Chapter 04 Tariffs

Tariffs
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Andreea Chiritescu
Eastern Illinois University
© 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 or service or otherwise on a password‐protected website for classroom use 1
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
© 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 or service or otherwise on a password‐protected website for classroom use 2
The Tariff Concept
• 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
TABLE 4.1 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
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
• Provides domestic producers more protection
during a business recession
Types of Tariffs
• 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
Types of Tariffs
• Ad valorem (of value) tariff
• Customs valuation problems
• Estimations by customs appraisers
• FOB vs. CIF valuation
• Free-on-board valuation
• Cost-insurance-freight valuation
• Includes transportation costs
Types of Tariffs
• Compound tariff
• Combination of specific and ad valorem tariffs
• For manufactured products
• Embodying raw materials that are subject to tariffs
• Specific tariff
• Neutralizes the cost disadvantage of domestic
manufacturers - from tariff protection granted to
domestic suppliers of raw materials
• Ad valorem tariff
• Protects the finished-goods industry
• United States - compound duty on woven
fabrics
• The specific portion of the duty ($0.485 cents)
compensates U.S. fabric manufacturers for the
tariff protection granted to U.S. cotton
producers
• The ad valorem portion of the duty (38
percent) provides protection for their own
woven fabrics.
TABLE 4.2 Selected U.S. tariffs
TABLE 4.3 Examples of tariffs, selected countries (in %)
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
TABLE 4.4 The effective rate of protection
• 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
 n  ab 
e
1 a
• 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
TABLE 4.5 China’s nominal and effective tariff rates in
forestry products, 2001
Tariff Escalation
• 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
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.
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
Outsourcing and Offshore-Assembly
Provision
• 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
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
• Tariff evasion
• Individuals or firms evade tariffs by illegal
means
and Tariff Evasion
• Ford Motor Company
• 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 vanns
• Cargo vans tariff: 25% (duty of $6,250)
• Completely legal
and Tariff Evasion
• 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
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
• No customs duties are owed until the goods are
withdrawn for domestic consumption
• Foreign-trade zone (FTZ)
• 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
• Customs duties are due when goods are
transferred from the FTZ for U.S. consumption
• Foreign-trade zone (FTZ)
• No time limit on how long goods can be stored
• General-purpose zones
• Public facilities
• Used by more than one firm
• Subzones
• A single firm’s site
• Used for more extensive manufacturing or
assembly
Tariff Effects: An Overview
• Tariff effects
• Higher price of imports
• Lower demand for imports
• Domestic suppliers expand output
• Benefits
• Domestic producers
Tariff Effects: An Overview
• Tariff - imposes costs to domestic economy
• Buyers will pay more for their protected U.S.-made
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
Tariff Welfare Effects
• 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
• A decrease in the market price
• Increase in the quantity purchased
• Larger consumer surplus
• A higher market price
• Reduce the amount purchased
• Shrink the consumer surplus
Tariff Welfare Effects
• Producer surplus
• Revenue producers receive over and above the
minimum amount required to induce them to
supply a good
• Affected by the market price
• A higher market price
• Increase in quantity supplied
• Higher surplus
• A lower market price
• Lower surplus
FIGURE 4.2 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.
Tariff Welfare Effects: Small-Nation Model
• Small nation
• Its imports - a very small portion of the world
market supply
• Price taker
• Tariff effects
• Raises the home price of imports by the full
amount of the duty
• Higher domestic production
• Lower domestic consumption
• Small nation - Tariff effects on nation’s welfare
• Consumer surplus falls
• Welfare effects of a tariff
• Revenue effect
• Redistribution effect
• Protective effect
• Consumption effect
• Additional tax revenue
• Benefits domestic producers
• Wastes resources
• Harms the domestic consumer
FIGURE 4.3 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.
• Revenue effect
• The government’s collections of duty
• Number of imports times the tariff
• Portion of the loss in consumer surplus
• Transferred to the government
• Does not result in an overall welfare loss
• Redistribution effect
• Transfer of the consumer surplus
• To the domestic producers of the import-competing
product
• Transfer of income from consumers to
producers
• Does not result in an overall loss of welfare for
the economy
• 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
• Loss of welfare
• Residual not accounted for elsewhere
• Loss of welfare occurs
• Increased price
• Lower consumption
• Deadweight loss of the tariff
GLOBALIZATION
Trade protectionism intensifies as global
economy falls into recession
• Global economic downturns - catalyst for trade

protectionism; 2007–2009,
• Decrease in the demand for goods and services
• Decline in international trade
• Credit crunch - extra squeeze on trade
• Shortfall of some $100 billion in trade finance –
90% of world trade
GLOBALIZATION
• Indiscriminate decrease in trade

