At the end of September, President Donald Trump levied approximately $200 billion worth of tariffs on the People’s Republic of China. What are tariffs, and why should you care?
First of all, when people are swinging numbers around that are in the hundreds of billions, you should probably pay attention. This amount of money has the potential to swing the economy significantly.
Tariffs are the most commonly used tool in the trade policy toolbox. They are essentially a tax levied on goods that are imported. In microeconomic terms, tariffs work pretty simply.
In a market, there are things called producer and consumer surpluses, which are the amounts of money producers and consumers respectively receive above the minimum they are willing to receive. When a tariff is levied, consumer surplus decreases because the average price of the goods they are buying goes up.
Part of this loss goes directly to domestic producers as more of their goods are purchased and their prices likely will go up to some extent. Another part of this loss goes to the federal government as they collect money from the tariff. The final portion is lost to the ether, and is considered “efficiency loss.” Imagine this is from the consumers who now can no longer afford to purchase the taxed goods because they are too expensive, so that exchange never occurs.
Let’s say that the tea industry in the United States is being outpriced significantly by the tea industry in the United Kingdom. They head to Washington, and convince the federal government that tea is important for our national security and that it is necessary to have a United States tea industry. The United States government decides to put a tariff on British tea, of say 50 cents per tea bag. Now for every tea bag that a British tea company ships into the United States, they will have to pay 50 cents to the United States government.
Now, they could choose to keep their prices the same, but it is likely that they do not make 50 cents of profit per tea bag, so instead they will increase their prices 50 cents in order to compensate. This may make their tea more expensive than the American equivalent, and if so, many consumers in America will start buying more American tea. Fantastic, right? The tea industry is saved, and in the event of a security incident, the American military will be well caffeinated.
Replace tea with steel or munitions and the security argument might actually make sense. For something like tea or children’s toys, the argument does not hold water. Other defenses include: Protecting infant industries and protection against dumping, which is an economic practice where a company will price below cost in order to capture a market in a foreign country.
With the first argument, it is difficult to determine if an industry actually needs protection, and once it becomes protected it is almost impossible to remove that protection without destroying the industry. For the second defense, it rarely occurs, and the United States market is so large that it would be quite difficult for a foreign corporation to capture market share before being caught and sent to the World Trade Organization.
The current administration frequently expresses its admiration for the free market and its benefits. Imposing a tariff is the opposite of a free market. It is the government directly interfering in a market by giving an unfair advantage to a subset of the participants. Their arguments that tariffs are helping certain industries in the United States are ignoring the structure of the modern global economy.
Goods are no longer made in a single location. An iPhone is not just made in China and shipped to the United States, it is made of parts from all over the world. Similarly, when imported steel is taxed, that affects dozens of industries all over the country who use that steel as an input in the products they produce. While United States Steel and Nucor may be able to hire more workers, hundreds all over the country may be forced to lay off workers or shut down due to the cost increases from the tariffs.
While there are some positive effects to tariffs, such as keeping industries necessary for national defense up and running, there are just too many negative effects to ignore their drain on the economy.