Tariffs

Difference Between Tariffs and Quotas

The difference between tariffs and quotas is that quotas limit the amount of a good that can be imported and a tariff makes it more expensive. A quota increases the price of a good because it creates a shortage in the domestic market by limiting how much of a good can be imported.

Both tariffs and quotas are trade barriers that are meant to reduce imports of a foreign goods into the market and keep domestic prices high. They are different means to the same end.

Even though tariffs and quotas have a similar result - an increase in price in the domestic market - the way they arrive at that result differs. Let's take a look.

Figure 1 below, shows a domestic market once a tariff has been applied on the imported good. If a nation engages in international trade without government intervention, the price of the good in the domestic market is at P_W. At this price the quantity demanded by consumers is Q_D. Domestic producers are not able to meet this level of demand at such a low price. At P_W they are only able to supply up to Q_S and the rest, Q_S to Q_D, is supplied by imports.

Domestic producers complain about low prices limiting their ability to produce and profit so the government places a tariff on the goods. This means it is more expensive for importers to bring in their goods. Instead of taking this reduction in profits, the importer transfers the tariff cost to the consumer by raising the purchase price. This can be seen in Figure 1 as the price increases from P_W to P_T.

This price increase means domestic producers can now supply more goods, up to Q_S1. The quantity demanded by consumers has been reduced since the price increased. To fill the supply and demand gap, foreign imports only make up Q_S1 to Q_D1. The tax revenue that the government earns is the number of goods supplied by imports multiplied by the tariff.

Since the government collects the tax revenue, it experiences the most direct benefit of a tariff. Domestic producers are next in line to benefit by enjoying the higher prices they can charge. The domestic consumer suffers the most.

Figure 2 shows what happens to the domestic market once a quota has been set. Without the quota, the equilibrium price is P_W and the quantity demanded is Q_D. Much like under a tariff, the domestic producers supply up to Q_S and the gap from Q_S to Q_D is filled by imports. Now, a quota is set into place, limiting the quantity imported to Q_Q to Q_S+D. This quantity is the same at every level of domestic production. Now, if the price were to remain the same at P_W, there would be a shortage from Q_Q to Q_D. To close this gap, the price increases to the new equilibrium price and quantity at P_Q and Q_S+D. Now, domestic producers supply up to Q_Q, and foreign producers supply the size of the quota from Q_Q to Q_S+D.

Quota rent is the profit that domestic importers and foreign producers are able to earn when a quota is put in place. Domestic importers are able to cash in on quota rents when the domestic government decides to license or provide permits to those domestic firms who are allowed to import. This keeps the profits from quota rents in the domestic economy. Quota rents are calculated by multiplying the quota's size by the price change. Foreign producers who import their goods benefit from the price increase caused by the quota as long as the domestic government does not regulate who can import with permits. Without regulation, foreign producers benefit since they can charge higher prices without changing production.

Even if domestic producers do not earn quota rent, the increase in price allows them to increase their levels of production. That means domestic producers benefit from quotas because the increase in production for them results in higher revenue.

Types of Tariff

There are several types of tariffs that a government can choose from. Each type of tariff has its own benefit and purpose.

One law, statement, or standard is not always the best solution for every situation, so it must be modified to produce the most desirable result. So let's look at the different types of tariffs.

The ad valorem tariff is the one that is the most familiar type of tariff since it functions in much the same way as an ad valorem tax one might come across, such as a real estate tax or sales tax.

Positive and Negative Effects of Tariffs

Tariffs, or taxes on imported goods, have long been a polemical issue in international trade because they can have both positive and negative effects on economy. From an economic perspective, the negative effect of tariffs is that they are often seen as a barrier to free trade, limiting competition and increasing consumer prices. However, in the real world, countries can face significant differences in their economic and political power, which can lead to abusive actions by larger countries. In this context, tariffs effects are positive because they are seen as a tool for protecting domestic industries and correcting imbalances in trade relations. We will explore both the positive and negative effects of tariffs, highlighting the complex trade-offs involved in their use.

Positive effects of tariffs

The positive effects of tariffs include the following:

1. Protection of domestic industries: Tariffs can protect local industries from foreign competition by making imported goods more expensive. This can help domestic industries to compete, grow and create jobs.
2. Revenue generation: Tariffs can generate revenue for the government, which can be used for public services and infrastructure development.
3. National security: Tariffs can be used to protect national security by limiting imports of certain products that could be used for military purposes.
4. Correcting trade imbalances: Tariffs can help to reduce trade imbalances between countries by limiting imports and promoting exports.

Negative effects of tariffs

The most important negative effects of tariffs include the following:

1. Increased prices: Tariffs can increase the price of imported goods, leading to higher consumer prices. This can particularly affect low-income households, who may be unable to afford higher prices.
2. Reduced consumer choice: Tariffs can limit consumer choice by making certain products more expensive or unavailable. This can lead to reduced competition and less innovation in the domestic market.
3. May lead to trade wars: Tariffs can lead to retaliation from other countries, which may impose tariffs on the importing country's products. This can lead to a trade war, harming both countries' economies.
4. Potential market inefficiency: Tariffs can lead to inefficiencies in the market, as they can distort prices and reduce economic efficiency.

Tariff Examples

The most common examples of tariffs are tariffs on agricultural products (grains, dairy, vegetables), industrial goods (steel, textiles, electronics) and energy products (oil, coal, gas). As you can see, these kinds of goods are crucial for the economy and society as a whole. Below is a list of three real-world examples of tariffs implemented in different countries:

• Japan's tariffs on agricultural imports: Japan has long protected its agricultural industry through high tariffs on imported agricultural products. These tariffs have helped to sustain Japanese agriculture and maintain rural communities. While there have been some calls for Japan to reduce its tariffs as part of trade negotiations, the country has largely been able to maintain its tariffs without significant negative effects.²
• Australia's tariffs on imported cars: Australia has historically protected its domestic car industry through very high tariffs on imported cars (up to 60% in the 1980s). In recent years, the Australian car industry has declined, with major producers pulling out of the country and there have been calls to reduce the tariffs even to 0%.⁴
• Brazil's tariffs on steel imports: Brazil has imposed tariffs on various steel products to protect its domestic steel industry. These tariffs have helped to sustain local steel manufacturing jobs and support the growth of the Brazilian steel sector but have led to trade wars with the US during Trump's presidency. ³

Trade War Example

A good example is a tariff placed on solar panels in 2018. Domestic solar panel producers petitioned the US government for protection from foreign producers like China, Taiwan, Malaysia, and South Korea.¹ They claimed that cheap solar panels that were being imported from these countries were damaging the domestic solar panel industry because they could not price match. The tariffs were placed against solar panels from China and Taiwan with a four-year lifespan.¹ The World Trade Organization (WTO) restricts the amount of time that tariffs can be imposed on other member countries without entitling the exporting country (China and Taiwan in this case) to reparations due to the loss of trade caused by the tariffs.

After the tariffs were set, the US experienced an increase in the price of solar panels and their installation. This resulted in fewer people and companies being able to install solar panels which set the US back in its efforts to switch to more sustainable energy sources.¹ Another effect of the tariff is that the solar industry might lose some large customers such as utility companies if they are unable to compete with the prices of energy sources such as wind, natural gas, and coal.

Finally, the US could also face retaliation from countries subject to the tariffs. Other countries can place tariffs or sanctions on US goods which would hurt US industries and exporters.