The drums of a trade war with China are echoing. Canada is miffed, with some of our neighbors to the north talking a boycott of U.S. goods. The European Union is looking to replace us with Australia as a trade partner. Markets are turbulent: the Dow’s 2018 gains have vanished, and the index posted a six-day losing streak for the first time since March 2017.
You know the cause: tariffs imposed by the Trump administration on friends and foes alike. But you may not know much about tariffs and their effects.
Here’s a primer. It may not tell you whether the U.S. economy will come out ahead, but you’ll have a better understanding of what’s happening and how it may affect you.
A tariff is a tax levied on any imported good. Tariffs are one of the oldest trade-policy instruments, dating back to the 18th century, if not before. Historically, the main objective of a tariff is to raise revenue. In fact, before ratifying the 16th Amendment in 1913 and formally creating the income tax, the U.S. government raised most of its revenue from tariffs.
There are two basic types of tariffs. A unit or specific tariff is a tax levied as a fixed charge for each quantity of goods imported – for example, $300 per ton of imported steel. An ad valorem (“according to value”) tariff is levied as a proportion of the value of imported goods. An example is a 20% tariff on imported automobiles or cars manufactured in the U.S. shipped to Japan. The 20% is a price increase on the value of the automobile, so a $20,000 American-made vehicle costs Japanese consumers $24,000 with the tariff. The price increase caused by the tariff protects Japanese carmakers from being undercut in Japan, but it also keeps prices artificially higher for Japanese car buyers.
So, tariffs increase the price of imported goods. Because a tariff is a tax, the U.S. government will see increased revenue as imports from China and elsewhere enter the domestic market with the levies in place. American industries also benefit from less foreign competition, since import prices are artificially inflated, reducing demand for goods coming from outside the United States.
But that’s not necessarily a benefit for consumers — either individuals or businesses — since higher import prices mean higher prices both for goods that are made overseas and goods that are made domestically.
Why wouldn’t tariffs drive down prices domestically? Well, if the price of steel, say, is inflated due to tariffs, individual consumers will pay more for products using steel, and businesses will pay more for steel that they use to make finished goods. Domestic producers are not forced to reduce their prices from increased competition, and domestic consumers are left paying higher prices as a result.
The effect of tariffs and trade barriers can shift. Costs can rise just in anticipation of tariffs even before the levies are put in place. In the short run, higher prices for goods can reduce consumption by both individual consumers and by businesses. During this period, some businesses will profit, and the government will see an increase in revenue from duties. But in the long term, these businesses may see a decline in efficiency due to a lack of competition, and are likely to eventually see a reduction in profits due to the emergence of replacements for their products.
Workers may not benefit, as well. For example, while tariffs on steel and aluminum would ideally increase employment in those industries, over time companies will become comfortable with the higher prices and not be able to compete with the larger overseas markets. But tariffs may allow companies that would not exist in a more competitive market to remain open, reducing efficiencies. As the higher manufacturing costs work through the economy, companies will look for other ways to cut costs to stay competitive. Trade Partnerships Worldwide, an international trade and economic consulting firm, estimates that in the long run more jobs would be lost than gained.
Free trade benefits consumers through increased choice and reduced prices, but because the global economy brings with it uncertainty, governments may impose tariffs and other trade barriers to protect selected industries. There is a delicate balance between the pursuit of efficiencies and the government’s need to ensure low unemployment and, in some cases, value certain production jobs over others. Because rising prices offset the decrease in quantities and trade patterns adjust to avoid trade barriers, trade protection measures will not necessarily lead to reduction in the trade deficit.
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