By Amitrajeet A. Batabyal
The world is lurching ever closer to a full-blown trade war as the U.S., China, Europe, Canada, and Mexico talk tariffs and retaliation. President Donald Trump made the initial salvo back in March, when he placed duties on steel and aluminum. These actions have prompted significant concern and discussion about the wisdom of this action.
As an economist who shares some of those concerns, I believe it’s important to first understand what a tariff actually is and does before we can determine whether Trump’s new trade barriers are good or bad.
Two kinds of tariffs
A tariff, simply put, is a tax levied on an imported good.
There are two types. A “unit” or specific tariff is a tax levied as a fixed charge for each unit of a good that is imported – for instance $300 per ton of imported steel. An “ad valorem” tariff is levied as a proportion of the value of imported goods. An example is a 20 percent tariff on imported automobiles. Both tariffs act in similar ways.
Tariffs are one of the oldest trade policy instruments, with their use dating back to at least the 18th century. Historically, the main objective of a tariff was 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.
Even so, the main purpose of a tariff these days tends to be about protecting particular domestic industries from foreign competition, alongside raising revenue.
Examining a tariff’s impact
The impact of a tariff depends on whether the levying country is large or small – not in terms of size but the potency of its trade and ability to influence world prices.
Ghana, for example, roughly the size of Minnesota with a population similar to Texas, is the world’s top exporter of cocoa. The Netherlands, meanwhile, slightly smaller than New Jersey, is the commodity’s biggest importer. As such, both countries’ trade policies can have a significant impact on the price of cocoa on global markets.
So if the Netherlands were to levy a tariff on imports of Ghanaian cocoa to protect a nascent – and currently imaginary – industry of small Dutch cocoa bean growers, there would generally be three effects.
First, the price of the import good, cocoa, would rise, making it more costly for domestic consumers of the product. This would be bad news for Dutch chocolatiers – the Netherlands is the world’s biggest exporter of cocoa butter – and citizens – who eat a lot of chocolate. But it’d be good news for companies in the domestic import-competing industry – the experimental Dutch farmers growing cocoa plants in a greenhouse – because the good they produce is now cheaper than the import, and so the cocoa butter makers would buy more of the local variety.
Second, because the tariff-levying country is large, it drives down the export price of the good in question. So the pre-tariff price at which Ghana can export cocoa to the Netherlands declines, Ghanaian growers and producers make less money, and the country’s economy is hurt. Economists call this a “terms of trade gain” for the country imposing the tariff. Such a tariff ensures that the price of cocoa in the Netherlands does not rise by the entire amount of the tariff.
Finally, the overall volume of trade in the product between the countries involved decreases because the demand for and supply of the good falls.
If the tariff-levying country is small, however, there are only two effects: The good’s price will go up – domestic consumers will pay more, while producers will sell more – and the country’s trade of the product will decline. The action will have no impact on global prices.
Benefits and costs
For a “large” country, the benefits of a tariff are mixed.
Consumers, whether businesses like Dutch cocoa butter makers or individuals who enjoy a tasty bar of dark chocolate, face higher prices and hence are the losers. The industry being protected, however, benefits by becoming more competitive and selling more of its wares. In addition, the government will gain a new source of revenue.
The net effect boils down to whether any gains in the terms of trade are greater than the resulting “efficiency loss” – that is, how much the tariff artificially distorts consumption and production decisions in negative ways.
If the magnitude of the terms of trade gain is larger than that of the efficiency loss, then the country benefits from the tariff. If not, then it loses.
For a small country with no market impact, the terms of trade gain is zero, hence a tariff unambiguously makes it worse off.
Political economy of tariffs
The fact that a large country can, in some cases, be better off with a tariff has led some to suggest that such nations ought to, when necessary, levy “optimal tariffs” against their trade partners.
An optimal tariff maximizes the difference between the terms of trade gain and the efficiency loss and hence is essentially a “beggar-thy-neighbor” trade policy.
In other words, the problem with such strategic tariffs is that in addition to frequently being illegal, they are not implemented in a vacuum. Aggrieved trade partners are likely to respond with appropriate tariffs or other trade policy instruments of their own.
These kind of sequential “tit-for-tat” actions can easily degenerate into a trade war. This is in part why trade economists are typically against restricted trade and for free trade.
Amitrajeet A. Batabyal is Arthur J. Gosnell Professor of Economics at Rochester Institute of Technology.
Jackson says
This is actually a failure of Congress. The Constitution gives to Congress the sole power to levy tariffs, not the president. Why are they letting him do this? The republicans in Congress are still on their hands and knees looking for their spines
Trump be Dump says
Tariffs do not work. Here’s why: Best case scenario Company A relocates to US to make product xzy to avoid tarrifs. Market price for xyz is inflated, due to tariffs. So newly relocated company within US sells product xyz at market price. It’s called capitalism. People do not get into business to kinda make profits.
But it’s the egg, that’s what will sink the Donald. The incredible, expensively edible, egg. Just watch!
JUDITH A SWEENEY says
I really wanted to learn the basics of tariffs. However your economic linguistics have confused me even further. I found it hard to read. Was looking for a story on Tariffs 101.
Jackson says
Kamala Ĥarris was right, it’s a tax on the American people.
