The last few weeks, I’ve been unable to open a news app or website without seeing news on tariffs near the top. It is hard to keep up with everything happening, enacted tariffs, delays, backtracking, etc. I’m not equipped to tell you what trade, prices, and the U.S. economic health will look like six months down the road, but I want to go over tariffs generally here to hopefully give some more insight into what’s going on.
Tariffs are taxes on the import of goods and raw materials that cross the border. While the taxes may be paid by the domestic importing company, they are ultimately paid by domestic consumers in the form of higher prices for imported goods. For example, if the U.S. imposed a 10% tariff on imported shoes from Germany, U.S. companies importing Adidas shoes would pay the tariff. Would Americans pay 10% more for their shoes? Probably not. Since there are many alternatives in the market, Americans would likely stomach some price increase, but it would likely fall short of the 10%. Therefore, retailers would pass on what they think they can to U.S. consumers but would likely have to take some of the tariff on the chin.
So maybe tariffs aren’t so bad if it increases government revenue without increasing taxes on Americans, right? Not necessarily. In the example above, athletic shoes, like those sold by Adidas, would be considered an elastic good in economic terms. In simpler terms, an elastic good is one that has many substitutes and is not essential for daily life. Yes, there may be some big fans of the company, but more people are going to look at competitors if Adidas tries to increase prices too much. Other goods or raw material are necessary for life – or inelastic – examples would include oil and gas, medicine, food, and water. For inelastic goods, or premium goods without perfect substitutes, consumers likely have to eat a much larger percentage of the tariff – especially when products cross borders many times in the manufacturing process. Having substitutes is key, and if there are none, we run out of options and must stomach higher costs, increasing overall inflation. Imposing tariffs also encourages retaliation from other countries which hurts domestic exports.
If results are mostly bad, why would anyone impose tariffs if it is an economic form of self-mutilation? While studying for my Economics degree, I had professors say free trade is preferable in most cases, and we should move toward globalization citing comparative advantage as the key to better outcomes. However, in certain geopolitical conditions, some trade protections may be strategically beneficial in a highly competitive global economy. When the more cutthroat world we live in starts to be more competitive, it can make sense to bolster domestic industries and try to bring manufacturing back home.
One key effect of tariffs is that they allow domestic industries to be more competitive on price and help protect jobs in strategically important industries.
Tariffs are complicated and often have second- and third-order consequences that we can’t see right away. If there is one thing it is causing right now is uncertainty. Markets do not like uncertainty, and I think we’re seeing that bearing out so far in February.
