Everyone who had the misfortune to see Trump’s various speeches on inauguration day got to see him explain that the word “tariff’ was the most beautiful word in the dictionary, only to catch himself and say, well, actually “God, religion and love” need to come first. – THEN would come tariff.
(Here’s the clip.)
Why is that word so beautiful according to Trump --- because tariffs are going to make us (the US) “…rich as Hell. It’s going to bring our country’s businesses back that left us.”
Before we get to the actual understanding of what tariffs are and do, let’s for a moment check out his assertion. Implicit in this assertion is that certain products that we used to produce we no longer produce because of imports. Actually, he was exaggerating. There is no question that many products produced in the US over the years have been subject to a great deal of successful competition from imports. I am old enough to remember when the VW was considered a curiosity and Japanese imports were considered really cheap excuses for cars. There are actually relatively few products that we don’t produce at all any more.
Here is a discussion of how and why the US has become too dependent on imports.
And to be fair, Trump’s support for protective tariffs has some historical evidence behind it. US industrialization began behind tariffs as early as 1816. 19th century industrialization in the US (and in places like Germany, France, Russia and Japan) was protected from (mostly British) competition by protective tariffs.
[A brief history of US protectionism, here.]
OK --- let’s get down to basics. A tariff is the tax imposed on goods that are imported into the United States. Say a car manufactured in Germany is imported into the United States with a value of $30,000. If the US were to impose a 10% tariff on that car, the importer would have to pay the German exporter $30,000 and then pay $3000 to the United States treasury. Note who pays it, the US importer. The US dealer who sells the car would have to pay the importer more than the $30,000 to give the importer some profit --- let’s say $1000 as well as the $3000 the importer paid the treasury. Final cost to the dealer --- $34,000.
[This example is ridiculously simplified. It assume the entire car was manufactured in Germany and shipped whole to the US. In fact, there are many components of cars produced in the US, that are imported and many “imported” cars have US components in them. For real details.]
Having spent $34,000 to buy a $31,000 car, the US dealer would have to decide how to sell the car. The US dealer would of course sell it at a higher price. Absent the tariff, the dealer could do a 20 percent mark up and offer the car for sale at $36,200. With the tariff, that same 20 percent markup would raise the price to over $40,000. That’s how tariffs work --- they raise prices.
Now, the goal from Trump’s point of view is that the amount of imports sold will fall dramatically and American consumers will switch from buying imported goods to buying domestically produced goods. In our automobile example, maybe the car dealer will stop offering those imports for sale and switch over to offering domestically manufactured cars. That is how a “protective” tariff is supposed to work. It’s supposed to protect American made products from foreign competition.
If that is all that would happen, there would be a balancing act between the growth of the businesses that are protected by the tariff and the higher prices that consumers would have to pay for the more expensive American versions. In the car example I just mentioned --- the $31.000 (non-tariff) price would force am American producer to charge something close to that to be competitive. With the tariff, an American competitor could charge, say anything below $40,000 and undercut the imports. In fact, with careful pricing, a seller of domestically produced cars can calibrate the price increase to low enough to be a better bargain the the imports, once the imports have been subject to a tariff. That’s how a protective tariff increases the demand for American produced products and at the same time contributes to a price increase.
[Virtually every economic forecaster believes that when Trump’s tariffs are in place, they will kick the rate of inflation upwards. The Federal Open Market Committee (FOMC) just concluded a meeting and ended up predicting a slowdown in growth and an uptick in inflation. See Fed decision recap: Powell says tariffs could delay progress on lowering inflation.] Please note --- nowhere in the very simplified story I just told is there any evidence that the foreign producer will “pay” the tariff.
But of course what I have just described is the first step in what might escalate into a full scale trade war --- THIS happened during the Great Depression. As it deepened from 1929-1931, country after country raising high protective tariffs against foreign producers or engaged in bilateral trade deals --- both aimed at keeping their domestic producers from having to cut back.. The US version was the Smoot-Hawley tariff of 1930---- which raised tariffs on average approximately 20%.
This was not the end of the story, however. Other countries imposed tariffs on US exports as retaliation. If “tariff” is Trump’s almost favorite word --- retaliation is definitely the favored word of those of us who think Trump’s tariffs would be a disaster.
During the Great Depression, other countries responded to Smoot-Hawley – Those tariffs by other countries led to U.S. exports falling from $7 billion in 1929 ($130 billion in today’s dollars) to $2.5 billion in 1932 ($58 billion in today’s dollars) Farm exports were down by one-third from their 1929 levels by 1933. International trade plummeted 65%.
That is what we in the US might experience as Canada, the EU and China respond in kind to our tariffs with tariffs of their own.
The reason trade wars are considered bad for the economy is because goods traded internationally are traded because they are produced relatively efficiently. Interfering with the free trade in goods, means the “protected” industries in the various countries that raise barriers are LESS efficient.
NOW --- in the early phases of industrialization when certain industries are just getting started in a particular country, there is an argument (and evidence) that protecting those industries until they can be competitive actually improves economic growth. But what Trump is up to is far from that, no matter how he tries to spin it.
Michael Meeropol is professor emeritus of Economics at Western New England University. He is the author with Howard and Paul Sherman of the recently published second edition of Principles of Macroeconomics: Activist vs. Austerity Policies.
The views expressed by commentators are solely those of the authors. They do not necessarily reflect the views of this station or its management.