Economic Costs and Benefits of Tariffs: An Unbiased Analysis
Part Two of Two
If you haven’t read the first part, it is here.
Just a recap: In the previous part, we discussed the issue with tariffs. Almost all taxes lead to a societal loss of efficiency as there is a wedge between the buyer’s and seller’s prices. This leads to someone who could buy at the seller’s price not buying at the buyer’s price. Tariffs have a worse loss than other taxes because they’re not a uniform tax. It's a tax on some goods from some countries and not others. This means buyers are not only buying less of what they should buy, but also different products than what would be optimal.
Potential Benefits of Tariffs: Infant Industries and Strategic Gains
Despite their efficiency costs, tariffs can have positive aspects under certain conditions. Economic theory and historical experience provide a few arguments where tariffs (or protective trade policies) might yield long-term benefits:
Protecting Infant Industries
The classic infant industry argument is that new or developing industries may initially be unable to compete with established foreign producers, but given time and protection, they can grow, learn, and eventually become efficient. Tariffs (or other barriers) give these industries a temporary shield from international competition during their “learning phase.” The potential benefits include developing domestic industrial capacity, creating jobs, and eventually establishing globally competitive firms.
Economist Paul Krugman’s work on strategic trade and new trade theory provides a formal underpinning to this idea. In models with economies of scale and imperfect competition, there can be multiple equilibria in trade: a country that manages to build a large industrial base in a sector can achieve lower costs and dominate global markets. In such cases, temporary protection or subsidies might allow a country’s firms to reach the scale needed to compete internationally. New Trade Theory (NTT) suggests that because of increasing returns to scale and network effects, it’s possible for similar countries to specialize in different industries and trade to their mutual benefit. Some proponents of NTT argue that targeted protectionist measures can jump-start an industry so that it later exports and benefits from scale economies. This is essentially a more formal, “high-tech” version of the infant industry argument that earlier economists had made in less quantitative terms.
Historical examples of infant industry protection are numerous. The United States itself, during the 19th century, maintained high tariffs to protect its budding manufacturing industries (e.g. textiles, steel) from European competition. This period coincided with rapid industrialization in the U.S. In the 20th century, countries like South Korea and Japan used tariffs and import restrictions in the post-WWII era to nurture industries such as steel, automobiles, and electronics. South Korea, for example, restricted imports of consumer goods and supported domestic chaebol firms; over a few decades, companies like Samsung (electronics) and Hyundai (autos) grew from infancy to world leaders. These East Asian “tiger” economies coupled tariff protection with aggressive export promotion – once the infant firms grew stronger, they were pushed to compete in global markets, which further improved their efficiency. This combined strategy of temporary protection + export discipline is often cited as a key to their success.
China is a more recent case often mentioned: during the late 20th and early 21st centuries, China kept relatively high tariffs and tight limits on foreign access in sectors it wished to develop (such as autos, telecommunications, and technology). For instance, imported cars in China faced steep tariffs (25% for many years), and foreign automakers were forced into joint ventures – this gave Chinese domestic auto firms a chance to develop. Today, China has several competitive car manufacturers (especially in electric vehicles) beginning to export globally, a development some attribute in part to those protective policies in the industry’s early stage. More generally, China’s combination of tariffs, subsidies, and industrial policies helped foster companies like Huawei (shielded from foreign competition in the domestic telecom market) and a massive domestic solar panel industry (aided by subsidies until it achieved dominant scale). These examples suggest that when tariffs are used strategically and alongside investments in innovation and skills, they can facilitate the rise of competitive domestic firms.
It is important to note, however, that infant industry protection is not guaranteed to succeed. For every South Korea or Japan, there have been cases where protection bred complacency or persistent inefficiency. A well-known example is Brazil’s computer industry in the 1980s. Brazil banned or heavily taxed imports of computer hardware to foster its local tech industry. While this created domestic assembly companies, the protected firms never achieved world-class efficiency. Computer prices in Brazil remained far higher than global levels, lagging in technology. A comparison of computer prices showed U.S. prices falling much faster than Brazilian prices in the 1980s, and the gap never closed. In fact, Brazil never became competitive in PCs without protection, and eventually the policy was reversed. This failure of infant industry protection taught a cautionary lesson: protection must be coupled with a path to improve and eventually face competition, or the “infant” never grows up. Other countries have similarly seen protected industries remain chronically uncompetitive – often at great cost to consumers (who pay higher prices) and to other industries that use those products.
