Critical Thinking : Trade Barriers: Additional Issues

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INTERNATIONAL ECONOMICS SEVENTEENTH EDITION

ROBERT J. CARBAUGH

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Chapter 4 Tariffs

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CHAPTER OUTLINE (1 of 3)

The Tariff Concept

Types of Tariffs

Effective Rate of Protection

Tariff Escalation

Outsourcing & Offshore Assembly Provision

Dodging Import Tariffs: Tariff Avoidance & Tariff Evasion

Postponing Import Tariffs

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CHAPTER OUTLINE (2 of 3)

Tariff Effects: An Overview

Tariff Welfare Effects: Consumer Surplus & Producer Surplus

Tariff Welfare Effects: Small-Nation Model

Tariff Welfare Effects: Large-Nation Model

Examples of U.S. Tariffs

How a Tariff Burdens Exporters

Tariffs and the Poor: Regressive Tariffs

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CHAPTER OUTLINE (3 of 3)

Arguments for Trade Restrictions

Would a Tariff Wall Really Protect U.S. Jobs?

The Political Economy of Protectionism

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Tariffs

Free-Trade argument posits that open markets foster most efficient use of world resources

But free trade policies often meet resistance among companies and workers who face losses in income and jobs because of import competition

Policymakers torn between global efficiency and needs of voting public

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The Tariff Concept (1 of 3)

Tariff

A tax (duty) levied on a product when it crosses national boundaries

Import tariff

Tax levied on an imported product

Most common; collected before shipment can be unloaded in domestic port

Export tariff

Tax imposed on an exported product

Less common; illegal under U.S. Constitution

Commonly used by developing nations

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The Tariff Concept (2 of 3)

Protective tariff

Protects domestic producers from foreign competition

Facilitates increase in output of import-competing producers

Revenue tariff

Generates tax revenues by placing tariffs on either imports or exports

Now only 1% of total federal revenues in U.S.

Many developing nations rely on tariffs as major source of income

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The Tariff Concept (3 of 3) Table 4.1

Taxes on International Trade as a Percentage of Government Revenues, 2013: Selected Countries

Developing Countries	Percentage	Advanced Countries	Percentage
Bahamas	43.2	New Zealand	2.7
Ethopia	29.8	Australia	1.8
Liberia	28.1	Japan	1.7
Bangladesh	26.7	United States	1.2
Grenada	25.4	Switzerland	1.0
Russian Federation	25.8	Norway	0.3
Philippines	19.9	Ireland	0.2
India	14.1	World average	3.8

Source: From World Bank Data at http://data.worldbank.org. See also International Monetary Fund, Government Finance Statistics, Yearbook, Washington, DC.

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Types of Tariffs (1 of 3)

Tariffs may be specific, ad valorem, or compound

Specific tariff

Fixed amount of money per physical unit of imported product (Ex: 15 cents/unit).

Relatively easy to apply and administer

Degree of protection varies inversely with changes in import prices

Provides domestic producers increased protection during recession (with falling prices)

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Types of Tariffs (2 of 3)

Tariffs may be specific, ad valorem, or compound (cont.)

Ad valorem tariff

Primarily used with manufactured goods because can be applied to products with range of grade variations

Fixed percentage of the value of imported product (Ex: 15%/unit)

Maintains constant degree of protection for domestic producers through the business cycle

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Types of Tariffs (3 of 3)

Tariffs may be specific, ad valorem, or compound (cont.)

