How Effective are Tariffs, Really?

Import tariffs have long been wielded as a tool of economic policy, promising to shield domestic industries from foreign competition and bolster national economic resilience. But do they truly protect firms, or do they impose unintended costs that outweigh their benefits?

Tariffs – taxes imposed on imported goods – have long been used as a tool of economic policy to shield domestic industries from foreign competition. The idea is simple: by increasing the cost of foreign products, consumers will be incentivised to purchase domestically produced goods, helping protect jobs and bolster national industries. This policy has been applied throughout history, with varying levels of success.

The United States’ use of tariffs, for example, dates back to the early days of the republic. The Tariff of 1789, one of the first acts of Congress, was designed to generate revenue for the federal government and protect fledgling American industries from foreign competition. Throughout the 19th century, tariffs played a central role in funding government operations and promoting industrialisation.

The Smoot-Hawley Tariff Act of 1930 marked a controversial chapter in tariff history. Enacted during the Great Depression, it significantly raised duties on thousands of imports, aiming to protect American farmers and manufacturers. Instead, it exacerbated the global economic downturn as retaliatory tariffs from trading partners crippled international trade.

More recently in 2018, the Trump administration imposed tariffs on steel and aluminium imports, among others, under the name of protecting national security. These tariffs aimed to revive the domestic steel industry but triggered widespread debate about their economic ramifications. They provide a modern lens through which to assess whether such measures achieve their intended outcomes.

The Promise and Pitfalls of Tariffs

Recent research from the Federal Reserve examining the stock-market performance of publicly traded US firms on days when tariff announcements were made found significant losses. Firms that were exposed to China – either through imports or exports – suffered the largest declines in stock prices. This negative impact was widespread, as even firms not directly exposed to China saw their stock prices fall.

Further analysis revealed that these immediate stock market losses were correlated with real-world declines in profits, employment, sales, and labour productivity in the years following the tariff announcements. For example, a drop in stock value of 0.56% was associated with a 12.9% decline in profits and a 3.9% reduction in employment.

Tariffs are designed to create a price advantage for domestic producers by raising the cost of imported goods. For example, steel tariffs increased the price of foreign steel, allowing USmanufacturers to charge higher prices without losing competitiveness. In theory, this protects jobs in sectors directly affected by foreign competition.

However, the consequences often ripple beyond the targeted industry. For every job preserved in the steel sector, multiple jobs may be at risk in industries that rely on steel as an input, such as automotive and construction. Higher raw material costs erode profit margins, increase consumer prices, and, in some cases, lead to layoffs.

The lesson from Smoot-Hawley is instructive. While the act aimed to protect US farmers and manufacturers, it sparked international retaliation that decimated American exports. The 2018 steel tariffs too led to higher US manufacturing costs and strained global trade relationships.

Do Tariffs Work in a Globalised Economy?

In today’s interconnected world, the efficacy of tariffs is further complicated by global supply chains. A significant portion of US imports, including steel, comes from allied nations like Canada and the European Union rather than adversaries. For example, Chinese steel made up only 3.5% of US steel imports when the 2018 tariffs were imposed. Moreover, many imported goods already face targeted duties under existing trade rules.

Retaliatory tariffs often undermine the intended benefits. Countries impacted by US tariffs frequently impose their own restrictions, targeting American exports such as soybeans and automobiles. This tit-for-tat dynamic can harm industries unrelated to the original tariff dispute.

Protecting jobs through tariffs, however, overlooks a fundamental trend: the role of automation and efficiency in reducing employment in manufacturing. The US steel industry, for example, has seen production remain stable even as employment has declined by over 30% since 2000. This is due to technological advances such as mini-mills, which significantly increase output per worker.

In this context, tariffs may offer only temporary relief. Without addressing underlying issues such as technological displacement and workforce training, industries may continue to face long-term structural challenges.

A Mixed Verdict

So, do import tariffs protect firms? The answer is both yes and no:

• Short-Term Gains: Tariffs can provide immediate relief to industries struggling with foreign competition, giving domestic firms breathing room to stabilise operations.
• Long-Term Costs: The broader economic costs – higher input prices, strained trade relationships, and retaliatory measures – often outweigh these benefits. Moreover, tariffs rarely address the deeper issues of automation, global supply chains, and workforce skill gaps.

To strengthen industries without relying on tariffs, policymakers can focus on several other strategies. Investing in innovation and workforce development is key to enhancing productivity and competitiveness, reducing the need for protectionist measures. Encouraging technological advancements and upskilling workers will help businesses stay competitive globally.

Pursuing targeted trade remedies can also address specific unfair trade practices without imposing blanket tariffs, which can harm the broader economy. This approach allows for more precise actions against harmful practices. Strengthening trade agreements with allies also creates a more level playing field, reducing the need for unilateral tariffs while fostering collaboration.