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President Donald Trump issued a memorandum on reciprocal trade and tariffs February 13, 2025, saying there is an economic and national security threat posed by trade deficits and aiming to address trade practices he deemed unfair to the US. The memorandum introduced a “fair and reciprocal plan” and directed the U.S. trade representative (USTR) and the Commerce Department to examine and equalize the tariff rates applied to US exports by each trading partner while considering non-tariff barriers such as value-added tax (VAT), government subsidies and other regulations affecting US companies.
Trump announced a new minimum 10% baseline tariff applied to all US trading partners and reciprocal duties ranging from 11% for the Democratic Republic of Congo to 49% for Cambodia and 54% for mainland China (34% plus the recently implemented 20% tariffs). These tariffs, calculated as half of the bilateral deficit relative to imports from each partner, target economies that run the largest bilateral trade surpluses with the US or those that impose significantly larger tariffs on US exports.
Canada and Mexico were exempted from additional duties as they remain subject to 25% tariffs for non-United States-Mexico-Canada Agreement (USMCA)-compliant goods. While roughly half of US imports from Mexico and 60% of US imports from Canada were non-USMCA compliant in 2024, we are assuming that 95% of imports from Mexico and 90% of imports from Canada will eventually become USMCA-compliant.
The administration divided the US trade balance for each trading partner by US imports from that economy, and divided that number by 2 with a minimum of a 10% tariff increase.
The official formula presented by the USTR is that the change in tariffs would be set to bring the bilateral trade balance with individual trading partners to zero assuming the price elasticity of import demand is 4 and the elasticity of import prices with respect to tariffs is 0.25. The administration then decided to reduce that number in half with Trump saying, “This is not full reciprocal; it is kind reciprocal.”
Key trade partners such as mainland China, the European Union, Vietnam, Japan, India and numerous ASEAN economies will face the highest increase in duties.
The sweeping tariffs were imposed under the International Emergency Economic Powers Act and will be imposed on April 5 for the additional 10% tariffs and April 9 for the additional reciprocal tariffs.
These tariffs will remain in effect “until such a time as President Trump determines that the threat posed by the trade deficit and underlying nonreciprocal treatment is satisfied, resolved, or mitigated.”
The administration confirmed that 25% tariffs on autos and parts would be implemented on April 3, that the “de minimis” exemption for goods worth less than US$800 from mainland China and Hong Kong would be terminated on May 2 and that the 25% tariffs on non-USMCA-compliant merchandise from Mexico and Canada would remain in effect.
Factoring all of the tariff announcements, including the recently implemented steel and aluminum tariffs, we estimate the average US tariff rate will increase by 21ppt to around 23% – the highest level since 1909 and the one of the highest average tariff rates in the world.
As we had predicted, the Trump administration is particularly interested in economies that have the largest trade surplus in goods with the US. While no specific economy list was provided, these likely include mainland China, Mexico, Vietnam, the European Union, Canada, Japan, South Korea, Taiwan and India, as they have the largest goods trade surplus with the US.
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Read moreSteep and permanent tariff increases against US trading partners would create a stagflationary shock — a negative economic hit combined with an inflationary impulse — while also triggering financial market volatility and dampening economic sentiment.
Assuming these tariffs remain in place and there is no retaliation, we estimate that US real GDP growth would be 1ppt lower in 2025 and 0.4ppt lower in 2026, relative to our baseline, assuming no retaliation from the US trading partners and no action by the Federal Reserve in response to the tariffs. As such, real GDP would be 1.0% lower in 2025 and 1.4% lower in 2026. Since some economies would be likely to retaliate, the final GDP loss would probably be higher.
For the median US household, this would represent an annual income loss of US$690 while for families in the bottom quintile, the loss would surpass US$1,000.
Importantly, we stress that retaliation and a significant adverse financial market reaction would exacerbate these shocks and push the US economy into a recession. Indeed, even after these sweeping trade announcements, much uncertainty remains as to the duration and potential exemptions and exclusions from these tariffs. This uncertainty is likely to adopt a wait-and-see approach from businesses and feed market volatility.
The inflationary impact of additional tariffs is a key source of concern, given the previously reported persistent inflationary pressures. We find that a substantial increase in tariffs would generate a significant inflationary impulse, with the overall rate of consumer price inflation 1.0ppt higher by Q4 2025.
