Trump has repeatedly said that he will place tariffs on to imports from countries like China in order to raise money for the US. He claims that this will enable him to reduce taxes for the “average” American and encourage home-grown production. But is that really the case?
A lot of Americans seemingly voted for Trump because his tariff rhetoric struck a chord with them but unfortunately a lot of people don’t seem to realise what a tariff is and the implications it will have for them and their budgets.
In this article we’ll take a look at what a tariff is, how they can be implemented and the effect that they will have on not only the US economy but world wide.
How Do Countries Trade?
Countries rely on trade in order to have access to goods that they can’t produce at home either through lack of natural resources, manufacturing capability or other factors.
Trade agreements are made between countries or trading blocs and these cover what goods can sent between the countries.
These agreements lay out if there are any tariffs (a form of import tax) levied on each type of good being imported.
There may also be “Quotas” stipulated in the agreement which places limits of the amount a certain type of goods that can be imported into the country.
These agreements are difficult to negotiate and may take years of talks before they are ratified. For example, a deal between the UK and Canada was called off after 2 years of negotiations[1]BBC News: Trade deals: What has the UK done since Brexit? and a deal being worked on between the UK and India has gone through 13 rounds of talks over at least 2 years with no deal signed as yet[2]Wikipedia: India–United Kingdom Free Trade Agreement.
Types Of Trade Agreements
There are two main types of trade agreement[3]Wall Street Mojo: Trade Agreement:
Free Trade Agreements
Free Trade Agreements (FTAs) allow for goods and services to be traded across borders with little-to-no government interference, fewer (or no) tariffs and minimal (or no) quotas.
A FTA doesn’t need to be formally agreed to, a government can just decide not to place restrictions on imports from certain countries which is called “laissez-faire trade” [4]Investopedia: Free Trade Agreement (FTA): Definition, How It Works, and Example.
Despite its name, a FTA may also place restrictions on certain imports such as drugs not regulated in the region or food with certain additives as an example.
FTAs generally lower prices for consumers but it can cause domestic industries to lose out on sales as they struggle to compete with cheaper foreign imports.
Businesses may also relocate to territories that have more favourable tax or labour regulations in order to export their goods at a more lower cost and therefore make more profit, or, as in the case of the UK company Dyson, relocate to a country that has favourable trade agreements in place with your main sales markets[5]Wired: Why is Dyson moving to Singapore? It’s not just Brexit.
Preferential Trade Agreements
A Preferential Trade Agreement (PTA) gives, as the name implies, access to a country’s market to preferred partner countries.
A PTA reduces tariffs (but doesn’t remove them completely) and also reduces other trade barriers such as granting increased quotas to the preferred partner country.
More than two-fifths of world trade operate under PTAs[6]Pressbooks: Trade: Preferential Agreements and their use is on the rise.
PTAs are usually narrower in scope than a FTA meaning that they can be faster to negotiate and implement but they may also be tied to wider-reaching standards such as ensuring basic human rights standards for workers are met[7]Cambridge University Press: Trading Human Rights: How Preferential Trade Agreements Influence Government Repression.
What Is A Tariff?
A tariff (also called a duty) is part of a trade agreement that levies a tax on goods brought into a country.
A tariff can be a flat fee, for example $500 per electric vehicle imported, or it could be a percentage (an ad valorem tariff) based on the declared value of the imported goods.
Donald Trump has regularly said at his rallies that he will impose tariffs on goods from China and implies that these tariffs will be paid by China in order to allow them to import their goods into the United States.
This is false.
The tariff is paid by the person importing the goods into the country, it is not paid by the person exporting the goods out of their country.
Here’s how the process actually works. We’ll use our electric car from above as an example and go through a simplified version of events:
- Acme Cars Inc.” is an electric car retailer based in the US. They don’t manufacture their own cars but resell them.
- Acme Cars Inc. places an order for 200 electric cars from Electro-Car-Co based in China. Acme pays Electro-Car-Co $5,000 per car
- Electro-Car-Co manufactures the 200 cars and notifies Acme they are ready to be shipped
- Acme pays Electro-Car-Co $1,000,000 for the cars. They then arrange for the cars to be placed on a cargo ship and pay the carrier $50,000 shipping costs
- The cargo ship arrives in the USA and the cars are offloaded into a customs hold. Customs inspects the vehicles and informs Acme Inc. that there is a customs duty (the tariff) of $100,000 to pay ($500 x 200 cars). The cars are not released from customs until Acme pays the tariff due.
