The Tariff — The Tax, Plate ii

A tariff puts a frontier inside the price. The same bale of cloth now has a value on the outward side of the customs house and another on the inward side, and the difference is the state's claim upon its passage. The promise made for that claim is usually a promise of shelter: the imported cloth will grow dearer, the home mill will recover its customers, and the foreign seller will pay for the privilege of entering. But a frontier separates accounts more readily than it separates markets. When the home buyer orders less, the foreign seller may lower his asking price; when that seller earns less, he may buy fewer goods from the country that taxed him. The price outside the customs house therefore belongs to the inquiry as much as the duty collected within it. The tariff is an instruction to widen a gap between two prices, one of which the instruction itself may move. Until both have been followed, neither the protection offered to the mill nor the burden laid upon the household has been measured.

The cleanest case is a country too small in the relevant market to change the price at which the rest of the world will trade.¹ Foreign suppliers can sell elsewhere at the going price; the home country's withdrawal does too little to alter that price. If the cloth costs ten abroad and the duty is two, the domestic buyer must pay twelve while imports continue, apart from transport and other costs held still for the example. Home mills expand into the shelter; home households economize on cloth; imports contract between the two movements. Part of the consumer's loss reaches domestic producers and part reaches the treasury, but some reaches nobody: cloth is made at home that could have been obtained more cheaply abroad, and cloth worth more than its foreign resource cost goes unbought. These are the familiar production and consumption losses of the tariff. The foreign address on the invoice has changed none of the accounting. With the outside price fixed, the levy enters the price at home, and the protection the mill receives is financed by the people purchasing its product. The mill's gain and the nation's gain are different entries in the ledger.

1. The benchmark assumes competitive markets, a homogeneous traded good, a fixed foreign price, continued imports, and no other distortion. The two losses arise from inefficient extra home production and forgone consumption. The small-country qualification concerns influence over the relevant trading price, rather than population alone. The simple numbers are illustrative accounting, not an estimate.

A country with power over the trading price faces a second margin: its reduced demand can make foreigners accept less for what they sell.² Suppose the outside price falls from ten to nine when the two-unit duty is imposed. The inside price becomes eleven, the treasury receives two on each imported unit, and the home buyer's price has risen by one. A part of the wedge has been borne abroad. The improvement is in the country's terms of trade — the amount of imports its exports can command — and it can, over a range, outweigh the domestic distortions the tariff creates. This is the source of the old argument for an optimal tariff. A government may use national purchasing power to obtain a better bargain for its citizens, rather as a large buyer bargains down the price of a shipment. Yet the analogy carries its limit with it. The gain is partly taken from the seller on the other side, and the seller's country has a government too. A policy that looks advantageous against a motionless trading partner can lose its advantage when that partner uses its own power in reply. A calculation made from one shore is incomplete as a calculation for the world.

2. A terms-of-trade gain is distinct from a gain in world efficiency. The usual competitive, otherwise undistorted benchmark sets that gain against domestic production and consumption losses; foreign retaliation changes the comparison. See Ralph Ossa and Stephen J. Redding, The Economics of Tariffs (2026), for the theoretical distinction. No claim about the incidence of a particular contemporary tariff follows from the numerical example.

Lloyd Metzler carried the movement of the outside price to the point at which the protective promise can reverse.³ In his analysis of 1949, a tariff could improve the terms of trade so strongly that the tariff-inclusive relative price of the imported good fell. The duty would then lower the relative home price of the very good whose producers it was intended to protect. There is no contradiction in the arithmetic: multiply the foreign relative price by one plus an ad valorem tariff, and the result can fall if the first factor falls sufficiently. The difficulty lies in obtaining that foreign-price movement, which a model must explain. Metzler's possibility belongs to a general-equilibrium account of trade, in which incomes, the expenditure of tariff revenue, and demand for each country's exports move together. It cannot be conjured out of the ordinary diagram with a downward-sloping home import demand and an upward-sloping foreign export supply held fixed. Within that diagram the inside price rises. The paradox is a result about the larger adjustment the small diagram leaves outside its frame.

3. Metzler, Tariffs, the Terms of Trade, and the Distribution of National Income (1949). The paradox concerns a fall in the domestic relative import price. Barry Eichengreen's 1979 model, pp. 26–27, explicitly identifies the terms-of-trade movement and the roles of demand elasticities and the disposition of tariff receipts. Its conditions are model-specific.

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The distinction between the ordinary result and the paradox is a distinction between two questions one is easily tempted to collapse.⁴ Does a tariff lower the price foreigners receive? It may, whenever the importing country possesses enough market power. Does that fall exceed the duty and carry the domestic relative price below its original level? This is the much stronger, exceptional possibility Metzler examined. Most foreign absorption of a tariff is entirely consistent with a higher domestic price. To speak carefully of incidence is therefore to retain three separate objects: the duty, the change in the foreign price, and the change in the home price. Protection adds a fourth question, for the home producer buys inputs as well as selling output. A levy on the machine or material he imports can raise his costs even while another levy shelters his product. And the relative price that directs production is a ratio: an industry's prospects depend upon what it receives compared with what its resources can earn elsewhere. The border names the place of collection. It leaves the economist the task of following the connected prices through which collection becomes consequence.

4. With a specific duty, the inside price equals the outside price plus the duty; with an ad valorem duty, it equals the outside price times one plus the rate. Ordinary partial-equilibrium incidence permits partial foreign absorption while still raising the home price. Metzler's reversal requires the broader adjustment. The identity alone is necessary bookkeeping, and supplies no behavioral prediction.

Even a tariff that successfully extracts a concession from abroad leaves a distributional argument to be settled at home. A protected mill can gain while its customers lose; a treasury can gain while an exporting industry faces weaker foreign demand; an owner of a scarce domestic substitute can collect a windfall while a manufacturer using that substitute pays more. The aggregate welfare calculation combines these changes under an accounting convention, and the convention does not compensate the people whose losses it adds to other people's gains. Nor does the calculation turn the revenue automatically into a benefit of equal worth to every citizen. The use of that revenue matters: it can finance services, replace other taxes, support particular producers, or be distributed in ways that change demand again. The country is the unit in which the terms-of-trade improvement is recorded; households and firms are the places where the improvement and the injury arrive. A defensible account must keep both scales in view. Otherwise an argument about the nation can quietly borrow the satisfaction of the sheltered producer and present it as the experience of everyone who lives within the frontier.

The tariff thus makes visible a limit upon the state's power that the rest of this volume will encounter within the country.⁵ The state can prescribe the wedge, but its incidence depends upon the opportunities available to the parties around it. At the border those opportunities extend through the world's markets: alternative buyers, alternative suppliers, the demand for exports, and the policies foreign governments choose in response. Metzler's extreme case gives the proposition its sharpest edge. An instrument adopted to raise a relative price can, under particular conditions, lower it; a word as confident as protection can describe an intention that the resulting prices fail to honor. The lesson is to state the conditions under which the intended shelter will exist, then to ask who pays for it and how long the bargain can endure. The next plate, The Shift, brings the same pursuit inside the frontier, where a law that names the payer still leaves the burden free to move. A duty is written at the customs house. Its effects are written across the market. The argument remains open.

5. The tariff's economic size depends on its market setting, revenue use, and trading partners' responses. Eichengreen's model, pp. 27–30, shows how changing the use of receipts changes the output result and why retaliation must enter the analysis. The conditional reversal of a relative price is a theoretical possibility, not a general prediction that tariffs make imports cheaper.