Sun, Nov 24, 2024 page9

• Determining the cost of tariffs

  • By Pinelopi Koujianou Goldberg
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  US president-elect Donald Trump’s promise to impose a 60 percent tariff on imports from China and a 10 to 20 percent tariff on all other imports has triggered a public debate about whether such policies are really so bad. After all, a tariff is a consumption tax and most economists favor taxes on consumption over income taxes, as the former are more efficient and easier to administer.

  However, tariffs have significant drawbacks. As they tax only imported products, they distort markets by shifting resources from more efficient foreign producers to less efficient domestic firms. This inefficiency comes at the expense of consumers and like most consumption taxes, tariffs are regressive, placing a heavier burden on low-income households that spend a larger share of their income on consumer goods.

  Still, tariffs do have political appeal. Critics of globalization in advanced economies have long said that the efficiency gains from recent decades of trade liberalization have been modest, relative to the disruptions caused. While US consumers benefited from lower prices on imported goods, particularly from China, these widely dispersed gains were less salient than the concentrated pain of factory closures and job losses in regions exposed to import competition.

  Against this backdrop, higher tariffs might not look so bad. Perhaps reversing globalization’s modest efficiency gains could redirect income toward domestic producers and workers. Perhaps the regressive effects of tariffs can be addressed with policies such as exemptions for de minimis imports (valued under US$800). Besides, while prices of taxed imports would increase, US consumers have not seemed especially appreciative of trade’s role in making the goods they consumed more affordable.

  The problem with such arguments is that they ignore the macroeconomic context. Inflation over the past three years has increased consumer sensitivity to price changes. Voters today would be far more attuned to the inflationary pressures of tariffs than they were in the past. While proponents of new tariffs say that China would bear the brunt of the financial burden, the evidence from the 2018 to 2019 tariffs shows otherwise: US consumers bore most of the cost.

  Considering that the previous tariffs were 10 percent to 25 percent, a 60 percent levy might shift some costs to China, but US consumers would still feel the sting.

  Even if US prices remained unchanged, unintended consequences could follow. If broad-based tariffs led to a sharp depreciation of China’s currency, the stronger US dollar would make Chinese imports relatively cheaper. This might partly offset the higher prices caused by tariffs, but it would undermine the original goal of making US manufacturing more competitive.

  Meanwhile, the stronger dollar would hurt US exports, worsening the trade deficit.

  That suggests that the multiple goals advertised for tariffs — reshoring manufacturing, reducing the trade deficit, generating revenue, lessening the US’ reliance on China and forcing Beijing into negotiations, all while minimizing the impact on consumers — often conflict with one another. That is because tariffs affect the US economy through prices. To boost US competitiveness or reduce the deficit, tariffs must raise import prices — a politically toxic outcome today.

  Reducing the US’ reliance on China is also complex, given that Chinese-made intermediates are embedded in many goods exported to the US from third countries. Since 2018 to 2019, China and several “bystander” countries have registered robust export growth despite tariffs. The proposed new tariffs might affect only direct Chinese exports to the US, not to other countries. Broadening them to more countries to curb China’s reach would exacerbate price pressures, because there would be fewer substitution possibilities for US consumers and businesses.

  The argument for tariffs as a revenue-generating mechanism is interesting and novel (in the sense that it has not been used for many centuries). However, it does not hold up. Tariffs cannot possibly replace income taxes as a source of revenue: The scale of the income tax base is roughly an order of magnitude larger than the scale of imports. Still, tariffs could generate some government revenue, with China potentially bearing part of the cost. If used as a short-term negotiating tactic, they could apply some economic pressure on China.

  Strengthening the US’ negotiating leverage is the most compelling argument for tariffs. The 2018 to 2019 tariffs led to the “phase one” agreement, a planned de-escalation in exchange for Chinese commitments to import more from the US and address concerns about intellectual property and technology transfers. Although the earlier tariffs marked the biggest departure from free trade since the 1930 Smoot-Hawley Act, their economic impact was modest and the agreement allowed the US to save face.

  However, the 2018 to 2019 tariffs were far from cost-free. They poisoned US-China relations, escalated tensions, pushed China into an alliance with Russia and Iran, and fueled anti-Asian sentiment domestically. They eroded the US’ relationships with allies who were not consulted and who found themselves also targeted by specific tariffs. And when all was said and done, the phase one deal’s full impact was never realized. The disruption to trade from the COVID-19 pandemic meant that China fell far short of its commitments to purchase goods from the US.

  Today’s tariff proposals risk repeating history, only on a grander scale. The incoming Trump administration would face a wary, inflation-sensitive public and a Chinese regime that is well prepared to pursue large-scale retaliation. Whether tariffs become a negotiating tool or a source of greater economic disruption depends on how the incoming US administration balances competing objectives. Reason and strategic foresight would be crucial.

  Pinelopi Koujianou Goldberg, a former World Bank Group chief economist and editor-in-chief of the American Economic Review, is professor of economics at Yale University.

  Copyright: Project Syndicate
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