What are the economic effects of a tariff increase in a large economy
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Economic Effects of a Tariff Increase in a Large Economy
Decline in Domestic Output and Productivity
A significant body of research indicates that tariff increases lead to a decline in domestic output and productivity. Studies using data from 151 countries over several decades consistently show that higher tariffs result in economically and statistically significant reductions in output growth and productivity1 2 3. This decline is more pronounced when tariffs are raised during economic expansions and in advanced economies1 2.
Increase in Unemployment and Inequality
Tariff hikes are also associated with higher unemployment and increased inequality. The imposition of tariffs disrupts labor markets, leading to job losses and greater income disparity1 2. This is because tariffs can make imported goods more expensive, reducing the overall demand for goods and services, which in turn affects employment levels.
Real Exchange Rate Appreciation
Another observed effect of tariff increases is the appreciation of the real exchange rate. This means that the domestic currency strengthens relative to foreign currencies, making exports more expensive and imports cheaper, which can further exacerbate the negative impact on domestic industries1 2.
Minimal Impact on Trade Balance
Interestingly, the impact of tariff increases on the trade balance is generally small. Despite the intention of tariffs to protect domestic industries by reducing imports, the overall effect on the trade balance is often negligible1 2. This is because the reduction in imports is often offset by a corresponding decrease in exports due to retaliatory tariffs and reduced competitiveness.
Negative Effects on Consumption and Investment
Higher tariffs act like a tax increase, negatively affecting consumption and investment. Consumers face higher prices for goods, reducing their purchasing power, while businesses face higher costs for imported inputs, leading to reduced investment in capital and innovation4. This can slow down economic growth and reduce the long-term productive capacity of the economy.
Disruption of Global Supply Chains
Tariff increases can significantly disrupt global supply chains, especially in economies that are deeply integrated into global trade networks. For instance, the U.S.-China trade war led to substantial changes in supply-chain networks, increased costs for intermediate and final goods, and reduced availability of imported varieties5 7. This disruption can lead to inefficiencies and increased costs for businesses, further hampering economic growth.
Reduction in Real Income
The full incidence of tariffs often falls on domestic consumers and importers, leading to a reduction in real income. For example, the tariffs introduced by the Trump administration in 2018 resulted in a monthly reduction of $1.4 billion in aggregate U.S. real income by the end of that year5. Similar patterns were observed in countries that retaliated with their own tariffs, indicating that trade wars can reduce real income globally.
Long-Term Negative Effects on Economic Growth
In the long run, persistent tariff increases can negatively affect the productive capacity of the economy. Higher tariffs can slow the accumulation of capital, shift resources into less productive sectors, reduce competition, and interfere with technological advancements4. These factors collectively contribute to a slower growth rate and reduced economic dynamism.
Conclusion
In summary, the economic effects of a tariff increase in a large economy are predominantly negative. Tariff hikes lead to declines in domestic output and productivity, higher unemployment and inequality, real exchange rate appreciation, and minimal impact on the trade balance. They also negatively affect consumption and investment, disrupt global supply chains, reduce real income, and have long-term detrimental effects on economic growth. These findings underscore the complex and often adverse consequences of protectionist trade policies.
Sources and full results
Most relevant research papers on this topic
Macroeconomic Consequences of Tariffs
Tariff increases lead to significant declines in domestic output and productivity, increased unemployment, higher inequality, and small effects on the trade balance.
The Macroeconomy After Tariffs
Tariff increases lead to significant declines in domestic output and productivity, higher unemployment, inequality, real exchange rate appreciation, and insignificant changes to the trade balance.
Are tariffs bad for growth? Yes, say five decades of data from 150 countries☆
Tariff increases are associated with a significant and persistent decline in output growth, supporting the view that the ongoing trade war may be costly for the global economy.
Observational StudyLong-Run Effects on Chinese GDP from U.S.-China Tariff Hikes
U.S.-China tariff hikes could negatively impact Chinese GDP by disrupting supply chains, affecting investment and hiring, and potentially slowing capital accumulation and technological advances.
The Impact of the 2018 Tariffs on Prices and Welfare
The Trump administration's tariffs in 2018 led to increased prices, supply-chain disruptions, and a $1.4 billion reduction in aggregate US real income per month.
Highly CitedEffects of Eliminating the US–China Trade Dispute Tariffs
Eliminating the US-China trade dispute tariffs could generate substantial real income gains for both countries and lower US consumer prices.
The Economic Effects of Trade Policy Uncertainty
Increases in trade policy uncertainty reduce business investment and activity in the U.S. economy.
Highly CitedTariffs and aggregate economic activity: Lessons from the Great Depression
Tariffs during the Great Depression had a significant impact on GDP, even when trade only represented a small share of output, due to material inputs and persistent tariff increases on capital accumulation.
Highly CitedThe effects of tariff increases on supply base complexity: A conceptual framework
Tariff increases can lead to firms adjusting their supply base structure and complexity to mitigate increased importing costs, with factors like severity, timing uncertainty, and geographical scope influencing this relationship.
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