3. Tariffs in General Tariffs are simply taxes a country places on its imports. Purpose of tariffs: to protect domestic (import-competing) industries to raise revenue for the government There are two sorts of tariffs: Specific Ad valorem.
4. Specific Tariffs Specific tariffs involve charging a tax per physical unit imported. For example, US tariff on frozen orange juice is 7.85¢ per liter. Specific tariffs may be easier to administer. Specific tariffs are less likely to maintain the same degree of protection in times of high inflation.
5. Ad Valorem Tariffs Ad valorem tariffs involve charging a tax as a percentage of the value of the good. For example, US tariff on golf clubs is 4.4%. Ad valorem tariffs may be more complicated to administer than specific tariffs, but do hold their protective value in the face of inflation.
6. Preferential Duties and the Generalized System of Preferences (GSP) Preferential duties: Tariff rates vary according to product’s geographic source. The GSP involves developing countries paying lower (or zero) tariffs when exporting to the developed world.
7. Permanent Normal Trade Relations Status (PNTR) PNTR status is a way to achieve non-discrimination in trade. If the U.S. negotiates a lower tariff with a PNTR country, U.S. tariffs fall for all countries with which the U.S. has a PNTR treaty. This is also called multilateralism (and once was called ‘most favored nation’ status).
8. Offshore Assembly Provisions With OAPs, the tariff applies only to the foreign value added. For example, if there is a tariff on computers, the tariff is not applied to the value of domestic-made components.
9. Measuring Tariffs This is sometimes referred to as the “height” of tariffs. There are two ways to measure this height: Unweighted average Weighted average
10. Unweighted Tariffs Suppose there are 3 imported goods. Good A has a 30% tariff Good B has a 40% tariff Good C has a 10% tariff The unweighted average is the simple average of the three: (30%+40%+10%)/3 = 26.7% Unfortunately, this doesn’t account for the fact that the quantities of each good that are imported may differ.
11. Weighted Tariffs Suppose there are 3 imported goods. Good A has a 30% tariff and 200 units are imported Good B has a 40% tariff tariff and 100 units are imported Good C has a 10% tariff tariff and 400 units are imported The weighted average is the simple average of the three:
12. Nominal and Effective Rates of Protection Nominal tariff rates apply only to final products. Effective tariff rates take into account not only tariffs on final products, but also those on inputs into the final product. Basic idea: A tariff on an intermediate good (e.g., steel) raises the cost of many final goods (cars) This reduces the protection afforded to auto makers.
13. Nominal Rate of Protection (NRP) First consider the nominal rate of protection (NRP). NRP = (PDt - PDFT)/ PDFT NRP is always equal to the tariff on the final product.
14. Effective Rate of Protection (ERP) First, let’s define value added VA = price of good - price of inputs Now we can define effective rate of protection ERP = (VADt - VADFT)/VADFT
15. ERP When tariffs on inputs > tariffs on final products, ERP < NRP. When tariffs on inputs < tariffs on final products, ERP > NRP. When tariffs on inputs = tariffs on final products, ERP = NRP.
16. ERP: The Bottom Line ERP gives an indication of the effects of the whole tariff structure on industries; NRP only looks at particular goods. ERPs have an impact on resource allocation: resources flow out of industries with low ERPs, and into industries with high ERPs.
17. Export Taxes An export tax is a tax a government places on its own exporters. Are applied for several reasons to raise government revenue. to encourage domestic processing of raw materials.
18. Export Subsidies Governments can encourage exports by paying exporters a certain premium per unit exported. Export subsidies work like export taxes in reverse.
19. Non-Tariff Barriers Trade gets restricted in ways not involving taxes: import quotas, “voluntary” export restraints (VERs), and other provisions.
20. Import Quotas Many countries restrict the quantity of certain imports allowed entry in a given time period (usually a year). Quotas affect the quantity directly and the price indirectly; tariffs do the opposite. However, in most respects quotas and tariffs have the same effects.
21. “Voluntary” Export Restraints Importing countries “persuade” exporting countries to voluntarily limit their exports. Example: 1.68 million Japanese cars permitted annually beginning in 1981. There is an implied threat of tariffs or quotas if exporting country doesn’t comply. VERs exist for political reasons, not economically valid ones.
