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

4
▻What is free trade?

5
 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)
7
 Introduction to trade policy

▰ How do government intervene in markets?

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

8
 Introduction to trade policy

Who pays for trade

restriction?

9
 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
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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

15
 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 pills is $15. Slide 19
Tariff welfare effects

Figure 6-7: Geometry of Consumer Surplus

Price, P

P1
b
P2

D
Slide 20
Q 1 Q2 Quantity, Q
 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 of $5 gains a producer surplus of $3. Slide 21
Tariff welfare effects

Figure 6-7: Geometry of Consumer Surplus

Price, P

P1
b
P2

D
Slide 22
Q 1 Q2 Quantity, Q
23
 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
25
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)
➜ Trends of Tariffication Slide 48
 Import Quotas

▰ Import Quotas: Theory

▻ An import quota is a direct restriction on the quantity of a good that is
imported.
▻ Example: The United States has a quota on imports of foreign cheese.
▻ The restriction is usually enforced by issuing licenses to some group of
individuals or firms.
▻ Example: The only firms allowed to import cheese are certain trading
companies.
▻ In some cases (e.g. sugar and apparel), the right to sell in the United States
is given directly to the governments of exporting countries.
Slide 49
 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 50
Figure 6-11: Import Quota - Trade and Welfare Effects

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 Quota versus tariffs

▰ The difference between a quota and a tariff is that with a

quota the government receives no revenue.
▰ In assessing the costs and benefits of an import quota, it is
crucial to determine who gets the rents.
▻ When the rights to sell in the domestic market are
assigned to governments of exporting countries, the
transfer of rents abroad makes the costs of a quota
substantially higher than the equivalent tariff.

Slide 52
 Quota versus tariffs

Figure 6-12: Trade

Effects of Tariffs
versus Quotas

Slide 53
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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Subsidies

▰ Export Subsidies: Theory

▻ Export subsidy
▻ A payment by the government to a firm or individual
that ships a good abroad
▻ When the government offers an export subsidy,
exporter will export the good up to the point
where the domestic price exceeds the foreign
price by the amount of the subsidy.
▻ It can be either specific or ad valorem.
Slide 55
Subsidies

Figure 6-13: Effects of an Export Subsidy

Price, P
S

PS
Subsidy PW a b c = producer gain
d
(a + b + c)
P*S e f g = consumer loss (a + b)
= cost of
government subsidy
(b + c + d + e + f + g)

Quantity, Q
Exports Slide 56
Subsidies

▻ An export subsidy raises prices in the exporting country

while lowering them in the importing country.
▻ In addition, and in contrast to a tariff, the export subsidy
worsens the terms of trade.
▻ An export subsidy unambiguously leads to costs that
exceed its benefits.

Slide 57
Subsidies

Figure 6-14: Europe’s Common Agricultural Program

Price, P S

Support price
EU price = cost of government
without subsidy
imports

World price

Quantity, Q
Slide 58
Exports
 Other Instruments of Trade Policy

▰ Voluntary Export Restraints

▻ A voluntary export restraint (VER) is an export quota
administered by the exporting country.
▻ It is also known as a voluntary restraint agreement
(VRA).
▻ This measure is mainly driven by the political
considerations of the importing country about trade
liberalization (not wanting to impose import quotas
openly). Slide 59
 Other Instruments of Trade Policy

▰ A VER is exactly like an import quota where the licenses are assigned to
foreign governments and is therefore very costly to the importing country.
▰ A VER is always more costly to the importing country than a tariff that
limits imports by the same amount.
▻ The tariff equivalent revenue becomes rents earned by foreigners under
the VER.
▻ Example: About 2/3 of the cost to consumers of the three
major U.S. voluntary restraints in textiles and apparel, steel,
and automobiles is accounted for by the rents earned by
foreigners.
▰ A VER produces a loss for the importing country. Slide 60
 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 61
 Other Instruments of Trade Policy

▰ Local content laws do not produce either government revenue or quota

rents.
▻ Instead, the difference between the prices of imports and domestic
goods gets averaged in the final price and is passed on to consumers.
▻ Example: Suppose that auto assembly firms are required to use
50% domestic parts. The cost of imported parts is $6000 and the
cost of the same parts domestically is $10,000. Then the average
cost of parts is $8000 (0.5 x $6000 + 0.5 x $10,000).
▻ Firms are allowed to satisfy their local content requirement by
exporting instead of using parts domestically.
Slide 62
The Effects of Trade Policy: A Summary

Table 6-1: Effects of Alternative Trade Policies

Slide 63
 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 8-64
 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 65