Antonia Diakantoni Hubert Escaith WTO Global Value Chains and Tariff Policy: Effective Protection in an Inter-Connected World Economy Antonia Diakantoni Hubert Escaith WTO WIOD CONSORTIUM MEETING, 25-26 MAY 2011 Sevilla, Spain.

Effective Protection Theory Nominal tariffs affect the domestic price of traded goods The higher the tariff, the higher the: Benefits for domestic firms producing the good Costs for domestic firms using the good as input Effective Protection for any given industry: Weights additional production costs against the additional benefits determined by nominal tariffs Effective Protection Rate (EPR) Tariff Escalation: Nominal tariffs increase with the degree of processing Effective Protection is low for producers of intermediate goods and high for producer of final goods Nominal and Effective Rate of Protections The nominal rate of protection is for the sector where the protection is given. The effective rate of protection is for the non-traded (processing) sector. Total revenue equals total cost (cost on processing input plus cost on raw materials):

Effective Protection Rate (EPR) Comparing the Value Added using actual tariffs on inputs (a tax) and on output (a subsidy from the producer perspective) with what would occur if international price prevailed. This equals (VAd - VAint ) where: VAd = domestic value added VAint = international value added Under simplifying assumptions consistent with the usual IO static models: Effective rate of protection equals (Tf − Ti) / VAint, where: Tf = the tariff paid by competing imports on the final product Ti = the tariffs paid on the importable inputs used to make that product.  

Global Value Chains, Tariff Escalation and Trade in Tasks Steep Tariff Escalation was a key feature of import substitution industrialization policies Low nominal tariffs on intermediate inputs or capital goods High tariffs on manufactured final (consumer) goods But since the end-1980s, industrialization of developing countries is increasingly export-led Processing imported inputs as part of international supply chains Trade in final goods displaced by trade in processed intermediates embedding the domestic value added (trade in tasks)

Trade in Tasks and Effective Protection Rate From an input-output perspective, high sectorial EPR protects primary factors in this industry and increases the “price” of the value added (compared to a “free market” situation) It is an incentive for moving productive factors (labour and investment) to the protected sector But reduces international price competitiveness as GVCs blur the dichotomy between tradables vs. non-tradables (trade in tasks=trade in value added) Expectations : The smaller the domestic economy, the lower the incentive for high EPRs Because trade within GVCs is very responsive to transaction costs, we expect a reduction in EPRs peaks during the 1990s for manufactured goods The higher the incidence of GVCs and the length of supply chains, the flatter the nominal protection ditribution (lower EPR) The smaller the domestic economy, the lower the incentive for high EPRs : EPR works only for domestic market, as exports face international prices. Heavily protected industries in large countries may cross-subsidize loss of external competitiveness thanks to higher profit realized on domestic market. Because trade within GVCs is very responsive to transaction costs, we expect a reduction in EPRs peaks during the 1990s for manufactured goods: large EPR is equivalent to exchange rate appreciation (higher price of value added) and is not compatible with export-led growth (unless exports are done in EPZ with special custom arrangements) The higher the incidence of GVCs and the length of supply chains, the flatter the EPR: In GVCs, exports include also intermediate goods such as parts and components. It becomes increasingly difficult to discriminate between importable inputs and exportable outputs.

Research Proposal Analyse the evolution of sectorial EPRs From 1995 to 2005 For a selection of developed and developing countries: USA and 9 Asian economies Using IDE-JETRO Asian Input-Output data base To disentangle the role of changes in tariff policy from the changes in production structure and technology Explore specific patterns related to the specificity of industries or the length of international supply chains (in particular, vulnerability to a supply shock affecting prices) Relate stylised facts with the recent literature/ discussion on GVCs

