Five ramifications of the auto tariffs for the U.S. economy

On Wednesday (March 27th) , President Trump announced a 25% tariff on imports of automobiles and parts. Importers are set to face tariffs on all non-U.S. import content effective April 3rd. This announcement will have wide-ranging ramifications due to the multi-layered supply chain linkages of the North American auto sector.

The North American auto sector is highly integrated. This goes back decades to the U.S.-Canada Auto Parts Pact in the mid-60s, when tariffs were eliminated on motor vehicles and parts. Mexico was also exempt from tariffs in the 80s. These policies incentivized producers to set up cross-border integrated supply chains and resulted in specialization and higher collective production volumes, boosting global competitiveness of the North American auto sector as a whole. The U.S. was able to gain access to cheaper parts by importing from countries with cheaper average labor costs, and this resulted in lower vehicle costs for consumers on both sides of the border.

Ahead of the implementation next week, we sought to spell out the potential impact of these tariffs to the U.S. auto sector. Here are five ways that the auto tariffs will impact the U.S. automotive sector and broader U.S. economy:

1. Tariffs could result in a near-term boost to growth from an inventory build-up

Ahead of the implementation of tariffs on the auto sector, the macroeconomic data has shown signs of firms attempting to front-run tariffs. So far, we have seen a notable uptick auto sector exports alongside higher automotive sector new orders and shipments in February – both are signs that international producers are stocking up on American inputs as a safeguard in the midst of uncertainty around tariffs and potential reciprocal tariffs. Alongside a run up in demand for U.S. exports, we also expect to see firms ramp up production to build up inventories, as it will be more expensive to produce after the policies come into full effect. A buildup in inventories may boost real GDP in the short run, as production temporarily speeds up to meet demand for inventories and exports ahead of policy implementation. But once the policy is implemented, this trend will likely reverse.

2. Tariffs will drive up consumer prices for new and used autos

This integrated supply chain means that the new American car that you drive off the lot is very likely to have intermediate components from Canada and/or Mexico embedded in the final product. According to Cox Automotive, this means that in the near-term, producers, on average, will be paying between $3000 and $6000 more to produce a vehicle in the U.S. depending on its foreign content. Whether or not this impacts the price you pay at the dealership depends on if producers can fully absorb this added cost. Falling corporate profits in the auto sector suggest that the ability of producers to absorb these added costs is likely limited. This implies that consumers will likely have to absorb a good share of this added cost. At a minimum, higher prices will result in a one-time level shift in new automotive prices that will show-up in the CPI data for at least 12-months. Additional tariffs on aluminum and steel as well as retaliatory measures could lead to additional price increases. There is an added risk that this will drive up demand for used cars (more on that below), which would exert upward pressure on prices for used vehicles as well. Whether this results in longer-term inflation – which would concern the Fed – will depend on consumer spending. If consumers race to purchase new cars to avoid additional tariffs, then auto dealers will likely maintain pricing power in the near term. Autos and parts account for just under 7% of the headline CPI basket and 9% of the core basket, so any significant price increases for consumers will show up in the broader measures.

3. Consumers may shift towards purchasing used autos

The February CPI report showed upward pressure on used autos relative to new autos. While one month doesn’t make a trend, this is illustrative of a broader theme that could take place – namely, a substitution effect where consumers are opting to purchase relatively cheaper used cars rather than brand new ones. During the pandemic, a global chip shortage significantly weighed on the global supply of new cars. Consumers then pivoted to purchase used autos. Since strong demand (partially thanks to pent-up pandemic savings) met with weak supply exerted upward pressure on prices, we saw demand for used vehicles surge. This time around, we may witness this phenomenon in reverse. Upward pressure on prices of new motor vehicles directly caused by tariffs could weigh on demand for new cars (notably for foreign cars and light trucks which account for about 25% of the U.S. market). Consumers may then opt to purchase used vehicles rather than new ones. The problem is, this substitution could drive prices for used cars higher as well. And if consumers continue to demand more used cars and fewer new cars, this could lead to a supply-demand imbalance and continue to drive prices for used autos higher.

4. Auto loan delinquency rates could rise

Tariffs can be characterized as a stagflationary shock – they exert upward pressure on prices leading to weaker demand for products. This puts the Federal Reserve in a tough position– having to weigh the costs of higher interest rates to curb inflation and the benefits of lower rates to prop up growth (at the risk of inflation re-accelerating). One thing we know for certain is that higher prices put consumers in a difficult position. In the near-term, wages haven’t had time to adjust (and in the face of weaker demand for goods and services…they may not). This means that cash-strapped consumers have to make tough choices. Many Americans are struggling to pay back loans, as indicated by the recent uptick in auto loan and credit card delinquencies. And the resumption of student loan repayments present another headwind for debt-burdened consumers in this high rate environment.

We know that the current economic backdrop is weighing on lower-and-middle-income consumers more. Non-revolving credit rose by $30 billion between November and January and consumer loan delinquencies are trending above pre-Covid levels. Upward pressure on auto prices could exacerbate this trend, leading to higher rates of delinquent auto (and other) loans.

5. Weaker demand for vehicles could drive layoffs in the sector

The current Administration has long touted tariffs as a means to reshore U.S. auto production, bringing jobs back to U.S. soil. While this is an appealing idea, the concern is that in practice, auto tariffs could do exactly the opposite of what the policy is intended to do. The U.S. auto sector directly accounts for just under 2% of payroll jobs (including manufacturing and dealers) and contributes a similar share to GDP. Higher prices for new vehicles could result in weaker domestic demand for cars. Middle-and-higher income Americans who frequently upgrade their vehicles may opt to hold onto their current models for a bit longer. Lower income Americans may buy cheaper and used vehicles and drive their existing cars into the ground before doing so. Demand for American autos from abroad could weaken both if reciprocal tariffs are implemented (due to higher costs) and even if they’re not (tariff policy may sour foreign appetite for U.S. products). Ultimately, weaker demand could result in a scaling back of production and translate to broader layoffs in the near-term.

Over the medium and longer term, will the reshoring movement create U.S. jobs? Maybe not. We have written here about how reshoring is not as simple as it sounds. While it requires significant levels of capital investment, the more pressing concern here is long-term labor availability. The U.S. population is aging rapidly, meaning we are currently facing a record number of retirements. In the long-term, these labor supply constraints will weigh on the feasibility of introducing more factories. Weaker immigration alongside skills-matching and geographic constraints add to the challenge.

Mike Reid is a Senior U.S. Economist at RBC. He is responsible for generating RBC’s U.S. economic outlook, providing commentary on macro indicators, and producing written analysis around the economic backdrop.

Carrie Freestone is a member of the macroeconomic analysis group and is responsible for examining key economic trends including consumer spending, labour markets, GDP, and inflation.

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