Trade policy
Governments shape trade through tariffs, quotas, and agreements. These policies protect some groups at the expense of others.
Tariffs
A tariff is a tax on imports. It raises the domestic price, which helps domestic producers sell more at higher prices and raises government revenue, but hurts consumers, who pay more and buy less. Because the losses to consumers exceed the gains to producers and government, a tariff creates deadweight loss.
Who pays tariffs
Although importers legally pay tariffs, the cost is largely passed on to domestic buyers. Studies of the US tariffs imposed in 2018-2019 found that most of the cost was borne by US firms and consumers through higher prices, rather than by foreign exporters.
Import quotas
An import quota limits the quantity of a good that may be imported. Like a tariff, it raises domestic prices and helps domestic producers, but instead of government revenue, the extra profit goes to whoever holds the rights to import (quota rents). Voluntary export restraints are a similar tool.
Subsidies to exporters
Export subsidies pay domestic firms to sell abroad, helping them compete but costing taxpayers and often provoking retaliation. Agricultural subsidies in rich countries have long been controversial because they can depress world prices and hurt farmers in poorer countries.
Arguments for protection
Arguments for trade barriers include protecting jobs in specific industries, national security (keeping capacity in defence-related goods), infant industry protection (shielding new industries until they become competitive), responding to unfair foreign subsidies, and maintaining labour and environmental standards. Economists accept some in limited cases but warn of misuse.
Arguments against protection
Protection raises prices for consumers and for firms using imported inputs, reduces competition and innovation, and invites retaliation. The Smoot-Hawley Tariff of 1930 raised US tariffs on thousands of goods; other countries retaliated, and world trade collapsed during the Great Depression.
Trade agreements
The World Trade Organization (WTO), founded in 1995 from the earlier GATT, sets rules for trade among its members and settles disputes. Regional agreements like the European Union's single market and the United States-Mexico-Canada Agreement (USMCA) lower barriers among their members.
Worked example
The world price of steel is 500 dollars a tonne. A 25% tariff raises the domestic price to 625. Domestic steelmakers expand output and earn more, the government collects revenue on remaining imports, but car makers and construction firms pay more for steel, raising their costs and prices. Total losses to users outweigh the gains.
Key takeaways
Tariffs raise domestic prices, helping producers and raising revenue but hurting consumers more, creating deadweight loss; their cost falls mostly on domestic buyers. Quotas have similar effects but create quota rents. Arguments for protection include jobs, security, and infant industries; risks include higher prices and retaliation, as with Smoot-Hawley. The WTO and regional agreements lower barriers.
Flashcard
Tax on imports
Check your understanding
Who mainly bore the cost of the US tariffs imposed in 2018-2019, according to most studies?