Passing on the Cost

One of the centerpieces of President Donald Trump's economic policy was the promise to enact protective tariffs on imports to dampen the influence of foreign competition on American sales. While to date the Trump administration has not released an official rate of the proposed tariff, White House Press Secretary has thrown out the tentative number of 20%, not as a concrete proposal, but as an example of what was possible. This has led to widespread speculation on how such tariffs could affect the American consumer, either beneficially or adversely. In this article, we explore one of the economic assumptions behind some of the opposition to protective tariffs.

Protective tariffs have always waxed and waned throughout American history; the Founding Fathers advocated heavily for protective tariffs as a means of encouraging industry in the young Republic - modern conservatives, by contrast, have tended to eschew tariffs as a violation of the concept of free trade. Consequently, Trump's protectionist policies have divided Republicans, who are typically divided between nationalists who favor them and neo-cons for whom any sort of protectionism is economic heresy.

One group most certainly opposed to tariffs are big retailers - your Wal-Marts, Krogers, and Home Depots. These large mega-retailers import the lion share of their merchandise from cheap producers in Asia or Mexico. These cheap imports help the mega-stores to undercut local competition, who cannot compete with their low prices. The profit made on such imports exists within the difference between the ultra-cheap third-world production cost and the much higher American retail sale cost. A protective tariff such as that proposed by Trump would eat into the profits of companies that rely on such business models.

In my home state of Michigan, several major retailers have voiced their opposition to the proposed tariff through the Michigan Retailers Association, a kind of lobbyist/interest group for retail stores. In an interview with the Michigan news agency Mlive, representatives of the MRA stated that the tariffs mean that "American consumers are being asked to foot the bill for a new $1 trillion tax" that would raise consumer costs on everyday necessities by as much as $1,700 per year. United States Congressman Justin Amash - a Michigan conservative elected on the Tea Party wave in 2010 - also opposes the Trump tariffs; his office's official statement says that "It will raise the prices of goods and services in the United States" and will hurt American families (ibid).

It is not the purpose of this article to debate the pros and cons of a protective tariff. I want to note the rationale the various opponents of the tax give for why it will be so harmful. From the same Mlive article linked above, we have the following comment from Michigan Retailers' Association spokesperson Tom Scott, who says, "No matter what you call it, you are raising the cost on retailers who have no choice but to pass it along to customers." This is the essential mechanics of how the tariff will supposedly equate to "a new $1 trillion tax" for which American consumers will have to "foot the bill."

Mr. Scott's statement rightly notes that the tax's immediate impact will be on the retailers, as the tax is paid by the American company paying to import the goods from out of the country. But note his comment that these retailers will then have "no choice" but to pass the increase along to the consumers. Why would the retailer have "no choice" about passing on the increased cost to the consumer? Is it true that a retailer has "no choice" about passing on costs?

In some cases this could be true, such as when the increased cost eats up the profit entirely, such that the business literally cannot survive without a price increase. Anyone who has worked in a pizza shop probably knows the most expensive ingredient on a pizza is the mozzarella cheese. If something happens and the cost of mozzarella increases such that it consumes the profit margin on an individual pizza, that pizzeria owner may have to raise his prices (i.e., pass the burden on to the consumer) in order to stay in business. Of course, even then he does not have "no choice"; he could try to cut his own expenses before resorting to a price increase, and only pass the cost on if that was not sufficient.

This scenario, however, is rare, as most price fluctuations retailers face are incremental. In the vast majority of circumstances, the price increase or tax does not of such a degree as to make or break the company entirely. Usually the retailer is faced with absorbing an increase that, while not breaking him, still cuts into his profit margin. He is faced with a prudential decision over what to do about that. This is especially the case with a mega-retailer like Wal-Mart, whose profits are so high that not even major shifts in production costs could totally destroy their profit margin. Even if the hypothetical 20% tariff was applied to every single import universally - which it wouldn't - the company would be a long, long way from the sort of insolvency that would necessitate Wal-Mart having "no choice" but to pass the increase on to consumers.

Obviously not every company has the magnitude or profits of Wal-Mart. Privately owned Michigan-based regional superstore Meijer posted a 2016 revenue of only $16 billion, clearly paltry compared to Wal-Mart's $130 billion gross profit for 2016. Does this mean production price increases in these medium sized mega-retailers would necessitate passing the cost on to consumers? The answer is no, for although Meijer's revenues are much smaller than Wal-Mart's, so are its expenses. Costs would have to increase dramatically to make passing the cost a matter of necessity.

It is clear that when Tom Smith of the Michigan Retailers Association says retailers will have "no choice" but to pass a production cost increase on to the consumer, what he means is that the retailer has no choice if they want to maintain their profit margin. I am certainly not arguing a company should not make profit. I am arguing against a kind of disingenuous economic assumption that a retailer has "no choice" but to pass increase costs on to the consumer. In the vast majority of cases, the retailer has several choices. He can examine his outlays and reduce expenditures. He might even want to lower consumer costs in an attempt to gain market share; I know the owner of service business who, when faced with rising prices, lowered his company's service calls in order to broaden his customer base at the expense of the competition. The strategy worked; he had record profits that year.

Of course, a retailer generally always has the option to simply absorb the increase. A retailer does have the choice to choose to keep his retail prices the same and accept diminished profits. Or he may have to take the diminished profits because of the nature of what he is selling. For example, to go back to pizza, a pizza shop who advertises a $7.00 pizza has invested considerable marketing in branding that particular product - he may have spent $20,000 advertising his $7.00 special. When the price of cheese increases, he isn't going to want to just change the price of the pizza. More than likely he will try to broaden his market share to attract a wider customer base.

There is no rule either economic or moral that a retailer has "no choice" but to pass on cost increases to consumers when the increase has not totally negated their profitability. Obviously a company wants to stay profitable. Obviously they have to reinvest parts of that profit back into the company to keep it growing and healthy. Obviously supply and demand fluctuate, and a company is going to be attentive anytime profits fall. This essay is not a tirade against the concept of profit. It is a tirade against turning a prudential, moral judgment into some kind of blind economic necessity. When a company faces an increase in production cost, nine times out of ten they have a choice on how they want to deal with it that is prudential, not compulsory. Unless the cost increase is so high as to wipe out all profits, the company always has a choice to absorb the cost instead of passing it on. It's not a matter of necessity.