Strategic Trade and Long-Term Gains
Krugman and other economists in the 1980s explored strategic trade policy, which is related to infant industry but focused on industries that are oligopolistic (a few large competitors globally) and have high R&D or scale economies (like aircraft manufacturing, semiconductors, etc.). The famous example is the Boeing vs. Airbus scenario. In a market that can only support one or two major firms, a government might use tariffs or, more directly, subsidies to ensure its national firm gains the upper hand. The Brander–Spencer model showed that an export subsidy could allow a domestic firm to pre-empt a foreign rival in such an industry, capturing monopoly profits that benefit the home country. In theory, a well-timed intervention in an industry like commercial aircraft manufacturing could yield national welfare gains by securing a larger share of global industry profits for the home country (essentially boosting national income at the expense of other countries, a “beggar-thy-neighbor” outcome). This is a positive aspect from the perspective of the country using the policy – though obviously not a benefit in the cooperative global sense.
Paul Krugman, who helped popularize these ideas, noted that strategic trade policy is powerful but also perilous. He characterized such policies as “beggar-thy-neighbor” – they can enrich the home country only by essentially taking market share or profits from others. If every nation tries the same strategy, they can cancel each other out or lead to trade conflicts. Moreover, strategic interventions require precise information and timing: the government needs to identify the right industry (one with the potential for large scale economies and profits) and not overshoot with support. Krugman himself cautioned that the Brander–Spencer result does not establish a general policy prescription for subsidies or protection, highlighting that it’s very sensitive to assumptions and hard to apply in practice. Many industries won’t meet the criteria, and picking winners ex ante is difficult. If applied to the wrong industry, tariffs can backfire – the protection just locks resources into a sector with no hope of true comparative advantage.
Another potential long-term benefit sometimes cited is that tariffs can be used to address market failures or externalities. For example, if an industry has positive spillovers to the rest of the economy (like learning-by-doing that spreads to other firms, or if it’s critical for national security or supply chain resilience), protecting that industry could yield broader benefits not captured by private market prices. A tariff can be a second-best policy to encourage production in such sectors. (A direct subsidy might be more efficient, but tariffs are sometimes the more politically feasible tool.) National security is often invoked: a country might impose tariffs on defense-related goods to ensure it has domestic production capability in case of conflict (for instance, tariffs on military equipment or strategic materials). While the economics in peacetime might favor importing those items more cheaply, the argument is that the insurance value of having a domestic industry justifies the cost. Indeed, U.S. law allows tariffs for national security reasons (Section 232 tariffs on steel/aluminum were justified this way). These benefits are hard to quantify but are part of the policy calculus beyond straightforward efficiency.
In summary, tariffs can have positive effects when used in a targeted, temporary, and strategic manner: they may nurture infant industries, counter certain unfair trade practices, or support sectors with large future potential or critical importance. The success stories of East Asian economies and even the early United States suggest that protective measures, coupled with strong industrial policies, education, and infrastructure investments, can catalyze development.
However, the conditions for success are stringent. Tariffs work best as part of a broader strategy, not as a stand-alone solution. And they must eventually be eased to expose firms to competition; otherwise, protection can breed inefficiency. The risks of using tariffs for long-term gains include fostering monopolies or vested interests that resist competition, burdening consumers for too long, and provoking retaliatory actions from trade partners that negate the gains. As Krugman and others have warned, while theoretically one can justify tariffs in special cases, practically it is challenging to get those policies right and not have them captured by politics or prolonged beyond their useful life.
Empirical Evidence and Case Studies
To balance the theory with real-world outcomes, we review evidence from recent U.S. tariff actions and examples from other countries. These cases illustrate the tangible costs and benefits of tariffs in practice.
