Chapter 4 Int Econ
Effective rate of protection
o If 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 o If tariff on finished product exceeds tariff on imported input •Effective tariff exceeds nominal tariff o tariff on finished product is less than tariff on
Tariff WELFARE effects
• *Consumer Surplus (CS)* - Difference between what buyers are willing & able to pay and the amount they actually pay • *Producer surplus (PS)* - Difference between what producers are willing and able to receive and the amount they actually receive - Inverse relationship between change in market price and CS; direct relationship between change in price and PS
TWE contin
*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
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) - Is only beneficial to importing nation - Is a *beggar-thy-neighbor* policy; could invite retaliation
How Tariff Burdens Exporters
Effects of import tariffs on exporters - *Higher production costs* - from imported inputs • Can result in higher prices and, depending on elasticity of demand, reduce overseas sales - *Raise cost of living* • Higher wages and higher production costs • International repercussions • Lead to reductions in domestic exports from possible retaliatory tariffs
Assumption of welfare effects
Most arguments justifying tariffs based on assumption that national welfare, as well as individual's welfare, will be enhanced • However, must differentiate between individual's welfare and national welfare • If tariff reductions result in greater welfare gains from trade and if adversely affected parties can be compensated for loss, overall national welfare will increase
effective rate of protection formula
e=(n-ab)/(1-a) • 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
Supply & Demand View of Protectionism + (costs to society)
*Supply* of protection depends on 1. Costs to society 2. Political importance of import-competing producers 3. Adjustment costs to rising import competition 4. Public sympathy for a group of domestic businesses or workers *Demand* for protection rises with 1. Intensification of domestic industry's comparative disadvantage 2. Higher levels of import penetration 3. Concentration of domestic production 4. Degree of export dependence 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
Arguments FOR trade RESTRICTIONS: 1. Job protection argument 2. Protection against cheap foreign labor 3. Fairness in Trade: Level Playing Field 4. Maintenance of the Domestic Standard of Living 5. Equalization of Production Costs 6. Infant-Industry Argument 7. Non-Economic Arguments
*Free-trade argument* - If each nation produces what it does best and permits trade, in long term, there will be • Lower prices • Higher levels of output, income, and consumption 1. *Job protection argument* • Job gains resulting from open trade more visible than job losses; has led U.S. business and labor leaders to oppose free trade • However, trade restrictions found to result in job gains for only a few industries, while job losses are spread across many industries • Each job saved ends up costing domestic consumers more than the worker's salary • Additionally, job protection argument fails to acknowledge dual nature of international trade; changes in a nation's imports are closely related to changes in its exports. 2. *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 3. *Fairness in Trade: Level Playing Field* • Domestic producers say import restrictions needed to offset foreign advantages, thus creating 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 4. *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
Examples of US tariffs: OBAMA TIRE tariff
*Obama's Tariffs on Chinese Tires* • China had agreed, as condition of entry to WTO in 2001, 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 tire production jobs lost • In 2009, Obama imposed tariff for 3 years in addition to existing tariff for low cost Chinese tire imports - Obama administration maintained tariffs would • Enforce rule China agreed to • Significantly reduce tire imports and boost U.S. industry sales & prices, profitability; • Have little or no impact on production of autos & light trucks because tires only small part of cost - 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
Protective vs. Revenue Tariffs
*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
Eg US: FOOT/ RUBBER tariff
*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. footware 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
Tariff Welfare Effects: Large Nation Model
*U.S. imposes tariff on automobile imports* • Prices increase for American consumers • Quantity demanded decreases - If significant enough - forces Japanese firms to reduce prices of their exports • Effect shared between U.S. consumers, who pay higher price, and Japanese firms, which receive lower price than under free trade - Difference between these prices is tariff duty - Terms of trade improve for U.S. at expense of Japan
Types Tariffs: -specific -Ad valorem -comp
- *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) - *Ad valorem tariff* • Fixed percentage of the value of imported product (Ex: 15%/unit) • Relatively expensive to estimate and administer due to changing import prices and custom valuation problems (CIF/FOB prices) • Maintains constant degree of protection for domestic producers through the business cycle • Customs valuation: determining value of imported product; is complex, subject to disagreement • U.S traditionally uses Free-on-board valuation (FOB), whereby tariff is applied to a product's value as it leaves the exporting country • Europe traditionally uses cost-insurance-freight valuation (CIF), whereby ad valorem tariffs are levied as a percentage of the imported commodity's total value as it arrives at its final destination - CIF price includes transportation costs, such as insurance and freight - *Compound tariff* • Applied to manufactured products composed of raw materials that are subject to tariffs • Specific portion of duty neutralizes cost disadvantage of domestic manufacturers resulting from tariff protection granted to domestic suppliers of raw materials
