Trade War Costs in a Supply Chain World

When Americans buy a car from Mexico, half of what they buy was earlier imported from the United States (74% of foreign imports in the car are from US, foreign imports and labor account for 2/3 of value, .74*.66=48.44–corrected from earlier version). 

The firms exporting vehicles from Mexico to the U.S. have set up very deep supply chains between the two countries — much deeper than previously thought. About 74 percent of all the foreign parts used by vehicle assemblers in Mexico that export to the U.S. are imported from the U.S. itself. In contrast, only 18 percent of the imported parts used by Mexican firms exporting to Germany come from the U.S. (see chart). Because the parts that come from the U.S. also include inputs from other countries, it is important to account for international trade along all stages of the supply chain. I estimate that thirty-eight percent of the value of the average finished vehicle exported from Mexico to the U.S. is American value returning home, more than double the 17 percent figure that had been commonly considered.

That’s Alonso de Gortari writing at EconoFact.

In a world with deep supply chains a trade war will be much more expensive than in a conventional world. In a conventional world, a tariff only reduces efficiency at the margin as it relocates production from foreign to domestic firms who in the initial equilibrium have equal costs. But in a deep supply chain world a tariff isn’t just a tax on imports it also raises the costs of production of domestic firms. In a deep supply chain world, for example, a tariff on car imports from Mexico raises the cost of US auto production.

Paul Krugman recently argued that for an equal reduction in trade, Trump’s trade war would be less costly than Brexit because Trump’s tariffs will raise revenue and only distort production on the margin. In contrast, he argued that Brexit would raise costs on all units of production. In a deep supply chain world, however, the difference between Brexit and Trumpit are not so large. In such a world, tariffs increase the price of imports and make it more costly to produce goods domestically.


Except one purpose of Brexit is explicitly to lower import tariffs. (We grow no oranges but have tariffs to protect Spain). And inframarginal effects of deregulation are potentially more substantial. (Currently all UK firms, even those that do not export, have to comply with all EU rules).

In theory post-Brexit Britain could be more free trade than the EU, but would they be in practice?

Free trade within Europe is no small thing, even if there are barriers to the rest of the world. Whether Britain will be free-er than that is a roll of the dice, depending partly on competence and partly on who happens to be in power when those decisions start to be made. Quite possibly Britain will use its newfound freedom to put up protective barriers rather than lower barriers (during a recent crisis with the local steel industry, politicians were lamenting that EU rules prevented them from propping up domestic steel makers).

I was mildly in favor of Brexit at the time of the referendum (though I don't have a vote). Since then, my opinion of the EU has not risen, but my opinion of British governance has dropped significantly. Now I'm not so sure.


On regulation, Krugman's article (which doesn't generally appear so bad) does seem to include the assumption that harmonized regulations increase the ease of doing business and competition, and so trade, and that's the last word on regulation.

Well, perhaps they do, but it's not the last word. Differentiated regulation also allows for greater differentiation and specialization between different countries. Greater specialization allows for the development of greater comparative advantage, which should increase trade in the long run.

A greater international degree of regulatory diversity between regimes increases the possibility that a key innovation will be produced in one regime. Say the world is under a two data regulation or two GMO regulation, rather than; it's less probable that any particular innovation will be prevented in both regimes, so you will see some innovations that simply would not arise in a "standardized world", whatever the benefits of the standardized world to supply chains and lower "costs to do business". That should increase growth in the longer run.

That opening sentence is not correct. It's 74% of the imported components that come from the U.S., not 74% of the car. Notice that Mexico doesn't appear in that pie chart.

The estimate of American value is 38%, included in the quoted section. And that is more than double someone else's estimate of the same thing, so probably subject to debate.

I'm 100% in favor of free trade, BTW. But let's get the numbers right.

Thanks. Fixed.

Analyzing Trump's trade war is a waste of time since it's simply a political issue with Trump, an issue to be won or lost in the news cycle. Tabarrok's view is the dominant view among economists and economic columnists including Robert Samuelson. In fact, Trump's economic advisor Peter Navarro argues that this is not really a trade issue but rather a national security issue (to prevent China from stealing our technology secrets). Even Trump's economic advisor is putting distance between himself and the likely adverse consequences of a trade war!

