1. Trade Policy: Tariff/Non-tariff Barriers
Dianna DaSilva- Glasgow

2. Outline The Introduction Equilibrium Analysis of a Tariff
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The Introduction
Equilibrium Analysis of a Tariff
Partial Theory of Tariff Structure
General Equilibrium Analysis of a Tariff in a Small Country
General Equilibrium Analysis of a Tariff in a Large Country
The Optimum Tariff
Non-tariff barriers
International Trade Theory- ECN 4202, 2016/2017

3. INTRODUCTION What are trade (commercial) policies?
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What are trade (commercial) policies?
What are the effects of trade restrictions?
Who will benefit and who will lose from these trade policy instruments?
Why do nations impose trade restrictions?
What are the costs and benefits of protection?
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4. INTRODUCTION
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Trade theories tell us that free trade maximizes world output and benefits all nations. The case for free trade is based on the theory of comparative advantage. When countries specialize and trade based on comparative advantage, consumers pay less and consume more, and resources are used more efficiently.
The HO theorem also assumes that there are no restrictions to trade. However, all nations impose some restrictions on the flow of international trade. These restrictions lowers the gains from trade.
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5. COMMERCIAL POLICIES
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Restrictions are normally imposed to protect domestic producers:
Protection is the practice of shielding a sector of the economy from foreign competition.
Arguments for protection:
Protection saves jobs
Some countries engage in unfair trade practices
Cheap foreign labor makes competition unfair
Protection safeguards national security
Protection discourages dependency
Protection safeguards infant industries
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6. COMMERCIAL POLICIES
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Commercial policies are the instruments used to protect domestic industries:
Commercial (trade policy) policies refers to tariff and other instruments such as quotas used to affect international commerce.
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7. Classification of Commercial Policy Instruments
COMMERCIAL POLICIES
Classification of Commercial Policy Instruments
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Commercial Policy Instruments
Trade Contraction
Trade Expansion
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Price
Quantity
Price
Quantity
Tariff
Export tax
Import quota
Voluntary Export Restraint (VER)
Import subsidy
Export subsidy
Voluntary Import Expansion (VIE)

