What is a tariff and how do they impact markets?

What is a tariff?

A tariff is a tax on imported goods by a government with the aim of regulating international trade. Usually, tariffs are imposed to protect domestic industries, generate government revenue or address national security concerns. There are two types of tariffs: specific tariffs which are a fixed charge per unit of imported goods, and ad valorem tariffs which are a percentage of the value of the imported product.

How is a tariff different from a tax?

While tariffs and taxes both bring in revenue for the government, they serve different purposes. Taxes are imposed on individuals and businesses within a country to fund public services. On the other hand, tariffs are imposed on goods imported from foreign countries.

The economic impact of tariffs

The intent of tariffs is to make domestic products more competitive against cheaper counterparts, make a more level playing field, and bring business back domestically by reducing the amount of business sent abroad.

As a knock-on effect, tariffs can have a big impact on three key aspects of the economy: growth, market share (the portion of a market controlled by a particular company or product) and consumer prices. Higher tariffs raise the cost of goods imported and lead to higher prices for consumers. Tariff wars like those seen in the first Trump administration often result in retaliatory tariffs from trading partners, further disrupting international trade. Many economists argue that tariffs reduce economic efficiency and hinder global economic integration:

1. Higher prices for consumers – higher tariffs make imported products more expensive and inflationary for goods and services.
2. Trade deficit adjustments – import tariffs can reduce the trade deficit by discouraging imports and promoting domestic production.
3. Protection of domestic industries – by making foreign goods more expensive tariffs help domestic producers compete better in the American market.
4. Impact on employment – while tariffs protect manufacturing jobs in some sectors, they can lead to job losses in industries that rely on imported raw materials.
5. Government revenue generation – tariffs are a customs duty and generate revenue for the government which can be used to fund infrastructure and social programs.
6. Foreign affairs and retaliation – trading partners often counter with tariffs which can harm exporters and escalate into full-blown tariff or trade wars.

How are tariffs collected and applied?

How tariffs are collected, applied and who by is obviously dependent on the type of tariff and which country is applying them.

In the United States, tariffs are collected by US Customs and Border Protection (CBP), an agency under the Department of Homeland Security (DHS). When imported goods arrive at US ports of entry, importers or brokers must declare the goods, pay the applicable import duties, and comply with trade regulations. The collected revenue is then transferred to the US Department of the Treasury. These tariffs are determined based on the Harmonized Tariff Schedule (HTS), which categorizes goods and assigns specific tariff rates. The revenue generated from tariffs contributes to government revenue and helps regulate foreign trade.

It’s worth noting that there are several different variables that go into tariffs, and they are not always automatically passed down to the consumer.

Tariffs and the US-China Trade War, 2018-2019

One of the most recent examples of tariffs was Trump’s tariffs on Chinese imports during his first term. The US imposed tariffs on hundreds of billions of dollars’ worth of goods imported from China, citing unfair trade practices and forced technology transfer. These tariffs led to retaliatory tariffs from China impacting American farmers, manufacturers and technology companies. Economists at institutions like the Peterson Institute and the Tax Foundation have analyzed the impact of these tariffs, with many suggesting it slowed global economic growth and increased costs for American consumers.

In another instance, tariffs were imposed on imported steel and aluminum in 2018 under section 232 of the trade expansion act due to national security concerns. While these tariffs protected domestic producers, they also led to higher prices for industries that rely on these raw materials.

Source: TradingView, StoneX

Here’s a chart of USD/CNH (US Dollar to Chinese Yuan) between the end of 2017 and March 2019. You can see the impact that tariffs had on this particular currency pair as the US and China imposed reciprocal tariffs for a period. Among the highlights on the reactive cycle are:

• Early 2018: US tariffs on solar panels, washing machines, steel, and aluminum.
• Mid-2018: China cancels soybean orders and retaliates with tariffs.
• Late 2018: US introduces 25% tariffs on $200 billion of Chinese imports, prompting further retaliation.
• Early 2019: Negotiations begin as the White House delays additional tariffs.

The chart visually represents how the trade war impacted the yuan’s exchange rate, showing significant devaluation of the Chinese Yuan (CNH) against the US Dollar (USD) as tariffs escalated.

To learn more, read about our dedicated article on The US-China Trade War of 2018.

Which markets have been most impacted by recent tariffs?

The trade wars of the modern era have seen tariffs on certain industries resulting in a bigger impact on specific markets. Some of the most impacted sectors have been:

• Agricultural products – when other countries impose tariffs on American goods, farmers face cancelled orders for shipments and further lower values for their goods.
• Automobile industry – import duties on foreign cars and vital components increase prices of vehicles and affect international manufacturers with operations in the US.
• Technology sector – forced technology transfer policies and trade policy measures against high-tech imports disrupt supply chains.
• Steel and aluminum – tariff rates on these commodities affect construction, manufacturing and national security sectors.
• Pharmaceutical and medical goods – tariffs on imported medical equipment can lead to higher healthcare costs.

Summary

Tariffs are a critical component of trade policy that shapes the economy of a country. While they may protect domestic products and industries from foreign competition, they can also increase prices and distort markets. Most economists agree that high tariffs and tariff wars disrupt world markets and slow down global economic growth.

As the trade policy debate continues, countries must balance domestic protection with the benefits of low tariffs and free trade agreements. Whether introducing new tariffs or reducing tariffs, a key role for policymakers is to carefully weigh the impact on overall growth, government revenue, market dynamics and international trade relations.