Intl trade suranovic-2006

International Trade Theory and
Policy Analysis
by Steven Suranovic

The George Washington University

©1997-2006 Steven M. Suranovic, ALL RIGHTS RESERVED

The content of this file is protected by copyright and other intellectual property laws. The content is owned
by Steven M. Suranovic. You MAY make a local copy of the work, a printed copy of the work and you
MAY redistribute up to 2 copies of the work provided that the work remains intact, with this copyright
message attached. You MAY NOT reproduce, sell, resell, publish, distribute, modify, display, repost or use
any portion of this Content in any other way or for any other purpose without the written consent of the
Study Center. Requests concerning acceptable usage should be directed to the webmaster@internationalecon.
com No warranty, expressed or implied, is made regarding the accuracy, adequacy, completeness, legality,
reliability or usefulness of the Content at the Study Center. All information is provided on an "as is" basis.

International Trade Theory & Policy
by Steven M. Suranovic

Chapter 5
Introductory Issues
©1997-2006 Steven M. Suranovic, Copyright Terms

Table of Contents Problem Sets

The International Economy LEVEL 1: Basic Definitional
5-1
LEVEL 2: Basic Intermediate
5-2 What is International LEVEL 3: Advanced Intermediate
Economics?
5-3 Brief Outline
LEVEL 1
5-4 Some Trade Terminology
5-5 Valuable Lessons of Jeopardy 5-1
International Trade Theory
5-5A Lesson A
5-5B Lesson B Answer Keys
5-5C Lesson C
r Internet Explorer Download
5-5D Lesson D
Center
5-5E Lesson E
5-5F Lesson F Answer keys to the problem sets are for sale
in Adobe Acrobat PDF format for easier
viewing and printing. Purchases must be
DOWNLOAD Chapter 5 in PDF format.
made using a recent Internet Explorer
browser. Revenues from these sales will
help us to expand and improve the content
at this site.

Related Links
r Deardorff's Glossary of International
r Think Again: International Trade
Economics
Article by Arvind Panagariya that
Alan Deardorff's (UMichigan)
highlights some important
collection of citations and definitions
regularities about international trade.
regarding international economics.

Copyright Notice: The content of this file is protected by copyright and other intellectual
property laws. The content is owned by Steven M. Suranovic. You MAY make a local copy
of the work, a printed copy of the work and you MAY redistribute up to 2 copies of the work
provided that the work remains intact, with this copyright message attached. You MAY NOT

reproduce, sell, resell, publish, distribute, modify, display, repost or use any portion of this
Content in any other way or for any other purpose without the written consent of the Study
Center. Requests concerning acceptable usage should be directed to the
webmaster@internationalecon.com No warranty, expressed or implied, is made regarding the
accuracy, adequacy, completeness, legality, reliability or usefulness of the Content at the
Study Center. All information is provided on an "as is" basis.

HOW TO CITE THIS PAGE
Suranovic, Steven, "International Trade Theory and Policy: Introductory Issues," The
International Economics Study Center, © 1997-2006, http://internationalecon.com/v1.0/ch5/
ch5.html.

The International Economy

by Steven Suranovic ©1997-2007

Trade 5-1
International economics is growing in importance as a field of study
because of the rapid integration of international economic markets. More
and more, businesses, consumers and governments realize that their lives
are increasingly affected, not just by what goes on in their own town, state
or country, but by what is happening around the world. Consumers can buy
goods and services from all over the world in their local shops. Local
businesses must compete with these foreign products. However, these same
businesses also have new opportunities to expand their markets by selling
in a multitude of other countries. The advance of telecommunications is
rapidly reducing the cost of providing services internationally and the
internet will assuredly change the nature of many products and services as
it expands markets even further than today.

Markets have been going global, and everyone knows it.

One simple way to see this is to look at the growth of exports in the world
during the past 50+ years. The following figure shows overall annual
exports measured in billions of US dollars from 1948 to 2005. Recognizing
that one country's exports are another country's imports, one can see the
exponential growth in trade during the past 50 years.

However, rapid growth in the value of exports does not necessarily indicate
that trade is becoming more important. Instead, one needs to look at the
share of traded goods in relation to the size of the world economy. The
adjoining figure shows world exports as a percentage of world GDP for the
years 1970 to 2005. It shows a steady increase in trade as a share of the size
of the world economy. World exports grew from just over 10% of GDP in
1970 to almost 30% by 2005. Thus, trade is not only rising rapidly in
absolute terms, it is becoming relatively more important too.

One other indicator of world interconnectedness can be seen in changes in
the amount of foreign direct investment (FDI). FDI is foreign ownership of
productive activities and thus is another way in which foreign economic
influence can affect a country. The adjoining figure shows the stock, or the
sum total value, of FDI around the world taken as a percentage of world
GDP between 1980 and 2004. It gives an indication of the importance of
foreign ownership and influence around the world. As can be seen, the
share of FDI has grown dramatically from around 5% of world GDP in
1980 to over 20% of GDP just 25 years later.