• Exports declined by 30 %
• China - targeted by the most governments for
protectionist measures
• Russia
• Increased tariffs on imported automobiles
• India
• Raised tariffs on steel imports
• Argentina
• New obstacles to imported auto parts and shoes
TABLE 4.6 Creeping protectionism during global economic downturn of
2008–2009: number of protectionist measures initiated*
GLOBALIZATION
• United States, steel industry

• Increased tariffs
• $100 billion U.S. steel market
• Not protected by the “Buy American ” legislation
• Fiscal stimulus program
• Shut out foreign companies from U.S. government
contracts (25% of new steel orders in 2009)
GLOBALIZATION
• United States, tires

• Tariffs of 25-35% on imports from China
• For the next three years
• Priced out of the market 17% of all tires sold in the
United States
• Forced up the market price for consumers
GLOBALIZATION
• Once trade barriers are increased

• 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
Tariff Welfare Effects: Large-Nation Model
• Large-nation
• An importing nation large enough
• Changes in the quantity of its imports
• By means of tariff policy
• Influence the world price of the product
• United States
• Autos, steel, oil, and consumer electronics
• Japan
• European Union
• 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
TABLE 4.7 Effects of increases in U.S. tariffs on the world price
of imported goods
• Economic effects of an import tariff
• Redistributive effect
• From domestic consumers to domestic producers
• Deadweight loss
• Revenue effect
• Domestic revenue effect
• Terms-of-trade effect
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.
• a specific tariff of $1,000 in figure 4.4
• shift in the total supply schedule from Sd+w to
Sd+w+t
• Market equilibrium shifts from point F to point G
• product price rises from $8,000 to $8,800
• consumer surplus falls by areas a b c d
• (a) $32,000 redistributive effect (transferred from
domestic consumers to domestic producers
• (d+b) tariff’s deadweight loss;
• reduced consumption (consumption effect $8,000)
• inefficient use of resources (protective effect $8,000).
• a specific tariff of $1,000 in figure 4.4…
• revenue effect c+e, or $40,000 (Total imported cars x Tax)
• domestic consumers pay only an additional $800 per imported

auto (not $1,000)
• Foreign supply price fell by $200 (less revenues for foreign
producers)
• the revenue effect of an import
• Amount of tariff revenue shifted from domestic consumers to the
tariff levying government
• 40 units x $800 portion of the import tariff borne by domestic consumers.
domestic revenue effect (c)
• tariff revenue extracted from foreign producers (lower price)
• 40 x $200, the terms-of-trade effect (e)
• In figure 4.4
• If e > (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
• Gain of improving terms of trade (area e)
• Loss in economic efficiency from the protective
effect (area b)
• Consumption effect (area d)
• Is only beneficial to the importing nation
• Beggar-thy-neighbor policy, could invite
retaliation
TRADE
CONFLICTS Gains from eliminating import tariffs
• If only United States removed tariffs and other

restraints on imported products
• Lowers the price of the affected imports
• Lower the price of the competing U.S. good
• Economic gains to the U.S. consumer
• Decrease the production costs
• Domestic profit reductions
TRADE
CONFLICTS Gains from eliminating import tariffs
• If only United States removed tariffs and other

restraints on imported products
• Displaced workers from the domestic industry
that loses protection
• U.S. government loses tax revenue
• Estimated annual economic welfare gains from
eliminating significant import restraints
• Welfare gain of about $3.7 billion to the U.S.
economy
TABLE 4.8 Economic welfare gains from liberalization of
significant import restraints*, 2005 (millions of dollars)
Annual change in Economic Welfare Import-Competing Industry

