The economics of tariffs

A central insight from neoclassical economics is that international trade operates like an improvement in production technology. It generates mutual aggregate welfare gains for countries as a whole, but creates winners and losers within countries. Tariffs are a tax on this trading technology and distort the prices faced by domestic consumers and producers. Large countries can use tariffs to improve their terms of trade on world markets. But if all countries try to do so, they can end up with lower welfare than if they cooperated to liberalize trade. Tariffs can be used to redistribute income between the winners and losers from trade within countries. But there can be other more efficient ways to achieve redistribution. Policies to promote economic activity in critical industries can be rationalized based on externalities or national security. But these arguments typically rationalize targeted policies towards those industries and tariffs can be dominated by other policy interventions. Empirical findings from the recent waves of US tariffs suggest that most of the incidence of these tariffs has been borne by US importers, wholesalers, retailers and consumers rather than by foreign exporters. These tariffs have led to a large-scale reorganization of US supply chains away from China to third countries. Although this reorganization has substantially reduced China's share of US imports, the US remains indirectly exposed to China through the imports of these third countries.