The Economics of Tariffs

Recently, President Trump unilaterally decided that the US is going to institute tariffs on both steel and aluminium. Tariffs have been used in the past by previous administrations and, indeed, other countries around the world. Tariffs, or customs duties, are taxes on imported products, usually in an ad valorem form, levied as a percentage increase on the price of the imported product. Tariffs are one of the oldest and most pervasive forms of protection and barrier to trade.

Who benefits from such a tax? In this case, steel and aluminium manufacturers. Who loses? Everyone else. In the US, the working population is estimated to be around 145 million. How many workers are employed in the steel and aluminium industry? That number is about 200 thousand. Doing the math, this tax will favour roughly 0.14% of the overall labour force. So, Trump is taxing the users of these materials whilst protecting those who manufacture the products.

Who pays for these taxes imposed on exporting countries? Everyone. Meaning, a 25% increase in steel imports will mean that consumers in the US will pay an additional 25% on steel inputs. That means new cars, beer, watches, household appliances, etc., will be more expensive. Why would a country assess such a punitive additional cost to consumers? In this writer’s humble opinion, for optics to look tough to the voting population (if the country is somewhat democratic). Anyone who has a rudimentary understanding of economics will likely agree that tariffs are generally bad for the economy. Furthermore, there is a strong likelihood of retaliation from exporting countries which could trigger a costly trade war. Europe, for example, has promised to put tariffs on Harley Davidsons, bourbon and blue jeans. These are specifically targeted at the home states of particular members of the US Congress.

As an investor, do tariffs impact your portfolio? Yes. It’s unlikely that increased costs, i.e., tariffs, will not have a negative impact on an investable portfolio. The US accounts for nearly 25% of world gross domestic product (GDP), which means the impacts of these increased expenses will spread throughout much of the world. In turn, these increased prices will have knock-on effects on businesses worldwide. Taxes are ultimately paid for by consumers as businesses pass these costs into their end products (goods and services).

What should an investor do? The primary defence against specific political risk, such as tariffs, is to make sure your portfolio is diversified geographically, as well as amongst sectors and industries. This will help mitigate the risk from any government or region as best one can.

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