Executive Summary

• Tomorrow, the United States will impose blanket 25% tariffs on Mexico, which has promised retaliation.
• Mexico has much stronger incentives to follow through with retaliation than they did during their first trade dispute with President Trump in 2018. They also have a large arsenal of economic tools at their disposal to put pressure on the United States.
• A prolonged trade war with Mexico would result not only in losses to American consumers, but also concentrated economic damage to the U.S. exporters. 

Introduction

In the 1955 movie A Rebel Without a Cause, James Dean introduced Americans to the game of “chicken,” wherein two cars accelerate towards each other until one swerves. The swerving car’s driver is labeled the “chicken,” and the steady driver wins. Eighty years later, the game of chicken is not just a symbol of youthful recklessness; it’s a useful framework for understanding a variety of international games.  

As a September piece from the Peterson Institute points out, President Donald Trump is particularly fond of playing chicken with trading partners. His strategy is to threaten both the American and the foreign partner’s economy with ruin in order to force concessions.  

Tomorrow, President Trump is once again hopping into the driver’s seat for his most ambitious trade gambit yet. On February 1st, the United States is set to impose 25% general tariffs on our two closest trading partners. Between them, Mexico and Canada account for nearly a quarter of the United States’ international trade volume, worth $1.6 trillion annually. In Mexico, Trump’s goals are not purely economic; he also hopes to win concessions on immigration policy and force Mexico to take more aggressive action against its fentanyl-producing cartels.  

So far, Mexico has responded to Trump’s threats with a combination of big words and small concessions. In an open letter to President Trump in late November, Mexican President Claudia Sheinbaum Pardo stated that Mexico would impose proportional retaliatory tariffs on the United States and argued that drug smuggling operations were a multinational problem that Mexico could not solve alone. On the other hand, Sheinbaum took credit for the 75% decrease in migrant interactions at the border in an attempt to show President Trump that Mexico is serious about curbing illegal immigration. She also imposed tariffs on Chinese goods being routed through Mexico to the United States last month in a further attempt to pacify her American counterpart.  

The History of U.S.- Mexico Trade Relations 

This is not the first time Trump has threatened tariffs against Mexico. In 2018, he leveraged the threat of tariffs in the renegotiation of the United States’ free trade agreement with Mexico and Canada, which was set to expire soon after. The resulting USMCA trade agreement reinstated free trade while also granting Trump politically important “Made In America” clauses for automobile manufacturers. Trump’s tariff threats even pressured Mexico into immigration concessions: the Mexican government sent troops to its borders to prevent immigrants from entering the United States. 

The United States and Mexico have a long history of free trade. NAFTA, the first pan-North American free trade agreement, went into effect in 1994, and the countries’ economies have become more intertwined since. While Mexico sees a greater percentage of its exports flow towards the United States than vice versa – 80% to America’s 16% – the United States is still strongly invested in the relationship; one-third of American export-oriented jobs are supported by Mexico. 

Mexico’s Growing Willpower 

After his success in 2018, it is perhaps unsurprising that President Trump has decided to run his now-familiar tariff playbook again. This time, however, he faces a much more stalwart Mexican government. For one, Sheinbaum has proven significantly more adversarial than her predecessor and mentor, President Andrés Manuel López Obrador. Her rhetoric has been stronger, her retaliation threats have been more aggressive, and she even speculated on January 29th that Trump’s tariff threats are a bluff.  

Sheinbaum is also in an extremely strong political position. Last June, she won a six-year term in the biggest landslide since 1982, and her approval tops 75%. While previous Mexican presidents might have balked at the political blow caused by a tariff-induced recession, Sheinbaum is rich in political capital to spend on a trade war. 

Sheinbaum also has much better information than her predecessor. Much of President Trump’s advantage lies in creating uncertainty, but his long history of bluffing to force trade concessions gives Sheinbaum a clear indication of his ultimate intentions. Trump’s current tariff threats against Mexico seem far less threatening after four full years of identical tactics against Mexico, Canada, Colombia, and European trading partners.  

