GK: Terms: TARIFF | TRADE WARS | FREE TRADE (ECONOMY)

The Trump administration last week announced a 25% tariff on steel imports and 10% on aluminum. Canada and Mexico, the top two overseas suppliers of the metals to the US, were exempt. The European Commission reacted with outrage, which included implied threats of a retaliatory trade war.

Tariff: Tariffs are used to restrict imports by increasing the price of goods and services purchased from overseas and making them less attractive to consumers. A specific tariff is levied as a fixed fee based on the type of item, for example, $1,000 on any car. An ad-valorem tariff is levied based on the item's value, for example, 10% of the car's value.

Governments may impose tariffs to raise revenue or to protect domestic industries – particularly nascent ones – from foreign competition. By making foreign-produced goods more expensive, tariffs can make domestic-produced ones more attractive. By protecting these industries, governments can also protect jobs. Tariffs can also be used as an extension of foreign policy: imposing tariffs on a trading partner's main exports is a way to exert economic leverage.

Tariffs can have unintended side-effects, however. They can make domestic industries less efficient by reducing competition. They can hurt domestic consumers, since a lack of competition tends to push up prices. They can generate tensions by favoring certain industries over others, as well as certain regions over others: tariffs designed to benefit manufacturers in cities may hurt consumers in rural areas, who do not benefit from the policy and are likely to pay more for manufactured goods. Finally, an attempt to pressure a rival country using tariffs can devolve into an unproductive cycle of retaliation, known as a trade war.

Trade Wars: A negative side effect of protectionism that occurs when Country A raises tariffs on Country B's imports in retaliation for Country B raising tarrifs on Country A's imports. Trade wars may be instigated when one country perceives another country's trading practices to be unfair or when domestic trade unions pressure politicians to make imported goods less attractive to consumers. Trade wars are also a result of a misunderstanding of the widespread benefits of free trade.

Free Trade: Free trade is a policy to eliminate discrimination against imports and exports. Buyers and sellers from different economies may voluntarily trade without a government applying tariffs, quotas, subsidies or prohibitions on goods and services. Free trade is the opposite of trade protectionism or economic isolationism. Politically, free trade policy may simply be the absence of any trade policies; a government need not do anything to promote free trade. This is referred to as “laissez-faire trade” or “trade liberalization.”

In a free trade regime, both economies can experience faster growth rates. This is no different than voluntary trade between neighbors, towns or states. Free trade enables companies to concentrate on manufacturing goods and services where they have a distinct comparative advantage, a benefit widely popularized by economist David Ricardo. By expanding the economy’s diversity of products, knowledge and skills, free trade also encourages specialization and the division of labor.

Credit: Investopedia