Basic Math, Good Intentions, and Unintended Consequences

Guest Opinion

By Tom Gutowski | Feb. 15, 2025

Imagine you’re an appliance dealer and you sell foreign made microwave ovens. You buy them for $80 each and sell them for $100. The $20 difference goes toward your expenses and leaves you with a small profit per machine. If the U.S. puts a 25 percent tariff on these ovens, your cost per unit will go up to $100: $80 for the microwave, plus $20 payable to U.S. customs. Obviously, you’ll need to raise your prices.

That’s the straightforward part. From here on, it gets complicated. The simplest scenario is that you raise the price of each unit by the amount of the tariff. Your competitors who sell microwaves not subject to the tariff (either domestically manufactured or coming from a country not affected by the tariff) would presumably now sell more units while you sell fewer, because yours have become more expensive.

Or, your competitors might raise their prices as much as you raise yours, with the idea that they’ll sell about the same number of units as in the past but make more money on each one. If they do that, consumers will end up paying more whichever one they buy. Or, your competitors could raise their prices, but by less than you do, so they make a little more profit per microwave, but also sell more because theirs are still somewhat cheaper than yours. Or, the foreign maker of the microwave ovens may lower its prices in an effort to remain competitive in the U.S. market. There are no hard and fast rules here.

Governments impose tariffs on foreign countries to make foreign goods more expensive and thus encourage consumers to buy domestically produced products. A government might do this to protect an industry that needs time to establish itself, that’s facing competition from countries with extremely low wages, that’s vital for defense purposes, or that’s being hurt by dumping (other countries selling goods below cost). Tariffs may also be used as a threat against another country to extract concessions that may or may not not have anything to do with trade.

The potential positive outcomes carry some downside risk. Consider, for example, our relationship with China, with whom we have a large trade deficit (meaning we buy a lot more from them than they do from us). If we substantially increase tariffs on Chinese goods, the price of those goods would go up and American consumers would then face a choice: either pay more for the Chinese products, or switch to American made merchandise.

In some cases, there might not be any comparable product made in America. Also, as described in the microwave example above, the price of competing American goods might go up as well. American manufacturers who use Chinese-made parts would have to charge more for their products unless and until they develop new supply chains, and they’d therefore be less competitive in the world marketplace.

American companies that have products assembled in China (e.g. Apple) would probably seek tariff waivers. If the waivers weren’t granted, they might charge more to compensate for the tariff, or they might move production out of China—but not necessarily to America. India and Vietnam come to mind. And China could impose retaliatory tariffs, reducing the amount of goods we sell to them. China could also work to develop closer relationships with other trading partners, with possible long-term negative consequences for us.

The threat of a major tariff increase can motivate the target country to develop closer ties with other trading partners, and can hurt both country’s economies by introducing uncertainty.

Before Trump recently threatened Columbia with a 25 percent tariff over a dispute involving deportation of Colombian nationals, many American companies had been investing there because of Columbia’s stability and its nearness to the U.S. Now, that process may be slowing while they reassess the situation, and there’s concern in some quarters that Columbia may end up getting cozier with China. Meanwhile the mere threat of a tariff caused already high prices for Colombian coffee to spike.

Tariffs are best used as part of a deliberate, well thought out trade strategy, and not impulsively. They generally ought to be set at moderate levels, lest they trigger unwanted effects. When the U.S. raised its already high tariffs via the Smoot-Hawley Tariff Act in 1930, other countries retaliated en masse; the resulting trade war reduced global commerce by more than 25 percent, deepening the Great Depression.

Tariffs can be used to generate revenue, but the constraint is that if tariffs are set high enough to be a major revenue source, they may be high enough to cause unintended and unwelcome consequences. Besides, the revenue comes from our own citizens, not from foreign countries, despite what Trump keeps saying on this subject.

Perhaps the biggest lesson is that tariffs are complicated. Anyone proposing to use massive tariff increases to produce rapid, major, and neatly targeted changes in trade patterns or relations with trading partners stands a good chance of being unpleasantly surprised.

Tom Gutowski holds a BA in Economics and a PhD in History.