Tariff Troubles: Will Consumers Feel the Pinch?

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Some see it as a trade war, others call it mere economic warfare, while others still say the noise we are hearing now is classic saber-rattling. But as jabs between President Trump and China and other countries escalate, it is the average U.S. consumer who bears watching. Consumer spending accounts for more than two-thirds of economic activity in the U.S.

The effects may be just beginning. New tariffs from the Trump administration will eat into corporate profits and spur inflation, many say. Though prices overall may rise, pork and soybean prices have plunged in the wake of Chinese retaliation directed at those products, and agriculture-dependent communities, despite a proposed $12 billion in aid to American farmers, are deeply worried. Automakers are revising downward financial forecasts, in part because of tariffs. General Motors says tariffs will lead to fewer jobs, lower wages, less investment in the future and price tags on its vehicles higher by thousands of dollars. Other industries have called for bailouts similar to what is being extended to farmers, but the U.S. Chamber of Commerce released analysis on Monday saying that it could cost $39 billion to cover losses to other sectors, including $7.6 billion to help auto and auto parts makers alone.

As market enthusiasm pauses — the Dow Jones Industrial Average has bobbed along a narrow range since the beginning of the year — it may be just a matter of time before consumer confidence begins to sag. Positivity about the economy slipped only a bit – less than 1% — in the University of Michigan’s July consumer survey. But expressions of negative concerns about the impact of tariffs have accelerated considerably, rising in Michigan’s survey from 15% in May to 21% in June and 35% in July, with consumers expressing worry about the future pace of economic growth and prospects for inflation.

Many see the need for trade reform, for sure. “To Trump, it appears, the choices are starkly clear: as the most powerful nation in the world today, the U.S. can either wait for death with a thousand cuts, or court death with a fighting chance of renewal,” says Z. John Zhang, Wharton marketing professor and director of the Penn Wharton China Center.

In the meantime, though, the U.S. and China appear to be locked in a standoff. Which country can better afford to stand firm before companies and consumers begin to suffer, and how long will this take?

“The pain threshold in a democratic country is always lower for sure,” says Zhang. “However, China does sell a lot more in the U.S. than the U.S. sells in China. In addition, the economic resilience and the mechanism of social and political stabilities differ in both countries. Under stress, both countries will suffer, but only time can tell whether President Trump or President Xi can hold his breath longer.”

The U.S. has three major trade feuds going at once. It is exchanging a series of tariffs and retaliatory moves with China, attempting to rewrite the terms of NAFTA with Canada and Mexico, and for the moment appears to be stepping down tensions with the E.U. that began with U.S. tariffs on steel and aluminum exports. Still, says Zhang, at this point “there is no sign that the U.S. economy is about to contract due to the onset or threat of trade wars.”

Trump has said that trade wars are easy to win and “tariffs are the greatest,” and he has promised a return to the golden age of U.S. manufacturing with high-paying jobs. Few see this as likely. But trade policy is a complex matrix, and companies and consumers will ultimately adjust to any new U.S. trade relationship with China and other countries, says Morris A. Cohen, Wharton professor of operations, information and decisions and co-director of the Fishman-Davidson Center for Service and Operations Management.

“The pain threshold in a democratic country is always lower for sure. However, China does sell a lot more in the U.S. than the U.S. sells in China.”–Z. John Zhang

“I’ve visited companies in Germany that have the highest labor costs in the world and they are globally competitive, so companies can figure out ways to sort their way through this,” Cohen says. “It’s a complicated situation and at the end of the day I think the net result is that it is very hard to say that you just push down one variable and this is what is going to happen.”

While the outcome of the current trade upheaval is far from clear, “it’s not as bad as people are saying,” says Cohen. “There will continue to be winners and losers and companies will adapt to the reality they need to deal with. But going back to the past? I don’t think so.”

The U.S. Consumer and the Tipping Point

Tariffs will surely lead to higher prices for imported goods and, to a lesser extent, prices for non-imported goods that use imported materials, says Zhang. “However, the overall impact in prices on consumers due to tariffs should not be exaggerated.”

