Tariff issues

Successive rounds of multilateral trade negotiations since 1947 have helped achieve deep reductions in import duties. This is particularly true for industrial goods, on which tariffs have fallen from around 40% at the end of World War II to a tenth of that today. Nevertheless, tariffs continue to influence trade patterns. By making products more expensive to consumers, tariffs hamper demand for imports. They also alter the relative prices of products, and can protect uncompetitive companies and their overpriced products. These distortions are particularly pronounced in many non-OECD countries where tariffs remain substantially higher than in the OECD area.

Tariffs on agricultural products are on average much higher than those on industrial products, although there is considerable diversity from country to country. Moreover, tariffs may be coupled with quotas whereby a country sets a tariff of, say, 10% on the first 10 000 units of imported grain (called the tariff rate quota, or TRQ) but increases it to 100% on any additional grain imports (called the above quota tariff). One OECD study found that such tariffs on agriculture products were equivalent, on average, to a straight tariff of 36% for OECD countries and 63% for selected non-OECD countries, compared with agricultural tariffs of 15% in OECD countries and 43% in non-OECD countries.

Even when tariffs have been reduced, the way they are structured continues to pose problems in both agriculture and industry. Problems exist with tariff escalation, low “nuisance” tariffs, high tariff dispersion and tariff peaks. Tariff peaks, defined as tariffs of 15% or more, often apply to products of particular concern to developing countries such as textiles, clothing and some agricultural products. In developing countries products such as tobacco, leather, cocoa, cotton, wood and paper are often subject to tariff escalation, meaning the rate is increased according to how much processing is involved in the product.

Textiles and clothing are in some ways a special case. The Multi-Fiber Arrangement agreed in the Uruguay Round brought an end to quotas on these goods – the system whereby only a specified quantity of goods could be imported over a given period. Countries that cannot use quotas to protect national industries may use tariffs instead, and the tariffs levied on textiles and clothing by some OECD countries remain relatively high.

Tariff reduction benefits both developed and developing countries. Consumers have more choice, with more products and a wider price range. By removing price distortions, tariff reduction also encourages resources to be used in a way that takes better advantage of a country’s strong points with respect to its partners. In other words, it allows comparative advantage to reveal itself. For developing countries, improved resource allocation and higher export revenue contribute to national income and increase the pool of resources available for development-related investment. In turn, economic development in these countries broadens the potential markets for OECD products. And by encouraging contacts between people, expanding trade can also contribute to increased cultural exchanges, co-operation in humanitarian efforts and healthier international relations.

Most studies suggest that the developing countries with the highest initial tariff rates stand to gain most from reducing their tariffs. Trade liberalization will have economic and social costs associated with transition of labor from one activity to another. Still, these costs tend to be short-term and are outweighed on average by the potential welfare gains that result from lowering trade barriers. Complementary economic, social or labor market policies can help ease the pain of adjustment and make trade liberalization more effective in promoting growth.

Taking the fully implemented Uruguay Round as a starting point, the OECD examined eight scenarios designed to reflect different levels of tariff reduction and the uniform reduction in trade costs by 1% of the value of trade. All these scenarios demonstrate the advantages of trade liberalization.

The least beneficial scenario involves a 50% cut in tariffs overall and the uniform reduction in trade costs, which nonetheless yields annual global gains of $117 billion.

An approach which reduces high tariffs by a higher proportion, with a maximum after-reform tariff of 5% on any item and the uniform reduction in trade costs, provides an even bigger lift. This so-called “Swiss formula” yields global gains of $158.5 billion – and all regions gain from the tariff reduction.

The largest overall gains result from a complete abolition of all merchandise tariffs and the uniform reduction in trade costs, which would boost the world economy by $173.5 billion per year.

It is important to bear in mind that these estimates, like many others, measure what are called static gains. They assume for ease of computation that the economy doesn’t build on initial improvements in productivity.

Economists know, however, that dynamic gains will also gradually accrue and these will be many times the size of the static gains. But they find it hard to measure such gains. Narrowly defined, dynamic gains are trade-related changes in the long-run rate of productivity growth. There is robust evidence that open economies are richer and more productive than closed economies. Trade and foreign direct investment (FDI) affect productivity levels and growth rates through better resource allocation, higher return to investment in capital and R&D, deepening specialization and technology spillovers. An increase in the share of trade in GDP of one percentage point raises the income level by between 0.9% and 3%.

If tariffs were eliminated, more than half (52%) of the benefit would be expected to accrue to developing countries. A combined package of complete tariff elimination and a reduction in trade costs would bring welfare gains equivalent to 1.37% of annual GDP in developing countries and 0.37% in developed countries. Under the Swiss formula scenario, developing countries’ share of the benefit would be 45% and if tariffs were halved, it would be 60%. While tariffs are an important source of government revenue in some countries, certain scenarios can minimize the loss of this revenue while still delivering significant welfare gains. This is true even under the Swiss formula approach, which cuts relatively high tariffs the most.

