Tariffs: A Double-Edged Sword That Cuts the One Who Wields it

Tariffs have grabbed the headlines ever since US President-elect Donald Trump’s election campaign. Countries are busy strategizing to brace for higher tariffs and engaging bilaterally with the US to avoid the imposition of this trade barrier. There are, however, several loud and glaring fallacies around tariffs and it’s time we talked about this to avoid logical missteps.

Tariffs Cut Both Ways

It’s not just exporting countries that benefit from free trade. Importing countries do too. Free trade raises incomes for both trading partners. Tariffs kill them.

Obsessive for Exporters

This is a no-brainer and the very purpose of imposing tariffs. They make goods exported by the targeted country more expensive and, therefore, less competitive. An increase in price adversely impacts demand for the goods exported.

Unintended Side Effects on the Imposing Country

Restrictions on free trade harm the very people they aim to protect. The burden of tariffs is on domestic consumers and producers, and not the exporting country. Tariffs artificially raise the price of imports. Higher consumer spending means lower savings and investments for the economy.

Tariffs are even more detrimental for developed countries, as most of the goods they import are intermediate products, purchased as inputs by businesses. Higher tariffs translate to higher input costs for companies, impacting their profit margins. Companies try to pass on the cost of tariffs to consumers, resulting in higher prices.

Businesses that are unable to transfer the cost of tariffs to consumers may try to protect their bottom line by reducing wages. This, too, reduces savings and investments in an economy.

Industries that are “protected” have no incentive to strive for high efficiency. Faced with no foreign competition, these companies are free to hike prices. This is why consumer prices often rise much more than the cost of tariffs levied.

Tariffs also results in resource allocation towards the protected industry or industries, which may be away from what consumers desire and demand.

Tariffs Are Not an Economic Tool

For decades, governments have promoted tariffs as a “protectionist” tool. The case is made on the grounds of protecting domestic producers from competition from cheaper foreign goods. Nothing can be further from the truth, unless the aim is to “protect” economies from progress!

Here’s the real reason. Just like all taxes, tariffs are a source of revenue for the government. Surprisingly, this is also not the leading reason for levying tariffs. They are mainly used as a tool to exert political leverage over another country.

Tariffs Intensify Recessionary Pressures

While tariffs are a geopolitical tool, they have grave economic consequences. Contrary to popular belief, protectionism does not create job opportunities. Faced by the Great Depression, the US passed the Smoot-Hawley Tariff Act in 1930, which raised tariffs on around 20,000 imported items by 40%-60%. The objective was to promote domestic businesses and trigger job creation. The tariffs had just the reverse effect. This is because other countries retaliated by raising tariffs on exports from the US.

The net effect was intensified recessionary pressures and the unemployment rate skyrocketing to 25% of the workforce.

The US wasn’t the only country to suffer from increased tariffs. Other countries retaliating caused global trade to contract by 65%.

Similarly, when the US imposed higher tariffs on China in 2018, retaliatory tariffs resulted in a 3.3% decline in US manufacturing output, leading to layoffs.

Triggering Economic Growth

If the US imposes tariffs, it will have implications for the global economy. After all, the US has been the world’s largest consumer for over a century, as the country has a much greater propensity to consume than it can produce.

To support businesses and spark economic growth, a government should negotiate with other nations to cut tariffs. Currently, tariffs imposed by the US is significantly below the global average. The country has a tariff rate of around 1.5%, versus more than 4% by the Middle East countries, almost 6% by India, and around 14% by Venezuela and Nigeria. Pressuring these countries to lower tariffs will help domestic businesses in the US.

Free Trade Benefits All

Over the last few decades, the volume and value of global trade have grown exponentially, with a decline in tariffs and other trade barriers. Free trade gives more choices to consumers at lower prices and forces businesses to strive for greater efficiency and innovation.