Finance Explained Simply
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Beginner5 min read

What are tariffs and how do they affect the economy?

By the FES team · Published 12 June 2026

In brief: A tariff is a tax imposed by a government on imported goods. It raises the price of those imports, making domestic alternatives more competitive. Governments use tariffs to protect industries, raise revenue, retaliate against trading partners, or as bargaining chips in trade negotiations. Tariffs have returned to the centre of economic debate, with the US imposing large tariff increases from 2018 onward. The economic consensus is that tariffs broadly reduce overall welfare, though they can benefit specific protected industries.

How a tariff works

Suppose the US imposes a 25% tariff on imported steel. An imported tonne of steel costing $800 now effectively costs $1,000 (the importer pays the $200 difference to the government). US steel producers can now charge closer to $1,000 without losing market share — they are shielded from foreign competition. The US government collects revenue. But: US manufacturers who use steel as an input (car makers, construction companies, appliance producers) face higher costs. Those higher costs are ultimately passed on to consumers. The tariff protects steelworkers at the expense of everyone who buys products made with steel.

Who Wins and Who Loses from a Tariff Winners • Domestic producers (protected from competition) • Government (collects tariff revenue) • Workers in protected sector Losers • Domestic consumers (pay higher prices) • Downstream industries (higher input costs) • Foreign exporters

Tariff escalation and trade wars

Trade wars occur when countries retaliate against each other’s tariffs with their own. The US–China trade dispute that began in 2018 is the most prominent recent example: the US imposed tariffs on Chinese goods; China retaliated with tariffs on US agricultural exports; both sides escalated. The result was higher prices for consumers in both countries, disrupted supply chains, and reduced bilateral trade — while the overall trade deficit the tariffs were designed to address did not meaningfully shrink. The broader lesson from trade history: escalating tariff wars typically damage both sides, with the bigger economy usually able to absorb the pain better.

~$80bn/yr
Estimated cost to US consumers of 2018–2019 tariffs (Peterson Institute estimate)
1930
Year of the Smoot-Hawley Tariff Act — widely cited as worsening the Great Depression

When tariffs might be justified

Despite the general economic consensus against tariffs, arguments for them exist. The "infant industry" argument: new industries may need protection until they achieve scale and competitiveness. Strategic industries: governments may want domestic capacity in semiconductors, defence, or food regardless of cost efficiency. Rebalancing unfair competition: if a foreign government subsidises its exports, a tariff can level the playing field. National security: supply chain resilience became a bipartisan priority after COVID exposed over-reliance on single-source imports.

“The gain from international trade comes not from exports, but from imports. We export only to get the means to import.” — Milton Friedman

What this means for you

Tariffs are not abstractions — they show up in the prices you pay. When tariffs are imposed on consumer electronics, clothing, or food ingredients, the cost passes through to retail prices. During the 2025 US tariff escalation, prices on a wide range of goods rose in the US even as the government argued the foreign country was "paying" the tariff. Economically, the importer pays the tariff, and that cost is shared between the foreign exporter (who accepts a lower price), the importer (squeezed margins), and the consumer (higher prices). The split depends on how price-elastic each market is.

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