International Economics 国际经济学 Lectured by Yuanfen Tu School of International Trade and Economics Email:jxnctyf@126.com

International Economics By Robert J. Carbaugh 13th Edition Chapter 4: Tariffs

Tariffs Free-Trade argument posits that open markets foster most efficient use of world resources But free trade policies often meet resistance among companies and workers who face losses in income and jobs because of import competition Policymakers torn between global efficiency and needs of voting public

The Tariff Concept Tariff A tax (duty) levied on a product when it crosses national boundaries Import tariff Tax levied on an imported product Most common; called a customs duty Export tariff Tax imposed on an exported product Less common; illegal under U.S. Constitution Commonly used by developing nations

The Tariff Concept Tariffs may be imposed for protection or revenue Protective tariff: designed to insulate import-competing producers from foreign competition Revenue tariff: imposed for the purpose of generating tax revenues Decreasing tariff revenue trend for industrial nations Percentage of government revenue derived from tariffs (Table 4.1)

Types of Tariffs (1 of 4) Tariffs may be specific, ad valorem, or compound Specific tariff Fixed amount of money per physical unit of imported product (Ex: 15 cents/unit). Relatively easy to apply and administer Degree of protection varies inversely with changes in import prices Provides domestic producers increased protection during recession (with falling prices)

Types of Tariffs Ad valorem (of value) tariff Continued Ad valorem (of value) tariff Fixed percentage of the value of the imported product Manufactured goods - Wide range of grade variations Constant degree of protection during periods of changing prices Administrative complexities: Customs valuation Determining the value of an import Variations in the methods used to determine values Example: Differences in the use of free-on-board (FOB) in the U.S., and cost-insurance-freight (CIF) in European countries

Types of Tariffs Compound tariff Continued Compound tariff Combination of specific and ad valorem tariffs Often applied to manufactured products embodying raw materials subject to tariffs Specific portion neutralizes the cost disadvantage resulting from tariff protection granted to domestic suppliers of raw materials Ad valorem portion of the duty grants protection to the finished-goods industry Tariffs for selected countries (Table 4.3)

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

Effective Rate of Protection Effective tariff rate Ex: If a finished desktop enters U.S. at a zero tariff rate, but imported components used in desktop production are taxed, then Dell is taxed instead of protected

The effective rate of protection TABLE 4.4 The effective rate of protection

Effective Rate of Protection Effective tariff rate, e e = The effective rate of protection n = the nominal tariff rate on the final product a = the ratio of the value of the imported input to the value of the finished product b = the nominal tariff rate on the imported input

Effective Rate of Protection If the tariff on the finished product Exceeds the tariff on the imported input Effective rate of protection exceeds the nominal tariff

Effective Rate of Protection If the tariff on the finished product Is less than the tariff on the imported input Effective rate of protection is less than the nominal tariff May even be negative Protects domestic suppliers of raw materials more than domestic manufacturers

China’s nominal and effective tariff rates in forestry products, 2001 TABLE 4.5 China’s nominal and effective tariff rates in forestry products, 2001

Tariff Escalation Tariff escalation Raw materials are often imported at zero or low tariff rates The nominal and effective protection increases at each stage of production Processed goods Higher import tariffs Discourage the growth of processing, hampering diversification into higher value-added exports for the less-developed nations.

FIGURE 4.1 Tariff escalation on industrial countries’ imports from developing countries Tariffs often rise significantly with the level of processing (tariff escalation) in many industrial countries. This is especially true for agricultural products. Tariff escalation in industrial countries has the potential of reducing demand for processed imports from developing countries, hampering diversification into higher-value added exports.

FIGURE 4.1 Tariffs often rise significantly with the level of processing (tariff escalation) in many industrial countries. This is especially true for agricultural products. Tariff escalation in industrial countries has the potential of reducing demand for processed imports from developing countries, hampering diversification into higher-value added exports.

