Chapter Introduction

On September 27, 2012, a tariff of 35% on U.S. imports of tires made in China expired, meaning that these products were no longer taxed as they crossed the U.S. border. The end of that tariff hardly made the news at all, especially as compared with the headlines when President Barack Obama first announced the tariff three years earlier, on September 11, 2009. At that time, the tariff was seen as a victory for the United Steelworkers, the union that represents American tire workers, but it was opposed by many economists as well as by a number of American tire-manufacturing companies. By approving this tariff in 2009, it is believed that President Obama won additional support from the labor movement for the health-care bill that would be considered later that year.

The tariff on Chinese-made tires announced by President Obama was not the first instance of a U.S. President—of either party—approving an import tariff soon after being elected. During the 2000 presidential campaign, George W. Bush promised that he would consider implementing a tariff on imports of steel. That promise was made for political purposes: It helped Bush secure votes in Pennsylvania, West Virginia, and Ohio, states that produce large amounts of steel. After he was elected, the U.S. tariffs on steel were increased in March 2002, though they were removed less than two years later, as we discuss later in this chapter.

The steel and tire tariffs are examples of trade policy, a government action meant to influence the amount of international trade. In earlier chapters, we learned that the opening of trade normally creates both winners and losers. Because the gains from trade are unevenly spread, it follows that firms, industries, and labor unions often feel that the government should do something to help maximize their gains or limit their losses from international trade. That “something” is trade policy, which includes the use of import tariffs (taxes on imports), import quotas (quantity limits on imports), and export subsidies (meaning that the seller receives a higher price than the buyer pays). In this chapter, we begin our investigation of trade policies by focusing on the effects of tariffs and quotas in a perfectly competitive industry. In the next chapter, we continue by discussing the use of import tariffs and quotas when the industry is imperfectly competitive.

President Obama and President Bush could not just put tariffs on imports of tires made in China and foreign steel. Rather, they had to follow the rules governing the use of tariffs that the United States and many other countries have agreed to follow. Under these rules, countries can temporarily increase tariffs to safeguard an industry against import competition. This “safeguard” rationale was used to increase the U.S. tariffs on steel and tires. The international body that governs these rules is called the World Trade Organization (WTO); its precursor was the General Agreement on Tariffs and Trade (GATT). This chapter first looks briefly at the history and development of the WTO and GATT.

Once the international context for setting trade policy has been established, the chapter examines in detail the most commonly used trade policy, the tariff. We explain the reasons why countries apply tariffs and the consequences of these tariffs on the producers and consumers in the importing and exporting countries. We show that import tariffs typically lead to welfare losses for “small” importing countries, by which we mean countries that are too small to affect world prices. Following that, we examine the situation for a “large” importing country, meaning a country that is a large enough buyer for its tariff to affect world prices. In that case, we find that the importing country can possibly gain by applying a tariff, but only at the expense of the exporting countries.

A third purpose of the chapter is to examine the use of an import quota, which is a limit on the quantity of a good that can be imported from a foreign country. Past examples of import quotas in the United States include limits on the imports of agricultural goods, automobiles, and steel. More recently, the United States and Europe imposed temporary quotas on the import of textile and apparel products from China. We note that, like a tariff, an import quota often imposes a cost on the importing country. Furthermore, we argue that the cost of quotas can sometimes be even greater than the cost of tariffs. For that reason, the use of quotas has been greatly reduced under the WTO, though they are still used in some cases.

Throughout this chapter, we assume that firms are perfectly competitive. That is, each firm produces a homogeneous good and is small compared with the market, which comprises many firms. Under perfect competition, each firm is a price taker in its market. In the next chapter, we learn that tariffs and quotas have different effects in imperfectly competitive markets.