22. Government Procurement Provisions Some countries require their government to purchase from domestic suppliers unless the imported version is substantially cheaper. Example: “Buy American” Act requires many U.S. government purchases to be from domestic firms unless domestic bid is more than 6% higher.
23. Domestic Content Provisions Some countries require that a certain percentage of the value of a good sold domestically must consist of domestic components or labor. Example: NAFTA members do not allow duty-free access to goods unless at least 62.5% of the goods’ value originates in NAFTA countries.
24. European Border Taxes European (and some other) countries have value added taxes that increase the prices of domestically produced goods. To compensate, European countries impose tariffs on imported products.
25. Other Non-Tariff Barriers Administrative classification Restrictions on trade in services Trade-related investment measures Exchange rate controls Quality provisions Packaging and labeling requirements
27. Consumer Surplus Consumer surplus (CS) is a measure of the overall well-being of consumers. CS is the area between the demand curve and the price. CS varies inversely with the price.
29. Producer Surplus Producer surplus (PS) is a measure of the well-being of producers. PS is the area between the supply curve and the price. PS varies directly with price.
31. Trade Restrictions in Partial Equilibrium: The Small Country Case What happens when a country imposes a tariff? Its domestic price rises. Therefore, tariffs: benefit domestic producers harm domestic consumers generate tariff revenue for the government
32. Tariffs: Small Country Case CS falls by area a+b+c+d, or $656.25. PS rises by area a, or $393.75. Revenue rises by area c, or $175. Deadweight loss is areas b+d, or $87.50. P S $1.35 a c d b $1 D Q 2000 1750 1000 1250 14-32
33. Tariffs: Small Country Case A tariff makes producers better off, but overall, the small country’s welfare falls.
34.
35.
36. Export Taxes: Small Country Case An export tax tariff makes consumers better off, but overall, the small country’s welfare falls.
37.
38. Export Subsidies: Small Country Case An export subsidy tariff makes producers better off, but overall, the small country’s welfare falls.
39.
40.
41.
42.
43.
44. Tariffs in General Equilibrium: Small Country Case In free trade, producer equilibrium is at B0, and consumer equilibrium is at C0. The tariff changes production to point B1;consumption moves to C1 (on a lower indifference curve). Y C0 C1 B1 B0 Px/Py(1+t) (Px/Py)0 X 14-56
45. Trade Restrictions in General Equilibrium: The Large Country Case To understand the effects of protectionism in the large country case we can use offer curve analysis.
46. Tariffs or Export Taxes (PX/PY)t OCA OCA' Y (PX/PY)FT OCB Y1 By imposing a tariff or an export tax, Country A decreases trade volume, but improves its terms of trade (note: B’s terms of trade deteriorate). Y2 X2 X1 X
47. Export Subsidies OCA (PX/PY)FT Y (PX/PY)ES OCB Y2 Y1 Country A’s terms of trade deteriorate; volume rises. X1 X2 X
48. Import Quotas OCFTA (PX/PY)FT Y (PX/PY)IQ OCFTB Y1 The quota causes the imposing country’s terms of trade to improve, and trade volume to fall. Y2 OCIQA X1 X X2
49. VERs OCFTA (PX/PY)E Y OCFTB Y1 The quota decreases trade volume, and causes A’s terms of trade to deteriorate. Y2 OCVERB X1 X
51. Is Protectionism Ever a Good Idea? Our trade theories tell us that generally free trade is the best policy. Why, then, is there so much protectionism? What are the arguments for protectionism, and are any of them valid?
52. Trade Policy as Part of Broader Social Policy Objectives There are a number of common arguments in favor of protection. These may help certain groups within a country, or may help a nation achieve some overall goal.
53. Argument #1: Government Revenue Tariffs, export taxes, and perhaps quotas, can be used to generate government revenue. Trade taxes are attractive because: They are easy to collect. For developing countries, there may not be much income to tax. If country is large, it can pass some of the tax burden to trading partners. In the longer term, income or consumption taxes may be better choices.
54. Argument #2: National Defense There may be industries that are vital to national security. If these industries are diminished because of import penetration, the country may be vulnerable during times of conflict. Could other policies (such as stockpiling or production subsidies) be better?
