Can Tariffs Actually Work?

tariffs have returned to the Forefront of economic debate since Donald Trump won the US election and began using them both as a negotiating threat and a tool to fix a long list of identified economic problems his policy of economic nationalism is nostalgically inspired by the 19th century when tariffs were the defining trade policy of the United States a policy that supposedly helped to keep income tax at zero and protected thriving Industries so if it worked for the USA once could it happen again it's an idea at the very least worth exploring since it's promising the

possibility that tariffs can create the fiscal wiggle room needed to lower taxes whilst Reviving The Old industrial Heartland of the world's largest economy even the most PR Global economists will admit that there's certainly reasons to impose tariffs that make economic sense that's why large growing economies like India Brazil and yes of course even China still use them fairly heavily but the world has changed dramatically since the US last year's tariffs with the breadth and depth of the level being proposed today nowadays American consumers are accustomed to cheap goods made through complex Global Supply chains that

depend on low trade barriers new tariffs would introduce barriers potentially forcing importing businesses to increase their prices just to stay profitable this would effectively mean that tariffs are just a sneaky way to tax consumers even so the industrial employment and strategic benefits of tariffs could still be worth a potential reduction in consumer purchasing power now of course recent debate on this issue has been highly politicized but at the end of the day tariffs are simply an economic tool like a spanner they aren't inherently good or bad need a Titan loosen Bolt the spanner is very

useful but if you need to perform brain surgery maybe consider using something else the point is generalized blanket statements that have been made about tariffs are are oversimplified because they cause different trade-offs in different markets which should be weighed up to get a sense of the net benefit or the net cost this means Newan is key now more than ever so as always we have some questions to answer how do tariffs work what can we learn about tariffs from chickens and washing machines and finally why might tariffs still be worth it even if they come

at an economic cost as someone who writes a lot whether it's scripting videos for economics explains or drafting important emails clear and effective communication is critical to my work but writing isn't always easy especially when you're staring at a blank page or trying to reword something for the 10th time so for this video we're partnering up with grammal a tool that I've actually been using for ages it just helps me make my writing better and it saves time one of the best parts is how seamlessly gram integrates into my workflow it works where you work

whether it's Google Docs Gmail slack or even LinkedIn you even upgrade to Gramm Le Pro which unlocks even more powerful features for example I can set a specific tone telling Gramm Le to be more casual confident and direct and it adjust my text to match plus they have this cool feature where it anticipates readers questions or concerns helping me f gaps up front whether it's providing just enough context or offering solutions to a problem that means less back and forth emails and editing for me there's a link in the description so you can check it

out for yourself clicking that link helps to support this channel so sign up and upgrade to graml Pro to level up your productivity a tariff is a targeted tax on imported goods paid directly by the domestic business that's importing it it's a type of government intervention that falls under the umbrella term of protectionism or even economic nationalism the basic idea is that a tariff on Imports makes them more expensive as a result of this domestic production becomes relatively cheaper so the market replaces imported goods for domestically produced Goods which Fosters investment employment and Industrial growth

in the domestic economy whilst the government earns itself an additional source of income this is a process known as import substitution industrialization numerous countries throughout history have used tariffs as a means to protect and develop their industrial base but there are few countries whose development story is so fundamentally linked to the use of tariffs as the United States of America making its contemporary image as the quartermaster of global free trade somewhat ironic tariffs were there from the very beginning with the second ever piece of legislation passed after the US Constitution was ratified being about a

tariff way back in 1789 the Alexander Hamilton of Broadway Fame respected Adam Smith's newly published foundational economic ideas about the power of the invisible ible hand of free market trade but he rejected it as a general rule for developing industry and building National wealth Hamilton knew that as the United States built its institutions and earned political Independence the country would not gain economic independence from Britain until it developed a manufacturing base that could produce its own Goods as efficiently and competitively Europe had already begun its Industrial Revolution and was producing key Goods like steel textiles

chemicals Precision Instruments and Machinery relatively cheaply and on mass us industry was behind the curve with less infrastructure capital and skilled labor it couldn't compete with the European producers in the free market even with the significant technological barriers to international trade at the time and so tariffs were introduced to raise the price of European Imports encouraging entrepreneurs to set up shop on us soil instead fostering domestic industrialization the passing of the stronger tariffs act continued into the late 19th century with the average tariff rate on targeted Goods eventually sitting above 40% and it worked us

