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The impact of tariff barriers on the importing economy.

| April 5, 2015

Tariff refers to the import duty or tax levied by the domestic government on imported goods (Anderson 1995). Just like the sales tax, tariffs are normally levied as a percentage of the total value of imported goods. However, unlike the sales tax, tariffs differ from one product to another and do not apply to domestically produced goods. Tariffs are often imposed by the government as a form of protectionism. That is, to protect fledging and inefficient domestic industries from foreign competition and to protect domestic producers from ‘dumping’ (Salvatore 2011).
While such imposition of tariffs may be justified as a form of protectionism, the implications on the economy is by no means trivial. According to the World Bank estimates, if trade barriers such as tariffs were to be removed then the global economy would more likely expand by 830 billion dollars by 2015 (Blinder and Baumoi 2010). The impact of these trade barriers on the welfare of the economy can be analyzed from two perspectives: tariff effects on the importing economy and the effects on the exporting economy. The impact, in all most all instances, is a net loss to the welfare of both the importing and exporting economies. Our analysis, however, will explore on the impact of tariff barriers on the importing economy.

The diagram below shows the cost and benefits of tariffs on the welfare of the imposing economy. In order to incorporate free trade into this model, we will use Pw which denotes the supply curve. The assumption made here is that the supply is perfectly elastic and that production is possible at a near infinite quantity at the given price (Lawrence, et al. 1986). While such an assumption is obviously unrealistic, the impact is unlikely to be of significance to the outcome of the model.


At Pw, world equilibrium, the domestic production is represented by S and the demand represented by D. Hence, the difference between the supply and demand (SD) is filled by imports. However, after tariff imposition, there is a rise in domestic price from Pw to Pt and a fall in foreign export prices from Pw to Pt* because of the tax difference between the consumers at home and producers abroad.
At this higher price level (Pt) the domestic supply increases from S to S*while the demand falls from D to D* due to the higher price. The new difference between supply and demand after the tariff imposition (S*D*) is filled by imports. Hence, tariff are seen to reduce the quantity of imports from SD to S*D*.
The tariffs, however, benefit the domestic producers who enjoy a gain in surplus. The tariffs expand the producer surplus from the region below Pw to that below Pt. Therefore, the producer gain is represented by area A. The government also gains from these tariffs as it charges an amount PtPt* for every of the imports. Since imports after tariff imposition are represented by S*D*, the government gains the area C and E.
On the other hand, consumers face a reduction in their welfare. Hence the consumer surplus which is represented by the area between the price line and demand curve shrinks from the area above Pw to that above Pt. That is, it shrinks by A, B, C and D.
The net welfare loss as a result of imposition of tariff will be calculated as:
Consumer loss – producer gain – government revenue
(A + B + C + D) – (C + E) – A
= B + D – E

Therefore, we can conclude that imposition of tariffs become only beneficial to the economy when the area given by E more than offsets the losses incurred by B and D. Hence, E represents the ‘terms of trade gain’ while B and D represents the ‘efficiency loss’.

Tariffs are viewed by neoclassical economic theorists as a distortion to the free market. Typical analyses have shown that while the domestic producers and government may benefit from tariff barriers, the net welfare effects on the importing country are negative. When analyzing the impact of tariffs on the importing economy, first we examine whether the economy is large enough such that its import policies affect the world prices. For small countries with insignificant effect on the world prices, the domestic producers and national government gains from such impositions while the domestic consumers lose.
The analysis is however affected in various ways in the case of a large country. Imposition of tariffs in a large country causes a triangle of national loss (comparable to that of the small economy) but also a rectangle of national gain since the foreign exporters are compelled to lower their prices (Salvatore 2011). The net effect will therefore depend on which among the two is larger.
The rectangle is larger for a small tariff hence a net gain on the importing country while for a prohibitive tariff the rectangle would disappear resulting in a net national loss (Irwin 2005). The country’s optimal tariff can be determined as it is inversely related to the price elasticity of foreign supply. There are also possible risks of retaliation from the foreign countries whose imports have been subjected to the imposition of tariffs.

Findings have confirmed that in general, tariffs tend to reduce the welfare in the economy imposing them. For example, in 1984, the US government spent large sums of money for various jobs that were preserved by tariffs (Hufbauer et al. 1994). Each job in the luggage industry that was preserved by tariff barriers cost the consumers around $1,285,000 annually. While each textile worker’s job that was saved cost consumers $199,000 annually. Further $1,044,000 was spent for preserving each of the softwood lumber jobs and $1,376,000 spent for each of the Benzenoid chemical industry job saved. Surely, spending such enormous sums on grounds of protectionism is plainly irrational.
Tariffs must therefore be carefully targeted since increases in such tariffs are likely to result in a reduction in the welfare of the economy imposing it. In the UK, since much of its economy is dependent on trade, a rise in the imposition of tariffs will certainly do more harm than good (Holden et al 1995). Higher tariffs will result in lower imports and lower exports due to retaliatory actions from those economies whose products have been subject to tariff imposition. The outcome will therefore be a lower rate of economic growth. However, it is worth noting that more than 60% of trade in the UK is now with the EU (Salvatore 2011). Therefore, if such protectionism is only applied to the non-EU countries, the net effect will be smaller and less severe.

While the tariffs may be justified on grounds of protectionism, especially from overseas competition, the economic value for such justifications are tenuous since they abstract from the danger of retaliation from the exporting economies. Despite short term gains from these forms of protectionism, tariffs and other trade barriers are harmful in the long-run.

Anderson, J.E., 1995. “Tariff index theory”. Review of International Economics 3, pp.156-173.
Blinder, A.S., and W.J. Baumoi, 2010. Macroeconomics: principles and policy. South-Western College Publishers.
Holden, K., M. Kent, and J.L. Thompson. 1995. The UK economy today. Oxford: Manchester University Press.
Hufbauer, C. Gary and A. Kimberly, 1994. Measuring the costs of protection in the United States. Washington, D.C.: Institute for International Economics.
Irwin, D.A., 2005. Free trade under fire. 2d ed. Princeton: Princeton University Press.
Lawrence, Z. Robert and R.E. Litan.1986. Saving Free Trade. Washington, D.C.: Brookings Institution.
Salvatore, D., 2011. International economics: Trade and finance. 10th edition, John Wiley & Sons.

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