Tariffs PowerPoint slides prepared by: Andreea Chiritescu Eastern Illinois University © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

The Tariff Concept Tariff Import tariff Export tariff A tax (duty) levied on a product when it crosses national boundaries Import tariff Tax levied on an imported product Export tariff Tax imposed on an exported product Often used by developing nations Raise revenue, increase the world price © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

The Tariff Concept Protective tariff Revenue tariff To reduce the amount of imports entering a country Insulating import-competing producers from foreign competition Allows an increase in the output of import-competing producers Revenue tariff To generate tax revenues Placed on either exports or imports © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

TABLE 4.1 Tariff revenues as a percentage of government revenues, 2007: selected countries Developing Countries Percentage Industrial Countries The Bahamas Guinea Ethiopia Ghana Sierra Leone Madagascar Dominican Republic Jordan 51.2 47.9 33.5 28.5 27.6 26.9 20.9 11.3 New Zealand Australia Japan Canada Switzerland United States United Kingdom Iceland 2.6 2.5 1.2 1.1 1.0 © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Types of Tariffs Specific tariff Fixed amount of money per physical unit of the imported product Relatively easy to apply and administer Degree of protection it affords domestic producers varies inversely with changes in import prices Provides domestic producers more protection during a business recession © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Types of Tariffs Ad valorem (of value) tariff Fixed percentage of the value of the imported product Distinguish among small differentials in product quality Tends to maintain a constant degree of protection for domestic producers © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Types of Tariffs Ad valorem (of value) tariff Customs valuation problems Estimations by customs appraisers FOB vs. CIF valuation Free-on-board valuation Cost-insurance-freight valuation Includes transportation costs © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Types of Tariffs Compound tariff Combination of specific and ad valorem tariffs For manufactured products Embodying raw materials that are subject to tariffs Specific tariff Neutralizes the cost disadvantage of domestic manufacturers - from tariff protection granted to domestic suppliers of raw materials Ad valorem tariff Protects the finished-goods industry © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

TABLE 4.2 Selected U.S. tariffs © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Examples of tariffs, selected countries (in %) TABLE 4.3 Examples of tariffs, selected countries (in %) © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Effective Rate of Protection Nominal tariff rate Published in the country’s tariff schedule Applies to the value of a finished product that is imported into a country Effective tariff rate Takes into account the nominal tariff rate On a finished product And any tariff rate applied to imported inputs Used in producing the finished product © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

