A Trade “Level Playing Field” Isn’t So Great
By Thomas Firey
China’s tariffs on imports are more than double the United States’ (calculated on a weighted-average basis). Critics of open trade cite this disparity and similar ones with other nations to justify America’s current trade wars. America should have a level playing field, they say.
By this, they seem to mean that the U.S. government should apply the same tariffs to other countries’ imports that those countries apply to U.S. exports. But a level playing field can be very, very bad because the gain to domestic producers from raising tariffs is more than offset by the loss to domestic consumers.
To better understand this, we need to think about supply and demand curves. If you took Econ 101, you likely remember the graph showing how a transaction tax reduces both producer and consumer surpluses by discouraging some transactions—a deadweight loss. The tax also reduces harms exchanges that do take place because some of the consumer and producer surpluses are transferred to the government.
Analyzing a tariff is more complicated because the tax affects only imports. To understand it, first consider what happens when a country opens itself to competitive world trade. The blue curves in the figure below show the equilibrium when there are only domestic supply and demand, resulting in price p (domestic only) and quantity demanded Q (domestic only). However, when the market opens to world supply (the green curve), a new equilibrium results. The price shifts to p (free trade) and the resulting quantity demanded at that price shifts to Q (free trade-world). At the new, lower price, domestic production can only provide Qs (free trade-domestic) while imports provide the rest.
Domestic suppliers’ dislike of the opening of their home markets is understandable: it reduces both the quantity they sell and the price they receive. As a result, these producers’ surplus shrinks from region A + B to just A. But consumers gain immensely from trade; they receive the transfer of domestic producer surplus B along with new surpluses C and D.
The next figure shows what happens when the country introduces a tariff. The equilibrium price rises from p (free trade) to p (tariff), with the difference between them equaling the tax. Domestic producers increase the quantity they sell in their home market to Qs (tariff-domestic). Imports make up the balance of the quantity demanded, Qs (tariff-world_, but that amount is much less than it was under the free-trade equilibrium.
As a result of the tariff, consumer surplus falls significantly. Region A is transferred to domestic producers. Region C is transferred to the government in the form of tax revenue. Region D is a deadweight loss of would-be truck sales that are forgone because of the higher price. Region B is also a deadweight loss resulting from resources in the domestic economy shifting from higher-valued industries to production of the tariffed good.
For a real-world example of this, consider the U.S. “Chicken Tax,” a 25% tariff on light trucks. It was imposed as part of a 1960s trade war over European barriers to U.S.-produced chicken (hence the name). The chicken barriers ended long ago but the light truck tariff remains in place today (though most SUVs have been exempted from it since 1989) and it applies to countries like Japan and South Korea that weren’t even involved in the 1960s trade war.
If you’ve shopped for a pickup, you’ve seen the effect of the Chicken Tax: prices are high and competition is limited because few imported pickups are on the market. As a result of the tax, some would-be American consumers forgo buying a truck—the deadweight loss. Others do buy a truck but have reduced consumer surplus because of the higher price.
Tariffs often have punitive intent (especially in a trade war) and thus are set very high. That means the resulting price increase is large, as is the deadweight loss and the decrease in consumer surplus. Hence, consumers want low, and preferably no, tariffs. It’s far better for consumers—and perhaps exporting producers—if tariffs in trading countries are low and uneven rather than higher but even.
Back in 1992, the weighted-average Chinese tariff was 32% while the weighted average U.S. tariff was 4%. As of 2016, those tariffs had fallen to 3.5% and 1.7%, respectively. So yes, China’s tariffs are more than double the United States’. But that is far better than the countries having a level playing field of tariffs of 10%, or 20%, or 32%.
Thomas A. Firey is a Cato Institute senior fellow and managing editor of Cato’s journal Regulation.