Both industry and agriculture contribute significantly to the overall welfare gains that can be achieved by reducing tariffs. However, under a full liberalization scenario, roughly two-thirds of the developing-country welfare gains come from removing tariff-related distortions in just three sectors: motor vehicles and parts; textiles and clothing; and processed agricultural products. Developing countries could benefit from liberalization that is limited primarily to developed countries. But they would benefit even more in absolute terms if they liberalized as well.

The simplest way to discourage trade is simply to ban it outright or, once a certain threshold is crossed, to apply what specialists call “prohibitions and quotas”. This type of practice became headline news in Europe and Asia when quotas were applied to textile imports from China to protect European producers. That measure was temporary and was said to have been employed for domestic economic reasons. But prohibitions put in place for non-economic reasons, especially to protect the environment and human safety and health, are found in virtually every country. Their use seems to be on the rise, increasing faster in developed countries with stricter social regulatory frameworks. In contrast, in developing countries the application of quotas and prohibitions for economic reasons, such as balance-of-payment problems and industry protection, generally seems to be declining.

Import prohibitions are commonly applied to trade of certain used goods, such as automobiles, auto parts, clothing and machinery. The circumstances surrounding these measures appear unclear at times, and may merit further investigation and possibly discussion in international trade negotiations. Some countries apply non-automatic import licensing. If it is made extremely difficult to obtain a licence, this kind of measure is, in practice, a prohibition.

When applied for non-economic reasons, import prohibitions are policy solutions aimed at ensuring that various regulatory objectives are met, and sovereign governments have every right to apply them. At the same time, governments should also consider whether import bans are the best solution and whether there exist other means to achieve their objectives without harming trade.

The way that border and behind the border policies are applied or administered can become a “procedural barrier to trade” which deserves attention in its own right. Trade can be influenced by the specific ways in which customs classification, valuation and clearance procedures are handled. It can also be affected by lengthy or duplicative product-approval or certification procedures, or even private restrictive practices that are tolerated by governments. For example, import quotas, product standards and other policies that directly or indirectly affect trade can be designed, applied or enforced in a non-transparent or arbitrary manner that puts foreign producers at a disadvantage.

These procedural aspects cause additional difficulties in export markets. WTO agreements covering various types of non-tariff barriers set out more or less detailed provisions that are designed to prevent, or at least minimise, adverse effects resulting from procedural barriers to trade. Yet exporters and policy makers continue to identify such barriers as significant impediments to trade and look towards further improvements of existing rules.

As any traveler carrying purchases through customs knows, imported goods are frequently subject to various customs fees and charges. On a bigger scale the same applies to businesses, and customs fees combined with tariffs add significantly to the costs of trading in many parts of the world. Low- and middle-income countries in particular levy high fees that may negatively affect trade. The use of customs fees and charges has evolved over time. More countries now charge importers fees for the use of various customs-related services. In practice, a great majority of these fees, like most other types of fees and charges, are applied ad valorem, meaning they are based on the value of the goods being imported and not on the underlying cost of the services rendered (if any). This is true for high-income and for lower-income countries alike. Traders would like to see a more precise definition of what constitutes the “services” that the fees are intended to cover, and along with many trade economists, they would argue that if fees were calculated on the basis of services actually rendered, trade costs would come down.

Imports are not the only goods taxed. Some countries, mainly developing and least-developed countries, also tax their own exports. Goods subject to such taxes include mineral and metal products, leather and hide and skin products, forestry products, fishery products, and various agricultural products. There are three main reasons why a country would tax its own exports: to hold down the domestic price of a key product, to gain revenue and to promote certain industries, such as those processing the taxed good.

In addition to export duties, governments sometimes set minimum export prices, or reduce VAT rebates which directly increases export prices. Other forms of export restrictions affect export volumes and include export bans, quotas and licensing requirements. Recent years have seen increased use of export restrictions, notably for agriculture and food products during 2007 and 2008. While these measures may have temporarily increased supply to the domestic markets, they prevented domestic producers from benefitting from higher world prices and put increased pressure on prices in importing countries. Overall, the restrictions probably exacerbated the situation and undermined trust in trade.

There could be substantial economic benefits from further liberalization of some non-tariff barriers, but given the problems collecting data on these barriers, the wide-scale impacts of removing them are hard to quantify. Attempts to do so tend to focus on one type of measure, and this probably underestimates both the importance of these barriers and gains from their removal. One study showed that removal of a selection of barriers would generate global gains on the order of $90 billion. Another calculated that lowering trade transaction costs by 1% would result in global welfare gains of $40 billion. This is far less than estimates for gains from improvements in ports, customs, regulations and service sector infrastructure, for example. Improvements of these types would raise countries with below-average performance halfway to the global median and would generate global increases in merchandise trade amounting to $377 billion, an almost 10% increase in total trade.

