Tariffs, Balance of Payments, and the Terms of Trade

Abstract

The purpose of this article is to investigate the effect of tariffs on the balance of payments and on the terms of trade. The approach is one of general equilibrium, and the attack is along the lines of comparative statics. Starting from a certain equilibrium position we try to determine the course of its displacement in response to a change in tariffs. All the basic conditions of equilibrium such as tastes, techniques and the available productive resources are supposed to remain constant: tariffs are the only independent variable of the system. The most common approach to the problem of tariffs is that not of general but of partial equilibrium. We argue that tariffs raise the home market prices of imports, that they reduce the volume of imports and depress the world market prices. They lead, therefore, to an improvement both in the balance of payments and in the terms of trade, the extent of the improvement in either of them being determined by the elasticities of demand and supply. We usually neglect the fact that the expansion in the production of the commodities protected by tariffs may require a diversion of some factors from the production of export goods, and that this may have an unfavourable effect on exports and on the balance of payments. Similarly, the reduction in the volume of imports means that less of those goods is being produced abroad and that the factors thus made unemployed may seek employment in the production of the goods which the country imposing the tariffs is exporting; this too may have an unfavourable effect on that country's exports and on its balance of payments. We neglect also the possibility that tariffs may stimulate investment in the industries producing goods competing with imports; this may lead to inflationary tendencies in the whole economy; some deflationary measures may therefore be required to keep the economy in balance; and these may result in a fall in the prices of exports, in a deterioration of the balance of payments, and in less favourable terms of trade. The present article is an attempt to take into account all these secondary effects. The analysis is based on a long and rather laborious argument in mathematics. In order, however, to make the article readable also to those who have no patience to follow pages of mathematics line by line and are, therefore, prepared to take certain