As part of the trade war with China, American president, Donald Trump, raised tariffs from 10% to 25% on 200 of the 250 billion Chinese imports that are currently the target of a surtax. What’s more, he initiated the procedures for the purpose of imposing tariffs on the remaining 300-some billion Chinese imports.
The American president says he is happy to see these tariffs fill the American treasury’s vault. Several economists believe that it is American consumers and businesses who are footing the bill. So who actually is?
To help us, economists use a branch of economic science called welfare theory. This theory seeks to provide a basis for public policy choices, the best possible choice being that which maximizes the total well-being of an economy. The calculation of well-being is based on the idea of economic surplus.
Basically, there is the consumer’s surplus and that of the producer or seller. The consumer’s surplus is benefit resulting from the fact that consumers would be willing to buy a product at a higher price than what they will effectively pay, the market price. This increases their well-being. The producer’s surplus occurs when producers would have accepted a lower price for their products than the market price they will actually receive, which increases their well-being.
Paul Krugman, recipient of a Nobel Prize in Economics, perfectly illustrated this theory in the New York Times on March 3. Let’s suppose that a product imported from China costs $100 before tariffs. With tariffs, the price increases to $125. If the product is imported and bought by an American consumer, that consumer will lose $25 of well-being per product purchased. However, the government will recoup this amount in tariff revenue. Thus, there is no effect on well-being of the economy as a whole.
It is more likely that American importers will try to find the same products from other countries. By substituting Chinese imports with equivalent products imported from Vietnam that cost $115 each, the consumer’s loss of well-being will be $15 per product purchased, but they will not be compensated by tariff revenue, since Vietnamese products are not targeted by these tariffs.
But what happens if an American producer offers a product equivalent to that of China at a price of $20? In situations of underemployment, where not all resources are utilized, the consumer’s loss of $20 of well-being would be compensated by an equivalent rise in the well-being of a domestic producer.
Currently, the United States is in near full employment. This means that production of an American substitute for imported goods requires resources that are not utilized to produce another manufactured good. It is therefore a loss of $20 for the consumer that hasn’t been recouped by domestic producers, which means a net loss for the American economy as a whole.
Therefore, tariffs will raise the price of imported Chinese goods for consumers and businesses worldwide, resulting in the United States importing from other countries and causing a zero-sum game when it comes to creating American manufacturing jobs. Nothing very favorable for the country.
An American study concluded that the loss in well-being is currently $1.4 billion per month, which is $17 billion per year. It’s a negligible loss of 0.1% of America’s GDP, but contrary to Trump’s affirmations, it is a loss nonetheless.