Confirmed: Raising tariffs is shooting yourself in the foot

As everybody knows from Econ 101, protective tariffs are harmful for the country that imposes them. A protective tariff is a tax on imports that is so high as to make all imports fall to zero.

But there is an argument why a low tariff may be better than no tariff at all. The reason is that a large country (large compared to its trading partners) faces an upward-sloping supply curve for its imports such that a fall in import demand lowers the world-market price of imported goods. Hence, part of the cost of the increased tariff would fall on the rest of the world due to lower export prices (a fall in the terms of trade) while the country that imposed the tariff might win overall.

Whatever the theoretical merits and demerits of this argument, recent experience with tariff increases in the US (aka Trump’s Trade War) provides powerful evidence against it.

In a newly released paper, Amiti, Redding and Weinstein show that the tariffs imposed last year by the Trump administration had two main effects:

1) US prices of imported goods rose one-for-one with increases in tariff rates.

2) Import demand decreased substantially with an estimated price elasticity of 6 (i.e. 6 percent lower imports for every 1 percent of higher tariffs).

As a consequence of these two results the paper estimates the welfare costs of the Trade War to be about 6.9 billion dollars. While that is not a huge number compared to the total size of the US economy, keep in mind that we’re only talking about a marginal change of the average tariffs from 1.5 to about 3.25 percent. And remember that the welfare costs rise with the square of the applied tariff rate. So should tariffs go up more in the future, the welfare costs will be much bigger.

I regard this as decisive evidence that the optimum tariff is indeed zero. Note that finding No. 1 implies that American consumers are paying the full cost of the tariff increase, with no terms-of-trade effect on the rest of the world. If even the largest economy in the world cannot improve their terms of trade by increasing tariffs, then smaller economies have no hope of doing so either. Raising tariffs is indeed shooting yourself in the foot.

Moreover, this paper is also a triumph for simple textbook economics. The results of Trump’s tariffs are exactly what one would expect from the kind of supply-and-demand model taught in Econ 101. As Tyler Cowen points out, the complete pass-through of tariffs to consumer prices also implies that monopoly power is not a big issue in these markets. It’s good to know that the much-maligned perfect competition partial equilibrium models still gets some important things right.

Economic Illiteracy: a public health issue

As a teacher of economics, I am always looking for good examples of economic illiteracy – a newspaper article or maybe a speech by a politician evincing a deep ignorance of simple economic principles. Unfortunately for me, such pieces are few and far between. Imagine, therefore, my delight when I read the following headline:

“When supplies of drugs run low, drug prices mysteriously rise, data shows”

At first, I was convinced that the author was just kidding, that this was a good piece of satire. But no. This is serious.

Here are some highlights:

When nearly 100 drugs became scarce between 2015 and 2016, their prices mysteriously increased more than twice as fast as their expected rate, an analysis recently published in the Annals of Internal Medicine reveals. The price hikes were highest if the pharmaceutical companies behind the drugs had little competition, the study also shows.

The authors—a group of researchers at the University of Pittsburgh and one at Harvard Medical School—can’t say for sure why the prices increased just based off the market data. But they can take a shot at possible explanations. The price hikes “may reflect manufacturers’ opportunistic behavior during shortages, when the imbalance between supply and demand increases willingness to pay,” they conclude.

Now, this would all be really funny, if it wasn’t the product of a group of highly respected researchers in medicine from top universities published in a peer-reviewed medical journal. But it becomes a public health issue when people end up making policy conclusions on economic illiteracy:

To combat potentially exploitative hikes, the authors offer a recommendation:

If manufacturers are observed using shortages to increase prices, public payers could set payment caps for drugs under shortage and limit price increases to those predicted in the absence of a shortage.

Yes, you guessed it: price controls are the obvious solution to a shortage-induced price increase. Face, meet palm!


Microeconomics of Everyone: Institutions and the Human Life Cycle

On the court of economics

Microeconomics deals with the behaviour of individual economic units and one important topic in this respect is the optimal use of limited resources (Pindyck and Rubinfeld, 2009, pp. 26-27). When it comes to limited resources there is one fundamentally relevant for all humans: time. Mainstream economic teaching deals with the use of time especially with respect to the optimal mixture of leisure and labour in order to income-based consumption (Burda and Wyplosz, 2009, p. 107).Also in an strictly economic perspective there may be more than these two alternatives to invest one’s time though — e.g. training and education — and one may question modelling the motivation of human behaviour within such superficial and exclusive framework. Although individual human behaviour for sure follows rational deliberations and adopted objectives, it first of all is motivated also by needs (Heckhausen and Heckhausen, 2010, p. 3).To this effect it is no surprise that according to a traditional definition economic science has to deal with needs or, more precisely, the spectre of activities serving the satisfaction of human needs (Wöhe and Döring, 2008, p. 1). The variety and complexity of human needs finally hints on the actual complexity of human behaviour and why it is guided by explicit and implicit rules. In economics such rules often are called institutions and exemplary try to ban opportunism and establish some predictability (Kasper and Streit, 2005, p. 2). Predictability it is what sometimes is supposed also for the course of human lives. It is this supposition — not any databased fact — this analysis deals with. The solely objective: sketch a model that is able to illustrate how institutions may impose a standardized human life cycle on members of modern societies.

