For the purpose of protecting the countries from foreign competition and dumping of foreign goods at cheaper prices, the importing countries started to impose tariffs and import duties. Tariffs restrict import of goods and services by increasing the price of the goods being imported from foreign countries which makes it less attractive for the consumers in home country. Tariffs are also as a source of revenue to the home Government and act as a protection to the infant domestic industries (Staff, 2018). Import duty is a type of tax, collected when the foreign goods enter the home country. The tax depends on the value of the goods being imported (Staff, 2018). Tariffs and Import duties act as trade barriers, both for the home country (the one imposing the tariff) and the foreign country (the one on whom tariff is imposed) (barriers, 2018).
Trade barriers were imposed because of the popular myth that trade barriers benefit the economy but the reality is that trade barriers benefit only the industry which the government is trying to protect at the expense of consumers, other industries and other countries.
Many papers have been written to validate the effects of tariffs and import duties on the industries and other countries. The debate on whether free trade is beneficial or not is going on since ages. From Ancient Greeks to the 21st Century economists, merchants, manufacturers and consumers have been pondering if trade brings harm or benefits.
Adam Smith propounded the theory of free trade in the 18th century and the British converted themselves to free markets in 19th century. This was a big significant change because British traders were rigid about their protectionism policies and to repeal their corn laws, they opened to free trade. Free trade is nothing but the act of buying foreign goods and services at the market price, i.e. without any restrictions or tax. In their paper Dakhlia & Nye (2004) computes a general equilibrium model to simulate the drop of British tariffs to zero. They assessed that the tariffs being imposed by them was way above the optimum tariff level and these tariffs were resulting in welfare loss. The removal of British tariffs resulted in net welfare and asserted that their policy was inconsistent with the theory of pure trade.
Before the onset of the Great Depression, the tariffs imposed by the Latin Americans were among the highest in the world. During the 1920s, it was Latin America who exploited globalisation the most but by 1930s, it was Latin America itself who became the most Anti-Global. Tariffs are imposed not only to protect the domestic industries but also to meet the revenue needs of the Government and to balance the trade deficit. Coatsworth and Williamson (2004) researched about the wide changes on tariff impositions in Latin America and according to them – during the decade before the Great Depression (1914), tariffs were rising in Latin America. The question arose that if Latin America favoured globalisation, then why were tariffs so high before World War? The paper suggests that the Great Depression acted as a turning point and the imposition of high tariffs helped the domestic producers who were competing in the foreign market and made their share in the export oriented economy. Latin America had more revenue needs than the protection of domestic countries.
Irwin (1998) analyses the fiscal aspects of the great tariff debate of 1888. After the Civil war was over, the U.S. government had accumulated high public debts. To repay the debt, high tariffs were imposed – it would raise the required revenue and also protect industries. By 1880s, FED had a huge budget surplus and both the Democrats and the Republicans were against the tariff policy. According to the Republicans, a lower import duty would lead to increas e in imports and reduced the surplus but nothing could be clearly said about the tariff recipients. The elasticity of demand for imports and the elasticity of supply of exports plays a huge role in determination of tariffs and import duties.
Broda, Limao and Weinstein (2008) observed that before World Trade Organisation was set up, countries tend to set tariff rates 9 percent higher for goods with high inelasticity of supply (imports) as compared to the ones which had high elasticity. They assessed that the variations in tariff can be easily explained by market power. The US trade restrictions were higher for the goods which were not covered by the WTO and also for the ones where the importers had huge market power. They find that the non-cooperative trade policy of a developed country like USA is strongly affected by the market power. For instance, the goods in which US had high market power, the statutory tariffs were 27% points higher in those goods.
Cantor, Laffer and Turney (1982) stated that a stagnant economy cannot be recovered with the help of tariffs, import duties and other trade barriers but from removal of these. If the US and Europe were to recover their ailing industries from stagnation then the solution does not lie in extending the damage to other countries by imposing further trade restrictions. The solution lies in reducing the barriers of trade between the economies. No country is made better off by pulling down the other one.
Baldwin (1960) asserts that imposition of tariffs effects the terms of trade of a country. The way in which the government spend the proceeds from tariffs does not impact the domestic offer curve of the country. According to Baldwin, the international offer curve shifts and the amount of exports that foreign traders are willing to buy for a given level of imports for a given ratio of domestic price is same under tariff conditions and free trade conditions.
