Tariffs: how they work and their real impact
In this week’s video insight, I discuss tariffs; what they are, how they work, and their broader impact. While much attention is on recent geopolitical theatrics, tariffs are reshaping trade and markets. Rather than speculating on their effects, I break down their mechanics, from taxation, to supply chains and consumer prices.
Transcript:
Hi, I’m Roger Montgomery and welcome to this week’s video insight. Notwithstanding the embarrassing and globally condemned display of attempted psyops, obvious ignorance, gaslighting and grifting/extortion towards Ukrainian President Volodymyr Zelensky at the White House, the next most talked about subject is tariffs.
What might be useful, however, is not yet another discussion about what they might mean for markets, but instead an explanation of what they are and how they work.
Tariffs are taxes governments impose on goods and services that are either imported into or exported out of a country. They’re typically applied to regulate international trade, protect domestic industries, or generate revenue.
A tariff is essentially a financial penalty – or sometimes an incentive mechanism – slapped onto the price of goods crossing borders. For example, if a country puts a 10 per cent tariff on imported steel, a $100 shipment of steel from abroad becomes $110 at the border.
A Fixed tariff is a set amount per unit (e.g., $5 per ton of wheat).
An ad valorem tariff is a percentage of the goods’ value (e.g., 10 per cent of the price).
More commonly, governments collect this tax from the importer, but sometimes it may be collected from the exporter.
When a tariff is imposed, it’s enforced at the point of entry – like a customs checkpoint. Importers (typically) pay the tariff to the government, and that cost is often passed down the supply chain.
Step one is the importer paying the extra amount to clear customs. Then, to cover the tariff, the importer might raise the price of the goods for wholesalers, retailers, or consumers.
As is often the intent, the consequent higher prices may shift demand as customers buy less of the imported goods and turn to domestic alternatives.
Governments typically set tariffs based on policy goals, trade agreements, or political pressure. For instance, the U.S. might slap tariffs on Chinese electronics to push companies to manufacture locally – as we are now seeing with Apple (NASDAQ:AAPL) committing to the construction of a manufacturing plant on U.S. soil.
One of the obvious, first-order consequences is higher prices for consumers: If a $50 imported shirt now carries a $10 tariff, consumers are paying $60 for that shirt.
Less obvious perhaps, is that the revenue from the tariff, making its way into public coffers. In 2022, U.S. customs collected about US$100 billion from tariffs.
Tariffs are often designed to protect local industries. For example, Australia’s luxury car tax was pitched to protect local manufacturing of Ford and Holden vehicles. Tariffs can help alleviate competition from cheaper foreign goods, giving local manufacturers room to grow, become more efficient and survive, but as the demise of Australian car manufacturing revealed, tariffs are not a cure all.
When tariffs discourage imports, they have the potential to narrow a trade deficit, which otherwise occurs when a country imports more than it exports.
In addition to direct consequences, a less obvious one is revealed when companies have to scramble to find domestic suppliers that don’t exist, or relocate production, which can take time and a lot of money.
The U.S. tariffs on Chinese goods imposed since 2018 have pushed some manufacturers to Vietnam or Mexico. Thus, tariffs may not have the desired effect of bringing manufacturing onshore.
Another significant second-order consequence is retaliation. The countries aggrieved by tariffs on their exports can hit back with their own tariffs. When the U.S. raised tariffs on European steel in 2018, the EU responded with tariffs on American whiskey and motorcycles. And it had an affect, in 2018, Harley-Davidson’s Europe sales were US$46.6 billion. At the end of 2019, sales had fallen by US$2 billion to US$44 billion.
Another consequence for the imposer of tariffs is the nudging of overall prices higher. Economists estimate first-term Trump-era tariffs added about 0.2 per cent to U.S. inflation.
Moreover, tariffs can spark trade wars, and sour diplomatic ties. The U.S.-China trade spat since 2018 is a textbook case – both sides dug in, and global supply chains took a hit.
A popular real-world example is the U.S. tariffs on washing machines from 2018. A 20-50 per cent tariff was slapped on imports to shield American manufacturers like Whirlpool. The direct result was that import prices jumped, and Whirlpool gained market share. The indirect cost, according to a University of Chicago study was that consumers paid US$1.5 billion more for washers and dryers over a couple of years, jobs didn’t increase as much as hoped, and production costs rose too.
Tariffs are a blunt tool. They can prop up local jobs in one sector (say, steel) but screw over others (like auto manufacturing, which relies on cheap imported steel). They’re also a gamble – protection might save an industry, or it might just make it lazy and less competitive long-term.
Economists argue over them endlessly. Free-trade fans say tariffs distort markets and hurt efficiency. Protectionists say they’re vital for sovereignty and jobs. The data’s mixed: tariffs can boost specific sectors in the short-term, but the broader economy often pays a higher, hidden cost in higher prices and lost trade opportunities. And I suspect that’s what the stock market is betting on right now.
That’s all we have time for, I look forward to seeing you next week. Please continue to follow us on facebook and twitter.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
