'Tariffs do more harm than good'

A long-standing challenge for the global economy is the possibility that some countries compete for export markets through artificially low prices. But punitive tariffs, if carried out, cause wider economic damage at home, says an International Monetary Fund (IMF) economist.

"Those who promote 'getting tough' with foreign trade partners through punitive tariffs should think carefully. It may be emotionally gratifying. It may boost specific industries. The threat may even frighten trade partners into changing their policies; but, ultimately, if carried out, such policies cause wider economic damage at home," Maurice Obstfeld, Economic Counsellor and Director of Research, IMF wrote on an official blog on Thursday.

"Political leaders and pundits sometimes propose import tariffs to offset the supposed price advantages and exert pressure for policy changes abroad. What proponents often fail to realise is that such tariff policies, while certainly hurting their targets, can also be very costly at home," Obstfeld said.

"And surprisingly, the self-inflicted harm can be substantial even when trade partners do not retaliate with tariffs of their own," Obstfeld noted.

The World Trade Organisation's (WTO) agreement on subsidies and countervailing measures allows a country unilaterally to apply a countervailing duty on imports of a good whose production has been subsidised.

Other policies that do not clearly fall under the strict WTO definition of a subsidy, including currency undervaluation and accompanying macroeconomic distortions, could also have a net effect of pushing export prices down, leading trade partners to cry foul, he said.

"Whatever the reason, political discourse perennially focuses on unilateral national action to 'get tough' with trade partners whose export prices are perceived to be artificially low," he added.

Countervailing protection may induce trade partners to impose retaliatory tariffs, possibly setting off mutually destructive trade wars, the economist said.

There is another big drawback of such tariffs: While they may give some relief to industries and workers that directly compete with the affected imports, they will be broadly contractionary, reducing output, investment, and employment in the whole economy.

"These negative effects follow even if trade partners do not retaliate, although if they did, the outcome would be even worse," he said.

This prediction may seem surprising: After all, by shifting demand toward domestically-produced goods and raising the prices of competing imports, wouldn't a tariff both raise output and employment and deliver welcome upward pressure on inflation?

The answer is "no" was pointed out more than a half century ago by Robert Mundell, winner of the 1999 Nobel Memorial Prize in Economic Sciences (and, incidentally, a staff member in the IMF's Research Department during the early 1960s).

Mundell perceived the key reason why a tariff could have these negative aggregate effects. By promising to improve the importer country's underlying balance of payments position, it causes the domestic currency to strengthen in the foreign exchange market, possibly reducing Gross Domestic Product (GDP) and employment (and in that case, worsening the trade deficit in the end).

"The effects will be harsher when the home country's central bank policy interest rate is at or near zero- a circumstance Mundell did not consider," Obstfeld said.

"In that case, the central bank is more constrained in using monetary policy to offset the tariff's contractionary effect," Obstfeld added.

--IANS

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