Tariffs

The Tariff Concept

• Tariff
• A tax (duty) levied on a product when it crosses national boundaries
• Import tariff
• Tax levied on an imported product
• Export tariff
• Tax imposed on an exported product
• Often used by developing nations
• Raise revenue, increase the world price
• Can Be
• Protective tariff
• To reduce the amount of imports entering a country
• Insulating import-competing producers from foreign competition
• Allows an increase in the output of import-competing producers
• Revenue tariff
• To generate tax revenues
• Placed on either exports or imports

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 Tariff revenues as a percentage of government
revenues, 2007: selected countries
Developing Countries Percentage Industrial Countries Percentag
e
The Bahamas 51.2 New Zealand 2.6
Guinea 47.9 Australia 2.5
Ethiopia 33.5 Japan 1.2
Ghana 28.5 Canada 1.2
Sierra Leone 27.6 Switzerland 1.2
Madagascar 26.9 United States 1.1
Dominican Republic 20.9 United Kingdom 1.0
Jordan 11.3 Iceland 1.0

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 Types of Tariffs
• Specific tariff
• Fixed amount of money per physical unit of the imported product
• Relatively easy to apply and administer
• Degree of protection it affords domestic producers varies inversely with changes in
import prices- higher the import prices lower the impact
• Provides domestic producers more protection during a business recession
• Ad valorem (of value) tariff
• Fixed percentage of the value of the imported product
• Distinguish among small differentials in product quality
• Tends to maintain a constant degree of protection for domestic producers
• Customs valuation problems
• Estimations by customs appraisers
• FOB vs. CIF valuation
• Free-on-board valuation
• Cost-insurance-freight valuation
• Includes transportation costs
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• Compound tariff
• Combination of specific and ad valorem tariffs
• For manufactured products using raw materials that are subject to tariffs
• Ex: compound duty on woven fabrics in USA with 48.5 cents per kg plus 38%
• Specific tariff on raw materials
• Neutralizes the cost disadvantage of domestic manufacturers because raw materials
cheaper abroad - tariff protection granted to domestic suppliers of raw materials
• Ad valorem tariff
• Protects the finished-goods industry

classroom use 5
Selected U.S. tariffs

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 Effective Rate of Protection
• Nominal tariff rate
• Published in the country’s tariff schedule
• Applies to the value of a finished product that is imported into a country
• Effective tariff rate
• Takes into account the nominal tariff rate
• On a finished product
• And any tariff rate applied to imported inputs used in producing the finished
product
• Effective tariff rate, e
• e = The effective rate of protection
• n = the nominal tariff rate on the final product
• a = the ratio of the value of the imported input to the value of the finished product
• b = the nominal tariff rate on the imported input

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• If tariff is 10% on finished product, and if the price same for Sony and Dell, then price $550
• However in case of Dell, as value added is only $100 due to assembly of inputs worth $400
imported tariff free, then $50 tariff means that Dell can go upto $150 as assembly costs, and still
meet the price of $550
• Implying Dell’s assembly cost could rise by 50%
• e= 0.1-0.8(0)/1-0.8
= 0.5 or 50%
If tariff on inputs 5%, then
e= 0.1-0.8(0.05)/1-0.8
= 0.3 or 30%
• If the tariff on the finished product
• Exceeds the tariff on the imported input
• Effective rate of protection exceeds the nominal tariff
• If the tariff on the finished product
• Is less than the tariff on the imported input
• Effective rate of protection is less than the nominal tariff
• May even be negative
• Protects domestic suppliers of raw materials more than domestic manufacturers
The effective rate of protection

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 China’s nominal and effective tariff rates in
forestry products, 2001

Tariff escalation
Raw materials are often
imported at zero or low
tariff rates
The nominal and effective
protection increases at each
stage of production
Processed goods
Higher import tariffs
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 FIGURE 4.1 Tariff escalation on industrial countries’
imports from developing countries

Tariffs often rise significantly with the level of processing (tariff escalation) in many industrial countries. This is
especially true for agricultural products. Tariff escalation in industrial countries has the potential of reducing demand
for processed imports from developing countries, hampering diversification into higher-value added exports.
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 Outsourcing and Offshore-Assembly
Provision
• Outsourcing
• Certain aspects of a product’s manufacture are performed in more than one country
• Improvements in cost competitiveness
• Penetrate foreign markets
• High tariffs or other trade barriers restrict the direct export of finished goods
• Unique foreign production technologies, labor skills, raw materials, or specialized
components
• Offshore-assembly provision (OAP)
• Favorable treatment to products assembled abroad from U.S.-manufactured components
• Cost of the U.S. component - not included in the dutiable value of the imported assembled article
• Incentives for foreign manufacturers to purchase components from U.S. sources
• Generates sales and jobs in the U.S. component industries