Zhang sees at least four alleviating factors for price increases. First, the sellers of imported goods always have incentives to absorb part of the tariffs to hold on to their customers. “It is never a profit-maximizing strategy for a seller of imported goods to pass 100% of tariff increases to consumers if consumers are somewhat price-elastic, i.e., they buy less if prices go up.”

Some customers are more price-sensitive than others — a characteristic to which the smart retailer will be alert. For example, if an importer acquires a good from a foreign country at an all-inclusive cost of $10 and sells it in the U.S. for $20, she makes a unit profit margin of 100%. If a new 25% tariff is imposed on the good, the acquisition cost for the importer will be $12.50. Says Zhang: “If the importer still sells the good at the price of $20, its unit margin will become 60%. Typically, the seller will increase its price somewhat and the extent of that increase will depend on how price-sensitive the affected consumers are.”

Second, consumers can always substitute away from the imported goods affected by higher tariffs to purchase cheaper alternatives if such alternatives exist. They can also delay purchases.

Third, tariffs will stimulate domestic import-competing industries and there will be some income effect for workers in those industries and beyond. “In other words, if your income is higher, price increases do not feel so painful,” Zhang says.

And fourth, retaliatory tariffs by other countries may increase the supply of the goods destined for foreign markets in the domestic market, so their prices may go lower.

Do consumers tend to change their buying habits? What is the tipping point that would make someone put off of a major purchase like a car?

The PWBM estimates that an all-out trade war would reduce GDP by 0.9% by 2027 and by 5.3% by 2040.

“A good analogy can be found in fluctuating gasoline prices,” says Zhang. “If the price increase is temporary or perceived to be so, consumers will be less likely to change their habits. If it is permanent, consumers will buy smaller cars and drive less for sure. Consumers who buy German cars are most likely not so price sensitive, so American-made cars may not benefit much from tariffs, if any at all. However, consumers who purchase goods imported from China can be quite price sensitive if they are not industrial buyers and because of this, the importers may absorb a substantial part of the tariff increase.”

Still, that doesn’t mean consumers won’t be feeling the pinch, said Syracuse University economics professor Mary E. Lovely in a recent segment on the Knowledge@Wharton show on Wharton Business Radio on SiriusXM. “But what is making it easier for President Trump to wage this trade war right now is the fact that the U.S. economy is performing beautifully right now. This should be a time where we’re really enjoying very healthy economic growth and investing like crazy in the future of American workers. But we’re not,” she said.

Much of the growth being experienced by the U.S. is being used in a way to mortgage our future, says Lovely, “because we’re laying down policies which bode ill for future investment into the United States, future competitiveness of U.S. products overseas. So again, the great economic growth that we’re experiencing — we’re even beginning to see increases in workers’ real wages — that is hiding the pain that we will experience long-term because of these really ill-considered policies.”

Consumers are already feeling tariffs and are likely to feel their effect more if threats of further tariffs materialize, said Lovely in a separate interview. “Obviously as we place tariffs on more and more goods, some of that extra tax has to be issued forward to consumers, but we don’t know how much,” she says.

Tariffs appear as if they discourage imports and help domestic producers — and they do, says Mauro F. Guillen, director of Wharton’s Lauder Institute and management professor. “But it only works in the short run. The domestic producers most likely will enjoy a windfall, but unless they innovate and try to become better, they will fall behind. In fact, tariffs discourage innovation. Protectionism breeds laziness. When an industry or company is protected it has less of an incentive to innovate.”

“There will continue to be winners and losers and companies will adapt to the reality they need to deal with. But going back to the past? I don’t think so.”–Morris A. Cohen

Bigger Tariffs, More Consumer Pain

The media has paid close attention to the Trump tariffs with stories about jobs being destroyed. But these accounts are just anecdotal. Will tariffs have an overall corrosive effect on the economy, and, if so, when?

Kent Smetters, a professor of business economics and public policy and faculty director of the Penn Wharton Budget Model, says it’s too soon to declare this a trade war. New tariffs, though, could lead to one, which would lower the GDP. If, however, U.S. trading partners respond with “trade opening” — actually reducing existing foreign tariffs against U.S. exports — the opposite would be true. The PWBM estimates that an all-out trade war would reduce GDP by 0.9% by 2027 and by 5.3% by 2040. Wages would decline by 1.1% by 2027 and 4.8% by 2040, relative to current policy.