Customs valuation: determining value of imported product; is complex, subject to disagreement

U.S. traditionally uses free-on-board valuation (FOB)⎯tariff applied to product’s value as it leaves exporting country

Europe traditionally uses cost-insurance-freight valuation (CIF)⎯tariffs levied as percentage of imported commodity’s total value upon arrival at final destination

Compound tariff

Applied to manufactured products composed of raw materials subject to tariffs

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Effective Rate of Protection (1 of 3)

Nominal and Effective tariff rates

Nominal tariff rate: rate published in country’s tariff schedule

Applies to value of finished product

Effective tariff rate: takes into account not only nominal tariff on finished good but any tariff applied to imported inputs

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Effective Rate of Protection (2 of 3)

Effective tariff rate (e) calculated as:

e = effective rate of protection

n = nominal tariff rate on final product

a = ratio of value of the imported input to value of finished product

b = nominal tariff rate on imported input

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Effective Rate of Protection (3 of 3)

If tariff on finished product is less than tariff on imported input

Effective rate of protection is less than nominal tariff (may even be negative)

Tariff protects domestic suppliers of raw materials more than domestic manufacturers

If tariff on finished product exceeds tariff on imported input

Effective tariff exceeds nominal tariff

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Tariff Escalation

Processed goods have higher import tariffs

Raw materials often imported at zero or low tariff rates; nominal and effective protection increases at each production stage

Tariff Escalations in Advanced and Developing Countries, 2012

AGRICULTURAL PRODUCTS

INDUSTRIAL PRODUCTS

Country	Primary Products	Processed Products	Primary Products	Processed Products
Bangladesh	17.5	23.0	9.1	15.4
Uganda	17.5	20.3	4.2	11.7
Argentina	5.7	11.5	2.9	9.5
Brazil	6.5	12.1	4.2	10.7
Russia	6.9	9.2	5.3	9.5
United States	1.0	2.8	1.3	2.8
Japan	4.5	10.9	0.5	1.9
World	12.0	15.1	5.6	7.7

Source: From World Bank Data at http://data.worldbank.org.

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Outsourcing & Offshore Assembly Provision

Outsourcing is key aspect of global economy

Ex: Electronic components made in the U.S. are shipped to another country with low labor costs for assembly into TV sets; assembled sets returned to U.S. for further processing or packaging & distribution

Each production stage in country where it incurs least cost

Offshore-assembly provision (OAP)

Provides favorable treatment to products assembled abroad from U.S.-made components

Incentivizes foreign manufacturers to purchase components from U.S. sources

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Dodging Import Tariffs: Tariff Avoidance & Tariff Evasion

Tariff avoidance

Legal utilization of tariff system to one’s own advantage

Tariff evasion

Evading tariffs by illegal means such as smuggling imported goods into a country

Ford strips its wagons to avoid high tariff

Ex: Ford strips its wagons to avoid high tariff

Ex: Smuggled steel evades U.S. tariffs

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Postponing Import Tariffs: Bonded Warehouse

Under U.S. tariff law, dutiable imports can be brought into U.S. and temporarily left in a bonded warehouse, duty free (up to 5 years)

Owners of warehouses must be bonded to ensure they will satisfy all customs duty obligations

Bonding company guarantees payment of custom duties if importing company unable to do so

When goods removed from warehouse, firm must pay duty on value at time of removal

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Foreign-Trade Zone (FMZ)

Area in U.S. where businesses operate without paying duties on imported products or materials as long as they remain in area and do not enter U.S. marketplace

In an FTZ, can do just about anything to merchandise – repair, repackage, assemble

FTZ program treats a product manufactured in FTZ as if it were imported, not made in U.S.

Customs duties are due when goods are transferred from FTZ for U.S. consumption

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Tariff Effects: An Overview

As taxes on imports, tariffs make items more expensive for consumers, reducing demand

Buyers pay more for U.S.-made goods than they would for imported goods under free trade

Job loss in retail and transportation sectors that import foreign-made goods

Job loss in any domestic industry that suffers retaliatory tariffs

Additional costs of imported inputs passed on to consumers through goods and services that use such inputs in production process

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Tariff Welfare Effects: Consumer Surplus & Producer Surplus (1 of 2)

Consumer Surplus (CS)

Difference between what buyers are willing & able to pay and the amount they actually pay