U.S has been sceptical about the free trade policies ever since. It has often accused free trade for increasing the competition for domestic producers and blamed the immigrants for stealing jobs from the Americans. Hughes (2005) discusses that the misunderstandings between US and China have led to a trade war. The growth rate of China have been consistent around 9% and US has accused China of selling its own goods at unfair prices to the foreign countries, of keeping labour wages low which allows them to produce at cheaper cost than other countries and of not meeting the commitments to the WTO. All these accusations are not meritorious but they were enough to open a trade war. China is a hub of foreign manufacturers and most of these companies are American. Production costs in China is lower as compared to other countries and this incentivised foreign firms to move their production to China.
Tariff acts as an addition to the total cost of imported goods and services. Since the election of Donald Trump as the President of United States, USA has adopted an anti-trade policy and has started to impose huge tariffs and import duties on the import of goods and services from foreign countries (Radcliffe, 2018). Free trade increases the number of goods and services available to the consumers and makes them better off but not every country favours free trade.
Tariffs are of many kinds:
These tariffs have their own costs and benefits. When a Tariff or an import duty is imposed then it not only affects the producers and the consumers but also the government and the workers. Let’s assume that US has imposed tariffs on import of plastic goods from China. This will increase the price of plastic goods in USA for the consumers but it will also benefit the producers of plastic goods in China as consumers will find it cheaper to purchase the goods manufactured in USA rather than in China. Consider the following graph:
In the graph above, price before the imposition of tariff is P1. After tariff, the price has increased to P2 – the quantity demanded has fallen from Q4 to Q3 and quantity supplied by the domestic producers has increased from Q1 to Q2. The imports before tariffs were Q4-Q1 and the imports after tariff is Q3-Q2. The increase in prices due to tariffs increases the cost to the consumers. Shaded region 1234 is the loss to the Consumer Surplus (2018).
It also affects the Government and the Producers. Considering the graph below:
The imposition of tariffs has a positive effect on domestic producers. The increase in prices, incentivises the producers to increase their production and the inefficient firms are encouraged to produce for the domestic market. However, this may not help the domestic firms to grow in the long run. The shaded region 1 is the increase in producer surplus after tariffs – as the production rises from Q1 to Q2.
If optimal tariff is imposed then the government might earn some revenue. It also depends on the elasticity of the goods being imported. If the good being imported is demand inelastic then the government’s revenue will rise. However if the good is elastic and the tariff is too high, then the US consumers might not import at all and no revenue will be earned by the US government. In the figure, the imposition of tariff increases government revenue – non shaded region 3. Net welfare loss in the home country is area 2 and 4.
The argument to support tariff imposition is that it provides employment in the domestic countries. However, tariff imposition has a cascading effect. If US imposes tariffs on Chinese imports then China will retaliate by imposing tariffs on US exports. It will not only effect US and China but also the other countries who are trading with US and China. The diffused costs (loses) due to tariffs and import duties are far greater than the concentrated benefits arising in the domestic country by protection of infant industries and employment generation (“Why Tariffs Get Passed—Even Though They Harm Way More People than They Help) | Ryan Young”, 2018).
In his paper “Trade Restrictiveness and Deadweight Losses from US Tariffs” Irwin (2010) calculated the trade restrictiveness index which showed that after the Civil War the static deadweight loss generated by the imposition of US tariffs was 1% of GDP and it fell continuously after that. However, the welfare loss induced by import duties were 40 cents for every $1 of revenue generated.
Even before Donald Trump started “Make in America” campaign, America has been levying taxes and tariffs to protect its industries. American Revolution was driven by “Taxation without representation”. The harshest retaliation was the Embargo of 1807, in response to the British aggressions. It was tariffs imposed on all manufactured imports from Abroad. Another remarkable protectionist measure was by President Hoover who enacted the Smoot-Hawley Act in 1930 to protect the domestic industries. It turned disastrous not only for America but also for other global trading countries (Smith, 2018).
