What History Tells Us About Who Pays for Tariff Hikes
President Trump’s new 25 percent tariffs on Mexican and Canadian goods, along with an additional 10 percent tariff on Chinese imports, sent markets on a wild ride on Tuesday.
Stocks began the day by falling sharply, then mounted an impressive recovery, only to end the session close to the lows of the day. Even so, the damage was hardly devastating. The Dow was down 1.55 percent, the S&P 500 around 1.2 percent, and the Nasdaq Composite 0.35 percent. That’s a bad day for investors long on U.S. equities but not out of the range of the ordinary ups and downs of the stock market.
Why didn’t the market have a more negative reaction to tariffs? The likely reason is that we’ve seen evidence of the impact of tariffs and they weigh on consumers far less than tariff-hating critics like to claim.
A study published in AER: Insights by economists Alberto Cavallo, Gita Gopinath, Brent Neiman, and Jenny Tang analyzed the effects of tariffs imposed in 2018 and found that while import prices increased almost in direct proportion to the tariffs, the impact on consumer prices was far more limited. Their research used detailed microdata from the Bureau of Labor Statistics and retail price tracking to measure how tariffs translated from import costs to store shelves. The findings showed that while U.S. importers faced higher costs, U.S. retailers absorbed much of the burden, often reducing their profit margins instead of passing higher costs to consumers.
The study found that, in many cases, retailers adjusted pricing strategies rather than immediately raising prices on tariffed goods. Using data from two large U.S. retailers, the researchers observed that even as the tariffs increased the cost of certain Chinese imports by 20 percent, retail prices on those goods only rose by about 0.7 percent on average. This suggests that retailers opted to sacrifice some of their profit margins rather than risk losing customers by passing the full costs along.
Free Market Prices Adjusted, Chinese Prices Didn’t
Additionally, the study highlighted key differences in how exporters reacted to tariffs. Chinese exporters, operating in a state-controlled economy with significant government subsidies, did not lower their prices in response to U.S. tariffs. By contrast, U.S. exporters facing retaliatory tariffs did reduce their prices, making their goods more competitive in foreign markets. This raises an interesting question: Could firms in freer economies, such as those in Mexico and Canada, respond to today’s tariffs by adjusting their pricing strategies? If so, it could mitigate some of the expected cost increases for American importers.
Another key factor that helped businesses manage tariffs in 2018 was the corporate tax cut, which reduced the rate from 35 percent to 21 percent. This provided firms with additional flexibility to absorb tariff-related costs without needing to raise prices. A similar approach today—through targeted tax reductions or regulatory relief—could help businesses remain competitive while adjusting to the new trade environment.
The history of tariffs suggests that initial fears of widespread consumer price increases were overstated. While import costs rise, competitive pressures within the retail sector limit how much of that increase gets passed along. Additionally, shifts in supply chains and pricing adjustments by exporters can play a significant role in moderating the effects of tariffs over time.
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