Although tariffs are in the news today, it’s astonishing how many people don’t know what they are or how they work. Briefly, a tariff is a tax a government levies on imports. It is not paid by the people of the country exporting goods, but by the people of the country importing the goods. A tariff is intended to raise — “inflate” — the prices of foreign goods for the presumed advantage of producers in the country which imposes the tariff; it “protects” domestic industry by artificially making foreign goods more expensive.
It works like this. People in Country A and in Country B both produce gollywumps. Gollywumps are luxury goods highly prized for the status they bring to those who purchase them. Unfortunately for the gollywump producers in Country A, their price to the consumer is $2.00, while gollywumps of equal quality imported from Country B cost the consumer $1.00. Naturally, people in Country A buy Country B’s gollywumps.
Under free market principles, the gollywumpers in Country A can do one of two things. They can either learn to produce gollywumps that can be sold for $1.00 or less, or they can go out of business. Under mercantilist principles, what Adam Smith deprecated in The Wealth of Nations (1776), they can persuade the government to forbid the import of gollywumps from Country B, or impose a tariff on Country B’s gollywumps to raise their price to the consumers of Country A.
The government of Country A decides to impose a 300% tariff on gollywumps from Country B. They figure consumers in Country A will do one of two things. 1) Stop buying Country B’s gollywumps formerly priced at $1.00 but which now cost them $3.00 and start buying Country A’s domestically produced gollywumps at $2.00, benefitting Country A’s gollywumpers. 2) Continue to buy Country B’s gollywumps at $3.00, with Country B’s gollywumpers still getting $1.00, but the government of Country A getting $2.00 from the consumers of Country A for every Country B gollywump sold in Country A.
Much to the astonishment of Country A’s government and gollywump producers, consumers simply stop buying gollywumps altogether. Gollywumps are, after all, a luxury good, and nobody really needs them. Besides, now that they cost so much, they are so five minutes ago, anyway. Country A’s gollywump producers declare bankruptcy.
Tariff Principle Number One: Tariffs don’t work when the tariffed goods are purely discretionary.
Suppose, however, that tariffs are imposed on essential goods, such as wheat. Cheap foreign wheat is making it impossible for farmers to sell their more expensive domestic grain at a profit. To protect domestic producers and keep the price of grain high, the government imposes a tariff on imported wheat. An example of this were the “Corn Laws” — tariffs on foreign wheat and other basic foodstuffs — in Great Britain, intended to prevent cheap foreign wheat from undercutting domestic producers.
The Corn Laws did no such thing. Instead, domestic wheat growers — mostly aristocrats with large estates — became increasingly inefficient, and food prices went up. At the same time, wages were going down as the Industrial Revolution took hold and advancing technology reduced the economic value of human labor. The poor were squeezed between rising food prices and falling wages.
Repeal of the Corn Laws in 1846 may have been a key factor in Great Britain avoiding much of the agitation that took place in the rest of Europe in 1848, “the Year of Revolution.” The repeal, a move by Sir Robert Peel in response to the Great Hunger in Ireland on which it had little effect, nevertheless continued the success of reforms like the Reform Act of 1832 and the Factory Acts which addressed social needs. This created a more stable economic and thus political environment.
Tariff Principle Number Two: Tariffs don’t work when the tariffed goods are essentials.
Suppose, though . . . no, don’t suppose anything. Tariffs don’t work as anything except as a form of economic warfare. Even in the best possible scenario, tariffs are not anything a government (or anyone else) should be playing around with. It does not increase tax collections, except in unusual circumstances, and then in generally unbeneficial ways.
The purpose of a tariff is not to raise revenue for the government per se, but to raise the prices of foreign goods to make the purchase of domestic goods more attractive to consumers if the foreign goods would otherwise be cheaper. A tariff is extremely regressive as it falls heavier on the poor who spend much more of their income on consumption than it does on the rich whose consumption expenses are sometimes negligible in comparison to those of the poor.
For example, a poor person may spend 100% of his or her income on consumption and still require assistance, while the most extravagant rich person might have difficulty spending even 0.1% of his or her income on consumption. Thus, a tariff that adds 25% to the price of a product could be an effective 25% tax on the poor, and an effective 0.0% tax on the rich.
In addition, tariffs are temporary measures intended to protect domestic production until domestic production can become competitive without tariffs. Tariffs only work when foreign goods are in direct competition with domestic goods. The idea is that when foreign goods are in direct competition with domestic goods, tariffs protect existing jobs and companies.
Because they create an unfair competitive advantage for existing domestic workers and companies, however, a tariff removes any domestic incentive to create more jobs or produce goods more efficiently. They increase incentives for foreign producers to become more competitive. They are also an incentive for domestic producers to raise their prices, not to decrease them and become more competitive.
Tariffs must therefore be temporary if a country wishes to remain competitive both domestically and in the global market. If tariffs are imposed on goods not produced domestically (i.e., there are no domestic substitutes), the result is purely inflationary. The higher the tariff, the greater the inflation; an importing country cannot at one and the same time impose tariffs and try to bring down inflation — it is a contradiction in terms.
Further, when tariffs are imposed on goods required by an importing country for its own production, the result is higher costs for domestic producers. This causes job loss and forces domestic companies out of business.
Some people like to cite the success of the McKinley tariffs of the 1890s in bringing the United States out of the Great Depression of 1893-1898. This is a fallacy. The tariffs made the situation worse than it otherwise had to be. Not greatly worse, admittedly, as the United States was then still largely an exporting country, and the harm was thereby minimized, although they didn’t help any, either. What brought the United States out of the Great Depression of 1893-1898 was not tariffs, but crop failure in Europe and bumper crops of wheat in the United States in the latter 1890s.
Instead of imposing tariffs, a better strategy would be to adopt the Economic Democracy Act. This could dramatically drive down the cost of domestic production, lowering prices without deflation, creating jobs, strengthening the currency, and making domestic goods more competitive naturally rather than punitively.
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