This article is part of “Business Basics» series where we ask experts to discuss key concepts in business, economics and finance.

Thanks to the decisive victory of United States President-elect Donald Trump, we will now hear a lot more of his favorite word.

It’s a kind of love story. On the electoral campaign trail in October, he said:

For me, the most beautiful word in the dictionary is “rate”.

Previously, he compared these speeches to real policies. During his last term, Trump imposed a series of tariffs.

Now set to return to the White House, he wants tariffs of 10 to 20 percent on all imports to the United States, and tariffs of 60 percent or more on those from China.

Most of us understand that tariffs are some sort of barrier to trade between countries. But how exactly do they work? Who pays for them – and what effects can they have on an economy?

Learn more:
What is comparative advantage?

What are the rates?

An import duty – sometimes called an import duty – is simply a tax on a good or service imported into a country. It is collected by the government of the country importing the product.

Concretely, how does this happen in practice?

Imagine Australia has decided to impose a 10% customs duty on all washing machines imported from South Korea.

If an Australian consumer or business wanted to import a washing machine from South Korea for $1,200, they would have to pay $120 to the Australian government upon entering the country.

So, all things being equal, the final price an Australian consumer would pay for this washing machine is $1,320.

If a local industry or another tariff-free country could produce a competing good at a similar price, it would have a cost advantage.

Other trade barriers

Because tariffs make imports more expensive, economists call them a trade barrier. They are not the only ones.

Another common non-tariff trade barrier is the import quota – a limit on the quantity of a particular product that can be imported into a country.

Governments can also create other non-tariff barriers to trade.

These include administrative or regulatory requirements, such as customs forms, labeling requirements or safety standards that differ between countries.

What are the effects?

Tariffs can have two main effects.

First, they generate tax revenue for the government. This is one of the main reasons why many countries have historically implemented tariff systems.

Borders and ports are natural places to record and regulate what enters and leaves a country. This makes them easy places to impose and enforce taxes.

Second, tariffs increase the cost of purchasing products produced in other countries. As such, they discourage this action and encourage alternatives, such as purchasing from domestic producers.

The protection of domestic workers and industries from foreign competition is the basis of the economic concept of “protectionism.”

The argument is that by making imports more expensive, tariffs will increase spending on domestically produced goods and services, leading to greater demand for domestic workers and helping a country’s local industries grow.

Learn more:
What is competition and why is it so important for pricing?

Changing producer is not always easy

Tariffs can increase employment and wages for workers in import-competing sectors. However, they can also impose costs and create higher prices for consumers.

It is true that foreign producers trying to sell their products under a tariff can reduce their prices to remain competitive as exporters, but this is not happening so far. At least part of the cost of any tariff imposed by a country will likely be passed on to consumers.

Just switching to domestic manufacturers probably means paying more. After all, without tariffs, buyers were choosing foreign producers for good reason.

Because they make it less profitable to sell their products domestically, tariffs also push some foreign producers out of the market altogether, reducing the variety of products available to consumers. Less foreign competition can also give domestic companies the opportunity to charge even higher prices.

Reduced productivity and risk of retaliation

Economy-wide, trade barriers such as tariffs can reduce overall productivity.

This is because they encourage industries to move away from producing products for which a country has a comparative advantage in areas where it is relatively ineffective.

They can also artificially keep producers smaller and less productive afloat, while downsizing larger, more productive producers.

Foreign countries can also respond to tariffs by retaliating and imposing their own tariffs.

We saw this under the previous Trump administration, which increase in prices on approximately $350 billion in Chinese products between 2018 and 2019.

Several analyzes looked at the effects and found that it was not foreign producers but domestic consumers – and especially domestic consumers. businesses that rely on imported goods – who paid the full price of the fares.

Furthermore, the tariffs introduced in 2018 and 2019 failed to increase American employment in the sectors they targeted, while the retaliatory tariffs they attracted reduced employment, primarily in agriculture.

The economists’ verdict

Tariffs can generate tax revenue and increase employment and wages in certain import-competing sectors. But they can also raise prices and reduce employment and wages in exporting sectors.

Do the benefits outweigh the costs? Economists are almost unanimous – and has been since centuries – that trade barriers have an overall negative effect on an economy.

But free trade does not benefit everyone, and tariffs are clearly enjoying a moment of political popularity. There are interesting times ahead.

Learn more:
Trump’s economic vision is no longer a “maybe.” Here’s what it could mean for Australia and the world