A trade opening, however, would have the opposite effect: GDP would increase between 0.2% to 0.7% by 2027 and between 1.3% and 4% by 2040. Wages would increase between 0.3% and 0.8% by 2027 and between 1.2% and 3.6% by 2040, relative to current policy.

“The downside risk of a trade war, therefore, is larger than the upside potential from a trade opening, the model concludes.

Tariffs on imports from China amount to a tax on American manufacturers and on global supply chains, stated the Tax Foundation, a tax policy think tank, in a July 6 position paper. “U.S. firms will initially pay the import tax to the U.S. government when they bring goods into the country. Firms that can will pass these costs on to the consumers of their products, leaving those consumers less money to spend elsewhere after paying higher prices for the goods affected by tariffs. Firms that cannot pass the costs on will, at best, have less cashflow to invest and expand in the U.S., or, at worst, will become unprofitable, lay off workers, or potentially go out of business. Though firms initially pay the tariffs to the government, it is individual Americans who bear the final burden of these tariffs.”

President Trump has proposed 25% tariffs on imported automobiles, SUVs, vans and trucks, as well as auto parts, and if those go into effect, between two-thirds and 100% of that increase will get passed onto consumers, according to a policy brief from the Peterson Institute for International Economics co-authored by Lovely. “Just about every automobile has some imported parts. There is virtually no car that is 100% U.S.-made, so there is nowhere to hide on these,” says Lovely. “These parts go back and forth across the border multiple times — they put a piece in a car and the body gets sent back.”

The expected increase could range from an additional $1,400 to $2,000 for a compact car to $7,000 for a luxury SUV, she says.

“Protectionism breeds laziness. When an industry or company is protected it has less of an incentive to innovate.”–Mauro F. Guillen

“Despite larger estimated price increases for luxury vehicles, less affluent buyers are likely to suffer more from an auto tariff because they spend a larger share of income on a new car purchase,” states the Peterson policy brief, which reports that vehicle purchases account for 12% of total income for households in the bottom fifth of the income distribution, while they account for only 3% of income among the top fifth.

If consumers think they can avoid the price hike by buying a used car they should think again. Fewer used cars will be available, Lovely says, because owners will hold on to them longer, and the relative scarcity will cause prices to rise.

Price hikes in many categories could intensify in coming months. Lovely says the first waves of tariffs were heavily weighted toward producers importing things to make other goods, so the effect on consumers is delayed. “Now, if President Trump makes good on his threat to go another $200 billion after that, he has to go to consumer goods — table wear, sneakers, clothing of all types, and that will trickle through very fast to consumers.”

Another consequence of tariffs, she says, is less choice for the American consumer, “which is something Americans take for granted at the grocery store, and those choices will be diminished because some products will be too expensive to be imported into this market. We will start to lose some of those things that make America a great place to shop.”

What about the concept that Americans will favor American-made products even if the price of a given item is higher? “I don’t know to what extent consumers care,” says Cohen. “The data doesn’t show that people will pay even a penny more for it. If you have a choice between two products, a dollar for one and a dollar and one cent for the other, most people won’t care where it’s made.”

Some have suggested that the tariffs and threats are about negotiating a better deal. After all, Cohen points out, looking back two or three decades, China has been the big winner. “China has successfully appropriated an increasing fraction of world trade and they’ve done it in a completely reasonable way, you might argue, by providing good products at a low price. What’s wrong with that? As a result they have taken away share from more developed countries.”

“If you have a choice between two products, a dollar for one and a dollar and one cent for the other, most people won’t care where it’s made.”–Morris A. Cohen

Cohen says the ultimate goal should be “to have a better trade relationship where we are closer to balance, where the real losers are protected and where governments can compete. But to say come back to America and produce everything there, that’s not happening.”

Zhang says that Trump believes there has been “a cold war of sorts against the U.S. in trade by many nations for many years, and the hour of reckoning has come after years of ineffective, genteel diplomacy. “

Yet he thinks there is hope. “I have no doubt that out of the chaos, ruins, and bruised relationships, a more fair trading system and a reinvigorated U.S. will emerge that will ultimately benefit global peace and prosperity for a long time to come.”

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