"It involves selectivity and judiciousness."
In normal times the words ‘tariff’ and ‘tariffs’ seldom figure in public discussions, the reasons being that they are technical words belonging to the world of fiscal policy. But these are not normal times, and sitting in the White House in Washington is a person who regards tariffs as parts of America’s arsenal of foreign-policy weapons. Thus, nowadays hardly a day passes without US and foreign media carrying stories about the imposition of new tariffs or tariff increases on a lengthening list of foreign countries. These include adversaries—led by Russia and China—and long-time allies such as Mexico, Canada, Japan and South Korea. Lead stories like “Trump Threatens Mexico,” “Trump to Slap Tariffs on $60 Billion Worth of Chinese Goods” and “Trump to Impose Tariffs on EU Aluminum Exports” have become familiar to televiewers and newspaper readers.
The president of the world’s most powerful country is so quick to impose tariffs on other countries’ exports—those of friends as well as adversaries—but he and his trade advisers don’t seem to be well versed in the economics of tariff policymaking. They seem to need to enroll in a Tariffs 101 course. I say this because of two tariff-related statements made by Mr. Trump. One was “A tariff is not a tax”; the other was “The tariffs (on Chinese goods) will be paid by the Chinese.” More serious misconceptions about the nature and impact of tariffs there couldn’t be.
When a fee or a charge or a levy is imposed by a government on an individual or an institution, you have a tax. Levies on imports from other countries go by another name—tariffs. Like all taxes, tariffs have to be paid. The tariffs will be directed at the individual or entity that exports the tariff-subject to the US. Who will eventually shoulder the US tariff—will depend on what economists call elasticity of demand, i.e., the degree of elasticity of demand for the product. If the product is price-elastic (highly sensitive to a change in price) or income-elastic (highly sensitive to a change in buyer income), the tariffed importer will be disinclined to pass the tariff on to the consumer and may decide to absorb the tariff, his profit margin in the process. If, on the other hand, the demand for the tariff-hit import is price-elastic and/or income-elastic, the US importer will be inclined to pass the tariff on to the consumer entirely or partially.
So, are Mr. Trump and his chief adviser correct in saying that the tariffs on the now-higher-tariffed Chinese goods will be borne by the Chinese? As explained above, it depends on the price and demand elasticities. If the US importers decide to pass the new or higher tariff on to the customers of Walmart, Costco and other retailers, it is the American consumer, not the Chinese exporter who will pay the tariff (tax, really). Considering that a considerable part of the US trade deficit with China consists of consumer-goods trade, the impacts of the higher US tariffs on American consumer welfare and price stability are obvious.
The concept of demand elasticity equally applies to higher US tariffs on Chinese production-goods exports. The only major difference is that in the case of American imports of Chinese machinery and other production goods, the issue of supply-chain stability comes to the fore; some Chinese production-goods exports may for one reason or another be difficult to replace. If such Chinese exports are price-inelastic or income-inelastic, the Trump tariffs or tariff increases will be passed on to—and be paid by—the American importers.
What all of the above means is that tariff policymaking involves selectivity and judiciousness. It cannot be done on a general, as-long-as-it’s-Chinese basis. If not done in a rational manner, a tariff program like the Trump administration’s can cause great harm and dislocation to a nation’s production sector. It goes without saying an American manufacturer faced with tariff-caused production cost increases will consider raising the prices of their products. There will be adverse repercussions for US competitiveness and consumer price stability.
The final part of Tariffs 101 is clear eye for the political fallout.
A crash Tariffs 101 course—that’s what Donald Trump and his trade and political advisers need to take.