The Trump-Era U.S. Tariffs (2018–2019)
In 2018, the United States under President Trump imposed significant tariffs for the first time in decades – marking a sharp turn from prior trade policy. Key measures included: a 25% tariff on steel imports and 10% on aluminum (justified by national security concerns), and Section 301 tariffs on roughly $300+ billion of imports from China (starting at 10%, later 25% on many items) in retaliation for China’s trade practices. The stated goals were to revive U.S. industries (like steel) and pressure China to change policies. What do the results show?
Price Increases and Consumer Costs: Studies consistently found that the tariffs led to higher prices for American consumers and businesses. The U.S. International Trade Commission (USITC) reported that import prices rose nearly one-for-one with the tariffs – e.g. prices of imported steel jumped 22% and aluminum 8% versus pre-tariff trends. A Tax Foundation review of several studies concluded U.S. consumers and firms bore the brunt of the tariffs’ costs. In many cases there was almost full pass-through of tariffs into domestic prices. For example, a University of Chicago study found that after tariffs on washing machines were imposed, the retail price of laundry appliances climbed by about 12% (machines cost ~$86 more, and even dryers – not tariffed – rose ~$92 as sellers bundled products). That tariff raised about $82 million in government revenue but cost U.S. consumers roughly $1.5 billion – a stark illustration of consumers paying ~18 times more in higher prices than the government received in tariff revenue. The difference went partly to domestic producers (e.g. Whirlpool enjoyed higher profit margins) and largely was a deadweight loss to consumers. Across all affected imports, researchers Amiti et al. (2020) and Fajgelbaum et al. (2020) found nearly 100% of the import tax was passed to U.S. buyers – foreign exporters did not significantly cut prices.
Impacts on U.S. Industry: The protected industries saw mixed results. U.S. steel producers initially benefited – capacity utilization rose and profits improved thanks to higher prices. However, since domestic demand was not significantly higher and global overcapacity remained, the boost was temporary; some smaller steel mills did restart, but overall employment in steel barely grew. Meanwhile, steel-using industries (from auto manufacturing to construction) faced substantially higher input costs. Studies by the Peterson Institute and others estimated that far more jobs were lost in steel-using sectors than jobs gained in steel production – as much as 75,000 jobs lost in the larger economy versus perhaps 8,700 jobs created or saved in steel, according to one analysis (a common finding was that each steel job saved by tariffs cost hundreds of thousands of dollars in consumer costs). Similarly, tariffs on Chinese intermediate goods hit U.S. manufacturing firms that relied on those inputs, in some cases leading to higher production costs and suppressed job growth in those downstream industries. On the other hand, a few targeted sectors like domestic appliance manufacturing did expand employment modestly after tariffs shielded them from import competition – but at a very high cost per job. One calculation for the washing machine tariffs put the cost at over $800,000 per job saved, once you factor in price hikes to consumers.
Macroeconomic Effects: At the aggregate level, the tariffs of 2018–2019 were sizable enough to have measurable macro impacts, though not catastrophic. The Tax Foundation’s general equilibrium model estimated the Trump-era tariffs (and foreign retaliation) effectively reduced U.S. long-run GDP by about 0.2%, and cost around 142,000 full-time equivalent jobs, relative to a no-tariff baseline. Other studies similarly found a small drag on U.S. growth: for instance, IMF researchers, Furceri et al. (2019), found that increases in tariff rates tend to modestly lower GDP and raise unemployment over a few years. By 2019, manufacturing output and investment in the U.S. had slowed partly due to trade policy uncertainty and higher input costs. The tariffs also prompted efficient supply-chain reallocation: many importers shifted sourcing from China to other countries like Vietnam or Mexico to avoid tariffs. While this mitigated some direct costs, it introduced new inefficiencies (higher transport costs, suboptimal suppliers). As for inflation, Federal Reserve economists estimated the tariff measures contributed on the order of 0.3 percentage points to core inflation in 2018–2019 – noticeable but not the primary driver of inflation at the time (which was low overall). Once in place, the tariffs mainly resulted in a level shift in prices for affected goods rather than continuously accelerating inflation.
