The Economics of a Tariff

I’ve been recently discussing free trade with Celeste Drake.  Celeste is an attorney for the AFL-CIO and, as one might expect, an advocate of trade barriers against imported goods.

Previously, I wrote an article showing part of the reasoning behind how we know trade benefits the country who receives the imports.  However, since that article didn’t cover the impact of tariffs specifically I’ve decided to expand upon it here for Celeste’s reading pleasure and yours.

Tariffs

A tariff is a sales tax levied on an imported good.  Most sales taxes are levied at the cash register, but a tariff is levied at an earlier stage.  Here is how they work:

US economy Before the Tariff:

The US economy before the tariff

In this graph you see that some American producers who could have made the good in question won’t end up producing it.  Only US producers who are about as efficient as the rest of the world will make the good, and the rest of our demand is filled by imports.

 

US Economy After the Tariff

The added cost of the tax / tariff shifts the global supply curve.  As a result of the higher price the less efficient US producers who previously couldn’t compete now begin producing the tariffed good and are enriched at the expense of every American consumer paying a higher price.  Now domestic producers make more of the good in question, but at a cost.  The tariff raises the price of the thing being imported, so at a higher price the quantity demanded is less.  So now American firms begin producing at quantity Q3 & the American consumer demands the amount of goods supplied at quantity Q4.

In other words we make more of this item & buy less of it…. anyone seeing inefficiencies yet?

Tariffs2

Harm Of The Tariff

The last graph I’m going to show you is the same as the one above, but I’ve highlighted 3 areas.  The first is the government’s tax receipts from the tariff, which is obviously the amount the tariff added to the purchase price times the quantity sold (the number of units sold between Q4 & Q3).

The other 2 boxes added are the economic inefficiency created by the tariff… technically called the “deadweight loss.”  In the simplest terms this is a loss to one party in the trade (either consumers or producers) that is not offset by the other side getting a gain.  This loss comes from the transactions that would have occurred without the tariff, but under the tariff regime didn’t take place.  Under a tariff both worldwide producers & American consumers become poorer:

  1. American producers should have been producing only a quantity of Q1, but instead the tariff let wasteful / inefficient producers make the extra units between Q1 & Q3.  So, there are fewer total goods worldwide than we otherwise were going to get if we put those resource to a more efficient use.
  2. American consumers also got hurt by the tariff because instead of having the higher quantity (Q2) of goods they were only received quantity Q4, and at a higher price.

Tariffs3

 

Cui bono?  Who Benefits?

After having the losses caused by the tariff explained did you notice the only two groups who were NOT harmed?  Both are small, special-interest groups who benefited at the expense of the whole rest of the world & at the expense of every consumer in America.  I’ve already alluded to them above:

  1. The inefficient producers that American consumers didn’t prefer to buy from at quantity Q1, but who Americans settled for buying from at quantity Q3.  This special-interest group wasn’t good enough to compete with other more efficient producers elsewhere in the world.  Once the more efficient producers were penalized by the tariff that the inefficient American producers were exempt from, then they were able to sell their goods at a higher price (world price + tariff) than it was actually worth.
  2. The federal government bureaucrats whose paycheck exists by taking a skim off the top from tax receipts.