Coffee or tea? The unintended consequences of tariffs

Coffee or tea? The unintended consequences of tariffs
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Today, America is a country that prefers hot coffee to tea. That was surely not always the case. Some, on good authority, claim it is a result of tariffs imposed by England on her colonies and the events surrounding the Boston Tea Party.

Yes, had it not been for tariffs and a search for substitutes, far more English-speaking Americans, like their British cousins, might still be enjoying a celebratory afternoon tea.

When the price of a commodity or service rises, whether due to tariffs, regulation or some market action, the quantity demanded falls. A search for substitutes ensues. At least this is how the economist’s “law of demand” is often described.

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The law of demand says little about the consequences of this search, but common sense tells us that sometimes, the replacement we discover works so well that entirely new consumption patterns emerge. Thus, tea tariffs and a popular backlash centuries ago helped birth a nation of coffee drinkers.

The law of substitution could be seen recently after the Trump administration’s 2018 decision to reimpose trade sanctions on Iran while vacating the 2015 nuclear weapons agreement. Not all buyers of Iranian oil, the United Kingdom and Germany included, were willing to quietly walk away. Their desire to hold course led to a search for substitutes.

This time, the substitution was not for the oil itself so much as for the U.S. dollar, which they used to pay for it. Now, Europeans have devised a totally new payment system that avoids the transfer of dollars across international lines. This, in turn, limits our ability to impose regulatory costs on those who are not willing to join in the sanctions game.

Until now, the dollar has been the supreme world reserve currency, and this Iranian oil move is not likely to topple the dollar from its lofty perch. But just as coffee drove out tea, maybe one cup at a time, the new EU payment mechanism could drive out dollars, at least for some transactions.

Another example of the law of substitution came as result of the Trump administration’s tariff war with China, which is now expanding to include an enlarged set of Chinese goods. 

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Consider the tariff on Chinese steel. When this tariff was first imposed, Arthur Kamler, president of the major U.S. bicycle maker Kent Manufacturing, described his search for substitutes. Some may have thought that high tariffs on Chinese steel would lead to increased shipments of American steel to Kent’s South Carolina plant.

This did not happen. Instead, Kamler immediately searched for and found substitute steel in Southeast Asia. As he put it, “We are not bringing jobs back to America with this thing. We are bringing jobs to different countries in Southeast Asia.”

As it turns out, a lot of U.S. manufacturers are behaving like Arthur Kamler. According to a recent report from the New York Federal Reserve Bank, as detailed in The Wall Street Journal:

Since the third round of U.S. tariffs on China went into effect in late September, U.S. imports from China have faltered. An 8% growth rate in October turned into an 18% decline on the year in March. Yet import growth from Taiwan has risen from 12% to 21% over the same period. Imports from Vietnam grew 34% in March, up from a 15% rate in October. 

Whether one likes it or not, markets have a way of delivering the goods. When governments attempt to control the free exchange of resources, creative people in pursuit of gains from trade do amazing things. And while we may expect some substitution, we don’t always account for how dramatically it can change the marketplace.

America is no longer a tea-sipping country. 

Bruce Yandle is a distinguished adjunct fellow with the Mercatus Center at George Mason University and dean emeritus of the Clemson College of Business and Behavioral Sciences.