International Trade Policy

INTERNATIONAL ECONOMICS 1
INTERNATIONAL TRADE
POLICY
-- Kiran Sakroji
Agenda
Objective What is International Trade
The aim of this Gains from International Trade

presentation is to Free Trade Vs. Protection
understand the
importance of Types of Tariffs
international trade Effects of tariffs

with specific
Non-Tariff barriers
emphasis on the
role played by Effect of Quotas
tariffs. India’s Foreign Trade Policy
The presentation Critical Evaluation
will be concluded
India’s Foreign Trade - Statistics2
with an overview of ECONOMICS
INTERNATIONAL
What is International
Trade?
• International trade focuses on transaction of real goods
and services across nations. These transactions usually
involve a physical movement of goods or a commitment of
tangible resources like labor services.
• Two basic theories that form the base of international trade:

– Theory of Absolute advantage  Adam Smith (1776)
– Theory of Comparative advantage  David Ricardo (1816)
Gains from International
Trade
• Encourages the development of the most efficient sources of
supply.
• Enables specialization on a large scale because of expanded
market, which enables the realization of economies of scale.
• International specialization makes goods available at cheaper
prices.
• Increase real incomes and consumption. This could lead to
expansion of employment and output and foster economic growth.
• Goods that cannot be domestically produced are made available
through international trade.
Problems of International
Trade
• Gains from trade are not equally distributed. Developed
countries gain comparatively more.
• Fast exhaustion of non-replineshable goods, especially in
case of less developed countries whose exports are mostly
natural resources or commodities embodying natural
resources.
• Sometimes ruins domestic competition and industries.
• Due to backlash effects, sometimes poor countries are
exploited.
• It brings in culture and value systems that go against the
long established values causing social upheavals.
Free trade Vs Protection
• Free trade refers to a trade policy without any tariffs,
quantitative restrictions, and other devices obstructing the
movement of goods between countries.
• Protection refers to a trade policy which imposes tariffs or

quotas or other restrictions on import and/or export of
commodities.
The reason for these trade barriers are that different nations want
to protect their domestic industries, to increase employment
opportunities, to improve their balance of payments and to
achieve other goals.
Arguments in defense of Free Trade
• Gains in output and well-being from specialization:

– Specializing in production of those goods in which the country is
more efficient can help increase the exports.
– Specialization leads to efficient allocation of resources.
– Specialization leads to higher level of output.
– Exporting the goods in which a country is relatively more efficient in
exchange of goods from other country in which the other country is
relatively more efficient, leads to increase in overall output and well-
being of both the countries.
ra de
Fr ee T
• Gains from Economies of Scale:
– Trade makes it possible for the producers to move beyond domestic
market into international market and therefore makes it worthwhile to
specialize and produce on a large scale and thereby to lower cost
per unit.
– Entire world becomes market for all types of goods.
• Promoting Economic Growth:

