The imposition of high tariffs by President Donald Trump yesterday suggests a review of the elementary economics of this sort of government intervention. A tariff (or tax) imposed by the government of country D (“domestic”) on a good G imported from country F (“foreign”) has three major effects.
First, the tariff increases the price of G in country D, including the prices of the Gs domestically produced: there cannot be two different prices for the same good in a free market. Second, the higher price of G in country D reduces its quantity demanded there but, in the usual simple model (and its college-level graphical representation), increases the proportion supplied by domestic producers. Third, consumers (or business input buyers and their own customers, up to the final consumers) in D are restrained in their preferred trades. Details and qualifications don’t change the gist of these conclusions. Consider:
(1) As economists know, it is not impossible that the price of G in D rises less than the tariff. If the residents of D consume a large part of the Gs produced in F, the reduction of the quantity demanded in D may push down the price of the imports—the producers in F “eating” part of the tariffs. What happens is that producers in F are losing such an important part of their market that consumers in D can bid down the price of G. This special case, which opens the possibility of an “optimal tariff” higher than zero, will not be frequent and will rarely cancel the whole price increase in D. Indeed, multiple economic studies have shown that American consumers paid most of the tariffs, if not all, imposed by Trump during his first mandate.
It may still be the producers of some goods imported into the United States (D) from Mexico or Canada (F) will absorb part of the tariff, but this will not generally be the case. That Donald Trump said he is sparing oil products from the highest tariffs announced yesterday would suggest that he himself, intuitively and confusedly, is somehow conscious that tariffs are generally paid by the consumers of the country whose government imposes them.
(2) Assuming, as economists do, that some individuals in D prefer the Gs produced domestically to those produced in F at equal price, quality, and brand reputation (“national preference”), the reduction in quantity demanded in D will first hit the Gs produced in F. This explains why producers (shareholders and workers) of G in country F will also suffer from the tariffs, and why they will lobby their government to retaliate against some other goods produced in D. To the extent that the residents of D have no (individual) “national preference” (they are simply free individuals in a free country or they can’t distinguish between gasoline produced from oil imported from bad Canadians and that produced by good Americans), the tariff may bring less new production in D and less reduction in imports than otherwise.
(3) From the perspective of human welfare, the third consequence—the reduction in trade among willing traders—is the most important even if it may not be immediately visible. Trade is the essence of economic (and social) life. Individuals specialize in what they do best (or least badly) and sell their products for lower prices than less efficient producers could quote. Buyers and final consumers thus obtain more for less: they sell their labor services to productive and competitive businesses at home and buy their goods from the most productive ones, whether the latter are in the same town, the same state or province, or across national borders. A tariff interferes with this process.
Competition and trade do create disruptions, but there is no other way to maximize general prosperity. Disruptions and commands by political authorities give no guarantee of that as human history tragically shows. At the limit, the alternative is between trade and war.
Trade retaliation only makes things worse. It is irrational from the point of view of general welfare: when you (the domestic ruler) hit your consumers in the face, I (the foreign ruler) retaliate by also hitting my consumers in the face.
For anybody without cognitive limitations, I believe, the elementary economics of trade is not very difficult to understand even if an effort is necessary. But here is something more difficult to learn, on the border of economics and moral-political philosophy. I fear it will be forever unknowable to Trump and all those who don’t clearly distinguish between collective and political choices on the one hand, and individual and private choices on the other hand. Competition and disruption (whether by trade, technological progress, change in consumer preferences, etc.) can, at least temporarily and locally, disadvantage some individuals. But from the perspective of general prosperity and human flourishing, it is better that any individual be constrained by the configuration resulting from the equal liberty of all individuals than to be bossed around by the coercive actions of a political ruler, whether a person or a collective.
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The Great Wall of America, by DALL-E (very imperfectly)
