Trade wars and tariffs: how they affect investment decisions

Have you noticed in the news lately how there is more and more talk about trade restrictions, sudden price rises or international economic tensions? Perhaps you have even wondered what is really behind these terms and political bluster. One such old but always topical issue that is making waves in the global economy and affecting all our daily lives is tariffs.

But what exactly are these tariffs? In the simplest terms, a tariff is a tax that a country imposes on cross-border goods. This article is a practical guide to understanding tariffs. Together we dive into the world of tariffs, find out why and how they are used, what their far-reaching consequences are for businesses and for you as a consumer and investor. We will also look at the past, as lessons from the past will help us to see today's events with a clearer perspective.

What are tariffs?

A tariff is essentially a tax that a country imposes on goods that it imports (known as a "customs duty"). import tariffs), or, although less frequently, goods leaving the country (export tariffs). Import tariffs dominate the daily economic debate and news coverage, as they are the most widespread and their impact is felt more widely.

Not all tariffs are the same. There are several types, the main ones being:

Ad valorem tariff (Ad valorem tariff): This is the most common type of tariff. It is set as a percentage of the declared value of the goods. For example, if an imported car is subject to the 10% tariff and the value of the car is €20 000, the tariff would be €2000.
Specific tariff: It is a fixed amount of money to be paid per unit of goods (e.g. kilogram, litre, piece), regardless of the value of the goods. For example, there may be a tariff of €1 per kilogram of sugar imported.
Combined tariff: As the name suggests, it consists of both of the above components - the value and the specific part.

Now the important question: who actually pays this tariff? Although legally the importer (the company bringing the goods in) pays the tariff at the border, the cost is usually passed on in the supply chain. This means that it ultimately reaches the consumer in the form of a higher price. Sometimes, especially when competition is fierce, a foreign producer or exporter may also absorb part of the tariff cost in order to maintain market share and avoid overcharging. But the rule of thumb is that tariffs tend to drive up the price of goods.

Why and how are tariffs used?

Countries do not impose tariffs arbitrarily. They are usually driven by specific objectives and strategies. Let's look at some of the main reasons:

Protection of domestic industry (protectionism): This is historically the most classic and common reason. Tariffs make imported goods more expensive, thereby giving an advantage to domestic producers who can compete on more favourable terms. In this way, the state can, for example, protect its own farmers from cheaper foreign production or support infant industries (the "infant industry argument").
Increasing public revenue: Particularly in the past, when other forms of taxation were less developed, tariffs were an important source of revenue for many countries. Nowadays, in developed countries (including those of the European Union), it is a secondary objective, but in some developing countries tariffs still play an important role in fiscal revenues.
Ensuring national security: Sometimes tariffs are imposed to protect strategic sectors. These can be defence industries, certain high-tech sectors, the pharmaceutical industry or even the food industry. The aim is to ensure that a country does not become overly dependent on other countries, especially potentially unfriendly partners, in critical sectors.
Countermeasures (retaliation): If one country imposes tariffs on goods from another country, the other country can respond with tariffs of its own. This is often referred to as a 'tariff-for-tariff' policy and can escalate into a trade war, with countries imposing restrictions one after the other.
Consumer protection (indirectly): Although more specific measures (such as sanitary and phytosanitary requirements), tariffs can also be used in exceptional cases to restrict imports of dangerous, low-quality or substandard products.
Environmental protection: This is a new and growing trend. A good example is the European Union's planned the Carbon Border Adjustment Mechanism (CBAM).. It aims to tax certain goods (such as steel, cement, aluminium, fertilisers, electricity) from countries with less stringent policies to limit greenhouse gas emissions. This is an attempt to avoid a 'carbon leakage' - where production moves from countries with stricter environmental requirements (such as the EU) to countries with less stringent requirements without reducing global emissions. It also provides an incentive for other countries to tighten their climate policies.

Tariffs are not introduced overnight. Usually, it is decided by the government or approved by a legislative body (parliament). At the international level, tariffs and trade policy are framed by. World Trade Organisation (WTO), to which most countries in the world have signed up. The WTO aims to promote freer trade and settle trade disputes. As far as the European Union is concerned, it is important to know that trade policy, including tariffs with third countries, is largely a shared competence of the Community - that is, the Member States pursue a common trade policy.

Effects of tariffs - short and long term domino effects

The impact of tariffs on the economy is complex and often controversial, creating both winners and losers. The effects can also vary in the short and long term.

