Liberation – Earlybirds Invest

Donald Trump has said that “tariff” is the “most beautiful word in the dictionary.” And throughout his first months in office, he has given Americans plenty of cause for googling that word’s definition.

The president announced Wednesday — a day he dubbed “Liberation Day” — that he will impose tariffs of at least 10 percent on all foreign-made goods. For products made in China, the tariff rate will be 34 percent; for those made in Vietnam, it will be 46 percent; for the European Union, it will be 20 percent. Trump framed these tariffs as “reciprocal,” meaning that that they match the level of trade restrictions that each foreign nation imposes on US products. But this is not true — Trump’s tariffs greatly exceed those of America’s targeted trade partners.

Before Wednesday, Trump had already announced tariffs on steel and aluminum made outside the US, all products made in Canada or Mexico, all Chinese goods, and all foreign-made cars, among other things.

The president’s prolific and haphazard tariff declarations have tanked stock markets, soured consumer sentiment, and thrilled some longtime critics of globalization.

Meanwhile, they’ve left some Americans concerned and confused; tariffs arguably haven’t been this relevant to the US economy in nearly a century. So many are understandably unsure about what tariffs are, how they affect consumers, why governments would implement them, and whether the president’s policy will work on its own terms.

Here’s the short answer: Tariffs are a tax on imported goods. They generally make affected consumer products more expensive. In theory, well-designed tariffs will also encourage targeted industries to produce more in the United States. And manufacturing certain goods domestically — instead of importing them from abroad —may have national security or economic benefits. Trump’s own rationales for his tariffs are numerous and shifting: He sees them as a tool for raising revenue, enhancing national security, and revitalizing the US economy by increasing domestic manufacturing jobs. But the president’s tariffs are so broad, high, and ever-changing that they could actually backfire.

What are tariffs? How will they affect consumers?

To understand what tariffs are — and how they work — it’s helpful to consider a concrete example. On April 3, Trump will impose a 25 percent tariff on all cars made outside the United States. This means businesses that import foreign-made automobiles — such as car dealerships — will need to pay a 25 percent tax on every foreign vehicle that they purchase.

When a business’s costs rise, it typically tries to compensate by raising prices. And the president actually needs his auto tariffs to raise the prices of foreign cars: The official point of this tariff is to encourage Americans to buy more domestically produced cars, so that more auto manufacturers locate production in the US. If the tariff doesn’t make foreign-made cars more expensive for US consumers, it won’t give them any incentive to “buy American.”

In practice, Trump’s auto tariffs are likely to increase the prices of all cars, including American-made ones. This is for two reasons: First, US car manufacturers will need to pay tariffs on foreign-made auto parts. And second, US auto companies will face weaker competition. Previously, American carmakers couldn’t raise prices without fearing that doing so would lead potential customers to purchase a German, Japanese, or South Korean car instead. Trump’s tariffs make that much less of a concern.

For these reasons, economists have estimated that Trump’s tariffs will raise US car prices by between $4,000 and $15,000 per vehicle.

These same basic dynamics apply to tariffs on other goods. Put a tariff on foreign-made washing machines, and US retailers that import such appliances will raise prices. American washing machine makers, meanwhile, will be able to charge more due to weaker competition.

And this actually happened: In 2018, Trump put a tariff on washing machines, which stayed in effect until 2023. During the four years that those tariffs were in place, the cost of laundry equipment in the US rose by 34 percent, much higher than the overall inflation rate over that period.

Trump’s current tariffs are poised to have an even bigger impact on Americans’ finances. According to a recent estimate from the Yale Budget Lab, Trump’s tariffs on Canada, Mexico, and China alone could reduce the average US household’s disposable income by as much as $2,000.

If tariffs hurt consumers, why would governments impose them? What are the benefits of tariffs?

There is little question that tariffs are bad for consumers. But in theory, they could still serve a nation’s interests in at least three ways:

By generating revenue. Since tariffs are a tax, they provide the government with revenue that it can use to pay down debts or finance spending. The US government actually used tariffs as its primary revenue source from the republic’s founding until the Civil War. But since the federal income tax was introduced in 1913, tariffs have become an increasingly marginal source of funds for the government.

Trump says he wants to change this. In fact, he has called for replacing income taxes with tariffs. And his administration claims that its auto tariffs will bring in $100 billion of revenue this year.

By nurturing highly valuable domestic industries. Many nations have successfully used tariffs to facilitate economic development.

For example, beginning in the 1960s, South Korea sought to build up its domestic car industry. But getting such an industry off the ground is difficult. In their first years of operation, South Korea carmakers had little hope of producing automobiles that were competitive with foreign ones in quality or price. By placing high tariffs on foreign-made cars, the South Korean government ensured that its domestic automakers would have a market for their less-than-stellar vehicles. Today, South Korean brands like Kia and Hyundai are globally competitive.

America’s car industry is much more mature today than South Korea’s was in the 1960s. But American auto manufacturers cannot make electric vehicles as efficiently as China can. Economic analysts disagree about whether it is important for America to have a globally competitive EV sector. But if we do want to nurture our electric vehicle industry, it makes some sense to put high tariffs on Chinese EVs — as both Joe Biden and Trump have done.

