The sudden announcement of sweeping tariffs by the US government on what president Donald Trump called ‘Liberation Day’ has brought renewed attention to trade barriers and their consequences.
The measures, which include a blanket import tariff and additional country-specific duties, illustrate how quickly trade policy can shift and how rapidly such decisions can introduce uncertainty into global markets. For investors, understanding what tariffs are and why governments impose them is critical to interpreting both the short-term volatility and the broader economic implications that follow these events.
DEFINING TARIFFS
A tariff is a tax levied by a government on goods that are imported from abroad. In some cases, countries may also apply tariffs to exported goods, although this is far less common.
Tariffs are collected at the border, typically by customs authorities and are paid by the importer. While governments do not set prices directly through tariffs, they affect the final price of imported goods, often making them less competitive compared to locally produced alternatives.
The mechanism of a tariff is simple: by increasing the cost of a foreign good, demand may shift toward domestic suppliers. However, the economic effects are rarely confined to that direct substitution. Tariffs can influence consumer prices, business input costs, supply chain strategies and even international diplomatic relations.
TYPES OF TARIFFS
Tariffs can take several forms, with the three most common being ad valorem, specific and compound tariffs.
An ad valorem tariff is calculated as a percentage of the value of the imported good. For example, a 10% tariff on a £1,000 piece of machinery would result in a £100 duty. This type of tariff adjusts automatically with the price of the good, which can help governments maintain consistent proportional revenue.
A specific tariff is a fixed fee based on a measurable unit, such as weight or quantity. For instance, a government might charge £50 per tonne of imported steel, regardless of its market value. This approach offers predictability but does not account for fluctuations in price or quality.
A compound tariff combines both ad valorem and specific elements. A compound tariff might apply a fixed fee plus a percentage of value – say, £10 per unit plus 5% of its total worth. These tariffs are more complex but can target both volume and value simultaneously.
Each type of tariff has different implications for pricing, revenue collection and trade negotiations. The choice of which to apply depends on a government’s objectives and the structure of the specific market in question.
WHY GOVERNMENTS IMPOSE TARIFFS
Governments use tariffs for a variety of economic and strategic reasons. One of the most common is to protect domestic industries from foreign competition. By making imported goods more expensive, tariffs can give local producers a price advantage, encouraging domestic production and preserving jobs in key sectors. This form of protectionism is often politically popular, especially in industries considered vital to national interest or employment.
Another key motivation is revenue generation. Particularly in developing countries with limited tax infrastructure, tariffs can provide a relatively straightforward way to collect funds for public spending. While less significant in advanced economies like the UK, this use of tariffs remains important in many parts of the world.
Tariffs are also used as a tool for retaliation or negotiation. When a country believes that its trading partner is engaging in unfair practices – such as dumping, subsidies or barriers to entry – it may impose tariffs in response. This is often framed as a corrective measure designed to level the playing field. However, retaliatory tariffs can escalate quickly, leading to broader trade disputes that affect multiple sectors and economies.
In some cases, tariffs serve strategic or security interests. A government might restrict imports of specific goods from certain countries due to geopolitical concerns or to maintain supply chain resilience in sensitive sectors like defence, energy or technology.
THE BROADER ECONOMIC CONTEXT
While tariffs are a direct policy instrument, their indirect effects can be far-reaching. For example, when tariffs raise the cost of intermediate goods – such as components used in manufacturing – they can reduce the competitiveness of domestic exporters who rely on those inputs. This creates a complex feedback loop that may not align with the original policy goal.
Moreover, global supply chains mean that goods often cross multiple borders before reaching their final destination. Tariffs applied at any stage can ripple through the chain, affecting pricing, delivery timelines and business decisions across regions. In this environment, sudden policy shifts like the US Liberation Day tariffs can have destabilising effects, not only on trade volumes but on investor sentiment and capital flows.
For investors, the key takeaway is that tariffs, while seemingly narrow in application, often act as broad signals of economic direction. They reflect deeper policy priorities and can shift the risk landscape in ways that affect equities, bonds, currencies and commodities. Understanding the mechanics of tariffs is the first step to assessing their wider market implications.
This Trustnet Learn article was written with assistance from artificial intelligence (AI). For more information, please visit our AI Statement.