As of Friday morning, the United States has levied 25% tariffs on nearly one-third of all Chinese products in response to President Xi Jinping of China reportedly reneging on parts of a drafted agreement presented to him post-negotiation by U.S. and Chinese officials. Tariffs and trade disputes have been front-page news for over a year now, and I get questions about them all the time. The details of how tariffs work aren’t hard to understand, but sometimes the economic consequences are. With tariffs back in the news I thought I’d take a moment to explain (written and graphically as we had to do in my graduate trade class) how these tariffs actually work.
U.S. Tariffs on Chinese Goods
The tariffs that President Trump has instituted are what’s called ‘ad-valorem’, which (in case you want to look fancy in your next policy discussion) means “according to value” in Latin. Essentially, ad-valorem tariffs are percentage based, i.e. a 20% tariff on $100 worth of Chinese car parts coming to the U.S. will cost $20. So, a U.S. manufacturer importing U.S. car parts from China will have to pay $120 for a part that, without tariffs, would cost $100. The intended effect is for U.S. buyers of Chinese goods to seek those goods elsewhere at a lower cost, effectively putting pressure on the Chinese sellers of those parts and indirectly pushing the Chinese government to agree to our trade terms.
Chinese ‘Retaliatory Tariffs’ on U.S. Goods
A retaliatory tariff is just a tax on goods coming from a country in response to that countries previously levied tariffs against the importing country. So, when we enacted tariffs on Chinese goods, they responded by enacting tariffs against us. Those tariffs are intended to have the same consequences on our producers as the tariffs we levied had on China’s producers; raise the price of our goods so that Chinese buyers turn elsewhere, damaging our producers’ market share. This is what it looks like on a normal Supply/Demand graph.
Normally we would represent this in what is called a ‘three-panel diagram’ but that’s a lot to explain in a short post like this so we’ll just look at the tariffs in the ‘U.S./China Market for Soybeans’, where China is the party with demand for soybeans and the U.S. is the party with a supply of soybeans.
When China levies their 20% tariff on U.S. Soybeans, it effectively raises the price at every quantity so the supply line shifts upward and angles up the further away it gets from the Price axis. The new equilibrium price and quantity moves from Q1, P1 to Q2, P2 where, because of an increased price of soybeans, a lower quantity is demanded. You could flip the names and change ‘Soybeans’ to car parts and see what our tariffs on Chinese car parts are doing in the marketplace for that good.
What does this all mean for us? It depends. For a short time, the goods with tariffs enacted upon them will be more expensive. In the long term, most analysts expect the U.S. and China to come to terms on a trade deal, hopefully with. Talks are expected to resume today (Friday, May 10, 2019), however in the mean-time President Trump has floated the idea of leveeing tariffs on even more Chinese goods. The end goal is establishing more fair trade practices.