INTERNATIONAL ECONOMICS

Lecturer: Vo Hoang Kim An

Email: vohoangkiman.cs2@ftu.edu.vn

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CHAPTER 6
INSTRUMENTS OF
TRADE POLICY
CHAPTER ORGANIZATION

▰ Introduction
▰ Basic Tariff Analysis
▰ Costs and Benefits of a Tariff
▰ Other Instruments of Trade Policy
▰ The Effects of Trade Policy: A Summary
▰ Summary

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1
INTRODUCTION TO
TRADE POLICY

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▻ What is free trade?

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 Introduction to trade policy

▰ What is free trade?

▻ Free trade occurs when governments do not attempt
to restrict what citizens can buy from another country
or what they can sell to another country

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 Introduction to trade policy

▰ Why do government intervene in markets?

▻ Benefits of free trade come in the long term, and are usually
spread widely across society
▻ Costs of free trade are felt rapidly and are usually concentrated in
specific sectors of the economy

Autarky Protectionism Free trade

(closed market) Trade
liberalization (Open market)
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 Introduction to trade policy

▰ How do government intervene in markets?

▻ Governments use various methods to intervene in
markets including tariff and non-tariff measures

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 Introduction to trade policy

Who pays for trade

restriction?

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 Arguments for trade restriction

▰ Job protection
▰ Protect against cheap foreign labor
▰ Fairness in trade – level playing field
▰ Protect domestic standard of living
▰ Equalization of production costs
▰ Infant-industry protection
▰ Political and social reasons
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2
TARIFFS
1. The tariff concept
2. Types of tariffs
3. Tariff welfare effects
4. Effective rate of protection
Slide 11
 The tariff concept

Tariff – Taxes levied on imports that effectively raise the cost of

imported products relative to domestic products

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 The tariff concept

Tariff
▻ Increase government revenues
▻ Force consumers to pay more for certain import
▻ Are pro-producer and anti-consumer
▻ Reduce the overall efficiency of the world economy

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 Defining tariffs

A tariff is a tax (duty) levied on products as they move between nations

Transaction/movement of goods
▻ Import tariff - levied on imports
▻ Export tariff - levied on exported goods as they leave the country
Main purpose
▻ Protective tariff - designed to insulate domestic producers from
competition
▻ Revenue tariff - intended to raise funds for the government (no longer 14
important in industrial countries)
 Group discussion

What is protective tariff?

Do you think if Vietnam’s government should impose protective
tariff to protect domestic industries? Why or why not?

Duration: 20 mins

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 Defining tariffs

Specific tariff
▻ Fixed monetary fee per unit of the product
Ad valorem tariff
▻ Levied as a percentage of the value of the product
Ad valorem tariff
▻ A combination of the above, often levied on finished goods whose
components are also subject to tariff if imported separately
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 Costs and Benefits of Tariffs

▻ A tariff raises the price of a good in the importing country, so we expect

it to hurt consumers and benefit producers there
▻ In addition, the government gains tariff revenue from a tariff
▻ How to measure the costs and benefits?
▻ We use the concept of consumer surplus and producer surplus

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 Basic Tariff Analysis

Consumer surplus?

Producer surplus?

Social welfare?

Slide 18
 Tariff welfare effects

▰ Consumer and Producer Surplus

▻ Consumer surplus

▻ It measures the amount a consumer gains from a purchase by the difference

between the price he actually pays and the price he would have been willing to
pay.

▻ It can be derived from the market demand curve.

▻ Graphically, it is equal to the area under the demand curve and above the price.

