An assessment of the current U.S. trade and tariff policy in the light of the economic theory

Table of content

Table of content

List of figures

1 Introduction

2 Theories behind trade and tariffs
2.1 International trade theory and the comparative advantage
2.2 Point of tariffs
2.3 Welfare effects of a tariff

3 Assessment ofU.S. trade and tariff policy
3.1 Background
3.2 Current issue and assessment

4 Conclusion

Bibliography

Internet sources

List of figures

Figure 1: Comparative advantage

Figure 2: Welfare effects

1 Introduction

In the year 2018 Trump and his administration imposed import tariffs. The tariffs had raged in rate between 10 and 50%. Especially China, the most important trading partner to the U.S. retaliated with tariffs on approximately $121 billion exports from the United States. This behaviour led to the “trade war” between the U.S. and China. Besides, the trading partner China, other trading partners got also imposed with higher tariffs. The behaviour from the U.S. raised some questions about the future path of international trade.¹

The following scientific essay is an analysis of the consequences of tariffs and trade and assesses the U.S. impact on international trade. The term paper is divided into two main parts. The first part includes a theoretical discussion of the international trade theory and provides an introduction to the comparative advantage. It represents an explanation of the usage of tariffs and how it affects a vast country like the United States. The second part is a short assessment of the U.S. trade and tariff policy. The background and the current issue will be discussed. In the end, there will be a summary with a conclusion of this term paper.

2 Theories behind trade and tariffs

2.1 International trade theory and the comparative advantage

International trade allows lower prices due to the more competitive pricing.²

The international trade theory deals with trade between countries but also the effects on these involved. There are two main theories the classical and the new trade theory. The classical theory is often connected to Adam Smith and his oeuvre - the wealth of eco­nomic nations. The main conclusion of his approach is that a state should focus on the production of those things that it can produce more cheaply than other states.³

In the Theory of Smith, trade only exist if one party is having a clear cost advantage. The economist David Ricardo expanded Smiths theory; the new trade theory. He said that each country should specialize in the production and export of those goods that it can produce with the smallest absolute cost disadvantage. Foreign trade is therefore also ben­eficial if a country is at a disadvantage in the production of all goods⁴ These findings led to the comparative advantage. The comparative advantage is not the same as the absolute advantage, which is advocated by Adam Smith. Smith argued only to produce goods if a country can produce more of the good with fewer or the same resources than the compet­itor its country.⁵

The comparative advantage describes the situation when countries produce what they do best and sell the remaining part. It is best explained in an example. Country A is producing wine and cheese with an absolute advantage. Country A can produce 500 grams of cheese in one hour and 1 litre of wine in two hours. Within in country B needs 6 hours to produce 500 grams of cheese and 3 hours for a litre of wine.⁶

Figure 1: Comparative advantage

Abbildung in dieser Leseprobe nicht enthalten

See PindyckR., RubinfeldD., Mikroökonomie, 2013, p. 826 et seq.

As clearly indicates, country A has a comparative advantage against country B in the production of cheese. The production costs in country A for cheese are half the production costs for wine. Whereas in country B the production costs of cheese are twice as high as the production costs of wine. In comparison, it gives a comparative advantage to country B, where wine can be made at half the cost of producing cheese. Assuming that both countries are selling their products for the same price and both are having a full employ­ment rate, the only opportunity to raise production of one good, is to produce less of the other. That is where the trade comes in. Without it country A could produce 24 hours for 24 pounds of cheese, 12 litres of wine or a combination of both. If they would only produce cheese, they could exchange it with country B for wine. If they would only pro­duce wine instead of cheese, they could only produce 12 litres in 24 hours. That is why country A should focus on producing cheese and bargain it for wine. If they would pro­duce the 24 pounds and sell 6 of them to country B, they could consume 18 pound of cheese and 6 litres of wine. If they would produce it themselves, they could only consume 18 pound of cheese and 3 litres of wine. Furthermore, country B would also gain an ad­vantage. If they focus on producing wine, they could produce 8 litres of wine in 24 hours. Then they could consume 2 litre of wine and 6 pounds of cheese. Without the trade and without focusing on wine, they could only consume 3 pound of cheese and 2 litres of wine.⁷

The concept of comparative advantage indicates that parties like countries may always derive economic benefit trough trade. Therefore, any understanding of international trade depends on an understanding of comparative advantage.⁸

2.2 Point of tariffs

Tariffs are “a tax levied when a good is imported”⁹, so it adds cost to the cost borne by consumers of imported or exported goods. The money collected under a tariff is called duty or customs duty. In the United States, those duties are collected by the U.S. Customs and Border Protection.¹⁰