The growth of international trade and investment has been stimulated
partly by the steady decline of trade barriers since the Great Depression of
the 1930s. In the post World War II era the General Agreement on Tariffs
and Trade, or GATT, was an agreement that prompted regular negotiations
among a growing body of members to reduce tariffs (import taxes) on
imported goods on a reciprocal basis. During each of these regular
negotiations, (eight of these rounds were completed between 1948 and
1994), countries promised to reduce their tariffs on imports in exchange for
concessions, or tariffs reductions, by other GATT members. When the
most recent completed round was finished in 1994, the member countries
succeeded in extending the agreement to include liberalization promises in
a much larger sphere of influence. Now countries would not only lower
tariffs on goods trade, but would begin to liberalize agriculture and services
market. They would eliminate the many quota systems - like the multi-fiber
agreement in clothing - that had sprouted up in previous decades. And they
would agree to adhere to certain minimum standards to protect intellectual
property rights such as patents, trademarks and copyrights. The WTO was
created to manage this system of new agreements, to provide a forum for
regular discussion of trade matters and to implement a well-defined process
for settling trade disputes that might arise among countries.

As of 2006, 149 countries were members of the WTO "trade liberalization
club" and many more countries were still negotiating entry. As the club
grows to include more members, and if the latest round of trade
liberalization discussion called the Doha round concludes with an
agreement, world markets will become increasingly open to trade and
investment. [Note: the Doha round of discussions was begun in 2001 and
remains uncompleted as of 2006]

Another international push for trade liberalization has come in the form of
regional free trade agreements. Over 200 regional trade agreements around
the world have been notified, or announced, to the WTO. Many countries

have negotiated these with neighboring countries or major trading partners,
to promote even faster trade liberalization. In part these have arisen
because of the slow, plodding pace of liberalization under the
GATT/WTO. In part it has occurred because countries have wished to
promote interdependence and connectedness with important economic or
strategic trade partners. In any case, the phenomenon serves to open
international markets even further than achieved in the WTO.

These changes in economic patterns and the trend towards ever increasing
openness are an important aspect of the more exhaustive phenomenon
known as globalization. Globalization more formally refers to the
economic, social, cultural or environmental changes that tend to
interconnect peoples around the world. Since the economic aspects of
globalization are certainly one of the most pervasive of these changes, it is
increasingly important to understand the implications of a global
marketplace on consumers, businesses and governments. That is where the
study of international economics begins.

International Trade Theory and Policy Lecture Notes: ©1997-2007 Steven M. Suranovic .
Last Updated on 12/24/06

What is International Economics?


Trade 5-2
International economics is a field of study which assesses the implications of
international trade in goods and services and international investment.

There are two broad sub-fields within international economics: international trade and
international finance.

International trade is a field in economics that applies microeconomic models to help
understand the international economy. Its content includes the same tools that are
introduced in microeconomics courses, including supply and demand analysis, firm and
consumer behavior, perfectly competitive, oligopolistic and monopolistic market
structures, and the effects of market distortions. The typical course describes economic
relationships between consumers, firms, factor owners, and the government.

The objective of an international trade course is to understand the effects on individuals
and businesses because of international trade itself, because of changes in trade policies
and due to changes in other economic conditions. The course will develop arguments
that support a free trade policy as well as arguments that support various types of
protectionist policies. By the end of the course, students should better understand the
centuries-old controversy between free trade and protectionism.

International finance applies macroeconomic models to help understand the
international economy. Its focus is on the interrelationships between aggregate economic
variables such as GDP, unemployment rates, inflation rates, trade balances, exchange
rates, interest rates, etc. This field expands macroeconomics to include international
exchanges. Its focus is on the significance of trade imbalances, the determinants of
exchange rates and the aggregate effects of government monetary and fiscal policies.
Among the most important issues addressed are the pros and cons of fixed versus
floating exchange rate systems. [Note: A separate collection of web materials on
international finance is available at The International Finance Webtext].

International Trade Theory and Policy Lecture Notes: ©1997-2006 Steven M. Suranovic Last Updated
on 7/17/04

Brief Outline


Trade 5-3
The course is divided into four distinct sections.
1. International Trade History and Current Issues

q The Terminology of International Trade

q Trade Policy Instruments

q Trade History

q Current Trade Issues

2. The Effects of International Trade

In this section a variety of models are developed which highlight the following five basic
reasons that trade occurs.

q differences in technology

q differences in resource endowments

q differences in consumer demand

q existence of economics of scale in production

q existence of government policies

The models address the effects that trade has on the prices of goods and services, the
profits of firms, the well-being of consumers, the wages of workers, and the return to
other factors of production.

3. The Effects of Trade Policies

These models address the effects that trade policies have on the prices of goods and
services, the profits of firms, the well-being of consumers, the wages of workers, the
return to other factors of production and the implications for the government budget.
This section is divided according to the following assumptions on market structure.

1. Perfect Competition
2. Market Imperfections and Distortions

4. Evaluating the Controversy: Free Trade or Protectionism?

This final section reviews the results of the course by applying them to the premier
controversy in international trade: whether to follow a policy of free trade or selected
protectionism. Using trade theory results, we develop the arguments that support a policy
of free trade and the arguments that support a policy of selected protectionism. We also
provide the counter-arguments or caveats that can be used against each of the arguments
supporting a particular position. In the end, the section does not reach a definitive
conclusion. It is left to the reader to decide which arguments carry the greatest validity.
However, the argument does "tilt" in the direction of free trade.

International Trade Theory and Policy Lecture Notes: ©1997-2006 Steven M. Suranovic. Last Updated
on 7/17/04

Some Trade Terminology


Trade 5-4
In trade policy discussions terms such as protectionism, free trade, and trade
liberalization are used repeatedly. It is worthwhile to define these terms at the beginning.
One other term is commonly used in the analysis of trade models, namely national
autarky, or just autarky.

