Tariffs in One Lesson

A topical addition to the regular series, this also serves to teach trade/balance of payments.

Imagine long ago two towns, Narnia and Farnia, nearby each other but which were isolated by mountains and seas from other distant cities. Separating the towns was a dense forest.

Each town has enough to be self sufficient, but they find many opportunities to trade with one another. To facilitate trade a small path through the forest has been forged and is largely maintained by Narnia, the wealthier of the two towns. There is quite a bit of trade in both directions.

They have some very limited trade with others from farther away, but this is not too often or extensive—the difficulties (transactions costs) are generally way too high.

By far the trade between the two towns dwarfs all other external trading combined.

People make things in both towns that are then sold in the other town. And often people travel from one town to another to perform service work. People also come to the other town to have service work done. The different combinations vary across all possibilities finding solutions that fit the buyers and sellers best in each particular situation.

As it happens to be, Narnia consumers end up buying more goods from Farnia than Narnia producers sell to Farnia as measured by total value. Hence, Narnia has a goods trade deficit with Farnia, but this is mere accounting.

Also as it happens to be, Narnia producers end up selling more services to Farnia than Narnia consumers buy from Farnia. Hence, Narnia has a services trade surplus with Farnia, but this is mere accounting. This difference is only about half of the difference between the value of goods bought/sold. Therefore, Farnia regularly finds itself with more Narnia dollars than it wants even after exchanging currencies a bit. So it ends up buying assets in Narnia with the difference. Narnians also buy assets in Farnia, but the net investment is by Farnians in Narnia. Hence, Narnia has an investment (capital) surplus with Farnia, but his is mere accounting.

These assets include land in Narnia, businesses in Narnia, and debt of Narnians. Obviously, these assets need to be desirable and productive for the Farnians to want them. Also obviously, the businesses owned by Farnia that are in Narnia employ Narnians. Very typically everyone who is a party to these many transactions is satisfied with the arrangements and exchanges.

One day when walking down the winding path through the forest, a group of Farnian traders came upon a very large boulder right in the middle of the path blocking passage. Legend has it that it was not known how it came to be. Some thought the gods had spawned it there. Others (Narnians and Farnians) felt the government of the other town had placed it there. Still others (Narnians and Farnians) thought the government of their own town had placed it there. Suspected culprits included producers in each town who wished to thwart competition from the other town. None of this mattered for the end result—that trade had become more expensive.

To facilitate trade, people from both towns worked to build a system of stairs and ramps up one side of the boulder and then down the other. This was a large, one-time expense which carried with it additional on-going maintenance costs. Explicitly Narnia bore these costs more than Farnia, but that was not the end result as these costs were passed on in both directions through higher prices on trade.

More importantly, trade itself became directly more expensive as it took more manpower and animal power to traverse the path with the boulder now a part of it. This also added to cost in terms of time. Even though Farnians generally did most of the delivery and shipment back and forth on the path, these costs were distributed in differing proportions depending on the unique circumstances of each type of good or service being traded.

This overall distribution of costs was very, very difficult to perceive much less calculate. All that was certain was that trade in goods and services was now more expensive; hence, there was less of it than before.

In some cases this was not too obvious a burden on individual exchanges. Buyers barely noticed that they were slightly poorer and sellers barely noticed a change in profits. But in other cases the change was stark. Buyers in those markets noticed when, say, they no longer had access to a special good or service that was only produced in the other town. Sellers too noticed these acute pains as they had greatly fewer customers.

Yet, the boulder remained and trade, albeit less of it, continued. For generations children in Narnia and Farnia would hear about the glory days of yore when there was no boulder. A time when anyone could make the journey that now was limited to those with strong legs and sturdy oxen.

“But be thankful,” the elders would chide them. For if it were not for the brave man who believed and proved that the boulder could be overcome, we would have no trade and much less wealth. And that is why we celebrate him and the boulder that bears his name, Mount Tariff.

PS: I gave up after many attempts to get ChatGPT to actually put the boulder across (blocking!) the path. AI can be as dense as politicians sometimes.