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Investment Outlook - Second Quarter 2018

What are Tariffs and How Do They Affect Us? 

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By: Nick Perini, CFA
Monday, July 16, 2018


“Tariff: A schedule of duties imposed by a government on imported or in some countries exported goods.” (Merriam-Webster)
 
Long before the potential trade war became a favored headline, countries had implemented tariffs to generate a revenue stream for the government and protect domestically produced goods.  In fact, nearly every country has tariffs; the United States has some of the lowest tariffs when compared to the rest of the world. 
 
Before 1913, tariffs were the United States government’s main source of revenue, and this held true for most countries.  As income tax became more widely accepted, and commerce became more global, the use of tariffs diminished.  Governments around the world have been moving towards free trade albeit with different vigor. 
 
There is a ripple effect to consider when thinking about tariffs. For example, take the steelworker living in Canton, Ohio. Due to lower labor and materials costs, it is often more affordable to purchase steel from foreign countries than it is to buy U.S. manufactured steel.  By placing a tariff on imported steel, the government is effectively raising the prices of those imports.  Given that these imports are more expensive, steel buyers have a greater incentive to buy domestically. A tariff on imports should help the domestic steel industry and in turn, benefit the steelworker. While this is true, it may have the negative effect of increasing the cost of steel that is used to build cars at the automotive plant in Ohio.  If the cars become costlier to produce, consumer prices could increase resulting in fewer units sold.  This trend may lead to layoffs or reduced hours for the automotive employees.
 
Another problem with tariffs is the possibility of a trade war. As more countries put tariffs in place to retaliate against another country’s tariffs, the whole thing can lead to a debilitating snowball where global trade seizes. Most governments realize that everyone loses in a trade war; it’s our hope and expectation that a trade war will not materialize.
 
A lynchpin of capitalism is that every country, region, state, or territory has a different set of circumstances that allow it to produce some things with greater efficiency than others. When one country has the relative advantage in producing a good or service, it’s in everyone’s best interest for them to specialize in that area while importing other goods and services to leverage the unique skills of their trading partners. It is this basic principle that leads to a more productive and efficient world. Tariffs hamper this efficiency from taking place.
 

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