Tariffs have become a significant topic in global economics and trade discussions. From historical implementations to modern-day debates, understanding what a tariff is and how it functions is crucial for navigating the complexities of international commerce. Monica Morlacco, a seasoned economist and assistant professor at the USC Dornsife College of Letters, Arts and Sciences, sheds light on tariffs, offering clear explanations of their mechanisms, beneficiaries, and economic consequences.
Defining Tariffs and Their Primary Functions
A tariff is fundamentally a tax levied on goods as they move across international borders. While the term “tariff” is often used broadly, it primarily refers to import tariffs, which are taxes imposed on goods being brought into a country. Although less common, export tariffs exist as taxes on goods leaving a country. It’s noteworthy that the United States Constitution explicitly prohibits export tariffs, as stated in Article I, Section 9.
Tariffs are strategically implemented with two primary objectives: protection and revenue generation.
- Protective Tariffs: These are designed to increase the price of imported goods, making them relatively more expensive compared to domestically produced goods. This price difference encourages consumers to favor local products, thereby “protecting” domestic industries from foreign competition.
- Revenue Tariffs: The main goal of revenue tariffs is to generate income for the government. Historically, tariffs served as a significant source of government funding, though this role has diminished in many developed economies over time.
Historical Context of Tariffs: A Global and U.S. Perspective
Tariffs are not a new phenomenon; their use dates back centuries across the globe. In the United States, tariffs have been part of the economic landscape since 1789. One of the first major pieces of legislation in the U.S. was a tariff law, enacted to provide financial support for the nascent government.
Monica Morlacco, USC Dornsife Economics Professor, explains tariffs and international trade policy.
While tariffs were once a major source of revenue for governments, particularly in the early 20th century, their importance in this regard has decreased in wealthier nations. For instance, in 1900, over 41% of the U.S. government’s income came from tariffs. However, by 2013, this figure had dramatically declined to just 2%. Conversely, many developing countries, such as the Bahamas and Ethiopia, still rely on tariffs for a considerable portion of their government revenue.
Despite the decline in revenue generation as the primary purpose, tariffs have seen a resurgence as a tool for protectionism. Governments often impose tariffs temporarily to shield specific domestic industries or to address perceived trade imbalances. The U.S., for example, implemented multiple rounds of tariffs in 2018 on various products, sectors, and countries, significantly increasing import tariffs from an average of 2.6% to 17% on over 12,000 different products.
The Authority to Impose Tariffs
In the United States, the power to set tariffs is constitutionally vested in Congress. However, Congress has delegated some authority to the President through specific laws, allowing the executive branch to impose tariffs under certain conditions. These presidential powers are typically invoked in situations related to national security concerns or during economic emergencies, granting the President flexibility to act swiftly in trade matters.
Understanding Who Pays and Who Benefits from Tariffs
When a tariff is imposed, the immediate payer in the U.S. is the importer. This is the company or entity that brings the goods into the country. They are responsible for paying the tariff to U.S. Customs and Border Protection, a division of the Department of Homeland Security, at the point of entry. However, the economic impact of a tariff extends far beyond just the importer.
The ultimate impact of a tariff is significantly influenced by the economic size and influence of the country imposing it. Economists differentiate between “large open economies” and “small open economies” in this context.
- Large Open Economy: A large open economy is one whose trade volume is substantial enough to influence global prices for goods. Changes in its demand or supply can shift world prices.
- Small Open Economy: Conversely, a small open economy’s trade activities are not significant enough to impact global prices. It is a price-taker in the international market.
Consider the example of the U.S., a large open economy, imposing a tariff on coffee imports:
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Increased Prices for Imported Coffee: The most direct effect is an increase in the price of imported coffee. This makes coffee more expensive for U.S. consumers and businesses, such as coffee shops and restaurants.
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Terms of Trade Advantage: Due to the U.S.’s large economy status, imposing a tariff can lead to a decrease in the world price of coffee. To maintain access to the large U.S. market, foreign coffee producers might lower their prices. This reduction in price paid to foreign exporters is known as a “terms of trade gain” for the U.S. It means the domestic price of imported coffee doesn’t increase by the full amount of the tariff because part of the tariff is effectively absorbed by the foreign exporter.
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Reduced Trade Volume: Tariffs inevitably lead to a decrease in the overall volume of coffee traded. Higher prices dampen U.S. demand for imported coffee, and foreign producers sell less coffee in total, resulting in a decline in global coffee exports.
In contrast, if a small open economy imposes a tariff, the situation is simpler. Foreign producers have no incentive to reduce their prices because the small economy’s demand is too insignificant to affect the global market. Therefore, the price of imported goods within the small economy rises by the full amount of the tariff. Trade volume still decreases, similar to a large economy, but without any “terms of trade gain.”
Adverse Effects of Tariffs and Retaliatory Measures
In a large open economy like the U.S., the effects of a tariff are a mix of positives and negatives. Consumers, both individuals and businesses, are negatively affected by the higher prices they must pay for imported goods. However, domestic industries that compete with imports benefit from tariffs because they face less foreign competition and can sell more of their products, potentially at higher prices. The government also gains additional revenue from the tariff collection.
The net economic effect for the country depends on whether the benefits, such as the “terms of trade gains,” outweigh the economic losses from distortions in production and consumption patterns caused by the tariff. If the terms of trade gains are larger than these negative effects, the country might see a net benefit. However, for a small country, without the ability to influence world prices and achieve terms of trade gains, tariffs generally lead to negative outcomes, increasing prices and reducing overall trade efficiency.
It’s crucial to remember that these effects are simplified and assume “all else is equal.” In reality, international trade is dynamic. A significant consideration is retaliatory tariffs. When one country imposes tariffs on another, the affected nations often respond by imposing their own tariffs on imports from the initial country. These retaliatory tariffs can amplify the negative economic consequences, limiting export market access and further increasing prices across various sectors.
The trade disputes of 2018 exemplify this. When the U.S. imposed tariffs, countries like China and the European Union retaliated with tariffs on U.S. exports. These retaliatory actions affected approximately $121 billion worth of U.S. exports, significantly broadening the negative economic impacts beyond the initially targeted sectors.
Further Resources for Learning About Tariffs
For those seeking a deeper understanding of tariffs and international economics, several resources are highly recommended. Textbooks such as International Economics: Theory and Policy by Paul R. Krugman, Maurice Obstfeld, and Marc Melitz, and International Trade by Robert C. Feenstra and Alan M. Taylor, offer comprehensive academic insights. For a more focused analysis of the costs associated with recent tariffs, The Economist article “Who Pays for Tariffs?” provides valuable perspectives. (Note that access to The Economist article may require a subscription).