- Acme pays US customs $100,000 and arranges for the cars to be transported to their main depot at a cost of $10,000. The total cost to get the cars to the US at this point is $1,160,000
- Once the cars are received at the main depot, their sales rooms across the country can place orders for the cars. Acme places a 30% markup on each vehicle so the retail price for each Acme car is $7,540.
At this point the tariff has been paid by Acme Inc. (not the Chinese company) and then passed on to the person buying the car.
So let’s say that Trump increases the electric car tariff for vehicles imported from China from $500 to $5000, how would that affect everything?
Well it wouldn’t affect Electro-Car-Co at all so they still charge Acme Cars Inc. $5,000 per car, the shipping cost are the same as well so in order to get the cars to the United States, Acme still pays the same $1,050,000 costs.
When the cars are offloaded in the US and inspected by customs, they calculate that the customs duty (tariff) Acme Cars Inc. has to pay to release the cars is now $1,000,000 ($5,000 per car x 200 cars). They still pay the same $10,000 to transport the cars to their depot.
Let’s say that Acme Cars Inc. still charge 30% markup and don’t increase this to cover the tariff increase as they’re passing this on to the customer any way. The cost of each car is now $13,390 which is an increase of almost 78 percent.
Remember – this is without Acme Inc. increasing their profit margin, all the extra costs are passed on to the consumer.
Now Acme Car Inc. might think that the 78% increase is far too much and customers won’t pay it so instead of 30% they reduce their markup to 20%. This would mean that each car now costs $12,360 which is still quite an increase but better for the customer.
The downside of this is that Acme Cars Inc. is now making less profit which means they will pay less tax.
So, to reiterate, at no point in the cycle of manufacturing or buying a car does anyone based in China pay a US tariff, instead the US-based company and ultimately the customers pay it.
So a Trump-imposed Tariff does not necessarily hurt China but it will hurt US consumers.
What Will Happen If Tariffs Are Increased?
As we saw in our example above the cost of goods and services to the end-consumer will increase or the government will receive less revenue from tax.
Some will argue that the tariffs will help increase production within the US so that companies can avoid paying the tariffs, however this may not mean lower costs to the consumer as the cost of domestic production will generally be higher.
Businesses may also stop importing certain goods altogether meaning less choice for consumers.
An increase in tariffs can also lead to protecting domestic businesses that won’t necessarily innovate leading to stagnation and America falling behind other global industries.
Increasing tariffs can also lead to affected countries reciprocating with their own tariffs, or boycotting buying goods from America completely.
We saw this in 2017 when Trump introduced a series of increasing tariffs on China and the EU, this saw the trading blocs freeze imports on certain goods such as soybeans, corn and peanuts[8]Forbes: Amid Trump Tariffs, Farm Bankruptcies And Suicides Rise.
This decimated farms leading to a government bailout of $12 billion [9]Wikipedia: Trump administration farmer bailouts essentially wiping out any income from the tariff increase (although the tariffs on China did not cover the payments directly as Trump had claimed[10]Politifact: U.S. farmers are receiving $16 billion “out of the tariffs that we’ve gotten from China.”). Additionally the bailout payments mainly went to larger farms leaving the smaller ones to fail and even some city residents with share in farms were claiming pay outs[11]The New York Times: A $12 Billion Program to Help Farmers Stung by Trump’s Trade War Has Aided Few by gaming the system.
Payments to farmers then grew to a massive $32 billion by 2020[12]Politico: ‘Here’s your check’: Trump’s massive payouts to farmers will be hard to pull back, making the tariff war essentially pointless.
Can Trump Even Increase Tariffs?
As we’ve noted above, trade agreements are a long and complicated process and due to their nature they must be passed by Congress in the United States in order to come in to law[13]Council on Foreign Relations: Election 2024: Donald Trump Has Vowed to Raise Tariffs. Can He?.
Trump was able to circumvent this in his first term by using the “International Emergency Economic Powers Act”[14]Center for Strategic And International Studies](Making Tariffs Great Again: Does President Trump Have Legal Authority to Implement New Tariffs on U.S. Trading Partners and China?, labelling China as a security risk in order to raise tariffs.
But according to investment analyst Kevin Fisher[15]Sky News Australia: Trump’s New Tariffs Won’t “Apply” To Australia, Trump would not be able to apply his tariff strategy across the board as he wants to as countries like Australia and the UK aren’t considered security risks however this didn’t stop him in 2018.
