What happens when a small country imposes a tariff?

Tariff Basics

A tariff is a type of tax levied by a country on an imported good at the border. Tariffs have historically been a tool for governments to collect revenues, but they are also a way for governments to try to protect domestic producers.

As a protectionist tool, a tariff increases the prices of imports. As a result, consumers would choose to buy the relatively less expensive domestic goods instead.

In today’s global economy, many products bought by consumers have parts from other countries or were assembled overseas. As a result, tariffs can also affect consumers of products that they believe were made in their home country.

Many economists, however, argue that tariffs create market distortions that can actually harm domestic consumers over time. They could also lead to the imposition of tit-for-tat tariffs among countries on their respective exports that could lead to a damaging trade war.

Key Takeaways

• Tariffs are duties on imports imposed by governments to raise revenue, protect domestic industries, or exert political leverage over another country.
• Tariffs often result in unwanted side effects, such as higher consumer prices.
• Tariffs have a long and contentious history, and the debate over whether they represent good or bad policy rages on to this day.

U.S. Tariffs and Free Trade

In today’s market-leaning global economy, tariffs have earned something of a bad reputation. Many economists argue that they are bad for the economy and harmful to consumers.

For instance, the Smoot-Hawley Tariff has been blamed for worsening the Great Depression in the 1930s. In an attempt to strengthen the U.S. economy during the Great Depression, Congress passed the Smoot-Hawley Tariff Act, which increased tariffs on farm products and manufactured goods. In response, other nations, also suffering from economic malaise, raised tariffs on American goods, bringing global trade to a standstill. Because of the tariffs during that era, economists have estimated that overall world trade declined about 66% from 1929 to 1934.

Since then, policymakers on both sides of the aisle have shied away from the use of trade barriers like tariffs and instead toward free-market policies that allow nations to specialize in certain industries and incentivize optimal efficiency. Indeed, the United States had not broadly imposed high tariffs on trading partners since the early 1930s.

This more-or-less laissez-faire approach to trade in the United States remained after World War II up until the election of President Donald Trump. Trump was one of a few presidents to speak openly about trade inequities and the threat of tariffs when he vowed to take a tough line against international trading partners, especially China, to help American blue-collar workers displaced by what he described as unfair trade practices. In addition to tariffs on Chinese imports, the Trump administration also levied taxes on products made in Canada, Mexico, and the European Union (EU), among others. These were subsequently rolled back by the Biden administration.

How a Tariff Works

Tariffs are used to restrict imports by increasing the price of goods and services purchased from another country, making them less attractive to domestic consumers. There are two types of tariffs:

• A specific tariff is levied as a fixed fee based on the type of item, such as a $1,000 tariff on a car.
• An ad valorem tariff is levied based on the item’s value, such as 10% of the value of the vehicle.

Governments may impose tariffs to raise revenue or protect domestic industries—especially nascent ones—from foreign competition. By making foreign-produced goods more expensive, tariffs can make domestically produced alternatives seem more attractive.

Governments that use tariffs to benefit particular industries often do so to protect companies and jobs. Tariffs can also be used as an extension of foreign policy: Imposing tariffs on a trading partner’s main exports is a way to exert economic leverage.

Tariffs can have unintended side effects. They can make domestic industries less efficient and innovative by reducing competition. They can hurt domestic consumers, since a lack of competition tends to push up prices. They can generate tensions by favoring certain industries, or geographic regions, over others.

For example, tariffs designed to help manufacturers in cities may hurt consumers in rural areas who do not benefit from the policy and are likely to pay more for manufactured goods. Finally, an attempt to pressure a rival country by using tariffs can devolve into an unproductive cycle of retaliation, sometimes known as a trade war.

The cost of tariffs is paid by consumers in the country that imposes the tariffs, not by the exporting country.

Trump’s Tariffs

The conversation about tariffs grew under then-President Trump as part of his economic policy, which was known as “America First.” This revolved around American protectionism, which typically means more tariffs.

The first tariffs imposed by the Trump administration were on solar panels and washing machines. Robert Lighthizer, the then-U.S. Trade Representative, announced that after consulting with the Trade Policy Committee and the U.S. International Trade Commission, Trump decided that “increased foreign imports of washers and solar cells and modules are a substantial cause of serious injury to domestic manufacturers.”

