Tariffs Are Worse Than You Were Told

Media criticisms of tariff to protect American manufacturers from imported products have been only about how tariffs increase the products' prices. You may conclude from this that our government might as well raise revenues with import taxes that consumers pay through higher prices. But, higher prices on products that pay tariffs are not the only cost of tariffs. They also have serious side effects that damage our economic health.

Damages Done by Tariffs

They Reduce Productivity by Reallocating Resources to Less Productive Uses

Tariffs are often placed on products that cost more to make here than to import from less developed countries where wages are lower. Their wages are lower because the products they make are less technologically advanced, and not as valuable. Our wages are higher because we have industries that are more technologically advanced and have higher productivity, which makes them more valuable.

With less foreign competition, the tariff-protected industries expand production. This sucks up land, labor and capital resources from the other more productive business that do not get tariffs, which also increases the costs and prices of these businesses

These other businesses have higher productivity in the US than elsewhere because they can compete with foreign producers without tariffs, or they may be exporters. Therefore, tariffs reduce total productivity because resources move from more productive businesses to less productive ones. And lower productivity translates into lower real incomes and standards of living.

An equal sales tax rate on all products does not cause declines in productivity from inefficient allocation of resources. Tariffs do more harm than just an increase in prices because they are relatively high taxes on selected imported products that encourage the expansion of businesses with lower productivity at the expense of the ones with higher productivity, Effect of Trump Tariffs on Productivity.

They Reduce Business Competition

Tariffs also reduce the number of competitors in the market. Competition is what induces businesses to be “on their toes”, cutting costs and innovating to avoid being outsold by competitors. The more competition, the more innovation and productivity, and the lower the costs, thus the lower the prices to consumers and the higher their real income. It is that simple.

An Increase in Tariff Rates Invites Retaliation From the Affected Countries

Retaliations are usually done with the intention to remove the retaliatory tariffs if we remove our tariff rate increases. But frequently, negotiations to return to the previous tariff levels, if they succeed, take years. Meanwhile, all countries lose by lowering their productivity and degree of competition. This is the height of a mad form of mutual self-inflicted harm and intergovernmental dysfunction.

Reasons why Arguments for Tariffs Are Usually Invalid

Tariffs Create Jobs

Tariffs may be able to create some jobs at a time of high rates of unemployment. But most of the time, increasing a tariff helps the protected industry grow, which is accomplished by hiring people from other businesses. It is really amusing to hear tariff supporters praising their job creation benefits when the unemployment rate is under 4% and there are labor shortages. What were they thinking?

Tariffs Reduce the Balance of Trade Deficit

When individuals borrow money to spend (a form of capital inflow), if they already had a cash flow deficit, it increases, and if they had a surplus, it declines.

When nations get an inflow of monetary capital import spending increases in relation to export earnings. So its international balance of trade develops a larger deficit or a smaller surplus.

With nations, the reason why this happens is a little more complex to explain because each nation uses a different currency. And the mechanics of how trade balances are affected by international capital flows involves the exchange rates of one currency for another. So, please stay with me on this one. This is an example of how international capital flows affect the trade balance:

When the US government has a rising deficit, because its spending is increasing more than its tax revenues, it borrows money by selling dollar-denominated interest-paying bonds in the world markets. And the foreign buyers of these bonds have to purchase them with dollars that they buy with their country’s currency.

This increase in the demand for dollars and their value in relation to other currencies, which makes imports into the US cheaper, and exports more expensive to people in other countries. And this leads to more import volume and lower export volume. Therefore, more movement of monetary capital to the US to finance a US government deficit leads to an increase in the balance of trade deficit, or the reduction of any surplus.

So, those who wants to reduce the deficit in the balance of trade should start working on reducing the US government’s deficit.

Any other type of additional inflow of monetary capital, such as increases in foreign private investment or loans to US businesses creates a larger deficit or smaller surplus in the balance of trade. And any kind of outflow of monetary capital, such as increased US private business investments in other countries, or loans to them, reduces a trade deficit or increases a surplus.

This is why we say that international capital flows drive the balance of trade.

Now, let us examine Donald Trumps proposal to place a 10% tariff on all imported products (assuming it is in addition to existing tariffs). This tax would initially cause a decline in the volume of imports, therefore, a decline in the supply of dollars in the international currency exchanges, making the dollar worth more, which makes: (a) imports cheaper to Americans and (b) our exports more expensive to the rest of the world.

The reduction of import volume from the tariff would be partially offset by the rise in the value of the dollar that lowers import prices and increases import volume. And the rise in export prices to other countries reduces export volume.

In the end, the balance of trade would not be much affected. But there would be a reduction in both imports and exports. And this reduces the efficiencies that come from specialization by each country on the products that they can produced at the lowest cost. Video about why tariffs don’t reduce trade deficits

So, Why Do We Have Tariffs If They Are so Bad?

Because the process of governing a nation is inherently imperfect.

Tariff gains go to a concentrated organized and relatively small groups of businesses and their workers, in large enough amounts to each to make it worthwhile to pay for the lobbyist and campaign contributions needed to get a tariff.

But the retail price increases and declines in productivity from tariffs are spread among millions of unorganized consumers in amounts too small to make worthwhile the cost of organizing and contributing to oppose the tariffs. Yes, politics is largely driven by economic calculations (as if you didn’t already know).

Beneficiaries of tariffs could be business owners and their workers, or voters in a district with tariff-protected businesses. Their political allies could be (a) members of Congress who represent a district benefiting from tariffs, or (b) members of Congress and the President who get campaign contributions, and lobbyist paid to support the tariffs.

The people who have to pay for the cost of tariffs are just about everyone else. And their total cost is higher than what the beneficiaries get, because the reduction in productivity from tariffs is a net loss to the economy.

References:

This link lets you know about The Convoluted World of Tariff Rates and Rules

This link shows Who Has Authority to Impose Tariffs