The Impact
of Tariffs on Consumers, Businesses and The Economy
Hemant W. Dandekar
A few friends and colleagues have asked me about the
US-China trade war and the impact of tariffs on consumers and businesses and
the broader economy. So I decided to put my thoughts on paper, guided by
writings of well known economists such as Ben Bernake[1]. So the questions I am trying to answer are:
1.
What are tariffs? Are they the only form of
trade protectionism or are there others?
2.
What is the justification behind imposing
tariffs?
3.
How do tariffs affect businesses and the broader
economy?
4.
What evidence do we have of the impact of
tariffs?
Tariffs and other
forms of trade protectionism.
Prof Guarino from Rutgers outlines the various forms of
trade protectionism in his blog[2]. Trade protectionism is certainly not
limited to just tariffs, other forms such as quotas, subsidies, local content
requirements, exchange rate controls etc. are quite prevalent.
1.
Tariffs:
Tariffs are taxes imposed on goods imported from countries or trading blocks.
They can be a fixed fee per unit or a % of value of the good. Tariffs are a
form of import tax and are collected by government. Tariffs are means to
restrict imports of goods and services and are meant to protect industries
producing such goods.
2.
Quotas:
Quotas are a restriction on the number or amount of certain goods or
commodities. Usually these are enforced by issuing import licenses to
individuals or companies.
3.
Subsidies:
They are government payment to producers. They can be in the form of cash
payments, low interest loans, tax breaks, free training for workers, land/manufacturing
space etc. Subsidies provide cash, reduce manufacturing costs and allow
domestic companies to compete against more efficient foreign competition or
allow domestic companies to export to foreign markets.
4.
Local
content requirements: Government may require a manufacture good to have say
a 75% local content or face tariffs or quotas.
5.
Exchange
rate controls: Countries can sell their currency (or adopt loose fiscal
policies) in the open market to create lower exchange rates. This causes the
good that are exported to be cheaper and imports more expensive, thus
encouraging exports and discouraging imports.
Justification for trade protectionism
Governments have used a number of
justifications for invoking trade restrictions.
These include:
1.
Protecting
Jobs and Industries: This is the most common argument If unlimited imports
are allowed domestic manufactures will suffer (if they have a higher cost
structure than foreign competitors). This will cause them to cut back
production. This will lead to loss of economies of scale and eventually manufacturers
will shut down and it will severely impact GDP.
2.
National
Security: Certain industries are crucial inputs for the defense industry
such as high tech electronics, semi-conductors, supercomputers, aviation
components etc. By protecting defense
industry from foreign competition a country’s existence is assured.
3.
Protecting
startups: Economies nurturing
nascent industries which are well established in other countries, argue for
protecting startups to give them time to establish themselves before they face foreign
competition. Otherwise, they may not survive if they compete against well
entrenched foreign competition.
Impact of Tariffs /
Trade Protectionism
For the sake of simplifying arguments we
will assume that the economy being affected is an ‘open economy.’ An open
economy is one where there is no restriction of flow of goods both exports and
imports. In an ‘open economy’ the price of a good is the same as the
equilibrium world price defined by global supply and demand.
1.
Impact on
goods and consumers: If a tariff is imposed, the price of the good is equal
to world price plus tariff. The government collect the tariff as a tax. The
consumer pays more (as more often then
not the business passes on the tax to the consumer especially if it is a unique
good), resulting in a reduction in consumer demand. The domestic producer is
better off, as the producer produces more and gets paid more for the good. The
foreign exporter is worse off, as due to demand drop fewer goods are imported. If
voluntary or involuntary import quotas are imposed, it benefits the holder of
import license who can charge more for the good since supply is limited. Tariffs
are inefficient as they force production to a higher cost producer and depress
consumption, thus reducing the overall economic pie. An alternative is free
trade where the winners (for e.g. consumers or retail stores) can compensate
the losers (worker training for new horizon industries) so that everyone is
better off.
2.
Impact on
broader economy: If consumers have to pay more then it will likely trigger
inflation. Similarly producers who import raw materials for producing goods
have to pay more resulting in either lower margins (resulting in cost cutting
or layoffs) or passing on the higher prices to consumers. This can also result
in inflation. Startups may never mature: If startups don’t face foreign
competition they will never know when they are at world class (quality and/or
cost structure). In essence they will never grow up and the economy will suffer
due to misallocation of resources. If due to protectionism trading partners
will take reciprocal actions and impose tariffs on all trade leading to lack of
free trade and a trade war. Availability of goods will be restricted across
many sectors of the economy. This will result in higher prices, inflation and
drop in demand. Exports will also become more expensive and as a result exports
will drop. Both of these would lead to
drop in GDP. Eventually this will lead to a global recession.
The consensus among economists is that in the short run
trade restrictions may help some industries / sectors of the economy, they do
more harm (lower exports, higher prices) than good in the long run. Free trade
leads to specialization and allocation of resources to the most efficient
player. Governments should build mechanism to distribute the surplus created by
free trade to help dislocated workers to learn and apply new skills in new
industries.
Real world evidence
of the impact of tariffs
In January 2018 the Trump administration imposed a 20%
tariff on the first 1.2 M washing machines and 50% tariff on all subsequent
units, imported in the US from all countries. A recent study by researchers
University of Chicago [3] showed that in February 2019 the average price of a
washer and dryer went up 12 % (they are often sold in pairs). Foreign producers
(LG/Samsung) made plans to produce them in the US thus potentially creating
1600 jobs and Whirlpool said it will add an additional 200 workers. The
government collected $82 Million in import taxes. However, these new jobs came
at a steep price: after taking into account government collections, consumers
paid on an average $817,000 per job!
The series of tariff announcements by the Trump
administration and the counter tariffs by China has started a trade war between
the two countries. This has begun to
show in the slowdown of the GDP of both US and China. According to IMF China’s
real GDP growth rate is likely to slow from 6.6% in 2018 to 6.1% in 2019. The
corresponding figures for the US are 2.9% in 2018 to 2.4% in 2019. Granted, not
all of these reductions in real GDP are due to the trade war (for e.g. waning
effect of fiscal stimulus due to tax cuts), but it does contribute to the
economic slowdown, due to reduction in demand in industries such as auto,
aircraft, agriculture, farm equipment etc.
Conclusion
The above examples show that there is a substantial price to
pay for imposing tariffs, both the cost to consumers and to the overall
economy. However, it is important to note that some of these steps may be
necessary as there are inherent trade barriers that countries such as China already had in place,
such as subsidies in terms of land and easy credit, exchange rate controls, not
to mention subsidies by allowing theft of intellectual property. We as a nation
have to be cognizant of this and also be aware of the costs we are willing/need
to pay in the short run for our trade partners to eliminate these trade controls
in the long run.
References
1.
Frank R. H., Bernake, B. S., ‘Protectionist
Policies: Tariffs and Quotas’, in Principles of Micro-Economics, 2nd
Ed, McGraw Hill, Irvin (2004).
2.
Guarino, A. S.,’ The Economic Effects of Trade
Protectionism,’ Focus Economics.com Blog, March 1, (2018).
3.
Flaaen Aaron, Hortaçsu Ali, and Tintelnot Felix,
” Effects of US Trade Policy: The Case of Washing Machines” Beckman Friedman
Initiative University of Chicago, April 2019