Two extreme states or conditions could potentially be created by national government
policies. At one extreme, a government could pursue a "laissez faire" policy with respect
to trade and thus impose no regulation whatsoever that would impede (or encourage) the
free voluntary exchange of goods between nations. We define this condition as free
trade. At the other extreme, a government could impose such restrictive regulations on
trade as to eliminate all incentive for international trade. We define this condition in
which no international trade occurs as national autarky. Autarky represents a state of
isolationism. (See Figure).

Probably, a pure state of free trade or autarky has never existed in the real world. All
nations impose some form of trade policies. And probably no government has ever had
such complete control over economic activity as to eliminate cross-border trade entirely.
The real world, instead, consists of countries that fall somewhere between these two
extremes. Some countries, such as Singapore and (formerly) Hong Kong, are considered
to be highly free trade oriented. Others, like North Korea and Cuba, have long been
relatively closed economies and thus are closer to the state of autarky. The rest of the
world lies somewhere in between.

Most policy discussions are not about whether governments should pursue one of these
two extremes. Instead, discussions focus on which direction a country should move
along the trade spectrum. Since every country today is somewhere in the middle,
discussions focus on whether policies should move the nation in the direction of free
trade or in the direction of autarky.

A movement in the direction of autarky occurs whenever a new trade policy is
implemented if it further restricts the free flow of goods and services between countries.
Since new trade policies invariably benefit domestic industries by reducing international
competition, it is also referred to as protectionism.

A movement in the direction of free trade occurs when regulations on trade are removed.
Since the elimination of trade policies will generally increase the amount of international
trade, it is referred to as trade liberalization.

Trade policy discussions typically focus, then, on whether the country should increase
protectionism or whether it should pursue trade liberalization.

Note that, according to this definition of protectionism, even policies that encourage
trade, such as export subsidies, are considered protectionist since they alter the pattern
of trade that would have prevailed in the absence of government intervention. This
implies that protectionism is much more complex than can be represented along a single
dimension (as suggested in the above diagram) since protection can both increase and
decrease trade flows. Nevertheless, the representation of the trade spectrum is useful in a
number of ways.

on 6/12/06

Valuable Lessons of International Trade Theory


Trade 5-5
In this section some of the most important lessons in international trade theory are
briefly presented. Often, the lessons that are most interesting and valuable are those that
teach something either counterintuitive, or at least contrary to popular opinions. A
number of these are represented below. Each explanation also provides links to the pages
where the arguments are more fully explained. (Note: For most students, following the
links initially may be more confusing than helpful. However, once reading through many
of the chapters, review of these lessons may help reinforce them).

A. The main support for free trade arises because free trade can raise aggregate
economic efficiency.

B. Trade theory shows that some people will suffer losses in free trade.

C. A country may benefit from free trade even if it is less efficient than all other
countries in every industry.

D. A domestic firm may lose out in international competition even if it is the
lowest-cost producer in the world.

E. Protection may be beneficial for a country.

F. Although protection can be beneficial, the case for free trade remains strong.

on 6/13/06

Lesson 5A


Trade 5-5A
The main support for free trade arises because free trade can raise
aggregate economic efficiency.

In most models of trade there is an improvement in aggregate efficiency when an
economy moves from autarky to free trade. This is the same as an increase in national
welfare. Efficiency improvements can be decomposed into two separate effects:
production efficiency and consumption efficiency. An improvement in production
efficiency means that countries can produce more goods and services with the same
amount of resources. In other words, productivity rises for the given resource
endowments available for use in production. Consumption efficiency improvements
mean, in essence, that consumers will have a more satisfying collection of goods and
services from which to choose.

Many economists define the objective of the economics discipline as seeking to identify
the best way to use scarce resources to satisfy the needs and wants of the people of a
country. Economic efficiency is the term economists use to formally measure this
objective. Since free trade tends to promote economic efficiency is so many models, this
is one of the strongest arguments in support of free trade.

This result is formally demonstrated in the Ricardian model (see page 40-9b), the
Immobile Factor model (see page 70-15), the Specific Factor model, the Heckscher-
Ohlin model (see page 60-10), the Demand Difference model, the simple Economies of
Scale model, (see page 80-3) and the Monopolistic Competition model (see page 80-5e).
It can also be demonstrated when a small country reduces barriers to trade (Consider the
analysis on page 90-11 in reverse). Each of these models shows that a country can have a
larger national output (i.e. GDP) and superior choices available in consumption as a
result of free trade.

on 6/13/06

Lesson 5B


Trade 5-5B
Trade theory shows that some people will suffer losses in free trade.
A common misperception about international economics is that it teaches that everyone
will benefit from free trade. One often hears that voluntary exchange, whether between
individuals or between nations, must benefit both parties to the transaction, otherwise the
transaction would not occur. Although this argument is valid for exchange between two
people, the conclusion changes when one considers two countries made up of multiple
individuals. (See pages 30-3 through 30-5)

Economists themselves often espouse the position that free trade is beneficial to all,
albeit often with the caveat, "... at least in the long run". In the short run, factors of
production may be relatively immobile across industries (see pages 70-1 and 70-2). In
the presence of immobility, it can be shown that while export industries would gain from
free trade, import-competing industries would lose (see page 70-17). Thus, in the short
run, resource adjustment problems can explain losses to some groups.

