Chain Reaction: US Tariffs and Global Supply Chains

The last time the US imposed sweeping global tariffs, manufacturing supply chains adapted to soften the blow. Transshipment was part of the story, but more durable supply chains and manufacturing capacity also emerged in countries including Vietnam, Mexico, and India (see “China and the Future of Global Supply Chains”). The current tariff shock is stronger than in 2018, yet uncertainty is also much higher. Although negotiations are still in flux, the conclusion of several framework deals with key diversification partners makes it possible to preview how this new round of tariffs could affect global supply chains.

What moves supply chains?

Supply chains tend to move when goods can be manufactured in countries with lower “landed costs”—the cost of production plus shipping, customs duties, and insurance. Tariffs directly impact these calculations, which helps explain why US imports from China declined after the US imposed Section 301 tariffs on $550 billion of imports from China in 2017 (Figure 1). Transshipment played a role, but it only explains part of shifting trade flows over the period. Crucially, manufacturing capacity expanded in a range of new “diversification” countries, leading to a restructuring of key global supply chains.

After the first round of Trump tariffs, supply chain shifts were most evident in low-skilled, labor-intensive products such as mass-market furniture (Figure 2). Low capex requirements, an abundance of low-skill labor in other markets, and sensitivity to changes in cost structure meant that the 25% tariffs on China made manufacturing hubs like Vietnam, Mexico, and Bangladesh attractive alternatives. In just a few years, manufacturing FDI surged in these countries, transforming them into more prominent suppliers to the US. Countries with the most favorable business environment, infrastructure, and skills, as well as strong local schemes to incentivize manufacturing and FDI, benefited most.

The shift away from China was less significant in sectors with higher profit margins (and hence less sensitivity to changes in cost structure), higher capex requirements, higher-skilled labor requirements, and manufacturing complexity. Sectors with high degrees of supplier co-location were also less likely to move out of China, though their exports to the US grew more slowly than other countries in some cases. Some sectors remained resilient despite 25% tariffs: China remained the top supplier of LED lamps and modules to the US, due to the efficiency of the country’s industrial clusters in electronics and significant economies of scale.

Emerging features of US trade deals

Given the substantial impact of tariffs on US-bound supply chains in President Trump’s first term, how might the ongoing trade war affect supply chains going forward? President Trump has announced framework trade deals with seven countries, and details of other countries’ negotiations have been leaked to the press. The framework trade deals are preliminary and still subject to changes, but the deals provide a sense of tariff levels moving forward across country groups and how the US is likely to approach negotiations with other partners.

In a nutshell, US trade relations are settling into five different tiers.

• Countries running a trade deficit or balanced trade with the US: These countries are generally subject only to 10% tariffs. Due to these low rates, they will be subject to heightened scrutiny to prevent transshipment of goods from high-tariff countries like China. Attention will be particularly sharp on trade hubs like Singapore.
• Mexico and Canada: USMCA plays a powerful role in maintaining regional integration. Imports from Mexico and Canada face fentanyl tariffs (25% on Mexico, 35% on Canada) unless they are USMCA-qualifying. But USMCA compliance rates are high: 77% of US imports from Mexico and 89% of imports from Canada entered the US duty-free in July (Figure 3). USMCA-qualifying cars and auto parts also receive lower rates, with no tariffs for now on parts, and tariffs only on the non-US content of imported cars. Mexico, too, is raising tariffs on Chinese content (at the urging of the US but also for its own trade defense purposes), raising the prospects of a USMCA renegotiation that preserves regional integration and deepens the formation of shared barriers to Chinese exports.

• Other like-minded advanced economies: Deals with like-minded advanced-economy partners (the EU, Japan, and possibly South Korea) are resulting in 15% tariffs, including for a range of Section 232 sectors, as well as carveouts for certain critical inputs such as generic pharmaceuticals and aircraft parts. These are typically paired with large investment commitments in the US, purchases of US marquee exports like aircraft and energy, and purchases of military equipment (Table 1).
• Emerging market manufacturing hubs: US tariffs on major manufacturing-oriented emerging markets (like Vietnam and Thailand) appear to be settling at 19-20%, with carve-outs for products the US does not produce domestically. These countries will also be subject to efforts to curb tariff evasion, given past patterns of China transshipping goods through ASEAN and strong upstream supply chain linkages with China. This will likely involve efforts to rewrite rules of origin to increase local content or limit content from non-market economies, and more broadly to prevent firms from evading tariffs through low-value-added activities like simple assembly in lower-tariff countries.
• Punitive targets: The administration will continue to use tariffs as a punitive tool, typified by US duties on India for Russian oil purchases and on Brazil for the prosecution of former president Jair Bolsonaro.

