By Phillip S. Coles
For MediaNews Group
Numerous economists and politicians continue to be astonished by mild inflation data. The May Consumer Price Index report indicated inflation was less than expected, with “limited effects from tariffs” and “defies tariff fears.” On June 23 Federal Reserve Vice Chair for Supervision Michelle Bowman said she was open to reducing interest rates because she said in part that “inflationary impact of President Donald Trump’s trade war has been smaller than feared … ” Some senators are so convinced that prices must be increasing that they doubt the government’s statistics.
However, no one should be surprised by the data because while tariffs can cause specific price increases, or a one-time price spike, they do not cause inflation, which is a persistent increase in prices over time. If they did, the Smoot–Hawley Tariffs of 1930 would have caused inflation. Instead, there was deflation and the Great Depression due to reduced trade and the Federal Reserve’s reduction in the money supply. In fact, the federal government was almost entirely funded by tariffs before 1913, without inducing inflation.
A tariff is a tax. Those proposing other tax increases, like income or corporate taxes, never raise concerns that they will cause inflation. Therefore, why would taxation from tariffs be different?
They aren’t because, assuming no increase in the money supply, if tariffs cause a product to become more expensive, consumers will either avoid that item, which reduces demand and in turn will lower the price, or they will have less money to buy something else, which will reduce the demand for that item, and its price will drop. Price reductions of some items cancel out price increases of others. The only way consumers will have sufficient cash to purchase both and create inflation is if the Federal Reserve makes more money available.
Businesspeople often try raising prices, but unless consumers buy, increases will not stick. We can pretend we set prices, but the buyer has a say. Markets determine prices, not executives. Additional evidence is that since markets set prices, often companies cannot pass on the full cost of tariffs.
However, all taxation is a drag on the economy, and implementing tariffs can disrupt supply chains. Of course, that is the strategy: Disrupt existing supply chains to get businesses to move production to the U.S..
Tax something and you get less of it. That is the idea behind sin taxes, for example, to reduce tobacco or alcohol consumption. Tax imports and you will get less trade, but countries benefit from free trade the same way individuals do from the division of labor. Countries have comparative advantages that make trading mutually beneficial.
Reduce trade, and what economists call deadweight losses are created because we would be making things that we could purchase elsewhere for less, preventing us from creating what we produce better. We all end up with less because of the opportunity costs of this misallocation. In addition, tariffs incentivize U.S. trading partners to do the same, lowering American exports and negating any advantages.
There are some caveats. One use for tariffs is to prod trading partners to reduce their tariffs. One can argue it is not “fair” to have disparities in relative tariffs rates. There is an argument to be made to level the playing field, but this is a recognition that tariffs are economically destructive by virtue of it being an attempt to get trading partners to lower their tariffs. It must be resolved quickly since businesspeople prefer bad policy to uncertainty. Many will sit on the sidelines till they have a clear idea of the rules of the road.
Even early economist Adam Smith argued for the use of tariffs on national security grounds. The U.S. would not want to find itself dependent on an adversary in the event of war. The U.S. was the arsenal of democracy during World War II because it produced war material at a much greater rate than the Axis powers.
Today China is the world’s manufacturing superpower, producing roughly twice the output of manufactured goods as the U.S. This is particularly true in strategically important industries such as shipbuilding that the U.S. once dominated and is now only a bit player. But this can be a slippery slope where everything can be argued as important to national security. Tariffs come at an economic cost and should only be used when they are worth the price.
So, while tariffs are not inflationary, they can reduce economic output and risk recession. Instead of hiding behind tariffs, U.S. companies must become more competitive, so people want to buy U.S. products instead of attempting to force them to with tariffs
Phillip S. Coles is teaching associate professor of supply chain management at Lehigh University.
Source: Berkshire mont
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