In the long run, once all resources can move to alternative industries, some models (e.g.
Ricardian) suggest that everyone in the economy would benefit from free trade (See page
40-9a). Other models (e.g. Heckscher-Ohlin) however, suggest that some groups may
continue to lose even in the long run (See page 60-12).

Another complication is that not everyone will make it to the long run. As John Maynard
Keynes once remarked, "In the long run, we are all dead." If not dead, it is surely true
that some individuals will retire from the labor force before the long run arrives. These
individuals may be unfortunate enough to experience only the negative short-run losses
to an industry. Upon retirement, their short-term losses may carry over to long-run losses.

Economists will often dismiss concerns about potential losses from trade liberalization
by proposing that compensation be provided. The "compensation principle" suggests that
some of the gains could be taken away from the winners and given to the losers such that
everyone becomes better-off as a result of free trade. Although the principle is valid
conceptually, effective implementation of it seems unlikely (See discussion on
page 60-13).

on 6/13/06

Lesson 5C


Trade 5-5C
A country may benefit from free trade even if it is less efficient than all
other countries in every industry.

It makes sense that one firm would be more successful than another firm in a local
market if it could produce its output more efficiently - that is at lower cost - than the
second firm. If the two firms produce identical products, then the less efficient firm is
likely to be driven out of business, generating losses. If we extend this example to an
international market then it would also make sense that a more efficient foreign firm
would absorb business from a less efficient domestic firm. Finally, suppose all firms in
all industries domestically were less efficient than all firms in all industries in the foreign
countries. It would then seem logically impossible for any domestic firms to succeed in
competition in the international market with the foreign firms. International competition
would seemingly have only negative effects upon the less efficient domestic firms and
the domestic country.

This seemingly logical conclusion is refuted by the Ricardian model of comparative
advantage. Ricardo demonstrated the surprising result that less efficient firms in a
country can indeed compete with foreign firms in international markets. In addition, by
moving to free trade, the less efficient country can generate welfare improvements for
everybody in the country. Free trade can even benefit a country that is less efficient at
producing everything (See page 40-9).

What's more, in a free market system, differences in prices and profit-seeking behavior
are all that is needed to induce countries to produce and export the "right" goods and
trade to their national benefit. (see especially 40-8)

on 6/13/06

Lesson 5D


Trade 5-5D
A domestic firm may lose out in international competition even if it is
the lowest-cost producer in the world.

This result is a corollary of Lesson 3. As argued there, it seems reasonable to think that a
more efficient firm (i.e., one who produces at lower cost) would drive its less efficient
competitors out of business. The same would seem to follow if the two firms are
domestic and foreign and the two firms compete in international markets.

However, the Ricardian model of comparative advantage argues that a firm in one
country, even if it is the lowest-cost producer in the world, may be forced out of business
once the country liberalizes trade with the rest of the world. Even more surprising,
despite the decline of this industry, the move to free trade can generate welfare
improvements for everybody in the country. In other words, losing production in a
highly efficient industry can be consistent with an improvement in welfare for
everyone. This contradicts the logic above which would suggest that more efficient
(lower-cost) firms should always win (See page 40-9).

It is important to note that this result does not imply that every decline of an efficient
industry will improve welfare. Instead, the model merely suggests that one should not
jump to the conclusion that the loss of an efficient industry will have negative effects for
the country as a whole.

on 6/13/06

Lesson 5E


Trade 5-5E
Protection may be beneficial for a country.
Sometimes the support for free trade by economists seems so strong that one might think
there is very little evidence to suggest that protection could be beneficial. In actuality,
there are numerous examples in the trade literature which show that protection can be
beneficial for a country. The examples fall into two categories.

The first category contains trade policies which raise domestic national welfare, but
which reduce aggregate world welfare at the same time. These type of policies are
sometimes called "beggar-thy-neighbor" policies since benefits to one country can only
arise by forcing losses upon its trading partners. The most notable example is the terms
of trade argument for protection which is valid whenever a country is either a large
importer or a large exporter of a product in international markets (See page 90-9). A
second type of beggar-thy-neighbor policy is strategic trade policy. These policies
benefit the domestic country by shifting profit away from either foreign firms or foreign
consumers (See pages 100-5).

The second category of beneficial trade policies are those which not only raise domestic
welfare but raise world welfare as well. Some trade policies may act to correct prevailing
market imperfections or distortions. If the welfare improvement caused by correcting the
imperfection or distortion exceeds any additional distortion caused by the trade policy,
then world welfare may rise. Many well-known justifications for protection, including
the potential for unemployment (see page 100-3), infant industries (see page 100-4), the
presence of foreign monopolies, (see page 100-5) and concern for national security (see
page 100-7), arise because of the assumption of market imperfections or distortions.

on 6/13/06

Lesson 5F


Trade 5-5F
Although protection can be beneficial, the case for free trade remains
strong.

The argument in support of free trade is often different depending on whether the
speaker is in a political setting or an academic setting. In a political setting, political
realities will often force the speaker to emphasize all of the positive aspects of free trade
and to hardly even mention any negative aspects. The reason for this is that talking
of the negative effects of free trade will offer up ammunition to one's opponents who
may then use these statements against him in future debates.

Since most people will have learned the argument for free trade by listening to political
and public policy debates in the news media, they are likely to believe that economics
teaches that free trade is good for all people, in all countries, at all times. This belief may
lead people, especially those obviously hurt by freer trade policies, to doubt whether
economics has anything useful to say about the real world.