On many issues, I agree with this view of Trump. However, on trade he has articulated a consistent and coherent protectionist view.

The argument that China wants to gain a technological edge, in part by stealing our secrets, does not conflict with that position but complements it (and Navarro never says it's "not really a trade issue". In the piece in question he also argues that it's a trade issue).

I disagree with Trump on this point, and yes, so do most economists. But credit where it is due: he has been consistent on this issue both before and after his election, and now he is trying to implement policies in line with his position.

Yes, Trump has been consistent, a consistent critic of trade "deficits". In his telling deficits are bad and the result of bad trade deals that he can rectify by employing his superior negotiating skills. To the general public, trade "deficits" do sound like we are on the losing side of trade. Trump promises to put us on the "winning" side of trade.

I agree that the trade deficit argument is weak, but Trump didn't exactly invent that.

The trade deficit "problem" as a topic of conversation predates Trump's political career by years.


No doubt, Chuck, but only rarely, in recent decades, has this "problem" led to major policy actions to solve it. Not now.

The trouble here is not just Trump's ignorance, it is also his love of blustering.

The USA actually runs a current account surplus in services with CHI [$10B]

Or, did.

Just nuke Red China and see what they can still can steal.

Yes. On many issues Trump is an opportunist. On trade he isn't. He's been consistently anti-free-trade since the 1980s and his stance has not evolved at all. There is absolutely no reason not to take him at his word when he argues against trade agreements. The people who think this is all a negotiating ploy are deluding themselves. Trump might use the "negotiating ploy" argument as an out if he gets boxed in - but his actual objective is to force Americans to 'buy American". he's NOT trying to get other countries to lower their tariffs. If we end up in that happy position, it won't be because of Trump, it will be because other people forced Trump to back down and let him save face by claiming it was all a negotiating tactic.

No. Trump is a free trader and always has been. He has repeatedly stated "I love trade. I'm a free trader, 100 percent." He has repeatedly offered trading partners bilateral tariff elimination. The problem is every one else wants to keep high taxes on US imports. The US economic commentariat is completely indifferent to the plight of US manufacturers, unless as in Alex's screed above, it has some connection to foreign imports. Make Foreign Exporters Great Again is the mantra of the US economics commentariat which has shown zero interest in promoting reciprocal free trade. As with immigration, the preferred policy position is send us everything you have got, subsidized or not, and treat the US as crappily as you please. That said, the best solution would be for Congress to unilaterally withdraw the US from all trade agreeements, to eliminate the US ability to impose tariffs, to adopt a VAT and tax all imports at a uniform rate across the board, much as every other country in the world does, and set the VAT at a level that would allow for a revenue-neutral elimination of corporate income taxes.

Yes, 100% total tariff elimination, or NOTHING!
That's not the negotiating stance of a person who is negotiating seriously. A person who is serious about eliminating tariffs will be willing to exchange incremental reductions in tariffs - not hold out and refuse to negotiate until the other side completely capitulates.

It's like he was trying to negotiate an arms control treaty by refusing to negotiate until the other side offered 100% total disarmament.

Edgar is right. Bilaterial free trade is better than unilateral free trade (which in turn is better than no free trade). So Trump is right, as I've said before, assuming no trade war, which seems to be the case since the USA is a monopolist buyer on tradeable goods and most countries cannot retaliate vs the USA.

As for AlexT's post, it ignores that supply chains come and go: today's complex supply chains are in response to 1980s Japan auto "voluntary" restraints on US imports, forcing the Japanese to build car factories in the USA (bonus trivia fact: Subaru and Toyota use the same Indiana car factory to make their US cars). It's no big deal to rearrange supply chains, give or take a few months or years.


+1, a good point which I have seen no serious discussion on. I think it might be a stretch to call the USA a monopolist buyer, but I do think it's highly probable that the US's trade buying is more discretionary than most foreign countries manufacturing is.

"bonus trivia fact: Subaru and Toyota use the same Indiana car factory to make their US cars"

This is just misleading and wrong. The US is huge. Toyota has 6 facilities in the US. The Indiana plant is one of 3 assembly plants.

Subaru had only 1 plant and it is in Indiana, but it's not the same plant.,_Inc.