Let’s play theory

First, a psychological framework is chosen whose complexity, as a precaution, does not excel the capability of minds believing in mainstream economic models. An adequate example seems to be given by the ERG theory of Alderfer (1972). It divides human needs in only three classes: existence needs, relatedness needs and growth needs. Existence needs as a classification with regard to economics especially refer to consumption. Relatedness needs refer to social and external esteem while growth needs as a classification refer to internal esteem and self actualization. Some underlying assumptions about the priority and interdependence of these three classifications may be captured in the following principals:

satisfaction-progression-hypotheses (satpro)

  • Satisfaction (sat) of existence needs (e) increases the dominance of relatedness needs (r) by their intensification (int).
  • Satisfaction of relatedness needs increases the dominance of growth needs (g) by their intensification.

frustration-hypotheses (fru)

  • Dissatisfaction (dis) of existence needs let their dominance increase by proportional intensification.
  • Dissatisfaction of relatedness needs let their dominance increase by proportional intensification.
  • Dissatisfaction of growth needs let their dominance increase by proportional intensification.

frustration-regression-hypotheses (frureg)

  • Dissatisfaction of relatedness needs also increases the dominance of existence needs by proportional intensification.
  • Dissatisfaction of growth needs also increases the dominance of relatedness needs by proportional intensification.


For simplicity this analysis does not apply all parts and interpretations of the underlying theory and the adopted ones are also applied in a simplified manner. Furthermore, it adds some assumptions to complete a system dynamics model of human behaviour (see fig. 1):

satisfaction-adaptation-hypotheses (satadap)

  • Needs constantly reappear according to a minimum amount (min) to be satisfied.
  • This minimum adapts in a logistic way to the level of satisfaction experienced.
  • Satisfaction only and directly depends on individual emphasis (emp) and the correspondingly dedicated budget (bud) of effort.
  • Individual emphasis is determined by the maximum of either dissatisfaction ot the minimum appearance anticipated by habit or some institutional necessity – like university (uni), a full-time job (job) or family (fam).


The institutions selected to mention rather occur sequential in human life cycle and probably demand to emphasize different classification of needs. In favour of an illustrative result it is assumed:

  • Studying at the university only implies that a large part of effort is dedicated to the satisfaction of growth needs.
  • After some years of studying the first full-time job is assumed to occur and require an even bigger part of daily time dedicated to the satisfaction of existential needs solely.
  • After some years within relatedness needs dominate a decision in favour of a family follows and from now on dedicates a given amount of effort to the satisfaction of relatedness needs.

Building a whole model on nothing but assumptions seems questionable, even more when there is not any underlying data applied for the hypothetical coefficients, the starting values for several state variables or the timing and extent of institutional limitations applied. Any ‘exemplary’ setting (see app. A) seem equally ‘arbitrary’. Every similarity between generated result and reality exists only by chance. The difference between ‘calibration’ and ‘manipulation’ vanishes. What stays, though, is the fun, playing at the buttons in order to illustrate a scenario for the aspired dramatic screenplay (see fig. 2):

  • University at first may imply an engorgement with regard to growth needs, while the rising concious about satisfied existence needs triggers relatedness needs.
  • The increased satisfaction of growth needs let the minimum appearance increase too, which causes trouble when the full-time job does not allow for full satisfaction of growth needs anymore.
  • While the minimum appearance of existence needs adapts towards the imposed satisfaction, the tensed situation leads to even more dissatisfaction of relatedness needs.
  • The thereby provoked decision in favour of a family in turn distorts the dominance of needs again implying once more a dissatisfaction of growth needs.
  • This in turn intensifies relatedness needs again and let their dissatisfaction increase to a long-term extent although family still imposes corresponding effort.


Barefaced interpretation

Within this screenplay institutions force people to emphasize the satisfaction of needs partly in contrast to their felt intensification. This leads to a rather abrupt distortion — engorgement of some needs simultaneous to the dissatisfaction of others. Quarter- and mid-life crises as well as enduring unmet relatedness needs occur as part of the human life cycle.

Why? Because the model says so. Why? Because some people think so. Why? Because to some extent it seems plausible and we maybe should discuss about restrictions we face, when we try to allocate our time — a resource perceived scarcer every year of our life using it path depended and partly far from economic optimality. So maybe the model explains nothing but the idea that we should try to explain ourselves a bit more. Even then do not underestimate this insight.


Appendix A: setting

  • coefficients: fru=0.3, frureg=0.05, satpro=0.05, satadap=0.1
  • starting vlaues: sat =min = int = emp for e =4, r=3, g=6
  • institutional restrictions: uni=8,  job=8, fam=3 of bud=16


  • Alderfer, Clayton (1972). Existence, Relatedness, and Growth: Human Needs in Organizational Settings. New York: Free Press.
  • Burda, Michael and Charles Wyplosz (2009). Macroeconomics: A European Text. 5th ed. Oxford: University Press.
  • Heckhausen, Jutta and Heinz Heckhausen (2010). Motivation und Handeln. 4th ed. Berlin: Springer.
  • Kasper, Wolfgang and Manfred E. Streit (2005). Institutional Economics: Social Order and Public Policy. Reprint. Cheltenham: Edward Elgar.
  • Pindyck, Robert and Daniel Rubinfeld (2009). Mikrookonomie. 7th ed. Munchen: Pearson Studium.
  • Wohe, Gunter and Ulrich Doring (2008). Einfuhrung in die Allgemeine Betriebswirtschaftslehre. 23rd ed. Munchen: Valen.