The inclusion of cuts in the UK’s announcement of No-Deal Tariffs sent headline writers scrabbling up idiot mountain, each racing to beat the next and plant a flag at peak idiocy by claiming prices were going to plummet or skyrocket.
They were able to get away with it for two reasons.
First, modern media is a hellscape dredged from ideas discarded by Dante as being too horrific for his Inferno.
Second, because the interaction between tariffs and consumer prices is complex and not something the general public has had much reason to consider in the past.
In this blog, I’m going to walk you through what tariffs are, who pays them, and why cutting a 10% tariff doesn’t mean you as a consumer are going to see a 10% cut on your shopping bill.
So, what are tariffs then?
Tariffs are taxes governments charge their citizens and firms when they want to purchase certain products internationally.
Unlike most taxes, which governments levy primarily to afford more aircraft carriers, the objective of tariffs is to try and change behavior. Through tariffs governments are trying to steer buyers toward products made domestically.
Fair enough, I’d sell my sister for a cheap blender. How do tariffs work?
Each government maintains a list of product categories which we nerds call “tariff lines.” Each of these ‘lines’ has a tariff level associated with it.
In the same way all conceivable aid projects can fit under one of the Sustainable Development Goals, every product on earth should fit under a tariff line (those of you who don’t work in international development will just have to take my word for how sick a burn that was).
Like the production of Romeo and Juliet I tried to put in on high-school without actually reading the play, moving something across a border involves three key protagonists:
The exporter who owns the good and wants to sell it abroad;
The importer who wants the good but lives in another country; and
A customs broker, who helps them sort out the paperwork and legalities to make it all happen.
As part of the process, the exporter issues an invoice to the importer for the goods being moved. This invoice includes the price.
The customs broker takes the invoice and looks up the correct tariff line for each product being moved and applies the tariff to the price. This is what the importer then has to pay to their government. In 98% of cases, the tariff will be a simple percentage of the invoiced price. This is what we used to call an ‘Ad Valorem’ tariff before Jacob Rees-Mogg made Latin feel dirty.
But if tariffs are just a percentage of the price, cutting them should reduce prices!
In theory yes, but in practice a tariff cut may never make it to your bill. This is because of the point of a product’s journey at which tariffs are calculated and charged.
The best way to understand this is a comparison with a sales tax (known as VAT in the UK and GST in Australia).
In the UK the standard VAT rate is 20%. To factor in VAT when selling you something shops take the price they were planning to sell it for and multiply by 1.2.
Therefore if you cut the VAT by 10%, shops really have no excuse but to drop prices to only 110% of what they’d charge without a tax. To quote a meerkat, and inexplicably, the Prime Minister of the world’s 5th largest economy, “Simples.”
So how come tariffs don’t work the same way?
Because as a consumer you’re very rarely the importer yourself and you’re often not purchasing what was imported.
The journey of a product to your shopping basket consists of many individual steps. Each of these steps ‘adds value’ atop the previous one.
The steak you buy at the supermarket started life as a cow, then became a carcass, which was then tested, graded, butchered into cuts, packaged, potentially matured, and finally sold to you by a store. Between each of these points it had to be transported, stored and kept safe from bears.
Every one of those steps costs money and the final price of your supermarket steak is an amalgamation of all them, including profits for everyone involved.
However, a tariff is charged on the value of the product in the state it’s in when it enters the country, not at the very end (like VAT). In a lot of cases, that means the tariff is being charged on a much smaller value.
If a steak at the supermarket costs $22/kg, you’d expect a 10% tariff reduction to drop the price to $20. But the meat (in the state it was in) may have only cost the importer $5.5 when it entered the country, so a 10% tariff reduction will (at best) only shave 50 cents off the price.
Ok, that all makes sense. Can I go now?
Not even close.
Because not all the goods on your supermarket shelf covered by the tariff you’re cutting actually paid it. In fact, many may not have.
There are three reasons:
The goods were produced domestically;
The goods were imported from a country which has a Free Trade Agreement or Customs Union with your country which eliminated the relevant tariff;
The goods were imported from a developing country to which your country unilaterally granted ‘preferences’ (reduced/eliminated tariffs) which included the relevant tariff.
There’s also smuggling I guess, but no one would be crazy enough to effectively legalize that on a scale sufficient to impact supermarket prices…
Sure, but there might still be cheaper products available elsewhere, right?
But think about it in terms of numbers. Let’s say you’re eliminating a 10% tariff.
For that tariff to have been effective at keeping out substantial volumes of foreign goods, those goods couldn’t have been more than 10% better value than domestic, FTA or preferential ones. Otherwise, the tariff wouldn’t have been enough, right?
So let’s say a porcupine from a non-FTA source previously subject to the tariff cost $100 ($110, with a 10% tariff), one of the UK’s FTA partners can sell the UK that porcupine for $104 and the UK produces $108 porcupines.
Eliminating the tariff would make the non-FTA porcupines cost competitive, likely at a price between $100 and $103. This amounts to only a net saving of 1-4% compared to the FTA partner (and as discussed above, likely to be highly diluted by further porcupine processing and retail markup).
By comparison, the GBP has fluctuated far more than 1-4% since the 2016 referendum.
So, are tariff cuts pointless then?
No, absolutely not.
As a Neoliberal Shill (tm) I believe tariffs aren’t optimal taxes and countries like Australia, New Zealand and Singapore are on the right track when they work toward gradually eliminating them.
Introducing tariffs where there weren’t any before is also a pretty harmful thing to do in most cases, especially when you do it on intermediate goods (like car parts) and inputs for industry like steel or aluminum (where the tariff is charged on the full price and you effectively make your own producers less competitive).
However, because I’m not a libertarian fanatic or paid by the Koch brothers (Yet. Call me Charles and David. I’m super mercenary and can definitely be bought), I can also be honest about how much difference a tariff cut is likely to make to your weekly shop.
In most cases, far less than you would expect.
I hope you enjoyed this article and found it useful.
If your organisation would be interested in compact, interactive and what-you-actually-need-to-know training on trade, negotiations and more, please take a look at the training ExplainTrade.com offers. We deliver tailored courses for students, government officials or private sector firms.
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