8. COMMERCIAL POLICIES Import tariff: a duty on the imported commodity
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Tariff is a tax or duty levied on the traded commodity as it crosses a national boundary.
Import tariff: a duty on the imported commodity
Export tariff: a duty on the exported commodity
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9. COMMERCIAL POLICIES
Tariffs can be classified as:
Specific tariffs
Taxes that are levied as a fixed charge for each unit of goods imported
Example: A specific tariff of $10 on each imported bicycle with an international price of $100 means that customs officials collect the fixed sum of $10.
Advalorem tariffs
A duty expressed as a fixed percentage of the value of the trade commodity.
Example: A 20% ad valorem tariff on bicycles generates a $20 payment on each $100 imported bicycle.
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10. COMMERCIAL POLICIES
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Compound tariffs- combination of fixed and advalorem tariffs
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11. NON-TARIFF BARRIERS
Non-tariff trade barriers or new protectionism are policies other than tariffs that restricts international trade.
Examples:
Quotas
Voluntary export restraints (VERs)
Government regulations (TBT, SPSS)
International cartels
Dumping
Export subsidies
Though NTBs differ the effects are similar. Exports are stimulated or imports restricted causing a misallocation of world resources.
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12. IMPORT QUOTAS
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Direct quantitative restrictions on the amount of goods allowed to be traded (usually below the free-trade level).
Import quotas limit imports to a specified level with certainty.
The restriction is usually enforced by issuing licenses to some group of individuals or firms.
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13. IMPORT QUOTAS Import quotas can be classified as: Global Quota:
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Import quotas can be classified as:
Global quota
Selective quota
Global Quota:
Restrict total quantity of an import, regardless of origin.
Leads to
Rush of import.
Distant locations are discriminated against.
Well connected large importers are favored.
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14. IMPORT QUOTAS Selective Quota:
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Selective Quota:
Restrict the quantity of a good coming from a particular country.
Distant location discrimination is eliminated
Others remain
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15. IMPORT QUOTAS Tariff-rate Quota- (A Two-tiered Tariff):
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Tariff-rate Quota- (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.
License on demand allocation: Licenses are required to import at within-quota tariff. If demand for licenses is less than the quota then first-come-first served system. If demand exceeds quota, import request is reduced proportionally.
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16. VOLUNTARY EXPORT RESTRAINTS
A voluntary export restraint (VER) is an export quota administered by the exporting country.
It is also known as a voluntary restraint agreement (VRA).
VERs are imposed at the request of the importer and are agreed to by the exporter to forestall other trade restrictions.
A VER is exactly like an import quota where the licenses are assigned to foreign governments and is therefore very costly to the importing country.
A VER is always more costly to the importing country than a tariff that limits imports by the same amount.
The tariff equivalent revenue becomes rents earned by foreigners under the VER.
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17. Orderly Marketing Agreements (OMA)
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Market sharing pact signed by trading partners
Intended to protect less efficient domestic producers
Usually involve voluntary export restraints, or quotas imposed on exports by the exporting country
Can lead to increased exports by other countries or transshipment
Transshipment occurs when an exporting nation ships to a third country, which then ships to the nation imposing the restriction.
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18. DOMESTIC CONTENT REQUIREMENTS
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Minimum percentage of a product’s total value that must be produced domestically to qualify for zero duty.
DCR increases production cost.
DCR imposes welfare losses on domestic consumers.
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19. PRODUCTION SUBSIDY
Payments made to import-competing producers to raise the price they receive above the market price.
It can be cash disbursements, tax concessions, insurance arrangements & loans at below market rates.
It increases domestic production & reduces imports.
Subsidy revenue accruing to the producer is absorbed by producer surplus & production deadweight loss.
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20. EXPORT SUBSIDY
Export subsidies are government payments made to domestic firms to encourage exports.
Export-Import Bank
Low-interest loans finance 10% of U.S. export; 40% export of Japan & France.
An export subsidy raises prices in the exporting country while lowering them in the importing country.
In addition, and in contrast to a tariff, the export subsidy worsens the terms of trade.
An export subsidy unambiguously leads to costs that exceed its benefits.
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21. Effects of an Export Subsidy
Price, P
Quantity, Q S S D PS
Subsidy a b c d
= producer gain
(a + b + c)
= consumer loss (a + b)
= cost of
government subsidy
(b + c + d + e + f + g) PW
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P*S
Exports
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22. DUMPING Closely related to subsidies is dumping.
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Closely related to subsidies is dumping.
Trade barriers are often policy reactions to dumping.
Dumping is the practice of selling a product at a lower price in export markets than at home (or exporting at prices below production cost)
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23. DUMPING How do export subsidies support dumping?
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How do export subsidies support dumping?
Price floors for agricultural products.
Low interest loans for foreign countries and firms to buy domestic goods.
Export subsidies raise the domestic price of the commodity but lowers the export price because firms increase exports and reduce domestic supply.
Hence: consumer welfare is lowered
Deadweight loss to exporting nation leading to misallocation of resources.
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24. DUMPING Types of Dumping: Sporadic dumping Predatory
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Types of Dumping:
Sporadic dumping
To clear unwanted inventories or cope with excess capacity.
Predatory
Temporary price reduction abroad to drive foreign producers out of the market.
Persistent dumping
Reaping greater profits by engaging in price discrimination.
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25. OTHER NTBS Automobile, electrical equipment
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Safety regulations
Automobile, electrical equipment
Health regulations
Sanitary and phytosanitary standards
Food safety standards
Hygienic production, packaging of food products, labeling requirements showing origin & contents
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26. OTHER NTBS Buy local campaigns; e.g. Buy American Act of 1933
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Buy local campaigns; e.g. Buy American Act of 1933
Domestic International Sales Corporation (DISC)- Reduces the effective rate of taxation on export income.
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27. WELFARE ANALYSIS OF TARIFFS
Tariffs are harmful to the welfare of a country because they increase the price of imported commodities and usually confer greater benefit on interest groups (small country).
The Smoot-Hawley tariff was the U.S. tariff law of the 1930s, which set the highest tariff in U.S. history (60 percent). It set off an international trade war and caused the decline in trade that is often considered a cause of the worldwide depression of the 1930s.
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28. WELFARE ANALYSIS FOR A SMALL COUNTRY
Using of partial equilibrium analysis.
A tariff raises the price of a good in the importing country and lowers it in the exporting country.
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29. PARTIAL EQUILIBRIUM ANALYSIS OF A TARIFF – A SMALL COUNTRY CASE
Partial Equilibrium Effects of a Tariff
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30. Consumer surplus 60$ reduction
Partial Equilibrium Analysis of a Tariff – A Small country case
Partial Equilibrium Effects of a Tariff
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New
consumer’s surplus
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Tariff
Consumer surplus 60$ reduction