Industries erupted tariffs made up 90% of federal income and the US government was so accustomed to getting its revenue from tariffs that income tax didn't even exist up until 1910 however the use of tariffs was hotly disputed at the time just like it is now while industrialization was concentrated in the north the higher tariffs indirectly harmed The Agrarian South which suffered from retaliatory European tariffs on their exports and slay produced Goods like cotton tobacco and sugar cane the South relied on these exports as a key source of income the mill Tariff was an additional grievance

for the southern states who were already breaking away from the union over the election of Lincoln and intent to end slavery so debate around tariffs in the US is nothing new but fast forward to the end of the second World War and the US flips the script the war was over its Industries had matured and it was ready to begin competing as a leader of free trade technological advancements in communication and transport made trade much more efficient and countries began to specialize to benefit from the principles of comparative advantage and absolute Advantage it also didn't

hurt that every single potential Global competitor at the time had been bombed into Rubble free trade was certified as the dominating economic order when the world Trade Organization open in 1995 which organized the decades long trend of lower tariffs and with this Supply chains continue to develop in their complexity to the point where it becomes common for an end of chain product to have parts from 10 or more different manufacturers or from different places in the world all this time free trade dominated trade policy across the world but this began to be seriously questioned when

the largest advocate of free trade imposed Landmark tariffs on its largest trade partner in 2018 and because of this we actually have pretty strong recent evidence of what the impacts of tariffs will actually be so what can we learn from us tariffs during this period Well to do that we have to look at everyone's favorite semi- durable consumer Appliance the washing machine a research paper by economists at the US Federal Reserve provided a fairly comprehensive account of the impact that the 2018 tariff had on washing machines it found that the businesses who were importing washing

machines passed the cost of the Tariff on to Consumers through price Rises which also created space for domestic producers to follow suit and increase their prices despite not even paying the Tariff it gets worse because the price price of dries also saw significant price increases a product which was not directly subject to a tariff but became collateral damage since the two goods are often sold together shockingly when taking into account the price increase of domestic washing machines as well as dries the Tariff elasticity of consumer prices was above one in layman's terms this means that

the additional price burden faced by consumers was larger than the Tariff itself at least in the year or two that followed the complete pass through of the 2018 tariffs on to Consumers was also evidenced in reports from the American economic Association and the the quarterly Journal of economics in effect this meant that tariffs were just a sneakier more convoluted way to tax consumers without having to actually call it tax in total the 2018 to 2019 tariffs imposed around $80 billion worth of indirect taxes on Americans which amounted to one of the largest tax increases in

decades now this part was already pretty well known but tariffs could still be worth it if the additional employment created by protecting domestic Industries outweigh the price increases for consumers in the of the washing machine specifically the additional cost of the Tariff for consumers amounted to $1.5 billion annually whilst it only brought in an additional $82 Million worth of government revenue annually 1,800 new jobs were created in the US meaning each job came at a cost to Consumers of a whopping $815,000 a year this is clearly an inefficient way to create jobs it would be

way more efficient to Simply fund ,800 new jobs by introducing a value added tax of a much smaller amount the evidence also suggests that tariffs can damage industry just as well well as it can protect it because it's not just consumers who buy imported goods it's businesses too the washing machine is an end product so it's not the best example of a business input but you know what is steel a 25% Tariff was whacked onto steel Imports in 2018 and suddenly the plates sheets strips beams bars rods pipes billets blooms and slabs that countless American

Industries needed as an import material became more expensive this reduced and in some cases eliminated profit margins in key domestic Industries like automotives construction and machine machery triggering layoffs so despite the Tariff increasing employment in the domestic steel and iron industry the tariffs caused a net reduction in manufacturing employment meaning for each new hire in US steel there were multiple layoffs in other Industries the net negative effect shows that there's just way more Industries in the US which use steel as an input of production than Industries where steel is the output of production so in

this particular case tariffs didn't protect from industrial decline it accelerated it at least in the immediate years that followed the decline in Industry also reflects the damaging consequences of ret I atory tariffs imposed by other countries the inevitable Counterstrike in any trade war in light of the 2018 tariffs China imposed a series of their own on the USA largely targeting agricultural food products this made American Agricultural exports more expensive for Chinese companies reducing the demand for these products resulting in less Revenue to provide income in the agricultural sector the US government prevented Mass layout by

directly paying farmers and purchasing agricultural products but this came at a hefty price $61 billion were spent on supporting us farmers who were impacted by Chinese tariffs from 2018 to 2020 which almost entirely canceled out the additional $66 billion the US government collected on tariffs imposed on China so tariffs certainly generate additional Revenue but through retaliation they create the need for more fiscal spending elsewhere so it's like an expensive game of whack-a-mole and as a result tariffs are unlikely to create the dramatic fiscal Surplus the US needs to reach the holy Promised Land of lower

income taxes now it's important to note that these studies were only done a year or two after tariffs came into effect which means we we can only use them reliably to understand the short run which is clearly bad for consumers and a lot of Industries but in the long run factors of production are by definition more flexible so it's entirely possible that the tariffs could bring more benefits than costs as factors of production are reallocated towards domestic production generating investment employment and growth now fortunately there are older tariffs where the effects have marinated for decades

a 25% tariff has placed on like trucks imported to the US in 1964 since then pickup trucks and SUVs have become the highest profit margin vehicles for us car makers for General Motors and stellantis serving as a Lifeline for the US automotive industry where offshoring and Outsourcing was driving industrial decline it also paved the way for foreign competitors to invest billions on us soil from the 1980s to the 2000s with Honda Toyota niss Mercedes-Benz and BMW building assembly plant in the American South to employ tens of thousands tariffs did exactly what it says on the

