What Are Tariffs and How Do They Effect the Economy?

In my article The Softwood Lumber Dispute we saw an example of a tariff placed on a foreign good. A tariff is simply a tax or duty placed on an imported good by a domestic government. Tariffs are usually levied as a percentage of the declared value of the good, similar to a sales tax. Unlike a sales tax, tariff rates are often different for every good and tariffs do not apply to domestically produced goods.

The upcoming book Advanced International Trade: Theory and Evidence by Robert Feenstra gives three situations in which governments often impose tariffs:

To protect fledgling domestic industries from foreign competition.
To protect aging and inefficient domestic industries from foreign competition.
To protect domestic producers from dumping by foreign companies or governments. Dumping occurs when a foreign company charges a price in the domestic market which is "too low". In most instances "too low" is generally understood to be a price which is lower in a foreign market than the price in the domestic market. In other instances "too low" means a price which is below cost, so the producer is losing money.

The cost of tariffs to the economy is not trivial. The World Bank estimates that if all barriers to trade such as tariffs were eliminated, the global economy would expand by 830 billion dollars by 2015. The economic effect of tariffs can be broken down into two components:

The impact to the country which has a tariff imposed on it.

The impact to the country imposing the tariff.

In almost all instances the tariff causes a net loss to the economies of both the country imposing the tariff and the country the tariff is imposed on.

Impact to the economy of a country with the tariff imposed on it.

It is easy to see why a foreign tariff hurts the economy of a country. A foreign tariff raises the costs of domestic producers which causes them to sell less in those foreign markets. In the case of the softwood lumber dispute, it is estimated that recent American tariffs have cost Canadian lumber producers 1.5 billion Canadian dollars. Producers cut production due to this reduction in demand which causes jobs to be lost. These job losses impact other industries as the demand for consumer products decreases because of the reduced employment level. Foreign tariffs, along with other forms of market restrictions, cause a decline in the economic health of a nation.

The next section explains why tariffs also hurt the economy of the country which imposes them.

Be sure to continue to page 2 of The Economic Effect of Tariffs