What is Tariff?

A tariff is a tax imposed by the government of one nation on imports from other nations.
The primary goal of tariffs is to reduce imports and increase domestic production. As taxes,
tariffs raise the demand price and lower the supply price, and thus reduce the quantity
exchanged. Tariffs are one of three common foreign trade policies designed to discourage
imports and/or encourage exports. The other two are import quotas and export subsidies. It adds
to the cost of imported goods and is one of several trade policies that a country can enact. Tariffs
are often created to protect infant industries and developing economies, but are also used by
more advanced economies with developed industries. It is also called a customs duty. Tariffs may
be distinguished from other taxes in that their predominant purpose is not financial but economic
not to increase a nation's revenue but to protect domestic industries from foreign competition.
For that reason, protective tariffs, as they are often called, are opposed by advocates of free trade.

History of Tariff

Tariffs have been used by governments since ancient times, although they were originally
sources of revenue rather than instruments of state economic policy. Early customs duties
consisted of payments for the use of trade and transportation facilities, including ports, markets,
streets, and bridges. By the 17th cent., however, they came to be levied only at the boundary of a
country and usually only on imports. At the same time, European powers established special low
tariff rates for trade with their possessions; such systems of colonial preference formed the basis
of the trading patterns that developed in the 17th and 18th cent.

Types of Tariffs
There are several types of tariffs:

Specific tariffs

Ad valorem tariffs

Specific Tariffs
A fixed fee levied on one unit of an imported good is referred to as a specific tariff. This tariff
can vary according to the type of good imported. For example, a country could levy a $15
tariff on each pair of shoes imported, but levy a $300 tariff on each computer imported.

Ad Valorem Tariffs
The phrase ad valorem is Latin for "according to value", and this type of tariff is levied on a
good based on a percentage of that good's value. An example of an ad valorem tariff would
be a 15% tariff levied by Bangladesh on U.S. automobiles. The 15% is a price increase on the
value of the automobile, so a $10,000 vehicle now costs $11,500 to Bangladeshi consumers.
This price increase protects domestic producers from being undercut, but also keeps prices
artificially high for Bangladeshi car shoppers.

Reasons for Imposing Tariff

1. Protecting Domestic Employment

The levying of tariffs is often highly politicized. The possibility of increased competition
from imported goods can threaten domestic industries. These domestic companies may
fire workers or shift production abroad to cut costs, which means higher unemployment
and a less happy electorate. The unemployment argument often shifts to domestic
industries complaining about cheap foreign labor, and how poor working conditions and
lack of regulation allow foreign companies to produce goods more cheaply. In
 economics, however, countries will continue to produce goods until they no longer have a
comparative advantage (not to be confused with an absolute advantage).

2. Protecting Consumers
A government may levy a tariff on products that it feels could endanger its population.
For example, South Korea may place a tariff on imported beef from the United States if it
thinks that the goods could be tainted with disease.

3. Infant Industries
The use of tariffs to protect infant industries can be seen by the Import Substitution
Industrialization (ISI) strategy employed by many developing nations. The government of
a developing economy will levy tariffs on imported goods in industries in which it wants
to foster growth. This increases the prices of imported goods and creates a domestic
market for domestically produced goods, while protecting those industries from being
forced out by more competitive pricing. It decreases unemployment and allows
developing countries to shift from agricultural products to finished goods.

Criticisms of this sort of protectionist strategy revolve around the cost of subsidizing the
development of infant industries. If an industry develops without competition, it could
wind up producing lower quality goods, and the subsidies required to keep the state-
backed industry afloat could sap economic growth.

4. National Security
Barriers are also employed by developed countries to protect certain industries that are
deemed strategically important, such as those supporting national security. Defense
industries are often viewed as vital to state interests, and often enjoy significant levels of
protection. For example, while both Western Europe and the United States are
industrialized, both are very protective of defense-oriented companies.

5. Retaliation
Countries may also set tariffs as a retaliation technique if they think that a trading partner
has not played by the rules. For example, if France believes that the United States has
 allowed its wine producers to call its domestically produced sparkling wines
"Champagne" (a name specific to the Champagne region of France) for too long, it may
levy a tariff on imported meat from the United States. If the U.S. agrees to crack down on
the improper labeling, France is likely to stop its retaliation. Retaliation can also be
employed if a trading partner goes against the government's foreign policy objectives.

Tariff as a pro-producer

Tariff is a pro-producer of any government. It is always seen that imposing of tariffs on

any sector has always a positive impact on the domestic producers of that product. Tariffs are
foreign trade policies undertaken by domestic government actions that are intended to "protect"
domestic production by restricting foreign competition. More specifically tariffs are taxes, either
per unit taxes or ad valorem taxes, placed on imports. The goal of tariff taxes is to increase the
demand price paid by domestic consumers (and reduce the supply price received by foreign
producers) and thus reduces the quantity of imports from the foreign sector to the domestic
economy. With fewer and more expensive imports coming in, buyers presumably turn to
domestic production to take up the slack.

