Tariffs and Trade Barriers for Global Economy

Topic Description

The topic that is the focus of this proposal is the introduction and implementation of tariffs and trade barriers with subsequent impacts on the domestic and international economies. A full design title in progress is, “An exploratory study of the drivers to introduce tariffs in a globalized economy and the impact of various trade barriers on the long-term health of a domestic and international economy.” The primary examples selected for investigation are the United States and the United Kingdom, which in recent years either have implemented or have outlined plans to introduce international tariffs as part of their economic policy.

The purpose of the paper will be to determine the causes and meaningful impacts on the economy by the recent introduction of tariffs. There is significant disagreement amongst economists, policy advisors, and pundits regarding the benefits and extent of the influence of tariffs. In the context of such major economic players as the United States and the United Kingdom, there are substantial impacts on the costs to the country implementing the tariffs, international goods production and supply chains, consumer prices, and political economies interconnected with international relations (Bernstein 2018). Therefore, it is important to examine a number of perspectives on the topic to answer the research question.

The primary research questions that will be examined in this proposal are:

1. What is the process of implementing tariffs?
2. Are the benefits of tariffs worth the considerable risks?
3. Is there a threat of retaliation from other countries?
4. What is the impact on international businesses and supply chains?
5. What is the extent of the impact on domestic economies and consumers?
6. Does the global economy benefit or struggle from trade barriers?

The questions outlined above provide a comprehensive framework to examine the topic from a wide variety of perspectives such as trade policy, political risk, logistics, and international business and economy. According to Baldwin (2014), the cross-border flow of goods, wealth, services, and technology through international production and supply-chains have radically transformed the global economy.

The famous GATT treaty which established the World Trade Organization took 40 years to implement various mechanisms eliminate trade barriers, reducing tariffs to near non-existent. Tariff cuts shifted the political power balance domestically and internationally, creating a liberalized political economy which is almost forced to maintain this strategy to continue growth and expansion (Baldwin 2014). Therefore, it is both surprising and illogical for the sudden transition to a tariff-based protective economy in many major global economies in recent years which is the primary topic of this paper.

Aims and Objectives

The interest of researching this topic has been due to the peak of news in recent months regarding them protectionist trade policies implemented by the President Trump’s administration in the United States and Theresa May’s pro-Brexit cabinet in the United Kingdom. These events and policies are highly controversial and complex in the midst of negotiations and everchanging economic environments.

This area of international business is inherently interesting for the author of this proposal. Furthermore, there is a significant scope of potential research in the midst of the current political events which requires addressing and investigation to identify risk and consequences for governments and companies. The author seeks to establish patterns and parallels among the ongoing situations in the US and the UK as potential warning signs and strategic guidance for the global economy.

Historically, tariffs have been implemented for a variety of reasons, ranging from protectionist measures to reduce the inflow of foreign goods and shielding of domestic industry, to political purposes of beginning trade wars or sanctioning other countries. Generally, experts indicate that tariffs and trade barriers are not beneficial for either domestic or international economy. However, it is rare that the effects are seen immediately, and tariffs have a distributive effect of being beneficial to some industries while devastating to other aspects of the economy.

Gains from tariffs are usually more impactful and visible than losses, making them a popular political tool. So, while, protected businesses and jobs in a specific industry are easily identified, the distributed costs and long-term costs to the country’s fiscal policy and population spending are much harder to pinpoint (Rickard 2018). It is the purpose of this proposal to investigate the intricacies of the tariff impacts beyond the superficial media portrayal.

In the context of rising nationalism, tariffs have become a popular political and trade policy tool, but the extent of impact and viability of such tariffs for the success of the economy which is often cited by politicians remains questionable. Evidence shows that three are political and economic limitations of tariff-based trade battles on multiple fronts that are being led by the United States and the United Kingdom (in the midst of Brexit) in recent years.

It creates risks that while certain industries benefit a small amount, others such as agriculture which is heavily dependent on subsidies, commodity prices, and other aspects of international trade, begin to collapse as part of incoherent economic policy. Many policymakers and economists have criticized the incoherent approach of creating a problem and attempting to resolve it through subsidy rather than not creating trade limitations in the first place (Barro 2018).

