President Donald Trump imposed steep 25% tariffs on all imported Mexican and Canadian goods Feb. 1. Although Trump paused the tariffs on our North American neighbors less than one week later, I’d like to present an alternate reality where these tariffs did take effect.
First, let’s observe the effect of tariffs on the average American consumer.
A tariff simply represents a tax levied on an imported product. For example, an imported Mexican avocado that previously cost $2 would now cost $2.50 — before sales tax.
Your first reaction may be negative, but let’s consider the tariff’s hypothetical impact on American avocado consumers. American-grown avocados are considered a substitute good for Mexican avocados. Applying microeconomic theory, when the price of Mexican avocados rises, the demand for American-grown avocados rises, since they’d theoretically be cheaper.
All else equal, this would benefit the American avocado industry as it would stimulate domestic avocado production.
That’s the core of American protectionism — to “protect” American industries from cheaper foreign counterparts.
Unfortunately, reality is not that simple. Several confounding factors influence markets, commodity pricing and industry performance — especially when analyzing the situation from the Mexican perspective.
A key feature of economic analysis is the influence of expectations. Immediately following Trump’s tariff announcement, the Mexican Peso to United States dollar exchange rate dramatically crashed, possibly due to investor uncertainty based on negative expectations regarding Mexico’s economic performance.
Exports make up net exports, a component of the country’s GDP calculation, the measure of a country’s aggregate production in a given year. As exports decline, so do net exports, therefore decreasing Mexico’s GDP.
Expectations of poor economic performance decrease demand for the Mexican Peso as foreign investors are unwilling to hold a volatile currency — a currency that experiences rapid fluctuations and unstable returns on investment.
Investors would reduce their Peso holdings and move to a more stable currency such as the U.S. Dollar. If this trend continued, the Peso would continue to depreciate and remain unattractive, potentially throughout the entire Trump presidency.
In our immediate tariff scenario, Mexico is not doomed. The near future remains uncertain, but a depreciation in the Peso may be a good thing.
Put simply, depreciation means that a country is relatively cheaper compared to a foreign currency. Consequently, foreign consumers may find Mexican goods relatively cheaper, thus increasing Mexican exports, net exports and eventually GDP. But, this only applies to countries other than the U.S.
In the short run, a tariff would have been detrimental to the Mexican economy, as 78.1% of Mexican exports are sent to the U.S. While Mexico could follow a self-fulfilling economic prophecy, it would be extremely gradual given Mexico’s reliance on the U.S. as its top trade partner.
If Trump followed through with the tariffs, the U.S. could expect retaliatory pressures, especially from Mexico and its allies.
As this presidency progresses, we must ask: how many of Trump’s threats will end as threats, and how many will he truly pursue?