Pogo says
@Related
As stated
https://www.google.com/search?q=regressive+vs+progressive+tax
Sherry says
Please watch this interview and analysis on the Canadian tariffs and the Canadian view of this terrible situation. . . with analysis of how the Canadians should respond. Very informative:
Ray W, says
The Editorial Board of the Wall Street Journal published its take on Trump’s tariffs.
“Tariffs are taxes, and Mr. Trump’s latest tariffs are estimated to be about an annual $150 billion tax increase. … Taxes are antigrowth. That’s the message investors are sending this week since Mr. Trump let his 25% tariffs on Canada and Mexico take effect. The President also raised his 10% tariff on China by another 10%. Canada ad China retaliated, while Mexico is holding off until Sunday.”
Re, immediate impacts? The Board suggests that Americans “[b]race for higher prices on berries, bell peppers, and, gulp, beer.”
It added: “The President also professes to love farmers, but he apparently loves tariffs more. … U.S. farmers are already squeezed by low crop prices and inflation. The American Farm Bureau Federation (AFBF) says farmers are losing money on almost every major crop planted for the third straight year. Tariffs will increase their pain. About 85% of the U.S. potash supply for (synthetic) fertilizer is imported from Canada. China is hitting U.S. farm exports with a 15% tariff, which will let farmers in Brazil and Australia grab market share.”
The Board concluded: “Mr. Trump’s tariff spree is the triumph of ideology over, well, common sense. Let’s hope the President soon comes to his senses.”
Make of this what you will.
Me?
Some economists argue that the average family will pay $1200-$1300 per year more, should the tariffs last that long. Others say more.
Some economists say new car prices might rise as much as $12,000 on an average car. Others, less. The Big Three carmakers have just persuaded the President to delay the tariffs on cars and car parts for one more month.
Regional gasoline and diesel prices are almost certain to be affected, but prices rise and fall for many reasons, so the amount might be masked. Nonetheless, a refinery in Canada that has for decades been providing, via pipeline, gasoline and diesel fuel to New England, its products will likely cost 10% more. Without American pipelines into the region to provide a substitute source of gasoline and diesel fuel, New Englanders will have little choice but to pay the higher tariff price at the pump.
In the end, Trump says the tariffs are to stop the flow of fentanyl across borders, though he has repeatedly said he wants to encourage foreign manufacturers to relocate factories here or to build new ones here. If that is so, the tariffs will have to be long term. No foreign business would move its manufacturing assets here if it thought the economic advantage gained by tariffs could evaporate overnight.
Pogo says
@Republicans aren’t republicans
All Americans, for the moment, live in a republic; the lickspittle and weirdos with the miniscule majority in the House of Representatives have spines — what they lack are brains, courage, and conscience. The party of, “term limited patriots — not professional politicians” is in fact a refuge for awkward weirdos, stooges and marionettes of vested interests, and run-of-the-mill self-dealing criminals in their career of choice. Decent, intelligent, and courageous patriots (once known as rock ribbed) have been deliberately and systematically purged from public life (while their own freak flags are tattoos on their faces behind their masks) — leaving a zombie choir of cowards dedicated to isolationism, chauvinism, messianic fanatic fundamentalism, jingoism, nativism, and racism from their seats on the public’s back.
FWIW, Article I, Section 8
https://www.google.com/search?q=The+Constitution+gives+to+Congress+the+sole+power+to+levy+tariffs
Edith Campins says
Surprise, Surprise. As the saying goes, we have met the enemy and it is us.
“Heather Saunders
Sep 20, 2024
In campaign speeches, Former President Donald Trump has routinely blamed undocumented immigrants for a rise in drug trafficking and overdose deaths across the U.S.-Mexico border, including bringing in more fentanyl, a synthetic opioid that is responsible for more than 72,000 overdose deaths in the U.S. last year alone.
But most fentanyl is being trafficked by American citizens, not migrants. Data from the United States Sentencing Commission shows that 86.4 percent of those sentenced for trafficking fentanyl were U.S. citizens. Among non-citizens, the data includes those lawfully present and undocumented. Fentanyl traffickers were 34 years old, on average, mostly men, and for about 4 in 10, this was their first offense. As of January 2024, about 65,000 people—mostly U.S. citizens—were serving a sentence in federal prison for drug trafficking.
Figure 1
The Vast Majority of People Sentenced for Fentanyl Trafficking are U.S. Citizens
Citizenship of people sentenced for trafficking fentanyl in FY 2023
Non-Citizens
13.6%U.S. Citizens
86.4%
Note: Non-citizens include both undocumented and those lawfully present.
Source: United States Sentencing Commission, 2023Get the dataDownload PNG
KFF.org
The amount of fentanyl seized by U.S. Customs and Border Protection close to doubled in one year, rising from 14,100 to 26,700 pounds from FY2022 to FY2023. About 2 mg of fentanyl can be lethal, according to the DEA (1 pound = 453,592 mg).
Efforts to stem the supply of fentanyl are one piece of trying to address the opioid epidemic – along with reducing demand for the drug through increasing treatment and public awareness.
To further restrict supply, Vice President Kamala Harris, the Democratic presidential nominee, has proposed expanded border security and investing in technology at borders and ports—adding to the supply-focused policies implemented during the Biden/Harris administration. Trump, the GOP nominee, proposes tightening border policies and increasing punishments, including seeking the death penalty for “drug smugglers and traffickers”—most of whom are U.S. citizens.”