The effective rate of protection TABLE 4.4 The effective rate of protection © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Tariff Effects: An Overview Higher price of imports Lower demand for imports Domestic suppliers expand output Benefits Domestic producers © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Tariff Effects: An Overview Tariff - imposes costs to domestic economy Buyers will pay more for their protected U.S.-made goods than they would have for the imported goods under free trade Jobs will be lost at retail and shipping companies that import foreign-made goods Jobs will be lost in any domestic industries that suffer from retaliatory tariffs The extra cost of the goods gets passed on to whatever products and services that use these goods in the production process © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Tariff Welfare Effects Consumer surplus The difference between the amount that buyers would be willing and able to pay for a good and the actual amount they do pay Affected by the market price A decrease in the market price Increase in the quantity purchased Larger consumer surplus A higher market price Reduce the amount purchased Shrink the consumer surplus © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Tariff Welfare Effects Producer surplus Revenue producers receive over and above the minimum amount required to induce them to supply a good Affected by the market price A higher market price Increase in quantity supplied Higher surplus A lower market price Lower surplus © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Consumer surplus and producer surplus FIGURE 4.2 Consumer surplus and producer surplus Consumer surplus is the difference between the maximum amount buyers are willing to pay for a given quantity of a good and the amount actually paid. Graphically, consumer surplus is represented by the area under the demand curve and above the good’s market price. Producer surplus is the revenue producers receive over and above the minimum necessary for production. Graphically, producer surplus is the area above the supply curve and below the good’s market price. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Tariff Welfare Effects: Small-Nation Model Its imports - a very small portion of the world market supply Price taker Tariff effects Raises the home price of imports by the full amount of the duty Higher domestic production Lower domestic consumption © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Tariff Welfare Effects: Small-Nation Model Small nation - Tariff effects on nation’s welfare Consumer surplus falls Welfare effects of a tariff Revenue effect Redistribution effect Protective effect Consumption effect Additional tax revenue Benefits domestic producers Wastes resources Harms the domestic consumer © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Tariff trade and welfare effects: small nation model FIGURE 4.3 Tariff trade and welfare effects: small nation model For a small nation, a tariff placed on an imported product is shifted totally to the domestic consumer via a higher product price. Consumer surplus falls as a result of the price increase. The small nation’s welfare decreases by an amount equal to the protective effect and consumption effect, the so-called deadweight losses due to a tariff. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Tariff Welfare Effects: Small-Nation Model Revenue effect The government’s collections of duty Number of imports times the tariff Portion of the loss in consumer surplus Transferred to the government Does not result in an overall welfare loss © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Tariff Welfare Effects: Small-Nation Model Redistribution effect Transfer of the consumer surplus To the domestic producers of the import-competing product Transfer of income from consumers to producers Does not result in an overall loss of welfare for the economy © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Tariff Welfare Effects: Small-Nation Model Protective effect Loss to the domestic economy From wasted resources used to produce additional goods at increasing unit costs Less efficient domestic production is substituted for more efficient foreign production Loss of welfare © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Tariff Welfare Effects: Small-Nation Model Consumption effect Residual not accounted for elsewhere Loss of welfare occurs Increased price Lower consumption Deadweight loss of the tariff Protective effect © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Trade protectionism intensifies as global economy falls into recession Global economic downturns - catalyst for trade protectionism; 2007–2009, Decrease in the demand for goods and services Decline in international trade Credit crunch - extra squeeze on trade Shortfall of some $100 billion in trade finance – 90% of world trade © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Trade protectionism intensifies as global economy falls into recession Indiscriminate decrease in trade Exports declined by 30 % China - targeted by the most governments for protectionist measures Russia Increased tariffs on imported automobiles India Raised tariffs on steel imports Argentina New obstacles to imported auto parts and shoes © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

TABLE 4.6 Creeping protectionism during global economic downturn of 2008–2009: number of protectionist measures initiated* © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Trade protectionism intensifies as global economy falls into recession United States, steel industry Increased tariffs $100 billion U.S. steel market Not protected by the “Buy American ” legislation Fiscal stimulus program Shut out foreign companies from U.S. government contracts (25% of new steel orders in 2009) © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Trade protectionism intensifies as global economy falls into recession United States, tires Tariffs of 25-35% on imports from China For the next three years Priced out of the market 17% of all tires sold in the United States Forced up the market price for consumers © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Trade protectionism intensifies as global economy falls into recession Once trade barriers are increased Can severely damage global supply chains It can take years of negotiation to dismantle trade barriers It can take years before global supply chains can be restored © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Tariff Welfare Effects: Large-Nation Model An importing nation large enough Changes in the quantity of its imports By means of tariff policy Influence the world price of the product United States Autos, steel, oil, and consumer electronics Japan European Union © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Tariff Welfare Effects: Large-Nation Model United States - tariff on automobile imports Prices increase for American consumers Decrease in the quantity demanded If significant enough - force Japanese firms to reduce the prices of their exports © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