•
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 Dodging Import Tariffs: Tariff Avoidance
and Tariff Evasion
• Tariff avoidance
• Legal utilization of the tariff system to one’s own advantage
• To reduce the amount of tariff that is payable by means that are within the law
• EX: Ford Motor Company- Completely legal
• Ships its Transit Connect five-passenger wagons
• From its factory in Turkey to Baltimore, MD
• Wagons: 2.5% tariff (duty of $625)
• Stripped and converted into cargo vans
• Cargo vans tariff: 25% (duty of $6,250)
• Tariff evasion
• Individuals or firms evade tariffs by illegal means
• EX: Smuggled steel evades U.S. tariff
• Falsely reclassify steel as a duty-free product
• Detach markings which indicate that the steel came from a country subject to tariffs
• Make it appear to have come from one that is exempt
• Alter the chemical composition of a steel product enough so that it can be labeled duty-free 13
 Postponing Import Tariffs
• Bonded warehouse
• Dutiable imports can be brought into the U.S. and temporarily left in a bonded warehouse, duty-free
• Imported goods - stored, repacked, or further processed - for up to five years, but not manufacturing
or assembly
• No customs duties are owed until the goods are withdrawn for domestic consumption
• Advantage for importer that if no good price domestically then export which cancels obligations to
pay duties
• Foreign-trade zone (FTZ), like SEZ in China/India
• An area within the U.S.
• Business can operate without the responsibility of paying customs duties on imported products or materials
• For as long as they remain within this area
• And do not enter the U.S. marketplace
• General-purpose zones
• Public facilities/ Used by more than one firm
• Subzones
• A single firm’s site/Used for more extensive manufacturing or assembly

• Customs duties are due when goods are transferred from the FTZ for U.S. consumption 14
 Tariff Effects:
• Tariff - imposes costs to domestic economy
• Buyers will pay more for their protected goods than they would have for the imported goods under free trade
• Jobs will be lost at retail and shipping companies that import foreign-made goods
• Jobs will be lost in any domestic industries that suffer from retaliatory tariffs
• The extra cost of the goods gets passed on to whatever products and services that use these goods in the production
process
• Consumer surplus
• The difference between the amount that buyers would be willing and able to pay for a good and the
actual amount they do pay
• Affected by the market price - decrease in the market price larger consumer surplus ; higher market
price reduce the consumer surplus
• Producer surplus
• Revenue producers receive over and above the minimum amount required to induce them to supply
a good
• Affected by the market price- higher market price higher surplus; lower market price lower surplus
• So tariffs by raising market prices reduce consumer surplus , but increases producer
surplus
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 Consumer surplus and producer surplus

Consumer surplus is the difference between the maximum amount buyers are willing to pay for a
given quantity of a good and the amount actually paid. Graphically, consumer surplus is represented
by the area under the demand curve and above the good’s market price. Producer surplus is the
revenue producers receive over and above the minimum necessary for production. Graphically,
producer surplus is the area above the supply curve and below the good’s market price.
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 Tariff Welfare Effects: Small-Nation Model

• Small nation
• Price taker as it imports a very small portion of the world market supply
• Tariff effects
• Raises the home price of imports by the full amount of the duty
• Higher domestic production ; lower domestic consumption
• Consumer surplus falls; producer surplus rises
• Overall effects:
• Revenue effect
• Redistribution effect
• Protective effect
• Consumption effect
• Revenue effect
• The government’s collections of duty: number of units of imports multiplied by
the tariff
• Portion of the loss in consumer surplus transferred to the government
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• Redistribution effect
• Transfer of the consumer surplus to the domestic producers of the import-competing
product
• Transfer of income from consumers to producers
• Protective effect
• Loss to the domestic economy
• From wasted resources used to produce additional goods at increasing unit costs
• Less efficient domestic production is substituted for more efficient foreign production
• Consumption effect
• Residual not accounted for elsewhere
• Loss of welfare occurs
• Increased price lower consumption
• Deadweight loss of the tariff
• Protective effect
• Consumption effect
 Tariff trade and welfare effects: small nation model

For a small nation, a tariff placed on an imported product is shifted totally to the domestic
consumer via a higher product price. Consumer surplus falls as a result of the price increase. The
small nation’s welfare decreases by an amount equal to the protective effect and consumption
effect, the so-called deadweight losses due to a tariff.
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© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product
• At equilibrium price $9500, qt supplied is 50 autos
• With opening of economy, world price of $8000 would be the supply curve because
unlimited quantity can be supplied at this price(small nation cannot influence price)
• Free trade equilibrium at F with demand 80 and domestic production 20; so
remaining 60 to be imported
• Consumers better off because more autos at lower price; but adverse impact on
domestic production with unemployment and falling sales and revenues
• Govt imposes tariff of $1000; but being small nation cannot influence(lower) world
price to counter increased tariff
• Implies full impact of tariff leading to price $9000 and demand of 60 units to be met
from domestic production of 40 quantity, and imports of 20 units
• Falling demand because of increased prices, increasing domestic production also
because of increased prices
• What is the overall impact on the economy?
• Consumer surplus falls from a+b+c+d+e+f+g to e+f+g;
• Loss of a+b+c+d in consumer surplus redistributed as follows
• Revenue effect c= $20000(20 imports x 1000) is the gain to govt in terms of
tariff
• Redistributive effect is a which is transfer of $30000 from consumer surplus
to producer surplus(40 x$1000=40000 - b=10000)
• Protective effect is b=$10000, loss to the economy in terms of wasted
resources to produce additional units at higher cost of 9000 instead of 8000
which is the world price
• Consumption effect d=$10000 not accounted anywhere is loss because of
increased prices leading to lower consumption, and is loss to economy
• So deadweight loss of the tariff is b+d= $20,000
 Trade protectionism intensifies as global
economy falls into recession

