Import Tariffs: Why?

Import tariffs are discouraged by economists but celebrated by certain politicians and economic agents. Donald Trump is currently their number one fan, having declared “tariff” as “the most beautiful word in the dictionary.”

Let us consider, for example, the tariffs imposed by the U.S. on European exports. Broadly speaking, this protection harms European exporters, generates revenue for the U.S. Treasury, helps some American companies (now protected from European competition), and most of all, harms the American consumer (who now pays more for the same product).

Under general conditions, economists show that the benefits of tariffs are smaller than the costs. This is what economists classify as a “potential Pareto worsening”: some win, others lose, but there is a net loss. (Vilfredo Pareto, an Italian economist from the 19th and 20th centuries, worked on this and related topics.)

Conversely, a reduction in import tariffs corresponds to a “potential Pareto improvement”: some win, others lose, but there is a net gain. If it were possible to transfer value between winners and losers, it would be possible to reach a situation in which everyone is better off — what economists classify as a “Pareto improvement” in the strict sense.

If the costs outweigh the benefits, why this wave of tariff protectionism?

First, there is always someone who benefits from a tariff. It is undeniable that various American companies and workers gain from import protection. It is also undeniable that, for “reasonable” tariff levels, higher tariffs bring more funds to the U.S. Treasury. In this context, if the “winners” carry more weight in the political decision-making process, then it is no surprise that “Pareto worsenings” are favored.

From a political standpoint, it’s important to remember a key asymmetry: the benefits of tariffs are highly concentrated — mostly accruing to the U.S. Treasury and to economic agents in specific sectors. The costs, on the other hand, are widely dispersed. Each American consumer ends up paying a little more for product X. That might not be much per person, but when multiplied by 300 or 400 million consumers, the total exceeds the gains of the (few) beneficiaries.

This is neither a Trump-exclusive issue nor a new one. For example, the U.S. peanut sector has been heavily protected by the government for decades. The average farmer earns something like $20,000 a year thanks to state protection. The average American consumer, in turn, pays $1 extra for the peanuts they consume annually. That’s not much (it’s hard not to say “it’s peanuts”). However, 300 million times $1 equals $300 million — more than the total gain to all peanut farmers combined. The “problem” is that the political cost of $1 more per consumer is much lower than the political benefit of $20,000 to a farmer. Tariff protection is a bad economic idea but a politically attractive one.

The great weakness of the economic argument is that the concept of “potential Pareto improvement” has little traction. Economists say that if peanut prices were lower and consumers compensated farmers with $25,000 per year, then everyone would be better off. The problem is that such proposals are full of “ifs.” Academic hypotheses don’t fill farmers’ pockets: until those hypothetical $25,000 payments materialize, they prefer the tariff barrier to the alternative of free trade.

Finally, in the specific case of the American president, beyond the factors mentioned above, tariffs also hold “political” value: they serve as a way to “reward” or “punish” countries — and their leaders — depending on whether they are on the list of the “good guys” or the “bad guys.”

To summarize, it is generally accepted that tariffs have a negative overall effect, but it is also accepted that, in today’s political context, avoiding them will be difficult.

Luís Cabral