At a global level, real GDP growth would be curbed by 0.5ppt in 2025 and 0.7ppt in 2026 amid increased protectionism and weaker US growth. Some of the hardest-hit economies include the Eurozone and mainland China. Eurozone real GDP growth would be reduced by 0.3ppt in 2025 and 0.9ppt in 2026, and mainland China growth would be reduced by 0.5ppt in 2025 and 1.2ppt in 2026.
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Read moreThe administration confirmed it is imposing automotive tariffs under Section 232 of the Trade Expansion Act (for which the original investigation concluded in February 2019), starting on April 3, citing national security concerns.
The 25% tariff affects imported passenger vehicles, including sedans, SUVs, crossovers, minivans and cargo vans, and light trucks. Key automobile parts such as engines, transmissions, powertrain parts and electrical components also fall under the tariff.
The US imported a total of US$247b of motor vehicles in 2024 plus US$143b of automotive parts. Assuming 90% of Canadian auto imports would eventually become USMCA-compliant and 95% of Mexican auto imports would become USMCA-compliant, that would represent a total of nearly US$300b of imports subject to the tariffs.
Assuming the tariffs are permanent, we estimate their impact to be a loss of 0.3% of GDP relative to a baseline in 2025, and a loss of 0.4% of GDP relative to a baseline in 2026. The impact on Consumer Price Index (CPI) inflation would +0.2% in 2025. For the EU, Canada and Mexico, the GDP loss relative to the baseline would be 0.1% in 2025 and 0.4% in 2026. For Japan, it would be 0.1% in 2025 and 0.3% in 2026. For mainland China, it would be 0.1% and 0.2% in 2025 and 2026, respectively.
President Trump is ending duty-free de minimis treatment for covered goods from mainland China and Hong Kong. Starting May 2, these goods will be subject to a duty rate of either 30% of their value or US$25 per item (increasing to US$50 per item after June 1, 2025).
The de minimis tariff exemption allows shipments bound for US businesses and consumers valued under US$800 (per person, per day) to enter the US free of duty and taxes. In 2023, U.S. Customs and Border Protection estimated a total of over 1 billion such shipments worth around US$54b entered the US if shipped through the international postal network. Covered goods shipped from mainland China and Hong Kong are subject to the reciprocal duties and all other applicable duties.
While the total value of these shipments is modest compared to total US imports of over US$3t, research suggests that the elimination of the de minimis exemption would lead to a reduction in aggregate welfare around US$12b, disproportionately hurting lower-income consumers. Since roughly US$18b of de minimis shipments come from mainland China, mostly via e-commerce platforms, we estimate the loss of welfare from eliminating the mainland China exemption to represent around US$4b.
As described above, our initial assessment of the economic impact of the new tariff measures points to a substantial hit to the US and global economy, with consumer spending possibly retrenching and a risk that the economy could fall into a recession.
On the growth front, the US economy could enter a recession in the second half of the year with a real GDP growth drag averaging 0.8ppt in 2025, bringing our average growth forecast from 1.5% down to 0.7%. By Q4 2025, real GDP could be contracting 0.5% y/y.
On the inflation front, the new reciprocal tariffs could raise US consumer price inflation by 0.8ppt by Q4 2025, with the inflationary impulse concentrated in the second quarter of the year.
Given the uncertainty surrounding the duration of the new tariffs and potential retaliation measures from targeted economies, we will adjust our baseline in the coming week to account for the latest developments. One thing is for sure though, the likelihood of a recession in the next 12 months has risen from 40% just two weeks ago to around 60% today.
Fed policymakers will maintain a reactionary stance in the coming month and will want to avoid front-running the impact of tariffs on output and inflation. We will likely see a growing fracture between those that are more concerned about the negative impact of tariffs on growth and employment and those more concerned about the risk of a de-anchoring of inflation expectations and persistently higher inflation.
There will be latent uncertainty in the coming months surrounding the breadth of the tariffs and their duration. In terms of breadth, the administration has already started discussing the possibility of exemptions and exclusions at the country and sector levels. We will be producing a follow-up note with product-level analysis using the EY UPGRADE CGE model.
Similarly, we shouldn’t discount the possibility of some tariffs being imposed for a short period and then removed or reduced. Many economies have already begun to seek negotiations with the Trump administration to lower the tariffs.
