The Economic Consequences of Tariffs

This is the first post in a three-part series on the history of tariffs. You can read the introduction by David Webster here.

Heather McKeen – Edwards

The idea of tariffs is far from new, politically or economically. In fact, most countries in the world have some tariffs right now. Tariffs are a type of trade barrier, and their goal is usually to slow down imports for a variety of domestic reasons. Historically, governments used them to build their own domestic industry by making the foreign versions of goods more expensive, thus reducing consumer demand for those goods. In today’s world this logic could be framed as an effort to ‘reshore’ industries that have moved overseas.

Beyond industrial development, there are two other common economic reasons for countries to apply a tariff. The first is compensation for perceived unfair trade practices in a sector. Somebody is doing something to manipulate the market, like dumping their goods cheaply in your country. That’s not fair, so you can compensate or retaliate by putting tariffs in place, though usually after trying a process of dispute settlement at the World Trade Organization (WTO) or other dispute-settlement mechanism first. The second is national security. Countries in general are usually concerned about giving up control over certain industries, particularly those that are strategically important. For example, if you don’t have any capacity to produce your own steel, it can affect security and military autonomy. We may see Trump invoke national security in justifying tariffs as it is one of the reasons in US law that he can unilaterally impose tariffs, but security aspects are not necessarily the underlying reason. In fact Trump has presented a myriad of inconsistent reasons in his rationale for tariffs over the past year. 

Tariffs are a tax on the importer of a good. The tariff is paid by the importer, but its actual cost is often passed on to consumers, because importers are faced with how to make back the money they lose in paying tariffs. A business can choose to simply absorb the cost, paying the tariffs but keeping prices the same, thereby sacrificing profit. That is unlikely to happen, particularly in sectors with low profit margins. Passing on the price increase to consumers is the common choice. A company’s input cost went up, so the prices also go up. U.S. President Trump claims to be able to both lower prices and increase tariffs, which is incredibly difficult to do at the same time, because someone must bear the cost. This is reinforced by the findings of a recent EY survey where half of the 4,000 US executives asked said they would be willing to pass up to two-thirds of the added tariffs costs onto consumers.

Consequentially, tariffs generally lead to prices increases not only in the tariff-affected industry but in all the industries that use parts or other inputs that are subject to the tariffs.  With energy or steel tariffs, for example, it is not just those industries affected. Think of all the things made using steel and the need for energy for factories which factor into pricing too. Most likely, these increased costs will be borne by the consumer as we saw in 2018/19, the last round of US tariffs which focused on Canadian steel (25%) and aluminum (10%). Several studies showed that US consumers did bear the brunt of costs for tariffs put in place on Canada and China at that time. Other studies pointed to further economic losses. A study by Kadee Russ and Lydia Cox determined that about 75,000 jobs were lost overall due to steel and aluminum using industries cutbacks. Even though the US gained jobs in the steel industry, they lost more jobs in the industries that had to pay more for steel. In general, if the idea is to increase reshoring, i.e. bringing production back to the domestic market and encouraging the purchase of domestic goods, industries tend to benefit more from subsidies and incentives. Tariffs are less effective.

What about the current US tariff threats?

One distinction that is important about our current discussion is the choice of a blanket tariff. A blanket tariff means tariffs on all of Canada’s exports to the United States. If the decision by the Trump government to impose a 25% blanket tariff remains, it does not matter what is produced or sold, everything is going to face this tariff. This is even broader than the controversial Hawley-Smoot tariff of 1929. Most recent tariffs, including the US ones from 2018/19, are sector-specific: steel, softwood lumber, energy, etc., and apply only to the named sectors. Unless you are a pure free neo-liberal market economist this later type of tariff, in and of itself, can have an economic role, but its usefulness is limited.

It’s also important to realize that the Trump government is not only talking about tariffs on Canada, but also about a 10% global tariff, up to 60% on China, 25% on Mexico, and a variety of tariffs for other countries. The tool is being aimed at everyone, and because of that it is easier to see it’s being used as a form of political leverage, not purely for economic reasons.

What will this mean for Canada?

If the US enacts their tariffs, Canada will feel negative economic consequences. The government is likely to respond with tariffs on US goods and other restrictions. When Canada retaliates with counter-tariffs, it will likely aim at agriculture and other industrial sectors that are important Canadian export markets in the United States. It is not as useful for Canada to target a product the US does not export here in large amounts as the point is to pick items that the other country is sensitive to, generate economic losses, and therefore increase political pressure for the Trump administration to abandon the original tariffs.  Canada will be helped in this if other countries face increased US tariffs at the same time, as the responses from most, if not all, of the affected countries will further increase this economic pressure.

Within Canada, governments will likely also take action to offset some of the economic losses, particularly those felt by exporters facing reduced demand from the US for their goods. This may involve some economic stimulus or stabilization programs, as well as efforts to reduce the remaining internal trade barriers that make it difficult to move goods and services between provinces and territories within Canada.

Heather McKeen-Edwards is an Associate Professor in the Department of Politics and International Studies at Bishop’s University. Specializing in International Political Economy, she teaches a range of courses at the intersection of political studies, economics, and business. She has contributed to various publications and projects that explore the intersection of global economy and public policy, particularly in the areas of global finance, global economic governance, and sport policy.