How a single country’s tariffs can result in the entire world economy losing out
Economics in News #2
In the previous and inaugural post, “What Trump’s Talks on Tariffs Mean for You and Me,” of the Economics in News series, I explained what are tariffs, their types, and how they are calculated.
Considering US President Donald Trump’s recent imposition of tariffs making the news, I also discussed how consumers living in the US would be impacted by tariffs imposed on steel and aluminum.
But what if you, like me, live in some other corner of the world? How would tariffs imposed on imports into the US affect us?
Alternatively, how would they affect the functioning of the world economy?
In this article, I have attempted to offer a clearer idea about the various effects of tariffs with the help of good old economics and a diagram, which will make it easier for you to visualize precisely how tariffs are actually damaging for the economy.
Let’s start by taking an example.
Say that the price of steel in the global market, i.e. the price at which you can buy or sell steel from other countries, is ‘Pw,’ which alternatively stands for “world price.”
When say the US imposes a tariff on steel, the price of steel in the US would go up by the amount of the tariff.
This will result in an increased price of steel, in the US, which will be equal to ‘Pw +t,’ where ‘t’ is the tariff amount.
Going back to when there were no tariffs, US firms that needed steel could buy 100 units of steel at price ‘Pw.’
However, US manufacturers of steel were only able to supply 20 units of steel.
So, US firms would bridge that gap between excess demand and insufficient supply by importing the 80 (=100–20) units of steel.
(I know the diagram looks scary, but if you keep reading, you’ll realize it’s really not.)
However, with an increase in the price to ‘Pw + t,” the US can now only afford to buy 70 units of steel.
Meanwhile, at an increased selling price of ‘Pw + t,’ US manufacturers are able to increase their production and supply to 40 units.
With a decreased demand and an increased domestic supply, US firms now have to import only 30 (=70–40) units of steel.
Thus far, it appears that the US firms that need steel will now have to pay a higher price, whereas US manufacturers of steel will now be able to get a higher price for that steel.
It seems that these domestic producers are the main beneficiaries, whereas only the US firms requiring steel are losing out by paying more.
However, if you observe this situation closely, you will realize that those US firms that could once have produced goods with 100 units of steel, can now only produce 70 units of steel worth of goods.
This decreased supply of raw material translates into decreased production of goods. Less goods produced means less goods available for consumers in that country. Less goods available means lesser consumption.
Lesser consumption… Well, theoretically, when consumers have lesser choices for consumption, it usually means a lesser standard of living or lesser consumer welfare, which is not good for the economy or any country.
(Psst… So, it’s not just US consumers who are losing out.)
From this, we understand that economics says that tariffs lead to lesser goods available in the market.
This combination of lesser supply and increased prices means that these relatively scarcer goods will only find a home in the hands of those you can really afford to spend the money to buy them.
Getting our head around the entire picture…
For a moment, let’s shift our focus to the other stakeholders involved here.
We observe that when tariffs are imposed on imports, the winning parties are the domestic suppliers and the government, which earns tax revenue through tariffs.
(This tax revenue is equal to the quantity of decreased imports, i.e. 30 units, multiplied by the tariff per unit, i.e. ‘t,’ and has been shown as the orange box in the above diagram.)
Meanwhile, domestic consumers lose out. What’s more is that the economy as a whole also loses out because of a phenomenon called “deadweight loss.”
Deadweight losses, as seen in the above diagram, occur when the winning party or parties win or earn less than the loss suffered by the losing party or parties.
So, US manufacturers of steel may be earning more now. The government may also be earning more revenue. However, US firms requiring steel have lost way more earnings than both of them.
(To better understand deadweight losses, check out this video that helped me when I first began learning about tariffs: “Tariff — Trade Protectionism by EconplusDal on YouTube”)
Since the increase in the earnings is less than the loss of earnings, it essentially means that the economy as a whole is worse off than it was before the imposition of the tariff.
Further, since domestic suppliers are producing more only because of the increased price, it means that more efficient suppliers elsewhere is the world, who could afford to produce and sell at a lower cost, are losing out.
What does that mean? It means that we are using up more of the world’s resources to produce lesser goods than before.
This translates into the entire world economy losing out.
So, cars, canned drinks, and motorcycles?
You get where this is going.
Up next…
We have seen the dangers that tariffs pose — on consumers, on the country imposing them, and on the world as a whole. Next, we will go deeper into the reasons why a country would impose tariffs and try to understand its rationale behind the same.
In the meantime…
If you feel that you are better off for having read this article, then the next time your eyes scan the headlines and you spot the word “tariff,” take a couple of seconds to mentally send us some love and blessings.
You can also make our day by sharing your feedback and suggestions in the Comments section below. After all, learning is a two-way process, and we would appreciate all the help we can get!
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