10 protecting domestic industry and encouraging long run investment but there was also downsides with essentially only three companies supplying the US light truck and suv Market there was much less competition which reduced pressure to innovate and increase efficiency and here lies the key point for tariffs to work the government must ensure that the protected domestic industry is competitive enough to prevent complacency and the abuse of Market power so that consumers get a fair deal if the government is going to block foreign competition they need to ensure that there is adequate domestic competition ultimately the Tariff

has meant that even to this day the US truck and suv Market is not as fiercely competitive as it could be and this has hurt consumer consum through higher prices and lower quality but even if a tariff is appropriately targeted and the market remains competitive its positive effect will still be susceptible to sneaky workarounds when Mercedes-Benz opened their Factory in South Carolina in 2006 it was clear that the SUV tariff had yet again strong armed a foreign producer into investing on us soil but it soon became clear that actually Mercedes-Benz was manufacturing its vans in

Germany disassembling the parts into the automotive equivalent of Ikea flat pack then shipping it to America to be reassembled dodging the 25% tariff on a techn ality this is clearly an inefficiency created by the Tariff barrier In fairness Mercedes have developed the capabilities of the plant gradually over time now assembling the engines and body parts too but it's an interesting example of the lengths that producers will go to to avoid taros other workarounds can be worse especially when tariffs are targeted on particular countries for example when the US tariffs landed on China in 2018 many

companies did move their manufacturing operations but not to the us just to other countries like Vietnam or Mexico where tariffs did not apply it's also possible to avoid tariffs by shipping the product to a middleman country to relabel and repackage before bringing it into the domestic Market point is there's a lot of options for companies to avoid tariffs before they choose the often more costly option of relocating their manufacturing to the domestic economy so there's many moving parts and trade-offs that are sensitive to the Tariff specifications markets targeted and countries affected blanket statements about tariffs

from all sides of what's become a politically charged debate ignore this nuance and here in lies the problem Trump has talked a lot about tariffs but he hasn't been precise on the tariffs he wants to impose which makes it very difficult to assess the economic impact if he wants to impose Universal tariffs on all Goods coming into the us then it seems like any industrial and fiscal benefits of tariffs would be more than canceled out by the damaging combination of higher input costs inflated consumer prices and retaliation this net negative effect could possibly be long

run and certainly short run so why would tariffs not benefit the US economy now when they worked wonders in the 19th century well back then Global Transport and communication was slow products were relatively simple and domestic labor was cheap now Global Transport and communication are quick products are more complex and domestic labor is expensive the era of free trade has meant that complex products are produced through International Supply chains where individual manufacturers have become highly specialized and often make use of heavily subsidized Industries with extremely loose labor regulations in developing economies this makes production efficient

and prices low the cats out of the bag so to speak it's become prohibitively expensive for many Industries to ever return to the US on mass they'd rather Dodge the Tariff by moving operations to another country or take the hit and pass it on to us consumers which would just redistribute money from consumers to the government without necessarily bringing jobs back to the US which is the whole point tariffs are still a useful tool to have in a modern economy but they should be used precisely instead of bluntly at a universal level where tariffs will

be placed on things that never were and never can be made in the domestic economy and to prevent maximum short-term economic shock tariffs need to be carefully planed and gradually introduced like Hamilton did so that the market can prepare and adjust instead of threatening huge tariff which erods trusts and keeps industry leaders uncertain on their next best move but even so even after all of this it could be argued that there are some markets where they're necessary despite the economic costs as the globalized world becomes increasingly tense and less stable countries are less comfortable with

relying on politically misaligned countries for their products Reliance is a vulnerability that can be exploited especially in strategically important sectors such as semiconductors energy Vehicles Rare Earth minerals and food if an event broke out that dramatically escalated tensions or even triggered a war one of the immediate moves would be to embargo trade with an enemy which if not prepared for could leave an Overexposed economy unable to produce the goods needed to sustain livelihoods and defense we're talking national security and at this point the debate around tarff becomes more of a geopolitical concern than an economic

one and for these reasons we've created a part two for this video on our sister Channel context matters which explains why Global powers are shifting towards protectionism after Decades of free trade and how this links with Rising nationalism and the risk of conflict you should be able to click to that video on your screen now thanks for watching mate bye