Tariffs are one of the most common protectionism policies. Raising import duties on certain goods to make them more expensive can encourage the domestic consumption of local counterparts and even embolden the domestic economy to develop or improve its domestic production. However, because it is almost always impossible to build either absolute or comparative advantage over other countries, there are instances when tariffs result in price hikes and even inflation.
The High Price of Protectionism: Negative and Limiting Impacts of Tariffs on Prices and Inflation
Explaining the Immediate Impact on Consumer Prices
There are several reasons why tariffs often result in price hikes. The most obvious one stems from the fact that increasing import duties increases the cost of importation. Importers do not shoulder the additional cost from tariffs out of their pockets. They pass it on to the consumers in the form of higher retail prices for them to maintain their profit margins.
For example, when a particular country increases the import duties on smartphones, the importers would sell these products above the suggested retail prices. This is the reason why smartphones in countries like Hong Kong and India where import duties are lower tend to be more affordable than countries in the European Union where import duties are higher.
Consider a 20 percent tariff on imported smartphones as another example. This would raise the price of a particular device from its base price of USD 500.00 to USD 600.00. The importers and their retail partners will factor in this price increase in their retail price. The same smartphone will retail for less than USD 600.00 in countries with lower tariffs.
Another reason why tariffs can result in price increases centers on their impact on production. The imposition of higher import duties can increase the direct costs of domestic producers who depend on imported raw materials or production inputs. Tariffs can also result in indirect costs from supply chain disruption. These costs are also passed on to the consumers.
Remember that an increase in import duties can increase importation costs or result in an increase in both direct and indirect costs. A blanket tariff on a range of products can contribute to cost-pull inflation in which the overall price level rises due to increased costs. This happens because businesses will always pass these higher costs to the consumers.
Tariffs can indeed protect domestic industries from foreign competitors and even encourage local production. However, while it benefits homegrown producers, it can lead to reduced competition and render consumers with fewer options. The absence of competitive pressure means that these domestic producers do not have an incentive to keep prices low.
A demand-pull inflation can even ensue if domestic producers are unable to keep up with growing domestic demand. The price increases occur because more people are chasing a very limited number of supplies. Some of these consumers might offer to pay higher prices. Others would have to turn to imported alternatives that are more expensive due to tariffs.
Notable Examples and Actual Correlation With Inflation
There are several examples or instances when the imposition of well-intended high tariffs or import duties resulted in an unintended consequence of price hikes. One of the most notable ones was the Corn Laws in the United Kingdom which included tariffs and other trade restrictions on imported corn and other food items. The laws were enforced from 1815 to 1846.
Mercantilism was at the heart of the Corn Laws. The goal was to maximize exports and minimize imports by keeping the prices of cereal grains high to favor domestic farmers. The unintended consequences include an increase in food prices and overall cost of living. The disposable income of the public also decreased and affected domestic sectors like manufacturing.
Economists generally agree that trade barriers like tariffs affect economic growth. This was seen in the United States-China Trade War under the first Trump administration. Economists M. Amiti, S. J. Redding, and D. E. Weinstein noted that the U.S. experienced a substantial increase in the prices of intermediaries and final goods due to its trade war with China.
It is still important to note that the effects of tariffs are not immediate. C. Alberto et al. used collected microdata to examine the impact of U.S. trade policy between 2018 and 2020. Results showed that the burden of tariffs had fallen primarily on U.S. firms rather than domestic importers and local consumers. Retailers also absorbed some of the costs to maintain price stability.
R. E. Scott and A. S. Hersh also examined the tariffs under the first Trump administration. Their analysis showed that the timing of these import duties shows no correlation with inflation. This is because the bulk of the tariffs were already in place before 2020 and inflation accelerated in March 2021 due to the coronavirus pandemic and the global supply chain crisis.
The inflationary effects of tariffs are still true. However, based on several analyses, they depend on several factors. D. Furceri et al. noted that impacts depend on the state of the domestic economy or whether it is in the expansionary or contraction phase. R. Batra also argued that tariffs often result in or produce inflation only in non-market and developing economies
Inflation tends to be high during growth periods. The negative impacts of tariffs are magnified due to the contractionary monetary policies aimed at controlling prices. Tariffs also tend to lead to inflation in countries or economies with structural weaknesses like limited domestic production, import dependencies, inflexible supply chains, and limited fiscal and monetary policy tools.
In a Nutshell: Tariffs Can Fuel Price Increases But Its Direct and Specific Impact on Inflation Depends
Tariffs increase prices of end-use products because they result in additional direct and indirect costs for importers, producers, and retailers. These costs are often passed on to the consumers. Hence, considering how hikes in import duties raise retail prices, it is easier for most people to assume and even conclude that they can also trigger inflation.
A blanket tariff on a wide range of imports can cause either cost-pull or demand-pull inflation since it affects a wider selection of raw materials and consumer products. This is especially true if there are limited domestic alternatives or if there is a limited domestic supply because domestic production output is unable to keep up with domestic demand.
Tariffs can also create additional inflationary pressure in an expanding or booming economy because the economic environment is already inflationary due to the increasing purchasing power of the people, expanding demand, and the resulting contractionary policies aimed at weakening demand to cool down economic activities can create price shocks.
However, it is important to underscore that tariffs do not cause inflation in certain cases. For example, in a contracting economy, firms are unable to pass the added costs to the consumers because demand is weak and people are sensitive to high prices. Contraction also often leads to excess supply and this creates downward pressure on prices.
There are also other factors that limit the impacts of high tariffs on prices and inflation. A strong domestic production provides consumers with non-tariffed alternatives and renders expensive imports negligible. Tariffs applied to goods that are not widely consumed are less likely to cause inflation. Currency appreciation can also offset tariff-induced cost hikes.
It is still possible for tariffs to cause runaway inflation. High import duties on food or inputs for food production can not only increase domestic food prices but also result in food shortages in countries with weak food security or are experiencing food insecurity. This can further result in a ripple effect that amplifies costs and prices across multiple industries and sectors.
FURTHER READINGS AND REFERENCES
- Amiti, M., Redding, S. J., and Weinstein, D. E. 2019. “The Impact of the 2018 Tariffs on Prices and Welfare.” Journal of Economic Perspectives. 33(4): 187-210. American Economic Association. DOI: 1257/jep.33.4.187
- Batra, R. 2001. “Are Tariffs Inflationary?” Review of International Economics. 9(3): 373-382. Wiley. DOI: 1111/1467-9396.00286
- Cavallo, A., Gopinath, G., Neiman, B., and Tang, J. 2021. “Tariff Pass-Through at the Border and at the Store: Evidence from US Trade Policy.” American Economic Review: Insights. 3(1): 19-34. American Economic Association. DOI: 1257/aeri.20190536
- Furceri, D., Hannan, S. A., Ostry, D. J., and Rose, A. K. 2019. “Macroeconomic Consequences of Tariffs.” IMF Working Paper. International Monetary Fund.
- Scott, R. E. and Hersh, A. S. 2022. “Tariff Increases Did Not Cause Inflation, and Their Removal Would Undermine Domestic Supply Chains.” Working Economic Blog. Economic Policy Institute. Available online