The first 1.2 million imported washing machines would be taxed at 20%, and the subsequently imported washers would be taxed at 50% in the following two years. For imported solar panel components, they would be taxed at 30%, with the rate declining over four years.

Soon after the tariffs on washing machines and solar panels were imposed, the Trump administration slapped tariffs on imported aluminum. After that, a 25% tariff on all imported steel was imposed in addition to the 10% tariff on aluminum in many countries.

What is notable here is that many of these countries were the United States’ top trading partners and allies, and they were not happy with these additional tariffs. In response, the EU issued a 10-page list of tariffs on U.S. goods, ranging from Harley-Davidson motorcycles to bourbon.

In a survey of economists conducted by Reuters, the Trump administration’s tariffs were very poorly received. Almost 80% of the 60 economists surveyed believed that the tariffs on steel and aluminum imports would actually harm the U.S. economy, with the rest believing that the tariffs would have little to no effect. All in all, none of the economists surveyed thought that the tariffs would benefit the economy.

So, did the Trump tariffs work in the end? According to economists from various nonpartisan and bipartisan think tanks, the answer is a resounding no. A CNBC study discovered that Trump’s tariffs actually hurt consumers greatly and equaled one of the largest U.S. tax increases in decades. Researchers have also found that the Trump tariffs lowered the real income of American workers and reduced gross domestic product (GDP) growth. In 2021, the Biden administration worked to undo many of these harmful trade barriers.

Companies affected by tariffs essentially have three options: Absorb the extra expense, increase prices, or move production to another country. In general, it is believed that Trump’s tariffs did more harm than good, costing companies billions of dollars and reducing the demand for exported goods that were hit with retaliatory tariffs.

Trump’s Tariffs Between the United States and China 

A few weeks after imposing these tariffs, fears of an all-out U.S. trade war seemed to be validated as the Trump administration imposed even more tariffs, this time on China. These tariffs came after the Office of the United States Trade Representative (USTR) released the results of its Section 301 investigation into China’s trade practices.

The 200-page report called out China’s use of preferential industrial policy to unfairly support Chinese firms, discrimination against foreign firms, and disregard for intellectual property.

Trump, in response to what he said were China’s unfair trading practices, imposed sweeping tariffs on $34 billion worth of Chinese goods. The tariffs targeted manufactured technology products from flat-screen televisions, aircraft parts, and medical devices to nuclear reactor parts and self-propelled machinery.

China promptly retaliated by imposing its own tariffs that targeted U.S. agricultural products such as pork, soybeans, and sorghum.

The Chinese tariffs targeted American farmers and big industrial-agriculture operations in the Midwest—the same political groups that voted for Trump in 2016 and, in theory, had the most influence on his policies.

The trade war continued after this, with both countries increasing tariffs—Trump in particular imposing levies on $200 billion worth of Chinese imports. The tariffs were also shown to reduce employment and economic output, impacting the overall U.S. economy and people’s livelihoods. The tariffs also did significant damage to relationships with other countries, particularly allies.

The U.S. trade deficit grew under Trump’s tariffs, from $481 billion in 2016 to $679 billion in 2020.

FAQs

What is an example of a tariff?

An example of a tariff could be a tariff on steel. This means that any steel imported from another country would incur a tariff—for example, 5% of the value of the imported goods—paid by the individual or business importing the goods.

What is the purpose of a tariff?

Tariffs are a way for governments to not only collect revenue but also protect domestic businesses. Tariffs increase the price of imported goods, making domestic goods cheaper in comparison.

Who benefits from a tariff?

The importing countries usually benefit from a tariff, as they are the ones imposing the tariff and collecting the revenue. Domestic businesses also benefit from tariffs because it makes their goods cheaper than imported goods, hence driving up the demand for their products.

How do tariffs hurt consumers?

Tariffs hurt consumers because it increases the price of imported goods. Because an importer has to pay a tax in the form of tariffs on the goods that they are importing, they pass this increased cost onto consumers in the form of higher prices.

How do tariffs affect you?

If you are a consumer, tariffs affect you because they result in an increase in the price of imported goods.

If you are a domestic producer, tariffs can help you by making your goods cheaper compared to international goods, thus helping your business.

If you export your goods to other countries that impose tariffs, this may reduce the demand for your goods, thus hurting your business.

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