55. Argument #3: Balance of Payments A country may wish to address a trade deficit by limiting imports. This would work if exports were not also diminished. However, a number of factors (e.g., retaliation by trading partners, a reduction of income abroad, a rise in value of domestic currency) make it likely that exports will fall. There is no guarantee that this approach will work.
56. Argument #4: Terms of Trade We’ve seen from offer curves that a country will improve its terms of trade by imposing a tariff or a quota, as long as it isn’t “small.” However, this assumes that the trading partner does not retaliate.
57. TOT2 Y TOT1 OCUS OCF When the U.S. imposes a tariff on French products, U.S. terms of trade improve (although volume decreases). X
58. Y TOT1 OCUS OCF However, it is very likely that France will retaliate with tariffs on U.S. products. Overall, the volume of trade declines, and the U.S. terms of trade may go up, down, or stay the same. X
59. Argument #5: Protection to Increase Nat’l Employment Unemployment high? Why not restrict imports? Wouldn’t this put Americans to work? No, because: Reduced income of trading partner lowers their demand for our exports. Our trading partners will likely retaliate. Our protection may trigger a dollar appreciation.
60. Argument #5: Protection to Increase Nat’l Employment Bottom line: jobs may be saved in the protected industry, but jobs in our export industries will be lost. In the U.S., export-industry jobs pay better on average than import-competing industries.
61. Argument #6: Protection to Increase Employment in a Particular Industry Even if overall employment isn’t increased under protectionism, tariffs can be used to increase employment in a particular industry. This will be costly, however. Consumers will be paying for every job created. A production subsidy might be a better idea.
62. Argument #7: Protection to Benefit Scarce Factor As we have seen, tariffs redistribute income from the owners of the relatively abundant factor to the owners of the relatively scarce factor. If this is the goal, fine: it will be costly, however.
63. Other Arguments Protection of certain key “national pride” industries Discriminatory protectionism: the Generalized System of Preferences (GSP)
64. Protection to Offset Market Imperfections Trade policy is sometimes used to correct for market failures caused by: externalities, foreign monopoly power, or domestic monopoly power.
65. Protection to Offset Externalities Let us consider two types of externalities: Negative consumption externalities: the consumption of a good by an individual may damage other individuals or society. Example: tobacco If the costs to society are ignored, too much of the good gets consumed. Positive production externalities: the production of a good yields benefits that affect other individuals or society. Example: skills that workers acquire at a firm can benefit other firms that might hire away the worker. If costs to society are ignored, too little is produced.
66. Protection to Extract Foreign Monopoly Profit If a foreign company is a global monopolist, a tariff may permit the domestic country to capture some of the monopolist’s profits. However, world efficiency and welfare are diminished because of the tariff. Would the foreign country retaliate?
67. Protection to Extract Domestic Monopoly Profit If a domestic company is a monopolist, an export tax may permit the government to capture some of the monopolist’s profits and transfer some of it back to consumers.
68. Protection as a Response to Int’l Policy Distortions Some protectionist policies by foreign countries may warrant protectionism in response. We’ll consider protection to offset dumping foreign subsidies
69. Tariffs to Offset Dumping Dumping occurs when: one country sells its product at a lower cost in the foreign market than in its domestic market, or when one country sells its product below cost in the foreign market.
70. Tariffs to Offset Dumping There are three types of dumping: Permanent (or persistent) dumping occurs when a foreign firm continually sells its product for a lower price than domestic firms. Often, this is because the firm faces competition when exporting, but has market power at home.
71. Tariffs to Offset Dumping Sporadic dumping occurs when the foreign exporter occasionally liquidates a surplus on the domestic market. Since this sort is short-term by definition, tariffs probably do more harm than good here.
72. Tariffs to Offset Dumping Predatory dumping: the idea is to sell below cost until rivals fold; then the predator can raise price to monopoly level. However, domestic firms could then enter the market again. It isn’t clear why a firm would want to do this. Still, if this behavior occurs it is probably inefficient.
73. Tariffs to Offset Foreign Subsidies When our trading partners subsidize their industries, we can punish those countries with countervailing duties. Foreign subsidies lower prices for domestic consumers. Still, foreign subsidies may harm domestic producers.