SIA automotive was started as a joint venture os Isuzu and Subaru in Lafayette, and after Isuzu withdrew, they have assembled a number of Toyota products as well. Toyota operates an assembly plant in Princeton, Indiana as well.

The US is not a monopolist buyer by any stretch.
The combined economies of the EU are larger then the US economy.
China's economy is larger than the US too.

Now maybe China's people can't afford the kinds of goods that the US does. But I don't think that's true for Europe. It's pretty much a 50-50 split between the US and europe.

This is an argument I've been making for a while. Import tariffs don't only affect US consumers, they affect US producers that use imported parts, often in products for export. Steel is a primary example. Caterpillar import steel, makes construction equipment out of it, and then exports it to foreign markets. Raising the price of steel thus raise the price of all of Caterpillars products in foreign markets. And Boeing, and others. The end result is that US producers of airplanes and cars and trucks and heavy equipment will lose market share in foreign markets. The steel tariffs only benefit US steel producers and then ONLY in domestic markets.
In general, if you think of the world as an interconnected supply chain, the supply chain is going to seek the path of least resistance, which means it's going to seek to locate along lowest-tariff pathways between countries. Any country that raises import tariffs is making itself an undesirable place to be anywhere in the supply chain except the bottom.

Tariffs are similar to taxes when they add up for the final good/service price....and the path of least resistance is not in the continental US, but Ireland.

What companies will do when pressed with new tariffs? Fight the tariffs directly or cover them with more creative accounting?

Or move production, which is what made the UK such a major auto manufacturing location for Japanese car companies. An advantage that Brexit just might ruin, regardless of how creative the accounting gets.

Go out of business because their competitors in other locations now have the most advantageous price point.


The more amusing thing would be to see what percentage of Mexican parts are used in German cars built in the U.S. such as the Mercedes GL class SUVs built in Alabama (and apparently only in Tuscaloosa) and then exported to Germany.

'a tariff on car imports from Mexico raises the cost of US auto production'

Technically, that probably should be 'car part imports from Mexico.' Importing cars from Mexico is unlikely to increase the cost of American automobile production as such, though clearly it will make Mexican exported cars more expensive, and thus cause problems for American part suppliers when sales decline.

'In contrast, he argued that Brexit would raise costs on all units of production'

Maxbe, but more relevant will be the reduction in manufacture as EU oriented production based in the UK will shift to the EU.

'In a deep supply chain world, however, the difference between Brexit and Trumpit are not so large.'

As will be discovered if Brexit causes the UK to crashing out of the common market, tariffs will not be the main source of economic pain involving UK exports to the EU over the medium term. (Short term, WTO default tariffs will likely prove painful for both parties, of course.)

"Trumpit" is a good coinage. Almost rhymes with drumbeat.

I prefer Dumpty as in is "Trumpty Dumpty promised a wall Trumpty Dumpty reneged on it all".

Well, Trump has been trying to get a wall. Fortunately, he's not a dictator.

What happened to Mexico paying for it?

Well... Trump said he would do that through tariffs on Mexico, which happen to be the topic of this very post.

Oh. Through tariffs it is now. Got it.


Of course, I'll be the first to admit that the lie Obama said when he claimed that PPACA would lower the average cost of healthcare insurance was just as ingenuous.

We live in a world where well-respected economists claim that unilateral disarmament on tariffs is the smart move, and also argue that the result of raising tariffs will be a trade war. Why can't we advise the other side to make the smart move?

You can but raising tariffs is like trying to get someone else not to commit suicide by putting a gun to your head and threatening to kill yourself if he jumps.

We all know that the proper response to a suicide threat is shooting the person that doesn't respect the regulation against suicide! The state should be in charge of who dies!

If that were true, then we have no complaints whatsoever against other countries having tariffs since they are only hurting themselves. I don't think that anyone really believes that.

They really are hurting primarily themselves. The countries with the lowest import tariffs are also the most prosperous, and that's not a coincidence. Other countries tariffs impose costs on specific American companies, but they also deprive their own consumers of the benefits of American-made products. Including consumers that are using them to make other products for export. Tariffs are taxes imposed on your own country, and it's always better to tax less and distort less. Import tariffs are distortions designed to benefit specific narrow interests, they are not overall beneficial to your own country.

