Macroeconomic Consequences of Tariffs



Davide Furceri et al | International Monetary Fund | University of California, Berkeley | Cato Institute

More than any other issue, there is agreement among economists that international trade should be free. This view dates back to Adam Smith or earlier and is supported by much reasoning. In general, economists believe that freely functioning markets are the best at allocating resources absent some distortion, externality, or other market failure; competitive markets tend to maximize output by directing resources to their most productive uses. Of course, there are market imperfections, but tariffs—taxes on imports—are almost never the optimal solution to such problems. Tariffs encourage the deflection of trade to inefficient producers and the smuggling of goods to evade those tariffs; such distortions reduce welfare. Furthermore, consumers lose more from tariffs than producers gain, so there is deadweight loss. The redistributions associated with tariffs tend to create vested interests, so harms tend to persist. Broad-based protectionism can also provoke retaliation, which adds further costs in other markets. All these losses to output are exacerbated if inputs are protected, since this adds to production costs.

Discussions of market imperfections and the like are naturally microeconomic in nature. Accordingly, most analyses of trade barriers are microeconomic in nature, focusing on individual industries. This makes sense. Artificial barriers to international trade have gradually fallen for most countries over the decades since the end of World War II. The exceptions to this trend tend to be concentrated in individual industries, often associated with agriculture or apparel. International commercial policy does not tend to be used as a macroeconomic tool, probably because of the availability of superior alternatives such as monetary and fiscal policy. In addition, there are strong theoretical reasons that economists abhor the use of protectionism as a macroeconomic policy; for instance, the broad imposition of tariffs may lead to offsetting changes in exchange rates. And while the imposition of a tariff can reduce the flow of imports, it is unlikely to change the trade balance unless it fundamentally alters the balance of saving and investment. Furthermore, economists believe that protectionist policies helped precipitate the collapse of international trade in the early 1930s and that this trade shrinkage was a plausible seed of World War II. Although protectionism has not been often used in practice as a macroeconomic policy (especially in advanced countries), most economists also agree that it should not be used as a macroeconomic policy.

But times change, and some economies have recently begun to use commercial policy seemingly for macroeconomic objectives, so it seems to be an appropriate time to study what the macroeconomic consequences of tariffs have actually been in practice (if there have been any). Most of the predisposition against protectionism within the economics profession is based on evidence that is theoretical, micro, or aggregate and dated. Accordingly, we study empirically the macroeconomic effects of tariffs using recent aggregate data.

CATO Macroeconomic Consequences of Tariffs

[To read the original research brief, click here.]

Copyright © 2019 Cato Institute. All rights reserved.