Originating in the work of English economist CHARLES BICKERDIKE (1876-1961), optimal tariff theory illustrates that it is possible for a country to improve its terms of trade by imposing a tariff or tax on certain imported goods.
The effect of optimal tariff is, ceteris paribus, a fall in demand for the taxed good; the country thus conducts a smaller level of trade on more favorable terms. The optimal is reached when the gain from the better terms of trade offsets the losses from the smaller volume of trade.
C F Bickerdike, ‘The Theory of Incipient Taxes’, Economic Journal, vol XVI (December 1906), 529-35; W M Corden, Trade Policy and Economic Welfare (Oxford, 1974)
A tariff is a tax imposed by a government on imports or exports of goods. Besides being a source of revenue for the government, import duties can also be a form of regulation of foreign trade and policy that taxes foreign products to encourage or safeguard domestic industry. Tariffs are among the most widely used instruments of protectionism, along with import and export quotas.
Tariffs can be fixed (a constant sum per unit of imported goods or a percentage of the price) or variable (the amount varies according to the price). Taxing imports means people are less likely to buy them as they become more expensive. The intention is that they buy local products instead, boosting their country’s economy. Tariffs therefore provide an incentive to develop production and replace imports with domestic products. Tariffs are meant to reduce pressure from foreign competition and reduce the trade deficit. They have historically been justified as a means to protect infant industries and to allow import substitution industrialization. Tariffs may also be used to rectify artificially low prices for certain imported goods, due to ‘dumping’, export subsidies or currency manipulation.
There is near unanimous consensus among economists that tariffs have a negative effect on economic growth and economic welfare, while free trade and the reduction of trade barriers has a positive effect on economic growth. However, liberalization of trade can cause significant and unequally distributed losses, and the economic dislocation of workers in import-competing sectors.