C.  Tariffs

• Tax on a product when it crosses international boundaries

• Could be on imports or exports

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1.  Types of tariffs

a.  Protective tariff - protect import-competing industries

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b.  Revenue tariff - generate tax revenue

• World average = 3.9 percent of government revenue

• U.S. = 1.3 percent

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c.  Specific tariff - fixed monetary amount per unit of import

• Ex. - Brooms ($0.32)

• Degree of protection varies inversely  with changes in import prices

- More protection when prices fall, less protection when prices rise

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b.  Ad valorem tariff - fixed percentage of the value of an import

• Ex. - Bicycles (5.5%)

• Good when products have a wide range of grade (and value) variations

- Constant degree of protection as prices change

• Valuation:

(1) Free-on-board (FOB) valuation - product's value as it leaves exporting country

(2) Cost-insurance-freight (CIF) valuation - product's value as it arrives at final destination

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c.  Compound tariff - combination of specific and ad valorem tariffs

• Ex. - Electricity meters ($0.16 + 1.5%)

• Specific portion compensates for cost disadvantage due to protection for domestic input suppliers

• Ad valorem portion is protection to finished goods industry

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2.  Effective rate of protection

• Amount that domestic prices can rise above foreign prices before being priced out of market

• Nominal tariff rate - published tariff schedule

• Effective tariff rate - gives effective rate of protection

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• Effective protection increases as value added decreases

• Tariff on imports used in production process reduces level of effective protection

• If inputs enter a country under low tariffs and final imported product is protected by high tariffs, effective protection rate is high

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• Tariff escalation - greater protection to intermediate and finished goods than to primary commodities

- Hurts development of processing in less developed countries

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3.  Dealing with tariffs

a.  Outsourcing

• Different aspects of manufacturing process done in different countries

• Foreign assembly of domestic components reduces costs

• Offshore-assembly provision (OAP) - if U.S. components are assembled into a finished product overseas and imported into the U.S., only the value added is subject to import duties

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• Gives incentives to buy U.S. components

• Encourages outsourcing of assembly

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b.  Postponing import duties

(1)  Bonded warehouse

• Buy imported products in bulk to reduce costs

• Duty-free if left in a bonded warehouse

• Tariff paid only when products taken out of warehouse to be used or sold

• No duty owed if products are exported

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(2)  Free trade zone (FTZ)

• Foreign products imported without tariffs

• Duties and taxes not paid unless product shipped to U.S. markets

• No duties if product is exported

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4.  Welfare effects

a.  Surplus

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b.  Small-nation model

• Imports are a small portion of the world market supply

• Small nation is a price taker - constant world price for import commodity

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(1)  Impact of free trade

• Consumers benefit - price lower, more quantity consumed

• Profits, production down in domestic industry => job loss

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(2)  Impact of tariff

• Consumer hurt - price increases, quantity consumed decreases

• Domestic production increases => jobs increase

• Imports decrease

• National welfare impacted

(a) Revenue effect - government's collection of duties

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(b)  Redistributive effect - transfer of consumer surplus to domestic producers

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(c)  Protective effect - wasted resources because product produced at higher cost

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(d)  Consumption effect - loss to consumer due to higher price and less consumption

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(e)  Deadweight loss - sum of protective effect and consumption effect

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b.  Large-nation model

• Country large enough to affect world price

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(a) Redistributive effect - transfer of consumer surplus to domestic producers

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(b)  Deadweight loss - sum of protective effect and consumption effect

• Protective effect - wasted resources because product produced at higher cost

• Consumption effect - loss to consumer due to higher price and less consumption

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(c) Revenue effect - government's collection of duties

• Domestic revenue effect - revenue shifted from domestic consumers to government

• Terms-of-trade effect - redistribution from foreign nation to tariff-levying nation because of new terms of trade

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5.  Effects on exporters

• Increases costs of inputs

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• Higher import prices => higher cost of living => higher wages for workers

• Fewer imports => less export revenue in foreign countries => foreign countries less able to import

• Exporters don't protest because:

- Cost increases are subtle and invisible

- Some firms don't form because of increased costs - no basis to oppose policies

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6.  Tariffs and the poor

• Welfare costs high

• Income distribution becomes more inequitable

• Tariffs high on cheap goods, lower on luxuries

• High burden on countries specializing in cheapest goods

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7.  Arguments for trade restrictions

• Argument for trade is lower prices and higher levels of output, income, and consumption

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a.  Job protection

• Dominant factor in government imposition of trade restrictions

• Ignores dual nature of trade - imports generate revenue for foreign countries, which allow those countries to import from domestic country

• Studies show trade restrictions have no long term effect on jobs

• Need to consider the cost of saving domestic jobs

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b.  Protection against cheap foreign labor

• Set tariff equal to wage differential

• Low wages alone don't guarantee low production costs - need to look at productivity too

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• Low wage countries have an advantage when labor requirement is higher than other factors

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c.  Fairness in trade (level playing field)

(1)  Advantages for foreign firms

• Environmental regulations

• Workplace safety

• Low corporate taxes and government regulation

• High trade barriers (subsidies)

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(2)  Counter arguments

• Consumers benefit from these practices

• Could lead to retaliation

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d.  Maintenance of domestic standard of living

• Encourage domestic spending => stimulates domestic economy

• Foreign economies hurt, could lead to retaliation

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e.  Production cost equalization

• Foreign firms have advantage because of lower wages, tax breaks, or government subsidies

• Levy a tariff to equalize costs

• Which costs should be used?

• Consumer would be subsidizing inefficient production

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f.  Infant industry argument

• Countries should temporarily shield newly developing industries from foreign competition

• Lift barriers after industries have time to develop and become efficient

• Difficult to remove protective barriers

• Difficult to determine which industries will eventually be able to handle foreign competition

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g.  Noneconomic arguments

(1) National security

• Problems during international crises if too dependent on foreign suppliers

• What is an essential industry?

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(2) Cultural and sociological considerations

• Protect against "cultural imperialism"

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8  Political economy of protectionism

a.  Supporters

• Import-competing companies, workers and unions, suppliers

• Highly concerned with protecting industries and jobs

• Impacts are concentrated and severe

• Import-competing industries can point to direct damage (sales, profits, jobs)

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b.  Opponents

• Exporting companies, consumers, suppliers

• Less organized

• Impacts are dispersed and small

• Damage to exporters is indirect (lower foreign income, retaliation)

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c.  Supply of protection by government depends on

• Cost to society (welfare loss)

- Higher cost => less likely to have protection

• Political importance of import-competing industry

-  Industry more important => more likely to have protection

• Adjustment cost

- High adjustment cost => more likely to have protection

• Public sympathy

- More public sympathy => more likely to have protection

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d.  Demand for protection by domestic industries depends on:

• Comparative disadvantage

- Greater disadvantage => more likely to demand protection

• Import penetration

- Higher level of import penetration => more likely to demand protection

• Concentration of domestic production

- Higher concentration => more likely to demand protection

• Export dependence

- Foreign sales a large portion of total sales => less likely to demand protection