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International trade has enjoyed relative stability in these last few decades—ruled by the arrangements of the General Agreement on Tariffs and Trade firstly and then by the regulations of the World Trade Organization.
What are tariffs?
In a nutshell, tariffs are an import tax. As such, they are generally considered part of the cost of goods sold because they are a direct cost associated with buying or producing a product. Most times, tariffs are set ad valorem, hence a percentage of the value of an import. But they could also be a specific tariff consisting of a fixed fee per unit of good (unit, ton, etc.), or even a combination of the two.
Simple examples here are the “Chicken Tax,” a 25% tariff on light trucks imported in the US that started in 1964 as a retaliatory measure against European tariffs on chicken imports ... and still in effect to this day. Under the Australian Cheese and Curd Quota Scheme, a tariff quota applies to certain types of cheese with a $0.096 duty per kilogram until 11,500 tonnes per year and a higher rate after that.
Who can decide on tariffs?
National governments, typically the legislative branch, have the authority to set tariffs to impose on their trading partners. In most cases, they do so for three reasons:
Increase revenue
Since tariffs are duties to be paid when importing a good, this creates a revenue stream for countries that can be used to balance their budget or for public services. As per the Council of the European Union, for instance, 13.7% of the EU budget comes from tariffs.
Protect domestic industry
By specifically increasing tariffs on a defined scope of products and making it redhibitory to import these goods, governments are essentially protecting the local industry and associated jobs by promoting local production, either via established national actors or via Foreign Direct Investment mechanisms, both resulting in strengthening domestic manufacturing.
Negotiation leverage
When emergency tariffs are imposed, these can be limited in time and used as leverage to encourage concessions from other countries. Once the trading partners have agreed on new terms and any trade imbalance is reduced, tariffs can be lifted. This has often been described as a tool of “hardball diplomacy,” and is usually only available to countries already in a commanding position.
International organizations such as the World Trade Organization can also influence—but not enforce—tariff policies through agreements. With its primary purpose being the promotion of open trade for the benefit of all and trade facilitation, when there are trade disputes such as disagreements between parties on tariffs, member countries can appeal to the World Trade Organization Dispute Settlement Body. If mediation fails, the Dispute Settlement Body can authorize the winning party to implement retaliatory measures such as trade sanctions.
Who pays tariffs?
It is the importer’s responsibility to determine and pay the right duty to the customs authorities in the importing country. Any errors in the customs clearance process—for example, incorrect classification of goods, undervaluation, and declaring the wrong country of origin—can lead to delays and even fines and penalties for underpayment or non-payment of tariffs of course but could also escalate to goods being seized until resolution or even legal actions with lawsuits and criminal charges being brought forward. All actors in the supply chain should also ensure they maintain evidence of origin throughout the end-to-end supply chain as evidence may be required to determine the true origin of goods and to substantiate claims of sufficient transformation.
Nevertheless, to maintain margins, or if absorbing increased costs would jeopardize the overall business sustainability, part or entirety of the duties can be passed on to customers—either directly to the consumer for wholesale products, or to other companies when the product enters a manufacturing process.
Realizing that tariffs could impede competition and impact end customers with higher prices, governments have collaborated on trade agreements. Sometimes even annulling tariffs for defined products or industries. This has shaped some sectors that have moved to an integrated value-added supply chain making full use of these trade agreements to optimize the manufacturing of products by focusing on areas of expertise and lower costs.
An example here would be the North American automotive sector where the United States and Canada have historically had a long-standing trade agreement that enables car manufacturers to buy raw materials in Canada, manufacture car components in the US, then move the components access border to Canada to enter the manufacturing of a large component and revert to the US to an assembly line, all without incurring duties at every crossing.
Long lasting effects
A pernicious aspect of temporarily imposed tariffs is that they often remain in place long after their intended effect. Much like in the example of the Chicken Tax mentioned earlier. They can also shift to non-tariff barriers if negotiations result in incomplete agreements. Affected industries, therefore, must adapt to a new normal, implement a longer-term mitigation approach, or accept the landscape that this creates a new de facto situation—which can be once again rapidly shaken by changing political factors.
In a growing networked economy where businesses, individuals, and governments are interconnected, protectionism and barriers can have unintended impacts that remain to be fully uncovered. Flexible planning and agility, enabling companies to react to changing environments, will be of the utmost importance for businesses worldwide.
I would like to thank The Chartered Institute of Export & International Trade for their collaboration on this article.
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