However, the academic argument for free trade, is much more sophisticated than the
typical political argument. As readers of this site will learn, free trade will cause harm to
some (see 5-5b), as well as good to others. Furthermore, certain selected protectionist
policies can be good for individuals, and for the nation (see 5-5e), but they will also
cause harm as well.

Thus, the choice between free trade and selected protection is not as simple as typically
presented by political advocates on one side or the other. In essence, one must choose
between the good and bad that comes with free trade, and the good and bad that comes
with selected protectionism. In weighing the alternatives, economists often conclude that
free trade is the more pragmatic choice, dominating, for a variety of reasons, selected
protectionist policies.

This more sophisticated argument for free trade is the topic of Chapter 120. The chapter
highlights both the positive and negative aspects of free trade policies and refers readers
back via hyperlinks to many sections in the main text to support each argument. Chapter
120 is useful to read at the beginning of your studies to see where the course is going. It
is even more important to read at the end, to see how everything covered in the text fits
into the argument supporting free trade. During this second reading, the hyperlinks will
become especially useful.

on 6/13/06

Trade Questions Jeopardy 5-1

DIRECTIONS: As in the popular TV game show, you are given an answer to a question and you
must respond with the question. For example, if the answer is "a tax on imports," then the
correct question is "What is a tariff?"

1. Of micro- or macro-economics, the one whose methods are mostly applied in an
international trade theory course.
2. Of micro- or macro-economics, the one whose methods are mostly applied in an
international finance theory course.
3. Term of French origin used to describe a total absence of government regulation.
4. Term used to describe a situation in which a country does not trade with any other
country.
5. The two types of economic efficiency.
6. Term given to the principle of redistribution between winners and losers.
7. Name of the economist who once remarked, "In the long run, we are all dead!"
8. Term used to describe policies which raise domestic welfare while reducing
welfare in the rest of the world.
9. Name given to a policy that shifts profits away from foreign firms towards the
domestic economy.
10. The premier controversy in international trade policy analysis.


by Steven M. Suranovic

Chapter 10
Trade Policy Tools


Chapter Overview LEVEL 1: Basic Definitional
10-0
LEVEL 2: Basic Intermediate
10-1 Import Tariffs LEVEL 3: Advanced Intermediate

10-1a US Tariffs - 2004
10-2 Import Quotas
LEVEL 1
10-3 Voluntary Export
Restraints (VERs) Jeopardy 10-1
10-3a US-Japan Automobile
VERs
10-3b Textile VERs Answer Keys
10-4 Export Taxes
10-5 Export Subsidies
Center
10-6 Voluntary Import
Expansions (VIEs) Answer keys to the problem sets are for sale
10-7 Other Trade Policy Tools in Adobe Acrobat PDF format for easier
viewing and printing. Purchases must be
made using a recent Internet Explorer
DOWNLOAD Chapter 10 in PDF format. browser. Revenues from these sales will
help us to expand and improve the content
at this site.

Related Links

r All About Textiles and Clothing and
the WTO
This page at the WTO website
r Tariff Rate Quota Administration provides a gateway to all sorts of
A briefing paper by the Economic information about textile and
Research Service at the US Dept. of clothing agreements.
Agriculture
r Agricultural Export Subsidies r South African Customs Tariffs
Overview Updated Weekly
Another briefing paper by the r Newly Independent States: Tariff
Economic Research Service at the Schedules
US Dept. of Agriculture This page provides links to tariffs
r Tariffication and Tariff Reduction schedules for many of the Newly
Another briefing paper by the Independent States.
Economic Research Service at the r APEC Country: Tariff Schedules
US Dept. of Agriculture This page provides links to tariffs
schedules for many of the APEC
countries. (You may need to register.
It is free).

property laws. The content is owned by Steven M. Suranovic. You MAY make a local copy
of the work, a printed copy of the work and you MAY redistribute up to 2 copies of the work

Suranovic, Steven, "International Trade Theory and Policy: Introductory Issues," The
International Economics Study Center, © 1997-2006, http://internationalecon.com/v1.0/ch10/
ch10.html.

Trade Policy Tools


Trade 10-0
Trade policies come in many varieties. Generally they consist of either taxes or
subsidies, quantitative restrictions or encouragements, on either imported or exported
goods, services and assets. In this section we describe many of the policies that countries
have implemented or have proposed implementing. For each policy we present examples
of their use in the US or in other countries. The purpose of this section is not to explain
the likely effects of each policy, but rather to define and describe the use of each policy.

q Import Tariffs
q Import Quotas
q Voluntary Export Restraints (VERs)
q Export Taxes
q Export Subsidies
q Voluntary Import Expansions (VIEs)
q Other Trade Policies

International Trade Theory and Policy Lecture Notes: ©1997-2006 Steven M. Suranovic

Import Tariffs


Trade 10-1
An import tariff is a tax collected on imported goods. Generally speaking, a tariff is any
tax or fee collected by a government. Sometimes tariff is used in a non-trade context, as
in railroad tariffs. However, the term is much more commonly applied to a tax on
imported goods.

There are two basic ways in which tariffs may be levied: specific tariffs and ad valorem
tariffs.

