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Explainer: Tariffs

July 27, 2018

There’s been a lot in the news lately about President Donald Trump’s “trade wars” with the rest of the world. But if you're not an economics student, tariffs can be hard to wrap your head around. So what are tariffs? What are they for? And are they good or bad? 

What are tariffs?


Trading imports and exports is a large part of the economies of many countries around the world. (Note: Imports come in, exports go out.) Typically, the world’s most successful economies have high levels of trade – e.g. US, China, Japan, Germany, UK. The governments of each country have the power to control how, when, what and with who their country trades with.

 

Free trade is a perfect situation in an ideal world where governments don’t control trade at all – they don’t impose any rules, policies or taxes that might impact trade. Economists think of it as "perfect" because economic theory prioritises something called the "free market", where businesses and customers aren't restricted by government rules. A fundamental assumption of economics is that free trade and the free market are good things that benefit everyone in the long term. (Explained later in this article.)

 

So, recently the world has made many steps towards free trade.

 

 

But what are tariffs, specifically?

 

Tariffs are taxes that a government puts on imports into a country. For example, let's say that Australia is importing hats from China. 

1. The picture above shows the situation in the hat industry. Australian businesses make hats for $10 each, while Chinese businesses make them for $5 - half the price.

 

 

 

 

2. The Chinese hat businesses sell their hats in China, but they want to make more money by selling the hats in Australia, too. So, these businesses sell some hats to Australian importing businesses. (Importing businesses buy stuff from other countries, then sell that stuff, at a profit, to domestic customers.)

 

 

 

3. To make some profit on each hat, Australian importing businesses raise the price of the hats that they bought from China to $6, and sell them to Australian customers. 

 

 

4. There are now two types of hats being sold in Australia - the $10 ones made in Australia, and the $6 made in China. The imported Chinese hats are almost half the price of the Australian-made ones, so everyone will buy the cheaper option. 

 

 

 

5. All Australian customers are buying the imported Chinese hats. This means that Australian hat-making businesses don't make profit, or even lose money. The Australian government sees this, and wants to help - remember, the government's role is to help its people. 

 

 

 

 

6. To help Australian hat-making businesses, the Australian government charges a tax on the Australian importing businesses responsible for buying and selling the hats from China. This tax is called a tariff.

 

 

 

7. Australian importing businesses now have to pay tax on every hat that they sell to Australian customers, but they still want to keep the same amount of profit as before, so they simply add the tax to their original price. Say that the tax per hat is $4 - add $4 tax to the original price of $6. The imported Chinese hats now cost $10, the same price as the Australian-made hats. 

 

 

 

8. The final step! Since both imported Chinese hats and Australian-made hats cost $10, there's a pretty even split between which type Australian customers buy. The government has succeeded in helping its local hat-making businesses. 

 

 

If you're still confused, don't worry too much. You don't need a perfect understanding of the tariff mechanism to get the main point: governments use tariffs to make imported stuff more expensive for their people to buy. This protects the local businesses who make the same stuff. 

 

With tariffs, imported stuff isn't way cheaper than locally-made stuff anymore. This gives local businesses more of an "equal" playing field. 

 

So why are some people so against tariffs? Here are the main arguments for and against. 

 

FOR


Protecting domestic employment

This is one of the most popular arguments for tariffs (and protection, in general.) Returning to the hat example: tariffs will protect Australia's hat businesses. These businesses will survive and grow, and employ more Australians to work for them. This will increase employment in Australia. On the other hand, if we don't protect our domestic businesses, they may be forced to decrease in size or shut down, hiring less and less people. This will decrease employment in Australia. 

 

Although this seems logical, economists around the world don't agree. That's because of an economic idea called efficiency - meaning making the most amount of stuff with the least amount of resources, time and effort. Remember that we said Australian-made hats are more expensive than imported ones? A good reason for that may be that Australia is less efficient at making hats, so it costs us more money and resources to do it. Meanwhile, China may be able to make hats more efficiently with less money and resources. (Of course, it's not entirely that simple, with other factors like quality coming into play. But efficiency does play a large role.) 

 

So even if we protect Australia's hat businesses, a tariff would be protecting an inefficient industry - aka an industry that wastes resources. And resources are scarce, so we never want to waste them! These wasted resources on the hat industry could have been used on building Australia's watch, or textbook, or ruler industry - these industries would have grown and eventually employed more people. Because of this, economists believe that free trade equals more employment in the long run. 

 

 

 

Protecting infant industries

An infant industry is a new industry that is just starting out. These small, inexperienced and weaker industries stand no chance against big, powerful industries making the same goods (probably at cheaper prices) overseas. So, some argue that these infant industries need protection in the short run, to give them a chance against huge international competitors. Although this is a valid argument for tariffs, the key is whether or not the taxes are truly only imposed in the short run, and removed as soon as the industry is strong enough to stand on its own. 

 

 

 

Protecting the environment

Australia has relatively high environmental standards and rules for businesses when compared to other countries. Australian businesses have to be more careful when making stuff, and consider their impact on the environment. This means that stuff made in Australia might be more expensive, because of the extra steps and precautions that Australian businesses have to take.

 

Other countries might not have these standards, and so their stuff can be made and sold at cheaper prices. For example, China's hat businesses might not have as many rules about carbon emissions or pollution, making them cheaper. But buying China's hats will encourage them to make more, having more and more harmful impacts on the environment.

 

So, to discourage Australian consumers from buying environmentally harmful hats from overseas, the government may impose tariffs. 

 

 

 

Revenue for the government

This isn't a hugely important argument, but it's worth noting: tariffs are fundamentally taxes that raise money for the government, to use in other areas. More money for the government to spend = (generally) more benefits for the people. 

 

 
 
 
AGAINST
 

Retaliation

Tariffs aren't as simple as one government choosing to protect their domestic industries. In many cases, if one country imposes a tariff, other countries will do the same in retaliation. If we impose tariffs on Chinese hats, maybe the Chinese government will impose tariffs on Australian beef. This means that both parties are worse off, and overall the world is further away from our free trade goal. 

 

Retaliation, guys.

 

 

Efficient use of resources

As we found out when discussing employment, the overall goal of all governments and economists is to find the most efficient allocation of resources. This means that the very limited amount of resources in our world are used to the best of their ability, to create the most goods. 

 

Inefficient industries are not competitive, meaning that they struggle to compete in the market with efficient industries. This is because they can't, or don't know how to make the same goods with fewer costs or waste. If we protect our inefficient domestic industries using tariffs, then we are encouraging an inefficient use of resources. This is bad for everyone in the long run, because once resources are wasted, they can't be used again. 

 

 

Encouraging competitive industries

Removing tariffs and protection ultimately means that some less efficient industries will shut down - so yes, the Australian hats industry may fail. (In fact, Australia's motor vehicle and textiles manufacturing industries have closed down or shrunk in recent years.) 

 

But the removal of inefficient industries leaves more resources for more efficient ones. It might also encourage less efficient industries to change their business structure to become more efficient and survive. So, instead of failing, Australian hats businesses might think of new, cheaper ways to make hats. In this way, removing protection encourages the most efficient industries to thrive in an economy.

 

When you're the most efficient industry in the economy 😩

 

 

Higher living standards for everyone

More competitive industries and efficient use of resources = increased overall production and lower prices in the economy. Also, less protection will mean more imports, giving consumers a wider variety of choice when buying similar products. In total, these effects are good for local consumers in the long run, raising their living standards and encouraging growth of the economy. 

 

 

And that was Explainer: Tariffs! Now that you're familiar with the economic theory, be sure to check in for the Recap: Trump's Trade Wars. 

 
 
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