– Raising the rate of saving and investment
• Free Trade  Increase in Real National Income  Higher level of
saving  Higher rate of investment & Capital formation  Economic
Growth
• Higher rate of saving makes it easier for the developing countries to
break the “Vicious circle of poverty” and to “Take-off into self-sustained
growth”
T rade
Free
• Promoting Economic Growth (contd):
– Import of Capital Goods:
• Trade permits import of capital goods, thereby accelerating industrial
growth.
• Capital goods adds to capital stock in a country and raises its productive
capacity.
– Transfer of technology:
• Without trade, every country would have to invent a wheel, steam
engine, electricity !!!
• Trade increase international diffusion of technology, and transfers
technology from developed countries to developing countries.
• Technology discovered / invented by one country can be developed and
enhanced by other country.
ra de
Fr ee T
• Promotes Competition and Prevents Monopoly:
– Absence of trade & Foreign competition  Domestic firms inefficient
 Rise in cost per unit of output  Higher prices of goods.
– Free trade & Foreign competition  Domestic firms increase their
efficiency  Employ low cost production techniques  lower prices
of products  Contribution to economic growth
– Free trade also compels domestic firms to be innovative and
improve the quality of product.
– Free trade provides the consumer with wide variety of products.
ra de
Fr ee T
Arguments in defense of Protection
• Nationalism:
– Nationalistic feeling or patriotism – Be American, Buy
American, Swadeshi etc.
– Patriotic feeling to protect indigenous industries or to provide
subsidies to domestic industries.
Counter-Argument:
– Such policy deny the people of a country the gains from trade such
as rise in productive efficiency and greater well-being, stimulus to
growth through higher capital formation and spread of superior
technology.
– Such policy promotes inefficiency and prevents rapid economic
n
growth against national interest.
e c ti o
Pr ot
• Employment Argument:
– Import of goods reduces employment. Hence, if goods are produced
at home, employment will increase.
– Since prices of imported goods are lower, domestic producers would
no be able to compete and will lead to increase in unemployment.
Counter Argument:
– Imposing barriers on imports will adversely affect the exports.
– Barriers on imports will cause retaliation from countries on whose
import the barriers are imposed, leading to reduction in export and
increase of unemployment in export industries.
e c ti on
Pr ot
• Infant Industry Argument:
– Infant industries should be given protection from the competition of
low-priced imports of mature and well-established industries.
– Protection for some time will allow infant industries to grow and
achieve production efficiency and economies of scale.
Counter Argument:
– Protection will handicap the industry to grow.
– Lack of growth and efficiency will harm the industry in long run.
– Example: Indian Automobile Industry -- Ambassador and Fiat
e c ti on
Pr ot
• Anti-dumping Argument:
– Dumping is a form of price discrimination, where one country dumps
goods in another country at a price much lower than the locally
produced goods of another country.
– Beneficial to consumers, harmful to producers.
– Foreign firms sell goods in other countries at low price to drive out
the competitors. After wash-out of competition from local producers,
they raise prices to obtain monopoly prices.
Counter Argument:
– Instead of imposing barriers, stringent laws should be enacted,
declaring dumping activities to be illegal.
e c ti on
Pr ot
Types of Tariffs
• Tariff is a tax or duty levied on goods when they enter or
leave the national boundary. In this sense tariff refers to
import duties or export duties. But for practical purposes, a
tariff is synonymous with import duties or custom duties.
• Tariffs can be of many types based on :

– Basis of purpose.
– Basis of origin and destination.
– Basis of country wise discrimination.
– Basis of Retaliation.
Types of Tariffs
ur pose
P Based on
Purpose
Revenue Tariff Protective Tariff

• Levied on luxury consumer
• Levied on goods to protect
goods.
domestic industry.
• Generating revenue is primary
• Generating revenue is
function
secondary function
• Lower import duties generate
more revenue.
Types of Tariffs
r i g in &
O
i nation Based on Origin
Dest
& Destination
Ad Valorem Duty Specific Duty Compound Duty Sliding Scale Duty
Types of Tariffs
n Based on
i natio
r im Country wise
Disc
discrimination
Single Column Tariff Double Column Tariff Multiple Column Tariff

Uniform rate of duty imposed Two different rate of duty Two or more different tariff
On similar commodities, irre- Imposed on similar or different Rates levied on each category
Spective of country of origin. commodities Of commodities.
General and Conventional Maximum and Minimum

Tariff Tariff
Types of Tariffs
l ia t ion
Reta
Based on Retaliation
Retaliatory Tariff: Countervailing Duty:

• To punish a country for its trade policy • To raise the price of a commodity
which harms its exports or balance of in order to protect producers of the
payments position. same commodity in the importing
country from cheap foreign
commodity, which has been subsidized.
Advantages
• Role of Tariff in Economic Development:
• Protection of Domestic Industries
• Improving Balance of Payments
• Increase in savings and investments.
• Increase in productivity
• Increase in employment
• Increase in public revenue
• Self-reliance.
Effect of Tariffs
• Example: Computer
• India has comparative Sd
disadvantage in production of
Price
computers.
• USA has comparative
E
advantage in production of Pd
computers
• Sd = Domestic supply
Pw
• Dd = Domestic demand
• OPd = Domestic price
• OQ = Quantity demanded and sold Dd
• OPw = World price