Outsourcing and Offshore-Assembly Provision Occur when certain aspects of a product’s manufacture are performed in more than one country Improvements in cost competitiveness Penetrate foreign markets High tariffs or other trade barriers restrict the direct export of finished goods Unique foreign production technologies, labor skills, raw materials, or specialized components

Outsourcing and Offshore-Assembly Provision A key aspect of the global economy Ex: Electronic components made in the U.S. are shipped to another country with low labor costs for assembly into TV sets Assembled sets returned to U.S. for further processing or packaging & distribution Important strategy for producers who locate each stage of production in country where it will incur the least cost

Outsourcing and Offshore-Assembly Provision Offshore-assembly provision (OAP) Favorable treatment to products assembled abroad from U.S.-manufactured components Cost of the U.S. component - not included in the dutiable value of the imported assembled article Incentives for foreign manufacturers to purchase components from U.S. sources Generates sales and jobs in the U.S. component industries

Dodging Import Tariffs: Tariff Avoidance and Tariff Evasion Legal utilization of the tariff system to one’s own advantage To reduce the amount of tariff that is payable by means that are within the law Tariff evasion Individuals or firms evade tariffs by illegal means

Dodging Import Tariffs: Tariff Avoidance and Tariff Evasion Ford Motor Company Ships its Transit Connect five-passenger wagons From its factory in Turkey to Baltimore, Maryland Wagons: 2.5% tariff (duty of $625) Stripped and converted into cargo vans Cargo vans tariff: 25% (duty of $6,250) Completely legal

Dodging Import Tariffs: Tariff Avoidance and Tariff Evasion Concerns the government and the steel industry Loss of tariff revenue Products made cheaper by tariff evasion Smuggled steel evades U.S. tariff Falsely reclassify steel as a duty-free product Detach markings which indicate that the steel came from a country subject to tariffs Make it appear to have come from one that is exempt Alter the chemical composition of a steel product enough so that it can be labeled duty-free

Postponing Import Duties Bonded warehouse Dutiable imports can be brought into the U.S. and temporarily left in a bonded warehouse, duty-free Imported goods - stored, repacked, or further processed - for up to five years No customs duties are owed until the goods are withdrawn for domestic consumption No duty required if withdrawn for export Imported components cannot be assembled into final products in a bonded warehouse.

Postponing Import Tariffs Foreign-trade zone (FTZ) An area within the U.S. Business can operate without the responsibility of paying customs duties on imported products or materials For as long as they remain within this area And do not enter the U.S. marketplace Customs duties are due when goods are transferred from the FTZ for U.S. consumption

Postponing Import Tariffs Foreign-trade zone (FTZ) No time limit on how long goods can be stored General-purpose zones Public facilities Used by more than one firm Sub-zones A single firm’s site Used for more extensive manufacturing or assembly Manufacturers seek FTZ status to obtain relief from ‘‘inverted’’ tariff schedules

Tariff Effects: An Overview Higher price of imports Lower demand for imports Domestic suppliers expand output Benefits Domestic producers

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

Tariff Welfare Effects: Consumer and Producer Surplus Consumer surplus Difference between the amount buyers would be willing and able to pay for a good, and the actual amount they pay Inversely proportionate to market price Producer surplus Revenue received over and above the minimum amount required to induce producers to supply goods Directly proportionate to market price Consumer surplus and producer surplus (Figure 4.2)

Tariff Welfare Effects: Small Nation Model Price taker nation Faces a constant world price level for its import commodity Introduction of import tariff: raises the home price of imports by the full amount of the duty, and the increase falls entirely on the domestic consumer Lowers national welfare (Figure 4.3) Revenue effect (area c) Redistribution effect (area a) Protective effect (area b) Consumption effect (area d) Deadweight loss (area b+d)

Tariff Welfare Effects: Small-Nation Model Revenue effect (Area c) 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

Tariff Welfare Effects: Small-Nation Model Redistribution effect (area a) 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

Tariff Welfare Effects: Small-Nation Model Protective effect (area b) 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

Tariff Welfare Effects: Small-Nation Model Consumption effect (area d) Residual not accounted for elsewhere Loss of welfare occurs Increased price Lower consumption Deadweight loss of the tariff Protective effect Consumption effect

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

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 The tariff incidence is shared between domestic consumers and foreign firms. Terms of trade can improve for nation imposing the tariff Effects of increases in U.S. tariffs on the world price of imported goods (Table 4.7)

Tariff Welfare Effects: Large-Nation Model Economic effects of an import tariff for a large nation (Figure 4.4) Redistributive effect (area a) From domestic consumers to domestic producers Deadweight loss (area b + d) Consumption effect Protective effect Revenue effect (area c + e) Domestic revenue effect Terms-of-trade effect

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 If e < (b + d) National welfare is diminished

