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Tariffs in a Globalized World

Author(s):
International Monetary Fund. Research Dept.
Published Date:
December 2018
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Illustration: Fabio Bolzan

sahmed@IMF.org

The last time there were tariffs in a meaningful way—and we have to go back really far, to the post–World War II era—global exports were around 5 percent of global GDP, a far cry from more than 20 percent of global GDP in 2017.1 With the advent of trade liberalization and globalization, tariffs were becoming a relic of the past. Not anymore!

How do economists deal with tariffs in a globalized world? Truth be told, economists are not huge tariff fans. At first blush, the pushback seems counterintuitive. If a country imposes tariffs, imported goods become more expensive, inducing consumers to switch to domestic products. Domestic production increases, imports decrease, and exports increase—leading to a decline in the current account deficit and an increase in domestic production.

However, in a world with cross-border production chains, product diversification, flexible exchange rates, and possible retaliation by other countries, the resulting impact of tariffs is far more elusive, depending upon the relative effect of a host of intricate factors.

Consider the dilemma of a car buyer in the US in a world where tariffs are imposed on all products, including cars and auto inputs. The choice is not between the cheaper Ford versus the tariff-induced more expensive Volkswagen. If the inputs used to produce the car (such as tires, aluminum, and rubber) are subject to tariffs, the cost of producing the domestic car would increase and might be transmitted to the buyer. The choice then becomes between the expensive Ford versus the expensive Volkswagen—whichever you choose, your wallet will be hurt. Similarly, the domestic car producer does not get a free pass. The increase in the cost of production could affect the volume of sales, both in the domestic and international markets.

Now multiply the car buyer-seller dilemma by all the products used within an economy. Furthermore, lower imports due to the tariff could be offset by an appreciation of the currency to achieve the external balance, leading to an overall contraction in exports, consumption, investment, and output.

A recent study takes a holistic view of the macroeconomic consequences of tariffs using data on 151 countries over the period 1963–2014. “Tariff increases lead to significant declines in domestic output and productivity in the medium term,” Davide Furceri, a senior economist in the IMF’s Research Department, says. “In addition, tariff increases result in more unemployment, higher inequality, and real exchange rate appreciation. There are only small effects on the trade balance.”

Professor Andrew K. Rose (University of California, Berkeley) highlights some of the interesting asymmetric effects found in the study: “The medium-term decline in output is higher if the tariff increase occurs during an economic expansion. Tariff increases also have more adverse effects for advanced economies than for poorer countries. Finally, the medium-term output effects associated with a tariff increase are not symmetric to those that follow tariff reduction.”

Jonathan D. Ostry, Deputy Director in the IMF’s Research Department, concludes: “Overall, our results suggest that tariff increases have adverse domestic macroeconomic and distributional consequences. Our results support the case for free trade and are in line with conventional wisdom.”

The title of a blog by Maurice Obstfeld—the IMF’s Economic Counsellor and Director of the Research Department—summarizes it all: “Tariffs Do More Harm than Good at Home.”

Similarly, the IMF G-20 surveillance note cautions that the imposition of tariffs by the United States and potential retaliatory measures by its trading partners could have significant costs for the global economy—reducing growth and investment, disrupting global supply chains, and hurting consumers. The IMF’s recent External Sector Report advises countries to avoid protectionist policies as they can have significant adverse effects on domestic and global growth, but have a limited impact on external imbalances.

Is this the first time since World War II that there are signs of rising trade protectionism? In his recent book Straight Talk on Trade, Harvard University economist Dani Rodrik draws the analogy of the trade protectionism chatter of the early 1980s, owing to stagflation in the advanced economies. Eventually, the world witnessed unprecedented expansion of global trade in the subsequent decades. Let’s not acquiesce to public transport just yet.

Photo: Stephen Jaffe

FURTHER on the MACROECONOMIC CONSEQUENCES of TARIFFS…

What is different about free trade compared to other free-market policies? Can free trade engender both economic growth and equality? Jonathan D. Ostry, Deputy Director of the Research Department at the IMF, on the hot seat.

CLICK HERE TO LISTEN

1Data sources: IMF, Direction of Trade, World Economic Outlook.

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