Now, we have Donald Trump engaging in a Trade War with China because he wants to prevent the transfer of American technology and property rights to China and protect the jobs of the Americans. China is accusing America of starting the largest trade war. In 2017, Trump withdrew the Trans-Pacific Partnership Trade Pact which now prevents the free trade of goods and services. Other than this- three tariff rounds worth $250 billion of goods have been imposed on Chinese goods. Beijing has retaliated to this in kind. If the two countries will not come to a deal then the taxes will start from 10% and rising to 25% in 2019. Trump has threatened to impose new tariffs worth $267 billion goods if China retaliates (“US-China trade row: What has happened so far?”, 2018).
This trade war will affect the entire global market. According to IMF the global worth would be reduced by 0.5%. China will definitely lose on $200 billion worth of exports. Other than this 4 million workers are on the verge of losing their jobs and there is a prediction of 2 to 3 year slack period for the firms.
U.S will also lose both politically and economically. It is expected to lose $50 billion on exports, 2,50,000 workers might lose their livelihoods. The political controversies and criticisms that will arise would be difficult to diffuse (Mercy A. Kuo, 2018).
Asian countries linked to China – like Singapore, Taiwan, South Korea and India will also be hurt. Singapore might lose on 0.8% of its economic growth as a lot of its manufacturing industries are set up in China. 30% of the goods that are exported to America comes from third party Asian countries. These countries will also lose on growth and employment.
Countries who act as global supply chains might benefit. If the trade war continues then the US firms will move their supply chain to other countries like Malaysia, Mexico, Vietnam, Indonesia and Peru as these are the safe countries. China might purchase its technical inputs from Canada, South Korea and Australia or it may produce at home.
The imposition of trade barriers in the form of tariffs and import duties effects the developing countries the most. Developing countries do not need tariff because they need policies that promote export and free trade that will allow them to import. The developed countries should avoid imlosing tariffs on heavy industry products that are being imported by the developing countries because developing countries are mostly labour intensive and they rely on the developed countries for their development.
Conclusion
Free trade benefits the global economy and sometimes trade barriers are necessary to protect the domestic industries. There should be an optimum level of restrictions imposed. The world has reached the level of globalisation where any negative shock to or from one country creates a domino effect for all the other economies. The trade war that is going on between US and China will drastically impact the global market. The trade deficits that occurs due to imports are not a loss to the domestic country because it signifies that the country is growing. If the home country can consume a good at a lower cost by importing the good then the country is benefitting. “Make in US” campaign is not going to benefit either the US or the global market. The paper aimed to assess the positive and negative impacts of Tariffs and Import Duties. From the literature and the current ongoing trade war we can conclude that Tariffs and Import Duties do greater harm than good. In the current scenario, China will retaliate because it will not swallow the harsh tariffs silently but America has a greater market power than China and it is hard to supress the superpowers. However, Donald Trump will have to bear the consequences of launching the war.
References
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Baldwin, R. (1960). The Effect of Tariffs on International and Domestic Prices. The Quarterly Journal of Economics, 74(1), 65-78. Retrieved from https://www.jstor.org/stable/1884134
barriers?, W. (2018). What are trade barriers?. Retrieved from https://tradebarriers.govt.nz/what-are-trade-barriers/
Broda, C., Limão, N., & Weinstein, D. (2008). Optimal Tariffs and Market Power: The Evidence. The American Economic Review, 98(5), 2032-2065. Retrieved from https://www.jstor.org/stable/29730161
Canto, V., Laffer, A., & James C. Turney. (1982). Trade Policy and the U.S. Economy. Financial Analysts Journal, 38(5), 27-46. Retrieved from https://www.jstor.org/stable/4478575
Coatsworth, J., & Williamson, J. (2004). Always Protectionist? Latin American Tariffs from Independence to Great Depression. Journal of Latin American Studies, 36(2), 205-232. Retrieved from https://www.jstor.org/stable/3875614
Dakhlia, S., & Nye, J. (2004). Tax Britannica: Nineteenth Century Tariffs and British National Income. Public Choice, 121(3/4), 309-333. Retrieved from https://www.jstor.org/stable/30026543
Hughes, N. (2005). A Trade War with China? Foreign Affairs, 84(4), 94-106. doi:10.2307/20034423
Irwin, D. (1998). Higher Tariffs, Lower Revenues? Analyzing the Fiscal Aspects of “The Great Tariff Debate of 1888”. The Journal of Economic History, 58(1), 59-72. Retrieved from https://www.jstor.org/stable/2566253
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