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Tariffs

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PowerPoint slides prepared by:

Andreea Chiritescu

Eastern Illinois University

The Tariff Concept

Tariff

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

Import tariff

Tax levied on an imported product

Export tariff

Tax imposed on an exported product

Often used by developing nations

Raise revenue, increase the world price

The Tariff Concept

Protective tariff

To reduce the amount of imports entering a country

Insulating import-competing producers from foreign competition

Allows an increase in the output of import-competing producers

Revenue tariff

To generate tax revenues

Placed on either exports or imports

Tariff revenues as a percentage of government revenues, 2007: selected countries

TABLE 4.1

Developing Countries	Percentage		Industrial Countries	Percentage
The Bahamas Guinea Ethiopia Ghana Sierra Leone Madagascar Dominican Republic Jordan	51.2 47.9 33.5 28.5 27.6 26.9 20.9 11.3		New Zealand Australia Japan Canada Switzerland United States United Kingdom Iceland	2.6 2.5 1.2 1.2 1.2 1.1 1.0 1.0

Types of Tariffs

Specific tariff

Fixed amount of money per physical unit of the imported product

Relatively easy to apply and administer

Degree of protection it affords domestic producers varies inversely with changes in import prices

Provides domestic producers more protection during a business recession

Types of Tariffs

Ad valorem (of value) tariff

Fixed percentage of the value of the imported product

Distinguish among small differentials in product quality

Tends to maintain a constant degree of protection for domestic producers

Types of Tariffs

Ad valorem (of value) tariff

Customs valuation problems

Estimations by customs appraisers

FOB vs. CIF valuation

Free-on-board valuation

Cost-insurance-freight valuation

Includes transportation costs

Types of Tariffs

Compound tariff

Combination of specific and ad valorem tariffs

For manufactured products

Embodying raw materials that are subject to tariffs

Specific tariff

Neutralizes the cost disadvantage of domestic manufacturers - from tariff protection granted to domestic suppliers of raw materials

Ad valorem tariff

Protects the finished-goods industry

Selected U.S. tariffs

TABLE 4.2

Examples of tariffs, selected countries (in %)

TABLE 4.3

Effective Rate of Protection

Nominal tariff rate

Published in the country’s tariff schedule

Applies to the value of a finished product that is imported into a country

Effective tariff rate

Takes into account the nominal tariff rate

On a finished product

And any tariff rate applied to imported inputs

Used in producing the finished product

The effective rate of protection

TABLE 4.4

Effective Rate of Protection

Effective tariff rate, e

e = The effective rate of protection

n = the nominal tariff rate on the final product

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

b = the nominal tariff rate on the imported input

Effective Rate of Protection

If the tariff on the finished product

Exceeds the tariff on the imported input

Effective rate of protection exceeds the nominal tariff

Effective Rate of Protection

If the tariff on the finished product

Is less than the tariff on the imported input

Effective rate of protection is less than the nominal tariff

May even be negative

Protects domestic suppliers of raw materials more than domestic manufacturers

China’s nominal and effective tariff rates in forestry products, 2001

TABLE 4.5

Tariff Escalation

Tariff escalation

Raw materials are often imported at zero or low tariff rates

The nominal and effective protection increases at each stage of production

Processed goods

Higher import tariffs

Tariffs often rise significantly with the level of processing (tariff escalation) in many industrial countries. This is especially true for agricultural products. Tariff escalation in industrial countries has the potential of reducing demand for processed imports from developing countries, hampering diversification into higher-value added exports.

Tariff escalation on industrial countries’ imports from developing countries

FIGURE 4.1

Outsourcing and Offshore-Assembly Provision

Outsourcing

Certain aspects of a product’s manufacture are performed in more than one country

Improvements in cost competitiveness

Penetrate foreign markets

High tariffs or other trade barriers restrict the direct export of finished goods

Unique foreign production technologies, labor skills, raw materials, or specialized components

Outsourcing and Offshore-Assembly Provision

Offshore-assembly provision (OAP)

Favorable treatment to products assembled abroad from U.S.-manufactured components

Cost of the U.S. component - not included in the dutiable value of the imported assembled article

Incentives for foreign manufacturers to purchase components from U.S. sources

Generates sales and jobs in the U.S. component industries

Dodging Import Tariffs: Tariff Avoidance and Tariff Evasion

Tariff avoidance

Legal utilization of the tariff system to one’s own advantage

To reduce the amount of tariff that is payable by means that are within the law

Tariff evasion

Individuals or firms evade tariffs by illegal means

Dodging Import Tariffs: Tariff Avoidance and Tariff Evasion

Ford Motor Company

Ships its Transit Connect five-passenger wagons

From its factory in Turkey to Baltimore, MD

Wagons: 2.5% tariff (duty of $625)

