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					Chapter 13

   Presented by:

   Mr.Kieran Kearney
     The Instruments of Trade Policy

Governments implement trade policy to affect imports and

How do they do it?

• Implement taxes, e.g. tax on imports i.e. tariffs.
• Adapt policies to affect trade, e.g. trade agreements.
• Use different mechanisms to protect home
  industries (protection), e.g. restrict imports, quotas
• Application of non-tariff policies to restrict trade, e.g.
Value added tax.
The Instruments of Trade Policy - Tariffs
 Tariffs are a tax on imports. Governments apply different
 types of tariffs and also implement different tariff policies
 and mechanisms to promote or restrict trade. Generally a
 tariff is used to protect home industry and to provide
 revenue to a Government.
 Specific areas we will examine in this presentation are as

 • Specific tariff.
 • Ad Valorem tariff.
 • Preferential duties, e.g. GSP.
 • Preferential policies, e.g. MFN
 • Offshore assembly provisions.
            Import Tariff: Specific Tariff

 • Definition:
     o Fixed rate of tax per physical unit of the good imported,
     o Example: 2,500 THB per ton of imported goods. So a
       delivery of 1000 tons would yield a tariff of 2,500,000
• Pro:
   easy to collect. The Tax authorities need only know the
  physical amount of the good imported.
• Con:
   tariff‟s effectiveness in protecting domestic industry falls as
  price of imported good rises.
   Why? If the cost of the good doubles, the tariff remains the
       Import Tariff: Ad Valorem Tariff
• Definition:
  o a tax measured as a percentage of the price of the imported
    good. If the Ad Valorem rate is 10%, and an imported good
    has a world price of 10 THB, then a tariff of 1 THB is
• Benefit:
  o maintains protective value as price increases. If the price of a
    good increases because of inflation, so does the tariff
• Cost:
  o customs officials must determine value of the good (whether
    stated price on the good is correct)
  o this can lead to over valuation of the good - more protection
    than desired by policy makers, and/or corruption.
Other Features of Tariff Instruments and
• Preferential Duties:

   o tariffs applied to imports from a particular country or
     group of countries
   o countries are charged a lower tariff than countries
     outside the group.
   o Trading blocs such as the EU, NAFTA, British
     commonwealth are examples of trading countries
     which permit preferential duties on member
Other Features of Tariff Instruments and
          Policy (continued)
 • Generalized System of Preferences:
   o developed countries charge lower or no tariffs for
     specific imports from developing countries
   o list of goods chosen by developed countries (textiles
     and clothing not included)
  Other Features of Tariff Instruments and
            Policy (continued)
• Most-favoured-nation treatment (MFN):
  o MFN or Normal trade relationships principle (NTR).
  o a country must give all countries who are part of the
    same MFN agreement, the same tariff treatment as the
    most favoured nation with which the country is trading
  o example: If U.S. and Canada lower tariffs on a specific
    goods, e.g. Canada reduces tariffs on computers from
    the USA and the USA reduces tariffs on mobile phones
    imported from Canada. If Bhutan has a MFN
    agreement with the USA, then Bhutan will receive the
    same tariff reduction on mobiles as Canada does. Also,
    if Bhutan has an agreement with Canada, it will get the
    same tariff reduction on computers (if it exports
    computers) that the US receives receives from Canada.
   Other Features of Tariff Instruments and
             Policy (continued)
 • Offshore Assembly Provisions (OAP)
    o also known as production-sharing arrangments.
    o Generally, an import tariff applies to the entire price of a
    o under OAP, the import tariff applies only to the part of the
      good that is produced abroad
• Example: a good with 15% tariff.
    o If the good is imported and costs 80 THB, then the tariff is
      12 THB.
    o 52 THB of good‟s components are produced in Thailand.
    o i.e. 52 THB of the value of the good is exported from
      Thailand and sent to a second country for assembly.
 • Tariff: without OAP tariff = 80 THBx0.15 = 12 THB
             with OAP tariff =
             80 THB – 52 THB * 0.15= 4.20 THB
            Measurement of Tariffs
How much price interference exists in a countries system of
 tariff? How do we determine the average tariff rate?
• Unweighted average tariff:
• given 3 goods with specified tariffs:
     A 10% B 15% C 20%
     Average: 10% + 15% + 20% / 3 = 15%
• Disadvantage:
   o this tariff doesn‟t take into account the quantity of goods
     to which each of these tariffs are applied,
   o if almost no good C is imported average MAY overstate
     country‟s level of protection
                 Measurement of Tariffs
• Weighted-average tariff (WAT):
   o each good‟s tariff is weighted by the value of imports to which it
     is applied
• Example: A 10% B 15 % C 20 %
     Quantity: A.500 THB B.200 THB C.100 THB
WAT = 0.10(500) + 0.15(200) + 0.20(100) = 100/800 =0.125= 12.5%
• Problem:
   o WAT puts too little weight on goods facing a high tariff
   o For example, a good facing a 200% tariff may not be imported.
     (This is called a PROHIBITIVE TARIFF).
   o The WAT underestimates the country‟s level of protection.
       Effective Rate of Protection (ERP)
• Measure of how a country‟s tariff structure protects
  domestic industries
• compares value added under protection with value
  added with free trade
   o value added is the value of output less the value of
     the inputs used in production
   o for ERP, we therefore need to know tariffs on final
     goods (produced at home and imported) and tariffs on
     the imported inputs
      Effective Rate of Protection (ERP)
VA under protection - VA with free trade / VA under free trade

