A Perspective on 2025 Tariffs
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Why Tariffs to Restore Trade Balances Won’t Always Lead to a 1:1 Price Increase for Consumers, and Shouldn’t Throw Your Strategies Off Balance
There’s a widespread assumption that tariffs—taxes on imported goods – automatically result in a direct, 1:1 price increase for consumers, meaning a 25% tariff would raise prices by 25% for buyers. However, economic realities tell a more nuanced story. Tariffs don’t necessarily lead to a proportional price increase, and here’s why.
First, companies don’t always pass on the full cost of tariffs to consumers. Businesses operate in competitive markets. Raising prices too high could drive customers to cheaper alternatives or domestic products. Firms might absorb some tariff costs to maintain market share, especially if consumers are highly sensitive to price changes in a price elastic environment. For example, if a U.S. retailer importing electronics faces a 25% tariff, they might only raise prices by 10% or less and sacrifice some profit margin to protect market share.
Second, companies can adjust their supply chains to mitigate tariff impacts. An S&P Global news release highlights strategies like stockpiling goods before tariffs hit, shifting production to untaxed countries, or negotiating lower prices with suppliers.[i] A U.S. manufacturer importing car parts from China might source from Mexico or Vietnam instead, thereby reducing the tariff burden and avoiding significant price hikes for consumers. These adjustments, while costly, prevent a direct 1:1 pass-through.
Third, consumer behavior and industry dynamics play a role. If a product has many substitutes—like clothing or electronics, consumers might switch to domestic or untaxed imports, pressuring companies to keep prices stable. The Investopedia piece on price elasticity of demand explains that inelastic goods (e.g., necessities with few substitutes) are more likely to see price increases, but elastic goods often don’t, as companies fear losing sales.[ii]
Fourth, currency adjustments can help mitigate higher prices. Sometimes, when a country like the U.S. imposes tariffs, the foreign exchange market responds. A stronger U.S. dollar can make imported goods relatively cheaper pre-tariff, offsetting some of the tariff’s cost. Conversely, a weaker currency in the exporting country (e.g., China) can lower the cost of their goods in U.S. dollars, reducing the price impact on consumers. These currency fluctuations, while complex, can dampen the direct effect of tariffs on consumer prices.
Finally, tariffs can encourage domestic production, potentially lowering reliance on imports over time. This has become a more important objective as the U.S. reliance on essentials like pharmaceuticals, rare earth minerals, and computer chips has grown. While initial disruptions due to tariffs might raise costs, long-term investments in U.S. manufacturing could stabilize or even reduce prices for some goods, countering the tariff’s initial impact. And, some would say, this protects the U.S. economy and benefits U.S. security.
As discussed above, tariffs don’t always increase prices on a 1:1 basis, but they do carry risks. Historically, tariffs have often negatively impacted lower-income individuals, as they tend to disproportionately affect the cost of essential goods. They can reduce trade and, by definition, have the potential to decrease GDP. However, it’s important to recognize that tariffs have also been used as a tool for protecting domestic industries, particularly in times of economic hardship or to foster nascent sectors. In some cases, tariffs have been instrumental in promoting economic growth by shielding local businesses from foreign competition. On the flip side, sentiment and uncertainty surrounding tariffs can lead to negative events like a slowing economy or higher inflation, as businesses and consumers navigate the resulting economic shifts. Ultimately, the impact of tariffs varies depending on their design, implementation, and the broader economic context in which they are applied.
In short, tariffs imposed to restore trade balances, may, in the shorter term, create uncertainty and imbalance in capital markets. As these policies and related negotiations play out, maintaining investor balance requires us to look toward the horizon. Highland is your partner in looking at your goals and making necessary adjustments to maintain steady progress toward the goals for your plan.
[i]https://www.pmi.spglobal.com/Public/Home/PressRelease/43935e9a8a5d4caa9391d5fd752245b6
[ii] https://www.investopedia.com/terms/p/priceelasticity.asp
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Highland Consulting Associates, Inc. is a registered investment adviser. Information presented is for educational purposes only and is not intended to make an offer of solicitation for the sale or purchase of specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.