Textiles and apparel $1,885 millions
Sugar 811
Dairy 573
Footwear 249
Ethyl alcohol 120
Beef 48
Tuna 24
Glass products 20
Tobacco 19
*Import tariffs, tariff-rate quotas, and import quotas
How a Tariff Burdens Exporters
• Effects of import tariffs on exporters
• Higher production costs – from imported inputs
• Cannot pass it to the buyers
• Higher prices
• Reduced overseas sales
• Raise the cost of living
• Higher wages
• Higher production costs
• International repercussions
• Lead to reductions in domestic exports
FIGURE 4.5 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.
Steel Tariffs Buy Time for Troubled Industry
• 2001, President Bush, import tariff program
• Revitalize steel industry
• American steel companies - lack of
competitiveness
• Heavy burden on American steel-using
industries
• Temporarily save roughly 6,000 jobs
• At a cost to U.S. consumers and steel-using firms:
$800,000 -$1.1 million per job
Steel Tariffs Buy Time for Troubled Industry
• 2001, President Bush, import tariff program
• Save 1 job in steel manufacturing – at a cost of
13 jobs in steel-using industries
• Increased production costs for a large number
of U.S. companies that use steel
• 2007, Government trade regulators
• Revoke tariffs on high-end steel imports from
certain countries
TABLE 4.9 President Bush’s steel trade remedy program of
2002–2003: selected products
Tariffs and the Poor
• 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
• Very poor countries in Asia and the Middle East
TABLE 4.10 U.S. tariffs are high on cheap goods, low on luxuries
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
• Omits: dual nature of international trade
• Trade restrictions on textiles and apparel, steel,
and automobiles
• Little or no positive effect on the level of
employment in the long run
• Job protection argument
• Job gains for only a few industries
• 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 for U.S.
producers to compete with producers using cheap
foreign labor
• Fails to recognize the links among efficiency,
wages, and production costs
• Low wages by themselves do not guarantee low
production costs
• Low-wage nations -competitive advantage
• Only in the production of goods requiring greater labor
and little of the other factor inputs
TABLE 4.11 Hourly compensation costs in U.S. dollars for
production workers in manufacturing, 2007
TABLE 4.12 Productivity, wages, and unit labor costs, relative to
the U.S.: total manufacturing, 2002 (U.S.= 1.0)
• Fairness in trade
• Foreign governments play by a different set of
rules
• Foreign firms unfair competitive advantages
• Trade benefits the domestic economy even if
foreign nations impose trade restrictions
• Does not recognize the potential impact on
global trade
• Maintenance of the domestic standard of living
• One nation imposes a tariff that improves its
income and employment
• At the expense of its trading partner’s living
standard
• Retaliatory tariffs
• Lower level of welfare for all nations
• Equalization of production costs
• Scientific tariff - to eliminate unfair competition
from abroad
• Problems
• Different costs across business
• Higher domestic prices
• Benefit efficient domestic companies
• Domestic consumer would be subsidizing inefficient
production
• Equalization of production costs
• Approximates a prohibitive tariff
• Completely contradicts the notion of comparative
advantage
• Wipes out the basis for trade and gains from trade
• Infant-industry argument
• Trading nations should temporarily shield their
newly developing industries from foreign
competition
• Once a protective tariff is imposed - very
difficult to remove
• Special-interest groups - convince policy makers
that further protection is justified
• Infant-industry argument
• Very difficult to determine which industries will
be capable of realizing comparative advantage
potential
• Not valid for mature, industrialized nations
• There may be other ways of insulating a
developing industry from cutthroat competition
• Subsidize the industry
• Noneconomic arguments
• National security argument
• Protect essential industries
• What constitutes an essential industry
• Cultural and sociological considerations
• Arguments justifying tariffs
• Based on the assumption that the national
welfare, as well as the individual’s welfare, will
be enhanced
TRADE
CONFLICTS Petition of the candle makers
• Frederic Bastiat, French Chamber of Deputies
• Satire of protectionists’ arguments, 1845
• A law be passed requiring people to shut all
windows, doors, and so forth
• So that the candle industry would be protected
from the “unfair” competition of the sun
• Great benefit to the candle industry
• Creating many new jobs and enriching suppliers
• 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
• Political economy of protectionism
• Protection-biased sector
• Seekers of protectionism
• Established firms in an aging industry - lost their
comparative advantage
• Free-trade-biased sector
• Exporting producers, their workers, and their
suppliers
• United States’ protection policy
• Dominated by special-interest groups that
represent producers
• Gains from protection – concentrated among well-
organized producers and labor unions
• Consumers
• Not organized; Losses widely dispersed
• Absorb individually a small & difficult-to-identify
cost;
• Uninformed
• Supply of protectionism
• By the domestic government
• Depends on:
• The costs to society
• The political importance of import-competing
producers
• Adjustment costs
• Public sympathy
• Demand of protectionism
• By the domestic companies and workers
• Depends on:
• Comparative disadvantage
• Import penetration
• Concentration
• Export dependence

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Tariffs

PowerPoint slides prepared by:

• Global economic downturns - catalyst for trade

• Indiscriminate decrease in trade

• United States, steel industry

• United States, tires

• Once trade barriers are increased

• domestic consumers pay only an additional $800 per imported

• If only United States removed tariffs and other

• If only United States removed tariffs and other

Annual change in Economic Welfare Import-Competing Industry

*Import tariffs, tariff-rate quotas, and import quotas

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