Impact on the domestic economy:

Manufacturers: Those domestic producers whose goods will be subject to import tariffs will initially be on the winning side. Their production will become relatively cheaper than that of their imported competitors, which could boost their sales and profits. On the other hand, those producers who use imported components or raw materials in their production process will suffer as their input costs increase. This may force them to raise prices or accept lower profit margins.
Consumers: In most cases, consumers are the losers because of tariffs. Imported goods become more expensive, and domestic producers may also increase prices as competitive pressure is reduced. The result is less choice and higher prices, reducing consumers' purchasing power.
Employment: The impact on employment is complex. In the sectors covered, there may be a short-term increase in jobs as domestic production increases. However, in other sectors, employment may fall. For example, if other countries respond with tariffs of their own, exporting firms and their workers will suffer. Similarly, firms whose input costs rise as a result of tariffs, forcing them to reduce or optimise production, may also suffer. The net impact on employment is often controversial and depends on many factors.
Inflation: Tariffs can put upward pressure on prices more broadly, contributing to the overall... inflation. If many goods become more expensive, consumers will have to spend more, which may reduce demand for other goods and services.

Impact on international trade:

Declining trade volumes: Higher prices and restrictions discourage both imports and exports. Global trade flows may decrease.
Supply challenges and supply chain restructuring: Companies used to stable supply chains will have to look for alternative markets or production sites to circumvent or mitigate the impact of tariffs. This can lead to shorter supply chains (so-called "shorting"). nearshoring), or to the relocation of production to friendlier countries (friend-shoring).
Trade wars: As mentioned, unilateral tariffs can easily trigger counter-tariffs, leading to an escalation of trade tensions. These 'trade wars' are damaging to all parties and create great uncertainty in the global economy.

Impact on global relations:

Political tensions: Trade conflicts are often not confined to the economic sphere, but can spill over into wider political disagreements and tensions between countries.
Weakening international institutions: When big countries start flouting international trade rules (such as those of the WTO) and taking unilateral decisions, it undermines the multilateral trading system that has helped ensure stability and growth for decades.

Reactions around the world and examples from today: tariff drama on stage

Tariffs are not just a theoretical concept in economics textbooks; they are very real and affect our daily lives. Let's look at some recent and telling examples:

US-China trade tensions: Since 2018, the world has been watching the US-China... trade dispute. It started with the US imposing massive tariffs on hundreds of billions of dollars worth of Chinese goods, from electronics and machinery to clothing and toys. China retaliated with tariffs of its own on US goods, especially agricultural products such as soybeans. The effects of this conflict have been wide-ranging: supply chains have been disrupted, companies have had to seek alternative markets and production sites, and global economic growth has taken a hit. While efforts have been made to ease tensions, many tariffs remain in place and the relationship is fragile. The European Union, including indirectly Estonian businesses and consumers, has had to navigate this conflict as it affects global prices and trade flows.
The EU's carbon tax mechanism (CBAM): This is one of the newest and most innovative examples of the use of tariffs for environmental purposes. The EU plans to phase in tariffs on imports of certain energy-intensive commodities (initially steel, cement, aluminium, fertilisers, electricity and hydrogen) from countries that do not put a price on greenhouse gas emissions comparable to the EU. The aim is to avoid EU companies, which have to pay for CO2 emissions, being put at a competitive disadvantage with imported goods from countries where there is no such cost. It also aims to motivate other countries to tighten up their climate policies. The CBAM is still in the early stages of implementation and its full impact will become clear in the coming years, but it has already generated much international debate.
Reactions to geopolitical conflicts: For example, following Russia's full-scale invasion of Ukraine in 2022, Western countries, including the EU, imposed massive sanctions against Russia. These included various import bans and tariffs on certain goods (e.g. steel, timber, alcohol), as well as export restrictions. Russia, in turn, responded with measures of its own. Such geopolitically motivated trade restrictions have drastically altered trade flows, prices (especially in the energy sector) and forced companies to adapt quickly.

Businesses and consumers will not remain passive bystanders in such situations. Companies may start to look for new suppliers, invest in relocation (e.g. back home or to nearby countries), change their products or target markets. Consumers may change their purchasing patterns, preferring cheaper alternatives, domestic products (if available and competitive) or reducing consumption of certain goods.