Another objective of this research is to identify the socio-political motivations for tariff implementation in the current political climate. A vital objective of this research is to apply and explore the current events through a variety of trade policy and economic models developed around the concept of tariffs. Theories of comparative advantage, terms of trade, trade liberalization, trade blocs, and factors of production and services all have potential applications in the scope of the primary research question.

Furthermore, the author of this proposal seeks to investigate how the economic models of classic trade theory hold up in the light of such drastic and unprecedented shifts in the balance and stability of the global economy. It is the intent of the author to initiate a research process that would provide a comprehensive overview of the issues at hand.

Literature Review

Purpose of implementing tariffs

Tariffs are a tax imposed on goods crossing the border through trade, such as export and import. Commonly it refers to the import tax placed on goods by a receiving country. Tariffs are the primary barrier to trade used for the primary functions of revenue, protection of domestic industry, and for economic punitive actions against other countries (Suranovic 2010). In most industrial nations, tariffs make up an insignificant amount of tax revenue, which makes tariffs in the modern world used for primarily industry protection by manipulating business environments in a manner that competitive environments are at a disadvantage (Hoda 2018). The figure below demonstrates that tariff tax has exponentially decreased since the introduction of the WTO and free trade agreements but is seeing a gradual rise in recent years.

There is an inherent strategic interdependence among countries in the global economy which guides tariff-setting decisions. Tariffs are a result of a static game by welfare-maximizing governments in a version of Nash equilibrium. The Mill-Bickerdike model suggests that there is an optimum tariff where there are benefit and gain from a country’s power in trade. As seen in the figure below, after the equilibrium which occurs at point E, the best government response to each other in tariffs, the aggregate welfare cannot be further increased (Grossman 2016).

Benefits v. risks of tariffs

In his book, Irwin (2015) suggests that the benefits of tariffs are largely uneven, with the primary winners being the government with additional revenue and particular industries that the tariffs are meant to protect. These effects are largely short-term for governments and businesses. The example of Brexit which will result in Britain no longer being a part of the EU customs, and thus closing its borders and implementing tariffs for its common trading partners.

There are a wide variety of benefits such as tighter control of borders for national interests, additional revenue for the government, and better competitive advantage for local firms (Dhingra, Huang, Ottaviano, Pessoa, Sampson & Reenen 2017). In other cases, Brandt and Morrow (2017) suggest that production-heavy countries such as China benefit from tariffs since it helps to organize exports and improve domestic production capabilities, being less challenged from abroad.

Meanwhile, the risks of tariffs, particularly in the long-term are significant. Tariffs create major disruptions to the global trade system, which has a ripple effect on a wide variety of aspects, ranging from supply chains to foreign direct investment (Conerly 2018). Governments are forced into hostile negotiations while businesses have to begin diversification of supply chains, not a cost that many can afford.

The modern system of trade was developed with minimal or non-existent tariffs, meaning that rapid implementation leads to severe disruption (Felbermayr, Heid & Larch 2014). It is vital to note that tariffs are believed to be a quick solution to vital economic problems for Western countries, such as outsourcing and trade deficit. However, in the long-term, trade barriers often exacerbate the issue, resulting in broken relationships and unbalanced economies without resolving the problems. Tariffs lead to economic stagnation on practically every indicator and can potentially drive domestic industries into the ground (Imbruno 2016).

Threat of retaliation

Most commonly, an import tariff is most likely to be faced with retaliation from trading partners or against whom the tariff was implemented, inherently beginning a trade war. By retaliating, the trading partner can reclaim partially at least some of the welfare loss generated. This leads to a series of responses based on subjective beliefs leading to a tit-for-tat situation. Even in WTO-authorized retaliatory measures, there are losses through illegal trade subsidies and overall firm share declines (Liebman & Tomlin 2015).

Based on the example of the large tariffs implemented by the Trump administration as a mechanism to balance the trade deficit, retaliation was inevitable due to the economic and political factors in China against whom the tariffs were targeted. However, sweeping tariffs on steel in order to protect the US industry resulted in retaliatory measures even from US-allied trading partners such as the EU and Canada in order to ensure a balance of trade and economic welfare recovery (Rosyadi & Widodo 2018).

