Why restrict trade?

1. Why restrict trade? • Benefits of free trade in final goods are spread widely • Tariffs on intermediate inputs tend to be low • Costs of free trade are felt rapidly by domestic producers • Costs are usually concentrated in specific sectors Carbaugh, Chap. 5

2. Tariffs Flavors of tariffs • Tariff: a tax (duty) on internationally traded products • Import tariff - levied on imports • Export tariff - levied on exported goods as they leave the country … unconstitutional in US • Protective tariff - insulate domestic producers from competition • Revenue tariff - raise funds for government Carbaugh, Chap. 5

3. Tariffs • Specific tariff • Fixed $ / unit • Ad valorem tariff • % of product’s value • Levied “free-on-board” (FOB) as it leaves port • Levied “cost-insurance-freight” (CIF) as it arrives in port • Compound tariff • Combination of fixed and ad valorem tariffs • Levied on finished goods whose imported inputs are also subject to tariff • Fixed portion offsets tariffs on raw materials paid by domestic producers • % portion protects domestic producers against finished good imports Carbaugh, Chap. 5

4. Tariffs Effective rate of protection • For a finished good, • Effective tariff rate = • {Nominal tariff – (% value Imports)x(Tariff on Imports)} (% Domestic Value Added) • The impact of a tariff is often different from its stated amount • Tariff Escalation: If domestic value added (domestic content) is low and tariffs on imports are also low Effective tariff >> Nominal tariff. Carbaugh, Chap. 5

5. Nominal and Effective Tariff Rates(US and Japan, early 1980s) USJapan NominalEffectiveNominalEffective Agriculture, fish, forest. 1.8% 1.9% 18.4% 21.4% Food, beverages,tobacco 4.7 10.6 25.4 50.3 Footwear 8.8 15.4 15.7 50.0 Furniture 4.1 5.5 5.1 10.3 Leather products 4.2 5.0 3.0 -14.8 Paper and paper products 0.2 -0.9 2.1 1.8 Textiles 9.2 18.0 3.3 2.4 Wearing apparel 22.7 43.3 13.4 42.2 Wood products 1.6 1.7 0.3 -30.6 Carbaugh, Chap. 5

6. Tariffs Avoiding and postponing tariffs • Production sharing special treatment for foreign assembly using domestic inputs • OAP: Offshore Assembly Provision • Maquiladoras • Bonded warehouses Assemble imported components and reexport duty free If sell domestically, tariff is levied only on imported value • Foreign trade zones (FTZ) Carbaugh, Chap. 5

7. Tariffs Tariff welfare effects • Consumer surplus • What buyers are willing to pay • Minus • What they actually pay • Producer surplus • What producers receive • Minus • Cost • (Minimum amount to induce them to produce a good) Carbaugh, Chap. 5

8. Tariffs Consumer and producer surplus Supply (minimum price) Price ($) Price ($) B Producer surplus Consumer surplus A C C (actual price) (actual price) A Total expenditure Total variable cost Demand (maximum price) B D E D Carbaugh, Chap. 5

9. g G e f Sd+w+t a b c d Welfare effects of tariffs Tariff trade and welfare effects Small nation model Sd H Price ($) E F Sd+w Dd Carbaugh, Chap. 5

10. Tariff effects Costs of import restrictions 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) • Production effect: output that cost more than it has to (b) • Consumption effect: surplus lost from reduced consumption (d) • Export industries face higher costs for inputs • Cost of living increases • Other nations may retaliate, further restricting trade Carbaugh, Chap. 5

11. Arguments for trade restrictions • 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 Carbaugh, Chap. 5