THE TARIFF increases that United States President Donald Trump announced are much ado about everything. The hikes in tariffs on imports to the USA are sweeping, broad-based, and seen to affect trade flows globally. I cannot claim to grasp the enormity of the entire matter, but this could possibly redraw the bounds of globalization as we know it.
Frankly, tariffs are a complicated lot because trade is such an intricate and complex transactional web. In fact, a whole organization — the World Trade Organization (WTO) — exists to arbiter this gargantuan ecosystem. An impact analysis will entail a great many number of permutations. The only certainty is that they result to higher prices for consumers or lower margins for the exporters and importers. Often, though, taxes -— and make no mistake, tariffs are taxes — are passed onto the consumer, so it will be inflationary. A quote from President Trump himself succinctly captures this truth: “Well, maybe the children will have two dolls instead of 30 dolls. And maybe the two dolls will cost a couple bucks more than they would normally.”
Tariffs are a fiscal tool that governments use to manage trade balances, protect domestic industries, or raise revenues. And though it is a fiscal tool, the impact of changes in tariffs can indirectly affect monetary policy as well. For example, tariffs can lead to higher prices or a depreciation of the currency because of a drop in trade. Consequently, this can cause monetary authorities to increase interest rates. Another instance is that higher tariffs may result to increased business uncertainty and reduced economic activity. This would lead monetary authorities to cut interest rates to stimulate the economy. The worst case is if the tariff disruptions lead to stagflation — a period of rising prices and stalling economic growth. Then, we could be in real trouble.
When the US government announced its intention to raise tariffs, the proverbial shot across the bow was an added 25% on imported cars aimed at Canada, Mexico, the European Union (EU) and Asia. Industry data shows that the US auto market in 2024 hit 15.9 million units, the highest since 2019. Of this total, nearly half were imported. According to S&P Global Mobility, Mexico exported 2.5 million vehicles to the USA in 2024, followed by South Korea with 1.4 million, Japan with 1.3 million and Canada with 1.1 million. Germany exported 430,000 vehicles and the UK shipped nearly 90,000. Combined, these account for over 80% of all car imports to America.
Ironically, China — which the US government points to as the one to bear the brunt of tariffs — accounted for only around 2% of car imports to the US last year. China became a powerhouse of auto manufacturing only in the last decade or two, leveraging its huge domestic market. As well, it focused on new energy vehicles (NEV), acknowledging that it was already too late to the internal combustion engine (ICE) party. By the time it was firing on all NEV cylinders, though, the demand for fully electrified vehicles in China and the rest of the world plateaued.
The USA and EU became wary of China exporting its excess capacity of EV production on the back of government subsidies. This resulted to the USA imposing a 100% tariff on Chinese-made EVs while the EU imposed tariffs (differing by manufacturer) ranging from 17.4% (BYD) to 20% (Geely) and 38.1% (SAIC). These tariffs likely kept the increase of exports to the USA at bay.
So, what is the likely effect of these tariff increases on the auto industry? Tariffs are like dikes that divert the flow of water; in the case of tariffs, it diverts the flow of trade and consumer choices. In the USA, it is expected that the higher tariffs will result to higher prices for imported automobiles, expectedly lowering demand for them and hopefully spurring import substitution with made-in-USA cars. This increase in locally built car sales will, in turn, create more jobs and a more robust auto sector. The potential reduction in tariff revenues due to decreased imports are, theoretically, compensated for by higher local value added.
Unless, of course, consumers accept the increased prices, and the sustained level of imports leads to a rise in government revenues and a rebalancing of trade with source countries. But, seriously, how likely is it that consumers would readily agree to a price increase in the magnitude of the proposed tariffs?
For example, assuming an imported vehicle from Mexico costs US$20,000, the added 10% baseline tariff — if non-compliant with the United States-Mexico-Canada Agreement (USMCA) — plus the 25% auto-specific tariff leads to a 35% add-on cost on the car of around US$7,000. That is pretty steep. Even assuming that car companies absorb, say, 25% of that added cost, that is still a US$5,250 increase. On the other hand, the application of the 25% tariff on imports of auto parts effective May 3, 2025 will reportedly cause car prices to rise by an average of US$4,000. I think car buyers will surely blink.
The other hope is that those exporters who are affected by the higher tariffs will consider onshoring their production of vehicles in the USA. This will effectively eliminate tariffs on their cars and allow them to sustain their sales volumes. Given the significant rate of increase in tariffs, perhaps, this would be enough to compensate for any cost penalties that production in the USA would entail. Cost penalties are incurred when the production costs in the host country are higher than those in the country of origin — for example labor, logistics, power, and raw material costs. In this case, trade imbalances will narrow and the reduction in tariff revenues will, once again, be compensated by increased local value added.
Building capacity and new auto plants, though, will take time — two to three years, maybe longer. In the meantime, the flow of goods will remain disrupted. As well, the gestation period for investments in new plants can run anywhere from five to 10 years depending on the scale of investment and production volume. This necessitates long-term policy stability. Since the imposition of tariffs is vested with the Executive branch, it is hard to predict whether the tariffs imposed by the current administration will carry forward to the next one or the one after.
One must remember that local production is a complex operation that must consider the intricacy of the global supply chain. Each automobile — the ICE kind — is comprised of around 30,000 components. The “Big 3” American auto makers — GM, Ford and Stellantis (formerly Chrysler) — sourced about 70% of their parts from the USA and Canada in 2007. By 2023, this is reported to have dropped to 40%. Rebuilding a parts-making industry in the USA will take time and will have to achieve competitive production costs versus the likes of China, Korea, Japan, Southeast Asia and even the EU. The span of planned tariffs covers auto parts, too, thus further complicating cost planning and parts sourcing.
(To be continued)