Since his campaign, President Trump has been highly vocal about his view that America has suffered due to unfavorable trade balances with various partners and U.S. manufacturers moving production abroad. He has repeatedly stated his intention to institute a substantial tariff program to address these issues. Such a program, however, would be counterproductive to Trump's economic growth goals. It would be more likely to raise prices, constrain consumer spending and depress economic growth than to create jobs. New-car sales would be at risk due to the direct impact of tariffs imposed on imported cars and parts as well as the indirect effects of tariffs levied on other goods.
What It Is:
At this time, what kind of tariff policy Trump will propose remains unclear. Since the beginning of his presidency, Trump has threatened to impose tariffs on the products sold by trade partners who do not play fair, such as a tariff of 45 percent on China's goods if China does not operate as a market economy, as well as up to 35 percent on U.S. manufacturers who build factories abroad to produce the goods they sell in the U.S. The administration has also mentioned implementing a tariff of 5, 10 or even 20 percent on all imports, in part to pay for the border wall with Mexico that Trump issued an executive order to build in January. Furthermore, Trump has acknowledged the possibility of instituting a border adjustment tax, which applies to all goods and services consumed domestically regardless of where they are produced or by whom. This type of tax differs from a tariff that is limited to specific imports or trade partners and would affect goods produced domestically as well as imports.
To date, however, Trump has not provided any concrete tariff plan. While he has some ability to levy tariffs himself, the only tariff Trump has actually levied is a duty of up to 24 percent on Canadian softwood lumber imports. In particular, his tax cut proposal announced last month was noticeably silent on the subject of a border adjustment tax, which was a key part of the plan drafted by Republicans Paul Ryan and Kevin Brady last summer.
Impact: Likely Negative
This Trump policy objective has strong potential to harm new-car sales. For now, we only consider the impact of a tariff placed on automotive and other imports since a border adjustment tax seems less likely, given its lack of mention in the recently proposed tax plan and lack of support from even House Republicans.
1) New-Car Prices
Edmunds estimates that 47 percent of new cars sold in the U.S. are made elsewhere, as well as some non-negligible share of parts on the remaining 53 percent due to globalized supply chains. Given the sizable import presence in the auto industry, Trump's proposed tariffs would dramatically increase new-car prices. For example, for imported vehicles, a 20 percent tariff could increase the average transaction price of a typically equipped new car by approximately $7,000, from $35,000 to $42,000, if automakers passed on the entire cost of the tariff to consumers.
What's more, price increases would likely not be limited to imported cars or cars with higher levels of imported content. As prices increased on these vehicles, demand would grow for vehicles less impacted by the tariffs. Given the extent of imported vehicles and parts, it is unlikely that manufacturers could readily adjust domestic production to meet the higher demand or that the additional vehicles could be produced as cheaply as their imported counterparts. In particular, labor tends to be more expensive in the U.S. As a result, prices on the less impacted vehicles would likely rise as well.
Since these price increases would occur without accompanying wage increases, levying tariffs on automotive imports would almost certainly be a large negative shock to new-car sales. To see this potential fallout, consider the price elasticity of demand for cars — that is, the estimated impact of a 1 percent increase in price on demand. Given the ability to postpone vehicle purchases, economists have typically found demand for cars to be highly elastic (very sensitive to price changes) in the short run. According to one estimate, a 1 percent increase in the market price of cars results in a 0.87 percent decrease in overall demand, meaning a 15 percent increase in price would result in a 13 percent drop in demand. Based on Edmunds' 2017 forecast of 17.2 million vehicles, annual new-car sales would sink to 15 million at this rate. Other estimates have found even higher declines in demand. This scenario is an upper bound of the impact on sales for a 20 percent tariff and assumes that import vehicle prices would increase by the full 20 percent and prices on other vehicles would increase by 10 percent. Since not all vehicle prices would be affected to the same degree, overall prices in the new-car market would be unlikely to increase by the full amount of the tariff. However, based on the above assumptions, even a 5 percent increase in overall prices could result in new-car sales decreasing to 16.5 million.
2) Economic Growth
While Trump's proposed tariffs could substantially depress the new-car market by raising prices, the impact of this policy would not necessarily stop there. The tariffs could extend well beyond the automotive industry, potentially to all imported goods.
To the extent that manufacturers and retailers pass on the higher costs of imported goods to consumers, prices would rise on these goods, increasing demand for domestically produced versions. Trump claims that the increase in demand for domestic products would create jobs and spur economic growth. But increasing domestic production and sourcing parts domestically could prove challenging to numerous industries, depending on the size of the U.S. industry and supply chains. And, as discussed above, U.S. labor costs could raise prices even if domestic production could be readily increased. Such inflation would slow economic growth.
Indeed, many economists believe that Trump's proposed tariffs would have a negative impact on GDP (cutting growth by 0.5 percentage point, by one estimate) and potentially threaten a global recession as other countries retaliated with their own tariffs and the efficiencies of free trade declined. The resulting changes in prices, consumer spending and economic growth would hurt new-car sales.
Likelihood of Implementation: Reasonably Low (Especially for Automotive)
Trump's promise to implement tariffs was a strong part of his campaign message, designed to appeal to voters who had lost jobs due to manufacturing moving abroad. As such, it is unlikely to fall completely by the wayside.
When it comes to automotive, however, tariffs are in direct conflict with Trump's economic growth targets and overall "Make America Great" initiative. Automotive is the largest manufacturing industry in the U.S., contributing 3 to 3.5 percent to GDP. Any hit to this industry resonates in a big way through the economy. As a result, we believe that any tariff policy will be designed to not derail auto sales.
For additional Edmunds commentary on the impact of Trump's policies on new-car sales: Peak Auto Sales Still to Come | Beyond Roads and Bridges: How Trump's Infrastructure Spending Plan Could Grow Auto Sales | Trump's Tax Cuts Are Not Likely to Bring Much Windfall to Auto Sales
Lacey Plache is the chief economist for Edmunds.com. Follow @AutoEconomist on Twitter.