Tariffs, much like taxes, inevitably lead to a phenomenon known as deadweight loss within the economy. This loss can be dissected into two primary categories: the consumption effect and the protective effect of the tariff.
The consumption effect refers to the opportunity costs incurred when a tariff inflates the prices of goods, thereby stifling trade that was previously beneficial. Simply put, when tariffs are imposed, consumers find themselves paying more for fewer productsâor, worse yet, paying the same price for reduced quantities.
At EconLog, we often delve into the consumption effect of tariffs because itâs a hot topic in media discussions. Most analyses focus on how tariffs impact consumer prices. However, today, I aim to shed light on the protective effect.
The protective effect stems from the productivity losses induced by tariffs. While domestic manufacturers ramp up their production, they do so with less efficiency compared to their foreign counterparts. To put it another way, producing additional units under a tariff regime consumes more resources than would be necessary under free trade conditions. Moreover, since protective tariffs shield domestic firms from foreign competition, they lack the motivation to innovate and enhance productivity.
To illustrate this, letâs consider a chart shared by the Council on Foreign Relations. In a blog post dated March 6, 2025, titled Steel Productivity has Plummeted Since Trumpâs 2018 Tariffs, authors Benn Steil and Elizabeth Harding present data showing that the productivity of steel workers has been on a downward trend since 2018. Before the tariffs were enacted, steel worker productivity was generally in line with other industries. Since then, while other sectors have boosted their productivity, steel has lagged behind. Of course, this data does not conclusively establish a causal link; a more thorough analysis would be required to ascertain whether the decline in productivity is a direct result of tariffs or merely coincidental. Still, the observed trend resonates with existing theories and historical evidence from previous tariff implementations, as highlighted in the work of Alexander Klein and Christopher Meissner in their paper Did Tariffs Make American Manufacturing Great? New Evidence from the Gilded Age. Essentially, tariffs tend to diminish productivity by necessitating the use of higher-cost resources for production.
Next, letâs turn to a recent report from Cleveland-Cliffs, a steel manufacturer based in Cleveland, Ohio. On June 4, the company abandoned plans for a new blast furnace at one of its facilities, which would have reduced costs while maintaining output levels. The reason? Rising tariffs on steel imports âforced Cleveland-Cliffs to prioritize short-term profitability.â In other words, the tariff framework discouraged the company from modernizing its equipment and becoming more competitive against international steel producers, exactly as economic theory predicts. The protective effect of tariffs results in heightened marginal costs and, since firms are shielded from competition, their drive to cut costs is significantly diminished.
Ultimately, free trade stands as the most advantageous optionâoften proving to be the best choice across various scenarios. Time and again, protectionist policies fall short of achieving their intended outcomes. A bit of economic insight (and perhaps a touch of political theory) illuminates the reasons behind these failures.
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[1] For a visual representation of these effects, you may find Figure 7.18 helpful. Take a closer look at it here. In this figure, Area B represents the deadweight loss from the protective effect, Area D illustrates the deadweight loss from the consumption effect, Area A denotes the redistributive effect (shifting consumer welfare to producers), and Area C reflects the revenue effect (redistributing consumer welfare to the government).
