Econ 101 is wrong about tariffs - by Brian Albrecht

I’ve taught thousands of economics students the introductory model of tariffs: a tariff on washing machines raises their price, harming households, but benefiting U.S. manufacturers. The households’ loss is larger, so the tariff ends up destroying wealth for the country. This conclusion makes economists unpopular with many politicians.

Recent research has convinced me that the Econ 101 story is generally too simple to apply in a modern economy. Pro-tariff politicians are right about that. But they have the direction wrong: tariffs are even worse than the textbook model suggests.

It’s usually not the main takeaway, but there is an upside to tariffs in the basic model; tariffs benefit domestic manufacturers. The standard trade model taught in Econ 101 is shown below. It’s supply and demand, but where the usual sloped curves are only the domestic supply and demand. On to that, we add a world supply curve that is horizontal at the price P_world. With the tariff, the price is bumped up to P_tariff.

By shielding domestic producers from foreign competition, tariffs allow these producers to charge higher prices and give them a new opportunity to expand production. The yellow region of producer surplus grows. That’s why companies facing import competition will lobby for trade barriers. For some people (and this is a normative argument, not a positive economic argument), the benefit to domestic producers and their employees is worth more than the harm to consumers; there’s a redistributive reason for the tariff. 

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