Protective-Tariffs are usually popular politically within a nation; however, worldwide -- average import tariffs are only about 3%. Much more significant are the endless national "regulations" & custins-rules on various imported products which reduce international commerce.

Trump has plainly said that he wants NO tariffs at all in world commerce.

Tactically, Trump is giving other 'uncooperative' nations a big dose of their-own-medicine -- to shock them into serious negotiations for removal of all trade restrictions, not just tariffs.


The incentives don't seem to line up in the US's favor here. The rest of the industrialized world is not a bombed out hell like it was at the end of WW2.


And what does that mean to the Harley workers in the U.S. that will likely lose their jobs as Harley moves production out of the U.S. in response to the fully legal (by WTO rules) tariffs imposed on the motorcycles that Hartley exports to the EU?

The trade wars begun have - and apparently, the dark side is clouding what this means.

(Hint - lots of countries are not going to be shocked into giving in to Trump's demands.)

You are deluding yourself. Trump has been anti-trade since the 1980s when he was complaining about Japanese cars. He is a dyed-in-the-wool "Buy American" hardliner. If he's claiming he wants zero tariffs everywhere he's only doing it to appease Republican free-traders, whilst knowing that of course zero tariffs everywhere is not in the cards and hence not really a threat to his actual goal of raising protectionist trade barriers at home.
In other words, he's not actually trying to negotiate gradually lower trade barriers. He's just using any non-zero tariffs anywhere as an excuse to push his real agenda. Just like he does on many other issues - pretends to support an ideal he knows won't happen so he can have a free hand to pursue a hardline agenda instead.

Just like he called the election process "sacred" when smearing Obama with surveillance accusations, even though he undermined the legitimacy of the election process when he announced he wouldn't accept the outcome unless he won.

The problem with Trump is that he is an incompetent liar. This may sound like an insult, but it's really just a description of his actual, well-documented behavior patterns. No rational actor on any side would ever trust him.

I still can't tell whether the majority of his supporters are simply irrational or whether they actually value his distructiveness for some psychological reason, e.g. payback against perceived wrongs.

Is there a difference? it is pure tribal affiliation. Trump has an R next to his name. Therefore he's their man. Come hell or high water, he's their chosen leader and it would be disloyal to question his judgement. Otherwise the terrorists Democrats win.

Smearing Obama with completely accurate -understated in retropsect- accusations that Obama surveilled him. This is a matter of record now that Obama fully weaponized the survellaince state and 3 letter agencies in service to the Democratic party. Its fact. You are showing your tribal colors.
Obama was a full on autocrat.

My point was that he called the election process "sacred" even though he himself undermined it by declaring he would accept the outcome only in case of his own victory. That point is independent of whether Obama actually surveilled him or not. I can't prove or disprove that specific allegation, but Trump is on record with repeated lies, more so than most politicians. I have no reason to trust his word on anything relevant.

This is not true just because you said it is.

Obama was not an autocrat, and neither his Trump (but he's trying!)


That's a fine idea, but the most recalcitrant trade barriers may have strong, concentrated (i.e. special interest) political support outside easy control by elected leaders. For example, look at US sugar quota interests.

Trump's attempts to "enrage and engage" is not going to solve these deeply entrenched barriers. It isn't an issue of motivating individual leaders, it is an issue of careful, cautious, and trust-building negotiation among many different interest holders in a foreign country. Trump can't even negotiate to get deals with his own GOP congressmen, how is he going to earn the trust of say Canadian Maple syrup farmers when Trump insults their Prime Minister?

There is zero evidence that "shock" is an effective free-trade negotiating tactic.

While this is an important issue, it looks like China has already been somewhat "shocked", and lots of other companies are, shockingly, adding to US manufacturing jobs -- thanks to Trump's tax cuts, deregulation, and focus on America First, including possible countervailing tariffs.

It remains possible that new tariffs by the US will fail to get lower tariffs by US trading partners, but it's pretty inconceivable that Hillary and the Dems would be getting lower tariffs, and it seems quite unlikely that any less shock would be more effective.

