Reciprocal Tariffs: Weird Science

We look at how reciprocal tariffs can turn into an exercise in qualitative, subjective reverse engineering of a threatening number.

Feb 14, 2025

The layers of factors cited as the “reciprocal tariff” inputs constitute a roll-your-own formula given the open-ended nature of variables. It will be interesting to see how tariff architects quantify what the non-tariff barriers in the trade partner market amount to for US tariff-setting.
The reference to VAT taxes, regulations, litigation, and any other structural nuance that the analysis comes up with (licensing, franchise laws, etc.) make the reciprocal tariffs a great negotiating tactic. However, it is a highly qualitative and subjective exercise that they downplay. The Art of the Deal lives on.
The flip side is always the reaction of the trade partner and where they can counter with their own policies. The reciprocal tariff process and assessing related risks opens up some challenges for the nations that have not been in the crosshairs to this point in Trump 2.0 – notably Japan, South Korea, and India.

The Reciprocal Tariff headlines are easy for the architects to sell under the heading of “They pay what we pay.” If only it was that simple. The current game plan is in some ways not much different than the 2019 attempt on this topic. That said, for anyone who listened to how Trump described the process and answered questions on it, the “what we pay” was not just a tariff number but included a laundry list of other variables across taxes, regulations and non-tariff items.

Naming VAT taxes as one variable struck many observers as especially strange since everyone (not just on US products) pays them in the major trade partner nations. In considering what might roll into “reciprocal,” Trump even cited litigation against some of the practices of the major tech operators. Currency manipulation has been kicked around as a subjective variable (anyone remember Navarro complaining about the “implied deutschemark” value as manipulation back in Trump 1.0?)

Overall, the Trump presentation and Q&A on the topic was the usual word salad (with way too many pieces of brown lettuce) that amounted to a rehash of some conceptual black holes. Top of the list was trade deficits as a “subsidy” paid by the US to a nation. That of course is in contrast to the idea that the purchase of goods is a decision made by arm’s length private sector buyers for economic reasons that have multiplier effects across the economy (see Tariffs: Questions to Ponder, Part 1 2-2-25, The Trade Picture: Facts to Respect, Topics to Ponder 2-6-25).

The 3% area negative hit to GDP on trade deficits also requires one to look at the much larger PCE, GPDI and Government spending lines and record stock markets on the other side of the total economic activity. Can you imagine Trump in that rabbit hole in a Q&A session on those topics? Now factor in the retaliation impacts as well. We already revisited the 2018-2019 memory lapses in other commentaries (see Histories: Asset Return Journey from 2016 to 2023 1-21-24, HY Pain: A 2018 Lookback to Ponder 8-3-24).

With the recent visit from Japan, it is worth looking at the trade checklist by nation again to keep in mind where Trump’s gripe on “trade deficit as subsidy” are concentrated:

This chart lines up the top trade partners by total trade (imports + exports). The column on the right is the (deficit)/surplus number. Many of these nations are (were?) allies, so the stakes are much higher than just a tariff.

The impact of trade deficits along the PCE and private sector investment lines across so many goods and services industries does not get reflected in Trump’s discussion points. Neither does the tax base and regional macro impact for state and local government investment and consumption. His advisers are “order takers” and not there to influence his narrow view on the trade topic.

The reality of an auto transplant and supplier chain boom over decades seem to earn no respect on what they have done for the US economy (and heavily geared to red states). Even Navarro has in the past belittled the economic value of the “boxes” of assembly plants.

The waves of economic activity that come with the imports, supplier chains and related services and infrastructure of course do not show up at the border in the trade number. We can see supplier chain items imported into the US, but that is a relatively small slice of the story. Trump also always ignores the major services surplus and offshore investments of US multinationals that can now repatriate the cash without tax risks after his tax bill. Some of the biggest importers into the US are US-owned operations offshore. That is very relevant in the stock markets.

Reciprocal tariff comments targeted the usual trade partner suspects…

Tariffs are usually reduced to simplistic sound bites with major factual misstatements and butchered concepts. As usual, Trump reserved a disproportionate share of time targeting Canada and his 51^st state pitch (see Trade Exposure: US-Canada Import/Export Mix 2024 2-7-25, US-Canada: Tariffs Now More than a Negotiating Tactic 1-9-25).