74. Strategic Trade Policy: Fostering Comparative Advantage Some argue that a country can foster comparative advantage by “strategic” trade policy. Possibilities include Protection of infant industries Protection to take advantage of economies of scale Protection to promote exports through research and development
75. Infant Industry Protection Basic idea: a country should protect a new industry from foreign competition until it grows up and gets big enough to realize economies of scale; that country may develop a comparative advantage! It is plain that domestic consumers will have to pay for this, but they may eventually benefit from having a globally efficient producer.
76. Infant Industry Protection Problems: Are there really economies of scale in the protected industry? If not, then the industry will never pay back what it cost to protect it. Protection may simply lead to inefficiency. There are typically factors at work to preserve the protection forever.
77. Economies of Scale in a Duopoly Framework Suppose firms take into account the actions of other firms. Suppose also there are economies of scale present. We can examine the effects of protection by considering each firm’s reaction function.
78. Economies of Scale in a Duopoly Framework Reaction functions slope downwards because increased sales by the other firm will depress price and profits, so sales are reduced. Xi* H (foreign-firm sales) F Equilibrium is reached at point E E F H Xi (home-firm sales)
79. Economies of Scale in a Duopoly Framework A tariff by the home country would shift the reaction function to the right, since the increased output lowers the home firm’s marginal cost. Xi* H' H (foreign-firm sales) F This reduces the foreign firm’s output and increases its marginal costs. F' E F E' F' H' H Xi (home-firm sales)
80. Economies of Scale in a Duopoly Framework It may be possible to use protection to help a domestic firm achieve economies of scale and an expanded market share. However, the foreign country may retaliate.
81. R&D and Home Firm Sales Suppose a firm can lower its marginal costs by investing in R&D. If the home country imposes a tariff, the home firm’s sales may rise. The increase in sales permits greater R&D investment; this lowers marginal costs and increases sales at the expense of the foreign firm. Retaliation may occur.
82. Export Subsidy in Duopoly Suppose a firm can lower its marginal costs with the help of an export subsidy. This may cause the foreign firm to exit the market. However, the foreign government may retaliate with their own export subsidy.
83. Strategic Government Interaction Suppose each country can choose free trade or protectionism. Suppose if Country I pursues free trade and Country II also does so, each country’s welfare is $100. If Country I pursues free trade but Country II engages in protectionism, Country I’s welfare is $50 and Country II’s is $120. If both countries are protectionist, welfare of each is $60.
85. Strategic Government Interaction The dominant strategy for each country is protectionism. This is the case even though free trade would enhance both countries’ welfare.
87. The Political Economy of Trade Policy Q: If free trade has so many economic benefits, why is there so much protectionism? A: The political economy of trade policy must be considered. Two main areas examine these political factors: the self-interest approach, and the social objectives approach.
88. The Self-Interest Approach to Trade Policy The median-voter model: public decision-makers can increase their re-election chances by voting to satisfy the median voter. This should mean that the will of the majority is followed. However, if some parties do not have full information, some policies that benefit only a few may be enacted.
89. The Self-Interest Approach to Trade Policy Interest groups can have great influence. The benefits of protectionist policies to interest group members may be great; the costs to the many other individuals may be so diffuse that no one individual has incentive to acquire information or participate.
90. The Social Objectives Approach to Trade Policy Some economists argue instead that a government may conduct trade policy in order to meet certain social objectives, such as avoiding loss of real incomes of certain groups, minimizing consumer loss, or improving real incomes of disadvantaged groups. Gov’t must stick to its guns; otherwise credibility suffers.
91. A Review of U.S. Trade Policy 1930: Smoot-Hawley (S-H) Tariff Eventually the S-H Tariff Act caused average tariff levels to rise to about 50%. Very quickly, our trading partners retaliated, and over the next three years U.S. exports fell dramatically. It is said that S-H put the “Great” in the Great Depression.
92. Reciprocal Trade Act (1934) Congress gave up its authority over trade negotiations to the President. The President was authorized to enter into bilateral negotiations with trading partners. Congress only authorized item-by-item reductions. Bottom line: tariffs fell, but slowly and painstakingly.
93. GATT and Multilateralism General Agreement on Tariffs and Trade (GATT) was born in 1947. GATT involved multilateral negotiations to lower trade barriers. In general GATT supports non-discrimination in trade. GATT established of the Most-Favored Nation principle (now called ‘Normal Trade Relations’).