O N Q H
• NH = Quantity of computers
imported. Quantity
Effect of Tariffs
• Consumption Effect:
• India imposes tariff of PwPt per Sd
computer imported.
Price
• Price of computer in India
becomes OPt.
E
• Demand reduces to OL due to Pd
increase in price.
Pt
• Consumption reduces by LH
quantity. Pw
• Due to increase in price, consumer

opts for substitute products.
Dd
• Thus imposing tariff results in
reduction of demand and O N Q L H
consumption.
Quantity
Effect of Tariffs
• Production Effect:
• Due to imposition of tariff, Sd
producers will be able to sell
Price
computers at higher price Opt
• Producers will produce and supply
more computers OM. Pd
E
• Domestic production will increase

Pt
by NM
• Thus imposing tariff results in Pw
increasing production efficiency

and also increasing employment to
a certain extent. Dd
O N M Q H
Quantity
Effect of Tariffs
• Trade Effect:
• Due to imposition of tariff, demand Sd
of computers reduces by LH
Price
quantity
• Due to imposition of tariff, supply
of computers increases by NM Pd
E
quantity.
• Results in reduction in imports. Pt
• Imported quantity changes from Pw
NH to ML.
• Thus imposing tariff results in total
reduction of imports and affects Dd
the trade. O N M Q L H
Quantity
Effect of Tariffs
• Revenue Effect:
• Govt. will gain from tariff, Sd
equivalent to an amount abCG.
Price
• This revenue gained by
Government is essentially transfer
of income from consumer to Pd
E
Government and does not

a b Govt. Revenue
represent any net change in Pt
nation’s well being. Pw

C G
• Thus imposing tariff does not
change the overall economic well
being of a nation. Dd
O N M Q L H
Quantity
Non-Tariff barriers
• Non-tariff barriers are administrative measures which act as
obstacle to imports and affect the international trade.
• Various types of NTB are:
– Quantitative Trade Restrictions: Import Quotas, Tariff quotas,
Voluntary Export Restraints (VER), Orderly Marketing Arrangements
(OMA), Multiple Fibre Arrangements (MFA) etc.
– Fiscal Measures: Export credit subsidy or tax concessions on
exports, exports tax, government procurement, anti-dumping duties,
countervailing duties, tied aid etc.
– Administrative Standards and Regulations: Health & Sanitary
regulations, environmental controls, customs valuation and
classification, marketing and packaging requirements, imports
licensing procedures etc.
– Other NTB include bilateral trade agreements, dumping international
commodity agreements, international cartels etc.
Effect of Quotas
• Domestic supply @ world price =
OQ1
SM SM + Quota
• Domestic demand @ world price =
Price
OQ3
• Import quantity required = Q1Q3
• Due to Quota imposition, quantity E
that can be imported = Q1Q2 Pa
Quota = Q1Q2 units
• New supply curve = SM + Quota Pd
A B
• Intersection of new supply curve

with domestic demand curve Pw
determines price Pd > Pw

• Thus Quota fixation leads to
increase in price and limits trade, DM
thus putting the consumer at loss.

O Q1 Q2 Q3
• However, unlike tariff, in quota,
there is no revenue collected by Quantity
the government.
India’s Foreign Trade
Policy (2004-2009)
• UPA announced India’s foreign trade policy on August 31, 2004.
• The Objective of FTP:

– To make India’s percentage share of global merchandise trade double by 2009
– To act as an effective instrument of economic growth by giving a thrust to employment

generation, especially in semi-urban and rural areas.
• The key strategies of FTP are:

– Unshackling of controls;
– Creating an atmosphere of trust and transparency;
– Simplifying the procedures and bringing down transaction costs;
– Adopting the fundamental principle that duties and levies should not be exported;
– Identifying and nurturing different special focus areas to facilitate development of India
as a global hub for manufacturing, trading and services.
Policy (2004-2009)
The various provisions of this FTP are as follows:
• Foreign Trade Target:
– Doubling of India’s share in world trade in five years. (From 0.8% to
1.5%)
– In absolute terms, it implies raising India’s exports from 61.9 billion
USD to 195 billion USD by 2009.
– Exports reached 101 billion USD in 2005-06.
• Focus on Employment generation through Export Strategy:
– Employment generation through various incentives provided to
Agriculture, handlooms, handicrafts, gems and jewellery, leather and
footwear.
– Non-IT services on which policy focuses are tourism, healthcare and
education.
Policy (2004-2009)
• Focus on Agro-exports to boost export growth:
– Providing fiscal incentives to exporters.
– Scheme called “Videsh Krishi Upaj and Gram Yojana” (VKUGY) to
promote export of fruits, vegetables, flowers and minor forest
produce and their value added products and other gram udyog
products by providing 5% customs duty credit on value of exports
made.
– Permission for duty-free import of capital goods for installation
anywhere in agri-export zones (AEZs)
– Liberalization of procedures for import of seeds, bulbs, tubers and
planting material and the export of plant portion, derivatives and
extracts.
– Scheme will also help boost the export of medicinal plants and
herbal products.
Policy (2004-2009)
• Exemption of Exports from Service Tax:
– Exports of all goods and services have been exempted from 10% service
tax and 2% cess on it.
• Promoting Exports of services:

– To accelerate services export, sop (concession) in terms of duty free
entitlement is provided to service providers. (10% of foreign exchange
earned).
– New Scheme “Target Plus” – Service exporters who achieve quantum
growth (more than 16% as fixed by commerce ministry) would be entitled
to substantially higher duty-free credit based on incremental exports. (In
2006, this scheme was replaced by Focus Product Scheme and Focus
Market Scheme to provide opportunities in semi urban and rural areas)
Policy (2004-2009)
• Establishment of Bio-Technology Parks
• Restrictions on imports of second-hand capital goods

waived:
– Capital goods regardless of age are made freely importable without
any minimum residual life condition.
– Will help in reducing the cost of investment and strengthening the
forces of industrial restructuring.
– However, Computers and Laptops are excluded.
Critical Evaluation
• India needs to boost manufacture exports by overhauling indirect taxes
like excise, Octroi etc.
• Single reasonable tariff rate needs to be put in place for all import goods.
(It will minimize the procedural complications and red-tape that goes with
trade)
• Implement liberal foreign investment policy (100% FDI).
• Liberalizing imports of second hand capital goods will have an adverse

effect on the domestic capital goods industry.
• Textile sector has been ignored.

International Trade Policy

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INTERNATIONAL ECONOMICS 1

The aim of this Gains from International Trade

international trade Effects of tariffs

• Two basic theories that form the base of international trade:

• Protection refers to a trade policy which imposes tariffs or

• Gains in output and well-being from specialization:

• Promoting Economic Growth:

• Tariffs can be of many types based on :

Revenue Tariff Protective Tariff

Ad Valorem Duty Specific Duty Compound Duty Sliding Scale Duty

Single Column Tariff Double Column Tariff Multiple Column Tariff

General and Conventional Maximum and Minimum

Retaliatory Tariff: Countervailing Duty:

• Protection of Domestic Industries

• Improving Balance of Payments

• Increase in savings and investments.

• Increase in public revenue

• OPw = World price

• Due to increase in price, consumer

producers will be able to sell

• Domestic production will increase

increasing production efficiency

• Imported quantity changes from Pw

equivalent to an amount abCG.

Government and does not

nation’s well being. Pw

• Intersection of new supply curve

determines price Pd > Pw

thus putting the consumer at loss.

• The Objective of FTP:

– To act as an effective instrument of economic growth by giving a thrust to employment

• The key strategies of FTP are:

• Promoting Exports of services:

• Restrictions on imports of second-hand capital goods

• Implement liberal foreign investment policy (100% FDI).

• Liberalizing imports of second hand capital goods will have an adverse

• Textile sector has been ignored.

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