▻ Example: Suppose a person is willing to pay $20 per packet of pills, but the price
is only $5. Then, the consumer surplus gained by the purchase of a packet of
Slide 19
pills is $15.
Tariff welfare effects

Figure 6-7: Geometry of Consumer Surplus

Price, P

P1
b
P2

Q1 Q2 Quantity, Q Slide 20
 Tariff welfare effects

▰ Consumer and Producer Surplus

▻ Producer surplus
▻ It measures the amount a producer gains from a sale by the
difference between the price he actually receives and the price at
which he would have been willing to sell.
▻ It can be derived from the market supply curve.
▻ Graphically, it is equal to the area above the supply curve and below
the price.
▻ Example: A producer willing to sell a good for $2 but receiving a price
Slide 21
of $5 gains a producer surplus of $3.
Tariff welfare effects

Figure 6-7: Geometry of Consumer Surplus

Price, P

P1
b
P2

Q1 Q2 Quantity, Q Slide 22
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 Basic Tariff Analysis

▰ The world price and quantity are determined by the intersection of

the Home import demand curve and Foreign export supply curve.
▻ Home import demand curve: the maximum quantity of imports
the Home country would like to consume at each price of the
imported good.
▻ Foreign export supply curve: the maximum quantity of exports
Foreign would like to provide the rest of the world at each price.
Slide 24
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Tariff welfare effects

Figure 6-9: Costs and Benefits of a Tariff for the Importing Country
Price, P S

= consumer loss (a + b + c + d)
= producer gain (a)
PT = government revenue gain (c + e)
a b c d
PW

D
S1 S2 D2 D1 Quantity, Q
Slide 26
QT
 Who pays for import restriction?

▰ Domestic consumers face increased costs

▻ Low-income consumers are especially hurt by tariffs on low-cost
imports
▰ Overall net loss for the economy (deadweight loss)
▰ Export industry face higher costs for inputs
▰ Cost of living increases
▰ Other nation may retaliate, further restricting trade
Slide 27
 Why do governments intervene in market?

There are two main arguments for government intervention in the

market
1. Political arguments – Concerned with protecting the interests
of certain groups within a nation (normally producers), often at
the expense of other groups (normally consumers)
2. Economic arguments – concerned with boosting the overall
wealth of a nation – benefits both producers and consumers
Slide 28
 What are the political arguments for government
interventions?

1. Protecting jobs – The most common political

reason for trade restrictions

Result from political pressures buy unions or industries

that are threatened by more efficient foreign producers,
and have more political clout than consumers

Slide 29
 What are the political arguments for government
interventions?

2. Protecting industries deemed important for nation

security – Industries are often protected because they
are deemed important for national security

Slide 30
 What are the political arguments for government
interventions?

3. Retaliation for unfair foreign competition – when

governments take, or threaten to take, specific actions,
other countries may remove trade barriers
▻ If threatened governments do not back down,
tensions can escalate and new trade barriers may
be enacted
▻ Risky strategy
4. Protecting consumers from “dangerous” products –
limit unsafe products
Slide 31
 What are the political arguments for government
interventions?

5. Furthering the goals of foreign policy– preferential

trade terms can be granted to countries that
government wants to build strong relations with

Trade policy can also be used to punish rogue tastes

Slide 32
 What are the political arguments for government
interventions?

6. Protecting the human rights of individuals in

exporting countries – through trade policy actions

7. Protecting the environment – international trade is

associated with a decline in environmental quality
▻ Concern over global warming
▻ Enforcement of environmental regulations
Slide 33
 What are the economic arguments for government
interventions?

1. The infant industry argument– an industry should

be protected until it can develop and be viable and
competitive internationally
▻ Accepted as a justification for temporary trade
restrictions under the WTO

Slide 34
 What are the economic arguments for government
interventions?

Questions:
When is an industry “grown” up?
Critics argue that if a country has the potential to
develop a viable competitive position, its firms should
be capable of raising necessary funds without
additional support from the government

Slide 35
 What are the economic arguments for government
interventions?