Aside from these groups, many Latin American and African countries that the US has not prioritized in negotiations are subject to a 15% reciprocal tariff. It seems unlikely that the administration will have much bandwidth to negotiate further with these countries on a bilateral basis. Still, these countries could proactively demand framework deal conditions aligned with emerging market manufacturing hubs in exchange for tariff concessions and purchase commitments. Plurilateral deals might also emerge—that is, a one-size-fits-all deal for several countries in a region—especially in Latin America, where US officials like Secretary of State Marco Rubio are looking to shore up the US position.

Impact on global supply chains

With a constantly shifting set of tariffs, deals, and exemptions, businesses are now trying to assess where tariff rates are settling and the effect they will have on global supply chains. To answer this question, we built a bottom-up tariff tool estimating the trade-weighted average US tariff rate by country, taking into account all tariff measures and exemptions as of mid-September (Figure 4).

According to our estimates, China’s trade-weighted average tariff rate is currently 41%, much higher than Vietnam’s 18%, Thailand’s 16%, and Malaysia’s 11%. The new tariffs also widen the tariff gap between China and these partners, from around seven percentage points (pp) in January 2025 to 24-30 pp today. India has a much higher trade-weighted tariff rate of 36% due to the Russian oil tariffs. The lowest trade-weighted average US tariffs fall around 10-15% including potential reshoring beneficiaries like Morocco and Costa Rica.

Of course, tariff rates differ from product to product (Figure 5). For example, there is a much narrower tariff differential (~10 pp) between China and Vietnam for products like video game consoles or ceramic kitchenware, as these are not subject to US Section 301 tariffs on China. In contrast, the tariff differential is highest for products subject to additional Section 301 tariffs, many of them introduced by the Biden administration, such as batteries (40pp differential with most Southeast Asian countries).

These datapoints have several implications for global supply chains:

Current tariff differentials will likely accelerate ongoing supply chain shifts to ASEAN. Over the past decade, global supply chains have moved toward ASEAN due to US tariffs and rising manufacturing costs in China. The ease of doing business in these countries, plus the geographic and cultural proximity to China, has drawn in both Chinese and foreign companies alike and will likely attract more companies facing high tariffs in China.

• For Vietnam, this likely means greater investment and US-bound trade in consumer electronics—a sector in which the country already has a strong manufacturing base, investment commitments, and a clear comparative advantage. Vietnam, a top supplier of furniture to the US, could also expand in the sector, depending on how broad the Section 232 tariffs on furniture announced on September 25 end up being. Since 2018, most furniture imports from China have faced a 25% Section 301 tariff, compared to no tariffs on imports from Vietnam. Now, US imports from China of upholstered wooden chairs, for example, are subject to a 55% tariff plus AD/CVD penalties, compared to only a 20% reciprocal tariff on Vietnam. Other sectors in which Vietnam is well-positioned to attract manufacturing investment include footwear, apparel, and household items like vacuum cleaners and fans.
• Thailand could see greater export-oriented manufacturing of lower complexity electronics. It is already the top supplier of US-bound printers, copiers, and fax machines, and could attract more US-oriented manufacturing from China. The same is true for printed circuit boards plus switches and routers, with US imports from Thailand subject to a 0% tariff, compared to a 27.5-45% tariff on imports from China.
• Malaysia could strengthen its position as a specialized producer of certain electronic components. Already, it is a hub for semiconductor assembly, testing, and packaging (ATP). Malaysia is already a top supplier to the US in some of these categories, and an update to the China Section 301 tariffs in 2024 increased the tariff differential further (e.g., 80% tariff on rubber surgical gloves from China compared to 19% tariff on those from Malaysia).

