Tariffs and Retaliation: No Simple Answers
It’s possible that more has been written about tariffs in 2025 than in the previous few decades combined. In the press, the arguments are necessarily rather elementary. David Ricardo’s (1817) classical economics position that all countries are better off if they specialise and trade is the starting point, implicit or explicit, from which arguments on both sides are launched. Briefly, if your country is good at gold mining but relatively (though not necessarily absolutely) bad at making T-shirts, you should concentrate on mining gold and trade your gold with the country that’s better (relatively) at making T-shirts. It is quite simple to show, under certain assumptions, that there will be more gold and more T-shirts for everyone as a result.
What happens, though, if the T-shirt workers in the gold mining country lobby to have their industry protected? Perhaps it makes political and economic sense to impose tariffs on the T-shirts coming in from the T-shirt country. If so, won’t everyone in both countries be worse off? Obviously not. The T-shirt workers in the gold mining country will probably be better off. As one can see, it takes but a simple example to transform what appears to be a black and white conclusion (i.e., countries should specialise and trade) and turn it some shade of grey. This leaves aside other considerations such as whether some industries, like pharmaceuticals, are strategically important and should always be protected to ensure domestic supply.
What does economics say about tariffs? Can countries benefit from imposing them? As you might imagine, there’s quite a vast literature. As you might also imagine, there is no absolutely clear-cut answer. When he died at the early age of 53 in 1977, Harry Johnson was considered a giant of the economics profession. As an entry point into the debate on tariffs and free trade, the student could do worse than consult Johnson’s work on the matter. In this regard, I think one short paper stands out. This paper is called Optimum Tariffs and Retaliation, published in the Review of Economic Studies in 1953. While technical, the logic can be followed if one devotes enough attention (unlike later economics papers that often require a knowledge of higher mathematics).
Johnson starts this paper by pointing out that the proposition that a country can improve its position relative to the free trade position by imposing tariffs has become generally accepted. Imagine a group of countries trading freely. If one of them imposes a tariff on the others, that country can carve off benefits for itself. One of these might be keeping its local T-shirt industry lobby happy by increasing employment in that sector. The difficulty comes into the analysis when one tries to work out what happens if the other countries retaliate. Then it gets tricky.
One school of thought, Johnson explains, maintains that all countries quickly find themselves worse off relative to the position of free trade. Johnson argues that this is incorrect. It’s not that simple. Rather, it is possible for a country to benefit by imposing a tariff even if the other countries retaliate. In fact, there is a range over which a country can gain from imposing tariffs even if the other countries retaliate. There is also a range over which the country imposing the tariffs will lose due to other countries’ retaliation. Johnson shows that the relative elasticity of demand for imports in the different countries is an important factor. It quickly becomes apparent that there is no simple answer.
Consider a situation in which countries A and B trade potato chips and apples. Both countries have domestic industries, but country A imports apples from country B and country B imports potato chips from country A to supplement domestic production. Country B’s potato chip workers lobby for protection, claiming that foreign competition is undermining domestic industry and causing job losses and economic malaise in the potato chip districts of several major cities.
In response to this lobbying, Country B imposes a tariff on country A’s potato chips and country A retaliates by imposing a tariff on country B’s apples. The result is that country A’s potato chips will be more expensive in country B and country B’s apples more expensive in country A. Does country B benefit or lose? Spend a moment trying to answer and you can see how there is no universally correct answer (though there may be a correct answer if one has the available data for the case under consideration). For instance, Country B can increase employment in its potato chip sector without losing out on apples if country A’s demand for apples is such that, despite retaliation (i.e., higher prices for B’s apples in country A), consumers in country A don’t change their demand significantly while consumers in country B happily shift their demand away from country A’s potato chips towards the domestically produced item. Of course, country B can also lose by its decision. If country A’s consumers drastically cut their demand for B’s apples while country B’s consumers prefer country A’s potato chips despite the higher price, country B can lose. It’s more complicated than that, as Johnson details, but that’s the general idea. And that’s just two countries and two goods. Quite simply, it’s never simple.
A Short Reading List (in chronological order):
- De Scitovszky, T. 1942. A Reconsideration of the Theory of Tariffs. Review of Economic Studies, 9, 89-110.
- Johnson, H.G. 1953-1954. Optimum Tariffs and Retaliation. Review of Economic Studies, 21, 142-153.
- Kemp, M.C. & Wan, H.Y. (Jr) 1972. The Gains from Free Trade. International Economic Review, 13, 509-522.
- Pincus, J.J. 1975. Pressure Groups and the Pattern of Tariffs. Journal of Political Economy, 83, 757-778.
- Gallarotti, G.M. Towards a Business Cycle Model of Tariffs. International Organisation, 39, 155-187.
- O’Rourke, K.H. 2000. Tariffs and Growth in the Late 19th Century. Economic Journal, 110, 456-483.
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