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Do tariffs boost output?

Discuss whether or not imposing tariffs on imports will increase a country’s output.

Category:

International Trade and Exchange Rates

CIE October/November 2023.

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Answer

Introduction

The imposition of tariffs has always been a widely discussed topic among economists. Tariffs are taxes or duties placed on imports, leading to increased prices of imported goods. The primary aim is to protect domestic firms and industries from inexpensive foreign substitutes. Nevertheless, the efficacy of tariffs in increasing a country's output remains a subject of debate. This essay seeks to shed light on the reasons for believing tariffs could enhance productivity, and why this notion might be questioned.

Theories Supporting Tariff Imposition

Imposing tariffs increases the price of imports, potentially leading to a decline in the demand for imported goods. As a consequence, consumers may shift their purchasing choices towards domestic products, culminating in increased demands for domestically produced items.

This demand surge can stimulate the country's industries to produce more goods and services, thereby resulting in a rise in domestic output. Subsequently, net exports (exports-imports) may increase owing to reduced imports, lifting total demand and output.

Another argument for imposing tariffs is that the revenue generated from these taxes can be used by the government to subsidise domestic goods. This can make domestically produced goods relatively more accessible and stimulate economic activity within the country, leading to an increase in output.

Limitations and Challenges with Tariff Implication

On the flip side, imposing tariffs might not effectively increase output because even with additional taxes, imported goods may continue to be cheaper than local alternatives owing to efficient production processes or lower costs in the foreign country. In such scenarios, demand for imported goods may not significantly decrease.

In some situations, there might be no locally produced substitutes for particular imports, meaning consumers are forced to endure the higher costs rather than switching to domestic alternatives. As a result, demand for those goods (both imported and locally produced) may fall, negatively impacting the country's output.

Additionally, imposing tariffs might inadvertently escalate production costs, especially if duties are levied on imported raw materials and capital goods, which are frequently integral to domestic manufacturing processes. This scenario can result in decreased production and, consequently, lower output.

One more substantial caveat associated with tariffs is the risk of retaliation from trading partners. Other countries may respond to tariff imposition by erecting trade barriers of their own, resulting in an increase in the cost of exports and depletion of demand for the country's goods in the international market. Consequently, this can lead to a decrease in export volumes and a reduction in national output.

Conclusion

In assessing whether tariffs lead to increased national output, the conflicting dynamics at play must be carefully reviewed. While the imposition of tariffs has the potential to spur local industries by reducing competitive pressures from imports, various scenarios might constrain or even counteract these positive effects. Finally, the broader impact on international trade relations and domestic cost structures must also be considered, as tariffs can ignite trade wars and might inadvertently inflate production costs.

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