Inverse relationship between change in market price and CS

Producer surplus (PS)

Difference between what producers are willing and able to receive and the amount they actually receive

Direct relationship between change in price and PS

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Tariff Welfare Effects: Consumer Surplus & Producer Surplus (2 of 2) Figure 4.1

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Tariff Welfare Effects: Small-Nation Model (1 of 4)

Small nations import very small portion of world market supply; unable to impact market price

Is a price taker, facing constant world prices for products it imports

Tariff effects

Raises home price of imported good by full amount of duty

Results in higher domestic production & PS

Lowers domestic consumption & decreases CS

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Tariff Welfare Effects: Small-Nation Model (2 of 4) Figure 4.2

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Tariff Welfare Effects: Small-Nation Model (3 of 4)

A small nation tariff effects on nation’s welfare:

Consumer surplus falls

Additional tax revenues

Benefits domestic producers

Wastes resources

Revenue effect (Area “c”)

Government’s collections of duty

Redistributive effect (Area “a”)

Transfer of consumer surplus to domestic producers

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Tariff Welfare Effects: Small-Nation Model (4 of 4)

A small nation tariff effects on nation’s welfare: (cont.)

Protective effect (Area “b”)

Loss to domestic economy from wasted resources used to produce at increasing unit costs

Consumption effect (Area “d”)

Decrease in consumption resulting from tariff’s artificially increasing price

Deadweight loss (Area “b” + “d”)

Protective effect and consumption combined

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Tariff Welfare Effects: Large-Nation Model (1 of 3)

Tariffs may increase national welfare when imposed by importing nation large enough that changes in its quantity of imports influence world price (ex: U.S., Japan, EU)

U.S. imposes tariff on automobile imports

Prices increase for American consumers, quantity demanded decreases

Effect shared between U.S. consumers, who pay higher price, and Japanese firms, which receive lower price than under free trade

Terms of trade improve for U.S. at Japan’s expense

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Tariff Welfare Effects: Large-Nation Model (2 of 3) Figure 4.3

If e > (b + d)

National welfare is increased

If e = (b + d)

National welfare remains constant

If e < (b + d)

National welfare is diminished

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Tariff Welfare Effects: Large-Nation Model (3 of 3)

Economic effects of an import tariff

Redistributive effect

From domestic consumers to domestic producers

Deadweight loss

Consumption effect

Protective effect

Revenue effect

Domestic revenue effect

Terms-of-trade effect

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Donald Trump’s “Border Tax” How to Pay for the Wall

Trump wants Mexico to pay for the border wall

Mexico refused

Trump declared a 20 percent border tax on Mexican imports

Violated NAFTA and WTO agreements

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The Optimum Tariff & Retaliation

Optimum tariff

Maximizes positive difference between gain of improving terms of trade (Area “e”) and loss in economic efficiency from the protective effect (Area “b”) and consumption effect (Area “d”)

Only beneficial to importing nation

Beggar-thy-neighbor policy; could invite retaliation

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Examples of U.S. Tariffs (1 of 3)

Obama’s Tariffs on Chinese Tires

As condition of entry to WTO in 2001, China agreed that other nations could clamp down on surges of imports from China without having to prove unfair trade practices

In 2004–2008, China increased tire shipments to U.S. by 300%; four U.S. tire plants closed, 4,500 jobs lost; Obama imposed tariffs for 3 more years

Obama administration maintained tariffs would enforce rule China agreed to; significantly reduce tire imports; boost U.S. sales, prices, profitability; and have little or no impact on production

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Examples of U.S. Tariffs (2 of 3)

Obama’s Tariffs on Chinese Tires

Critics argued

Action opposed by U.S. tire firms because already had abandoned making low-cost tires

Not profitable to produce cheap tires in U.S. because of competition from foreign companies

To compete, U.S. manufacturers would have to revamp factory lines to produce tires

If Chinese tires blocked, Brazil, Indonesia, others will supply, but will take time; in meantime, will be shortages of low cost tires in U.S. & prices rising by 20–30%

Tariff produced mixed results

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Examples of U.S. Tariffs (3 of 3)

Should Footwear Tariffs be Given the Boot?

