So, think through the standard points about trade tariffs. We stick a tax upon goods as they cross the border, inwards. The first two possible responses are:
1) Producers, or importers, cut prices and profit margins in order to be able to keep selling. No inflationary impact.
2) They don’t, they raises prices, inflationary impact.
Which happens depends. Largely on the elasticity of demand for the items. That closely allied to the substituitability. For example, short term demand for oil is notably inelastic. We don’t change our use very much with respect to changes in price. Because we’ve already got a car with a certain engine size, we live so far from the office and supermarket, home heating is done by this system here and so on. Demand for oil from a specific place is hugely elastic. Stick a $100 a barrel tax upon oil from Iran and Iran only and no one will use any Iranian oil at all. Because we can all go use Saudi, Texas, fracked, Venezuelan instead.
Which happens depends upon the specifics of the item. So, we get an idea of inflationary impact from tariffs.[perfectpullquote align=”full” bordertop=”false” cite=”” link=”” color=”” class=”” size=””]In all, those goods subject to tariffs account for about 5% in the core CPI, and China accounts for varying amounts of imports, suggesting the impact on these prices will vary. Still, this bottom-up approach would suggest that if all of the tariffs are passed through to the consumer, it would boost year-over-year growth in the core CPI by 0.4 of a percentage point. Odds are that the impact will be smaller, as some U.S. businesses will eat the cost or risk losing sales. Therefore, we expect the boost to inflation will be closer to 0.2 of a percentage point.[/perfectpullquote]
OK, that’s fine and there we are. However, this doesn’t in fact tell us the whole story. The inflationary impact will be more than that:[perfectpullquote align=”full” bordertop=”false” cite=”” link=”” color=”” class=”” size=””] There’s nothing wrong with that analysis as far as it goes. But I’m not certain that it goes far enough. Because what’s the other thing that happens when we impose tariffs. In fact, what’s one reason we do impose tariffs? So that domestic producers can raise their prices. Think what happens when we have anti-dumping tariffs. Our claim is that the foreigners are selling too cheap. This means that our domestic producers cannot compete. We have the tariffs so that – expressly because we want this to happen – domestic producers can raise their prices. Do note that economic effects do not depend on why we’re doing something, they depend upon what we’ve done. So, impose tariffs and that means that domestic producers can raise prices. Thus the inflationary effect of tariffs isn’t just the price change from imports, but that plus also the domestic price rises they enable. [/perfectpullquote]
The effects of tariffs are worse than the usual estimates tell us. And that’s even with the usual estimates telling us that tariffs are already a bad idea. Why not just not have them therefore?