A specific tariff is levied as a fixed charge per unit of imports. For example, the US
government levies a 5.1 cent specific tariff on every wristwatch imported into the US.
Thus, if 1000 watches are imported, the US government collects $51 in tariff revenue. In
this case, $51 is collected whether the watch is a $40 Swatch or a $5000 Rolex.

An ad valorem tariff is levied as a fixed percentage of the value of the commodity
imported. "Ad valorem" is Latin for "on value" or "in proportion to the value." The US
currently levies a 2.5% ad valorem tariff on imported automobiles. Thus if $100,000
worth of autos are imported, the US government collects $2,500 in tariff revenue. In this
case, $2500 is collected whether two $50,000 BMWs are imported or ten $10,000
Hyundais.

Occasionally both a specific and an ad valorem tariff are levied on the same product
simultaneously. This is known as a two-part tariff. For example, wristwatches imported
into the US face the 5.1 cent specific tariff as well as a 6.25% ad valorem tariff on the
case and the strap and a 5.3% ad valorem tariff on the battery. Perhaps this should be
called a three-part tariff!

As the above examples suggest, different tariffs are generally applied to different
commodities. Governments rarely apply the same tariff to all goods and services
imported into the country. One exception to this occurred in 1971 when President Nixon,
in a last-ditch effort to save the Bretton Woods system of fixed exchange rates, imposed
a 10% ad valorem tariff on all imported goods from IMF member countries. But
incidents such as this are uncommon.

Thus, instead of one tariff rate, countries have a tariff schedule which specifies the tariff
collected on every particular good and service. The schedule of tariffs charged in all
import commodity categories is called the Harmonized Tariff Schedule of the United
States (HTS). The commodity classifications are based on the international Harmonized
Commodity Coding and Classification System (or the Harmonized System) established
by the World Customs Organization.


Selected US Tariffs - 2004


Trade 10-1a
The table below contains a selection of the US tariff rates specified in the 2004 US
Harmonized Tariff Schedule (HTS). The complete US HTS is available at the US
International Trade Commision website HERE. The US Treasury department provides
historical US tariff schedules dating back to 1997 HERE. To see a small sample of US
tariff rates from 1996, Click HERE.

The tariff schedule below displays three columns. The first column shows the product
classification number. The first two numbers refer to the chapter, the most general
product specification. For example, 08 refers to chapter 8, "Edible fruit and nuts; peel of
citrus fruit or melons." The product classification becomes more specific for each digit to
the right. Thus 0805 refers more specifically to "Citrus fruit, fresh or dried." 0805 40
refers to "Grapefruit," and 0805 40 40 refers to "Grapefruit entering between August 1
and September 30." This classification system is harmonized among about 200 countries
up to the first 6 digits and is overseen by the World Customs Organization.

The second column gives a brief description of the product. The third column displays
the "General Rate of Duty" for that particular product. This is the tariff that the US
applies to all countries with Most Favored Nation (MFN) status, or as it is now referred to
in the US, "Normal Trade Relations" (NTR). The status was renamed NTR to provide a
more accurate description of the term. One provision in our GATT/WTO agreements is
that the US promises to provide every WTO member country with MFN status. As a
matter of policy, the US also typically grants most non-WTO countries with the same
status. For example, Russia is currently (Sept 2004) not a member of the WTO, but the
US applies our NTR tariffs rates on imports from them.

The final column lists special rates of duty that apply to select countries under special
circumstances. For each product you will see a tariff rate followed by a list of symbols in
parentheses. The symbols indicate the trade act or free trade agreement that provides
special tariff treatment to those countries. A complete list of these is shown below.
Symbols that include a "+" or "*" generally refer to special exceptions that apply for
some countries with that product. The non-MFN tariff rate is also listed in this column.
The only countries now subject to the non-MFN tariffs are Cuba, Laos and North Korea.
(Note, Cuba is a WTO member, thus the US does not always honor its WTO obligations)
The last countries removed from the Non-MFN category were Serbia and Montenegro in
December 2003. Ten years ago, other countries in the non-MFN category included
Vietnam, Iran and Afghanistan. Finally, note that some countries, such as Cuba, have
other provisions, such as trade embargoes, that further restrict access of their products.

Special Tariff Classifications in the US

A, A*, A+ Generalized System of Preferences (GSP) (More info: page 11)

B Automotive Products Trade Act (More info: page 21)

CA, MX North American FTA (NAFTA)
Canada and Mexico (More info: page 31)

D African Growth and Opportunity Act (More info: page 170)

E Carribean Basin Economic Recovery Act (More info: page 23)

IL US-Israel FTA (More info: page 26)

J, J*, J+ Andean Trade Preference Act (More info: page 29)

R US-Carribean Trade Partnership Act (More info: page 171)

JO US-Jordan FTA (More info: page 172)

SG US-Singapore FTA (More info: page 176)

CL US-Chile FTA (More info: page 267)

The products presented below were selected to demonstrate several noteworthy features
of US trade policy. The WTO reports in the 2004 US Trade Policy Review that most
goods enter the US either duty free or with very low tariffs. Coffee and FAX machines
are two goods, shown below, representative of the many goods that enter duty free. The
average MFN tariff in the US in 2002 was about 5% although for agricultural goods the
rate was almost twice as high. About 7% of US tariffs exceed 15%, these mostly on
sensitive products such as peanuts, dairy, footwear, textiles and clothing. The trade-
weighted average tariff in the US was only about 1.5% in 2003.

