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Carbaugh, Chap. 4 1 Why restrict trade? Benefits of free trade come in the long term, and are usually spread widely across society Costs of free trade.

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Presentation on theme: "Carbaugh, Chap. 4 1 Why restrict trade? Benefits of free trade come in the long term, and are usually spread widely across society Costs of free trade."— Presentation transcript:

1 Carbaugh, Chap. 4 1 Why restrict trade? Benefits of free trade come in the long term, and are usually spread widely across society Costs of free trade are felt rapidly and are usually concentrated in specific sectors of the economy (usually import-competing industries and scarce factors) Tariffs

2 Carbaugh, Chap. 4 2 Defining tariffs A tariff is a tax (duty) levied on products (final goods, intermediates or raw materials) as they move between nations Import tariff - levied on imports Export tariff - levied on exported goods as they leave the country Protective tariff - designed to insulate domestic producers from competition Revenue tariff - intended to raise funds for the government budget (no longer important in industrial countries) Tariffs

3 Carbaugh, Chap. 4 3 Types of tariff Specific tariff – a fixed monetary fee per unit. Ad valorem tariff A percentage of the value of the product (like a sales tax) - FOB vs. CIF Compound tariff A combination of the above, often levied on finished goods whose components are also subject to tariff if imported separately Tariffs

4 Carbaugh, Chap. 4 4 Selected US tariffs Tariffs ProductDuty Rate Brooms32 cents each Fishing reels24 cents each Wrist watches (without jewels) 29 cents each Ball bearings2.4% ad valorem Electrical motors6.7% ad valorem Bicycles5.5% ad valorem Wool blankets1.8 cents/kg + 6% ad valorem Electricity meters16 cents each + 1.5% ad valorem Auto transmission shafts25 cents each + 3.9% ad valorem Source: U.S. International Trade Commission, Tariff Schedules of the United States (Washington, DC: U.S. Government Printing Office, 2004); affairs.htm.

5 Carbaugh, Chap. 4 5 Effective rate of protection The impact of a tariff often differs from its stated nominal tariff rate The effective tariff rate measures the total increase in domestic production that the tariff makes possible, compared to free trade Measures the degree to which domestic producers can be less efficient compared to foreign producers. Domestic producers may use imported inputs which are subject to tariffs, so calculation of the effective tariff rate is not simple Tariffs

6 Carbaugh, Chap. 4 6 Effective rate of protection t e = (t nom – t i *a)/(1 – a) a = value imports/value final good t i = tariff rate on imported inputs t e = value added/(original value added) The higher t i (tariff on imported inputs), the lower the effective tariff since domestic producers pay more for their inputs. If imported inputs have low duties and final goods have high duties then the effective tariff rate is high; called tariff escalation.

7 Carbaugh, Chap. 4 7 Example Free trade price $100, inputs $80; t i = 0%. Free Trade: DomesticForeign Components$ 80 $ 80 Value added$ 20 $ 20 Price$100 $100

8 Carbaugh, Chap. 4 8 Ad valorem final good tariff = 10%; Price = $110 Tariff:DomesticForeign Components$ 80 $ 80 Value added$ 30 $ 20 Tariff ------- $ 10 Price $110 $110 t e = value added/value added = ($30 - $20)/$20 = 0.5 or 50% effective tariff rate. t e = (t nom – t i *a)/(1 – a) = {0.1 – (0)*(0.80)}/(1 – 0.80) = 0.1/0.2 = 0.5 = 50% effective tariff rate.

9 Carbaugh, Chap. 4 9 Tariff on inputs: t i = 10% Tariff:DomesticForeign Components$ 88 $ 80 Value added$ 22 $ 20 Tariff ------- $ 10 Price $110 $110 t e = value added/value added = ($22 - $20)/$20 = 0.1 or 10% effective tariff rate. t e = (t nom – t i *a)/(1 – a) = {0.1 – (0.10)*(0.80)}/(1 – 0.80) = 0.02/0.2 = 0.10 = 10% effective tariff rate.