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

How a Tariff Burdens Exporters Higher prices of imports due to tariffs injure domestic exporters Exports often purchase imported inputs subject to tariffs that increase the cost of inputs, leads to higher prices and reduced overseas sales Example: Caterpillar Inc. (Figure 4.5) Raises the cost of living by increasing the price of imports International repercussions lead to reductions in domestic exports

How a Tariff Burdens Exporters Continued Domestic exporters do not protest policies on tariff-induced cost increases because: Increases are subtle and invisible Magnitude of increases render companies incapable of developing No tangible basis for political resistance

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

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

TABLE 4.9 President Bush’s steel trade remedy program of 2002–2003: selected products

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

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

Arguments for Trade Restrictions Free-trade argument states: Long run benefits can include lower prices, higher output, income, and consumption than could be achieved in isolation. Trade barriers prevent the economy from undergoing adjustment, resulting in economic stagnation Protectionists’ view: Free trade is theoretical, not applicable in real world Non-economic benefits such as national security more than offset economic losses

Job Protection Dominant factor influencing the call for trade restrictions This view fails to acknowledge the dual nature of international trade. Changes in a nation’s imports of goods and services are closely related to changes in its exports. Trade restrictions on textiles and apparel, steel, and automobiles Little or no positive effect on the level of employment in the long run

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 59

Protection Against Cheap Foreign Labor Using tariffs to defend domestic jobs against cheap foreign labor (Table 4.11) Tariffs on imported goods equal to wage differential Limitations of cheap-foreign-labor argument: Productive superiority of domestic labor more than offsets the higher domestic wage rate, the home nation’s labor costs will actually be less than they are abroad. Low wages by themselves do not guarantee low production costs (Table 4.12) Low-wage nations tend to have a competitive advantage where labor requirement is higher than other factor inputs

Fairness in Trade: A Level Playing Field Alleged advantages for foreign firms Weak pollution control regulations; worker safety Low corporate taxes and compliance with other employment regulations High trade barriers; subsidies Arguments against levying restrictions Domestic economy benefits from trade even if foreign nations impose trade restrictions Argument does not recognize potential impact on global trade

Maintenance of the Domestic Standard of Living Advocates of trade barriers Tariffs help maintain high income levels and employment Tariffs encourage home spending, which stimulates domestic economic activity Considerations in this argument: All nations cannot levy tariffs to bolster domestic living standards Tariffs result in redistribution of gains from trade among nations. Possibility of retaliatory tariffs

Production Costs Equalization Scientific tariff Eliminate unfair competition from abroad Imposition of tariffs equivalent to the cost differential Problems associated with scientific tariff Cost comparison not achievable due to differences in costs from business to business Approximates prohibitive tariff Contradicts the notion of comparative advantage

Arguments for Trade Restrictions Infant-industry argument Trading nations should temporarily shield their newly developing industries from foreign competition Once a protective tariff is imposed - very difficult to remove Special-interest groups - convince policy makers that further protection is justified

Arguments for Trade Restrictions Infant-industry argument Very difficult to determine which industries will be capable of realizing comparative advantage potential Not valid for mature, industrialized nations There may be other ways of insulating a developing industry from cutthroat competition Subsidize the industry

Non-economic Arguments National security argument Heavy dependence on foreign suppliers What constitutes an essential industry Cultural and sociological considerations These arguments constitute legitimate reasons Most arguments justifying tariffs Based on the assumption that national welfare, as well as the individual’s welfare, will be enhanced

Arguments for Trade Restrictions Political economy of protectionism Elected officials form policies to maximize votes and remain in office Bias in the political system that favors protectionism Protection-biased sector Import competing producers Labor unions - in that industry Suppliers to the producers in the industry

Arguments for Trade Restrictions Political economy of protectionism Protection-biased sector Seekers of protectionism Established firms in an aging industry - lost their comparative advantage Free-trade-biased sector Exporting producers, their workers, and their suppliers

Arguments for Trade Restrictions United States’ protection policy Dominated by special-interest groups that represent producers Gains from protection – concentrated among well-organized producers and labor unions Consumers Not organized; Losses widely dispersed Absorb individually a small & difficult-to-identify cost;

Arguments for Trade Restrictions Supply of protectionism By the domestic government Depends on: The costs to society The political importance of import-competing producers Adjustment costs Public sympathy

Arguments for Trade Restrictions Demand of protectionism By the domestic companies and workers Depends on: Comparative disadvantage Import penetration Concentration Export dependence