Impact on international business and supply chains

Handley (2014) demonstrates that tariffs create a certain level of uncertainty and protectionism over trade conditions which is vital for heterogeneous firms, thus having real economic effects. Such trade conditions create an option value of waiting for entry into a new market, thus inducing delay. In turn, this creates a fixed cost of entry with a myriad of negative impacts on the margin of trade. Administrative barriers such as tariffs negatively impact trade volumes and shipping decisions. Costs accrue with every shipment, and since consumers and producers prefer frequent shipments, these tariffs result in welfare loss. As a result, a minor tariff adjustment of 9 per cent can impact shipping costs by as much as 50 per cent (Hornok & Koren 2015).

Eckhardt and Poletti (2015) note that tariffs impact the variable costs of imports with tariffs impacting a variety of distributive effects such as barriers to exports and prices. It creates an additional challenge for businesses which attempt to navigate a wide array of non-tariff barriers in modern trade regulation. Blanchard, Bown, and Johnson (2015) argue tariffs eventually have a trickle-down effect on supply chains and procurement departments of firms. There are additional costs introduced with tariffs on transportation, manufacturing, and importing of raw materials. Well-established logistical chains may no longer be efficient, cost-effective, or appropriate under regulation, forcing supply chains to begin processes of source optimization or diversification, that further creates barriers to growth and trade.

Impact on domestic economies and consumers

The impact of the Lerner symmetry is vital in an open economy New Keynesian model. A direct trickle-down effect of tariffs and subsidies to prices and subsequent slowing exchange rate adjustments leads to significant deviations from the Lerner symmetry. This deviation does not necessarily impact global output but requires a redistribution of production and consumption in individual countries. If a trade war begins with a high rise in tariffs, macroeconomic impacts can be significant by permanently lowering income and trade volumes (Lindé & Pescatori 2019).

In the case of the US-China trade war, the countries are largely domestically oriented economies with exports to each other amount to no more than 2 per cent of the GDP for each nation. However, as tensions increase, the consequences will grow, ranging from political to economic outcomes. The tit-for-tat cycle of tariffs makes producers less competitive, with the prices falling on consumers. Despite the significant attempts of leadership to create barriers, the world’s leading economies will never be fully independent, but rather they are engaged with other economies either competing or complementing each other (Dollar & Petri 2018).

Furthermore, the reduced competition of protectionist trade policy is considered to stifle innovation in the domestic industry. Higher tariffs commonly pass on the cost to domestic consumers by raising the cost of living. This can occur either due to importers raising prices to mitigate the tariff costs or domestic producers doing the same thing since the tariff tax of importing resources and hiring labour for local production is more expensive than outsourcing (Clarke, Serwicka & Winters 2017).

Overall state of the global economy

The benefit of free trade agreements is their contribution to the predictability of trade policy and the global economy. The WTO with its multitude of regulations ensures that the flow of trade and goods goes smoothly and freely, with the commitment from its members to prevent trade barriers and tariffs above bound rates. While it is expected that policy regimes may change and there is some flexibility, the risk of tariff reversal creates a fundamental change in trade, thus leading to uncertainty and disruption of flow for goods and wealth (Osnago, Piermartini & Rocha 2015).

Simonovska and Waugh (2014) suggest that international trade critically depends on trade elasticity which is a factor of trade frictions. The border effect of a tariff equivalent is inversely proportional to assumed elasticity of trade. Therefore, variations in tariffs serve as an explanation of any reduction or growth in world trade, since trade elasticity is one of the key indicators for structural models and welfare cost of international trade.

Up to date, the announced tariffs, particularly in the United States and China trade war is relatively small, with a modest impact on global trade. However, they carry the risk of escalation of trade tensions and a reverse to the globalization trends that has been ongoing for the past decades which has led to improvements in quality and standards of both products and life. Carried out simulations indicate that the further rise of protectionism and the implementation of tariffs on behalf of major trading powers, along with similar retaliation from partners, will result in a clearly negative outcome for the global economy. It will particularly impact countries such as the US and the UK that are dependent on global value chains and financial markets for growth (Qualietti 2018).

