When I was an economics professor with John Brown University, the subject of tariffs was just a part of one class session. I never thought I would see the impact it is currently having on the world economy and trade. Everyone should have a general understanding of how increased tariffs will affect their lives and should pay special attention to the present turbulence in international markets. Let’s take a five-minute quick course on tariff issues.
Tariffs are taxes governments place on products and services imported from other countries. They are a percentage of the prices of the imports, just like a sales tax. But the tariff is paid by the supplier, not the buyer. For a realistic example, if a Volkswagen is imported from Germany with the original price tag of $40,000, and the U.S. government places a 2.5% tariff on it, the manufacturer will charge the wholesale consumer $41,000 for the vehicle to make up for the $1,000 tariff charge. Conversely, if a Ford is exported to Germany with the original price tag of $40,000, and Germany places a 10% tariff on it, the manufacturer will charge the German wholesaler $44,000 for the vehicle to make up for the $4,000 tariff charge.
Proceeds from these tariffs go to the government which imposes the tariffs. So, the $1,000 U.S. tariff on the Volkswagen is paid by the car’s German manufacturer to the U.S. treasury. The $4,000 Germany tariff on the Ford is paid by the car’s U.S. manufacturer to the German treasury. No one in the sales transactions gets any of the tariff money. Tariffs are supplements to the treasuries of both governments. In fact, tariffs were the primary source for funding the U.S. government prior to the introduction of income taxes in 1913.
Tariffs are an immediate financial burden for both the supplier and the consumer. The manufacturer and service provider’s export customers have to pay a higher price for their products and services than the consumers of domestic products and services pay. This is true of both countries involved. Therefore, it is more difficult for these manufacturers and service providers to compete with their foreign competitors whose same products and services are lower in price. On the other hand, the consumers in each country have to pay a higher price for desired imports from the other country.
In the example above, the Ford maker is disadvantaged in the German market, since Fords are $4,000 higher priced than Volkswagens. Similarly, the Volkswagen maker is disadvantaged in the U.S. market, since Volkswagens are $1,000 higher priced than Fords. The U.S. consumers will probably buy more Fords than Volkswagens, because the Fords are $1,000 lower priced. The German consumers will probably buy more Volkswagens than Fords, because the Volkswagens are $4,000 lower priced.
The offsetting advanatage to each automaker is that the tariffs tend to protect the domestic market. Ford will sell more Fords in the U.S., and Volkswagen will sell more Volkswagens in Germany, since the exports are higher in price. Often, this advantage of tariffs is more profitable than having a more equatible international market.
Note that the example demonstrates a greater advantage for Germany than for the U.S. The 10% German tariff on U.S. cars is stardard throughout the European Union nations. This uneven playing field for international trade is mostly what is driving President Trump to raise tariffs rather dramatically. For decades of world trade, tariffs in other countries have been greater than U.S. tariffs. This is one of the reasons the U.S. has a substantial trade deficit with the majority of other nations, meaning the other nations export more to the U.S. than the U.S. exports to them. With the uneven tariffs in the example, many more Volkswagens are purchased in the U.S. than Fords in Germany. This is true of products and services traded with most countries.
China is an outlier in this world-wide tariff standoff, refusing to negotiate and slapping unprecedented tariffs on the U.S. in retaliation. Although all tariff tensions have a political dynamic, China’s President Xi is taking it to a whole new level with a 125% tariff on U.S. imports. President Trump has responded with a 145% tariff on China imports. This essentially shuts down most trade between the two nations and can’t possibly remain in effect very long.
After years of this tariff and trade imbalance uncorrected by previous administrations, President Trump is invoking unusually high tariffs to shock the world trade markets into lowering their tariffs. Many nations are panicking and running to the U.S. negotiating table. Until this economic instability settles, American consumers will pay higher prices on imported products and services, and manufacturers and service providers will have fewer sales abroad. Of course, this instability results in nervous investors and a volatile stock market. I believe, eventually, we will find a more equivocal balance of trade with fewer tariffs or more reciprocal tariffs–each nation matching the tariff percentage of its trading partner. When we will reach that international trade utopia is anyone’s guess. But we had to do something, and the president is doing it.