Stripped and converted into cargo vanns

Cargo vans tariff: 25% (duty of $6,250)

Completely legal

Dodging Import Tariffs: Tariff Avoidance and Tariff Evasion

Smuggled steel evades U.S. tariff

Falsely reclassify steel as a duty-free product

Detach markings which indicate that the steel came from a country subject to tariffs

Make it appear to have come from one that is exempt

Alter the chemical composition of a steel product enough so that it can be labeled duty-free

Postponing Import Tariffs

Bonded warehouse

Dutiable imports can be brought into the U.S. and temporarily left in a bonded warehouse, duty-free

Imported goods - stored, repacked, or further processed - for up to five years

No customs duties are owed until the goods are withdrawn for domestic consumption

Postponing Import Tariffs

Foreign-trade zone (FTZ)

An area within the U.S.

Business can operate without the responsibility of paying customs duties on imported products or materials

For as long as they remain within this area

And do not enter the U.S. marketplace

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

Postponing Import Tariffs

Foreign-trade zone (FTZ)

No time limit on how long goods can be stored

General-purpose zones

Public facilities

Used by more than one firm

Subzones

A single firm’s site

Used for more extensive manufacturing or assembly

Tariff Effects: An Overview

Tariff effects

Higher price of imports

Lower demand for imports

Domestic suppliers expand output

Benefits

Domestic producers

Tariff Effects: An Overview

Tariff - imposes costs to domestic economy

Buyers will pay more for their protected U.S.-made goods than they would have for the imported goods under free trade

Jobs will be lost at retail and shipping companies that import foreign-made goods

Jobs will be lost in any domestic industries that suffer from retaliatory tariffs

The extra cost of the goods gets passed on to whatever products and services that use these goods in the production process

Tariff Welfare Effects

Consumer surplus

The difference between the amount that buyers would be willing and able to pay for a good and the actual amount they do pay

Affected by the market price

A decrease in the market price

Increase in the quantity purchased

Larger consumer surplus

A higher market price

Reduce the amount purchased

Shrink the consumer surplus

Tariff Welfare Effects

Producer surplus

Revenue producers receive over and above the minimum amount required to induce them to supply a good

Affected by the market price

A higher market price

Increase in quantity supplied

Higher surplus

A lower market price

Lower surplus

Consumer surplus is the difference between the maximum amount buyers are willing to pay for a given quantity of a good and the amount actually paid. Graphically, consumer surplus is represented by the area under the demand curve and above the good’s market price. Producer surplus is the revenue producers receive over and above the minimum necessary for production. Graphically, producer surplus is the area above the supply curve and below the good’s market price.

Consumer surplus and producer surplus

FIGURE 4.2

Tariff Welfare Effects: Small-Nation Model

Small nation

Its imports - a very small portion of the world market supply

Price taker

Tariff effects

Raises the home price of imports by the full amount of the duty

Higher domestic production

Lower domestic consumption

Tariff Welfare Effects: Small-Nation Model

Small nation - Tariff effects on nation’s welfare

Consumer surplus falls

Welfare effects of a tariff

Revenue effect

Redistribution effect

Protective effect

Consumption effect

Additional tax revenue

Benefits domestic producers

Wastes resources

Harms the domestic consumer

For a small nation, a tariff placed on an imported product is shifted totally to the domestic consumer via a higher product price. Consumer surplus falls as a result of the price increase. The small nation’s welfare decreases by an amount equal to the protective effect and consumption effect, the so-called deadweight losses due to a tariff.

Tariff trade and welfare effects: small nation model

FIGURE 4.3

Tariff Welfare Effects: Small-Nation Model

Revenue effect

The government’s collections of duty

Number of imports times the tariff

Portion of the loss in consumer surplus

Transferred to the government

Does not result in an overall welfare loss

Tariff Welfare Effects: Small-Nation Model

Redistribution effect

Transfer of the consumer surplus

To the domestic producers of the import-competing product

Transfer of income from consumers to producers

Does not result in an overall loss of welfare for the economy

Tariff Welfare Effects: Small-Nation Model

Protective effect

Loss to the domestic economy

From wasted resources used to produce additional goods at increasing unit costs

Less efficient domestic production is substituted for more efficient foreign production

