Readers Question: When a country face a recession, can they just increase the import taxes? so the country local production is increased to meet the demand and improve the employment as well as the economy?
It is an interesting question because often policy makers are tempted to pursue this as a strategy to boost domestic demand in the face of a recession.
If a country increases import taxes (tariff), then it may cause a shift to domestic demand. Higher tariffs on imports will increase the cost of imports, and therefore consumers will buy less imports and increased demand for domestic production. This will have a positive impact on employment and economic growth.
For example, if the US imposes a tariff on imports of foreign cars, there will be a shift to domestic car production which will cause higher domestic demand.
Problem of Import Tariffs.
The problem of imposing import tariffs is that other countries tend to retaliate and impose their own import tariffs. Therefore, the US car industry may get a temporary boost in demand. But, in response China and Japan impose tariffs on US exports of automobiles / electronics. Therefore although some US domestic producers gain from the US import tariffs. Others will later lose out because other countries put taxes on US exports.
Therefore, the retaliation tends to wipe out the gains from the initial import tax.
But, it may get worse. By imposing various tariffs, countries may end up specialising in goods where they don’t have a comparative advantage. If there is a decline in trade, firms will also not be able to benefit from economies of scale. (see: benefits of free trade) Models of free trade suggest bilateral tariffs lead to a decline in economic welfare for all countries concerned.
Global Recession and Tariffs
If the global economy is facing an economic downturn (e.g. like 2011) then all countries are seeking to increase domestic demand and boost economic growth. Therefore, if the US raised tariffs, it is likely to lead quick retaliation. China and Japan would not be happy to see a decline in exports to US because they need to increase their own demand.
It is important to understand that tariffs don’t create any additional demand, they merely shift demand from one part of the world to another. US import tariffs may increase US demand at the expense of demand and growth in Asia.
If the world economy was growing very strongly and a small country raised tariffs, it is possible that other countries wouldn’t bother to retaliate. In this case, the import tariffs may play a role in boost domestic demand.
Protectionism and the Great Depression
Arguably protectionist policies in the 1930s aggravated the decline in global trade and global economic growth. Faced with dramatic falls in domestic demand, countries began imposing import tariffs to try and protect and boost certain industries. However, this led to a global round of higher tariffs which led to a fall in international trade. (causes of Great Depression)
Alternative Policies to Avoid Recession
Rather than try and reduce import demand, it is better for policy makers to deal with the fundamental lack of demand in the economy. They can do this through expansionary monetary and fiscal policies. See: Policies to avoid recession.
- Currency wars – another form of protectionism