How High Tariffs Could Lead to Financial Crisis?

Let us state this question in a different way: could high customs tariffs provoke a financial crisis?

 

Profit is the main force driving the market mechanisms. The greater the profit, the better. This is the basic principle of the capitalist lifestyle. Company management is successful if it can profit from any situation.

 

Customs tariffs on imported goods are raised to increase the competitiveness of domestic producers. The following mechanism is expected to achieve this goal:

 

The customs tariffs increase the cost of imported goods. Manufacturers of imported goods want to collect the “usual” (pre-tariff) profit. They are forced to raise prices for their goods. Prices for domestic goods remain at the same level, they are lower than prices for imported goods. Demand for more expensive imported goods is falling and demand for less expensive domestic goods is growing. The revenues of domestic producers are increasing, and their profits are growing accordingly.

 

Domestic producers are satisfied with their “usual” (pre-tariff) profit, they invest the extra profit in improvement of production, improvement of quality and reduction of the cost of their goods. The quality of domestic goods is equalized with the quality of imported goods, and then surpasses it. At the same time, the cost of domestic goods is lower than the cost of imported goods. Now domestic goods can compete on equal terms with imported ones, and customs tariffs can be removed.

 

This mechanism, as you see, is very complicated. The state has neither capabilities nor means nor control procedures for all elements of this mechanism. As a result, it happens according to Chernomyrdin, “We wanted the best but it turned out as usual.”

 

Where does this mechanism fail? In the assumption that domestic producers art content with pre-tariff profits and invest the extra profit in innovations. This assumption contradicts the main driving force of the capitalist economy: collect the maximum profit now and don't care what happens next.

 

Investing in innovation is risky, especially during the crisis. It is not known whether the company survives to a happy moment when innovations begin to pay off. Innovation is a risky thing: one commercial success, on average, needs up to 3,000 raw ideas. A bird in hand is worth two in the bush.

 

The company management makes the best decision in the current situation: raise the prices of their goods, receive the maximum profit, and do not change anything in goods or in production. Maximum profit, minimum risk in a situation of crisis uncertainty. This is the wisest thing that could be done.

 

Yes, it is wise within the company. But what happens in the framework of the country's economy?

 

Many years ago I read a Chinese parable. Ten Chinese men decided to celebrate the New Year together. They agreed that everyone would bring a jug of wine and pour it into one large pot, then they would drink from it. One of them thought, “If I bring a jug of warm water, no one would notice, but I save.” He did so. The whole New Year's Eve these Chinese men were sitting around the pot and drinking nauseating lukewarm water...

 

The behavior of companies resembles these "wise" Chinese men.

 

Failure in the mechanism of increasing the competitiveness of domestic producers by raising customs tariffs leads to a general slowdown in the flow of innovation. As a result, another investment “bubble” inflates and bursts. This bubble hits an increasingly unstable financial system and causes its collapse.

Suggested Solutions | Financial and Systemic CrisesThe Consequences of Trade Wars

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Len Kaplan

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