A final substantial difference between now and 2018 is the ambition of Trump’s requests. In 2018, Trump’s goals were primarily economic and mostly performative, such as his “Made in America” clauses forcing some Mexican products to be finished in the USA. This time, Trump is more focused on Mexico’s fentanyl production and has doubled down on demands to curb immigration.  

The problem with these demands is that they back Mexico into a corner. On the immigration side, Mexico is already taking legal action against nearly triple the number of migrants passing through Mexico than in 2022. When it comes to cartels, Mexico’s short-term options are equally limited. From 2006-2021, Mexico waged a bloody war on cartels. Instead of defeating the cartels, however, Mexico’s homicide rate tripled, and previously monolithic cartels became a much more decentralized network of criminals. This dispersed, whack-a-mole dynamic has defined the fentanyl era of trafficking and frustrated officials on both sides of the border. 

While there are long-term structural changes Mexico can use to address these problems, there are no quick fixes available anymore. Sheinbaum’s popularity largely rests on her commitment to less draconian tactics against the cartels, and a re-ignition of the failed Mexican War on Drugs is politically impossible. With no real short-term solutions available to satisfy Trump’s demands, Sheinbaum has no choice but to engage in a trade war with the United States. 

Retaliation Options 

Mexico has a variety of retaliatory tools available to address American tariffs. Research from the IMF has shown that temporary retaliatory trade barriers have increased in popularity since 2000, and finds that trade-restricted actors use them consistently. Here are some of the temporary trade barriers available to Mexico:  

1. Tariffs on Commodities: In 2018, Mexico’s first move was to impose tariffs on $3 billion in steel and agricultural products. In 2023, the United States exported over $25.5 billion in agricultural and food products to Mexico, along with more than $22 billion in metals and cement. These exports account for 17% and 18% of total U.S. exports in these categories, respectively. Tariffs on these commodities, especially if they were combined with roughly equal-sized penalties from Canada, would result in significant losses for some of President Trump’s most important constituents. 
2. Tariffs on Automobiles: One of the ironies of these negotiations is that one of Trump’s biggest 2018 wins provides Mexico with a major lever over the United States. The “Made in America” provision for automobile manufacturers has driven car manufacturers like GM, Ford, and Honda to ship their cars back and forth over the border eight times on average before they are sold in the United States. This means Mexico can match the U.S.’s ability to pressure industrial zones on the opposite side of the border. If Mexico decides to retaliate on automobiles, the American automobile industry in states such as South Carolina will likely grind to a halt. 
3. Licensing and Prohibitions: Mexico already has an extensive licensing system in place for industrial products and consumer goods, including steel, iron, and footwear. For the most part, these licenses are automatically granted. However, under tense trade relations, the Mexican government would have the ability to take either official or unofficial action to cease issuing these licenses. 
4. Border Zone Subsidization: Mexico currently subsidizes the construction of factories in its northern border region through tax breaks. This federally driven development strategy helps the U.S. in two ways. First, it artificially boosts Mexican exports to the United States and provides Americans with cheaper products. Second, and more importantly, its primary purpose is to create jobs for the hundreds of thousands of Central American migrants headed towards the U.S. border. The program is successful, too: in 2017, the program permanently employed 80% of the 300,000 migrants headed for the United States. Due to its importance to the Mexican economy, this legal framework could not be dismantled overnight. However, in the event of a protracted trade war, the Mexican government could lift its subsidization of the border zone or even tip the scales the other way. This move would simultaneously damage American consumers and send a wave of Central American migrants over the border. 

Conclusion 

It’s no secret that a trade war with Mexico would cause significant damage to U.S. consumers. Sustained 25% tariffs would result in up to $900 of losses for the average American household. But the consumer damages only tell part of the story. While it is easy for the Administration to sweep widely distributed consumer costs under the rug, aggressive retaliation from Mexico would cause concentrated economic damage for auto workers, farmers, steelworkers, and transportation companies. The Trump Administration should consider the potential damage to America’s manufacturing and agricultural sectors when starting its next game of economic chicken. Mexico may not be willing to swerve.