Loss of welfare

Tariff Welfare Effects: Small-Nation Model

Consumption effect

Residual not accounted for elsewhere

Loss of welfare occurs

Increased price

Lower consumption

Deadweight loss of the tariff

Protective effect

Consumption effect

Trade protectionism intensifies as global economy falls into recession

Global economic downturns - catalyst for trade protectionism; 2007–2009,

Decrease in the demand for goods and services

Decline in international trade

Credit crunch - extra squeeze on trade

Shortfall of some $100 billion in trade finance – 90% of world trade

GLOBALIZATION

Trade protectionism intensifies as global economy falls into recession

Indiscriminate decrease in trade

Exports declined by 30 %

China - targeted by the most governments for protectionist measures

Russia

Increased tariffs on imported automobiles

India

Raised tariffs on steel imports

Argentina

New obstacles to imported auto parts and shoes

GLOBALIZATION

Creeping protectionism during global economic downturn of 2008–2009: number of protectionist measures initiated*

TABLE 4.6

Trade protectionism intensifies as global economy falls into recession

United States, steel industry

Increased tariffs

$100 billion U.S. steel market

Not protected by the “Buy American ” legislation

Fiscal stimulus program

Shut out foreign companies from U.S. government contracts (25% of new steel orders in 2009)

GLOBALIZATION

Trade protectionism intensifies as global economy falls into recession

United States, tires

Tariffs of 25-35% on imports from China

For the next three years

Priced out of the market 17% of all tires sold in the United States

Forced up the market price for consumers

GLOBALIZATION

Trade protectionism intensifies as global economy falls into recession

Once trade barriers are increased

Can severely damage global supply chains

It can take years of negotiation to dismantle trade barriers

It can take years before global supply chains can be restored

GLOBALIZATION

Tariff Welfare Effects: Large-Nation Model

Large-nation

An importing nation large enough

Changes in the quantity of its imports

By means of tariff policy

Influence the world price of the product

United States

Autos, steel, oil, and consumer electronics

Japan

European Union

Tariff Welfare Effects: Large-Nation Model

United States - tariff on automobile imports

Prices increase for American consumers

Decrease in the quantity demanded

If significant enough - force Japanese firms to reduce the prices of their exports

Effects of increases in U.S. tariffs on the world price of imported goods

TABLE 4.7

Tariff Welfare Effects: Large-Nation Model

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

For a large nation, a tariff on an imported product may be partially shifted to the domestic consumer via a higher product price and partially absorbed by the foreign exporter via a lower export price. The extent by which a tariff is absorbed by the foreign exporter constitutes a welfare gain for the home country. This gain offsets some (all) of the deadweight welfare losses due to the tariff’s consumption and protective effects.

Tariff trade and welfare effects: large nation model

FIGURE 4.4

Tariff Welfare Effects: Large-Nation Model

In figure 4.4

If e > (b + d)

National welfare is increased

If e = (b + d)

National welfare remains constant

If e > (b + d)

National welfare is diminished

Tariff Welfare Effects: Large-Nation Model

Optimum tariff

Maximize the positive difference between

Gain of improving terms of trade (area e)

Loss in economic efficiency from the protective effect (area b)

Consumption effect (area d)

Is only beneficial to the importing nation

Beggar-thy-neighbor policy, could invite retaliation

Gains from eliminating import tariffs

If only United States removed tariffs and other restraints on imported products

Lowers the price of the affected imports

Lower the price of the competing U.S. good

Economic gains to the U.S. consumer

Decrease the production costs

Domestic profit reductions

TRADE CONFLICTS

Gains from eliminating import tariffs

If only United States removed tariffs and other restraints on imported products

Displaced workers from the domestic industry that loses protection

U.S. government loses tax revenue

Estimated annual economic welfare gains from eliminating significant import restraints

Welfare gain of about $3.7 billion to the U.S. economy

TRADE CONFLICTS

Economic welfare gains from liberalization of significant import restraints*, 2005 (millions of dollars)

TABLE 4.8

Annual change in Economic Welfare	Import-Competing Industry
Textiles and apparel Sugar Dairy Footwear Ethyl alcohol Beef Tuna Glass products Tobacco	$1,885 millions 811 573 249 120 48 24 20 19

*Import tariffs, tariff-rate quotas, and import quotas

How a Tariff Burdens Exporters

Effects of import tariffs on exporters

Higher production costs – from imported inputs

Cannot pass it to the buyers

Higher prices

Reduced overseas sales

Raise the cost of living

Higher wages

Higher production costs

International repercussions

Lead to reductions in domestic exports

A tariff placed on imported steel increases the costs of a steel-using manufacturer. This increase leads to a higher price charged by the manufacturer and a loss of international competitiveness.

