It’s difficult to explain a complex topic in a single post so I will attempt this in two parts. First, I’ll address tariffs in general and why they are for the most part shortsighted. In a following post I’ll address Trump’s misconceptions about trade.

Let’s first try to understand why a country would impose restrictions on trade in the first place. Governments most commonly limit imports to protect industries in which the government either wants to promote growth or protect domestic employment. Those restrictions can take several forms:

• Specific or ad valorem tariffs. A fixed fee levied on one unit of an imported good, such as $200 on each computer, is known as a specific tariff. A tariff based on a percentage of a good’s value (e.g. 15% on each automobile) is an ad valorem tariff.
• These may be granted to companies importing goods a government would like to restrict (e.g. wine). By limiting the number of licensees, the government effectively limits the number of foreign competitors faced by domestic producers.
• Import quotas. Often used in conjunction with licenses, this is a restriction placed on the amount of a particular good that can be imported.
• Local content requirements. Instead of utilizing import quotas, a government can require that a certain percentage of a good be made domestically. The new USMCA agreement replacing NAFTA includes many such requirements.

Sometimes a government will impose a restriction based on national security or on public safety. Trump has claimed the former for his recently-enacted steel tariffs. The Japanese government cites the latter in prohibiting imports of various U.S. foodstuffs grown using pesticides. Countries will also sometimes use tariffs purely for retaliation, as we are seeing today by China as Trump accelerates his trade war with them. All these situations tend to be highly politicized and rarely substantiated on an economic basis.

Who benefits from tariffs? Initially the government and businesses in the protected industries. The government gains revenue from the levied duties. The companies benefit from rising prices due to reduced competition. Some may see a short-term increase in profits and may even increase hiring. Longer-term however, the effect on businesses and on consumers tends to be more negative. In a capitalistic global economy, artificially-limited competition supports inefficient producers who can command artificially higher prices. This can result in consumers paying more, reducing their disposable income and concomitantly their spending. Alternatively investors might eschew the domestic companies in favor of their stronger global competitors. The net effect in either case is to slow down growth in the local economy.

In an ideal capitalistic world there would be no tariffs. Companies would compete based on their resources, and governments would use the taxes from their earnings both to benefit their citizens and to support business growth. In such a model different countries would tend to grow industries that benefit from the natural resources together with the educational infrastructure in which they’ve invested, such as the coffee industry in Colombia or the financial industry in Switzerland. Governments that would like to develop an industry can make the needed investments and reap the rewards. India is an example of a country that has focused on developing a robust high-tech industry.

I support the goal of eliminating tariffs worldwide. However, in my opinion Trump’s goal of a zero balance of trade with each individual trading partner is illogical and his approach is impractical. More on that in a future post…