External Sector
Tariffs: The price for being foreign
What It Is and How It Works
A tariff is a tax by a government on imported goods from other nations. The tax increases the cost of imported goods (and domestic products that use imported inputs) in the country. The idea is often to get people to purchase domestically produced products rather than foreign ones. Governments sometimes implement tariffs to generate revenue or to exert pressure on other nations during trade conflicts.
Though the majority of tariffs are differentiated according to the kind of imported product, some also differ according to the nation of origin. This enables governments to aim at particular industries or trading partners.
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The Policy’s Impact
Tariffs can help local businesses by making their products more competitive against cheaper imports. However, they can also lead to higher prices for consumers. Most modern economies rely on complex trade networks where goods and materials come from many countries. When a tariff is applied, it can increase costs throughout the supply chain, making it more expensive to produce and sell goods.
A common misconception is that tariffs only affect companies. In reality, businesses often raise the prices of their products to cover the added costs, meaning consumers end up paying more. Over time, tariffs can slow economic growth and reduce trade between countries.
Furthermore, since no country can produce all the inputs for every good, an indiscriminate tariff increase can sometimes backfire. For example, a government may raise tariffs on cell phones to protect local manufacturers. Still, if those manufacturers rely on imported microchips, the higher tariffs can hurt the industry by increasing production costs.
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Stakeholders and Political Implications
Tariffs impact businesses, consumers, and governments. Local businesses may benefit by facing less competition from cheaper foreign products, while consumers may face higher prices for goods. Governments earn revenue from tariffs but may risk damaging trade relationships with other countries.
Some view tariffs as a way to protect jobs and industries, particularly in sectors like manufacturing. Others argue that tariffs harm the economy by raising costs and limiting consumer choices. Countries sometimes use tariffs to pressure trade partners into policy changes or new trade deals.
Currently, developing countries tend to apply higher tariffs on industrial goods, while countries in the global north often protect their agricultural sectors more.
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How Tariffs Can Lead to Trade Wars
Tariffs can also lead to trade wars, where countries retaliate by imposing tariffs. For example, Country A imposes a 10% tariff on all imports to protect local industries. In response, Country B, a major trade partner of Country A, imposes a 15% tariff on Country A’s agricultural products. This creates a back-and-forth situation where each country increases tariffs on the other's goods. The escalation of these tariffs can disrupt global trade, raise prices for consumers, and damage economic relationships between countries. Furthermore, directly targeting a country’s economy can increase military tensions and lead to full-fledged war.
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Real World Examples
Trump's 10% Flat-Rate Tariff (April 2025): On April 2, 2025, President Donald Trump announced a baseline 10% tariff on all imported goods, effective April 5, 2025. This policy was implemented under the International Emergency Economic Powers Act, citing a national emergency due to a significant trade deficit and perceived unfair trade practices by other nations.