Tariffs are essentially taxes or duties placed on an imported good or service by a domestic government, making domestic goods cheaper for domestic consumers and imported goods more expensive for companies exporting goods from their industry into the domestic industry.

Tariffs are normally levied by a domestic government as a percentage of the declared value of the good or service and act similar to a sales tax. Unlike sales tax, however, tariff rates often vary depending on the good or service and do not apply to domestic goods, only imports coming into the domestic industry.

When high tariffs are levied by a domestic government, it reduces the imports of a given product or service because the high tariff leads to a higher price for the domestic consumer and a higher import cost for foreign suppliers or producers. Tariffs are also used to create favorable trading conditions between certain countries, while hampering the trading conditions of other countries.

There are two general types of tariffs levied by domestic governments: ad valorem tax and a specific tariff. Ad valorem tax is a percentage of the value of the good or service, while a specific tariff is a tax based on a set fee per number of items or weight of the items.

Tariffs are usually levied by domestic governments to protect new industries against foreign competition, to protect aging industries against foreign competition, to protect against foreign companies offering their products for a price lower than their costs and to raise revenue.

Do Tariffs Protect Infant Industries?

Many development policy analysts and industry-specific advocates argue it's sometimes necessary to implement import tariffs to protect infant domestic industries from foreign competitors. This argument has existed for centuries: Adam Smith, for example, directly advocated for it in The Wealth of Nations, but in practice, infant industry techniques have a poor track record. There are many possible explanations for this, some economic and some political.

The infant industry argument does not extend to all types of producers. Industries requiring high economic capital have the most apparent need for state protection from foreign competition. This is because manufacturing and technological production is important to building long-term economic growth, yet establishing these types of firms is both risky and time consuming.

Even though it likely results in forcing local consumers to pay a higher price for domestic goods, proponents of this theory suggest that the initial disadvantages are outweighed by future gains. However, potential success stories are few and far between. Economists disagree about the importance of tariffs in developing markets in the United States, Germany and Japan during their respective industrialization periods. Similar tariffs have been tried for key industries in India, Malaysia, Indonesia, Singapore and Hong Kong with very poor results.

One common criticism is that protectionism only works if the domestic firms are well-run and if other government laws allow for sustained growth. Companies still require access to capital and competitive tax rates. Additionally, other countries may respond by instituting their own sanctions. Others have theorized that development only occurs where there are gains from trade and that tariffs distort trade, investment and consumption too much for those gains to be realized.

(For more, see: The Basics of Tariffs and Trade Barriers.)

  1. The risks businesses face in international finance

    When an organization engages in international financing activities, it takes on additional risk, including foreign exchange ... Read Answer >>
  2. How does comparative advantage render protectionism unnecessary?

    Find out how economic theory can debunk protectionist policies in international trade and how comparative advantage demonstrates ... Read Answer >>
  3. How is comparative advantage used as a justification for free trade policies?

    See why comparative advantage leads to the advocacy of free trade policies between international actors and why rent-seeking ... Read Answer >>
  4. What is a trade deficit and what effect will it have on the stock market?

    A trade deficit, which is also referred to as net exports, is an economic condition that occurs when a country is importing ... Read Answer >>
  5. What impact does the balance of trade have on GDP calculations?

    Read about the impact of the balance of trade on a nation's gross domestic product, and why each of these figures can be ... Read Answer >>
  6. Which factors can influence a country's balance of trade?

    Find out about the factors that affect a country's overall balance of trade and how it is used as an economic indicator. Read Answer >>
Related Articles
  1. Investing

    E*TRADE: With Tariffs Official, Best to Take a Wait-and-See Approach

    With tariff proposals now signed by President Donald Trump, investors are best served taking a wait-and-see approach, advised E*TRADE.
  2. Investing

    Charles Schwab: Investors Should Have Global Exposure Despite Tariffs

    Despite the new tariffs, Charles Schwab said that everyone should have international stocks in their portfolio.
  3. Investing

    U.S. Steel Poised for Breakout, Tariff or No Tariff: E*TRADE

    Whether or not President Trump's steel tariff proposal is enacted, E*TRADE sees room for growth in U.S. Steel shares.
  4. Investing

    Which Stocks Will Win or Lose From Steel, Aluminum Tariffs?

    Here is a list of stocks that will win or lose from the recently announced steel and aluminum import tariffs
  5. Investing

    Vanguard's Davis: Tariffs Will Be a Non-Event

    Vanguard isn't concerned about the new tariffs, saying that the policy will have little impact on the economy.
  6. Insights

    Trump's Steel and Aluminum Tariffs: What You Need to Know

    A look at key issues regarding the latest import tariffs on steel and aluminium announced by President Trump
  7. Investing

    Charles Schwab: Trade Issues to Create Bouts of Market Volatility

    Charles Schwab said that the tariffs proposed by President Trump will create bouts of volatility.
  8. Insights

    Why Deficits Are Flawed Measures of Unfair Trade

    Trump’s obsession with erasing the $500B U.S. trade deficit is flawed economics, experts say.
  9. Investing

    Ford Shares Jump on Morgan Stanley Double Upgrade

    Ford's stock is gaining in pre-market action after Morgan Stanley upgraded the car maker to overweight.
  1. Multiple Column Tariff

    A tariff system where the tariff rate or import tax assessed ...
  2. Protectionism

    Protectionism refers to government actions and policies that ...
  3. Smoot-Hawley Tariff Act

    The Smoot-Hawley Tariff Act, known formally as the United States ...
  4. Customs Barrier

    Any measure designed to limit international trade. A customs ...
  5. Import Duty

    Import duty is a tax collected on imports and some exports by ...
  6. Infant-Industry Theory

    The infant-industry theory argues that emerging domestic industries ...
Trading Center