Increased Tariffs' Impact on the Economy
A new theoretical framework by economists Rodriguez-Clare, Ulate, and Vasquez (2025) sheds light on the potential effects of specific tariff increases on U.S. employment, real income, and trade patterns across states. The study, which uses a dynamic trade and reallocation model with downward nominal wage rigidities, focuses on a scenario of a 25% increase in the import tariff on Canadian and Mexican goods, a 30% increase in the import tariff on Chinese goods, and a 10% increase in the import tariff on goods from all other countries.
Key findings from the analysis reveal that the higher tariffs induce an expansion in U.S. manufacturing employment as import competition declines. However, this manufacturing gain is offset by declines in service and agricultural employment. Overall employment falls due to lower real wages which reduce labor-force participation.
For the U.S. as a whole, the model predicts a real income decline of about 1% by 2028, the assumed final year of the tariffs in their baseline. The losses are unevenly distributed across states—around half of the states experience net losses, some with real income drops exceeding 3%, due to differences in industrial structure and trade exposure.
The imposed tariffs and retaliatory measures cause shifts in trade patterns, including import diversion away from China toward Mexico, as supported by firm-level evidence showing a 25 percentage point tariff raise on Chinese goods increases Mexican exports to the U.S. by about 4.2%. Tariff-generated fiscal revenues are redistributed across states, influencing their net gains or losses.
The trade diversion benefits certain groups of workers more than others. Evidence shows wage gains are concentrated among female, unskilled, younger, and non-permanently insured workers, thus reducing wage inequality within firms.
The dynamic model incorporates sectoral and state-level heterogeneity and accounts for nominal wage rigidities affecting labor supply. It does not incorporate effects on overall inflation, trade deficits, or capital accumulation, nor does it model uncertain geopolitical shifts beyond tariffs.
According to the study, some of the states where real income falls the most are Texas, California, and Michigan, while real income rises the most in Colorado, Wyoming, and Oklahoma. The analysis uses a framework that explicitly accounts for U.S. trade patterns and incorporates data for 87 regions and 15 sectors.
Overall, real value-added falls by as much as 1.2% in the scenario. The model-based analysis finds that the assumed scenario of tariff increases would lead to an increase in employment for the U.S. manufacturing sector, but this comes at the expense of employment in the services and agricultural sectors, resulting in a projected overall decline in U.S. employment. The results suggest that 31 states would gain real income, in some cases as much as 1.7%, while the remaining 19 states would lose, with some experiencing declines greater than 2%.
In light of the new theoretical framework by Rodriguez-Clare, Ulate, and Vasquez (2025), changes in labor markets can be observed due to the imposed tariffs, with potential effects on employment, income, and trade patterns across states. The study's findings indicate that the expansion in U.S. manufacturing employment, despite a decline in service and agricultural employment, is influenced by finance, as the tariffs generate fiscal revenues that are redistributed across states, impacting their net gains or losses.
