The US President, Donald Trump, threw a wrench into global trade markets when he announced steep tariffs on imported steel and aluminum, in addition to his previous action on dishwashers and solar panels.
The news affected the US Dollar and other USD-denominated assets. With volatility around the corner, there’s no better time to consider the impact of tariffs on international trade.
Before we talk about tariffs and its impact on international trade, let us first briefly look at the concept of international trade. International trade brings about an increase in the amount of products from which domestic consumers can choose, reduces the cost of the products as a result of increased competition while allowing domestic industries to export their products abroad. All these features of international trade seem to be beneficial, but free trade is not widely accepted by all parties as totally beneficial. In 2018, President Trump announced new tariffs on Chinese imports, which amount to billions of dollars. In retaliation, the Chinese government has also announced tariffs on U.S imported goods, such as pork and steel.
What is a Tariff?
In its simplest meaning, a tariff is a tax. A tariff adds to the price of imported products and it is one of the many trade policies countries enact.
Why Tariffs and Trade Barriers?
For one, developing countries impose tariffs on products to discourage their importation to protect infant industries and developing economies. On the other hand, advanced economies, despite their developed industries, also create tariffs for several reasons. Below are the top five reasons why tariffs are created:
- Protecting Infant Industries: many developing countries use tariffs as a strategy to protect infant industries. In such cases, the government will impose tariffs on imported products in industries it wants to encourage to grow. This pushes the prices of the imported products upwards and creates a favorable domestic market for locally made goods. This results in more competitive pricing and provides protection for local industries against the possibility of early failure. Furthermore, it creates more jobs/employment opportunities and allows developing nations to move from raw materials to finished products.
- Protecting Domestic Employment: when more products enter a country from abroad, this can become a threat to domestic industries. The increased competition between imported and domestic goods can make domestic industries reduce their workforce and/or take their production abroad to mitigate costs. The result of this can be higher rates of unemployment.
- Protecting Consumers: a government may impose a tariff on products it feels possess potential health risks. An example of this would be a tariff on imported cigarettes or certain foods products, if it feels the product is not healthy for their citizens.
- National Security: developed countries also use barriers in the form of tariffs to protect certain industries it feels are strategically important, such as those supporting national security. These industries are of great interest to the government, and therefore, enjoy a great deal of protection.
- Retaliation: if a country feels its trading partner has deviated from the rules, it can also set tariffs as a retaliation technique. A good example is the Chinese government’s tariff on imported pork and steel from the U.S in response to their tariff on Chinese imports.
Different Types of Tariffs and Trade Barriers
- Specific Tariffs: this is a fixed tariff on an imported product. A specific tariff varies from one product to another.
- Ad Valorem Tariffs: ad valorem, a Latin phrase meaning “according to value,” and this type of tariff is imposed on a product depending on a percentage of the value of that product.
Non-tariff barriers to trade include:
Licenses: the government can grant a license to a business despite a restriction on a particular product to allow them to import a product into the country. This restricts competition and increases costs for consumers.
Voluntary Export Restraints (VER): as the name implies, this type of trade barrier is “voluntary” and it is created by the exporting country and not the importing one. It is usually imposed at the request of the importing country.
Import Quotas: the restriction on the quantity of a particular product that can be imported is called import quota. A barrier like this is usually associated with the issuance of licenses.
Local Content Requirement: rather than imposing a quota on the number of products that can be imported, the government of a country may encourage the domestic production of a certain percentage of such product.
Since the 1930s, a lot of developed countries have made concerted efforts to reduce tariffs and trade barriers, leading to improved global integration and globalization. However, the impact of increased tariffs and trade barriers on international trade will shift over time with a short and long-term effect on businesses, consumers, and government. In the short term, the higher cost of imported products will compel individual consumers and businesses to reduce consumption and dependency on such products. The government will record an increased revenue from duties and some businesses will profit for a period. However, in the long run, there may be a decline in efficiency by these businesses since there will be reduced competition. They may also begin to lose margin and market share when alternative products begin to emerge.
In conclusion, free trade benefits consumers via reduced prices and increased choices. However, since the global economy has its uncertainty, various governments impose tariffs and other trade barriers to protect domestic industries. This helps the government creates a balance between the quest for efficiencies and the need to ensure low unemployment.
Compliments of Jaguar Freight, a member of the EACCNY.