GED Explains: Border Adjustment Tax

  • Export subsidies increase the country’s exports, causing the appreciation described above.
  • An import tax reduces the country’s imports and therefore, exports for other countries. Falling exports mean lower demand for the currency of foreign countries, so causing foreign currencies to depreciate. If foreign currencies depreciate, this automatically means that the domestic currency will appreciate.
  • Before the tax on imported products is introduced, the European product costs $10 in the USA.
  • After the import tax is introduced, if the European company wishes to continue to obtain a price of €10 for this product, it will have to raise the price to €12.50 (20% of €12.50 = €2.50).
  • With the exchange rate assumed here ($1 = €1), the price in the USA will rise to $12.50. Because of the higher gross price of the European product, demand among US consumers for the product will fall. As a consequence, the euro will depreciate.
  • Coming back to our example, this will result in the dollar appreciating by 25 per cent, i.e. $1 = €1.25. Correspondingly, the euro will depreciate by 20 per cent (€1 = $0.80).
  • The gross price which the American consumers pay would therefore return to €12.50, which at $0.80 to €1 = $10. As a consequence, the import volumes in demand from US consumers will remain constant.
  • Calculated in dollars, European companies will obtain a lower net price at a gross price of $10 ($10 minus $2 =$8), due to the import tax payable. However, due to the dollar’s 25-per cent appreciation, this will still mean a net price of €10 ($8 at €1.25 per euro = €10). This means that European companies’ supply volumes in the USA will remain unchanged.
  • Before the export subsidy is introduced, an American product worth $10 costs €10 in Europe.
  • A 20 per cent export subsidy reduces the production costs by $2, so that the American company can sell its products in Europe for a price of $8, which equals €8. This lower price leads to an increase in demand in Europe for products from the USA, which means that the USA can increase its exports.
  • This higher demand for exports among Europeans increases the demand for dollars, causing that currency to appreciate. This appreciation results in an increase of the price of American products, calculated in euro. The dollar appreciates by 25 per cent, meaning that American products in Europe will once again cost $8. €1.25 per dollar = €10. Since the price for the US product in Europe calculated in euro will remain unchanged at €10, exports from the USA will still correspond with their original level.
  • Due to the appreciation of the dollar and the depreciation of the euro accompanying it, American companies will now only receive $8 for each unit of product sold in Europe. However, the American state will pay a subsidy of $2, meaning that total revenue will be $10. This will keep the export volumes supplied by US companies constant.




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Global & European Dynamics

Global & European Dynamics

Our mission on this blog is to shed light on Europe’s role in the world economy.

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