Tariffs and Import Duties- Effects on Industries and Other Economies, Costs and Benefits of a Tariff

This paper evaluates the impact of tariffs and import duties on industries and economies. It assesses the costs and benefits associated with the imposition of tariffs and import duties and their cascading effects on other economies. The ongoing US-China trade war is evaluated as a case study.

Running Head: INTERNATIONAL TRADE AND ENTERPRISES
Topic:
Tariffs and Import Duties- Effects on Industries and Other Economies, Costs and
Benefits of a Tariff

INTERNATIONAL TRADE AND ENTERPRISES 2
ABSTRACT
The advent of Globalisation is as old as humanity. Mankind has been known to share
knowledge, culture, traditions and goods and services even before Money was introduced.
Even if humans were not aware of money, they were aware that “there is no such thing as
free lunch”, hence the system of barter exchange was followed. The sharing was not limited
within clusters or regions or within specific countries. It was spread all over the World.
Vasco Da Gama has been known to take a tour around Africa seeking monopoly rent from
Spice traders of Arab. Christopher Columbus found America during his quest for Spices.
When all these discoveries were made, mankind not only realised about their endowment of
resources but also realised that they can always be better off if they link with economies and
share with them. Meanwhile, David Ricardo explained the concept of comparative advantage
to his fellow humans and emphasised upon efficiency in production and consumption if the
countries produced the goods in which they have a lower opportunity cost. This would not
only help in international trading but also make each countries better off. As the economies
started to trade, some economies became suspicious about the benefits of trade and thought of
imposing trade restrictions in the form of tariffs and import duties. The purpose of the paper
is to assess the impact of tariffs and import duties on the industries and other economies. The
paper will evaluate the costs and benefits associated with the imposition of tariffs and import
duties and what are its cascading effects on other economies. The impact will be evaluated by
assessing the ongoing US-China trade war.

INTERNATIONAL TRADE AND ENTERPRISES 3
INTRODUCTION
For the purpose of protecting the countries from foreign competition and dumping of
foreign goods at cheaper prices, the importing countries started to impose tariffs and import
duties. Tariffs restrict import of goods and services by increasing the price of the goods being
imported from foreign countries which makes it less attractive for the consumers in home
country. Tariffs are also as a source of revenue to the home Government and act as a
protection to the infant domestic industries (Staff, 2018). Import duty is a type of tax,
collected when the foreign goods enter the home country. The tax depends on the value of the
goods being imported (Staff, 2018). Tariffs and Import duties act as trade barriers, both for
the home country (the one imposing the tariff) and the foreign country (the one on whom
tariff is imposed) (barriers, 2018).
Trade barriers were imposed because of the popular myth that trade barriers benefit
the economy but the reality is that trade barriers benefit only the industry which the
government is trying to protect at the expense of consumers, other industries and other
countries.
Literature Review
Many papers have been written to validate the effects of tariffs and import duties on
the industries and other countries. The debate on whether free trade is beneficial or not is
going on since ages. From Ancient Greeks to the 21st Century economists, merchants,
manufacturers and consumers have been pondering if trade brings harm or benefits.
Adam Smith propounded the theory of free trade in the 18th century and the British
converted themselves to free markets in 19th century. This was a big significant change
because British traders were rigid about their protectionism policies and to repeal their corn
laws, they opened to free trade. Free trade is nothing but the act of buying foreign goods and

INTERNATIONAL TRADE AND ENTERPRISES 4
services at the market price, i.e. without any restrictions or tax. In their paper Dakhlia & Nye
(2004) computes a general equilibrium model to simulate the drop of British tariffs to zero.
They assessed that the tariffs being imposed by them was way above the optimum tariff level
and these tariffs were resulting in welfare loss. The removal of British tariffs resulted in net
welfare and asserted that their policy was inconsistent with the theory of pure trade.
Before the onset of the Great Depression, the tariffs imposed by the Latin Americans
were among the highest in the world. During the 1920s, it was Latin America who exploited
globalisation the most but by 1930s, it was Latin America itself who became the most Anti-
Global. Tariffs are imposed not only to protect the domestic industries but also to meet the
revenue needs of the Government and to balance the trade deficit. Coatsworth and
Williamson (2004) researched about the wide changes on tariff impositions in Latin America
and according to them – during the decade before the Great Depression (1914), tariffs were
rising in Latin America. The question arose that if Latin America favoured globalisation, then
why were tariffs so high before World War? The paper suggests that the Great Depression
acted as a turning point and the imposition of high tariffs helped the domestic producers who
were competing in the foreign market and made their share in the export oriented economy.
Latin America had more revenue needs than the protection of domestic countries.
Irwin (1998) analyses the fiscal aspects of the great tariff debate of 1888. After the
Civil war was over, the U.S. government had accumulated high public debts. To repay the
debt, high tariffs were imposed – it would raise the required revenue and also protect
industries. By 1880s, FED had a huge budget surplus and both the Democrats and the
Republicans were against the tariff policy. According to the Republicans, a lower import duty
would lead to increas e in imports and reduced the surplus but nothing could be clearly said
about the tariff recipients. The elasticity of demand for imports and the elasticity of supply of
exports plays a huge role in determination of tariffs and import duties.