31. Partial Equilibrium Analysis of a Tariff – A Small country case
Partial Equilibrium Effects of a Tariff
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15$증

32. Partial Equilibrium Analysis of a Tariff – A Small country case
Partial Equilibrium Effects of a Tariff
Production surplus =a= 15$
Production = 10X
Consumer surplus = a+b+c+d= -60$
Consumption = 20X
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Protection cost
Deadweight cost
=b+d= 15$
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Tariff revenue = c =30$
a=15$
c=30$
b=5$
d=10$

33. Partial Equilibrium Analysis of a Tariff – A Small country case
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As a result of the price change:
Consumers lose in the importing country
Producers gain in the importing country
Government imposing the tariff, gains revenues
Effects can be summarized as:
Consumption effect
Production effect
Trade effect
Revenue effect
Effect on consumer surplus
Effect on producer surplus
Deadweight loss
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34. The Theory of Tariff Structure
The Rate of Effective Protection (nominal vs. real tariffs)
The formula:
(t – aiti)
(1 – ai)
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g = =
Where g = the rate of effective protection to producers of the final commodity
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t = the nominal tariff rate on consumers of the final commodity
ai = the ratio of the cost of the imported input to the price of the final commodity in the absence of tariffs
ti = the nominal tariff rate on the imported input

35. The Theory of Tariff Structure
The Rate of Effective Protection
Example: Suppose that $80 of imported wool goes into the domestic production of a suit. Suppose also that the free trade price of the suit is $100 but the nation imposes a 10 percent nominal tariff on each imported suit. (110$)
Nominal Tariff Rate = 10%
Effective rate of protection= 0.1 – 0.8 (0) / (0.1 – 0.8) = 50%
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36. The Theory of Tariff Structure
Generalization and Evaluation of the Theory of Effective Protection
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(1) If ai = 0, g = t
(2) For any given values of ai and ti, g is larger the greater is the value of t.
(3) For any given values of ai and ti, g is larger the greater is the value of ai.
(4) The value of g exceeds, is equal to, or is smaller than t, as ti is smaller than, equal to, or larger than t.
(5) When aiti exceeds t, the rate of effective protection is negative.
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37. WELFARE EFFECTS OF QUOTAS
The effects of a quota are similar to a tariff:
If the quota is less than is currently imported, it will lead to excess demand and will raise the price of the commodity.
Some production is shifted to domestic producers who are higher cost suppliers.
A quota therefore leads to a misallocation of resources.
License holders are able to buy imports and resell them at a higher price in the domestic market.
The profits received by the holders of import licenses are known as quota rents.
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38. Import Quota vs. Import Tariffs
Effect on demand
Price & quantity effect
With a quota, an increase in demand domestically will increase the domestic price of the imported commodity and lead to substitution by domestically produced goods.
With a tariff an increase in domestic demand leads to an increase in imports at the tariff inclusive price.
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39. Import Quota vs. Import Tariffs
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Government Revenue Effect
Tariff leads to government revenue quota may not produce any revenues. However the distribution of import licenses can lead to revenues
Auction in a competitive market
Captures monopoly profit
Official judgments
Corruption
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40. General Equilibrium Analysis of a Tariff in a Small Country
A tariff in a small country reduces consumption and increases production of the imported commodity (See fig 8.5)
The Stolper-Samuelson Theorem
An increase in the relative price of a commodity (for example, as a result of a tariff) raises the return or earnings of the factor used intensively in the production of the commodity.
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Thus the real return to the nation’s scare factor of production will rise with the imposition of a tariff.
Recall: Factor Price Equalization Theorem.

