The Instruments of Trade Policy Chapter 13 The Instruments of Trade Policy McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

Learning Objectives Describe the different tax instruments employed to influence imports. Discuss policies used to affect exports. Explain the problems encountered in measuring the presence of protection. Summarize the different nontariff policies used to restrict trade.

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 and ad valorem.

Specific Tariffs Specific tariffs involve charging a tax per physical unit imported. For example, the 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.

Ad Valorem Tariffs Ad valorem tariffs involve charging a tax as a percentage of the value of the good. For example, the 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.

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.

Permanent Normal Trade Relations Status 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).

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.

Measuring Tariffs How can we tell how much tariff protection a country has on average? This is sometimes referred to as the “height” of tariffs. There are two ways to measure this height: Unweighted average Weighted average

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.

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: [(30%)(200)+(40%)(100)+(10%)(400)]/ (200+100+400) = 20%

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.

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.

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.

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.

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.

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.

Export Subsidies Governments can encourage exports by paying exporters a certain premium per unit exported. Export subsidies work like export taxes in reverse.

Non-Tariff Barriers Trade gets restricted in ways not involving taxes: import quotas, “voluntary” export restraints (VERs), and other provisions.

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.

“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.

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.

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.

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.

Other Non-Tariff Barriers Administrative classification Restrictions on trade in services Trade-related investment measures Exchange rate controls Quality provisions Packaging and labeling requirements