With Trump controlling pretty much all areas of the Government he would likely be able to pass legislation to amend trade agreements (or just ignore them completely) claiming that foreign nations are trading unfairly which would enable him to use section 301 of the 1974 Trade Act in order to retaliate[16]Council on Foreign Relations: Election 2024: Donald Trump Has Vowed to Raise Tariffs. Can He?.
So given that Trump has multiple ways he can move forward with his tariffs agenda it’s highly likely they will be one of the first policies he enacts after taking office in January 2025.
How Will It Affect The US Economy?
Unless companies absorb the cost of the tariff or are able to negotiate lower prices with their suppliers the increased costs will be passed on to consumers with some economists stating this will be a minimum of $2,600 a year for each household[17]The New York Times: Higher Prices, Trade Wars and More: What to Know About Trump’s Tariffs, excluding large/luxury purchases, with some experts putting it as high as $4,000 per household[18]AP News: Trump favors huge new tariffs. What are they, and how do they work?.
This is turn will mean that consumers have less disposable income to spend which will have a knock-on effect of reducing the size of the economy.
Some also state that an increase in tariffs will have an inflationary effect with businesses using the increased prices due to tariffs as a way to increase the price to the customer over-and-above the expected tariff-led increase[19]Investing.com: Four ways tariffs drive up inflation.
The higher prices then leads to an increase in higher wage demands in order to compensate from the rising cost of living[20]Snopes.com: Trump’s Proposed Tariffs: What Are They, and How Would They Affect US Economy? which pushes prices up even further in an inflationary cycle.
Due to the increased tariffs, foreign businesses may begin to withdraw from operating in or trading with the US meaning that the remaining businesses face less competition, and this may cause a further rise in prices as they capitalise on being able to increase their profits without the fear of having to deal with cheaper rivals.
As we saw during the last Trump presidency, trade can actually be reduced in certain sectors such as farming and steel manufacture thanks to the tariffs being placed on the US by affected nations.
While some American companies may be able to make up the shortfall due to increased domestic sales (as the steel and aluminium manufacturing sectors did previously), the companies buying these products will have to deal with increased costs which they will pass on to their customers and halt expansion or hiring plans[21]Snopes.com: Trump’s Proposed Tariffs: What Are They, and How Would They Affect US Economy?. This further reduces economic growth and can lead to stagnation or even a recession in severe cases.
What Effect Will It Have On The World Economies?
You might think that an increase in tariffs on Chinese imports will only affect those in the US but it can have a knock-on effect.
Increasing tariffs in for one country can have unintended global effects so while Trump might increase tariffs on China by 100% and only 5% on the UK, this does not necessarily mean that the UK will escape unscathed.
Due to global supply chains, imposing tariffs on one country can still increase prices in another.
For example, increased Trump tariffs on China may make a lot of US producers move manufacturing domestically. Because of lower revenue from the US market, Chinese companies will have to make up that shortfall and could increase their prices which means other markets such as the UK, EU and Australasia pay more for their goods – a cost that will have to be absorbed or passed on to their customers[22]European Central Bank: The effects of tariff hikes in a world of global value chains.
Additionally, as Chinese companies seek to make up their lost revenue they may look to moving into markets they would not usually operate in. This could mean increased competition in some trading blocs like the EU meaning that companies already operating in that area will have to compete with more companies which may be offering lower prices.
While this could mean lower prices to consumers, reduced profitability of EU based companies would lead to less expansion, less job creation and also less tax paid.
Disruption to the supply chain could also lead to delays in components being shipped out which would then impact the ability of companies to manufacture their products in a timely fashion, impacting sales and profitability further.
So Are Trump’s Tariffs Going To Work?
It remains to be seen whether a Trump government’s tariff policy will raise enough money in order to both offset the lost revenue some sectors will see and cover his proposed tax cuts.
Trump will certainly have to find additional funds to bail out sectors harmed by his increased tariffs and as we saw in 2020, at a cost of $32 billion, it won’t be an insignificant sum.
How much this package will need to be and where this money will come from is currently unknown and it’s something worth keeping an eye on.
It could be that due to the cost of living implications which are already hitting a lot of Americans very hard Trump decides to dial back his proposed tariff increases although as it was such a main part of his campaign and he’s made so much of it it’s unlikely that will happen.
What is certain is that consumers – particularly those less well off who often rely on cheaper imported goods – will bear the brunt of the tariff price increases and will it will be these people that suffer, not China.
Katy is the editor-in-chief of FlippingHeck.com a blog about Self-Improvement, Productivity and Small Business Tips. When she’s not working, she enjoys gaming, making music and Reviewing Things.
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