41. The Theory of Tariff Structure- Tariff Escalation
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FIGURE 8-4 Pre- and Post-Uruguay Round Cascading Tariff Structure in Industrial Countries.

42. GENERAL EQUILIBRIUM ANALYSIS OF A TARIFF IN A LARGE COUNTRY
When a nation imposes a tariff, its offer curve shifts toward the axis measuring its importable commodity by the amount of the import tariff.
Why? For any amount of the export commodity, importers now want sufficiently more of the import commodity to also cover the tariff.
Effects:
(1) Reduces the volume of trade  reduces the nation’s welfare
(2) Improves the nation’s terms of trade  increases the nation’s welfare
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43. General Equilibrium Analysis of a Tariff in a Large Country
8.6. Illustration of the Effects of a Tariff in a Large Country
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60Y-60X
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40Y-50X
Px/Py = 0.8
2- WHY?
FIGURE 8-6 General Equilibrium Effects of a Tariff in a Large Country (N2)

44. General Equilibrium Analysis of a Tariff in a Large Country
8.5B. Illustration of the Effects of a Tariff in a Large Country
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FIGURE 8-6 General Equilibrium Effects of a Tariff in a Large Country

45. The Optimum Tariff
The Meaning of the Concept of Optimum Tariff and Retaliation
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Optimum tariff: the tariff rate that maximizes the net benefit resulting from the improvement in the nation’s terms of trade against the negative effect resulting from reduction in the volume of trade.
What if the trade partner retaliates?
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46. The Optimum Tariff FIGURE 8-7 The Optimum Tariff and Retaliation.
Illustration of the Optimum Tariff and Retaliation
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Eventually, both nations are likely to lose all or most of the benefits from trade
Free trade maximizes world welfare
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FIGURE 8-7 The Optimum Tariff and Retaliation.