There is strong evidence from NATO, and the failure of our NATO allies to pony up the 2% they agreed to for defense, that "being nice" doesn't result in our allies being fair, or even in fulfilling their commitments. Kyoto & Paris climate accords are other agreements our EU allies signed, but are failing to live up to.

I say, let's give shock a chance.


lol. The US have always been one of the biggest blockers of effective climate prevention and are out of the Paris accord completely. It would be outright stupid for other countries to reduce their emissions while top emitters just burn the same fossil fuels more cheaply.

Although I don't really mind that one, climate change is too slow and time discounting is a thing.

What this means is quite simple. I do work at an automotive electronics manufacturing plant, in Canada. It has been very interesting to see the progression of events over the last couple decades, and this is exactly what Trump is trying to change.

They started with a module that turned the lights on in the dark, now are making things like seat heater controls and touch lamps in the vehicle. The devices have a circuit board with electronics, usually a pic. They are encapsulated within epoxy, and have a plug or wire harness.

They do the R&D, write the code, develop and test the prototypes. The circuit boards are made somewhere else. Locally they have board stuffing machines that place the surface mount electronic components onto the circuit boards and solder them. Fully automated; a stack of boards and rolls of electronic components, a machine that places the devices and an oven that melts the solder to fix them in place. The labor is inspection; people watching monitors, others manually checking the boards.

If that is all that is needed, ie. the automation can place all the components, they are encapulated, tested and shipped.

If there are wire harnesses needed, they are shipped to a factory in Mexico where labor is cheaper. Some components are shipped both ways, started here, labor applied in Mexico, then returned for more specialized or automated finishing.

So the proportion of value that Mexico offers is simply cheap labor under cheap labor rules.

They reorganized this way when there was a unionization drive. There were hundreds of people in the plant. Now there aren't.

We have both a provincial and federal government who considers this employer and others as an enemy and requiring expensive and instrusive regulation, and a handy victim where they can promise wonderful things to their voters and get them to pay for them. Directly. The US had a government like that for 24 years as well. All these arrangements are quite new, driven by both the increase in cost of employing people and the opening of borders, improvements in logistics handling, and the low cost regimes eager for the business.

A pretty good gig if you are on the right side of it.

Likely this plant will be seriously harmed by the collapse in negotiations between Canada and the US. I wouldn't doubt that moving operations is in motion already. The 'human capital' is pretty minimal, and the few product lines and equipment could be moved quite easily.

Trump seems to be the first politician that I've every heard that understands the dynamics and sees the need to reign in the regulatory state. The logistics of shipping products multiple times for long distances is cheaper than dealing with some apparatchik in the US.

The level of anger from the Democrats who represent these people is understandable.

How much is a “percentage of parts”? Since the term is written and/or edited by an economist, I would like to assume that this is a percentage of the *value* of those parts. But the plain language of the post does sound like it’s based on a count, not nearly so interesting. What data are we actually talking about?

@Alex: for the sake of this young future professor related to the Mexican ex-president who signed into NAFTA?

I am for free trade, meaning free movement of goods and services, but there is a problem with equating that to zero tariff. It penalizes domestic producers.

We have a big modern society with a fair of social programs, and we tax all domestic activity to support those programs. When a new car hits a showroom floor, its cost has embedded in it everything from real estate taxes on the factory, payroll taxes on the employee, corporate taxes on the producer. The foreign car shows up at the dock it has no cost component funding American government federal state or local. If a car comes from a low tax low-wage environment that represents a real competitive advantage, while at the same time cutting a relative hole our government revenue.

It would not be protectionism in my book to pick some number for uniform tariffs designed to balance things out. And it seems fair that stuff sold here supports our system, our jobs training, our retirement.

There is a simple way that does not involve import tariffs to ensure that stuff sold in America funds the American government. It is called a sales tax.

That applies to both, of course, and so does not make up the difference. It certainly doesn't allow a transfer to the American manufacturing workers now recognized as losers in trade liberalization.

A VAT-style adjustment at the border would though.

That is fine if the goal is to fill government coffers. In fact defenders of the status quo would like that; more money for them to play with and they can show how much they care by sending a cheque to the people who can't work.

In the end, all the taxes are paid by the ultimate consumers.