The pro-producing motive of tariff can be further described by the economic concept of
Aggregate Demand, which is also known as the Keynesian view, named after John Maynard
Keynes. Aggregate demand is the demand of the entire country in a full. It represents individual
demand of every entity, whether person or business, in the national boundary, in a whole.
Aggregate demand is exhibited by the formula:

AD = C + G + I+ N - X

Where C is the total consumption, G is the government expenditure, I is the investment

made by the citizens and businesses in the country, N is the total export and X is the imports. A
higher aggregate demand results in increasing output of firms to meet the demand. Although a
higher aggregate demand means higher inflation pressure, it also means higher employment of
the citizens as firms increase their output. So any governments priority should be to increase the
aggregate demand by manipulating any of the variables in the equation.

If government imposes tariff on any product, import of that product is clearly

discouraged by the government and imports become expensive, since extra tax, or surcharge has
to be paid for that product. Due to the extra charge, the final price of the imported goods
increases and as a result demand for imported goods goes down. And as the demand goes down,
import of the particular good goes down. And therefore the decrease of import will increase the
aggregate demand of a country, which will be responded by the increased output of the domestic
firms in the similar industry, which means they will employ more people. The employment level
goes up and the GDP of the country also increases and the productivity of the country also
increases. Therefore tariff is a pro-producer in a sense it increases the productivity of the country.

Even if the import does not decrease, higher tariff on a product will result in higher
income for the government in a country. Higher income from tariff in a country will enable the
government to spend more. More government spending means higher aggregate demand in a
country, as government spending is one of the variables in the equation. It happens as
government starts pouring money into the economy, by spending on projects or other
investments, more people get employed and their buying power increases, so they consume more
and productivity of domestic firms goes up.

An imposition of tariff on any product benefits the domestic producers. As the end price
of the product goes up, people demand local goods, and more importantly competitions for a
domestic firm goes down. All being equal, now the local firms can compete with the foreign
products, if not with anything, then price. This gives the local producers a temporary advantage,
and they make high profits. This state of the industry attracts more investors to invest in the
industry, and as a result, I in the above equation go up, which means higher GDP, more
production and more employment.
 Positive effects of tariff on productivity can be described more by analyzing the law of
supply and demand through the Comparative Advantage theory of David Ricardo.

This graph demonstrates the benefits of tariffs to a domestic industry. Assume that
Bangladesh wants to protect a domestic industry that is only able to produce and sell televisions
at the price Ptariff. Since there are other countries that are exporting the same televisions at a price
of Pworld, Bangladesh's industry is threatened to go out of business should televisions be imported
into their country without a tariff. This graph also shows that as long as Ptariff does not fall above
the intersection of the Supply and Demand lines, then equilibrium can be reached in which there
are no shortages of demand or excesses of supply, and so Bangladesh's industry can produce and
sell televisions to the same degree as manufacturers in any other country.
 In this case, the higher price would not cause domestic production to increase from QS1 to
QS2, since it has already been assumed in our example that Bangladesh cannot afford to enter the
television market below the price Ptariff as the world economy has for price Pworld. The effect of the
tariff would limit imports and create a higher demand for domestically produced televisions (QS2
- QS1) but have no effect on consumer prices, since the graph shows that for all quantities to the
left of the intersection of the Supply and Demand curves, consumers will buy whatever
televisions enter the market. As increasing television sales allow more television producers to
enter the market and the quantity of imported + domestic televisions in Bangladesh approaches
QE then the tariff can be phased out since the market will be at equilibrium (E) and the PE market
price will be enough for Bangladesh's television manufacturers to stay in business.

Tariff as anti-consumerism.

Since imposition of tariffs mean a higher end price, tariffs are ought to be anti-
consumerism. Tariffs increase the prices of imported goods. Because of this, domestic producers
are not forced to reduce their prices from increased competition, and domestic consumers are left
paying higher prices as a result. Tariffs also reduce efficiencies by allowing companies that
would not exist in a more competitive market to remain open.

The fact that tariff is anti-consumerism can further be analyzed by the supply side of the
economics, also known as the Monetarist view. It said that equilibrium will only occur when
supply is equal to demand in all markets, and that economy will automatically gravitate towards
this natural equilibrium unless hindered by market imperfections, and tariff is one of those
imperfections. It is the role of the government to free up the economy by removing these
imperfections. A country produces what it is good at, and the amount which matches with its
capabilities and resources. Any deficit amount should be imported from the foreign countries. If
a country could produce the amount the people demand, it would. By increasing the tariff, the
government just increases the end price of the products and frees up the internal market for the
domestic producers.
 Tariffs also reduce efficiencies by allowing companies that would not exist in a more
competitive market to remain open. In an open market situation, the foreign products, with their
product quality and attributes, would rule over the market. In the process of competition, the
domestic firms would improve themselves in terms of product attributes and qualities to gain and
retain a greater market share. As a result consumers will have a wide array of options of product,
both local and imported, which are of equal qualities. And in the competition, the firms would
lower their prices to generate higher sale. As a result consumers will get product with lower
prices, and they would be benefited in the operation of pure competition. Whereas the sluggish
and lazy industry may not like to face the competition and remain inefficient even under the
protection cover provided through tariffs. If argued in a different manner, import tariffs reduce
the overall efficiency of the world economy. They reduce efficiency because a protective tariff
encourages domestic firms to produce products at home that, in theory, could be produced more
efficiently abroad. The consequence is an inefficient utilization of resources.

