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March 26, 2018 at 10:07 AM
Recent tariff talks have spooked the financial markets, sending stock prices lower. In this post, we’ll look at how tariffs work, why they exist, what has happened recently, and what we might expect in the near term.
How They Work and Why They Exist
Tariffs are a tax added to the price of goods. To explain, let’s assume a U.S.-based company manufactures refrigerators and sells them for $1,000. If a Chinese-based company can produce refrigerators with the same quality and features at a lower cost, and sell them in the U.S. market for $800, the Chinese company should capture a larger share of the market. This would cause the U.S. company to lose sales and perhaps reduce its workforce.
To combat this, the U.S. government could impose a 25% tariff on refrigerators imported from China. This would make the price of the Chinese refrigerators the same as those made in the U.S.A. (ex: Step 1: $800 x 25% = $200; Step 2: $800 + $200 = $1,000). Because this tariff would reduce the number of Chinese refrigerators sold, China might impose a high tariff on automobiles imported from the U.S. This would reduce exports (sales) for U.S. auto manufacturers. Then the U.S. might impose additional tariffs on other Chinese imports, and eventually, we have a trade war. An imbalanced trade policy can stifle economic growth in the country that has negotiated the worse deal.
Regulations, Taxes and Tariffs
Due to the 2008 Great Recession, the Obama administration and Congress added a host of new regulations and the regulatory environment became quite burdensome to U.S. businesses. In addition, the extremely onerous and lengthy legislation, known as Obamacare, compounded an already difficult situation. Businesses were so concerned, in fact, that they amassed historically high levels of cash rather than invest it.
