1. Tariffs
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)
Carbaugh, Chap. 4

2. Tariffs
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)
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
Carbaugh, Chap. 4

4. Selected US tariffs Tariffs Product Duty Rate Brooms 32 cents each
Fishing reels
24 cents each
Wrist watches (without jewels)
29 cents each
Ball bearings
2.4% ad valorem
Electrical motors
6.7% ad valorem
Bicycles
5.5% ad valorem
Wool blankets
1.8 cents/kg + 6% ad valorem
Electricity meters
16 cents each + 1.5% ad valorem
Auto transmission shafts
25 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.
Carbaugh, Chap. 4

5. Effective rate of protection
Tariffs
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
Carbaugh, Chap. 4

6. Effective rate of protection
te = (tnom – ti*a)/(1 – a)
a = value imports/value final good
ti = tariff rate on imported inputs
te = Dvalue added/(original value added)
The higher ti (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.
Carbaugh, Chap. 4

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

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

9. Tariff: Domestic Foreign Components $ 88 $ 80 Value added $ 22 $ 20
Tariff on inputs: ti = 10%
Tariff: Domestic Foreign
Components $ $ 80
Value added $ $ 20
Tariff $ 10
Price $ $110
te = Dvalue added/value added = ($22 - $20)/$20 = 0.1 or 10% effective tariff rate.
te = (tnom – ti*a)/(1 – a) = {0.1 – (0.10)*(0.80)}/(1 – 0.80) = 0.02/0.2 = 0.10 = 10% effective tariff rate.
Carbaugh, Chap. 4

10. Nominal & effective tariff rates
Tariffs
Nominal & effective tariff rates
Product
United States
Japan
European Union
Nominal rate (%)
Effective rate (%)
Agriculture, forestry, fish
1.8%
1.9%
18.4%
21.4%
4.8%
4.1%
Food, beverages, tobacco
4.7
10.6
25.4
50.3
10.1
17.8
Textiles
9.2
18.0
3.3
2.4
7.2
8.8
Wearing apparel
22.7
43.3
13.8
42.2
13.4
19.3
Leather products
4.2
5.0
3.0
–14.8
2.0
–2.2
Footwear
15.4
15.7
50.0
11.6
20.1
Wood products
1.6
1.7
0.3
–30.6
2.5
Furniture and fixtures
4.1
5.5
5.1
10.3
5.6
11.3
Paper and paper products
0.2
-0.9
2.1
1.8
5.4
8.3
Printing and publishing
0.7
0.9
0.1
–1.5
-1.0
*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.
Carbaugh, Chap. 4

11. Who pays for import restrictions?
Tariff effects
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
Carbaugh, Chap. 4

12. Arguments for trade restrictions
Reasons for tariffs
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
Carbaugh, Chap. 4

13. Politics of protectionism
Reasons for tariffs
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
Carbaugh, Chap. 4

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

15. Types of non-tariff barriers
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
Carbaugh, Chap. 4

16. Tariff-rate quota The tariff-rate quota is a two-tiered tariff
Types of non-tariff barriers
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
Carbaugh, Chap. 4

17. Domestic content requirements
Types of non-tariff barriers
Domestic content requirements
Rules that require a certain percentage of a product’s 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
Carbaugh, Chap. 4

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

19. Subsidies Domestic subsidy Export subsidy
Types of non-tariff barriers
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
Carbaugh, Chap. 4

20. Types of non-tariff barriers
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
Carbaugh, Chap. 4

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