During 1930s, tariffs introduced to protect rubber & canvas shoe industry

Although other tariffs eliminated since 1930s, footwear tariffs have continued

U.S. footwear industry now nearly extinct; almost 99% of footwear sold in U.S. imported

Affordable Footwear Act introduced in 2013

Attempts to abolish most severe footwear tariffs and lower prices of shoes

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How a Tariff Burdens Exporters

Effects of import tariffs on exporters

Higher production costs from imported inputs and reduction in CS

Can result in higher prices and, depending on elasticity of demand, reduce overseas sales

Raise cost of living

International repercussions lead to reduction in domestic exports

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Tariffs and the Poor: Regressive Tariffs (1 of 2)

Tariffs are inequitable

Impose most severe costs on low-income families – tend to be regressive

Higher tariffs imposed on cheap goods than on luxuries

Affect different countries in different ways

Tend to burden countries (e.g., poor countries in Asia and Middle East) that specialize in production and sale of cheaper goods

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Tariffs and the Poor: Regressive Tariffs (2 of 2) Table 4.7

U.S. Tariffs Are High on Cheap Goods, Low on Luxuries

Product	Tariff Rate (percent)
Men’s knitted shirts
Synthetic fiber	32.5
Cotton	20.0
Silk	1.9
Handbags
Plastic-sided	16.8
Leather, under $20	10.0
Reptile leather	5.3

Source: From U.S. International Trade Commission, Tariff Schedules of the United States, Washington, DC, Government Printing Office, 2013, available at http://www.usitc.gov/taffairs.htm.

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Arguments for Trade Restrictions (1 of 9)

Free-trade argument

If each nation produces what it does best and permits trade, in long term, there will be lower prices and higher levels of output, income, and consumption

Job protection argument

Job gains less visible than job losses

Trade restrictions result in job gains for few industries; job losses are spread out

Saved jobs costs more than worker’s salary

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Arguments for Trade Restrictions (2 of 9)

Protection against cheap foreign labor

Low wages abroad makes it hard for U.S. firms to compete with firms using cheap foreign labor

Fails to recognize links among efficiency, wages, and production costs

Low wages do not guarantee low costs

Low-wage nations have competitive advantage only in goods requiring greater labor and few other factor inputs

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Arguments for Trade Restrictions (3 of 9) Table 4.9

Hourly Compensation Costs in U.S. Dollars for Production Workers in Manufacturing, 2015

Country	Hourly Compensation (dollars per hour)
Norway	49.67
Germany	42.42
United States	37.71
United Kingdom	31.44
Japan	23.60
Taiwan	9.51
Mexico	5.90
Philippines	2.16

Source: From The Conference Board, International Comparisons of Hourly Compensation Costs in Manufacturing, 2015, April 12, 2016, available at www.conference-board.org.

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Arguments for Trade Restrictions (4 of 9) Table 4.10

Productivity, Wages, and Unit Labor Costs, Relative to the United States: Total Manufacturing (United States = 1.0)

Country	Labor Productivity Relative to United States	Wages Relative to United States*	Unit Labor Cost Relative to United States
Hong Kong (2008)	0.21	0.44	2.09
Mauritius (2007)	0.06	0.12	2.00
South Africa (2008)	0.14	0.27	1.93
European Union (2009)	0.46	0.84	1.83
United Kingdom (2009)	0.50	0.84	1.68	U.S. More Competitive
Singapore (2008)	0.40	0.61	1.53	U.S. Less Competitive
Japan (2008)	0.67	0.72	1.07
Mexico (2009)	0.18	0.17	0.94
South Korea (2006)	0.71	0.61	0.86
Poland (2006)	0.26	0.20	0.77
China (2008)	0.12	0.08	0.67

*At market exchange rate.