Trade Balances and Revenue: Tariff advocates hoped to reduce the U.S. trade deficit and bring back manufacturing. In reality, the overall trade deficit did not improve (it actually widened in 2018–2019, as strong U.S. growth pulled in imports and exports fell in retaliation-hit sectors). Tariff revenue did increase – the U.S. Treasury collected roughly $80 billion/year in customs duties during 2019–2020, up from around $35–40 billion pre-tariffs. However, this was still a small fraction of U.S. fiscal needs (tariffs went from ~1% to ~2% of federal revenue). Moreover, a large portion of the tariff revenue was spent offsetting losses to sectors hurt by retaliation (for example, over $28 billion was paid to farmers to compensate for export losses when China retaliated against U.S. agriculture). So, the net fiscal gain was minor.
Overall, the Trump-era case highlights the trade-offs of tariffs: they did provide relief and higher prices to certain industries (steel, appliances, solar panel makers, etc.), and perhaps bolstered those sectors in the short term. But the costs to consumers and other businesses were substantial, and economy-wide the tariffs functioned as an inefficient tax that likely dampened growth modestly. By 2021–2022, U.S. inflation spiked (for other reasons like supply shocks and monetary factors), and there were debates about whether removing the tariffs could help. The consensus from studies was that removing the remaining tariffs on Chinese goods could reduce CPI by about 0.2–0.3 percentage points – a small but non-trivial effect. As of 2024, most of those tariffs remain in place, and they continue to be a point of discussion in U.S. trade policy (weighing the geopolitical goals versus the economic costs).
Tariffs in Industrial Policy: Outside of China and the Asian Tigers
Many countries have used tariffs as part of their industrialization strategy. We examine a few notable examples outside what was previously mentioned:
Tariffs for Revenue in Developing Nations: In many poorer countries, more mundane use of tariffs has been simply to collect revenue. Countries with weak tax administration find tariffs easier to collect (at ports) than income or sales taxes. This is an economic rationale for tariffs, though not an efficiency gain, just practicality. High reliance on tariff revenue can impede growth by keeping trade costs high, but if the alternative is no revenue for public investment, there’s a short-term trade-off. Over time, most countries try to shift toward domestic taxes as institutions improve, because excessive tariff reliance has been linked with slower growth. For instance, numerous African countries reduced tariffs in the 2000s in favor of VATs and saw increased trade volumes. The Peterson Institute notes that today it is “mainly poor countries” that use tariffs as a major revenue source, while advanced economies have moved away from them.
Recent Protective Moves in Advanced Economies: It’s worth noting that even developed countries occasionally resort to tariffs in strategic contexts. The European Union in 2023 imposed tariffs on imports of Chinese electric vehicles, aiming to protect European auto manufacturers from a surge of cheaper EVs. This is a contemporary example of an infant industry argument – in this case, Europe trying to shield its EV industry (although Europe’s auto industry is not “infant,” its electric segment is in transition and feels vulnerable to Chinese competition). The debate there mirrors many points discussed: proponents argue it gives breathing room to EU manufacturers to innovate and scale up EV production; opponents worry it will raise car prices and invite retaliation (and that European consumers effectively subsidize automakers via higher prices). The outcome remains to be seen. Similarly, the U.S. in 2022 used tariffs and incentives under the Inflation Reduction Act to boost domestic renewable energy and battery industries, invoking both economic and security justifications (reducing dependence on China for critical clean-energy components). These cases show that the appeal of tariffs for strategic reasons persists, even in economies that generally favor free trade.
Summarizing the above analysis, a few empirical patterns emerge:
Tariffs almost always raise prices for consumers in the imposing country, with few exceptions. Foreign producers seldom lower their prices enough to offset a tariff, meaning domestic prices reflect the tax. This has been seen in the U.S.-China trade war, historical tariff episodes, and numerous product-specific studies.