By improving national security. Some goods and commodities have military value. Relying on foreign nations for steel, ammunition, advanced semiconductors, or various other technologies could undermine a country’s national security — after all, foreign nations could theoretically choke off America’s access to militarily valuable technologies in the midst of a conflict. And many of Trump’s tariffs are officially intended to enhance America’s capacity to produce materials necessary for war.

How have recent administrations used tariffs?

The United States had used tariffs to nurture its infant industries during the 19th and early 20th centuries. But in the wake of World War II, America pursued the open exchange of goods across borders.

With much of Europe and Asia in ruins, US manufacturers did not need tariffs to dominate global industry. Meanwhile, America’s foreign policy establishment feared that communism would take root in Western Europe and Japan if they did not successfully rebuild their industrial economies. Therefore, to foster healthy capitalist growth abroad — while lowering prices for Americans — the US pursued tariff reduction.

The United States did occasionally enact new tariffs between the Second World War and Trump’s first election. For example, in 1987, Ronald Reagan put a 100 percent tariff on Japanese computers, televisions, and power tools, after Japan blocked US-made semiconductors from its market. But the general direction of US trade policy between Harry Truman’s presidency and Trump’s first term was toward freer trade.

What will be the effect of Trump’s tariffs specifically?

Unfortunately, it seems unlikely that Trump’s tariffs will generate reliable revenue, strengthen American manufacturing, or improve US national security. (And their odds of advancing Trump’s more peculiar trade policy goals, such as coercing Canada into becoming the 51st state, are even slimmer.)

There is a simple problem with tariffs as a revenue source: The more a tariff encourages consumers to buy domestically produced goods, the less revenue it generates. For example, if a tariff on foreign cars leads everyone to buy American vehicles, then the car tariff will cease generating revenue. Thus, for Trump’s tariffs to provide a steady source of revenue, they would need to be so low that importers continue purchasing lots of foreign-made goods (and thus paying taxes on them).

But Trump’s tariffs in many sectors are very high, precisely because he wants Americans to purchase fewer foreign-made goods. So the president’s tariffs can’t plausibly provide enough consistent revenue to offset his proposed tax cuts (let alone, to fully replace the federal income tax).

Meanwhile, his tariffs could actually hurt US manufacturing for at least three reasons:

First, Trump’s tariffs apply to a vast number of industrial inputs, such as metals, energy, and electronics. This will raise costs for US manufacturers, forcing them to raise prices, which will render their products less appealing to foreign consumers. Further, tariffs on inputs will also give companies an incentive to locate factories in other countries, where they will not have to pay, for example, a 25 percent tax on parts and materials made in Canada or Mexico.

Second, Trump’s tariffs will reduce the real wages of American workers. If the average US household’s disposable income drops by $2,000, that family will likely spend less money on goods. This could ultimately reduce demand for US-made products.

Indeed, the market research firm Cox Automotive believes that this is precisely what will happen with Trump’s car tariffs. In its analysis, US car plants will likely have to cut production by 30 percent, as consumers will respond to rising prices by postponing car purchases.

Third, foreign countries are retaliating against Trump’s trade policies by placing tariffs on American-made goods. And that will limit the global sales of American manufacturers. This will be especially true of America’s most innovative and advanced industries, such as pharmaceuticals, chemicals, and medical equipment, which are more likely to sell their wares globally.

We’ve already seen Trump’s tariffs backfire for these reasons. According to a 2019 Federal Reserve analysis, the tariffs Trump imposed during his first term reduced manufacturing employment in affected industries.

Finally, the tariffs’ hypothetical national security benefits are dubious. America’s security likely depends more on strong international alliances than the amount of steel we produce domestically. And Trump’s tariffs have antagonized America’s closest allies while undermining our nation’s credibility as a dealmaker: In 2018, Trump himself reached a trade agreement with the governments of Canada and Mexico. Yet he nevertheless applied 25 percent tariffs on both countries this year, in direct violation of his own trade deal.

If the United States is unwilling to abide by the terms of the agreements it orchestrates, other countries have less incentive to cooperate with us.

In sum, Trump’s tariffs are likely to raise prices, weaken US manufacturers, and undermine America’s alliances and global influence.

How long will Trump’s tariffs be in effect?

It’s unclear how lasting Trump’s tariffs will prove to be. He has framed some of the duties — such as his 25 percent tariffs on Canada and Mexico — as a potentially temporary bargaining chip in negotiations over trade and border security. But he has suggested that others will be permanent.

As the costs of Trump’s trade policies to US consumers and manufacturers mount, it is possible that the administration will decide its agenda is politically unsustainable. Already, Trump’s tariffs are deeply unpopular, with 61 percent of voters disapproving of them in a recent CNN poll.

Update, April 2, 4:50 pm ET: This post was updated to include information from Trump’s speech about tariffs.

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Key Takeaways

What are tariffs? How will they affect consumers?

If tariffs hurt consumers, why would governments impose them? What are the benefits of tariffs?

How have recent administrations used tariffs?

What will be the effect of Trump’s tariffs specifically?

How long will Trump’s tariffs be in effect?

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