94. GATT: Early Rounds Negotiations (called “rounds”) occurred every few years. The first two rounds were: Geneva (1947), and France (1949). These first rounds were very successful, mainly because protectionist groups within each country hadn’t gotten organized.
95. GATT: Early Rounds Other early rounds: England (1951) Geneva (1956) “Dillon Round” (Geneva, 1962) These rounds were less successful than the first two, but progress was made.
96. GATT: The Kennedy Round In 1962, Congress passed the Trade Expansion Act (TEA). President was authorized to make tariff cuts across the board, not just item-by-item. Trade Adjustment Assistance: industries “damaged” by imports could receive unemployment compensation and retraining for workers.
97. GATT: The Kennedy Round 70 countries participated in the Kennedy round. Negotiations went from 1964-1967, and were named in memory of President Kennedy. Tariffs on manufactured goods were reduced by one-third.
98. GATT: The Tokyo Round The Trade Reform Act (TRA): 1974 President authorized to complete further tariff reductions of 60%. get rid of any tariff under 5% (“nuisance” tariffs). The Tokyo round ended in 1979, with average tariff reductions of 30%.
99. GATT: The Uruguay Round Tariff levels were by this time quite low. Negotiations began in earnest in 1986.
100. The Uruguay Round: Agenda Further tariff reductions Reductions in non-tariff barriers Negotiations regarding the Multi-Fiber Agreement (MFA) Trade in services Anti-dumping duties Agricultural protection Intellectual property rights
101. Uruguay Round: Actions Most tariffs to be cut another 34%; others eliminated. MFA to be phased out over 10 year period. Many remaining quota to be converted to tariffs. Patent protection to be tightened somewhat. Very little progress was made with services. Agricultural subsidies to be cut over a 6 - 10 year period.
102. The World Trade Organization (WTO) The Uruguay round was the end of GATT. GATT’s successor, the WTO, was approved during the Uruguay round. WTO was established January 1, 1995. WTO has 148 member countries (Cambodia most recently). In theory, WTO has a stronger dispute-settling mechanism.
103. Trade Policy Issues After the Uruguay Round Many countries wanted further relaxation of protectionism in agriculture. Developed countries wanted to discuss labor and environmental standards. Other issues being discussed included trade in services, anti-trust policy, the Multi-Fiber Agreement phase-out, and others.
104. WTO and the Doha Round WTO trade ministers met in Seattle in 1999 to set an agenda; no agreement was reached due in part to anti-trade demonstrations. WTO members met in Doha, Qatar in November of 2001 to set an agenda for the round. An attempt at meeting in Mexico City ended bitterly in 2003. Negotiations still haven’t started.
105. WTO and the Doha Round The agenda will include continued reductions in trade barriers, cutting farm subsidies, patent laws, and other issues. Doha is supposed to be the round that addresses developing countries’ concerns.
106. Recent U.S. Actions “Banana War” with Europe U.S. argued that EU is discriminating against bananas from Central and South America. WTO sided with the U.S. Hormone-treated U.S. beef Europe has objected to importation of U.S. beef on health grounds. WTO allowed U.S. to impose tariffs on some European products. An agreement was reached in 2009.
107. Recent U.S. Actions Extra-Territorial Income Exclusion U.S. provides tax relief to exporting countries. WTO has ruled this to be illegal. U.S. has unilaterally imposed tariffs on steel and textiles. U.S. has had a long-term dispute with Canada regarding softwood lumber. U.S. has been active in negotiating bilateral free trade agreements outside of the WTO framework.
108. Recent U.S. Actions There is much concern in the U.S. over “outsourcing.” For example, call centers in India In the short run, outsourcing causes job losses and other dislocations. In the longer term, the U.S. economy may benefit from this specialization, and may even gain jobs.
109. The Conduct of Trade Policy Should trade policy be “rules-based” or “results-based?” Rules-based policies follow rules embodied by the WTO and similar organizations. These embrace the normal trade relations concept. These follow WTO standards on anti-dumping duties, countervailing duties, etc.
110. The Conduct of Trade Policy Results-based policies suggest aggressive unilateral action to ensure that certain results are achieved. For example, the U.S. may demand penetration of a particular foreign market of a certain percentage. Failure by the trading partner to comply would result in trade sanctions. This notion is also referred to as “industrial policy” or “managed trade.”
