Duties USA and competitiveness: why the elasticity of substitution matters

With the new Executive Order “Further Modifying the Reciprocal Tariff Rates”, signed on July 31, 2025, the Trump administration revised the system of reciprocal tariffs introduced on April 2, 2025. Initially, an additional universal tariff of 10% was applied to all imports, with higher rates only for certain countries.
As of August 7, 2025, the new tariffs came into effect: additional ad valorem duties, differentiated for each trading partner depending on its negotiating position with the United States. This approach creates a hierarchy of competitiveness, making imports from some countries relatively more advantageous compared to others.

As discussed in the article "Italian Food Exports to the U.S.: Who Bears the Tariff?" on the case of Italian exports to the United States, an increase in customs duties leads to a rise in import prices, if the cost of the tariff is passed on, even partially, to the final price for the American consumer.
This reduces the competitiveness of foreign products and, at the same time, penalizes U.S. consumers, who are forced to choose between paying a higher price or replacing imported goods with alternative products.

How can we analyze the effects of an increase in import tariffs on U.S. foreign demand?

The reaction of U.S. foreign demand depends on how willing consumers are to adjust their choices in response to price changes generated by customs duties. This effect can be measured through the trade substitution elasticity with respect to relative prices, which in this context is articulated into two main components:

• Elasticity of substitution between imports and domestic production, which measures how the demand for imported goods changes relative to that for domestically produced goods, as relative prices vary (for example, following the application of a new import tariff);
• Elasticity of substitution between foreign suppliers, which indicates the propensity of U.S. consumers to replace a good from a given country with a similar product offered by another country, in response to relative price changes.

These two mechanisms operate simultaneously and together shape the reaction of U.S. demand at the level of individual products.

The intensity of the effect depends not only on the level of the tariff introduced, but also on other factors such as the type of good (consumer or investment) and U.S. consumer preferences. The latter are particularly relevant, as they affect the degree of substitutability: high-quality goods with distinctive characteristics (such as French Champagne or Italian Grana Padano cheese) tend to be less substitutable, leading consumers to purchase them even at higher prices. Conversely, standardized products sold on a large scale are easily replaced by cheaper alternatives, whether domestically produced or imported from other countries.

Another factor to consider concerns the share of the tariff actually passed on to the final price in the United States. This share depends on the margin that exporting companies are willing to absorb by reducing their profits, in order not to lose their foothold in the U.S. market.

Measuring substitution elasticities provides significant advantages from two perspectives:

• Policy: it allows forecasting the performance of a country’s exports following trade shocks, such as an increase in customs tariffs;
• Business: it serves as a useful tool for defining the pricing strategies of exporting firms, which can adapt their commercial decisions to the new market conditions.

Quantifying trade substitution elasticity: between challenges and opportunities

The estimation of product-specific substitution elasticities (both between imports and domestic production, and between imports from different countries) is a recurring theme in the economic literature, but it faces methodological challenges and, above all, the limited availability of reliable data.
On the one hand, detailed information on imports and their prices at the product level is available; on the other hand, data on domestic demand and prices of national goods are only available at the macro-sector level, making them of little use for capturing substitution effects at the micro level. For this reason, the elasticity of substitution between imports and domestic production cannot be accurately measured for individual products. Conversely, the data available on imports and their origin make it possible to estimate the elasticity of substitution between foreign suppliers.

Although the two elasticities are not necessarily equal for a given product, it is reasonable to assume that they are correlated. In other words, if a good shows a high elasticity of substitution between foreign suppliers, it is likely to also display a high elasticity of substitution with respect to domestic supply. Conversely, if imported goods from different countries are not easily substitutable, they likely have characteristics that also make them less substitutable with domestic production. As a result, a measure of the elasticity of substitution between foreign suppliers can be used as a proxy for the elasticity of substitution between imports and domestic production.

In this regard, StudiaBo is currently carrying out a project aimed at estimating substitution elasticities between foreign suppliers, using the Ulisse database and a gravity model that explains trade flows between two countries as a function of the overall intensity of their exchanges and the relative price of the flow compared to the average import price in the destination country. The first results appear promising and seem able to provide at least an approximate measure of the level of substitution elasticity between foreign suppliers and, indirectly, between imports and domestic production.

Product substitutability: a factor to be measured

So far, the impact of U.S. trade policy on foreign demand has remained limited, partly mitigated by the front-loading phenomenon observed in the first quarter of 2025. However, the new “reciprocal” tariffs — which are unlikely to be lifted in the short term — together with additional factors such as inflation, could significantly affect the relative prices of imported goods in the United States in the coming months.

For European companies, the U.S. market continues to be the main export destination outside the Single Market, with a value of €140 billion in the second quarter of 2025. In this context, understanding how easily a product can be substituted in the U.S. market is strategic information for maintaining and strengthening competitiveness.