Tariffs Part II: A Policy Analysis
The Basics of the Tariff
Tariffs are taxes. That should not be overlooked. Advocates tend to omit this fact. When tariffs are increased, taxes are going up. In addition to that, tariffs restrict trade, and most economists (left, right and center) since Adam Smith agree that more trade is preferable to less trade. People and countries that do not trade are relatively poorer than those that do. Trade leads to higher efficiency in resource use, greater variety in goods for consumers, lower prices, and stronger economic growth. That is what theory suggests and historical experience confirms.
However, there are goals besides growth and economic efficiency, and there are subtleties and distinctions to the overall impact and effect of tariffs. The general impacts are clear, but the details are a little more nuanced, as explained below.
The reasons for tariffs, like any tax, are not clear-cut. Some taxes are imposed to change behavior, like the so-called sin taxes, and some taxes are imposed to raise revenue for the government. We see these reasons with tariffs in both the economics and the politics of them as explained below.
The Economics of Tariffs
A Protective Tariff: As stated above, a tariff is a tax, designed as a tax on the importing company, and it appears as though the company pays it. The counter argument is that the company just passes that tax onto the consumers in the form of higher prices, ultimately making it a tax on consumers. As far as this goes, it is true, but there is an assumption built into this analysis that does not hold in all cases. If the tariff is being enacted as protection for less efficient domestic producers from more efficient (lower-priced) imports, then the consumer will pay the tax. There is room for the importer to raise its prices and still be competitive. Consumers pay most of the tax of a protective tariff.
A Revenue Tariff: However, if the domestic producers and the importers are price competitive, and there is no room for a price increase, then much (maybe all) of the tariff will be paid by the importer. They cannot pass the price increase along to the consumer, because if they do, the consumer has lower-priced options and can make an easy change. There is however the risk that the tariff could be high enough to drive the importer out of the market, and no one really wants that because choices and competition are good. Importers pay most of the tax on a revenue tariff, but there is a risk that revenue tariffs can be set too high, and then there will be no revenue.
Economists call this concept elasticity, which is a measure of how responsive demand is to a price change. When consumers have options, their demand is very elastic; a small price change can result in lots of consumers making consumption changes. Think like this, if one candy bar at the checkout counter has increased in price, it is easy to switch to another. In these sorts of markets, a revenue tariff can work — if, by “work,” we mean increase government revenues with minimal harm to domestic consumers. But in markets where the importer is the most efficient producer and/or consumers have few options, demand is inelastic, and the importer can just pass the tax, or most of it, on to the consumer. Think of the Super Bowl, there are only so many seats in the stadium; if you want one, you have to pay the price, and if there is a sales or event tax, that is going to just be passed along to the consumer.
The Politics of Tariffs
However, there is more to this conversation, there are other goals in the world, and it is possible that a tariff is an effective way to achieve them. America is the most sought-after market on the planet; every producer wants access to the American consumer. I do not think we appreciate how valuable the American market is. China is a bigger economy but not by much and only because it has 1.4 billion people. The U.S. is second in GDP and almost double the size of the world’s third-largest economy (India), but in per capital GDP, China is 97th ($22,000) and India is 152nd, ($9,200). The U.S. is 13th ($72,000), and the 12 countries in front of us have a combined population that is less than New York City. We are the largest rich country by far and richest large country by far. Access to our market is the “golden ticket,” and controlling that access and threatening that access may accomplish other goals.
Of course, such a threat does not carry any weight if there is no follow through, and that is the other side of this. If there has to be follow through, the U.S. is such a large, diverse economy, it can sustain a tariff with less damage. There will be some harm, and it could add up long term — but not like in a small country where the impact will be large and immediate. So, if the U.S. government has goals it wants to accomplish, a tariff (or a threat) may be an efficient way to accomplish them, probably more effective than diplomatic pressure, certainly better than military action, and far more immediate than some sort of international boycott. This tactic may only be available to the United States and possibly China, but it has proven effective recently.
Tariffs are an economic and political tool. As an economist, I stand with most of my profession and argue against them for economic reasons: They often increase prices, reduce choices, hide inefficiency, and slow growth. But, if there are global, political goals to be achieved and a tariff can achieve them, it may well be the low-cost policy option. The problem is we can never really tell what the motivations are and they can not be announced when playing geo-political poker. The president cannot show his hand, even to his own people.