How an import tariff burdens domestic exporters

FIGURE 4.5

Steel Tariffs Buy Time for Troubled Industry

2001, President Bush, import tariff program

Revitalize steel industry

American steel companies - lack of competitiveness

Heavy burden on American steel-using industries

Temporarily save roughly 6,000 jobs

At a cost to U.S. consumers and steel-using firms: $800,000 -$1.1 million per job

Steel Tariffs Buy Time for Troubled Industry

2001, President Bush, import tariff program

Save 1 job in steel manufacturing – at a cost of 13 jobs in steel-using industries

Increased production costs for a large number of U.S. companies that use steel

2007, Government trade regulators

Revoke tariffs on high-end steel imports from certain countries

President Bush’s steel trade remedy program of 2002–2003: selected products

TABLE 4.9

Tariffs and the Poor

Tariffs are inequitable

Impose the most severe costs on low-income families

Higher tariffs on cheap goods than luxuries

Affect different countries in different ways

Burdens countries that specialize in the cheapest goods

Very poor countries in Asia and the Middle East

U.S. tariffs are high on cheap goods, low on luxuries

TABLE 4.10

Arguments for Trade Restrictions

Free-trade argument

If each nation produces what it does best and permits trade

In the long term

Lower prices

Higher levels of output, income, and consumption

Arguments for Trade Restrictions

Job protection argument

Alleged job losses to foreign competition

Omits: dual nature of international trade

Trade restrictions on textiles and apparel, steel, and automobiles

Little or no positive effect on the level of employment in the long run

Arguments for Trade Restrictions

Job protection argument

Job gains for only a few industries

Job losses spread across many industries

Each job saved

Ends up costing domestic consumers more than the worker’s salary

Arguments for Trade Restrictions

Protection against cheap foreign labor

Low wages abroad make it difficult for U.S. producers to compete with producers using cheap foreign labor

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

Low wages by themselves do not guarantee low production costs

Low-wage nations -competitive advantage

Only in the production of goods requiring greater labor and little of the other factor inputs

Hourly compensation costs in U.S. dollars for production workers in manufacturing, 2007

TABLE 4.11

Productivity, wages, and unit labor costs, relative to the U.S.: total manufacturing, 2002 (U.S.= 1.0)

TABLE 4.12

Arguments for Trade Restrictions

Fairness in trade

Foreign governments play by a different set of rules

Foreign firms unfair competitive advantages

Trade benefits the domestic economy even if foreign nations impose trade restrictions

Does not recognize the potential impact on global trade

Arguments for Trade Restrictions

Maintenance of the domestic standard of living

One nation imposes a tariff that improves its income and employment

At the expense of its trading partner’s living standard

Retaliatory tariffs

Lower level of welfare for all nations

Arguments for Trade Restrictions

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 would be subsidizing inefficient production

Arguments for Trade Restrictions

Equalization of production costs

Approximates a prohibitive tariff

Completely contradicts the notion of comparative advantage

Wipes out the basis for trade and gains from trade

Arguments for Trade Restrictions

Infant-industry argument

Trading nations should temporarily shield their newly developing industries from foreign competition

Once a protective tariff is imposed - very difficult to remove

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

Arguments for Trade Restrictions

Infant-industry argument

Very difficult to determine which industries will be capable of realizing comparative advantage potential

Not valid for mature, industrialized nations

There may be other ways of insulating a developing industry from cutthroat competition

Subsidize the industry

Arguments for Trade Restrictions

Noneconomic arguments

National security argument

Protect essential industries

What constitutes an essential industry

Cultural and sociological considerations

Arguments justifying tariffs

Based on the assumption that the national welfare, as well as the individual’s welfare, will be enhanced

Petition of the candle makers

Frederic Bastiat, French Chamber of Deputies

Satire of protectionists’ arguments, 1845

A law be passed requiring people to shut all windows, doors, and so forth

So that the candle industry would be protected from the “unfair” competition of the sun

Great benefit to the candle industry

Creating many new jobs and enriching suppliers

TRADE CONFLICTS

Arguments for Trade Restrictions

Political economy of protectionism

Elected officials form policies to maximize votes and remain in office

Bias in the political system that favors protectionism

Protection-biased sector

Import competing producers

Labor unions - in that industry

Suppliers to the producers in the industry

Arguments for Trade Restrictions

Political economy of protectionism

Protection-biased sector

Seekers of protectionism

Established firms in an aging industry - lost their comparative advantage

Free-trade-biased sector

Exporting producers, their workers, and their suppliers

Arguments for Trade Restrictions

United States’ protection policy

Dominated by special-interest groups that represent producers

Gains from protection – concentrated among well-organized producers and labor unions

Consumers

Not organized; Losses widely dispersed

Absorb individually a small & difficult-to-identify cost;

Uninformed

Arguments for Trade Restrictions

Supply of protectionism

By the domestic government

Depends on:

The costs to society

The political importance of import-competing producers

Adjustment costs

Public sympathy

Arguments for Trade Restrictions

Demand of protectionism

By the domestic companies and workers

Depends on:

Comparative disadvantage

Import penetration

Concentration

Export dependence

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