For Mexico, USMCA exemptions induce reshoring more for products subject to reciprocal tariffs, less so for 232s. USMCA exemptions are highly advantageous, but this advantage is becoming less clear as new 232 national security-related tariffs are released. While the US has created partial USMCA exemptions for the 25% autos and auto parts tariffs, Mexican car exports are now competing against EU and Japanese auto exports at only 15%. More 232 tariffs are coming in areas where Mexico specializes for the US export market, including furniture and medical supplies. This remains a key uncertainty as the US and Mexico begin negotiating USMCA renewal.

India is well-positioned as a diversification partner if it manages to reach a deal with the US that reduces its reciprocal tariff rate in line with ASEAN countries and eliminates the additional 25% tariff on Russian oil. Assuming this is the case, India could see further growth in smartphones and laptops, like Vietnam. Dell, HP, Lenovo, Foxconn, Pegatron, and dozens of other electronics companies have pledged to invest in the country, aided by Narendra Modi’s “Make in India” incentives. The same is true for apparel and household goods, given India’s established manufacturing capacity and US companies’ commitment to source more from India in these categories. Regardless of how negotiations with the US evolve, India is likely to expand exports of solar PV to the US, due to high anti-dumping/countervailing duties on the other top suppliers in Vietnam, Thailand, Malaysia, and Cambodia.

African and Latin American economies, many of which are subject to a 10% or 15% tariff, could attract diversification investment at the margins. Turkey, Egypt, and Morocco are becoming larger players in global textile manufacturing and could increase their share of US imports in the category. Ethiopia, Kenya, Guatemala, Honduras, and El Salvador are seeing interest from investors in apparel manufacturing. Still, for most countries in this category, diversification is likely to be limited in the near term due to workforce constraints, comparatively weak infrastructure, and policy instability. Concerns that the US could unexpectedly impose punitive tariffs, like the threat of 50% tariffs on Colombian imports earlier this year, will also matter.

For all these countries, tariffs likely won’t be enough to move supply chains where the tariff differential is too small, where capital expenditure requirements are high, or where China already has hyper-competitive industrial clusters. In these industries, additional policy incentives would be needed to move the needle, like subsidies or non-tariff barriers such as local content or cybersecurity requirements. The use of information and communications technology and services (ICTS)-style restrictions on devices containing content from China is a critical area to watch going forward.

What’s different this time?

During Trump’s first trade war, tariff differentials were crucial to understanding business decisions to maintain or shift supply chains away from China. Today, however, additional factors weigh in the balance, both as drivers and arrestors of further supply chain diversification:

De-risking appetite: Companies today are more sensitive to the risks of relying on China for global production. Some companies have shifted capacity out of China over the past few years, even in the absence of high tariffs or other restrictions. Apple, for example, began encouraging its suppliers to shift at least 15-30% of manufacturing out of China starting in 2019, despite receiving exemptions from the tariffs imposed during President Trump’s first trade war with China. Other companies may take similar steps, regardless of tariffs, in anticipation of continued trade and geopolitical tensions.

Raising trade barriers to Chinese imports beyond the US: China’s overcapacity has led more countries—the EU, Mexico, Canada, Brazil, and India, for example—to raise tariffs and non-tariff barriers to Chinese imports. If this trend continues, it will expand the total available market for ex-China production and increase incentives to shift supply chains.

Tariff uncertainty: Manufacturing firms today face mixed messages on US trade goals and high uncertainty about long-term tariff levels. Maximizing tariff revenues requires the US to have low enough tariffs to preserve import volumes, but incentivizing onshoring to the US requires very high tariffs in strategic sectors. Inflation management and China de-risking are additional considerations. In short, until US goals are clarified, firms will find it hard to plan around future tariff levels.

Economic conditions in China: China’s economic conditions today are less conducive to supply chain diversification than they were five years ago. While China’s economic slowdown makes it a less attractive market for some companies, persistent deflation and the weak currency make it more attractive for export-oriented manufacturing. Since 2020, China has also built significant new production capacity, resulting in overcapacity that can be exported at low prices. Our conversations with China-based exporters suggest that these factors, plus China’s continued manufacturing efficiency gains, mean that even a 30pp tariff differential could be manageable in some sectors.

Resource constraints: Today, the US has higher tariffs on more products from more countries than at any point since the establishment of the modern global trade system. These have two deleterious effects: First, they increase inflation, which reduces total demand in the US, affecting company sales and increasing the cost of onshoring via higher labor, input, and production costs. Second, they decrease corporate margins, if and where firms are compelled to “eat” the tariffs instead of passing them on to consumers. Both involve reduced budgets for new investment.

