Economics of Tariffs

Tariffs are a macroeconomic shock to the global economy. Polls of economists reveal that 93% of economists believe tariffs leave the economy imposing them worse off.

Economists classify tariffs as a regressive tax where most of the tax burden falls on consumers with lower incomes.

Economists have documented that tariffs reduce business competitiveness by shielding domestic suppliers from competition. In 1960, Turkiye had high effective tariffs of around 30%, similar to where the U.S. is heading today. The results were that Turkiye was known for high cost and questionable quality offerings. We expect the same result from the current round of tariffs in the United States.

Tariffs are generally hard to unwind and, over time, raise little revenue. For example, the 1963 “Chicken Tax” imposed by President Lyndon Baines Johnson was a 25% tax on imported pickup trucks in response to European levies on American poultry. That was 62 years ago. Today, it remains. Almost all pickup trucks sold in the United States are made here, and Europe still doesn’t buy U.S. chickens. As for revenue, last year the chicken tax on pickups raised only $104 million in revenue, or 0.002% of the federal 7 trillion-dollar US budget.

Tariffs are the highest they have been since 1940 and heading towards a high not last seen since 1910. The average effective tariff is currently at 13.4% according to JP Morgan Chase Economists. They are headed to 20.6% according to Yale Budget Lab.

In comparison, last year, they were 2.3%, aligned with where many of our peer Western countries are. The trade-weighted average tariff in the European Union is 1.34%. That in Australia is 2%. Japan is a whopping 4.3%.

CEO and CFO Response to Tariffs

My Pricing Spineometer research reveals that CEO’s and CFO’s will respond to cost increases, and tariffs are a cost increase, with a price increase. They have a responsibility to maintain business profitability. The open issue is one of timing and size, not the direction of prices.

On timing, the best practice is to be concurrent with the cost increase, or within 90 days if it can be postponed. Lagging senior executives express regret that action wasn’t taken sooner. During that interim period between choosing to raise a price and execution, customers must be informed, price lists must be updated, and commercial policy must be reviewed. Discounts and promotions must be reviewed and may be reduced.

On size, executives overwhelmingly take one of two approaches to a sudden cost increase. Most commonly, they pass through the cost increase to hold the contribution constant. This is a dollar-neutral profit decision. Less frequently, they hold the margin percentage constant. This margin-neutral approach is dollar profit contribution positive. Absorbing the cost increase is rare but possible with high-margin items.

Value-Based Pricing encourages companies to hold their differential value constant relative to competitors. With all competitors in an industry raising prices in response to tariffs, thus raising your company’s prices in response to a tariff is aligned with the principles of Value-Based Pricing.

Yes, a price increase will likely hurt volume. Tariffs deliver a deadweight loss to the economy, raising prices and reducing the quantity sold. This is the expected direction.

There are situations where tariffs will help a company, but others will lose. Tariffs have asymmetric impacts on competitors. Some competitors are harmed. Others can gain volume or raise prices even though tariffs do not impact them.

Tariffs’ most significant impact is the possible destruction of market access. For example, Volkswagen Group reported a 16% decline in U.S. sales following the imposition of a 25% tariff on imported cars. Many of those sales went to other competitors such as Ford, General Motors, or Stellantis.

Tariffs enable a price increase even if a company does not pay the tariff. U.S. Steel announced a $50-a-ton price increase for flat-rolled steel in January in response to a tariff on imported steel. Nucor likewise raised its price by $25 a ton, according to steel customers.

Tariffs should drive a review of rebate policies. Cross-border rebates may need to cease if the invoice price is used to calculate the tariff, not the net price. Tiered dollar-based rebates, often called growth rebates or revenue rebates, will be easier for customers to hit, resulting in your rebate cost increasing even though your quantity of units sold did not rise, and may have even slipped. Quantity-based rebates may be more useful at this time. Yes, quantity rebates are generally an anathema to many in the pricing world, but given the current input cost inflation and price impact, they are appropriate for some businesses today.

Staffing Impact

With decreased demand for some companies, especially non-U.S. companies, we may anticipate reductions in force to arise. Executives should be leery of cutting pricing and supply chain staff. They should be looking to increase staffing and seniority levels in these functions.

Tariffs put more emphasis on pricing and supply chain capability and agility. In pricing, companies should be able to pounce on an opportunistic or business resiliency price increase.

Of the 138 companies reviewed in my Pricing Spineometer series that began in 2022, bankruptcy appeared only in those that scored a 1, the lowest score possible.

Make sure you have the pricing capability, internal or outsourced, required to survive today. While research demonstrates that most U.S. and E.U. businesses operate on an annual price increase cycle, it will not work with high input cost volatility. That is what tariffs are causing.