Let’s take up this question of lobby groups, or rent-seeking behaviour as it is formally described. We argued earlier that trade barriers could have positive and negative consequences, depending on whether you look at their economic, social, environmental or other motivations and consequences. Trade barriers and trade policy can promote inequities and should not be examined in isolation from their political-economic environment. Tariffs, for example, tend to be highest on goods that represent an important portion of the purchases made by poorer consumers. They also tend to provide the most protection to goods that are produced by the most politically powerful industry groups, although there are notable exceptions such as oil. Both factors combined skew the distribution of income towards the richest groups in society.

Policy decisions then are influenced by a number of factors other than efficiency or well-being, including special interests, biases and access to information. At the start of this book, we mentioned how the price of sugar influenced Hershey’s decision to move chocolate production to Mexico. The US sugar industry is often quoted as an example of how poor trade policy can harm business and consumers. Tariffs, quotas and subsidies make the product twice as expensive in the American market as on world markets, and in fact the industry would probably not exist in Florida if the government hadn’t drained the Everglades and managed the ecosystem for the benefit of growers

Adam Smith and his contemporaries considered these aspects, while in modern times James Buchanan, Kenneth Arrow, Douglas North and Mancur Olson are among the leading thinkers on the subject. A few of their conclusions are worth mentioning here.

· If government appears to be increasingly sympathetic to calls for trade protection, lobbyists will be increasingly employed by groups to argue their case – and consequently trade barriers will tend to rise, more new infant industries will tend to get support and more old infant industries will not lose their subsidies.

· Politicians need to target median voters (in democratic states) or median constituents (in other states) to retain power – so middle income people will tend to benefit more from policy action than the poor and trade barriers will never disappear because foreigners don’t get a vote.

· Groups where potential policy gains are concentrated will lobby harder than groups with more diffuse gains – meaning firms will tend to get more trade protection and consumers will lose out.

· Civil servants are at least partly motivated by working in expanding organisations and on relatively good employment terms – and thus government programmes have a tendency to expand beyond the size required to perform a specific function.

The factors listed above can cause complications for countries trying to ensure that scarce resources are used wisely and that the distribution of income is in accord with the wishes of society. We cannot assume that government intervention will definitely correct market failure. Government intervention may actually make matters worse.

For these reasons public economics puts forward a three-part framework for policy analysis:

· How is a market performing?

· Is there market failure (a necessary condition for government intervention)?

· If government intervened with a particular policy intervention, would it be likely to improve matters or make them worse (“collective” failure)?

Now, if we refer back to our discussion on infant industries, there are a few classic examples of collective failure in the OECD countries. OECD agricultural policies were designed before and after World War II to deal with various crises. The original problems have long since disappeared but the median voter problem and other political economy issues are making it very difficult for governments to remove agricultural support policies. Witness the hold-ups in the WTO. A couple of other industries have had similar histories. For many years, motor vehicle industries were heavily subsidised in many countries. So too were “national” airlines. They were considered strategic or infant industries, or else national champions, and it often took decades to wean them off high levels of subsidy. It is also worth noting the choice of wording in government support presentations. Calling an industry “strategic” infers commercial promise. In fact, most government subsidies are given to failing firms.

Trade policy is not the cause of the economic difficulties that emerged in late 2008, nor does it offer the solution. But trade policy can contribute in three important ways.

First, a clear statement of concrete plans by governments to stop the spread of protectionism and to open markets further to competitive suppliers would help to restore confidence in markets, and in governments’ ability to work together in pursuit of common aims.

Second, action is needed to avoid a policy shift towards greater protectionism. Protectionism has a high cost. By closing borders or otherwise restricting markets, consumers pay more, firms incur higher costs, and choice is limited. Consider a world with just two traders: you and me. If I no longer import from you, you no longer have the foreign exchange that is needed to import from me. And so on, across the globe. While an individual government might have some success with protectionist policies, as more governments employ the same approach, every country loses. In short, global protectionism means job losses, including in the relatively competitive export sector, to the long-term benefit of no one.

We generally think of protectionism in terms of measures at the border – tariffs, quotas or other mechanisms that restrict trade or make imported products more expensive. But there is a wide array of measures that governments can take behind their borders that have very similar effects – including various forms of direct subsidies. Support to one sector in one country, whatever the motivation, disadvantages competing sectors in other countries. As other countries then move “to level the playing field”, a subsidy competition is launched that in the end benefits no country. But those that receive the subsidies may be better off than otherwise, and will vigorously defend their new entitlements. This explains in large part why subsidies to deal with a short term problem often prove almost impossible to remove.

The reasons for imposing barriers to trade can be economic, environmental, social, political, or a combination of these. Any number of factors may be more important than a particular trade opportunity. But what is important is that such decisions are clear and transparent, and that the benefits and the costs are well understood. Tariffs, even complex schemes, are relatively visible; many non-tariff barriers are much more complex, seldom very transparent, and their impact unclear.

Governments have a particular responsibility to ensure that the full range of impacts of tariff and non-tariff barriers, both intended essential if explicit policy objectives are to be met at the least cost and without unintended negative consequences. It is also essential in order to ensure that narrow special interests do not benefit at the expense of others. Experience has shown that even ineffective policies, once in place, are difficult to remove. The “first best” course of action is to avoid poor policy choices.