2. Strategic trade policy – first-mover advantages can

be important to success
▻ Governments can help firms from their countries
attain these advantages
▻ Governments can help firms overcome barriers to
entry into industries where foreign firms have an
initial advantage
Slide 36
 Politics of protectionism

❖ “Supply of protectionism” (trade policy) depends on:

▻ The cost to society of restricting trade
▻ The political importance of the import-competing
industries
▻ Magnitude of the adjustment costs from free trade
▻ Public sympathy for those sectors hurt by free
trade
Slide 37
 Politics of protectionism

❖ “Demand of protectionism” depends on:

▻ The amount of the import-competing industry’s
comparative advantage
▻ The level of import penetration
▻ The level of concentration in the affected sector
▻ The degree of export dependence in the sector

Slide 38
 When should governments avoid using trade
barriers

Paul Krugman argues that strategic trade policies

aimed at establishing domestic firms in a dominant
position in a global industry are:

Beggar-thy-neighbor policies that boost national

income at the expense of other countries
▻ Countries that attempt to use such policies will
probably provoke retaliation
Slide 39
 Tariffs

Tax rates for imported goods:

a) Preferential tax rate (MFN tax rate):
Preferential tax rate are rates applicable to imported
goods originated from countries or groups of countries
which have reached agreements on
most-favored-nation (MFN) treatment in trade relations
with Vietnam. Preferential tax rates are specified for
every goods item in Preferential Import Tariff.
Slide 40
 Tariffs

Tax rates for imported goods:

b) Specifically preferential tax rate (FTA tax rate):
Specifically preferential tax rates are rates applicable to imported
goods originated from countries or groups of countries those have
reached agreements with Vietnam on specifically preferential
import tax rates under the institution of free trade areas, tariffs
alliance, or aiming to facilitate border trade exchanges and other
cases of specially preferential treatment. Specifically preferential
tax rates shall applicable specifically to every goods item
according to the provisions of the agreements Slide 41
 Tariffs

Tax rates for imported goods:

c) Ordinary tax rates:
▻ Ordinary tax rates are rates applicable to imported goods
originated from countries or groups of countries with which
Vietnam has not reached any agreement on MFN or on
specially preferential import tax rates.
▻ Ordinary tax rates is 50% higher than the preferential tax rate
of each goods item specified in the Preferential Import
Tariffs Nomenclature (or equal to 150% MFN rate)
Slide 42
 Customs Valuation

Valuation methods:
1. The transaction value of the imported goods;
2. The transaction value of the identical goods;
3. The transaction value of the similar goods;
4. The deductive value method;
5. The computed value method;
6. The fall-back method.
Slide 43
 How do governments intervene in markets?

Governments use various methods to

intervene in markets including tariff and
non-tariff measures

Non-tariff measures?

Slide 44
3
NON-TARIFF TRADE BARRIERS
1. Import quota
2. Quota versus tariffs
3. Tariff-rate quota
4. Subsidies 45
 Non-tariff measures

Non-tariff measures (NTMs) can be defined as ”policy

measures, other than ordinary customs tariffs, that can
potentially have an economic effect on international trade in
goods, changing quantities traded, or both.”
These consist of mandatory requirements, rules, or regulations
that are legally set by the government of the exporting,
importing, or transit country.
https://www.youtube.com/watch?v=_WHfSk6Pyys

Slide 46
Non-tariff measures

Non-tariff measures (NTMs)

Vs.
Non-tariff barriers (NTBs)

Slide 47
 Non-tariff measures
Some popular NTMs:
▻ Quantitative restrictions: prohibition, quota, import licensing
(non-automatic license)
▻ Trading rights
▻ Para-tariff measures: surcharge, customs valuation
▻ Price control
▻ Technical measures (Technical Barriers to Trade – TBT)
▻ Distribution restrictions
▻ Trade-related investment measures
▻ Administrative procedures
▻ Trade remedies (anti-dumping, countervailing, safeguard measures)
Slide 48
➜ Trends of Tariffication
WTO: In a nutshell

Slide 49
 WTO AGREEMENTS: GATT 1994
1. Agriculture (AoA)
2. Sanitary and Phytosanitary Measures (SPS)
3. Textile and Clothing Note (Terminated on 1 Jan 2005)
4. Technical Barrier to Trade (TBT)
5. Trade-Related Investment Measures (TRIMs)
6. Anti-Dumping (Article VI of GATT 1994) (ADA)
7. Customs Valuation (Article VII of GATT 1994) (ACV)
8. Preshipment inspection
9. Rules Of Origin (ROO)
10. Import Licensing (ILP_
11. Subsidies and Countervailing Measures (SCM)
Slide 50
 Non-tariff measures

