Impact of US tariffs

Readers Question: I’m an American, and I have a question on tariffs. Donald Trump has said he will place a tariff on all Chinese steel, and on Mexican cars. My question is, “Are tariffs still useful, and if so, why not put tariffs on all cars from Japan, Korea, Mexico, and Germany?”

A tariff on Chinese Steel is designed to help the US steel industry. At the moment, American producers may find it cheaper to import steel from China so US steel producers lose out. This has led to job losses in the US steel industry.

steel-industry-us-decline
US Steel industry

Higher tariffs on imports will cause firms to purchase more domestically produced US steel. This will benefit US steel industry and protect / create jobs in US steel industry.

It is a similar situation with tariffs on cars from Mexico. For US consumers it will make US produced cars relatively more attractive. A tariff on exports from Mexico, will discourage US car firms moving production to Mexico and help keep US car jobs in America.

However, this is only part of the equation. There are two major drawbacks to placing tariffs on imports:

  1. More expensive prices for consumers
  2. Retaliation on US exports – harming US export industry

If US places tariffs on imports of steel and cars, this will lead to higher costs of production and higher prices for consumers. The rise in price may be relatively marginal, but spread over the whole economy, the rise in prices will reduce discretionary (disposable) income. This in turn will lead to a decline in demand for other goods produced in the US.

This effect is less noticeable, than say highly visible job losses in steel industry. But, if tariffs lead to higher prices, other firms in the US economy will be imperceptibly affected, with a decline in demand for other goods.

Retaliation. If the US place tariffs on Chinese imports, China can retaliate and place tariffs on US exports. For example, China has already threatened to block  iPhones, soybean and maize exports. As a Chinese paper stated, in retaliation to Chinese imports, China could:

A batch of Boeing orders will be replaced by Airbus. US auto and iPhone sales in China will suffer a setback, and US soybean and maize imports will be halted. China can also limit the number of Chinese students studying in the US. (link)

It is unusual for a country to put up tariffs without some kind of retaliation. What would happen in this case is that tariffs would shift resources. It would benefit some industries (steel / cars) which benefit from the import tariffs. But, equally it would harm the export industries where the US has more of a comparative advantage.

In terms of jobs, tariffs create winners and losers, but overall unemployment would not be reduced.

Furthermore higher tariffs could have further negative effects

  • Reduced economic growth. A trade war could destabilise investment and the higher prices reduce consumer spending. Lower economic growth would lead to a lower rate of job creation or even higher unemployment.
  • Protect the wrong industries. Industries wanting tariffs are usually those which are losing international competitiveness and in long-term decline – the industries which can’t compete with foreign firms. Some argue tariffs can merely prolong the economic inefficiency of supporting inefficient firms. It is better to promote industries, where the US has a more obvious comparative advantage e.g. – Boeing, iPhones, International students.

Evaluation

  • One defense for higher tariffs could be that US firms are not actually facing fair competition. For example, if the ultra low Chinese steel prices are due to state supported over-capacity. This over-capacity is driving prices below their long-term equilibrium. If the US steel industry closes down, it would give China more monopoly power and, in the future, they could raise prices significantly. Therefore, on the grounds of promoting international competition there is a justification to try and protect the industry from this unusual situation of ultra-low prices.
    • I’m not sure how valid this point is – I’m not sure that the Chinese over-capacity will prove temporary. Even if true, tariffs will still lead to the problem of retaliation and higher prices.
  • Another argument which used to be made is that China was a currency manipulator – artificially reducing its currency to give exporters an unfair advantage. This may have been true a few years ago but – given the recent appreciation in the value of the Chinese Yuan –  most economists would no longer accept it as a fair accusation.

Conclusion

In summary, tariffs can be useful for offering temporary support for a particular industry. But, tariffs need to be viewed in the wider context of how they are very likely to cause problems for other industries and the wider economy. Tariffs don’t really tackle with the fundamental issues of regional decline, rising inequality and technology related job losses.

Diagram showing effect of Tariffs

effect-of-tariffs-2

  • Without any trade, the equilibrium price is £1.80 and a quantity of 40 million
  • With a tariff of £0.40, the price of imports will be £1.60.
  • The quantity of imports at £1.60 is (50-30) = 20 million.
  • See more at: effect of tariffs

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2 thoughts on “Impact of US tariffs

  1. Can you explain the diagram further, I don’t understand. What exactly is it showing? What is the equilibrium price? The equilibrium of what? What is quantity? What is S and D? What is domestic referring to?

    1. It is more for students of economics It is supply and demand diagram. It shows domestic supply and also the global supply (shown by horizontal supply curve). With free trade, the price would be £1.20. WIth Tariffs, the price would rise to £1.60. WIth no trade at all, the price would be set by domestic supply and demand at £1.80. There is more at http://www.economicshelp.org/blog/glossary/tariffs/

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