10 Carbaugh, Chap. 4 10 Nominal & effective tariff rates Tariffs Product United StatesJapanEuropean Union Nominal rate (%) Effective rate (%) Nominal rate (%) Effective rate (%) Nominal rate (%) Effective rate (%) Agriculture, forestry, fish 1.8%1.9%18.4%21.4%4.8%4.1% Food, beverages, tobacco 4.710.625.450.310.117.8 Textiles Wearing apparel 22.743.313.842.213.419.3 Leather products–14.82.0–2.2 Footwear 8.815.415.750.011.620.1 Wood products– Furniture and fixtures Paper and paper products 0.2- Printing and publishing–1.52.1 *Following the completion of the Tokyo Round of Multilateral Trade Negotiations in 1979. Source: Alan Deardorff and Robert Stern, The Effects of the Tokyo Round on the Structure of Protection, in R. Baldwin and A. Krueger, The Structure and Evolution of Recent U.S. Trade Policy (Chicago: University of Chicago Press, 1984), 368–377.

11 Carbaugh, Chap. 4 11 Who pays for import restrictions? Domestic consumers face increased costs Low income consumers are especially hurt by tariffs on low-cost imports Overall the economy suffers DWL due to production and consumption effects Export industries face higher costs for inputs Cost of living increases Other nations may retaliate, further restricting trade Tariff effects

12 Carbaugh, Chap. 4 12 Arguments for trade restrictions Job protection Protect against cheap foreign labor Fairness in trade - level playing field Protect domestic standard of living Equalization of production costs Infant-industry protection Political and social reasons Reasons for tariffs

13 Carbaugh, Chap. 4 13 Politics of protectionism Supply of protectionism (trade policy) depends on: the cost to society of restricting trade the political importance of the import- competing industries Magnitude of the adjustment costs from free trade Public sympathy for those sectors hurt by free trade Reasons for tariffs

14 Carbaugh, Chap. 4 14 Politics of protectionism Demand for protectionism depends on: The amount of the import-competing industrys comparative disadvantage The level of import penetration The level of concentration in the affected sector The degree of export dependence in the sector Reasons for tariffs

15 Carbaugh, Chap. 4 15 Import quotas Quotas are a restriction on the quantity of a good that may be imported in any one period (usually below free-trade levels) Global quotas restrict the total quantity of an import, regardless of origin Selective quotas restrict the quantity of a good coming from a particular country Types of non-tariff barriers

16 Carbaugh, Chap. 4 16 Tariff-rate quota The tariff-rate quota is a two-tiered tariff A specified number of goods (up to the quota limit) may be imported at one (lower) tariff rate, while imports in excess of the quota face a higher tariff rate Types of non-tariff barriers

17 Carbaugh, Chap. 4 17 Domestic content requirements Rules that require a certain percentage of a products total value to be produced domestically Often has the effect of forcing lower-priced imports to include higher-cost domestic components or be assembled in a higher- cost domestic market Types of non-tariff barriers

18 Carbaugh, Chap. 4 18 Domestic content: trade & welfare effects Types of non-tariff barriers

19 Carbaugh, Chap. 4 19 Subsidies Domestic subsidy Payments made to import-competing producers to raise the price they receive above the market price Export subsidy Payments and incentives offered to export producers intended to raise the volume of exports Types of non-tariff barriers

20 Carbaugh, Chap. 4 20 Dumping The practice of selling a product at a lower price in export markets than at home (or exporting at prices below production cost) Sporadic dumping - to clear unwanted inventories or cope with excess capacity Predatory dumping - to undermine foreign competitors Persistent dumping - reaping greater profits by engaging in price discrimination Types of non-tariff barriers

21 Carbaugh, Chap. 4 21 Other NTBs Government procurement policies Social regulations (health, environmental and safety rules can also restrict trade) Sea transport and freight restrictions Types of non-tariff barriers

22 Carbaugh, Chap. 4 22 Case for Free Trade Not based on claim that everyone is better off with free trade Modern case against free trade is based on: The infant industry argument, The terms of trade argument, Arguments concerning income redistribution

23 Carbaugh, Chap. 4 23 Case for Free Trade Consumption Efficiency Production Efficiency Compensation Principle: TAA for displaced workers Introduces competition into imperfectly competitive markets Helps country avoid tit-for-tat retaliation Reduces interest group lobbying

24 Carbaugh, Chap. 4 24 Case Against Selected Protectionism 1) Potential reactions by others in response to a country's protection, 2) Superior policies to raise economic efficiency relative to a trade policy, 3) Information deficiencies which can inhibit the implementation of appropriate policies, 4) Problems created by lobbying within democratic political systems.

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