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A closer look at how tariffs work

Like many of you, I first learned about tariffs and the impacts on international trade and global economies from my history books. Now, one of the most common questions I get from farmers who see the word "tariff" in the news almost daily is "how do tariffs really work?"

Tariffs are designed to protect domestic businesses — often specific industries like steel or agriculture — and can generate revenue for the government. Basically, they are a tax on imports and are typically calculated as a percentage of the price that a buyer pays a foreign seller.

Let's say, for example, that a U.S. manufacturer wanted to buy a machinery part that is made in China. That specific part normally sells for $100. But now, the U.S. has imposed a 25 percent tariff on imports from China. Instead of $100, the price would be $125, with the tariff portion collected at one of our 328 official ports of entry. Eventually that tariff revenue would flow to the U.S. government.

The opposite applies in countries like China, who have retaliated by imposing steep tariffs on U.S. products like pork and soybeans. A Chinese buyer would have to pay a higher price, or in most cases, simply stop buying from the U.S. and purchase from elsewhere, like Brazil.

With China buying up all of Brazil's soybeans, former Brazilian customers like the European Union will likely start buying from the U.S., the only other major supplier.

With tariffs in place, trade flows tend to reroute to the most cost-effective supply chains, but that doesn't mean that some U.S. farmers won't face steep losses in the meantime.

U.S. pork producers now face punitive tariffs of 62 percent on exports to China, a market that represented 17 percent of total U.S. exports by value in 2017, according to the National Pork Producers Council. Iowa State University has estimated that from early March through May, when trade disputes were escalating, producers lost $18 per hog, or more than $2 billion on an annualized basis.

Most economists will tell you tariffs have not worked well over the long-term. For example, the U.S. Congress imposed the Fordney-McCumber Tariff of 1922 to protect U.S farmers after World War I. At that time, Europe was recovering from the war and producing more of their own commodities. U.S. agriculture was becoming more mechanized and productive. With low demand and relatively high production, commodity prices in the U.S. dropped dramatically. The measure gave President Warren Harding the power to raise or lower tariff rates as recommended by the Tariff Commission.

U.S. trading partners then created or raised their own tariffs. Some formed new trading relationships to circumvent the U.S.

Over the short-term, the tariffs worked to bump up U.S. farm income a bit. But then farmers figured out that their production costs were increasing, too.

By 1927, there was growing recognition among global leaders attending a League of Nations meeting that tariffs needed to end. However, some countries moved to increase their tariffs.

Just a couple of years later with the Great Depression approaching, the interest in increasing tariff levels and applying even more tariffs rose again. Several industries quickly jumped on the tariff bandwagon, with promises of new prosperity to come. The Smoot-Hawley Tariff bill was signed into law in 1930, raising tariffs on over 20,000 products.

Then, the Great Depression hit America. There's considerable disagreement among economists about whether Smoot-Hawley made the Great Depression worse, prolonged it, or both. However, voters decided they wanted a change in political direction. President Franklin Delano Roosevelt, a Democrat who won by a landslide in 1932, pledged to lower tariffs. He was able to negotiate bilateral tariff reductions and eventually work toward a multilateral trading framework.

Fast forward to 2018 and some economists predict that the history of tariffs is about to repeat itself.

But President Trump and one of his top economic advisors, Peter Navarro, are convinced that their tariff strategy is the right one at the right time. Navarro has publicly argued that, while past tariffs are protectionist, this round against China is defensive and long overdue.

One big difference between now and the early 1900s is that the U.S. economy is humming along nicely, growing at a rate of 4.1 percent. In addition, unemployment is at historical lows. Regulatory burdens are being lifted.

Throughout his campaign and presidency, Trump maintained that other countries are treating U.S. companies and farmers unfairly and this is a good time to maximize pressure and fight back with tariffs on countries like China, Canada, Mexico and the European Community.

So far, U.S. farmers and ranchers are nervous about Trump's strategy — especially with China. Farm income has dropped by more than half since 2013, and commodity prices continue to suffer.

However, many farmers tell me they are willing to give Trump the benefit of the doubt for trying to force other countries to abolish their tariffs.

"A lot of people are looking long-term," said North Dakota Agriculture Commissioner Doug Goehring, who also farms in his home state, "even though they may be concerned" during the short term. "And so am I," he adds.

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