How Well Can the US Absorb Tariff Shock?
Citing national security, President Trump signed a proclamation adding 25% tariffs on US vehicle and parts imports to be phased in within coming days and weeks.
As car and truck production has become highly integrated across North America since a free trade agreement was reached in 1994, most “US vehicles” will rise in price for American consumers in addition to the brands from Asia and Europe.
With US auto-related imports about $475 billion in 2024, the administration’s estimate that the tariffs could raise $100 billion seems plausible. This is because cross-border supply chains planned over many years can’t quickly be replaced with output sourced solely within US borders.
Used vehicles and parts will rise in price as demand shifts from new vehicles to avoid the full price spike. Other tariffs on inputs such as steel and aluminum will also impact industry costs.
3 Things to Know
Auto Tariffs Move the US Closer to a Supply Shock
With news reports of US tariff actions at an unprecedented level, a jump in short-term consumer inflation expectations has exceeded actual consumer price increases to date.
What the actual tariffs will be — and the extent of any pass through to consumer prices — is uncertain. But the “fear quotient” seems to be rising well ahead of the actual tariff shock.
As an example, US car and truck sales — both imports and domestics — have held up far better than consumer sentiment readings and consumer buying intentions in the year-to-date. This data all precedes President Trump’s new auto tariff announcement.
These Actions Have No Precedent
While clearly brimming with apprehension, the imposition of large-scale U.S. tariffs and subsequent retaliation is still a real shock to come. One plausible estimate for a “large scale” rise in US tariffs — even if unevenly applied — is a rise in the effective tariff rate on goods imports from roughly 2% to 12%.
This would increase tariff (tax) collections by about US$300 billion, or just over 1% of US GDP.
This “static” number would push up costs and reduce real economic growth, spread between inflation and unit sales. It excludes retaliation measures on U.S. exporters. While some domestic activity measures — such as steel production — could rise in the short term to take advantage of higher prices, the impact on US growth excludes any impact from business uncertainty over the economic outlook.
Policy shocks such as a discrete rise in tax rates have a distinctly different impact than “natural” developments in business activity, such as supply and demand imbalances that arise over long periods of prosperity. U.S. business cycle turning points have occurred when producers overestimate or underestimate demand.
This causes production and employment to plunge into recession at an economic peak and then recover at recessionary troughs. The vulnerable periods are those when producers are far too optimistic over future demand, when they overproduce.
Memorable examples from industry include the telecom equipment boom of the late 1990s, the home production boom of the mid-2000s and the oil production boom of the mid-2010s. In some of these periods of excess optimism, only a modest shock catalyzed a business cycle “purge.”
Can the Global Economy Escape Relatively Unscathed?
The severe swings in the economy during the pandemic and the tighter monetary policy of 2022/2023 have actually made the US and world economy a bit more resilient to facing shocks in our view.
Business investment has been lean relative to corporate profits amid caution. A drop in corporate profits for roughly half of the industry sectors in 2023 means the mild profit recovery of 2024 may remain intact even with tariffs in 2025.
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