President Trump intends to reshape the relationship between the United States and Mexico. From building a border wall to renegotiating NAFTA, there is a lot of change about. I decided to write about the potential impact of a 20% import tax. This is not only intended to help educate others as to what is going on, but to also help me understand the scope of this potential changes. I understand that the “suggested” import tax is only a negotiating tool to help persuade Mexico to pay for the wall. However, an import tax like this would likely have some serious ramifications. This is a complex topic that is currently in flux so keep in mind that what is published today can easily change in the days or weeks ahead.
Trade: It’s important
This really shouldn’t be said, but trade between countries is extremely important. If done correctly, it promotes progress and prosperity for all involved. 74.7% of the United States’ total trade is from 15 countries alone, and Mexico is 3rd on that list (14.2%). In terms of exports, Mexico is our 2nd largest partner at 16.0% and they are our 3rd largest importing partner at 13.3%. In total, our total trade was $531B in 2015 with a trade deficit of -$58B.
US Export Partners
US Import Partners
From Mexico’s point of view, we are much bigger piece of their trading pie. The United States represents 81% of their exports and 48% of their imports.
Mexico’s Export Partners
Mexico’s Import Partners
A 20% import tax for Mexican goods entering the US would clearly hurt Mexico as this would affect 81% of Mexico’s exports. From a trade perspective, Mexico has much more to lose than the US would if President Trump were to make good on this threat. However, imports and exports represent only a piece of a country’s economy. Think back to your ECON 101 class. If you remember, the components of GDP are as follows:
GDP = Consumption + Investment + Government + Net Exports
Net Exports is imports minus exports. So, if a country were to have a trade deficit (like the U.S. has), then Net Exports would be a drag to the overall economy (-$58B deficit in 2015). When President Trump tweets about this deficit, this is what he is referring to.
The GDP Impact
Forecasting the overall impact of a 20% import tax is a near impossible thing. One would assume that US consumers would be able to absorb come of the 20% price increase, but it is not that easy. Take, for example, the price of avocados. If Mexican avocados were to increase by 20%, I would assume that US consumers would buy Californian avocados instead. But, if the price of Toyotas being imported into the country were to increase by 20%, wouldn’t US consumers buy a Hyundai built in the US instead? Or perhaps another alternative? I don’t know. Nonetheless, I am still interested to see which country is more vulnerable and by how much. It is a relatively easy task to calculate the nominal impact for both the US and Mexico. So lets assume that a 20% tax increase on imports from Mexico to the US were only to affect those goods and not consumption, future investments, etc. just so we are able to see a hypothetical impact.
The $74B difference (total tax enacted per year) would definitely have an adverse affect for both the US and Mexico. Under this scenario, Mexico would enter into a recession with a -5.87% drop is production (again, assuming that all else is equal) and the US would feel a -0.39% reduction in economic expansion, but not a recession. Also notice that I did not include a $74B positive amount to the US Government line item (additional tax receipts) as these funds would theoretically go towards the cost of building a 2,000 foot wall.
There are a lot of other questions that I don’t have an answer for, but should be considered:
- Are some of these exporting/importing companies able to absorb the 20% tax rate and not pass the cost along to the consumer? Additionally, would US consumers be able to absorb a higher cost? Would they look elsewhere for similar goods (likely)?
- Would the number of goods and services drop if a 20% tax rate were enacted? (likely) Would Mexico be able to export these “lost” goods to other countries? Likewise, would the US be able to import these “lost” goods from other sources? Or, perhaps, would we be able to create these goods and services ourselves over time?
- Would Mexico retaliate and enact an export tax on US goods, even though they rely on our country more than we rely on them?
- What type of social impact would this have on US consumers?
The US is clearly in a position of strength and President Trump is likely using the threat of a 20% import tax as a bargaining chip. But if he were to make good on this threat, it would likely impact us more than he would realize.