The Instruments of Trade Policy
Tariffs: definitions and measurement
Nontariff Barriers: From quotas to
administrative
regulations
Import Tariff: Specific Tariff
• Definition:
– fixed monetary tax per physical unit of the
good imported
• Benefit: – ease of collection
• Cost:
– tariff’s effectiveness in protecting domestic
industry falls as price of imported good rises
– Why? because tariff becomes a smaller and
smaller portion of the total cost of the good as
its price rises
Import Tariff: Ad Valorem Tariff
• Definition:
– a tax measured as a percentage of the price of the
imported good
• Benefit:
– maintains protective value as price increases
• Cost:
– customs officials must determine value of good
(whether stated price on good is correct)
– this can lead to overvaluation of good - more
protection than desired by policy makers, and/or
corruption
Other Features of Tariff Schedules
• Preferential Duties:
– tariffs applied to imports from particular group
of countries
– countries are charged a lower tariff than
countries outside the group
• Generalized System of Preferences:
– developed countries charge lower tariffs for
specific imports from developing countries
– list of goods chosen by developed countries
(textiles and clothing not included)
Other Features of Tariff Schedules
• Most-favoured-nation treatment (MFN):
– WTO principle
– a country must give all countries who are part of
the WTO the same tariff treatment as the most-
favoured nation with which the country is trading
– example: If U.S. and Canada lower tariffs on
goods, then the tariff should be lower for all
countries who import the good to Canada or the
U.S.
– MFN has not been followed when countries sign
free trade deal
Other Features of Tariff Schedules
• Offshore Assembly Provisions (OAP)
– an import tariff applies to the entire price of a good
– under OAP, the import tariff applies only to the part of
the good that is produced abroad
• Example: good with 10% tariff
– a good’s components are produced at home, and cost
$10
– the good is sent to a second country for assembly,
assembly costs $12
• Tariff: without OAP tariff = $12x0.10 = $ 1.20
with OAP tariff = $ 2x0.10 = $0.20
Measurement of Tariffs
• Unweighted average tariff:
• given 3 goods with specified tariffs:
A 10% B 15% C 20%
Average: 10% + 15% + 20% = 15%
3
• Disadvantage:
– this tariff doesn’t take into account the quantity of
goods to which each of these tariffs are applied,
– if almost no good C is imported average MAY
overstate country’s level of protection
Measurement of Tariffs
• Weighted-average tariff (WAT):
– 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 B $ 200 C $100
WAT = 0.10($500) + 0.15($200) + 0.20($100) = 100 =0.125
$500+$200+$100 800
• Problem:
– WAT puts too little weight on goods facing a high tariff
– For example, a good facing a 200% tariff may not be
imported. (This is called a PROHIBITIVE TARIFF).
– 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 (VA) under
protection with value added with free trade
• NOTE:
– value added is the value of output less the value
of the inputs used in production
– for ERP, we therefore need to know tariffs on
final goods (produced at home and imported)
and tariffs on imported inputs
Effective Rate of Protection (ERP)
ERP = VA under protection - VA with free trade
VA under free trade
Example:
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 example, the ‘nominal’ tariff on the final
good is 10%. This is the tariff that would be
quoted by the home country.
• However, the EFR on the same good is
19.7%. The result is due to lower tariff on
production inputs than on the final product
• If a country uses this rule in setting tariffs, it
is said to have an “escalated tariff
structure”
Effective Rate of Protection (ERP)
• In General:
Nominal > Weighted-average > Nominal
Tariff on = nominal tariff rate EFR = Tariff on
Final Good < on the inputs < Final
Good
• Note:
– 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
Nontariff Barriers (NTBs)
• Export tax:
– tax on exports, usually to raise revenue for government
– can be either specific or ad valorem
– export tax reduces size of international trade
• Export subsidy:
– negative export tax
– attempts to increase the flow of trade
– distorts the pattern of trade from that of comparative,
and can be very costly to the exporting country
government
– subsidies lead to battles over “unfair trade”
Nontariff Barriers (NTBs)
• Import quotas
– limit on the quantity of goods that can be
imported
– limit causes the price at home to increase,
which gives the same effect as a tariff
– if demand for the good increases, a fixed import
quota has the same effect as an ever-rising tariff
Nontariff Barriers (NTBs)
• Voluntary Export Restraints (VERS)
– alternative to import quota
– importing home country pressures exporting country
to restrain its exports to the home market
– usually such agreements are made with the threat of
quotas being imposed if exports are not limited
• Government Procurement Provisions:
– government often tells its bodies to buy home
produced goods unless the import is significantly
cheaper than the home produced competing good
– this has the same effect as a tariff
Nontariff Barriers (NTBs)
• Domestic content provisions:
– products must contain a certain amount of value added in
the home country to sold in the home country
– very restrictive policy
– usually seen in developing countries trying to grow
through import substitution
• Value-added tax: (VAT, also Canadian GST)
– alternative to sales tax, but each level of production
receives a tax rebate on inputs, eliminating double
taxation
– goods (and inputs) are taxed when imported, but taxes
are rebated if the final good is exported
Nontariff Barriers (NTBs)
• Administrative Classification
– goods have different tariffs - a good may be
classified as a high-tariff good to increase
protection to local market
• Restrictions on Trade in Services:
– 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
– performance requirements: forcing a foreign investor
to use domestic inputs, or export final product
• Additional Restrictions
– foreign exchange controls, import licences
– 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:
– health, environmental, safety standards, domestic
subsidies, stumpage fees, labelling, patents - do they all
need to be harmonized? (made identical? )