TABLE 4.7 Effects of increases in U.S. tariffs on the world price of imported goods © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Tariff Welfare Effects: Large-Nation Model Economic effects of an import tariff Redistributive effect From domestic consumers to domestic producers Deadweight loss Consumption effect Protective effect Revenue effect Domestic revenue effect Terms-of-trade effect © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Tariff trade and welfare effects: large nation model FIGURE 4.4 Tariff trade and welfare effects: large nation model For a large nation, a tariff on an imported product may be partially shifted to the domestic consumer via a higher product price and partially absorbed by the foreign exporter via a lower export price. The extent by which a tariff is absorbed by the foreign exporter constitutes a welfare gain for the home country. This gain offsets some (all) of the deadweight welfare losses due to the tariff’s consumption and protective effects. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Tariff Welfare Effects: Large-Nation Model In figure 4.4 If e > (b + d) National welfare is increased If e = (b + d) National welfare remains constant National welfare is diminished © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Tariff Welfare Effects: Large-Nation Model Optimum tariff Maximize the positive difference between Gain of improving terms of trade (area e) Loss in economic efficiency from the protective effect (area b) Consumption effect (area d) Is only beneficial to the importing nation Beggar-thy-neighbor policy, could invite retaliation © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Gains from eliminating import tariffs If only United States removed tariffs and other restraints on imported products Lowers the price of the affected imports Lower the price of the competing U.S. good Economic gains to the U.S. consumer Decrease the production costs Domestic profit reductions © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Gains from eliminating import tariffs If only United States removed tariffs and other restraints on imported products Displaced workers from the domestic industry that loses protection U.S. government loses tax revenue Estimated annual economic welfare gains from eliminating significant import restraints Welfare gain of about $3.7 billion to the U.S. economy © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

TABLE 4.8 Economic welfare gains from liberalization of significant import restraints*, 2005 (millions of dollars) Annual change in Economic Welfare Import-Competing Industry Textiles and apparel Sugar Dairy Footwear Ethyl alcohol Beef Tuna Glass products Tobacco $1,885 millions 811 573 249 120 48 24 20 19 *Import tariffs, tariff-rate quotas, and import quotas © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

How a Tariff Burdens Exporters Effects of import tariffs on exporters Higher production costs – from imported inputs Cannot pass it to the buyers Higher prices Reduced overseas sales Raise the cost of living Higher wages Higher production costs International repercussions Lead to reductions in domestic exports © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

How an import tariff burdens domestic exporters FIGURE 4.5 How an import tariff burdens domestic exporters A tariff placed on imported steel increases the costs of a steel-using manufacturer. This increase leads to a higher price charged by the manufacturer and a loss of international competitiveness. © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Steel Tariffs Buy Time for Troubled Industry 2001, President Bush, import tariff program Revitalize steel industry American steel companies - lack of competitiveness Heavy burden on American steel-using industries Temporarily save roughly 6,000 jobs At a cost to U.S. consumers and steel-using firms: $800,000 -$1.1 million per job © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Steel Tariffs Buy Time for Troubled Industry 2001, President Bush, import tariff program Save 1 job in steel manufacturing – at a cost of 13 jobs in steel-using industries Increased production costs for a large number of U.S. companies that use steel 2007, Government trade regulators Revoke tariffs on high-end steel imports from certain countries © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

TABLE 4.9 President Bush’s steel trade remedy program of 2002–2003: selected products © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Tariffs and the Poor Tariffs are inequitable Impose the most severe costs on low-income families Higher tariffs on cheap goods than luxuries Affect different countries in different ways Burdens countries that specialize in the cheapest goods Very poor countries in Asia and the Middle East © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

U.S. tariffs are high on cheap goods, low on luxuries TABLE 4.10 U.S. tariffs are high on cheap goods, low on luxuries © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Arguments for Trade Restrictions Free-trade argument If each nation produces what it does best and permits trade In the long term Lower prices Higher levels of output, income, and consumption © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Arguments for Trade Restrictions Job protection argument Alleged job losses to foreign competition Omits: dual nature of international trade Trade restrictions on textiles and apparel, steel, and automobiles Little or no positive effect on the level of employment in the long run © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Arguments for Trade Restrictions Job protection argument Job gains for only a few industries Job losses spread across many industries Each job saved Ends up costing domestic consumers more than the worker’s salary © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

Arguments for Trade Restrictions Protection against cheap foreign labor Low wages abroad make it difficult for U.S. producers to compete with producers using cheap foreign labor Fails to recognize the links among efficiency, wages, and production costs Low wages by themselves do not guarantee low production costs Low-wage nations -competitive advantage Only in the production of goods requiring greater labor and little of the other factor inputs © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

TABLE 4.11 Hourly compensation costs in U.S. dollars for production workers in manufacturing, 2007 © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use

TABLE 4.12 Productivity, wages, and unit labor costs, relative to the U.S.: total manufacturing, 2002 (U.S.= 1.0) © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password‐protected website for classroom use