Trade War – The Effect of Tariffs on the U.S. Economy
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Trade War – The Effect of Tariffs on the U.S. Economy

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We all know Trump is taking open fire on China in an effort to level-off the playing field. Headlines shouter one tariff after another in order to protect Americans from unfair competition. And, it seems Trump’s trade-war-strategy is paying off for the United States. In May 2018, China officials had announced they were willing to reduce America’s trade deficit, and currently both countries negotiate a better deal for the U.S. However, despite the advances for Trump, tariff measures also burden the American society. In fact, imposing tariffs have widespread consequences for the entire U.S. economy.

Tariff Concept Explained

Tariff is just another word for taxes levied on foreign goods. It is a measure for politicians to either protect domestic industries or to raise tax revenues. In case of the US-China trade war, Trump claims to use tariffs as a measure to eliminate unfair trade practices. In other words, Trump taxes Chinese goods to protect American companies from China.

What happens in effect, is that Chinese goods become more expensive for American consumers. I.e. inexpensive Chinese products are charged with an additional tax. As a result, they become equally expensive as American goods. This in turn, weakens the demand for Chinese products which leads to more opportunity for American firms.

Protection for American Firms

washing machineTariffs protect American firms from foreign competition. Suppose in the era before the trade war, two different washing machines are sold in the U.S. One is a Chinese brand called Haier, the other is an American brand called Speed Queen. The former sells for $400 and the latter is priced at $450.

In this case, the Chinese brand might appear more attractive to you due to its cheaper price. However, under trade-war-circumstances the Chinese brand suddenly becomes more expensive. Due to a tariff of 20% on washing machines imported from China, the Hair machine suddenly costs $480 dollars.

In this situation, the American brand might seem more appealing to you since it became the more affordable option. Hence, there is a likely chance that the American company will sell much more machines under trade-war-circumstances. Thus, American firms are protected from Chinese competition.

Consumers Pay the Price

American consumerA tariff levied on Chinese products results in a loss of consumer savings. Due to tariffs, consumers pay a higher price for their goods than they would under normal circumstances.

Recall our example of washing machines in the previous paragraph. In an ordinary situation, the minimum price of a machine is $400. However, with a tariff, the minimum price is raised to $450. This means that consumers have to spend $50 more to obtain a device. The extra $50 represents a loss in consumer savings.

In economics, this principle is referred to as loss in consumer surplus. The difference between the actual price paid and the amount consumers are willing to pay is called consumer surplus. The actual amount (market price) is often lower than the amount consumers are willing to pay.

For example, you might be willing to spend $600 on a washing machine simply because you need it. However, the machine’s actual price is $400. This saves you $200 which represents your surplus. You can either save it or spend it on other items.

 

Tariffs Hurt Exporters

trade war export effect

Tariffs on Chinese goods result in a reduction of domestic exports. Because of tariffs, imported products become more expensive for American producers. Hence, it will cost an American firm more to produce a certain product. This leads to a reduction in exports because American products become more expensive on world markets.

To illustrate this effect, consider the case of Trump’s tariffs on steel. In March 2018, Trump imposed a 25% tariff on steel imported from China. As a result, American car manufacturers experienced a price increase of 25% on raw materials. Consequently, American cars became more expensive which resulted in a decline in exports.

 

Other Costs for Society

tariff dollar costBesides consumers and exporters, many other industries suffer indirectly from tariffs. The most vicious is the logistics industry. Due to fewer imports, freight forwarders are left with idle capacity.

Another example is the retail industry. Especially stores that sell goods originated from China. Due to higher prices, these stores experience a decrease in demand and thus a decline in revenue.

Furthermore, many other industries suffer from retaliatory tariffs. For instance, the airline industry. China has imposed a retaliatory tariff of 25% on American made airplanes. This measure does not only affect Boeing, it also effects Boeing’s sub suppliers and their sub suppliers. In other words, a trade war creates casualties in all layers of society.

Why Trump Imposes All These Tariffs?

My personal guess would be: Trump would like to reduce America’s trade deficit with China. In 2017, imports from China equaled $522.9 billion while exports to China were $ 187.5 billion. This means a deficit of $335.4 billion (imports exceed exports).

A trade deficit could have all kinds of negative consequences for the U.S. economy. For example, higher unemployment rates and higher interest rates. In order to eliminate these effects and to stimulate more growth for the economy, Trump might use tariffs as means to drive down America’s trade deficit.

To illustrate, the U.S. is China’s largest trading partner. If, due to tariffs, Chinese goods become more expensive, demand declines for these goods. And when the Americans buy fewer products from China, Chinese companies face serious losses. Hence, Chinese firms might lower their prices in order to avoid a decline in sales. This in turn leads to a lower deficit since imports become cheaper while exports remain the same price.

In a Nutshell

Trump’s tariff policy has widespread effects for the U.S. economy. Although it may protect certain industries, it certainly hurts others. Due to tariffs, consumers and exporters suffer from serious losses. Moreover, many domestic industries are negatively affected. Examples are the logistics industry and the retail industry. Both experience a decline in activity. With all these consequences for the economy, one question remains: Will a lower trade deficit and the protection of domestic producers outweigh the other costs borne on society?

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Written by
Ezra Bisschop
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