The benefits of tariffs (jobs or profits saved in the protected industry) are typically concentrated and visible, while the costs (slightly higher prices for millions of consumers, diffuse job losses in other sectors) are spread out. This asymmetry often makes tariffs politically attractive despite net economic costs.
Tariffs can be effective in fostering domestic industries when carefully applied as part of a broader development strategy (as in East Asia). But without competition and sunset plans, they risk entrenching uncompetitive firms (as seen in some Latin American attempts). The success stories often involved export competition as the true test.
Modern global supply chains complicate the picture – tariffs on intermediate goods can boomerang and hurt a country’s own exporters. The 2018 U.S. tariffs showed how integrated the economy is: tariffs on Chinese components hurt American manufacturers, and retaliation hurt farmers. In a globalized economy, protection for one sector often means pain for another within the same country.
There is evidence that over the long run, more open economies tend to have higher productivity and growth, whereas economies with high tariff barriers tend to lag. For example, an IMF study (Furceri et al.) found that a tariff increase of 1 percentage point reduces output by about 0.4% after a few years on average. Conversely, episodes of trade liberalization (tariff cuts) are often linked to faster growth and lower prices (India’s 1991 reforms, China’s WTO entry, etc.). This doesn’t prove causation in every case, but it aligns with the view that the efficiency gains from free trade usually outweigh the loss of protection.
Conclusion
Tariffs are a double-edged sword in economic policy. On one side, they can provide short-term protection and a policy lever to nurture industries, retaliate against unfair trade, or achieve non-economic goals like national security. Historical and contemporary examples show that tariffs, used judiciously, have sometimes contributed to building competitive industries – particularly when coupled with broader industrial policies and when the protection is temporary. The infant industry argument and new trade theory demonstrate that under specific conditions (learning curves, scale economies, oligopolies), a tariff or subsidy can theoretically yield long-term national gains. These potential benefits make tariffs attractive to policymakers looking to develop certain sectors or to shelter domestic jobs from global competition.
On the other side, the economic costs of tariffs are well-documented. Tariffs act as a tax on consumers and importing firms, raising prices and creating deadweight losses as some mutually beneficial trade is foregone. They tend to be an inefficient way to raise revenue or protect jobs, often costing consumers many times the income saved in the protected industry. By distorting prices, tariffs can lead to resource misallocation, where society’s labor and capital produce things at higher cost domestically rather than sourcing them more cheaply. Over time, this can reduce productivity and growth. Tariffs can also provoke inflationary pressures in the short term (by pushing up prices of goods) and invite retaliation internationally, which may hurt exporters and global economic stability. Compared to broad-based taxes, tariffs usually impose a larger economic drag for each dollar of revenue raised, and their burdens fall disproportionately on certain consumers and downstream industries.
For the United States, which today is a relatively open economy, the consensus of economists is that recent tariff increases have hurt more than helped in net terms. Consumers and many businesses bore higher costs, while gains (like a brief revival in steel output) were limited and possibly unsustainable without ongoing protection. At the same time, the U.S. experience reminds us that policy objectives are not only about GDP – concerns about trade fairness, strategic supply chains, or political preferences have kept tariffs on the agenda. Going forward, the challenge for policymakers is to balance these considerations: using tariffs sparingly and strategically if at all, and prioritizing alternative measures (like direct subsidies for innovation, adjustment assistance for workers, or international agreements) to achieve similar ends with less economic distortion.
In conclusion, tariffs come with significant economic costs in efficiency and higher prices, which generally outweigh their benefits for mature economies under most circumstances. However, in certain contexts – developing new industries, addressing strategic needs, or bargaining in trade negotiations – tariffs can play a role if implemented carefully and temporarily. An unbiased look at theory and evidence suggests that while tariffs can protect and even create specific jobs or industries in the short run, the long-run prosperity of an economy is better served by open competition complemented by smart industrial policies rather than by permanent tariff barriers. As history and empirical studies show, nations that have prospered tend to use tariffs as a targeted tool rather than a broad policy platform, mindful of the delicate trade-offs involved.
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