From Mike Moffatt, Your Guide to Economics.
How Tariffs Affect The Economy
In my article The Softwood Lumber Dispute we saw an example of a tariff placed on a
foreign good. A tariff is simply a tax or duty placed on an imported good by a domestic
government. Tariffs are usually levied as a percentage of the declared value of the good,
similar to a sales tax. Unlike a sales tax, tariff rates are often different for every good and
tariffs do not apply to domestically produced goods.
The upcoming book Advanced International Trade: Theory and Evidence by Robert
Feenstra gives three situations in which governments often impose tariffs:
• To protect fledgling domestic industries from foreign competition.
• To protect aging and inefficient domestic industries from foreign competition.
• To protect domestic producers from dumping by foreign companies or
governments. Dumping occurs when a foreign company charges a price in the
domestic market which is "too low". In most instances "too low" is generally
understood to be a price which is lower in a foreign market than the price in the
domestic market. In other instances "too low" means a price which is below cost,
so the producer is losing money.
The cost of tariffs to the economy is not trivial. The World Bank estimates that if all
barriers to trade such as tariffs were eliminated, the global economy would expand by
830 billion dollars by 2015. The economic effect of tariffs can be broken down into two
• The impact to the country which has a tariff imposed on it.
• The impact to the country imposing the tariff.
In almost all instances the tariff causes a net loss to the economies of both the country
imposing the tariff and the country the tariff is imposed on.
Impact to the economy of a country with the tariff imposed on it.
It is easy to see why a foreign tariff hurts the economy of a country. A foreign tariff
raises the costs of domestic producers which causes them to sell less in those foreign
markets. In the case of the softwood lumber dispute, it is estimated that recent American
tariffs have cost Canadian lumber producers 1.5 billion Canadian dollars. Producers cut
production due to this reduction in demand which causes jobs to be lost. These job losses
impact other industries as the demand for consumer products decreases because of the
reduced employment level. Foreign tariffs, along with other forms of market restrictions,
cause a decline in the economic health of a nation.
The next section explains why tariffs also hurt the economy of the country which imposes
them. The Effect of Tariffs on the Country Imposing Them
Except in all but the rarest of instances, tariffs hurt the country that imposes them, as their
costs outweigh their benefits. Tariffs are a boon to domestic producers who now face
reduced competition in their home market. The reduced competition causes prices to rise.
The sales of domestic producers should also rise, all else being equal. The increased
production and price causes domestic producers to hire more workers which causes
consumer spending to rise. The tariffs also increase government revenues that can be
used to the benefit of the economy.
There are costs to tariffs, however. Now the price of the good with the tariff has
increased, the consumer is forced to either buy less of this good or less of some other
good. The price increase can be thought of as a reduction in consumer income. Since
consumers are purchasing less, domestic producers in other industries are selling less,
causing a decline in the economy.
Generally the benefit caused by the increased domestic production in the tariff protected
industry plus the increased government revenues does not offset the losses the increased
prices cause consumers and the costs of imposing and collecting the tariff. We haven't
even considered the possibility that other countries might put tariffs on our goods in
retaliation, which we know would be costly to us. Even if they do not, the tariff is still
costly to the economy. In my article The Effect of Taxes on Economic Growth we saw
that increased taxes cause consumers to alter their behavior which in turn causes the
economy to be less efficient. Adam Smith's The Wealth of Nations showed how
international trade increases the wealth of an economy. Any mechanism designed to slow
international trade will have the effect of reducing economic growth. For these reasons
economic theory teaches us that tariffs will be harmful to the country imposing them.
That's how it should work in theory. How does it work in practice?
Empirical Evidence on the Effect of Tariffs on the Country Imposing
Study after study has shown that tariffs cause reduced economic growth to the country
imposing them. A few of examples:
1. The essay on Free Trade at The Concise Encyclopedia of Economics looks at the
issue of international trade policy. In the essay, Alan Blinder states tha