INTERNATIONAL TRADE AND ENTERPRISES 5
Broda, Limao and Weinstein (2008) observed that before World Trade Organisation
was set up, countries tend to set tariff rates 9 percent higher for goods with high inelasticity
of supply (imports) as compared to the ones which had high elasticity. They assessed that the
variations in tariff can be easily explained by market power. The US trade restrictions were
higher for the goods which were not covered by the WTO and also for the ones where the
importers had huge market power. They find that the non-cooperative trade policy of a
developed country like USA is strongly affected by the market power. For instance, the goods
in which US had high market power, the statutory tariffs were 27% points higher in those
goods.
Cantor, Laffer and Turney (1982) stated that a stagnant economy cannot be recovered
with the help of tariffs, import duties and other trade barriers but from removal of these. If the
US and Europe were to recover their ailing industries from stagnation then the solution does
not lie in extending the damage to other countries by imposing further trade restrictions. The
solution lies in reducing the barriers of trade between the economies. No country is made
better off by pulling down the other one.
Baldwin (1960) asserts that imposition of tariffs effects the terms of trade of a
country. The way in which the government spend the proceeds from tariffs does not impact
the domestic offer curve of the country. According to Baldwin, the international offer curve
shifts and the amount of exports that foreign traders are willing to buy for a given level of
imports for a given ratio of domestic price is same under tariff conditions and free trade
conditions.
U.S has been sceptical about the free trade policies ever since. It has often accused
free trade for increasing the competition for domestic producers and blamed the immigrants
for stealing jobs from the Americans. Hughes (2005) discusses that the misunderstandings

INTERNATIONAL TRADE AND ENTERPRISES 6
between US and China have led to a trade war. The growth rate of China have been
consistent around 9% and US has accused China of selling its own goods at unfair prices to
the foreign countries, of keeping labour wages low which allows them to produce at cheaper
cost than other countries and of not meeting the commitments to the WTO. All these
accusations are not meritorious but they were enough to open a trade war. China is a hub of
foreign manufacturers and most of these companies are American. Production costs in China
is lower as compared to other countries and this incentivised foreign firms to move their
production to China.
Costs and Benefits of Tariffs and Import Duties
Tariff acts as an addition to the total cost of imported goods and services. Since the
election of Donald Trump as the President of United States, USA has adopted an anti-trade
policy and has started to impose huge tariffs and import duties on the import of goods and
services from foreign countries (Radcliffe, 2018). Free trade increases the number of goods
and services available to the consumers and makes them better off but not every country
favours free trade.
Tariffs are of many kinds:
 Ad Valorem tariffs
 Import Quotas
 Specific tariffs
 Voluntary export restraints
 Licenses
 Local Content Requirements
These tariffs have their own costs and benefits. When a Tariff or an import duty is
imposed then it not only affects the producers and the consumers but also the government and

INTERNATIONAL TRADE AND ENTERPRISES 7
the workers. Let’s assume that US has imposed tariffs on import of plastic goods from China.
This will increase the price of plastic goods in USA for the consumers but it will also benefit
the producers of plastic goods in China as consumers will find it cheaper to purchase the
goods manufactured in USA rather than in China. Consider the following graph:
In the graph above, price before the imposition of tariff is P1. After tariff, the price
has increased to P2 - the quantity demanded has fallen from Q4 to Q3 and quantity supplied
by the domestic producers has increased from Q1 to Q2. The imports before tariffs were Q4-
Q1 and the imports after tariff is Q3-Q2. The increase in prices due to tariffs increases the
cost to the consumers. Shaded region 1234 is the loss to the Consumer Surplus (2018).
It also affects the Government and the Producers. Considering the graph below:

INTERNATIONAL TRADE AND ENTERPRISES 8
The imposition of tariffs has a positive effect on domestic producers. The increase in
prices, incentivises the producers to increase their production and the inefficient firms are
encouraged to produce for the domestic market. However, this may not help the domestic
firms to grow in the long run. The shaded region 1 is the increase in producer surplus after
tariffs – as the production rises from Q1 to Q2.
If optimal tariff is imposed then the government might earn some revenue. It also
depends on the elasticity of the goods being imported. If the good being imported is demand
inelastic then the government’s revenue will rise. However if the good is elastic and the tariff
is too high, then the US consumers might not import at all and no revenue will be earned by
the US government. In the figure, the imposition of tariff increases government revenue –
non shaded region 3. Net welfare loss in the home country is area 2 and 4.
The argument to support tariff imposition is that it provides employment in the
domestic countries. However, tariff imposition has a cascading effect. If US imposes tariffs
on Chinese imports then China will retaliate by imposing tariffs on US exports. It will not
only effect US and China but also the other countries who are trading with US and China.
The diffused costs (loses) due to tariffs and import duties are far greater than the concentrated

