1. Research

Who pays the tariff?

Michael Spencer
+8522203 8303
Deutsche Bank Research Management
Stefan Schneider

Who pays when a tariff is imposed on an imported product? Formally, of course, it is the importer that is assessed the tariff. But if the exporter has lowered her price, the tariff-inclusive price may not be higher than the prevailing price before the tariff was introduced.

For a large economy like the US, indeed, the optimal tariff rate may not be zero if it is able to exploit its market power by using a tariff to tilt the dollar terms of trade to its advantage. It's possible that after the US tariffs were imposed, the incipient decline in demand for imports could have led to a fall in the ex-tariff price from China so that the exporter at least shares some of the cost of the tariff.
In the extreme, the exporter may price to market, absorbing all of the cost of the tariff to avoid losing sales in the US. US President Trump, it seems, believes this is what has happened over the past year. In a May 5 Tweet, he said: "For 10 months, China has been paying Tariffs to the USA of 5% on 50 Billion Dollars of High Tech, and 10% on 200 Billion Dollars of other goods...The Tariffs paid to the USA have had little impact on product cost, mostly borne by China."

The conventional view, however, is that of a price-taking economy levying a tariff that raises the domestic price of the imported good, making domestically supplied alternatives more attractive and choking off demand for imports. In that scenario, the tariff is not only formally paid by the importer but is in fact borne in full by the importer as exporters don't lower their pre-tariff prices. When we ask "who pays" then, we're asking whether, and by how much, US import prices (measured before tariffs are applied) and US producer or consumer prices have changed after the tariffs were applied.

A little over a year after the US-China trade war began, we are in a position to assess the evidence on this question. And the evidence is clear: tariffs have been fully passed through to importers in both the US and China. Along the way, we've learned something of the limits to which supply-chain relocation can offset trade restrictions.

This is an excerpt of "The Asia Economist: Who pays the tariff?",  published on May 10, 2019.
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