One interesting feature of the tariff schedule is the degree of specificity of the products in
the HTS schedule. Besides product type, categories are divided according to weight, size
or the time of year. Note especially the description of ceramic tableware and bicycles.

Tariffs vary according to time of entry, as with cauliflower, grapefruit and grapes. This
reflects the harvest season for those product in the US. When the tariff is low, that
product is out of season in the US. Higher tariffs are in place when US output in the
product rises.

Notice the tariffs on cauliflower and broccoli. They are lower if the vegetables are
unprocessed. If the product is cut or sliced before arriving in the US, the tariff rises to
14%. This reflects a case of tariff escalation. Tariff escalation means charging a higher
tariff the greater the degree of processing for a product. This is a common practice
among many developed countries and serves to protect domestic processing industries.
Developing countries complain that these practices impede their development by
preventing them from competing in more advanced industries. Consequently, tariff
escalation is a common topic of discussion during trade liberalization talks.

Tariffs rates also vary with different components of the same product, as with watches.
Note also that watches have both specific tariffs and ad valorem tariffs applied.

Notice that tariffs on cars in the US is 2.5%, but the tariff on truck imports is 10 times
that rate at 25%. The truck tariff dates back to 1963 and is sometimes referred to as the
"chicken tax." It was implemented, primarily to affect Volkswagon, in retaliation for
West Germany's high tariff on chicken imports from the US. Today, Canada and Mexico
are exempt from the tariff due to NAFTA and Australia will also be exempt with the new
US-Australia FTA. The truck tax is set to be a contentious issue in current US-Thailand
FTA discussions.

The tariff rates themselves are typically set to several significant digits. One has to
wonder why the US charges 4.4% on golf clubs rather than an even 4 or 5%. Much
worse is the tariff rate on cane sugar with six significant digits.

The special tariff rates are often labeled "Free," meaning thise goods enter duty-free from
that group of countries. Note that Chile and Singapore sometimes have tariff rates in
between the MFN rate and zero. This reflects the phase in process of the free trade area.
Most FTAs include a 5-15 year phase in period during which time tariffs are reduced
annually towards zero.

Selected Tariffs in the US 2004

HTS Code Description MFN/NTR Special Tariff
Tariff

0704.10.20 Cauliflower, Broccoli 2.5% (June 5- Free (A,CA,
Oct 25) CL,E, IL,J,JO,
MX,SG)
0704.10.40 10% (Other,
not reduced in Free (A,CA,
size) CL,E, IL,J,JO,
MX)
0704.10.60 7.5% (SG)
14% (Cut or
sliced) Free (A,CA,
CL,E, IL,J,JO,
MX)
12.2% (SG)

Non-MFN:
50%

0805.40.40 Grapefruit 1.9¢/kg (Aug- Free (CA,D,E,
Sep) IL, J,JO,MX,
SG)
1.6¢/kg (CL)
0805.40.60 1.5¢/kg (Oct)
Free (CA,D,E,
IL, J,JO,MX,
SG)
0805.40.80 2.5¢/kg (Nov- 1.1¢/kg (CL)
Jul)
Free (CA,D,E,
IL, J,JO,MX)
2.2¢/kg (CL,
SG)

Non-MFN:
3.3¢/kg

0806.10.20 Grapes, fresh $1.13/m3 (Feb Free (A+,CA,
15-Mar 31) CL,D,E, IL,J,
0806.10.40 JO,MX,SG)
Free (Apr 1-
0806.10.60 Jun 30) Non-MFN:
$8.83/m3
$1.80/m3 (any
other time)

6912.00.45 Ceramic tableware; plates not 4.5% Free (A+,CA,
over 22.9 cm in maximum CL,D,E, J,JO,
diameter and valued over $6 MX,SG)
per dozen; plates over 22.9 but
not over 27.9 cm in maximum
diameter and valued over $8.50
per dozen Non-MFN:
55%

7116.10.25 Cultured Pearls 5.5% Free (A,CA,
CL,L,J, JO,
MX)

4.1% (SG)

Non-MFN:
110%

8703.2x.00 Motor cars, principally 2.5% Free (A+,B,
designed for the transport of CA,CL,D, E,
persons, of all cylinder IL,J,JO,MX,
capacities SG)

Non-MFN:
10%

8704.22.50 Motor vehicles for the 25% Free (A+,B,
transport of goods (i.e., trucks), CA,CL,D, E,
gross vehicle weight exceeding IL,J,MX)
5 metric tons but less than 20
metric tons 15% (JO)

22.5% (SG)

Non-MFN:
25%

8712.00.15 Bicycles having both wheels 11% Free (A+,CA,
not exceeding 63.5 cm in CL,D,E, IL,J,
diameter MX)

2.2% (JO)

9.6% (SG)

Non-MFN:
30%

1701.11.05 Cane sugar: 1.4606¢/kg Free (A*,CA,
less .020668¢/ CL,E*,IL, J,JO,
kg for each MX,SG)
degree under
100 degrees Non-MFN:
but not less 4.3817¢/kg
than .943854¢/ less .0622005¢/
kg kg for each
degree under
100 degrees
but not less
than
2.831562¢/kg

6404.11.20 Sports footwear; tennis shoes, 10.5% Free (CA,CL,
basket-ball shoes, gym shoes, D,IL,J+, MX,
training shoes and the like: R)
Having uppers of which over
50% of the external surface 2.1% (JO)
area is leather.
9.1% (SG)

