Repeat after me: tariffs primarily hurt domestic consumers – not foreign exporters
Both the Remainers who want us to stay within the EU’s protectionist customs union, as well as Brexiteers who advocate using tariffs to “punish” the EU in the event that it turns down tariff-free trade arrangements, seem to completely misunderstand this crucial point.
Consider a report from Civitas released last week, written up by its pro-Brexit director David Green for another publication. He purports to show that the UK is in a position of huge strength in seeking a free trade deal with the EU. Why? “If we leave the EU without a trade agreement,” he says, “it will cost the remaining EU members £12.9bn in tariffs whereas it will cost us only £5.2bn”. No. The implicit assumption here is that the cost of tariffs is borne by exporter producers rather than our domestic consumers.
Now, it is indeed in the interest of both the UK and the EU to maintain tariff-free trade, which is mutually beneficial. But in economic terms the result of no tariff-free deal being reached is almost exactly the reverse of what Green believes in terms of the country effects.
In the short term, it would be extremely inconvenient for UK and EU producers to find tariffs applied to their goods, affecting demand patterns. But producers can ultimately sell their goods elsewhere and, if they cannot, post-tariff prices will almost certainly rise. Consumers, on the other hand, cannot avoid tariffs.
As tariffs raise prices, the consumer is forced to either buy less of this good or less of some other good. The price increase can be thought of as a reduction in consumer income and choice – it hurts the economy negatively twice: through raising consumer prices directly and insulating domestic firms from competition that enhances innovation and productivity.
The £12.9bn figure Green cites, then, far from showing the cost “to the EU” of us imposing tariffs, shows the huge cost the UK government would impose on its own domestic consumers were it to be stupid enough to participate in tit-for-tat protectionism.
Once one realises this, one sees that the best response in enhancing overall economic welfare to new tariffs imposed by the EU would be to do…nothing. In fact, although the first best economic outcome would be to maintain tariff-free trade with the EU while using exit from the customs union to embrace unilateral free trade with the rest of the world, facing EU tariffs on our exported goods is not a good reason to adopt a tariff structure ourselves in return. This is why the Economists for Brexit group, of which I am a member, has suggested that Britain should adopt unilateral free trade irrespective of whether it obtains a tariff-free trade agreement with the EU.
Understanding this essential point about who suffers most from protectionism means that you see the futility of many other suggestions too. Many Brexiteers suggest we should seek to compensate exporters whose products might face EU tariffs with subsidies or tax breaks to leave their trading positions unchanged overall.
This is not quite as economically illiterate as the above analysis – in theory export subsidies could be used to correct for trade-distorting tariff structures around the world. We could have our all-knowing government calculate the response of demand and supply to tariffs imposed worldwide, and perfectly correct for a “second best” world.
In reality, markets are extraordinarily dynamic, governments lack the knowledge for this sort of policy, and export subsidies just become another form of protectionism. There will be observable benefits to producers in receipt of them, but consumers overall would be negatively affected. It would also prevent some of the biggest potential economic gains from leaving the EU from being realised – the improved productiveness of the economy which comes from trading goods and services facing global competition at world prices.
The essential take-away is this: the costs from protectionism almost always exceed any benefits – and the costs are overwhelmingly borne by consumers. While exporting industries will put pressure on governments in both the UK and EU to maintain free trade (and hooray for these groups arguing for the right policy albeit for the wrong reasons), a failure to put the consumer at the heart of trade thinking risks legitimising tit-for-tat protectionism through tariffs and subsidies should these negotiations fail.
This article was first published in City AM.