Understanding Tariffs

If you have tuned into the news you may have heard some talk about President Trump threatening to use tariffs on one country or another. But how well do you understand tariffs? You may ask: How will tariffs effect me as a consumer? What about how it will effect me as an investor?

To gain a better understanding I turned to Stephen Miran, current chair of the council of Economic Advisers of the United States. Last year when Miran was a senior analyst at Hudson Bay Capital, he wrote A Users Guide to Restructuring the Global Trading System. The paper is 41 pages long and has very insightful information, however, I read it so you don’t have to. Though I freely admit that I still have a lot to learn on this subject, I was able to learn enough to pass along some points of that article.

Let’s start with the basics, what tariff’s are. Simply, a tariff is a tax imposed on country or a particular set of goods. Why do we use them? It could be that we are trying to discourage consumers from buying foreign product from a specific nation. It could be to help grow a sector of our own American business. It may also be a way for the government to generate revenue without taxing it’s own people. Recently, such as in 2018, we have used it as a tool to leverage better terms in trade agreements. President Trump used this rather successfully in 2018-2019 against China.

For decades, the US has held some of the lowest tariff rates in the world. For example, the European Union has a 10% tariff on US made cars, while the US has only a 2.5% tariff on EU cars. This has led to trade imbalances over the years. The US imports more foreign products than it exports. US manufacturing jobs have steadily declined since the 1960’s. This is partly due to exporting less product but also due to rising labor costs as minimum wage has increased over the decades.

If the US was to raise tariffs for example in the car market, it could potentially make foreign cars more expensive, leading to American consumers more likely to buy American made cars. I say “potentially” because the burden of a tariff may rely on the consumer or the foreign country. If the burden is put on the consumer, that means that due to the higher tariff rate, the price of the cars increases so that the underlying profit margin is unaffected. This leads to foreign cars costing more and American cars seeming like a better deal. If you love a car from a foreign manufacturer you may have to prepare to spend more. If this were to be the case over several years or decades, foreign cars would likely not be as present in America, and to replace them, more American cars would have to built and sold. This would effectively boost American car manufacturing.

However, the burden of the tariff may not be passed onto the consumer but instead to the foreign government. We saw this with China in 2018-2019. Chinese exports did not raise prices in America because they did not want their exports to shrink over time. Instead the Chinese population paid for those tariff’s and not the American population. In this case, the American consumer did not have to pay more for Chinese goods, and as a result there was no increase of the rates of America importing Chinese goods which in effect, did not help grow American manufacturing. So what did happen? The Chinese government paid these tariff’s, which was used as revenue for the US government. Using this revenue, the US government could use that money to fund programs that would have otherwise be funded by American tax dollars.

At a very basic look, tariffs can be used as a tool to negotiate for better deals like in 2018-2019. Tariffs can also be used to generate income for the US. Tariffs can also try to promote American products over foreign products. This is a brief and simple view of tariffs. There are other economic implications, effects on the stock market, as well as national security to consider. We will continue to dive deeper into this subject in future articles, as well as have sit-down interviews with professors and economists to gain insights on world trade from those much more versed in the subject. So stay tuned!