The impact of tariffs on demand

In recent weeks I have seen several comments on social media from Brexit supporters (some close to government) that a Britain outside the single market will be able to force a trade deal on EU countries which is beneficial to UK industry.  Their argument goes as follows:

  1. Britain is a big export market for EU goods
  2. Without a free trade agreement, exports from the EU will suffer
  3. EU exporters will therefore put pressure on the Commission and the Council of Ministers to ensure their UK exports are not affected by tariffs.

The example often given with this argument is that of the German car industry with the claim that the UK is the biggest importer of German cars.

I find this argument extremely simplistic and not a true representation of the car market in Europe or of the effect of pricing in that market.

Liam Fox MP, the minister responsible for new trade deals following Brexit; is apparently in favour of the UK leaving both the single market and the European Customs Union.  He is arguing that the UK’s new trading relationship with Europe should be based on World Trade Organisation rules.  Currently the WTO advises a 10% tariff on motor vehicles.

Several marketing and economic theories relate to price.  The first is that price can be used to position products in their market and to reflect quality.  For example, for many years Stella Artois advertised their lager as ‘Reassuringly Expensive’ i.e. that you paid more but received a higher quality product.  Contrastingly, Aldi currently advertise their products as being of equivalent quality to big name brands but at a value price point.

Secondly, there is the economic theory of Price Elasticity of demand.  This states that in some markets a small change in price can have a dramatic effect on consumer demand (an elastic market) but in other markets a similar change of price will not affect demand (an inelastic market.

Thirdly, there is the theory of psychological pricing.  That price represents the consumers expectations in relation to a product or brand and that if the price is not in line with those expectations consumers will experience cognitive dissonance.

Taking these theories in account, how would a 10% tariff affect the sale of BMWs compared to the more utilitarian Nissan.

BMWs and other German car, such as Mercedes and Porche, are marketed as prestigious marques.  They are sold at a price premium.  The higher price of these vehicles reflects the quality of the brand and meets the expectations of their affluent professional target market segment.

Sunderland built Nissans are sold as mid-market family cars where value for money is seen as an important element of the marketing proposition.

A 10% tariff on a £40,000 BMW would increase the price to £44,000.  A £15,000 Nissan would rise in price on the continent to the Euro equivalent of £16,500.  It is probable that BMW’s target market is far more inelastic than that of Nissan.  It is likely that the rise in price would have a far greater effect on the demand for Nissans than it would for BMWs.  UK exports of family cars to the EU could easily be hit harder than sales of BMW’s in the UK.

The Brexiteers argument also ignores the ability of BMW, Mercedes, Audi, etc. to absorb some of the tariff cost or to alter their product ranges to take account of the tariff.  For example, BMW could decide to target a different mix of market segments; reducing the exportation of base models to the UK and concentrating more on the premium level models which offer a greater margin.

It seems that Leave supporters are taking a basic accountancy view on the effect of tariffs.  They are ignoring the marketing aspects to pricing and the fact that German cars are sold in more price inelastic segments of the market than that of the family cars exported out of the UK.

I believe that the best future for UK industry is to be part of the single market.  However, this position will require the UK to accept free movement of labour and to pay access fees.  I doubt many on the Leave side of the argument will be willing accept these conditions.

If there is to be a tariff war between the UK and Europe, only one side will win, and it won’t be Britain.