• Once trade barriers are increased

• Beggar thy neighbor policy
• Can severely damage global supply chains
• It can take years of negotiation to dismantle trade barriers
• It can take years before global supply chains can be restored

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 Tariff Welfare Effects: Large-Nation Model
• Large-nation
• An importing nation large enough: changes in the quantity of its imports because of tariff would influence the
world price
• United States- autos, steel, oil, and consumer electronics
• United States - tariff on automobile imports
• Prices increase for American consumers, decrease in the quantity demanded
• If significant enough - force Japanese firms to reduce the prices of their exports
• With free trade market equilibrium at F, but with tariff equilibrium is at G, so consumer surplus falls by
a+b+c+d
• In figure world price reduced from $8000 to $7800
• If e(=$200 x 40) > (b + d)
• National welfare is increased
• If e = (b + d)
• National welfare remains constant
• If e < (b + d)
• National welfare is diminished
• Optimum tariff : maximize the positive difference between e and b+d
• But beggar-thy-neighbor policy could invite retaliation

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FIGURE 4.4 Tariff trade and welfare effects: large nation model

For a large nation, a tariff on an imported product may be partially shifted to the domestic consumer via a
higher product price and partially absorbed by the foreign exporter via a lower export price. The extent by
which a tariff is absorbed by the foreign exporter constitutes a welfare gain for the home country. This gain
offsets some (all) of the deadweight welfare losses due to the tariff’s consumption and protective effects.
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Effects of increases in U.S. tariffs on the world price
of imported goods

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• Effects of import tariffs on exporters
• Higher production costs – from imported inputs
• Higher prices
• Reduced overseas sales
• Raise the cost of living
• Higher wages
• Higher production costs
• International repercussions
• Lead to reductions in domestic exports
• Tariffs are inequitable
• Impose the most severe costs on low-income families
• Higher tariffs on cheap goods than luxuries
• Affect different countries in different ways
• Burdens countries that specialize in the cheapest goods

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 How an import tariff burdens domestic exporters

A tariff placed on imported steel increases the costs of a steel-using manufacturer. This
increase leads to a higher price charged by the manufacturer and a loss of international
competitiveness.
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 Arguments for Trade Restrictions

• Free-trade argument
• If each nation produces what it does best and permits trade
• In the long term, lower prices, higher levels of output, income, and consumption
• Job protection argument
• Alleged job losses to foreign competition
• Trade restrictions on textiles and apparel, steel, and automobiles
• Little or no positive effect on the level of employment in the long run
• Job losses spread across many industries
• Each job saved ends up costing domestic consumers more than the worker’s salary
• Protection against cheap foreign labor
• Low wages abroad make it difficult to compete with producers using cheap foreign labor
• Low wages by themselves do not guarantee low production costs, productivity is important
• Low-wage nations -competitive advantage
• Only in the production of goods requiring greater labor and little of the other factor inputs

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Hourly compensation costs in U.S. dollars for
production workers in manufacturing, 2007

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Productivity, wages, and unit labor costs, relative to
the U.S.: total manufacturing, 2002 (U.S.= 1.0)

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©
• Fairness : Foreign governments may be liberal in terms of corporate taxes, less
environmental regulations, and lower employer obligations in terms of minimum wages
and overtime pay
• However to be seen if trade benefits the domestic economy even if foreign nations impose trade
restrictions
• Helps in maintaining standard of living by restricting imports and thereby increasing
expenditure on domestic goods
• But cannot be applied universally for all countries, as it is a case of beggar thy neighbor policy
• Equalization of production costs by levying tariffs scientifically to eliminate all differences
arising out of cheap labor, taxes
• Tariffs equivalent to cost differential should be imposed
• Infant Industry argument to protect upcoming industries against competition from well
established industries abroad
• Used by developing countries; once imposed difficult to remove and so subsidy may be a better way
• Noneconomic arguments like national security, social and cultural reasons

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• Political economy of protectionism
• Elected officials form policies to maximize votes and remain in office
• Bias in the political system that favors protectionism
• Protection-biased sector
• Import competing producers
• Labor unions - in that industry
• Suppliers to the producers in the industry
• Established firms in an aging industry - lost their comparative advantage
• Demand of protectionism by the domestic companies and workers
• Depends on: Comparative disadvantage, Import penetration
• Supply of protectionism by the domestic government
• Depends on: costs to society, political importance of import-competing producers,
public sympathy

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