Tariffs and Nontariff Barriers

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International Economics
Chapter 4

• Tariffs and Nontariff Barriers

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Chapter 4 Tariffs and Nontariff Barriers

• 4.1 Theories for Trade Protection
• 4.2 Tariffs
• 4.3 Nontariff Trade Barriers

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4.1 Theories for Trade Protection

• Infant Industry Argument
• This argument contends that for free trade to be
  meaningful, trading countries should temporarily
  shield their newly developing industries from
  foreign competition.

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4.1 Theories for Trade Protection

• Some truths in the infant industry argument
• Once a protective tariff is imposed, it is very
  difficult to remove, even after industrial
  maturity has been achieved.
• It is very difficult to determine which
  industries will be capable of realizing
  comparative advantage potential and thus merit
  protection.
• The argument generally is not valid for mature,
  industrialized countries.
• There may be other ways of insulating a
  developing industry from cutthroat competition.
  Rather than adopt a protective tariff, the
  government could grant a subsidy to the industry.

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4.1 Theories for Trade Protection

• Terms of Trade Argument
• In some cases, the terms of trade benefits of a
  tariff outweigh its costs, so there is a
  terms-of-trade argument for a tariff.
• The terms of trade argument against free trade,
  then, is intellectually impeccable but of
  doubtful usefulness.
• In practice, it is emphasized more by economists
  as a theoretical proposition than it is used by
  governments as a justification for trade policy.

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4.1 Theories for Trade Protection

• Domestic Market Failure Argument
• Theory of the second best
• When economists apply the theory of the second
  best to trade policy, they argue that
  imperfections in the internal functioning of an
  economy may justify interfering in its external
  economic relations.
• This argument accepts that international trade is
  not the source of the problem but suggests
  nonetheless that trade policy can provide at
  least a partial solution.

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4.1 Theories for Trade Protection

• Strategic Trade Policy
• Because of the small number of firms, the
  assumption of perfect competition does not apply.
  There are only a few firms in effective
  competition in some industries.
• This argument locates the market failure that
  justifies government intervention in the lack of
  perfect competition.
• It is possible in principle for a government to
  alter the rules of the game to shift these excess
  returns from foreign to domestic firms.

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Chapter 4 Tariffs and Nontariff Barriers

• 4.1 Theories for Trade Protection
• 4.2 Tariffs
• 4.3 Nontariff Trade Barriers

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4.2 Tariffs

• A tariff is simply a tax (duty) levied on a
  product when it crosses national boundaries.
• Import tariff v.s. Export tariff
• Protective tariff v.s. Revenue tariff
• Types of Tariffs
• Specific Tariff
• Ad Valorem Tariff
• Compound Tariff

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4.2 Tariffs

• Effective Rate of Protection (ERP)
• the percentage change in the value added in an
  industry because of the imposition of a tariff
  structure by the country rather than the
  existence of free trade.

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4.2 Tariffs

• Calculation of ERP (Way I)

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4.2 Tariffs

• Calculation of ERP (Way II)

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4.2 Tariffs

• Three general rules about the relationship
  between nominal rates and effective rates of
  protection
• If the nominal tariff rate on the final good is
  higher than the weighted average nominal tariff
  rate on the inputs, then the ERP will be higher
  than the nominal rate on the final goods
• If the nominal tariff rate on the final good is
  lower than the weighted average nominal tariff
  rate on the inputs, then the ERP will be lower
  than the nominal rate on the final goods
• If the nominal tariff rate on the final good is
  equal to the weighted average nominal tariff rate
  on the inputs, then the ERP will be equal to the
  nominal rate on the final goods.

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4.2 Tariffs

• Two consequences of the effective rate
  calculation
• The degree of effective protection increases as
  the value added by domestic producers declines.
• In the formula, the higher the value of aij
  is, the greater the effective protection rate for
  any given nominal tariff rate on the final
  product will be.
• A tariff on imports used in the production
  process reduces the level of effective
  protection.
• In the formula, as ti rises, the numerator of
  the formula decreases and hence ERP decreases.

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4.2 Tariffs

• Conclusion
• when material inputs or intermediate products
  enter a country at a very low duty while the
  final imported commodity is protected by a high
  duty, the result tends to be a high protection
  rate for the domestic producers. The nominal
  tariff rate on finished goods thus understates
  the effective rate of protection.
• But should a tariff be imposed on imported inputs
  that exceeds that on the finished good, the
  nominal tariff rate on the finished product would
  tend to overstate its protective effect.