Reference List

Baldwin, R 2014, ‘WTO 2.0: Governance of 21st century trade’, The Review of International Organizations, vol. 9, no. 2, pp. 261-283.

Barro, J 2018, ‘Trump finally seems to be realizing the political risks that tariffs pose for him’, Business Insider. Web.

Bernstein, J 2018, ‘Here’s why a) the economic impacts of Trump’s tariffs are often exaggerated and b) they still stinks’, The Washington Post. Web.

Blanchard, EK, Bown, CP & Johnson, RC 2016, Global supply chains and trade policy. Web.

Brandt, L & Morrow, PM 2017, ‘Tariffs and the organization of trade in China’, Journal of International Economics, vol. 104, pp. 85-103.

Clarke, S, Serwicka, I & Winters, AL 2017, ‘Will Brexit raise the cost of living?’, National Institute Economic Review, vol. 242, no. 1, pp. 37-50.

Connerly, B 2018, ‘Trump’s tariffs, supply chains and other risks’, Forbes. Web.

Dhingra, S, Huang, H, Ottaviano, G, Pessoa, JP, Sampson, T, & Reenen JV 2017, ‘The costs and benefits of leaving the EU: trade effects’, Economic Policy, vol. 32, no. 92, pp. 651-705.

Dollar, D & Petri, PA 2018, ‘Why it’s time to end the tit-for-tat tariffs in the U.S.-China trade war’. Web.

Eckhardt, J & Poletti, A 2015, ‘The politics of global value chains: import-dependent firms and the EU-Asia trade agreements’, Journal of European Public Policy, vol. 23, no. 10, pp. 1543-1562.

Felbermayr, G, Heid, B & Larch, M 2014, ‘TTIP: small gains, high risks?’. Web.

Grossman, GM 2016, ‘The purpose of trade agreements’, in K Bagwell & RW Staiger (eds), Handbook of commercial policy (vol. 1), Elsevier, Amsterdam, Netherlands, pp. 379-434.

Handley, K 2014, ‘Exporting under trade policy uncertainty: theory and evidence’, Journal of International Economics, vol. 94, no. 1, pp. 50-66.

Hoda, A 2018, Tariff negotiations and renegotiations under the GATT and the WTO: Procedures and practices (2nd ed.), Cambridge University Press, Cambridge, UK.

Hornok, C & Koren, M 2015, ‘Administrative barriers to trade’, Journal of International Economics, vol. 96, no. 1, pp. 110-122.

Imbruno, M 2016, ‘China and WTO liberalization: imports, tariffs and non-tariff barriers’, China Economic Review, vol. 38, pp. 222-237.

Irwin, DA 2015, Free trade under fire (4th ed.), Princeton University Press, Princeton, NJ.

Liebman, BH & Tomlin, K 2014, ‘World Trade Organization sanctions, implementation, and retaliation’, Empirical Economics, vol. 48, no. 2, pp. 715-745.

Lindé, J & Pescatori, A 2019, ‘The macroeconomic effects of trade tariffs: revisiting the Lerner symmetry result’, Journal of International Money and Finance, Accepted manuscript.

Osnago, A, Piermartini, R & Rocha, N 2017, Trade policy uncertainty as barrier to trade. Web.

Qualietti, L 2018, ‘Implications of rising trade tensions for the global economy’, ECB Economic Bulletin, vol. 3, pp. 21-25. Web.

Rickard, S 2018, ‘What provoked Trump’s tariffs: politics or economics?’. Web.

Rosyadi, SA & Widodo, T 2018, ‘Impact of Donald Trump’s tariff increase against Chinese imports on global economy: Global Trade Analysis Project (GTAP) model’, Journal of Chinese Economic and Business Studies, vol. 16, no. 2, pp. 125-145.

Simonovska, I & Waugh, ME 2014, ‘The elasticity of trade: estimates and evidence’, Journal of International Economics, vol. 92, no. 1, pp. 34-50.

Suranovic, S 2010, Policy and theory of international trade, Saylor Foundation. Web.

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