Author’s Note: This post was originally published as a blog post on my personal website (now closed) on January 23, 2019. Since closing the website, I’ve had several requests for this post. Econlib has kindly allowed me to repost it here. I’ve made some minor edits to grammar and style, but the post is otherwise identical. The original version is available on the Wayback Machine. here.
his A 1987 Economic Review article detailing the history of optimal tariffsThomas Humphrey wrote:
The optimal tariff model makes the unrealistic assumptions that (1) other countries will not retaliate with tariffs of their own, (2) the elasticities of supply and demand in foreign trade are not large enough to make tariffs ineffective in the long run, (3) optimal tariff rates can be precisely identified and skillfully administered, and (4) politicians can resist pressures to raise tariffs above the optimal levels.
These four objections to the optimal tariff model are difficult to overcome when treating the model as a policy procedure. I have written about these other points before (as have many others who are much smarter than me), but I will focus on the second point and try not to make it contrived.
It is undisputed that the optimal tariff model depends on the elasticity of demand and supply. In fact, this is how tariffs are calculated. However, if we take into account condition (2) above, we can see that the optimal tariff is at best a short-run policy. This is because Law of demand.
Most people tend to think of the law of demand in its general form: as the price of a good increases, the quantity demanded of that good falls, all else being equal. But there’s a second law of demand: the longer prices remain relatively high, the more elastic the demand for a good becomes.
Because the goal of a tariff is to raise the relative price of a good, the demand for that good will become more elastic as long as the tariff remains in place. In fact, if the tariff remains in place and all other things are equal, after enough time, the tariff can make the demand curve for a good perfectly elastic. A perfectly elastic demand curve indicates that there are no consumer welfare gains from trade. With no consumer welfare, the tariff becomes a net benefit to the country in question. Thus, the optimal tariff cannot be sustained in the long run, but only in the short run given the second law of demand.
One might counter: “But wait, John, you sly, handsome devil! That just means that the optimal tariff needs to be lowered. There is no reason to think that tariffs will ultimately result in a net welfare loss.”
It is certainly possible that a benevolent government could squeeze all the benefits out of a tariff by constantly adjusting the optimal tariff as elasticities change. But here Public Choice will appear. Gordon Tulloch As argued in 1975, government support for businesses is very hard to remove. Domestic producers have taken advantage of the benefits that tariffs have provided. Removing the tariff does not eat into the “super-normal” profits of monopolies, but rather into their normal profits. These businesses would be legitimately hurt in terms of profits by the removal or modification of protections such as the optimal tariff. Any adjustment to the optimal tariff, even if called for by the economic scenario, is likely to be resisted vigorously by the affected businesses. The resulting stagnation would likely result in an optimal tariff that is too high. Any short-run gains from the optimal tariff (assuming all the above conditions are met) are likely to be eroded by this suboptimal tariff resulting from the change elasticity and lack of change in the statutory tariff.
Within the framework of general equilibrium theory, optimal tariffs make perfect sense. But when time and public choice come into play, the rationality of optimal tariffs becomes moot. And, as GMU economist Garrett Jones likes to say, in a pitched battle between general equilibrium and public choice, public choice always wins.
John Murphy is an assistant professor of economics at Nicholls State University.
