Tariffs and Trade Wars, and Taxes, Oh My!

Man your battle stations--it’s time for a trade war! If you’ve been following the news, it’s likely you have been bombarded with near constant updates about escalatory tariffs and the looming threat of trade wars as the new administration has been following up on its promise to impose tariffs of 10-60% of all U.S. imports. Within the first few weeks, we have seen the posturing with Mexico, Canada, and China. The Trump administration has now ordered 25% tariffs on aluminum and steel. But what are tariffs and how do they result in a trade war? And how might trade wars impact consumers, entrepreneurs and the economy?

First, tariffs are taxes imposed by one country on goods imported from another country. Advocates for tariffs contend that they can be used to protect domestic production in specific economic sectors and shield workers from unfair forms of competition from specific trading partners (like those abusing labor rights). As the Economic Policy Institute explains, “as part of a strategic suite of complementary industrial policies, tariffs can help sustain and support the development of key industries and maintain them during periods when trading partners are engaged in market-distorting subsidization of their exports. Tariffs can also help correct these pervasive distortions and improve economic efficiency, allowing firms to thrive in the face of these distortions.” For example, “U.S. steel and aluminum producers have faced chronic global oversupply that has largely been caused by subsidies (direct and indirect) that trading partner governments have given their own domestic producers—who are among the world’s worst polluters.” And the COVID-19 pandemic reminded us that, when trade routes are disrupted, strong domestic manufacturing capabilities can be critical to supplying life-saving medicine and equipment.

However, tariffs also come with risks. Generally, tariffs do not reduce trade deficits because broad-based tariffs also reduce exports as other countries often respond with their own retaliatory tariffs. This can cause tit-for-tat escalatory tariffs as countries raise the stakes and pressure on each other, resulting in a “trade war”. Trading partners can also intentionally push down the value of their own currency against the dollar through exchange rate management policies to offset the competitive ground lost in U.S. markets, effectively making U.S. products more expensive.

Consumers will be on the front lines of any trade war, but tariffs can cause ripples up and down the economy. Consumers will often pay higher prices because of the struggle on manufacturers to find the inputs necessary to make their products, but those high prices and complex supply chains can have downward pressure on the valuation of businesses that are dependent on access to international markets for supply inputs or for sale of goods. A trade war could even make entrepreneurs less likely to form new businesses or expand their businesses in new markets because of the uncertainty of international market forces. Conversely, businesses that manage their own production may be more appealing to strategic investors or acquirors as those businesses may be less vulnerable to the escalatory pressure of tariffs or an all-out trade war

Ultimately, consumers. businesses, and entrepreneurs will need to remain nimble enough to adapt to an unpredictable environment.