In a recent discussion surrounding the impact of U.S. tariffs on manufacturing jobs, I referenced an article from the Wall Street Journal which highlighted that American tariffs have had minimal effect on Chinese exports; instead, these exports are simply re-routed to other nations. In my earlier commentary, I examined the implications of this shift on U.S. manufacturing jobs. Here, I delve into the ramifications concerning who ultimately shoulders the tax burden of these tariffs.
Economists typically assert that the burden of a tariff predominantly falls on the importing country. Our introductory economic models reinforce this notion, suggesting that the entire weight of a tariff is borne by the importing nation. However, as regular readers of this blog are aware, this assertion is not entirely foolproof. Our introductory courses also instruct that the distribution of tax burdens is dictated by the relative elasticities of supply and demand; those least responsive to price fluctuations will bear a heftier burden. Thus, the party most sensitive to price changes will experience a lighter load. In conventional international trade models, we often assume a perfectly elastic supply of imported goods, indicating that foreign suppliers can easily redirect their products elsewhere if prices rise. Consequently, the importing country ends up absorbing the full brunt of the tax, a scenario described in economic terms as the small-country tariff model, where the importing nation is too insignificant to sway global prices.
But what happens when this assumption doesn’t hold? Consider a scenario in which the importing nation is substantial enough to affect global prices. This brings us to the large-country model. When a large importer adjusts its purchasing habits, it can influence world prices; an uptick in demand can elevate prices, while a decrease can lower them. In such cases, the global supply curve becomes relatively inelastic — it slopes upwards, reflecting that global producers will respond to shifts in demand by altering their output accordingly.
The large-country model presents a fascinating twist. A modest tariff could feasibly enhance the large country’s terms of trade, while simultaneously diminishing those of its trading partners. The terms of trade can be defined as follows:
Terms of Trade = Export Price Index/Import Price Index
Simply put, the terms of trade illustrate the cost (in terms of exports) for a nation to acquire imports. By imposing a tariff, the importing nation reduces its demand for foreign goods. Under the large-country model, if the demand decreases sufficiently, the world price of the good will also drop, leading exporters to absorb part of the tariff burden to maintain profitability. As a result, while domestic imports decline, the price of goods does not necessarily rise by the full tariff amount.
In conclusion, if a country is large enough, understands relative elasticities, and the exporting nations’ responses remain limited to lowering prices on the tariffed goods (without retaliation or pulling back on their own imports), a small tariff could potentially enhance the welfare of the importing country. Although there’s an inherent loss from reduced imports—since imports are the very essence of international trade—this can be offset by lower prices. If the benefits of reduced prices surpass the disadvantages of diminished imports, the country’s overall welfare can see a marginal improvement. This ideal tariff is what we call an optimal tariff; it is designed to maximize total economic welfare within a nation.
You can find discussions of these models in any International Trade textbook. I recommend International Economics by Robert Carbaugh, which is approachable for those with just a basic understanding of economics.
Some proponents argue that the U.S. is indeed large enough for imposed tariffs to enhance domestic welfare. However, evidence quickly emerged indicating that the premise of an optimal tariff was undermined; following the tariff impositions in 2025, other countries retaliated with their own tariffs. Various studies suggest that American consumers are shouldering nearly the entire tariff burden.
A recent piece from the WSJ highlights another critical point: at least in the context of China, the U.S. does not qualify as a sufficiently large country. According to data from the U.S. Census Bureau, U.S. imports from China have plummeted by about 45.6% compared to last year, yet China’s exports have risen. Instead of lowering prices, China has simply sought out alternative buyers for its products. This suggests that U.S. consumers are likely absorbing the entire tariff burden on Chinese goods. The tariffs have curtailed imports and inflated prices for American consumers, without affecting global prices; China has merely redirected its sales. In practical terms, the supply curve has remained, for all intents and purposes, perfectly elastic.
The utility of a model lies in its capacity to elucidate real-world dynamics and facilitate predictions. The realism or complexity of a model does not necessarily equate to its efficacy. In many respects, the large-country model offers a more accurate representation than the small-country model. It is unlikely that any nation, especially the United States, is so inconsequential that it cannot sway global prices. Ultimately, trade is conducted by individuals, not nations, making it reasonable to expect some degree of influence on a case-by-case basis. Nevertheless, while the large-country model may offer insights, it often falls short in providing clear explanations of real-world outcomes. The small-country model, despite its oversimplification, tends to yield more straightforward analyses, at least as a preliminary assessment of impacts.