Sanitary and Phytosanitary Measures (SPS):

▻ Measures that are applied to protect human or animal life from risks
arising from: additives, contaminants, toxins or disease-causing
organisms in food
▻ Geographical restrictions on eligibility: Imports of dairy products
from countries

Slide 51
 Non-tariff measures

Technical Barriers to Trade (TBT):

▻ Measures referring to technical regulations, and procedures for
assessment of conformity with technical regulations and standards.
▻ Labelling requirement. Eg: Refrigerators need to carry a label
indicating their size, weight, and electricity consumption level

Slide 52
 Import Quotas

▰ Import Quotas: Theory

▻ An import quota is a direct restriction on the quantity of a good that
is imported in any one period (usually below free-trade level).
▻ Global quotas restrict the total quantity of an import, regardless of
origin
▻ Selective quotas restrict the quantity of a good coming from a
particular country

Slide 53
 Import Quotas

▰ An import quota always raises the domestic price of the

imported good.
▰ License holders are able to buy imports and resell them at a
higher price in the domestic market.
▻ The profits received by the holders of import licenses are
known as quota rents.

Slide 54
Figure 6-11: Import Quota - Trade and Welfare Effects

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Tariff-rate quota

▰ The tariff-rate quota is a two-tiered tariff

▻ A specified number of goods (up to the quota limit) may
be imported at one (lower) tariff rate, while imports in
excess of the quota face a higher tariff rate

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 Other Instruments of Trade Policy

▰ Voluntary Export Restraints

▻ A voluntary export restraint (VER) works like an export quota, except that
the quota is administered by the exporting country rather than the
importing country
▻ It is also known as a voluntary restraint agreement (VRA).
▻ However, these restraints are usually requested by importing country
▻ The profits or rents from this policy are earned by foreign governments or
foreign producers.
Slide 59
 Other Instruments of Trade Policy

▰ Local Content Requirements

▻ A local content requirement is a regulation that requires that some
specified fraction of a final good be produced domestically.
▻ This fraction can be specified in physical units or in value
terms.
▻ Local content laws have been widely used by developing countries
trying to shift their manufacturing base from assembly back into
intermediate goods.
Slide 60
 Other Instruments of Trade Policy

▰ Local Content Requirements

▻ From the viewpoint of domestic producers of inputs, a local
content requirement provide protection in the same way that an
import quota would.
▻ From the viewpoint of firms that must buy domestic inputs,
however, the requirement does not place a strict limit on imports,
but allow firms to import more if they also use more domestic
parts.
Slide 61
Subsidies

▰ Domestic Subsidy:
▻ Payments made to import-competing producers to raise the
price they receive above the market price
▰ Export subsidy:
▻ Payments and incentives offered to export producers
intended to raise the volume of exports

Slide 62
Main instruments of trade restrictions

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The Effects of Trade Policy: A Summary

Table 6-1: Effects of Alternative Trade Policies

Slide 64
 Summary

▰ A tariff drives a wedge between foreign and domestic prices, raising the
domestic price but by less than the tariff rate (except in the “small” country
case).
▻ In the small country case, a tariff is fully reflected in domestic prices.
▰ The costs and benefits of a tariff or other trade policy instruments may be
measured using the concepts of consumer and producer surplus.
▻ The domestic producers of a good gain
▻ The domestic consumers lose
▻ The government collects tariff revenue
Slide 8-65
 Summary

▰ The net welfare effect of a tariff can be separated into two parts:
▻ Efficiency (consumption and production) loss
▻ Terms of trade gain (is zero in the case of a small country)
▰ An export subsidy causes efficiency losses similar to a tariff but
compounds these losses by causing a deterioration of the terms of trade.
▰ Under import quotas and voluntary export restraints the government of the
importing country receives no revenue.

Slide 66