In Mexico, the top individual income tax rate is 35 percent, and the corporate tax rate is 30 percent. Mexico also has a 16% VAT. So still a goodly amount of tax being paid for Mexican operations.

But let's face it, the vast majority of US taxes come from income taxes of CEOs, bankers, lawyers & doctors. The top 1% of taxpayers account for more income taxes paid than the bottom 90% combined, and those 1% are not auto workers. Income taxes paid by individuals account for 47% of all US taxes, payroll taxes are 34% (but of course everyone "gets that back" as medicare/social security, right?), and corporate income taxes account for only 11% of US taxes.


Back when GM was the nation's largest employer that was a big domestic tax base.

Avoiding (evading?) U.S. taxes becomes much more difficult if production is returned to the U.S. "Supply chain" means "transfer pricing" and transfer pricing is the opportunity to deflect income to tax havens. Sure, disrupting supply chains won't end the quest for tax avoidance, but the schemes will involve more risk, including the risk of a long vacation at taxpayer expense.

Related note:

Harley-Davidson, the iconic American motorcycle brand, will shift some manufacturing overseas in response to the raising of trade barriers on both sides of the Atlantic."

" Still, it's worth noting that the company has scaled back its American production lines in recent years in favor of opening a new plant in India, where motorbikes are highly sought, to get around a massive import tariff imposed there. Harley-Davidson has plans to open another facility in Thailand for the same reason."

The article states that tariffs are bad, but the evidence listed in the article seems to indicate that countries with high tariffs end up with additional manufacturing jobs. Frankly, if you are in favor of low tariffs, this is not the article you should write.

I think the math actually favors low tariffs, but the evidence listed here indicates that the US (a country with a large trade deficit and relatively low manufacturing rate) would gain manufacturing jobs from higher tariffs.

To be clear, when I said " the math actually favors low tariffs", I mean that the lower average prices paid by the American consumer, combined with the large gains by importers will be higher than the value of the skilled manufacturing jobs that are lost. However, the gains are not evenly distributed.

Conversely, it's clear that Japan, Germany and China, manage to do very well by emphasizing manufacturing jobs.

The US maintains about the same manufacturing output growth as Germany, with about the same level of general unemployment, and a lower % of employment in the manufacturing sector.

It's not so clear how Germany really do "very well" by comparison. Unless employment in manufacturing specifically rather than actual manufacturing output or employment in general is for some reason the desired outcome.

From what I understand, you protect manufacturing jobs when you put a tariff on finished goods (motorcycle) but not so much when you put the tariff on intermediate goods (steel, aluminum, components).

Poor Harley Davidson is going to pay both EU and Trump tariffs.

I'm not sure what drives your conclusion that "in a world with deep supply chains a trade war will be much more expensive than in a conventional world." Deep supply chains also suggest high adaptability from a Hayekian point of view. It also seems counter-intuitive that productivity losses are significant where trade is really an off-shore tax scheme (e.g. everything is produced in U.S., then shipped to Mexico for final assembly and then re-sold into the U.S.). It's not comparative advantage that leads to that equilibrium, its tax and regulatory regimes.

"... who in the initial equilibrium have equal costs. "
Trump is claiming, with some good justification, that the current trade deals are NOT free trade, nor are they fair trade. Unless current tariffs and tariff-equivalent non-tariff barriers are included in the analysis, these "pro-free-trade" papers are pretty close to the usual elitist anti-Trump fake news.

I'm in favor of free trade. Trump says he's in favor of it -- but what we now have is an unfair non-free trade set of agreements.

Please have the intellectual courage to explicitly claim that the current regime is free trade -- or else, if it's not (and we all know it's not), what the current status is.

Finally, it looks to me like Trump's threat of a trade war is, like his threat of more pressure on North Korea, part of his bargaining -- with the goal of getting more exports for the US. It's pretty clear to me that taking countering tariffs off the negotiation table means the US is not serious about renegotiation. But Trump is serious enough about getting a better deal that he's willing to risk both sides getting poorer -- but the other side hurting more than the US.

But trade wars are so easy! #covfefe

I'm no economist, but I think what this analysis is saying is that Trump is an idiot.

I didn't know it was this much!

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