundation estimates that the new rules will reduce 2026 tax liabilities for manufacturers by over 2% and other industries by half that amount.

In mid-November, the U.S. administration reversed its stance on tariffing agricultural products after domestic consumers recoiled from rapid increases of food prices. And allowing banks to hold smaller capital buffers, together with a 30% reduction in supervisory and regulatory units of the U.S. Federal Reserve (Fed), is estimated to free several trillion dollars’ worth in lending capacity.[2]

Lower corporate taxes and more lending, not to mention a possible “housing emergency” to lower mortgage rates in a bid to revive the moribund housing market, all suggest stronger, broader GDP growth in 2026.

But inflation is likely to prove sticky, especially since much of the tariff impact is still working its way through the economy, and new tariffs—on kitchen cabinets and bathroom vanities, for example—have yet to take effect.

Inflation is likely to prove sticky, especially since much of the tariff impact is still working its way through the economy.

Europe and China: Shifting Toward Domestic Revival

All these tariffs and “America First” policies appear to have produced a broad focus on reviving domestic market dynamism in Europe and China.

Europe’s New Growth Era

European exporters are facing major headwinds from U.S. tariffs and Chinese competition. German exports to the United States fell by 7.4% in the first nine months of 2025. And although the European Union (EU) negotiated a trade deal that taxes steel and aluminum as final products, U.S. authorities have been applying the negotiated tariff rate of 50% on 407 steel and aluminum “derivative” products (which are capital and consumer goods produced in Europe) as well, further crimping European exporters. And in the latest negotiations twist, U.S. Secretary of Commerce Howard Lutnick and U.S. Trade Representative Jamieson Greer used their late-November trip to Brussels to make tariff relief contingent on the EU scrapping its digital regulations.

In response, Germany, the single largest economy within the euro area, abandoned its decades-old self-imposed fiscal austerity in favor of investing in national infrastructure and defense. Although the size of the investment is enormous—€500 billion relative to Germany’s €4.5 trillion-sized economy—the infrastructure upgrade is urgently needed. 

Hence, the fiscal multiplier from this spending is likely to be significantly more than one, meaning that for every €1 spent, the returns to the economy will be several times higher. Once the funds disbursement gains steam, it is likely to help Germany register economic growth in 2026 after four years of stagnation.

In addition, much of the government funds in Germany and elsewhere in Europe are increasingly likely to be spent purchasing from domestic producers; “Made in Europe” is now an explicit policy aim across the continent.

The rest of the EU is not standing still. According to the Centre for European Policy Studies, the EU has been generating more start-ups than the United States in each of the last five years, and many acknowledge the continent’s highly skilled and increasingly entrepreneurial labor force.

What is needed is domestically generated financial capital, which the European Commission already identified earlier in 2025. Change in Europe tends to be slow, but the continent is undeniably moving toward incentivizing more growth after years of focus on fiscal austerity.

“Made in Europe” is now an explicit policy aim across the continent.

China’s Path to Market Efficiency

In China, rather than supporting start-ups, winding down companies is identified as a key impediment to building a truly single, domestic market. Local governments tend to support local firms via tax breaks, preferential access to bank lending, and other schemes; they prop up local champions and resist industry consolidation, often leading to overcapacity and meager profits for all.

This is a complex challenge involving revenue sharing among central and regional fiscal authorities. For the past 18 months, local authorities have been issuing bonds as a means of debt swap, and local government financing vehicles are supposed to be wound down by June 2027. For now, aggregate government deficit is running in double digits of the country’s GDP, but domestic consumption is likely to remain depressed in 2026, as housing prices continue to adjust.

Chinese authorities have also made periodic efforts to support residential real estate activity and household incomes, and we are likely to see renewed efforts in 2026. However, China’s residential real-estate sector must continue to downsize, and housing prices are not yet done decelerating. International experience suggests that a housing market correction typically lasts about five years and results in cumulative price declines of 40% to 60%.

Chinese Housing Prices Are Still Decelerating

China’s housing sector has continued its multiyear price adjustment. Lessons from the United States, Japan, and other countries indicate that similar corrections can last five years or more, signaling that domestic housing prices in China may still have room to fall.

Sources: Federal Reserve Economic Data (FRED) database and William Blair, as of November 2025. FRED housing index data (y axis) measures the cumulate decrease in housing prices from peak (set to 100 in each case).

China’s prices are down approximately 20% from their peak, but are likely to decline further, as affordability is still an issue. A modestly sized apartment in Shanghai still retails for about $3 million. For as long as the housing slump will continue, China’s domestic consumption will likely remain challenged.

Conclusion

In summary, growth is likely to broaden and accelerate in two of the world’s three principal demand centers in 2026. EM exporters of industrial commodities are also likely to continue experiencing material improvement in fortunes in 2026.

Although the U.S. dollar may not depreciate much further from current levels unless growth in Europe and in Japan surprises materially to the upside, broad-based economic growth and ample liquidity are likely to provide a fertile ground for EM assets.

Olga Bitel, partner, is a global strategist on William Blair’s global equity team.

Emerging Markets 2026 Outlook Series

Part 1 | Protectionism, Policy Shifts, and the New Economic Reality

Part 2 | EM Equity Outlook 2026: From Rebound to Rotation

Part 3 | EM Debt Outlook 2026: Momentum Continues

Part 4 | China: Repositioning for the Next Phase of Global Industrialization

[1]Source: Bloomberg. [2] Source: Financial Times.