Do Tariffs Help or Hurt the Economy?

Note: this is a lightly edited version of my new Econ Quick Takes video.

I’ve already covered the fact that tariffs will, in general, raise prices for domestic buyers. But one might ask whether that price increase is worth it to help domestic producers of that good. The short answer is that it’s not worth it. Let’s unpack this.

First, will a tariff help domestic producers of that good? The answer is “yes.” Existing producers of the relevant good will be able to sell it for a higher price because a tariff will in general raise domestic prices too. Because foreign producers are disadvantaged by the tariff, domestic producers will likely increase their output. They can also sell at a higher price-a clear win-win for them. New domestic producers may enter the market too.

But, the extra revenue for domestic producers is not a free lunch. It comes from buyers paying more for the good. So what the tariffs end up doing is transferring money from domestic buyers to domestic producers.

So how do we know this transfer created by the tariffs isn’t worth it? Here’s the source of the problem. Higher prices mean fewer buyers-unless they don’t care about price, which is rare. So some buyers that would have bought the good at a lower price will no longer get to do so. And that’s what we call a “deadweight loss” because that loss of consumption is pure economic waste.

The same problem arises when tariffs are applied to intermediate imported goods that other domestic producers use as inputs. These producers too will have to raise their prices and, unlike domestic producers that produce the good on which the tariff has been imposed, producers that use imports as inputs will not be helped by the tariff. Their total production will shrink-because consumers will respond to higher prices by buying less-and some of them may even have to exit the market. That’s another source of deadweight loss: a loss of economic activity from which no one benefits.

On top of that, tariffs help prop up high-cost production that would not be able to compete in the absence of tariffs. And here it’s helpful to remember that resources-raw materials, our time, our efforts-are scarce, and we want them to be directed to their best possible use. When we implement tariffs, we are effectively subsidizing inefficient production and diverting resources from other, likely more worthwhile uses.

Does this mean tariffs are never warranted? Not necessarily. There are genuine national security concerns in some cases-we wouldn’t want to rely on a potential adversary to produce our weapons, for example-but the vast majority of tariffs can’t be justified on national security grounds. They’re just taxing domestic consumers and propping up high-cost production.

But what if the government wants to help domestic industries or workers hurt by trade? What’s a better approach? There are plenty of options because there are many things that private firms and markets don’t do well. For example, the government can help fund education to raise the skills of US workers or re-training programs or even just cash transfers to help workers who are displaced from their industries. Government can also subsidize research and development to help firms improve their production techniques and develop new ones. All of these options are much better than tariffs.

So why do so many governments implement tariffs anyway? One hypothesis is that the losers from tariffs-the consumers-are scattered and not well-organized. Consumers may also not be able to distinguish modest price increases from inflation, so if the tariff isn’t huge, they may not even realize they’re being taxed. But if a hundred million consumers have to pay even an extra $10 a year for something, that’s a billion dollars right there. And just like that, a hidden tax takes a billion dollars out of consumers’ pockets-without them even noticing.

Originally published at https://mytwocentsandcounting.substack.com.