As a reminder on Canada, the tariffs he has already proposed on some of Canada’s major imports into the US (see Aluminum and Steel Tariffs: The Target is Canada 2-10-25) has zero to do with “reciprocal” given the nature of the NAFTA/USMCA history. What is unfolding now is a current breach and eventual termination of the USMCA.

Trump also aired out the usual grievances with the EU, where reciprocal tariffs have more application. The EU as the #1 trade partner is a story we have looked at in past commentaries, and the significant non-tariff factors in markets such as the EU, Japan, and South Korea could be a gold mine of subjective variables to manipulate to reverse engineer some big “reciprocal tariff” numbers. The EU trade numbers are daunting as a high value added mix of incoming imports and given major end markets where the EU can find substitutes - notably in Energy (see US-EU Trade: The Final Import/Export Mix 2024 2-11-25, Tariffs: The EU Meets the New World…Again…Maybe 10-29-24).

We say manipulate and reverse engineer for a reason. We would expect to see the “hockey stick” of tariff add-ons as the Trump tariff trade team digs in. Anyone who has looked at multinational companies or reads industry trade rags knows that life across another border is target rich to find anomalies that make life more difficult for US companies. Trade groups will have lists of gripes ready to roll. We are curious if the climate regs of the EU will get pulled into the reciprocal tariff checklist. Team Trump will need to pad the tariff revenue for legislative purposes on the US with reconciliation, and that is a set of motives that has been getting more airtime of late.

The nature of the EU leaves a lot of room for non-tariff regulatory, structural and legal (antitrust, taxes on tech, etc.) factors that the US “analysis” can roll up into a big tariff number. That tariff number on the EU will naturally be met with a proportionate, bureaucratic, and certain retaliation. We reproduce the EU import chart below:

That is a lot of big-ticket lines not so easily substituted for the many US-based buyers that made a private sector “business economics” decision to buy them in the first place.

Trump’s brief reference to autos in his comments implies he might seek to go the route of steel and aluminum tariffs. That would be a throwdown of epic proportions with Japan, South Korea and the EU (via Germany). The reactions there would be going after non-auto sectors in the US with agriculture at the top of the list but also spread to defense and aerospace among others. The aero & defense trade rags are filled with news of supplier chain problems, and aerospace cannot afford more. Europe is watching the largest land war since WWII and are scrambling to produce more of their own weapons and could/should do a lot more on that front if the US is an unreliable ally and NATO is a target.

China as a cornerstone supplier of the US auto sector would also raise more than a few threats around a counterattack on the production chain. As the UAW discovered long ago, the targeting of select product segments can bring down the supplier-to-OEM chain for select models (e.g. a single windshield wiper plant was one of the classics to slow production to a crawl in a bygone contract round). The legacy Detroit 3 caught onto that game in later UAW deals. China presumably has product segments ready to target.

One man’s negotiation tactic is another man’s reason to defer decisions…

The bottom line on this week is that the tariff delay is good news, but the desire to control the headlines and dribble out more threats are consistent with the Trump playbook. The risk there is that such drawn out gamesmanship can affect capital budgeting decisions and investment initiatives (and even M&A) when the underlying variables in revenue and costs and timing cannot be framed (“guessed”).

The flip side of “negotiation tactic” is that companies can stall decisions on the private sector side. We saw that in 2018’s poor equity markets and the 2019 Fed easing on weak investment and exports. The Fed even said so in 2019.

See also:

Tariff links:

US-EU Trade: The Final Import/Export Mix 2024 2-11-25

Aluminum and Steel Tariffs: The Target is Canada 2-10-25

US-Mexico Trade: Import/Export Mix for 2024 2-10-25

Trade Exposure: US-Canada Import/Export Mix 2024 2-7-25

US Trade with the World: Import and Export Mix 2-6-25

The Trade Picture: Facts to Respect, Topics to Ponder 2-6-25

Tariffs: Questions to Ponder, Part 1 2-2-25

US-Canada: Tariffs Now More than a Negotiating Tactic 1-9-25

Trade: Oct 2024 Flows, Tariff Countdown 12-5-24

Mexico: Tariffs as the Economic Alamo 11-26-24