Some recent headlines in the local media read:
Those business leaders are correct. The proposed tariffs would harm Minnesota’s economy.
The precise details of the proposed tariffs are somewhat fluid, but the current iteration is a 25% tax on all imports from Mexico and Canada, along with an additional 10% tax on imports from China. That would add 25% to the price of anything imported from Mexico and Canada, which provide about 30% of US imports (China provides another 15%).
There are those, including some of President Trump’s supporters, who will tell you that the Mexicans and Canadians will swallow this extra cost; that they will mark down the original price by the amount of the tariff so that they bear the burden. This is nonsense, to put it politely. The Mexicans and Canadians are unlikely to be making 25% profit on these sales and are even more unlikely to sell these items at a loss. Maybe they will sell them to someone paying a higher price or maybe they will simply stop selling them at all. Sure, they will lose out on the revenue, but we will lose out on the product.
There are those, on the other hand, including many economists, who will tell you that the burden of the tariff will be passed on to the American consumer. Many of these people, of course, argue for higher corporate taxes and say that the burden of these won’t be passed on to the consumer, but that is a point for another day. The point is that if American consumers could simply swallow a price for a good 25% higher than now without reducing their purchases, the sellers would hike the price by 25% anyway, tariff or no tariff.
The key point is elasticities. If the demand for a good is “price elastic” that means that the quantity demanded varies according to price, and these variations will be greater or smaller depending on whether the elasticity is greater or smaller. There are many determinates of price elasticity, including the availability of substitutes. If the price of butter gets hiked, demand is likely to fall quite sharply as people buy margarine instead. Of course, with the extra demand, the price of margarine is likely to rise. Not all substitutes are “perfect,” but if the price hike is large enough, people will accept less and less perfect ones.
What about the case where demand is “price inelastic,” so that demand does not vary with price? In this case, an increase in the price of the good will mean a reduction in the consumer’s spending on other goods, and their price will fall (that is why there is no “wage-price spiral”). The consumer will be no better off, the producers of the other goods – and their employees – will be worse off, but the government will have a few extra dollars. A tariff is just a tax, after all.
There really is no such thing as a free lunch. Someone will bear the burden of these tariffs and it will, most likely, be split between American consumers and foreign producers with the precise outcome determined by the relevant elasticities.
Some tell me that these tariffs aren’t meant as economic policy but as leverage to pursue other ends. I hope that is correct, though I think there is enough in President Trump’s long history of statements on such issues to believe that he really does subscribe to mercantilist views where trade is a zero sum game. On the campaign trail, one of President Trump’s trump cards – pun intended – was the strong performance of the economy in his first term and polling generally showed that the economy was the main issue people voted on. These proposed tariffs are bad economics. They could be even worse politics.