On the flip side, it remains to be seen how the US administration will address certain products like pharmaceuticals, semiconductors, lumber, energy and critical minerals that were excluded from the recent tariff announcements but have been identified by President Trump as targets for future sectoral tariffs.
Beyond immediate cost pressures, higher tariffs will undermine corporate and household sentiment on the economy while diverting production resources to resilience building. With consumers and businesses increasingly worried about the economic outlook, a wait-and-see approach is likely to be favored, and both groups could scale back future spending and investment intentions. This is particularly true as trade uncertainty has fed market volatility, with the US equity market underperforming. The ensuing negative wealth effect is likely to further constrain business investment and consumer spending.
To offset both the challenges around trade uncertainty and the higher cost of doing trade, businesses will adjust their strategies. Some will diversify supply chains, shifting sourcing to economies less impacted by the tariffs, while others may invest in automation and cost take-out exercises to cut costs and reduce dependence on imports.
We anticipate that the US economy will be among the economies most adversely affected by reciprocal tariffs, with the long-term impact on real GDP expected to be negative 0.7% — worth around US$200b annually.
Tariffs lead to an increase in import prices, which raises production costs and lowers output across multiple US sectors. Increased pressure to source production domestically further raises domestic prices, leading to accelerating producer and consumer price inflation that outpaces wage growth. The resulting negative income shock weighs on consumer spending, which ends up on a lower trajectory.
In addition, the higher cost of goods sold weighs on exports, further exacerbating the negative impact to GDP. Over time, this reduces the US share of international trade by 1.8ppt, to 11.8% of total world exports.
Finally, with firms less able to access the best or cheapest inputs, innovation is restrained. Domestic resources get diverted to less productive domestic sectors and global supply chains become less efficient, slowing productivity growth.
From a sectoral perspective, the US metals sector is likely to experience the largest output reductions, with cutbacks reaching 8.5%. As US products become more expensive, foreign demand falls, leading to a drop in exports. A similar effect is expected in other largely export-oriented US sectors, such as coke and petroleum, chemicals, electronics and transport equipment.
Excluding Canada and Mexico from the additional reciprocal tariffs would benefit both of these economies. In the case of Mexico, the positive 0.5% impact on real GDP is rooted in a significant increase in the output of sectors such as electronics and electrical equipment. Their exports currently constitute a significant portion of the country’s exports to the US, and therefore, strong export growth translates into a large boost in production. Simultaneously, negative effects resulting from rising production costs and prices of Mexican goods can be observed in many other sectors that are not as export-oriented. However, the net impact of the US reciprocal tariffs remains positive on the Mexican economy due to its exemption from these measures and the fact that we believe 95% of US-Mexico trade will eventually be considered USMCA-compliant (and thus not subject to 25% duties).
The electronics and electrical equipment sectors are also the main beneficiaries of the reciprocal tariff exemption for Canada. Aside from them, only the leather products, textiles and apparel sectors experience such a substantial upswing in production. As goods from current main US suppliers become more expensive, the US demand for Canadian imports of these sectors rises significantly. However, if our scenario accounted for other tariffs (such as on motor vehicles) imposed on Canada, the overall effects on the Canadian economy would differ.1
Apart from the US, Vietnam and mainland China are predicted to be the most negatively affected by the introduction of reciprocal tariffs. This is due to a sizable change in the tariff rate imposed on imports from these economies to the US. Sectors related to clothing and footwear creation, and other manufacturing sectors are among those that suffer most due to the cutbacks in exports.
Some economies, such as Japan and the EU, may see a modest negative long-term effect, while others, such as Australia and the UK, may not experience any significant output loss in the long term. This results mostly from trade redirection to different export destinations.
Importantly, if retaliatory tariffs were introduced in response to the reciprocal tariffs, then the long-term output losses would be more significant. This would provide additional incentives for most US trade partners to focus on reinforcing trade relations with other economies to minimize long-term economic losses. US output and exports would bear the consequences of such a geopolitical shift.
Changes in trade relations and primary export destinations can also be observed at the sector level, boosting production in some sectors in certain economies, while causing reductions in others.2
The views reflected in this article are the views of the author(s) and do not necessarily reflect the views of Ernst & Young LLP or other members of the global EY organization.