INTERNATIONAL TRADE AND ENTERPRISES 9
benefits arising in the domestic country by protection of infant industries and employment
generation ("Why Tariffs Get Passed—Even Though They Harm Way More People than
They Help) | Ryan Young", 2018).
In his paper “Trade Restrictiveness and Deadweight Losses from US Tariffs” Irwin
(2010) calculated the trade restrictiveness index which showed that after the Civil War the
static deadweight loss generated by the imposition of US tariffs was 1% of GDP and it fell
continuously after that. However, the welfare loss induced by import duties were 40 cents for
every $1 of revenue generated.
The Ongoing Trade War
Even before Donald Trump started “Make in America” campaign, America has been
levying taxes and tariffs to protect its industries. American Revolution was driven by
“Taxation without representation”. The harshest retaliation was the Embargo of 1807, in
response to the British aggressions. It was tariffs imposed on all manufactured imports from
Abroad. Another remarkable protectionist measure was by President Hoover who enacted the
Smoot-Hawley Act in 1930 to protect the domestic industries. It turned disastrous not only
for America but also for other global trading countries (Smith, 2018).
Now, we have Donald Trump engaging in a Trade War with China because he wants
to prevent the transfer of American technology and property rights to China and protect the
jobs of the Americans. China is accusing America of starting the largest trade war. In 2017,
Trump withdrew the Trans-Pacific Partnership Trade Pact which now prevents the free trade
of goods and services. Other than this- three tariff rounds worth $250 billion of goods have
been imposed on Chinese goods. Beijing has retaliated to this in kind. If the two countries
will not come to a deal then the taxes will start from 10% and rising to 25% in 2019. Trump

INTERNATIONAL TRADE AND ENTERPRISES 10
has threatened to impose new tariffs worth $267 billion goods if China retaliates ("US-China
trade row: What has happened so far?", 2018).
This trade war will affect the entire global market. According to IMF the global worth
would be reduced by 0.5%. China will definitely lose on $200 billion worth of exports. Other
than this 4 million workers are on the verge of losing their jobs and there is a prediction of 2
to 3 year slack period for the firms.
U.S will also lose both politically and economically. It is expected to lose $50 billion
on exports, 2,50,000 workers might lose their livelihoods. The political controversies and
criticisms that will arise would be difficult to diffuse (Mercy A. Kuo, 2018).
Asian countries linked to China – like Singapore, Taiwan, South Korea and India will
also be hurt. Singapore might lose on 0.8% of its economic growth as a lot of its
manufacturing industries are set up in China. 30% of the goods that are exported to America
comes from third party Asian countries. These countries will also lose on growth and
employment.
Countries who act as global supply chains might benefit. If the trade war continues
then the US firms will move their supply chain to other countries like Malaysia, Mexico,
Vietnam, Indonesia and Peru as these are the safe countries. China might purchase its
technical inputs from Canada, South Korea and Australia or it may produce at home.
The imposition of trade barriers in the form of tariffs and import duties effects the
developing countries the most. Developing countries do not need tariff because they need
policies that promote export and free trade that will allow them to import. The developed
countries should avoid imlosing tariffs on heavy industry products that are being imported by
the developing countries because developing countries are mostly labour intensive and they
rely on the developed countries for their development.

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Conclusion
Free trade benefits the global economy and sometimes trade barriers are necessary to
protect the domestic industries. There should be an optimum level of restrictions imposed.
The world has reached the level of globalisation where any negative shock to or from one
country creates a domino effect for all the other economies. The trade war that is going on
between US and China will drastically impact the global market. The trade deficits that
occurs due to imports are not a loss to the domestic country because it signifies that the
country is growing. If the home country can consume a good at a lower cost by importing the
good then the country is benefitting. “Make in US” campaign is not going to benefit either
the US or the global market. The paper aimed to assess the positive and negative impacts of
Tariffs and Import Duties. From the literature and the current ongoing trade war we can
conclude that Tariffs and Import Duties do greater harm than good. In the current scenario,
China will retaliate because it will not swallow the harsh tariffs silently but America has a
greater market power than China and it is hard to supress the superpowers. However, Donald
Trump will have to bear the consequences of launching the war.

INTERNATIONAL TRADE AND ENTERPRISES 12
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