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The Fallacy of Price Hikes Caused by Tariffs

The Fallacy of Price Hikes Caused by Tariffs
(David Watmough/Dreamstime)

Michael Busler By Monday, 03 June 2019 10:42 AM Current | Bio | Archive

Nearly all economists will agree that placing tariffs on imported goods will have a negative impact on the economy. Prices of finished goods will rise and there may be reduced quantities available to consumers.

Without tariffs, each country would produce the goods that they can produce most efficiently and then trade for other goods. With permanent tariffs, that changes.

Producing most efficiently means producing at a cost lower than another country. If the trade is truly free (and fair), both the producing country and the receiving country benefit from free trade. When the trade is not fair, one country has an advantage while the other loses. This is what President Donald Trump is trying to fix.

After Trump was sworn into office, he looked at every trade agreement the U.S. had with our trading partners. For whatever reason, every agreement was slanted in favor of our trading partner and to the detriment of the U.S.

For instance, we charge China and the European Union a 2½% tariff on cars made there and sold in the U.S. For a car made in the U.S. and sold in Europe, a 10% tariff is charged. When the U.S. cars are sold in China a 25% tariff is charged.

Trump wanted every trade agreement re-negotiated so that the agreements were fair, meaning we each either charge no tariff or at least the same tariff. Of course our trading partners, knowing that they are in a very favorable position, were reluctant and attempted to stall any new negotiations.

How would a businessperson react when trading partners are reluctant to negotiate?

A businessperson would create a sense of urgency. That’s exactly what Trump has done by placing crippling tariffs on virtually every trading partner. His tactic is working extremely well.

Mexico, Canada and South Korea have agreed to new deals. Japan and India are negotiating and for the first time since President Richard Nixon normalized relations with China, they too are at the bargaining table. But there is no agreement with China as of yet.

Meanwhile, the tariffs are getting steeper and being placed on more goods.

But who actually pays the tariffs?

Trump says the Chinese will pay the tariffs. Others say the consumers will pay. Who is right? The answer is that they both are. That’s because some of the increased cost caused by the tariffs will be paid by the supplier of the product and some of the increased cost will be paid by consumers.

How much of the tariff will consumers actually pay?

A group of sneaker and footwear brands in a letter posted on the Footwear Distributors and Retailers of America (FDRA) website claims footwear prices will increase so the consumer will pay the tariff. FDRA claims “a regular canvas sneaker that currently costs $49.99 would cost $65.57 under the new tariffs. Running shoes that now cost $150 could exceed $200.

That statement doesn’t appear to be accurate. Let’s say that there is a 25% tariff placed on Nike sneakers imported from China. If the sneakers retail for $150, the retailer is probably paying Nike about $100, noting the $50 difference represents the retailer’s gross profit. If Nike is selling to the retailer for $100, they probably have a total cost of about $70, noting they earn a $30 gross profit.

That means Nike is probably paying about $40 for the sneakers from China, with the remailing $30 of their $70 cost is for overhead, advertising and other related costs. That means Nike paid the Chinese manufacturer $40 per pair.

By placing a 25% tariff on the $40 sneakers, the cost would now be $50 for Nike: a $10 increase.

How much of that extra $10 could be passed on to the consumer?

It depends on how badly consumers prefer Nike sneakers over the numerous other brands. If by raising the price the full $10, many consumers refrain from buying Nike and move to another brand, Nike will not be able to pass the full $10 price increase onto consumers.

Usually what happens is that a portion of the cost increase will be passed along to consumers, perhaps only $5 or $6. That means the 25% tariff was partially paid by consumers and partially paid by the producer. For most products, this is usually what happens.

Trump touts free markets. That includes free trade markets. As long as the trade agreements are fair, both sides should benefit. Trump would prefer no tariffs on anything and that is the goal he is trying to reach. While that likely won’t happen, what will happen is that low tariffs will remain but our trading partners will charge us the same rate that we charge them.

That’s how free and fair trade works. While there is admittedly some short-term pain for companies who are hurt by Trump’s tariffs and from the reciprocal tariffs placed on our goods by foreign governments, the long term will result in positive gains with foreign markets finally opened to U.S. manufacturers.

Trump always plays the long game.

Dr. Michael Busler, Ph.D., is a public policy analyst and a Professor of Finance at Stockton University in Galloway, New Jersey, where he teaches undergraduate and graduate courses in Finance and Economics. He has written Op-ed columns in major newspapers for more than 35 years.

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Trump says the Chinese will pay the tariffs. Others say the consumers will pay. Who is right? The answer is that they both are.
busler, trump, price, hikes, tariffs
Monday, 03 June 2019 10:42 AM
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