Research Proposal (2) Descriptive and Exploratory Data Analysis … to establish stylized facts Counterfactuals to separate the role of tariffs from the changes in production structure: Controlling for technical coefficients and changing tariffs Controlling for tariffs and changing technical coefficients Relating observation with the incidence of price shocks in a “trade in tasks” framework (production networks) Approximating the length of international supply chains through Average Propagation Length Based on Dietzenbacher and Romero (2007), we compute APL on Ghosh matrices for year 2008 But in additon, we rescale the resulting APLs, in order to correct for the bias identified by these authors (negative correlation between the size of the effect and its length). The APL coefficients were weighted by the size of the forward effect- The simulation was done restricting the measure of the indicator to manufacture sectors, and discarding domestically induced impacts. Rescaled APL# for computers and electronic equipment are by far the dominant sector, when both the intensity and the length of the shock are considered. The relative size of the second sector, metals and metal product, represents only 40 per cent of the former. The economic weight of computers and electronic equipment is due to both a relatively high APL and a large Ghosh coefficient, reflecting the fact that the production of electronic equipment is vertically integrated and are used as inputs by many other sectors.

Some preliminary results: EPR 1995-2005 Simple average of countries and sectors

Comparison of China's nominal and EPR rates (2005) In particular China shows overall the most significant decrease in EPR between 1995 and 2005 China's nominal protection has globally decreased over the 15-years range except for two sectors "Chemical fertilizers and pesticides" and "Other metallic ore". The EPRs for the same period show an increase of the protection in at least 15 sectors. For another 15 sectors the protection is negative (Drugs and medicine, Crude petroleum and natural gas, Timber/ Forestry/ Wooden furniture, Food crops, Leather and leather products, Motor cycles and other transport equipment, Other metallic ore/ Iron ore, Electronics and electronic products, Pulp and paper, Spinning and Slaughtering, meat products and dairy products) For very few sectors we observed a decrease of the nominal protection between 1995 and 2005 and an increase of the EPR for the same reference years. For China that was observed for the following sectors: Other chemical products, Other rubber products, Fishery, Shipbuilding and Milled grain and flour.

Average propagation length of a supply shock index 100 = highest sectoral value, 2008 Length weighted by size of shock (Ghosh) from industrial and electronic products, non-domestic effects only. Based on Dietzenbacher and Romero (2007), we computed APL on Ghosh matrices for year 2008 Furthermore, we rescaled the resulting APLs, in order to correct for the bias identified by these authors (negative correlation between the size of the effect and its length). The APL coefficients were weighted by the size of the forward effect, giving the APL# The simulation was done restricting the measure of the indicator to manufacture sectors, and discarding domestically induced impacts. The results, provide a measure of the economic relevance of the average propagation length, by sector. Also gives an indication of the sensibility of sectoral GCV to a price increase in an up-stream establishment Rescaled APL# for computers and electronic equipment are by far the dominant sector, when both the intensity and the length of the shock are considered. The relative size of the second sector, metals and metal product, represents only 40 per cent of the former. The economic weight of computers and electronic equipment is due to both a relatively high APL and a large Ghosh coefficient, reflecting the fact that the production of electronic equipment is vertically integrated and are used as inputs by many other sectors.

Caveats (besides numerous data issues): EPR is a descriptive more than a normative tool Positive theory: tariffs affect the allocation of resources (the «raison d’être» of protectionism) … But they also eventually affect consumption and (potentially at least) terms of trade EPR is a partial equilibrium tool, but Indirect effects (e.g. substitution) would need to be modelled through General Equilibrium Models. Comparative statics (e.g. 2005 vs. 1995) controlling separately for changes in tariffs and changes in production structure: Will shed some light on substitution effects But cannot isolate them from other changes in the institutional and economic environments.

Antonia Diakantoni Hubert Escaith WTO Global Value Chains and Tariff Policy: Effective Protection in an Inter-Connected World Economy Thank you Antonia Diakantoni Hubert Escaith WTO The “Made in the World” initiative has been launched by the WTO to support the exchange of projects, experiences and practical approaches in measuring and analysing trade in value added.