President Trump has shown that he is eager to use tariffs as a policy tool to reduce the trade deficit, raise government revenue, counter unfair trade practices, protect manufacturing jobs, and negotiate a level playing field with our trading partners. His tariff announcements have created uncertainty, stirred mixed emotions, and prompted responses from market participants and trading partners. Let’s examine some essential aspects of tariffs to get a clearer understanding of the issue.

First, a tariff is a tax on an imported product imposed by the government of the importing country. Tariffs generally raise the price for the final consumers. For example, a tariff on Mexican avocados will raise prices for American consumers, as more than 80% of avocados consumed in the U.S. are imported from Mexico. In addition, since many American companies import raw materials and intermediate goods for the production of their final products, higher tariffs will increase their cost of production, potentially making prices higher as these companies seek to pass on the higher cost to the final consumers.

Second, tariffs can help protect domestic producers, allowing them to compete against foreign producers on the domestic market. For example, a 25% tariff on imported Chinese steel can help some American steel producers stay in business (otherwise, they would not be able to compete with cheap Chinese steel absent the tariff). So, the argument is that the protection of domestic industries helps maintain the industrial base of the U.S. and keep good-paying jobs for American workers. But it should be noted that excessive protectionism would make domestic firms less innovative in the long run, as they may rely on government support rather than seeking competitive advantages on their own.

Third, if faced with high tariffs, given the importance of the American market, some multinational corporations, such as automakers and semiconductor manufacturers, may relocate some of their production to the U.S. to bypass tariffs. This would potentially boost business investment, a positive factor for the economy in terms of increasing domestic production and creating jobs. However, such relocating decisions often involve other factors such as government regulations and incentives.

Fourth, raising tariffs creates trade tensions and risks retaliations by other countries. This will hurt U.S. exports as foreign countries retaliate with higher tariffs. An escalating trade war will impose costs on all involved parties and disrupt global supply chains (since many products are produced by sourcing inputs from across the globe).

The U.S. can use tariffs as a significant policy tool because it is the world’s largest market, which many other countries depend on for their exports. The Trump Administration has said it will start to implement reciprocal tariffs early next month. According to President Trump, reciprocal tariffs mean “we charge them what they charge us.” For example, the European Union currently imposes a 10% tariff on American cars while the U.S. only charges 2.5% on cars imported from Europe. So, to be reciprocal, the EU needs to cut its tariff rate down to 2.5% or the U.S. will raise its rate to 10%. Although complicated and controversial, the implementation of reciprocal tariffs could lead to more favorable trade terms if other countries choose to lower their tariffs and remove their non-tariff barriers on American products to avoid increasing U.S. rates. But if our trading partners do not reciprocate, the risk of escalating trade conflicts will be high.

Tariffs are an important part of trade policy, which is mostly shaped by domestic politics. While they can protect certain domestic industries and influence negotiations, they also carry risks of leading to trade wars and disrupting the global supply chain. The challenge for the current presidential administration is how to balance protectionist measures with international economic cooperation to promote prosperity and stability.