Chinese restrictions on investment, equipment, people, and know-how: China today is more willing to restrict outbound investment and the transfer of people, machinery, and know-how than it was five years ago. China has already taken increasingly aggressive steps against supply chain diversification by instructing companies from BYD to Shein to keep their manufacturing in China and restricting exports of critical raw materials and certain manufacturing technologies. China is imposing retaliatory measures to dissuade countries from raising tariffs, which may delay or reverse policy action. We expect China to ramp up restrictions as more manufacturing moves overseas, especially given weak domestic growth and rising unemployment. This could slow diversification in the near-term, given the importance of Chinese companies in ex-China supply chains. However, in the long run, it will also strengthen the impulse to de-risk some supply chains, like critical raw materials and batteries.

What to watch going forward

Looking ahead, four factors could affect the tariff differential between China and alternative diversification hubs, and hence the degree of supply chain diversification:

China negotiations: If companies think the US will lower China tariffs, they are likely to delay or abandon diversification plans. Without a significant tariff gap, many firms will be better off producing and exporting out of China. Key signposts to watch will therefore include US-China negotiations, especially over fentanyl (20pp of nominal China tariffs); Chinese restrictions on critical raw materials (as a lever to bring tariffs down); US core inflation (as a driver of US trade policy loosening); Supreme Court decisions (see below); and pressure from politically important constituencies subject to Chinese retaliation.

IEEPA ruling: Unlike President Trump’s first trade war, which began with a formal Section 301 investigation, most tariffs to date have been imposed using emergency powers. If the US Supreme Court strikes down or limits the reach of tariffs imposed under the International Emergency Economic Powers Act (IEEPA), 30pp of China tariffs will come into question—dramatically reducing the gap between China and other emerging manufacturing hubs, who might decide to cling to their deal with the US to avoid further, painful negotiations. If tariffs are struck down, the Trump administration might lean on other tariff tools to rebuild leverage (especially Section 122 and 338), or extend the scope of the Section 301 tariffs on China. Alternatively, it could impose non-trade barriers, like ICTS restrictions, to a broader range of sectors. Still, these moves will have to be weighed against potential retaliation from China.

Transshipment tariffs and rules of origin: The administration has signaled an intent to monitor and crack down on transshipment through low-tariff countries like Singapore, threatening a 40% “transshipment tariff” on goods that inappropriately change their country of origin. The US may also try to negotiate limits on content from non-market economies. This was signaled in the US-Indonesia joint statement, which included a provision that the countries would negotiate rules of origin so that the benefits would “accrue primarily to the United States and Indonesia.”

Depending on how these are structured, proposed tariffs on goods transshipped from China or with Chinese content could either stifle or accelerate diversification of supply chains away from China. Most sectors that successfully diversified away from China since 2017 did so with heavy reliance on intermediate goods from China. If the US imposes steep and immediate tariffs on Chinese content, it will be much more difficult and costly for companies to move their supply chains. However, if the US phases in tariffs on Chinese content or otherwise provides exemptions for companies diversifying, it will create a significant incentive for companies to build up ex-China production of intermediate inputs and components.

However, implementation will be an enormous challenge. Negotiating the specific rules of origin will be difficult particularly: USTR has limited  bandwidth as it is hammering out multiple deals at once. Monitoring and enforcing limits on Chinese content will also be a substantial challenge for US Customs.

Section 232 investigations: The US is advancing Section 232 investigations on imports of pharmaceuticals, medical supplies, semiconductors, lumber, and furniture (to name a few) for which India, Vietnam, Malaysia, and other emerging markets are major suppliers. These investigations are likely to result in tariffs or other restrictions, like quotas, at varying levels by country. As investigations move forward and new tariffs are announced, the Section 232s are going to occupy an even larger share of US imports and will eclipse the reciprocal tariffs as the focal point of partner negotiations.

Increasingly, the US is also exploring ways to create individual company exemptions for the Section 232 tariffs based on their investment commitments. A post from Trump’s Truth Social account announced that companies not currently manufacturing or building capacity in the US for branded or patented pharmaceuticals would face 100% tariffs. How these exemptions are granted and enforced will be a key area to watch going forward.