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4.2 Tariffs

• Tariff Escalation
• The tariff structures have generally been
  characterized by rising rates that give greater
  protection to intermediate and finished products
  than to primary commodities.
• The tariff structures of the industrialized
  countries may indeed discourage the growth of
  processing, thus hampering diversification into
  higher value-added exports for the less developed
  countries, worsening the potential competitive
  position of the less-developed countries in the
  manufacturing and processing sectors.

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4.2 Tariffs

• Tariff Welfare Effects
• Consumer Surplus
• Consumer surplus refers to the difference between
  the amount that buyers would be willing and able
  to pay for a good and the actual amount they do
  pay.
• Producer Surplus
• Producer surplus is the revenue producers receive
  over and above the minimum amount required to
  induce them to supply the good.

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4.2 Tariffs
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4.2 Tariffs

• Trade Welfare Effect of Tariff in a Partial
  Equilibrium Setting
• The Small-Nation Case

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4.2 Tariffs

• The redistributive effect (Area a)
• the transfer of consumer surplus, in monetary
  terms, to the domestic producers of the
  import-competing product.
• The protective effect (Area b)
• the loss to the domestic economy resulting from
  wasted resources used to produce additional cloth
  at increasing unit costs.
• The domestic revenue effect (Area c)
• the tariff proceeds paid by country As consumers
  to its government.
• The consumption effect (Area d)
• arises from the decrease in consumption resulting
  from the tariff's artificially increasing the
  price.
• The deadweight loss (Areas b d)
• represents a real cost to a community, not a
  transfer to other sectors of the economy.

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4.2 Tariffs
Welfare Cost of a Tariff Imposed by a Small
Nation

• Levying an import tariff, therefore, reduces a
  small country's welfare.

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4.2 Tariffs

• The Large-Nation Case
• The equilibrium world price is defined as the
  price at which the quantity that consumers in
  Country A want to import is equal to the quantity
  that producers in Country B want to export. In
  the diagram, this price is denoted by PFT.

International Free-Trade Equilibrium
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4.2 Tariffs

• The size of the tariff equals the difference
  between the price consumers in country A pay for
  the product (PT) and the price producers in
  country B receive (P'). That is, the per unit
  tariff of t equals PT -P' .

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4.2 Tariffs

• The redistributive effect (Area a)
• the transfer of consumer surplus, in monetary
  terms, to the domestic producers of the
  import-competing product.
• The protective effect (Area b)
• the loss to the domestic economy resulting from
  wasted resources used to produce additional cloth
  at increasing unit costs.
• The domestic revenue effect (Area c)
• the tariff proceeds paid by country As consumers
  to its government.
• The consumption effect (Area d)
• arises from the decrease in consumption resulting
  from the tariff's artificially increasing the
  price.
• The terms of trade effect (Area e)
• the amount of the tariff revenue paid by
  foreigners because the world price of their
  exports has fallen.

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4.2 Tariffs

• The change in welfare in country A brought about
  by the imposition of a tariff equals e-(bd).
  This amount could be positive or negative,
  depending on the relative sizes of the two terms.
  
• Optimal tariff the tariff would be set to a
  level that maximizes the area e-(bd).

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4.2 Tariffs

• Trade Welfare Effect of Tariff in a General
  Equilibrium Setting
• The Small-Nation Case

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4.2 Tariffs

• The reduction in welfare comes from two effects
• The economy no longer produces at a point that
  maximizes the value of income at world prices.
  The budget constraint that passes through B1 lies
  inside the constraint passing through B0.
• Consumers do not choose the welfare-maximizing
  point on the budget constraint they do not move
  up to an indifference curve that is tangent to
  the economy's actual budget constraint.

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4.2 Tariffs

• The Large-Nation Case

With the imposition of a tariff, Country Is
offer curve OCI shifts inward to OCI'.
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4.2 Tariffs
The Impact of a Tariff
The equilibrium quantity of exports falls from
OB1 to OB2, and the quantity of imports falls
from OA1 to OA2. Country Is terms of trade
improve from TOT1 to TOT2.
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Chapter 4 Tariffs and Nontariff Barriers

• 4.1 Theories for Trade Protection
• 4.2 Tariffs
• 4.3 Nontariff Trade Barriers

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4.3 Nontariff Trade Barriers

• An Introduction to Nontariff Trade Barriers
• Import Quota
• An import quota is a physical restriction on the
  quantity of goods that may be imported during a
  specific period the quota generally limits
  imports to a level below which imports would
  occur under free-trade conditions.
• A common practice to administer an import quota
  is for the government to require an import
  license. Each license specifies the volume of
  imports allowed, and the total volume allowed
  should not exceed the quota.
• Import quotas on manufactured goods have been
  outlawed by the World Trade Organization.