In 2017 U.S. import duties totalled up to $33.1. billion. That is 1,4% of the total value of all imported goods. That makes U.S. tariffs among the lowest in the world. However, that does not mean that every item entering the U.S. is facing a 1.4% tariff. Some items are not taxed at all, while others like shoes are taxed around 11%. Upping that 11% to some­thing like 25-30% can cost the makers of these products a lot. Especially when consider­ing that 98% of shoes sold in the U.S. are made overseas. As an example, if a watch cost the customer $10 and adds in a 20% tariff, the customer has to pay $12 per watch he is buying. For one watch is does not occur a lot, but if a retailer wants so to sell 15,000 watches, the total cost has now gone from $150,000 to $180,000. These 30,000 are unex­pected cost for businesses.¹¹

From the above point of view, tariffs appear unnecessary. Nevertheless, it is one trade policy that a country can enact.¹² This trade policy is called protectionism. It describes the action “of a government to help its country’s trade or industry by taxing goods bought from another country”.¹³ The protectionism is based on two main reasons. The first reason is that the government is receiving money. In the United States, the revenue goes to the general fund of the U.S. Treasury, which helps pay for the running the government. The second reason is the protectionism itself and with it the pursuit of self-sufficiency of a country. Tariffs can help to protect some domestic industries from competition abroad. As an example, if a car from Germany is charged with higher taxes, a customer is more attracted to buy a car from the United States. The business may now find a way to produce its product in the domestic country to avoid the tariff. It has to be considered that the supplies used to produce a good are likely to need to be imported from another country. Those supplies probably will have their own tariffs.¹⁴

An option to avoid tariffs is to buy these supplies or the whole good from another country that is not subject to the tariffs. In the United States, the products from China are granted with higher tariffs as on products ofVietnam. So, if the domestic seller is buying it from Vietnam, China will gain a lost. That is how the domestic country can protect its trade.¹⁵

2.3 Welfare effects of a tariff

When considering the welfare effect, it has to be distinguished between a small and a large country. For example, a small country like Luxemburg cannot influence the world price. If it places a tariff on an imported good. Because of the length and the focus on the United States in this essay, the welfare effect of tariffs will be explained on a large im­porting country. A vast country has its effect on the world market and its prices.¹⁶

The imposition of duty has different effects on the welfare of the operators in the countries concerned. The figure compares the importing country, the world market and the export­ing market.

Figure 2: Welfare effects

Abbildung in dieser Leseprobe nicht enthalten

Source: See https://are.berkeley.edu/~fally/Courses/Econl81Lecture8b.pdf., access 15/08/2020

The figure shows the considered the welfare changes for the importing country. The price increased by the customs duty leads to a profit for the producers of the importing country in the amount of the orange area. This area results from the fact that without the trade restriction, there is a producer's pension of the area below the world market price without customs duty and above the supply curve. Due to the price increase, this rent in­creases by the orange area. Consumers, on the other hand, suffer a loss in the amount of the orange + pink + coral area.¹⁷

[...]

¹ See https://economics.princeton.edu/2019/10/30/the-impact-of-the-2018-trade-war-on-u-s-prices-and- welfare/, access 15/08/2020

² See https://www.investopedia.com/insights/what-is-international-trade/, access 02/08/2020

³ See Smith,A., Wealth of nations, 2010, p. 157 et seq.

⁴ See https://www.bpb.de/nachschlagen/lexika/lexikon-der-wirtschaft/19802/komparative-kosten, access 02/08/2020

⁵ See PindyckR., RubinfeldD., Mikroökonomie, 2013, p. 826.

⁶ See PindyckR., RubinfeldD., Mikroökonomie, 2013, p. 826.

⁷ See PindyckR., RubinfeldD., Mikroökonomie, 2013, p. 826 et seq.

⁸ See https://www.economicsonline.co.uk/Global_economics/Comparative_advantage.html, access 02/08/2020

⁹ Krugmann P., ObstfeldM., International Economics, 2005, p.186.

¹⁰ See https://www.cnbc.com/2018/08/22/trade-war-and-tariffs-cnbc-explains.html, access 09/08/2020

¹¹ See https://www.cnbc.com/2018/08/22/trade-war-and-tariJfs-cnbc-explains.html, access 09/08/2020

¹² See Krugmann P., ObstfeldM., International Economics, 2005, p.186.

¹³ https://dictionary.cambridge.org/de/worterbuch/englisch/protectionism, access 09/08/2020

¹⁴ See https://www.bbc.com/news/world-43512098, access 09/08/2020

¹⁵ See https://www.bbc.com/news/world-43512098, access 09/08/2020

¹⁶ See https://are.berkeley.edu/~fally/Courses/Econl81Lecture8b.pdf, access 15/08/2020

¹⁷ See PindyckR., RubinfeldD., Mikroökonomie, 2013, p. 464 et seq.