47. PERSISTENCE OF TRADE BARRIERS?
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Special interest groups: organized industries receive higher levels of protection.
Features of organized industries:
Only a few firms comprise the industry
Mostly consumer products are produced
Geographically decentralized
Employ a large number of workers (voting power)
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48. PERSISTENCE OF TRADE BARRIERS?
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Status quo: governments are more likely to protect industries that have received protection in the past.
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49. PERSISTENCE OF TRADE BARRIERS?
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Political economy: protection is more likely to be directed at industries that compete with products produced from developing countries because they have less economic and political power than industrial countries to fight trade restrictions successfully. See case studies 9-7 and 9-8.
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50. PERSISTENCE OF TRADE BARRIERS?
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Infant industry argument: argument by developing countries of the need for activist trade policy and protectionism to give young industries time to mature and be able to effectively compete with imports.
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51. PERSISTENCE OF TRADE BARRIERS?
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Optimum tariff argument: tariff barriers allow a large nation to be able to improve its terms of trade by reducing the volume of trade.
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52. PERSISTENCE OF TRADE BARRIERS?
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Industrial and strategic trade policy: argument by developed countries of the need for activist trade policy and protectionism in order to derive a comparative advantage in the high-technology industries. These industries have high external economies and can therefore have a positive impact on growth. However, their development requires economies of scale. They are also subject to high risks.
Examples: steel industry (1950s); semiconductors (1970s and 1980s); Concorde (1970s); Airbus (1970s)
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53. PERSISTENCE OF TRADE BARRIERS?
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Trade and industrial policies of Japan in the semiconductors industry:
Research and development
Tax concessions for investments in the industry
Government- industry cooperation (Public-Private Partnerships- PPP)
Trade barriers
Emphasis on science and mathematics
As a result of these policies Japan nearly overtook the US in this industry by the 1980s.
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54. Game theory and strategic trade policy (James Brander and Barbara Spencer (1985)
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Assumptions:
Two firms producing a new product, aircraft
To make a profit ($100 mn), each firm requires the entire world market
If both were to operate in the market they would make a loss of $10 mn.
A subsidy ($15 mn) would allow one firm, say Airbus, to make a profit ($5 mn) but would force out the competitor, Boeing.
If Boeing retaliates with a subsidy they can both continue to operate.
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55. Two- Firm Competition and Strategic Trade Policy
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Two- Firm Competition and Strategic Trade Policy
Airbus
Produce
Don’t Produce
Boeing
-10,-10
100,0
Don’t produce
0, 100
0,0
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56. US Response to foreign industrial targeting and strategic trade policies
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Sematech created in Texas in 1987: was initially a non-profit consortium of 14 major US semiconductor manufacturers created to compete with Japanese manufactures of semiconductors.
1991 semicondutor agreement with Japan where Japan agreed to assist US computer chip producers to gain to 20% share of Japanese chip market.
1990 agreement between the US and Japan for Japan to open up its construction market to US firms under threat of closure of the US market to Japanese.
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57. US Response to foreign industrial targeting and strategic trade policies
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2005 textile and apparel agreement with China to reduce Chinese exports of textile and apparel to the US
Bananas Dispute in the WTO
EU’s ban of imports of American hormone- treated beef
Brazil case brought against the US for $3 bn subsidies given to US cotton farmers.
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58. GLOBAL COMMERCIAL POLICIES
GATT created in 1947 on the principles of (1) non- discrimination, (2) elimination of nontariff trade barriers, (3) consultation in solving trade disputes. Based on multilateral trade negotiations.
Prior to GATT the ITO (1947) governed world trade
GATT covered 90% of world trade and covered 123 countries by 1993 excluding China and the countries of the USSR.
Tariffs under GATT were reduced by 35% under five trade negotiations between 1947 and 1962.
In 1965 GATT catered for preferential treatment of developing countries
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59. Global commercial policies
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GATT did not have much success because negotiations were on a product- by- product basis
Following GATT there were eight rounds of negotiations that have contributed to tariff reductions.
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60. KENNEDY ROUND (6TH ROUND)
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Brought about a GATT anti-dumping Agreement and a section on development.
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61. TOKYO ROUND (7TH ROUND) 1973- 1979
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The first major attempt to tackle trade barriers that do not take the form of tariffs, and to improve the system,
Agreements on non-tariff barriers adopted.
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62. URUGUAY ROUND (8TH ROUND)
Adoption of new rules governing agriculture re:
Market access
Domestic support
Export subsidies
New rules on Sanitary & Phytosanitary (SPS)
New rules on Services (GATS)
New rules for Trade in Intellectual Properties (TRIPS)
Creation of the WTO in 1995 under the Marrakesh agreement
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63. PRINCIPLES OF THE WTO
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Non-discrimination: the most favoured nation (MFN) rule, and the national treatment policy.
Reciprocity.
Binding and enforceable commitments.
Transparency.
Safety valves.
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64. DOHA ROUND (9TH ROUND) Launched in 2001
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Launched in 2001
Focus on development re reducing barriers to trade for developing countries.
No agreement to date.
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65. Further reading Salvatore (2007) , Chapters 8 & 9 9/12/2018
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