Source: The author wishes to thank Professor Steven Golub of Swarthmore College, who provided data for this table. Refer to his CESifo Working Paper at the Center for Economic Studies, University of Munich, Munich, Germany, 2011. See also Janet Ceglowski and Stephen Golub, “Are China’s Labor Costs Still

Low?” This paper was prepared for the CESifo conference on China and the Global Economy Post Crisis, held in Venice, Italy, July 18–19, 2011.

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Arguments for Trade Restrictions (5 of 9)

Fairness in Trade: Level Playing Field

Domestic producers say import restrictions need to offset foreign advantages, to create level playing field

Rationale for restrictions is that foreign governments play by different rules, giving foreign firms unfair competitive advantage

Trade benefits domestic economy even if foreign nations impose trade restrictions

Fair trade argument overlooks potential impact of trade restrictions on global trade

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Arguments for Trade Restrictions (6 of 9)

Maintenance of the Domestic Standard of Living

Advocates of trade barriers often contend tariffs are useful in maintaining high level of income and employment in home nation

However, one nation imposes a tariff that improves its income and employment at the expense of its trading partner’s living standard (beggar-thy-neighbor policy)

May spark retaliatory tariffs, resulting in lower level of welfare for all nations

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Arguments for Trade Restrictions (7 of 9)

Equalization of Production Costs

Scientific tariff - to eliminate unfair competition from abroad

Problems

Different costs across business

Higher domestic prices

Benefit efficient domestic companies

Domestic consumer subsidizing inefficient production

Scientific tariff approximates prohibitive tariff

Completely contradicts notion of comparative advantage & eliminates basis/gains for/from trade

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Arguments for Trade Restrictions (8 of 9)

Infant-Industry Argument

Trading nations temporarily shield newly developing industries from foreign competition

If protective tariff imposed, difficult to remove

Special-interest groups - convince policy makers that further protection is justified

Difficult to determine which industries will realize comparative advantage in long-run

Not valid for mature, industrialized nations

Alternative=providing domestic industry subsidy

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Arguments for Trade Restrictions (9 of 9)

Noneconomic Arguments

National security argument

Protect essential industries

What constitutes an “essential” industry?

Cultural and sociological considerations

Assumption that national and individual’s welfare enhanced by tariffs

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Would a Tariff Wall Really Protect U.S. Jobs?

Trade protectionism political priority in 2016 presidential election

Tariffs on imported steel tend to have a positive, direct effect on jobs for American steel workers, but can have less visible, indirect effects on others

Tariff-related gains for Americans is a complex issue

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Political Economy of Protectionism

Elected officials formulate policies to maximize votes and remain in office

Bias in the political system favors protectionism

Protection-biased sector

Import competing producers

Labor unions - in protected industry

Suppliers of producers in protected industry

Established firms in aging industry that could lose their comparative advantage

Free-trade-biased sector

Exporting producers, their workers, and their suppliers

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A Supply & Demand View of Protectionism (1 of 3)

Though protectionism provides benefits to domestic producers, society as whole pays costs

Losses of consumer surplus because of higher prices

Resulting deadweight losses

Lost economies of scale as further opportunities are lost

Loss of incentive for technological development provided by import competition

The higher the costs of protection, the less likely a government is to shield an industry from import competition

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A Supply & Demand View of Protectionism (2 of 3)

Supply of protectionism increases, depending on:

Political importance of import-competing industry

Whether domestic firms and workers face large costs of adjusting to rising import competition

Public sympathy for a group of domestic businesses or workers

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A Supply & Demand View of Protectionism (3 of 3)

Demand for protection rises with:

Intensification of domestic industry’s comparative disadvantage

Higher levels of import penetration

Concentration of domestic production

Degree of export dependence

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