The diagram below shows the costs and benefits of imposing a tariff on a good in the domestic
economy, Home.
When incorporating free international trade into the model we use a supply curve denoted as Pw.
This curve makes the assumption that the international supply of the good or service is perfectly
elastic and that the world can produce at a near infinite quantity at the given price. Obviously, in
real world conditions this is somewhat unrealistic, but making such assumptions is unlikely to
have a material impact on the outcome of the model.

At world equilibrium, Pw, Home produced only S amount of the good, but had a demand of D.
The difference between S and D, SD was filled by importing from abroad. After the imposition
of tariff, domestic price rises from Pw to Pt but foreign export prices fall from Pw to Pt* due to
the difference in tax incidence on the consumers (at home) and producers (abroad).

At the new price level at Home, Pt, which is higher than the previous Pw, more of the good is
produced at Home it now makes S* of the good. Due to the higher price, only D* of the good
is demanded by Home. The difference between S* and D*, S*D* is filled by importing from
abroad. Thus, imposition of tariffs reduce the quantity of imports from SD to S*D*.

Domestic producers enjoy a gain in their surplus. Producer surplus, defined as the difference
between what the producers were willing to receive by selling a good and the actual price of the
good, expands from the region below Pw to the region below Pt. Therefore, the domestic
producers gain an amount shown by the area A.

Domestic consumers face a higher price, reducing their welfare. Consumer surplus is the area
between the price line and the demand curve. Therefore, the consumer surplus shrinks from the
area above Pw to the area above Pt, i.e. it shrinks by the areas A, B, C and D.

The government gains from the tariffs. It charges an amount PtPt* of tariff for every good
imported. Since S*D* goods are imported, the government gains an area of C and E.

The net loss to the society due to the tariff would be given by the total costs of the tariff minus its
benefits to the society. Therefore, we can conclude that the net welfare loss due to the tariff is
equal to: Consumer Loss Government revenue Producer gain
or graphically, this gain is given by the areas shown by:

(A + B + C + D) (C + E) A

=B+DE

that is, tariffs are beneficial to the society if the area given by the rectangle E more than offsets
the losses shown by triangles B and D. Rectangle E is called the terms of trade gain whereas
the two triangles B and D are also called efficiency loss, as this cost is incurred because tariffs
reduce the incentives for the society to consume and produce.

The model above is only completely accurate in the extreme case where none of the consumers
belong to the producers group and the cost of the product is a fraction of their wages. If instead,
we take the opposite extreme, and assume all consumers come from the producers' group, and
also assume their only purchasing power comes from the wages earned in production and the
product costs their whole wage, then the graph looks radically different. Without tariffs, only
those producers/consumers able to produce the product at the world price will have the money to
purchase it at that price.

Note also, that with or without tariffs, there is no incentive to buy the imported goods over the
domestic, as the price of each is the same. Only by altering available purchasing power through
debt, selling off assets, or new wages from new forms of domestic production, will the imported
goods be purchased. Or, of course, if its price were only a fraction of wages.

In the real world, as more imports replace domestic goods, they consume a larger fraction of
available domestic wages, moving the graph towards this view of the model. If new forms of
production are not found in time, the nation will go bankrupt, and internal political pressures will
lead to debt default, extreme tariffs, or worse.

Establishing tariffs inefficiently slows down this process at the expense of the consumer's real
wages, allowing more time for new forms of production to be developed, but also buttresses
industries which may never regain competitive prices.
 Conclusion

The benefits of tariffs are uneven. Because a tariff is a tax, the government will see
increased revenue as imports enter the domestic market. Domestic industries also benefit from a
reduction in competition, since import prices are artificially inflated. Unfortunately for
consumers - both individual consumers and businesses - higher import prices mean higher prices
for goods. If the price of steel is inflated due to tariffs, individual consumers pay more for
products using steel, and businesses pay more for steel that they use to make goods. In short,
tariffs and trade barriers tend to be pro-producer and anti-consumer.

Import tariffs reduce the overall efficiency of the world economy. They reduce efficiency
because a protective tariff encourages domestic firms to produce products at home that, in theory,
could be produced more efficiently abroad. The consequence is an inefficient utilization of
resources.

The effect of tariffs and trade barriers on businesses, consumers and the government
shifts over time. In the short run, higher prices for goods can reduce consumption by individual
consumers and by businesses. During this time period, businesses will profit and the government
will see an increase in revenue from duties. In the long term, businesses may see a decline in
efficiency due to a lack of competition, and may also see a reduction in profits due to the
emergence of substitutes for their products. For the government, the long-term effect of subsidies
is an increase in the demand for public services, since increased prices, especially in foodstuffs,
leaves less disposable income.
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