What Trump’s talks on tariffs mean for you and me
Economics in News #1
Hello and Namaste! I am delighted to introduce a new series titled Economics in News under the Simplifying Economics category of our publication.
A little bit about this series…
In Economics in News, I will mainly be explaining technical terms, economic concepts, etc. that often pop up in news but appear too daunting. Occasionally, I would also like to challenge myself by helping you understand the economics behind news that do not have anything to do with the economy.
Let’s get started!
I recently finished an undergraduate course on International Economics, wherein we learned about tariffs in what seemed to me a completely new light.
Coincidentally, US President Donald Trump has also been in the news lately for his international trade policy decisions revolving around multiple new impositions of tariffs.
Considering how the two and two go together, what better an occasion to start off this series by talking about tariffs?
Let’s start by asking ourselves, “What are tariffs?”
A tariff can largely be categorized as a kind of trade barrier.
What’s a trade barrier? Obviously, it is something that hurts the trade taking place between two countries. But, how?
How do tariffs work?
Tariffs work in two ways, depending on whether they are being imposed on imports or exports.
Tariffs are essentially taxes slapped on to goods to increase their cost. And because the goods become costlier, less people are willing to buy them.
Import tariffs are taxes on imports. They inhibit the number of imports coming into a country. Meanwhile, export tariffs, being taxes on exports, put a curb on the number of goods being exported from a country.
How does a tariff obstruct international trade?
Since international trade is the movement of goods or services between countries, tariffs obstruct cross-border trade by doing precisely the above — decreasing imports and/or exports.
It is understandable that a country would impose tariffs on imports.
After all, when you buy goods, you have to pay the seller. In case of imports, you are the one who is buying, and a foreign country is the seller.
This means that you owe money to the foreign country.
So, more imports mean more outflow of foreign exchange or domestic currency, aka money!
Now, why a country would charge tax on its exports when the same exports bring in foreign exchange would be a good question.
One potential reason is that sometimes, domestic producers may be getting better prices for their products when they export them vis-à-vis when they sell them in the domestic market.
While the exports are cheap or valuable enough for foreign consumers to prefer them over the same kind of goods produced (if available) in their own country, these goods may become too expensive for the domestic consumers, if sold at the export price in the domestic market.
For example, let’s say that there are Chinese manufacturers producing toy cars and selling them at $5 per car.
From the point of view of a Chinese consumer, paying $5 for a toy car is too expensive. However, if a consumer in the US were to look at it, he/she may feel that $5 for a toy car is a reasonable price and would be willing to pay for it.
Since the Chinese manufacturers know that they won’t be able to sell their cars in their own country’s market, they may decide to export these toy cars to the US.
But, what happens to the Chinese consumers then? If all toy cars are exported to the US, then there would be none left for Chinese consumers.
The government doesn’t want its people to lose out on the consumption of toy cars. Therefore, it imposes a tariff or tax on the export of these toy cars, making them more expensive to sell in the global market.
Because the toy cars are now sold at say, $7 per car, consumers in the US may choose to not buy them at the increased price. Chinese manufacturers, hence, may decrease their exports and start turning their attention towards selling to domestic consumers.
Thus, to make sure that domestic consumers don’t lose out or have to lower their consumption because of a greater number of goods being exported, the government may impose a tariff on exports.
However, export tariffs are a lot more rare than import tariffs. Usually, when people use the word “tariff” in daily parlance, they are referring to import tariffs.
So, it’s that simple?
The government levies tax on imports and exports and this solves the problems of excess outflow of money (in case of imports) and/or lower domestic consumption (in case of exports)?
Well. It’s not that simple.
(But, hey. We’ll make it simple without being simplistic. Just for you.😌)
Tariffs, besides being classified as import tariffs or export tariffs based on the kind of goods on which they are imposed, can also be categorized in three other ways based on how they are calculated — (i) ad valorem, (ii) specific, or (iii) compound.
Ad valorem tariffs are those calculated as a percentage of the value of goods to be taxed.
Specific tariffs indicate a specified amount of money to be paid per unit.
Since economics tends to be a lot more digestible when chocolate is involved, say you are importing 100 bars of chocolate, and the specific tariff is Rs. 10 per chocolate bar. Here, you will be paying Rs. 1000 in total. On the other hand, if the tariff is Rs. 10 per chocolate bar plus 15 per cent, then this will be considered a compound tariff.
Compound tariffs are, thus, a combination of both ad valorem and specified tariffs.
But, how does all of this affect me?
The economy is a circular phenomenon. What affects one part of it, invariably goes on to affect all of it.
If Trump decides that he will tax the steel and aluminum being imported into the US, his move will first directly affect American companies and manufacturers. How? By making it costlier for them to import these metals.
Though the intent behind imposing tariffs is to protect the domestic manufacturers of steel and aluminum, companies who have been importing these metals may not be able to switch suppliers immediately.
Or, it may be possible that local suppliers do not produce steel or aluminum of the grade or quality required by US manufacturers.
Further, local suppliers may not have the capacity to increase their production at the required rate.
In the immediate short run, a majority of manufacturers may thus, probably go on importing these metals, which are now available only at a higher rate.
Because these companies now have to pay more to get the same quantity of raw material, they may be forced to raise the price of their manufactured goods.
This is where ordinary consumers like you and me come into the picture.
When those companies raise the price of their products, it becomes more expensive for everyone else in the subsequent supply chain to buy that product.
So, if you are living in the US, then any consumer product that uses steel or aluminum, e.g. motorcycles, cars, canned drinks like beer and soup, could potentially become more expensive.
That doesn’t sound fun at all!
Not only that, but the quantity supplied for consumption also decreases.
That means lesser cars, motorcycles, and canned drinks available for everyone in the market!
And lesser goods means lesser production, which could translate into layoffs and lesser jobs for those in the above industries.
No wonder economists advocate free trade and minimum restrictions.
Up next…
Understand tariffs with the help of a diagram, which will help you visualize precisely how tariffs can be damaging to not only domestic consumers, but also the world economy.
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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