Historical examples and lessons learned

History is full of examples of the ups and downs of protectionism and their consequences. Some of them are particularly cautionary:

Smoot-Hawley tariff (USA, 1930): This is perhaps one of the most notorious examples of the harmfulness of protectionism. In 1930, at the start of the Great Depression, US President Herbert Hoover signed the Smoot-Hawley Tariff Act, which raised tariffs on thousands of imported goods to record highs. The aim was to protect American farmers and industry from foreign competition. But the result was disastrous. Other countries quickly responded with high tariffs of their own on US goods. International trade collapsed - within a few years, world trade was down by nearly two-thirds. Many historians and economists believe that, while the Smoot-Hawley tariff may not have directly caused the Great Depression, it significantly exacerbated it and prolonged the crisis. It remains a cautionary tale of how well-intentioned protectionism can lead to unintended and devastating results.
Land laws (Corn Laws) in Great Britain (1815-1846): After the end of the Napoleonic wars, the landowning class that dominated Britain's parliament introduced the Corn Laws. These laws severely restricted and heavily taxed imports of cheaper imported grain to keep the price of domestic grain artificially high and protect landowners' incomes. This, however, led to high food prices, which hit the working class and urban populations particularly hard, causing social unrest and poverty. After decades of debate and struggle, the Corn Laws were repealed in 1846. This is seen as an important turning point in Britain's move towards free trade, which contributed to the country's economic prosperity in the second half of the 19th century, although it was a painful process for domestic farmers.

What lessons can we take from these and other historical examples?

Protectionism can benefit a narrow interest group or sector in the short term, but in the long term it can damage the economy as a whole. This could reduce innovation, hamper competitiveness and raise prices for consumers.
There are rarely clear winners in trade wars. In most cases, all parties lose out as trade volumes fall, uncertainty grows and economic growth slows.
While fully unrestricted free trade is an ideal that is difficult to achieve in practice and can have its downsides (e.g. social inequalities, environmental damage), it is... open markets and a rules-based international trading system. (as WTO seeks to represent) has historically proved more beneficial than broad and unpredictable protectionism.

Tariffs and the investor - what should you keep in mind?

If you're an investor or thinking about investing, it's important to understand how tariffs and wider trade policies can affect your portfolio. Here are some food for thought:

- Sectoral impact: Tariffs do not affect all businesses and sectors in the same way.
- Importers and producers dependent on imports: Companies that import a lot of goods for sale (e.g. retailers) or use a lot of imported components in their production (e.g. many industrial companies) may suffer from tariffs. Their costs will rise, which could reduce profit margins or force prices up, which in turn could reduce demand.
- Exporters: Companies that sell a large part of their production to foreign markets are vulnerable to countervailing tariffs. If the destination country imposes tariffs on their products, they become more expensive and less competitive there.
- Domestic competitors to imports: Those firms competing on the domestic market with imported goods stand to gain in the short term if tariffs are imposed on foreign competitors.
- Market volatility: News of the imposition of tariffs, the breakdown of trade negotiations or the escalation of trade tensions often create uncertainty and volatility in markets. This can affect stock prices (especially in the sectors or countries concerned), currency exchange rates and also commodity prices.
- The importance of diversification: This is the golden rule of investing, and it applies here too. Don't put all your eggs in one basket. Diversify your investments geographically (across countries and regions) and across sectors. This will help to hedge the risks arising from trade policy decisions in a particular country or sector.
- Long-term vs short-term perspective: Trade policy can be volatile and political winds can change quickly. A long-term investor should focus primarily on the fundamentals of companies - their business model, competitive advantages, financial position and adaptability - rather than on short-term political ups and downs. At the same time, it should be aware that long-term protectionist trends or significant changes in global trade relations may alter the attractiveness of certain markets or sectors in the long term.
- Follow news and analysis: Keep up to date with major trade policy developments and read reliable analyses of their potential impact. This will help you make more informed investment decisions.

Summary

As we have seen, tariffs are a complex and multi-faceted economic policy tool. They have the potential to protect domestic industry and generate revenue for the state, but at the same time they can raise prices for consumers, harm exporters, reduce overall welfare and create international tensions. History has shown that protectionism can have serious negative consequences, especially if it becomes widespread and leads to trade wars.

So what are the trends for the future? In recent years, we have seen signs of a slight increase in protectionism and a rethinking of the current principles of globalisation. Geopolitical considerations are playing an increasing role in trade relations. Countries are thinking more about strategic autonomy and security of supply chains. At the same time, the global economy and international supply chains are so deeply integrated that it would be extremely costly and difficult, if not impossible, to fully untangle them. In the future, we are likely to continue to see a search for a balance between the ideals of free trade and protectionist pressures, with a possible focus on more selective protectionism in certain strategic sectors and on regional trade blocs.

As an informed citizen, consumer and potential investor, it is important for you to understand these dynamics. Tariffs are just one piece of the puzzle in a large and ever-changing economic picture, but understanding this piece will help you better navigate today's complex world and make more informed decisions that will affect your wallet and your future.