Trump’s policies drive up import prices, raising costs for consumers and limiting access to affordable goods. The 2018 tariffs highlighted this, increasing freight costs and potentially affected U.S. and global GDP.
Over recent months, tariffs have been a central theme in Donald Trump’s campaign for the U.S. Presidential Election. Trump has expressed strong support for imposing new and substantial tariffs. But what exactly are tariffs, and how do they function?
In this explainer, we’ll break down what tariffs are, how they work, and why they often end up impacting consumers negatively.
In simplistic terms, tariffs is simply a tax on imports. However, it is important to note that these tariffs are not paid by the exporting countries. Instead, domestic companies (i.e., the importers) would have to pay for the tariffs.
Tariffs are typically imposed to protect the domestic industries of a country. By making imports more expensive through tariffs, the government can prevent international companies from undercutting the prices of domestic companies.
Imagine a scenario where an American car costs $45k to the retail public while a Chinese car costs $30k to import with an additional 60% or 18k in tariffs. In this scenario, there is no incentive for the rational consumer to purchase the Chinese car as it is simply more expensive.
For the importer, those who are wise will know that there is no demand; hence, no reason to import.
Generating revenues for the domestic government is yet another key reason why governments typically impose tariffs. According to the Tax Foundation, a 10% universal tariff would raise $2 trillion in revenue for 2025 through 2034.
Oh you bet! Unfortunately, consumers will face higher costs. It is a price to pay to ensure that the demand goes to the domestic product as production and manufacturing in the United States are generally more expensive due to higher labor costs. After all, nowhere else in the world but the United States allows truck drivers to earn $100,000 a year.
So how do the consumers get affected? Consumers are affected by the eradication or inflation of the cheaper imported product. If tariffs are imposed on the imported products, importers will charge higher prices to consumers to recoup their losses. Alternatively, just as the above car examples, importers will decide that there is no incentive to import the product, leaving only the more expensive domestic product in the market. In either cases, consumers will have to pay higher prices.
That being said, the biggest assumption here is that domestic products are always more expensive than the imported products. However, in a scenario where two products are already priced the similarly (pre-tariffs); the introduction of tariffs will simply make the domestic product more attractive. In this case, consumer do not pay for higher prices and simply switch to the domestic products.
Ultimately Tariffs Must Be High Enough For Donald Trump's Masterplan To Work
Trump's objective is to ultimately restore demand in domestic products. However, it is important to note that the tariffs must be high enough to eradicate demand for the imported product.
For example, if an American toothbrush costs $15 dollars while an imported toothbrush costs $7 after tariffs, consumers will still choose the imported product as it is cheaper. In such a case, the tariffs are merely a means to generate revenue for the government.
The consumer is not incentivized to choose the domestic toothbrush and continues to demand for the imported product.
In other words, the exporting country still benefits from sustained demand; consumers pay for higher imported products and domestic producers still do not benefit from any demand.
For now, details are scant on Trump's actual tariffs plan. What we do know is that the incoming POTUS will impose a tariff rate of at least 60% on China's products. Reuters indicated a potential 60% to 200% tariff rate on Chinese products. For all other countries, between 10% to 20% on imported products.
If history is any useful, in the short-term, we should expect a huge inflation in consumer prices through ocean freight rates. In 2018, importers rush to import as many products they can before the actual tariffs went into effect, causing a huge spike in ocean freight rates. At one point, ocean freight rates almost doubled.
The spike of ocean freight rates is merely the onset of the trade war. After US trading partners retaliate on Trump's 2018 tariffs, we saw the increased costs through tariffs costing the average American household at least $800 per annum.
In addition, supply chains shifted, leading to increase costs and inefficiencies. According to the a study conducted by IMF, the trade war between US and China has the potential to cause global GDP to reduce by 0.8%. US's GDP may fall by 0.6% while China's GDP may be affected by up to 2%.
Automotive is highly likely to be one of the targets for Trump's tariffs; expect a huge disruption to supply chains and investment plans. If tariffs are implemented, auto companies are likely to raise production in the United States (e.g. Tesla had already said they will increase local production in July 2024 and will pause plans to build a factory in Mexico). Those who do not have production capacity in United States will, unfortunately, have to pass on the costs to consumers. Oxford Economics expect that prices will rise by 3.7% if tariffs are imposed. Both Mexico and Germany is likely to be affected as US remains their biggest export market.
In the Aerospace industry, tariffs will most likely translate into higher costs for airlines and ticket prices for passengers. Boeing will most likely be the world's punching bag, receiving retaliatory tariffs; it is likely that Boeing will lose a lot of sales to Airbus. Moreover, Boeing does not have overseas production facilities to bypass these potential retaliatory tariffs.
Closing Remarks
Overall, market participants are expecting a higher inflationary environment with the implemented tariffs.
An environment with higher inflation may affect the Fed's plan to reduce and normalize interest rates, resulting in a period of "higher for longer" rates.
For now, market participants should closely monitor the developments pertaining the tariffs. If the tariffs are officially imposed, it is likely that we will see deteriorating sales in companies that are heavily dependent on each other's economy, resulting in a huge deterioration in their share prices.
Disclaimer: All information provided is intended solely for general informational purposes. Seven Insights does not take into account individual financial goals or situations and does not provide personalized investment advice. Seven Insights is not a licensed securities dealer, broker, U.S. investment adviser, or investment bank.
