Nate Bruce, Farm Business Management Specialist, nsbruce@udel.edu
Renewed discussion on tariffs in the news has picked up recently with the November elections around the corner. A mainstay of the trade war with China is the implementation of tariffs on imports by both governments. Reciprocal tariffs have become common place and many different products have become impacted, including agricultural commodities. These tariffs have shifted international trade significantly in the last five years with the flow of agricultural commodities being heavily impacted. This article will discuss why tariffs are used, how tariffs work, and how they impact prices on commodities.
In the simplest terms, a tariff is essentially a protectionist trade policy used to raise the price of imported products compared to domestically produced products. Tariffs are paid to a customs agency as a tax on an imported product. A major misconception on tariffs is that the tax is paid by a foreign originator. Instead, it is the domestic user that is responsible for the tax. With that being said, a tariffs sole purpose is to raise the price of the foreign product for consumers, relative to the domestically produced product. Foreign products can be cheaper to produce due to differences in production costs. A tariff’s main purpose is to make these products more expensive for domestic consumers to force them into purchasing the domestic product or a foreign product from a different country originator.
There are several reasons why a tariff may be implemented on imports. A government may decide to enact a tariff on imports to protect local consumers. For example, Mexico may place a tariff on American grain imports if they feel genetically modified commodities are dangerous for human consumption. A government may introduce a tariff on imported goods to protect industries in the best interest of preserving national security. Tariffs can also be used to retaliate against trade partners as a response to perceived unfair trading practices. Retaliatory tariffs have become a common mainstay of the trade war with China. Tariffs can also be used to protect industries that have not reached their full potential yet. This strategy is used by governments to foster growth in sectors that they wish to advance. For example, during Japan’s economic growth post World War Two, Japan enacted tariffs on American imported automobiles to expand that sector into what we now see today.
Tariffs increase the price paid for a product by domestic producers. In a perfect open trade economy, the price paid by consumers is the point where the supply and demand curve intersect. This can be seen in the chart below. Below is the graphical representation of how price is determined if a product is imported under free trade. The red line is domestic demand (DD). The blue line is domestic supply (DS). The price of goods at home is the equilibrium between domestic demand (DD) and domestic supply (DS) and is given as price P. The world price of the product is P* where the light blue world supply (WS) curve intersects both domestic demand (DD) and domestic supply (DS). For consumers to be able to purchase the product at a lower price, the country must import Qd – Qw worth of product. Qd represents the quantity that domestic production can produce while Qw represents the quantity needed to be imported from the world.
If tariffs are introduced, the price of the product will increase. Below is a graphical representation of how the price of the product increases as a result of implementing tariffs. P* is the original price of the product while P1 is the price after the implementation of the tariff. Imports decrease as a result of the tariff, decreasing Qw imports. With less competition from imports, domestic producers are willing to produce more of the product, increasing Qd.
Chinese tariffs heavily impacted American agricultural imports. A USDA study found that Chinese tariffs on American agricultural imports from mid-2018 to the end of 2019 resulted in a $27 billion agricultural loss with soybeans making up 71% of the total loss. Below is a pie chart that shows the agricultural exports to China that were most impacted by retaliatory tariffs. These tariffs ultimately have resulted in Chinese importers ramping up purchases of Brazilian soybeans due to them being cheaper to import. Increased commodity exports to China resulted in one of the largest expansions in grain prices, in addition to expansion in ethanol. Tariffs have ultimately had a negative impact on domestic grain prices for producers.
