The 2025 US tariff increases varied significantly across most economies. This column argues that the economic impact of these tariffs will also not be uniform. Using a multi-sector, multi-region computable general equilibrium model, it estimates that US real GDP will decrease by around 4%, and that larger adverse impacts are expected in Canada and Mexico. Meanwhile, real GDP is estimated to increase in the economies that agreed tariff deals with the US. Overall, the significance of trade diversion effects should not be overlooked when estimating the effects of tariffs across economies.
There is concern that US tariff hikes under the Trump administration will adversely affect the world economy. Gensler et al. (2025) argued that “the policies of the new administration are likely to weigh negatively on both the US and global economy in the short and long term.” That said, US tariff hikes will not be uniform across economies. The degree of economic impact should vary among economies in positive and negative directions alongside the magnitudes of impact.
Lesson from the first Trump administration
In 2018, the US started to hike tariffs on imports from China and China responded by raising import tariffs on the US. The average US tariff rate on imports from China rose from 2.6% in January 2018 to 17.5% in September 2019, according to Bekkers and Schroeter (2020). On the other hand, China’s average import tariff rate on the US rose from 6.2% to 16.4% in the same period.
In the meantime, US trade deficits with China decreased from $375.2 billion in 2017 to $295.4 billion in 2024. That said, US trade deficits with Japan and Germany remained broadly unchanged while those with Mexico, Canada, Viet Nam, and others increased significantly, resulting in the expansion of overall US trade deficits from $792.4 billion to $1,202.2 billion.
US imports from China decreased to some extent but were replaced by imports from North America, Asia, and others and increases in US domestic production were limited. These data clearly indicate that bilateral tariff hikes decrease bilateral trade but create trade for third-party economies due to trade diversion effects.
Keys to the second Trump administration
US President Trump raised tariffs on imports of steel and aluminium to 50% in 2025 and imposed an additional 25% tariff on imports of motor vehicles and parts. Meanwhile, he announced reciprocal tariff rates for each competing economy on 2 April. He introduced a uniform 10% baseline tariff, and later, on 31 July, announced the application of lower than initial reciprocal tariffs on economies that agreed to tariff negotiations, but then imposed higher additional tariffs on China, Canada, Mexico, and others as is shown in Table 1. What is important here is that the additional US tariffs are varied and specific to individual economies.
The estimated impacts of the above US tariff hikes on production in each economy are shown in Table 2. These are based on a multi-region multi-sector computable general equilibrium (CGE) model provided by the Global Trade Analysis Project (see Kawasaki 2025a). US real GDP is projected to decrease by around 4%, which is larger than the annual economic growth rate. Real GDP will decrease to a limited extent in China, but the adverse impact on Canada and Mexico, whose trade dependency ratios on the US are significantly higher than those of other economies, will be substantially larger than that of the US.
Table 1 US reciprocal tariff rates
Source: Based on Fact Sheet, White House and others.
On the other hand, real GDP is set to increase in the economies for which tariff negotiations with the US have been agreed upon. Meanwhile, their motor vehicles and parts production would decrease under initial reciprocal tariffs but would increase under the new reciprocal tariffs. The US will still impose tariffs on those economies, but they will be lower than those imposed on other economies. Price competitiveness of those economies against other economies will improve inside the US market, resulting in the chance of increased exports to the US.
As a matter of fact, Japan’s real GDP is estimated to decrease from -0.7% to -0.8% due to trade loss effects resulting from US tariffs on Japan, but will increase due to trade diversion effects resulting from US tariffs on China (0.6%), Canada (0.6%), and Mexico (0.3%), based on the estimated impact of US tariffs by trade partner established in Kawasaki (2025b). With all factors taken into consideration, Japan’s real GDP will not necessarily decrease.
Table 2 Impact on production
Source: Based on Kawasaki (2025a).
It must be noted that GDP measures development of domestic production, which is different from national income. Substantial decreases in production of motor vehicles and parts in North America include decreases in local production by other economies through overseas investment. There is concern that revenues from overseas investment in those economies could be adversely affected to a substantial extent.
Appropriate economic analysis and firm behaviour
Values of Japan’s exports to the US decreased from 10 to 11% in May, June, and July 2025 but the major cause for the decrease has been declining export prices. The purchasing power parity rate of the Japanese yen (JPY) is around 93 yen for one US dollar in 2025 according to the International Monetary Fund’s World Economic Outlook. Under the current exchange rate of JPY140 to JPY150 to the US dollar, Japanese firms should be able to handle a few tens of percent tariffs. As a matter of fact, real exports of goods and services in Q2 2025 increased by 4.9% year-on-year and real GDP also increased by 1.2%.
That said, there is concern of the risk of a self-generated economic downturn if economic agents, including firms, take inappropriate actions. The FY2025 white paper on the economy and public finance noted that if the negative perceptions regarding the uncertainty connected to the impact of the US tariff measures were to spread to economic agents, the real economy would be substantially affected.
Economists are required to provide appropriate economic analysis to aid firms in taking effective action. The US tariffs are a worldwide trade and economic agenda, but the adverse impact of the tariff hikes within bilateral relations should be the sole emphasis: as discussed above, tertiary economies benefit due to trade diversion effects resulting from multilateral relationships should not be overlooked.
Source : VOXeu
