Trump’s Proposed Tariff on Mexican Exports Will Backfire

Guest post by George DeMartino.

The new Trump proposal (now under consideration by his administration) to get Mexico to pay for the proposed wall along the Mexican border through a 20% tax on Mexican exports to the US violates a range of international trade laws, and is apt to generate retaliation by Mexico. Mexico’s right to retaliate is assured by the WTO, and so would survive any attempt by the Trump Administration to cancel NAFTA. That retaliation could hurt important sectors of the US economy given that Mexico now absorbs about 15% of total US exports. But in addition to the harms from retaliation (and from the wall itself), the funding proposal is likely to backfire in at least five ways.

1. The incidence of the tax will fall heavily on American firms at home that import from Mexico, American consumers, and American firms in Mexico that export to the US. US retailers will look to offset higher import costs by reducing other expenses, such as by shedding employees. So will firms that import inputs from Mexico for final assembly in the US. Here, too, pressure will mount to cut costs in ways that harm American workers. And for goods without immediate substitutes, like some agricultural goods, US consumers will be on the hook for a greater share of the tax. Despite appearances and Trump’s claims to the contrary, then, Americans will pay a substantial share of the costs for Trump’s wall. But don’t expect Trump to trouble himself with the basic math.

2. For Mexican exports for which there are ready substitutes, Mexican and US firms producing in Mexico will bear a greater share of the tax in the form of reduced revenues as they struggle to maintain their exports to the US. But very soon Mexican exports to the US will decline as US importers look to buy from other countries. The decline would of course reduce the expected revenues from the tax, and trigger other unintended effects (see #5, below).

3. President Trump will say that the tax will induce US companies producing in Mexico to relocate production and jobs back to the US. It is unlikely most will do so. If corporations in Mexico think the tax is likely to persist, they are more likely to move production to other low-waged countries than back to the US.

4. In fact, if the tax persists for even a year or two, it is much more likely to accelerate a trend already under way—the substitution of Chinese for Mexican goods in US markets. China has posed a serious threat to Mexican exports of high-skilled and medium-skilled manufactured products for at least a decade. The Trump tax will only accelerate the trend. And so Chinese leaders are apt to be even happier about the tax (and, also, about the Trump wall) than are Trump supporters in the US. It’s not at all far-fetched to argue that the primary beneficiary of the tax on Mexican exports to the US will be China,followed by a small number of other low-waged countries that will rush to exploit the opportunity created by increased Mexican prices in the US market.

5. The social impact in Mexico could be severe. Like most economic shocks, the tariff will hurt the most vulnerable communities rather than the administration of Mexican President Peña Nieto, who could very well begin to reverse his abysmal level of domestic support by standing up to Trump. To the degree that the Trump tax reduces Mexican exports, it can be expected to increase the number of financially desperate Mexican workers trying to enter the US—legally and illegally—and even push some displaced workers into illicit market activity. And so the Trump tax will undermine the very purpose for which it is intended—to reduce illegal border crossings—while harming working people on both sides of the wall.