Analytical Chapter: Modelling trade policy uncertainty and changes in tariffs

Trade policy uncertainty (TPU) matters because firms making long-term commitments depend on stable and predictable trade policies; when uncertainty around future tariffs and trade relations increases, firms may delay or scale back investments, reducing trade flows, limiting productivity gains, and lowering economic growth. (pp. 22)
TPU can be quantified through analyzing "tariff water": the difference between the maximum tariff a member can apply under WTO rules ("bound tariff") and the rate a member actually applies; this gap is a key structural indicator of policy space; a large gap implies that a government has significant leeway to raise tariffs without breaching international commitments, creating uncertainty for businesses - a risk that costs could rise unexpectedly. (pp. 22-23)
News-based economic uncertainty indices, firm-level surveys, historical events that reduce policy uncertainty, and policy reversals with immediate negative effects are all methods that can capture TPU dynamics. (p. 23)
Tariff increases and TPU impacts are analyzed in the WTO Global Trade Model (GTM), with four scenarios considered in the analysis:
1. Scenario i assumes heightened uncertainty surrounding trade with the US, that trade water increases by 25% on goods trade with all trading partners, a trade elasticity of 5, no surge in probability of tariff increases, increasing long-run TPU by about 2.4%;
2. Scenario ii builds on scenario I, adding all tariff increases since the beginning of 2025 until 14 April 2025;
3. Scenario iii adds all reciprocal tariff rates initially announced by the US for all trading partners;
4. Scenario iv adds a broader proliferation of uncertainty with TPU extending beyond the US and affecting bilateral goods trade between all economies. (pp. 23-26)

Under scenario ii, the average US tariff rate without reciprocal tariffs increases to 9% using 2024 trade weights and decreases to 11.4% with projected 2025 trade weights as trade diversion leads to a shift away from imports from China towards other sources of supply. (p. 26, Chart 15)

Scenario i simulations suggest that TPU has a meaningful dampening effect on trade flows, leading to lower exports and weaker economic activity; TPU in trade with the US reduces the projected growth in global exports and global GDP by 0.5% and 0.25%, respectively, with most of the losses occurring in North America given that a large share of trade with the US takes place within North America (pp. 26-27, Chart 16)
Scenario ii predicts a 3% decline in global real goods exports and a 61% reduction in global GDP in 2025, demonstrating that one-sixth of trade contraction is attributable to TPU alone; for GDP about 40% of the impact comes from TPU; the fall in exports comes both from real appreciation and increased prices of intermediate inputs; LDCS see a projected rise in exports because of expected greater opportunities for export to the US in sectors where China currently has a large share. (pp. 26-27, Chart 16)
Scenario iii sees a reduction in global trade growth of 3.5% with the additional loss in global GDP relatively limited to 0.65%; additional trade reductions are concentrated in Europe or Asia; because of trade diversion, South and Central American trade reduction could fall slightly. (p. 27)
Scenario iv assumes TPU could spread because of economic pressures for trade-restrictive measures, geoeconomic considerations leading to political pressure to introduce tariffs or other trade-restrictive measures, and/or the effects on the credibility of the principles of the multilateral trading system; global real goods exports would fall further to a cumulative decline of 4.3%, with global GDP losses reaching 1.12%; broader uncertainty would likely weigh more heavily on high-income economies though LDCS would be particularly affected and their projected GDP losses would rise to 0.74%. (pp. 27-28)
There is a strong negative correlation between projected fall in GDP and the share of goods exports to the US, with Mexico and Canada projected to incur large GDP losses because of their exposure to increased TPU given their high export shares to the US; most regions are projected to see a fall in exports to the US with the largest reduction for China; in sectors where China currently has a large market share, other economies can be expected to gain an advantage in export opportunities; most regions will see increases in Chinese imports, with North and South America (ex-US) expected to see the highest increases. (pp. 28-29, Charts 17-18)