Good F is the final good, and goods A and B are inputs to F.
1 unit of A and 1 unit of B is used to make F.
Under free trade,
PF (PF‟)= price of final good w/o tariff (with tariff)
PA(PA‟) = price of input A without tariff (with tariff)
PB(PB‟) = price of input B without tariff (with tariff)
Let PF=$1,000, PA=$500, PB= $200
Let tF= 0.10, tA= 0.05, tB=0.08
VA= $1000 - $500 - $200 = $300
VA‟= $1000x1.10 - $500x1.05 - $300x1.08 = $359
EFR = ($359-$300)/$300 =0.197 or 19.7 %
       Effective Rate of Protection (ERP)
• In the example, the „nominal‟ tariff on the final good is
  10%. This is the tariff that would be quoted by the home
• However, the EFR on the same good is 19.7%. The
  result is due to lower tariffs on the production inputs
  than on the final product, i.e. %% on A and 8% on B.
• With tariffs industry F has an increase in value greater
  than with free trade.
• Therefore there is an incentive for factors of production
  in other industries to move into industry F.
• If a country uses this rule in setting tariffs, it is said to
  have an “escalated tariff structure”, i.e. it sets tariff
  rates higher on finished imported goods than on inputs
  and raw materials.

The effect of a tariff on the terms of trade.
  By reducing the demand for imports, a tariff levied by a large country
causes the prices of those imported goods to fall on the world market
relative to the country's exports, improving its terms of trade.
With escalated tariff structures which protect manufacturing industry more
than intermediary goods and raw materials, an so discriminate against
developing countries, because I they are forced to continue to export raw
materials and import manufactured goods.
On clothing: U.S. has 27.8% nominal tariff and 50.6 % EFR
On textiles: U.S. has 14.4 % nominal tariff , but a 28.3 % EFR
         Export taxes and Subsidies

Countries also influence the free flow of exports by the
implementing the following instruments;
• Export tax levied on home produced goods destined for
export only.
• Export subsidy is a payment to a company to promote
export of the specific good.
• Export tax:

  o   tax on exports, usually to raise revenue for government
  o   can be either specific or ad valorem
  o   export tax reduces size of international trade

• Export subsidy:

  o negative export tax
  o attempts to increase the flow of trade
  o distorts the pattern of trade from that of comparative, and can
    be very costly to the exporting country government
  o subsidies lead to battles over “unfair trade”
            Nontariff Barriers (NTBs)

• Import quotas

  o   limit on the quantity of goods that can be imported

  o   limit causes the price at home to increase, which
      gives the same effect as a tariff

  o   if demand for the good increases, a fixed import
      quota has the same effect as an ever-rising tariff
   Nontariff Barriers (NTBs) to free trade.
• Voluntary Export Restraints (VERS)

  o alternative to import quota
  o importing home country pressures exporting country to
    restrain its exports to the home market
  o usually such agreements are made with the threat of quotas
    being imposed if exports are not limited

• Government Procurement Provisions:

  o government often tells its bodies to buy home produced
    goods unless the import is significantly cheaper than the
    home produced competing good
  o this has the same effect as a tariff
              Nontariff Barriers (NTBs)
• Domestic content provisions:

  o products must contain a certain amount of value added in the
    home country to be sold in the home country
  o very restrictive policy
  o usually seen in developing countries trying to grow through
    import substitution

• Value-added tax: (VAT, also Canadian GST)

  o alternative to sales tax, but each level of production receives a
    tax rebate on inputs, eliminating double taxation
  o goods (and inputs) are taxed when imported, but taxes are
    rebated if the final good is exported
            Nontariff Barriers (NTBs)

• Administrative Classification

   o   goods have different tariffs - a good may be classified
       as a high-tariff good to increase protection to local

• Restrictions on Trade in Services:

   o   restrictions on banking, insurance, transportation, all
       lower the volume of trade (i.e. only local banks may
       take personal deposits, only Canadian airlines may fly
       between Canadian cities
              Nontariff Barriers (NTBs)
• Trade-Related Investment Measures

  oVarious policy steps associated with foreign investment
   activity within a country.
  Eg: performance requirements: forcing a foreign investor to use
   domestic inputs, or export final product

• Additional Restrictions

  o   Generalized exchange control
  o   advance deposit requirements - firm has to deposit funds with
      government equal to a percent of future import (to be refunded
      when import purchased)
• Domestic Policies:

  o health, environmental, safety standards
  o packaging, labeling requirements &intellectual
    property rights
  o Subsidies to domestic firms - do they all need to be
    harmonized? (made identical? )

Many forms of control affect international trade.

For instance, reducing the demand for imports, a tariff
levied by a large country causes the prices of those
imported goods to fall on the world market relative to the
country's exports, improving its terms of trade (TOT)

“Thus, free trade does not exist in the real world”

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