Tariff Effects
- 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
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
Outsourcing
-A key aspect of the 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 •Important strategy for producers who locate each stage of production in country where it will incur the least cost
Tariff
-A tax (duty) levied on a product when it crosses national boundaries 1. *Import tariff*: Tax levied on an imported product...Most common; called a customs duty 2. *Export tariff*: Tax imposed on an exported product...Less common; illegal under U.S. Constitution...Commonly used by developing nations
Tariff escalation
-Raw materials often imported at zero or low tariff rates -Nominal and effective protection increases at each stage of production -Processed goods •Higher import tariffs
Postponing Import Tariffs 1. Bonded Warehouse 2. Foreign-Trade Zone
1. *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 2. *Foreign-Trade Zone* • Similar to bonded warehouse, foreign trade zone (FTZ) is area in U.S. where business can 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 --FTZs Benefit Motor Vehicle Importers • Ex.: Toyota vehicle processing centers located in FTZ sites in U.S. • Primary benefit for Toyota is postponement of payment of duties until vehicle has been processed and shipped to dealer • For parts imported into U.S., Toyota also has parts distribution centers located within FTZ sites • Toyota can avoid payments of customs duties on parts that become obsolete and are destroyed
Nominal vs Effective 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. Ex: If Dell manufacturers desktops assembled elsewhere, and finished desktop enters U.S. at a zero tariff rate, but imported components used in desktop production are taxed, then Dell is taxed instead of protected
Dodging import tariffs
• *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 Examples: 1. *Ford* strips its wagons to avoid high tariff •25% tariff on imports of foreign made commercial vans; 2.5% tariff on passenger vans •Ford ships passenger vans to U.S. (2.5% tariff) •At U.S. processing facility, become cargo vans: •Rear windows removed, replaced with metal •Rear seats and seat belts removed; new floorboard •5-passenger van converted to 2-passenger cargo van •All this within letter of law •Other auto manufacturers use different methods 2. *Smuggled Steel* Evades U.S. tariffs •About half of imported steel subject to tariff •Depends on type of steel product (about 1,000), and country of origin (about 100) •Difficult for customs service to monitor all shipments because of limited staff; small risk of being caught •An importer may falsely reclassify steel as a duty-free product •Small importers more likely to try
Tariff welfare effects: SMALL NATION model
• A small nation... - Imports 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 A small nation - tariff effects on nation's welfare • Consumer surplus falls • Additional tax revenues • Benefits domestic producers • Wastes resources • Revenue effect - Government's collections of duty • Redistributive effect - Transfer of consumer surplus to domestic producers • Protective effect - Loss to domestic economy from wasted resources used to produce autos at increasing unit costs • Consumption effect - Decrease in consumption resulting from tariff artificially increasing price • Deadweight loss - Protective effect and consumption effect combine to create deadweight loss of tariff *Revenue Effect* (Area "c") • The government's collection of duties calculated as quantity of imports times tariff rate • Loss of consumer surplus - transferred to government *Redistributive Effect* (Area "a") • Transfer of consumer surplus to domestic producers of import-competing product • Transfer of income from consumers to producers *Protective effect* (Area "b") • Loss to domestic economy • Wasted resources used to produce additional goods at increasing unit costs • Less efficient domestic production replaces more efficient foreign production • Loss of welfare *Consumption effect* (Area "d") • Residual not accounted for elsewhere • Loss of welfare arises from • Increased price • Lower consumption *Deadweight loss of tariff* (Area "b+d") • Protective effect • Consumption effect
LARGE NATION model
• A tariff may increase national welfare when imposed by an importing nation large enough so that changes in its quantity of imports influence world price • This *large* nation status applies to U.S., a large importer of autos, steel, oil & consumer electronics as well as to Japan, and the European Union
Tariffs and the Poor
• 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
Offshore Assembly Provision (OAP)
•Tariff Act of 1930 created OAP •Provides favorable treatment to products assembled abroad from U.S. made components •Cost of U.S. component not included in dutiable value of imported assembled article •Incentivizes foreign manufacturers to purchase components from U.S. sources •Generates sales and jobs in U.S. component industries