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4.3 Nontariff Trade Barriers

• Tariff-Rate Quota A Two-Tier Tariff
• a tariff-rate quota displays both tariff-like
  and quota-like characteristics. This device
  allows a specified number of goods to be imported
  at one tariff rate (the within-quota tariff
  rate), whereas any imports above this level face
  a higher tariff rate (the over-quota tariff
  rate).
• a tariff rate quota is a two-tier tariff.

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4.3 Nontariff Trade Barriers

• Orderly Marketing Agreements
• An orderly marketing agreement (OMA) is a
  market-sharing pact negotiated by trading
  partners.
• Its main purpose is to moderate the intensity of
  international competition, allowing less
  efficient domestic producers to participate in
  markets that would otherwise have been lost to
  foreign producers who sell a superior product at
  a lower price.
• A typical OMA consists of voluntary quotas
  applied to exports. These controls are known as
  voluntary export restraints (VERs) they are
  sometimes supplemented by backup import controls
  to ensure that the restraints are effective.

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4.3 Nontariff Trade Barriers

• Domestic Content Requirements
• To limit the practice of outsourcing, organized
  labor has lobbied for the use of domestic content
  requirements.
• The effect of content requirements is to pressure
  both domestic and foreign firms who sell products
  in the home country to use domestic inputs
  (workers) in the production of those products.
• Manufacturers generally lobby against domestic
  content requirements, because they prevent
  manufacturers from obtaining inputs at the lowest
  cost, thus contributing to higher product prices
  and loss of competitiveness.

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4.3 Nontariff Trade Barriers

• Subsidies
• National governments sometimes grant subsidies
  to their producers to help improve their trade
  position.
• Governmental subsidies assume a variety of forms,
  including outright cash disbursements, tax
  concessions, insurance arrangements, and loans at
  below-market interest rates.
• Two types of subsidies
• a domestic subsidy which is sometimes granted to
  producers of import-competing goods
• an export subsidy which goes to producers of the
  goods that are to be sold overseas.

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4.3 Nontariff Trade Barriers

• Dumping
• Dumping is recognized as a form of international
  price discrimination.
• It occurs when foreign buyers are charged lower
  prices than domestic buyers for an identical
  product, after allowing for transportation costs
  and tariff duties. Selling in foreign markets at
  a price below the cost of production is also
  considered dumping.
• Commercial dumping is generally viewed as
  sporadic, predatory, or persistent in nature.
  Each type is practiced under different
  circumstances.

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4.3 Nontariff Trade Barriers

• The effects of an Import Quota

• In the absence of trade, equilibrium would occur
  at Point E with the domestic price of cloth
  equaling P.
• The free-trade equilibrium is located at Point F,
  the domestic price of cloth would fall to the
  world price PW.
• The imposition of the quota changes the amount of
  cloth supplied to the importing country, a new
  equilibrium is reached at G.

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4.3 Nontariff Trade Barriers

• The country loses Areas bcd under a quota.
• The redistributive effect (Area a)
• The protective effect (Area b)
• The domestic revenue effect (Area c)
• Area c accrues to the foreign producers and makes
  them more profitable.
• The consumption effect (Area d)
• The deadweight loss (Areas b d)

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4.3 Nontariff Trade Barriers

• Two methods available for a government or
  community to capture Area c from foreign
  producers under a quota.
• The domestic government could auction quotas to
  importers in a free market. The limited quota
  supply would go to those importers most in need
  of the product who would pay the higher price.
• Convert the quota into an equivalent tariff.

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4.3 Nontariff Trade Barriers

• Quota and equivalent tariff
• The losses for consumers and community are much
  larger in the case of a quota than in the case of
  a tariff when demand increases.

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4.3 Nontariff Trade Barriers

• The Effects of an Export Subsidy

• Consumers lose Area ab in the form of higher
  taxes.
• Producers gain Area a in profits.
• The cost to the community is Area b, that is the
  production deadweight cost of the subsidy.
• Subsidies are superior to protection in another
  way they are more visible.