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Tariff Basics: Advantages and Disadvantages

The English word “tariff” comes from the Italian word “tariffa” which was further derived from a similar-sounding Arabic word that translated to “notification” or “inventory of fees to be paid” in English. The origin of the modern English word reflects the historical role of tariffs as a list or schedule of duties payable on goods passing through borders. Hence, in modern usage, a tariff is a tax or duty imposed by a government of a particular country or a supranational organization on imported or exported goods. There are several arguments favoring tariffs. However, there are also arguments against their imposition.

Advantages of Tariffs: Arguments Favoring Tariff Imposition

Tariffs can serve multiple beneficial purposes. These range from bolstering the productivity of the domestic economy, regulating international trade exposure and participation, or as a tool of foreign policy. Hence, more often than not, the arguments favoring tariff impositions are often anchored on either one or at least one of these purposes. Take note of the following:

1. Generating Government Revenue

Remember that tariffs are taxes. One of the advantages of tariff imposition is that it can help a government create an additional revenue stream apart from its domestic taxation regime. A tariff can also be a more reliable source of government revenue for some export-dependent countries with less reliable or lower local tax collection.

India is one of the largest consumers of gold in the world. The Indian government increased its import duty on gold to 12.5 percent in 2020. This has become a key driver of government revenue. The U.S. also imposed tariffs on a range of Chinese imports in 2018. It collected about USD 79.1 billion from these tariffs from 2018 to 2019.

2. Protecting the Domestic Economy

Tariffs or protective tariffs are one of the common instruments of protectionism. A government would raise import duties on certain imported goods to make them more expensive and encourage consumers to purchase local counterparts. This helps in protecting domestic industries. It can also be used as a tool to reduce the trade deficit of a country.

A 25 percent tariff on steel and 10 percent on aluminum imports were imposed by the U.S. in 2018 to protect its homegrown steel and aluminum industries. The European Union has long been using tariffs to protect its agricultural sector. This also promotes the food security of EU countries by reducing their dependence on food importation.

3. Foreign Policy and National Security

Some governments resort to imposing higher tariffs as a foreign policy tool and form of economic sanction to exert economic pressure or influence the behavior of a target country. Most countries also use higher tariffs to raise the entry barriers in certain strategic sectors like defense and energy to reduce exposure to foreign dependence and influence.

The US-China Trade War under the first-term Trump administration saw high tariffs on imported Chinese goods not only to address the U.S. trade deficit but also to pressure the Chinese into reforming certain policies. The Biden administration imposed tariffs on Russian goods following the Ukraine-Russia Conflict escalation in 2022.

4. Encouraging Better Trade Agreements

Another purpose and advantage of tariffs is that they can provide bargaining power when used as a negotiating tool. This is true for countries with attractive imports due to either absolute advantage or comparative advantage. These countries can threaten with higher tariffs to pressure others to make concessions or change their trade policies.

The U.S. government used the tariffs it imposed on steel and aluminum imports to renegotiate the North American Free Trade Agreement and come up with the US-Mexico-Canada Agreement. The Chinese government often uses retaliatory tariffs against countries that impose or planning to impose high tariffs on imported Chinese goods.

Disadvantages Tariffs: Arguments Against Tariff Imposition

Tariffs can be useful and advantageous to a certain extent but they come with strategic economic and geopolitical risks. Some tariffs can be disadvantageous. Proponents of trade liberalization and free trade have also based their arguments against tariff imposition on the grounds of neoclassical and liberal economic principles. Take note of the following:

1. Economic Inefficiency and Distortion

A high tariff on imports can create inefficiencies because it promotes artificial support for less competitive domestic industries. This runs against the principles of competition through market liberalization. Furthermore, when considered as a substantial source of government revenue, it can create inefficiencies in the entire tax regime.

The inefficiencies and distortion can impact the domestic economy. The tariffs on imported sugar in the U.S. have resulted in higher-than-global-average prices of sugar. Some manufacturers moved to countries like Canada and Mexico. The tariffs on agricultural products in the EU have artificially inflated the prices of many food items in the region.

2. Risk of Retaliation and Trade Wars

One of the arguments against tariffs is that it can trigger affected countries to retaliate. The worst-case scenario is a full-blown trade war involving a cycle of increasing tariffs and trade restrictions. The longer and more impactful results are domestic economic downturn, strained international relations, and global supply chain disruptions.

The most notable modern example of tariff imposition resulting in a full-blown trade war is the US-China Trade War that escalated in 2018. The Anglo-Irish Trade War that spanned from 1932 to 1938 involved the United Kingdom and Ireland imposing tariffs against one another. This resulted in political tension and economic hardships.

3. Producer and Consumer Impacts

Domestic producers who depend on imported raw materials also face increased costs when import tariffs affect their supplies. This also happens when the country imposing the tariffs does not have enough supplies for domestic raw materials. Retaliatory tariffs from foreign countries will also make the exported domestic products less appealing.

Furthermore, because tariffs increase the cost of imported goods, they often result in higher prices for end users or the consumers if there are limited domestic counterparts or alternatives. Businesses essentially pass the cost to the consumers. Tariffs also reduce the selection of goods available to the consumers. This leaves them with fewer options.

4. Global Supply Chain Disruptions

Another disadvantage of tariffs is that it can disrupt global supply chains. Note that this is also one of the main arguments against tariff imposition. The globalized economy depends on supply chains that often span multiple countries. Tariffs imposed by other countries can make it more difficult for domestic exporters to market and sell their products abroad.

The US-China Trade War that began in 2018 disrupted the supply chains for electronic components and textiles. This affected U.S. companies involved in electronics and textile manufacturing. The new tariffs that come from Brexit resulted in British automakers dealing with bottlenecks, higher export and import costs, and production schedule disruptions.

Summary and Takeaways: Pros and Cons of Tariff Imposition

Tariffs can benefit a country by generating government revenue, protecting domestic industries, and serving as tools for foreign policy. However, because they carry economic and political risks, their disadvantages or potential downsides should be taken into consideration. These include economic inefficiencies, risks of retaliatory trade wars, higher costs for consumers, and potential disruptions to global supply chains. Each benefit and drawback underscore the complex balancing act governments must navigate when deciding to impose tariffs.

Nevertheless, while tariffs can offer short-term economic protection and can be used as leverage to maintain a geopolitical stance or trading bargaining power, they can also lead to long-term economic distortions and strained international relations. For governments, understanding the broader impact of tariffs—especially in a globally interconnected economy—is crucial. Policymakers should consider both the immediate economic benefits and the potential for downstream impacts, including retaliatory actions and price inflation.