Non-MFN:
35%

9506.31.00 Golf clubs 4.4% Free (A,CA,
CL,E,IL, J,JO,
MX,SG)

Non-MFN:
30%

9101.11.40 Wristwatches 51¢ each + 38.2¢ each +
6.25% on case 4.6% on case
and strap + and strap +
5.3% on 3.9% on
battery battery (CL,
SG)

Free (CA,D,E,
IL,J, J+,JO,
MX,R

8517.21.00 Fax machines Free Non-MFN:
35%

0901.21.00 Coffee, non-decaffeinated Free Non-MFN:
Free

0902.10.10 Tea, green tea, flavored 6.4% Free (A,CA,
CL,E,IL, J,JO,
MX)

4.8% (SG)

Non-MFN:
20%

One thing to think about while reviewing this tariff schedule is the administrative cost of
monitoring and taxing imported goods. Not only does the customs service incur costs to

properly categorize and measure goods entering the country, but foreign firms
themselves must be attuned to the intricacies of the tariff schedule of all of the countries
to which it exports. All of this requires the attention and time of employees of the firms
and represents a cost of doing business. These administrative costs are rarely included in
the evaluation of trade policies.

An administratively cheaper alternative would be to charge a fixed ad valorem tariff on
all goods that enter, much like a local sales tax. However, it would be almost impossible
for political reasons to switch to this much simpler alternative.

International Trade Theory and Policy Lecture Notes: ©1997-2006 Steven M. Suranovic, Last Updated
on 6/13/06

Import Quotas


Trade 10-2
Import quotas are limitations on the quantity of goods that can be imported into the
country during a specified period of time. An import quota is typically set below the free
trade level of imports. In this case it is called a binding quota. If a quota is set at or above
the free trade level of imports then it is referred to as a non-binding quota. Goods that are
illegal within a country effectively have a quota set equal to zero. Thus many countries
have a zero quota on narcotics and other illicit drugs.

There are two basic types of quotas: absolute quotas and tariff-rate quotas. Absolute
quotas limit the quantity of imports to a specified level during a specified period of time.
Sometimes these quotas are set globally and thus affect all imports while sometimes they
are set only against specified countries. Absolute quotas are generally administered on a
first-come first-served basis. For this reason, many quotas are filled shortly after the
opening of the quota period. Tariff-rate quotas allow a specified quantity of goods to be
imported at a reduced tariff rate during the specified quota period.

In the US in 1996, milk, cream, brooms, ethyl alcohol, anchovies, tuna, olives and durum
wheat were subject to tariff-rate quotas. Other quotas exist on peanuts, cotton, sugar and
syrup.

In the US most quotas are administered the US Customs Service. The exceptions include
dairy products, administered by the Department of Agriculture, and watches and watch
movements, administered by the Departments of the Interior and the Commerce
Department.


Voluntary Export Restraints (VERs)


Trade 10-3
A voluntary export restraint is a restriction set by a government on the quantity of
goods that can be exported out of a country during a specified period of time. Often the
word voluntary is placed in quotes because these restraints are typically implemented
upon the insistence of the importing nations.

Typically VERs arise when the import-competing industries seek protection from a surge
of imports from particular exporting countries. VERs are then offered by the exporter to
appease the importing country and to avoid the effects of possible trade restraints on the
part of the importer. Thus VERs are rarely completely voluntary.

Also, VERs are typically implemented on a bilateral basis, that is, on exports from one
exporter to one importing country. VERs have been used since the 1930s at least, and
have been applied to products ranging from textiles and footwear to steel, machine tools
and automobiles. They became a popular form of protection during the 1980s, perhaps in
part because they did not violate countries' agreements under the GATT. As a result of
the Uruguay round of the GATT, completed in 1994, WTO members agreed not to
implement any new VERs and to phase out any existing VERs over a four year period.
Exceptions can be granted for one sector in each importing country.

Some interesting examples of VERs occured with auto exports from Japan in the early
1980s and with textile exports in the 1950s and 60s.

q US-Japan Automobile VERs
q Textile VERs


US-Japan Automobile VERs


Trade 10-3a
In 1981, the US was suffering the effects of the second OPEC oil price shock. Faced
with higher gasoline prices, consumers began to shift their demand from low fuel
efficiency US autos to higher fuel efficiency Japanese autos. This increase in auto
imports contributed to lower sales and profits of US automakers. Chrysler Corporation
nearly went bankrupt in 1981, and probably would have, if the US government had not bailed
it out with subsidized loans. The US auto industry filed an escape clause petition with
the International Trade Commision, but the ITC failed to find material injury as a result
of the Japanese imports. The US was suffering from a recession at that time which also
contributed to the decline in demand for US autos. The Japanese, faced with continuing
calls by the US auto industry for legislated protection and following discussions with the
US trade representative's office, eventually announced VERs on auto exports. These
VERs were renewed regularly and lasted until the early 1990s.

The bilateral nature of VERs contributes to a series of subsequent effects. Since a VER
can raise the price of the product in the importing country, there is an incentive created to
circumvent the restriction. In the case of the Japanese auto VERs, the circumvention took
a variety of forms. Since the quantity of auto trade between Japan and the US was
limited but the value of trade was not, Japanese automakers began upgrading the quality
of their exports to raise their profitability. By the late 1980s, new higher-quality auto
lines such as Acura, Infiniti, and Lexus made their debut. Alternatively, Japanese autos
assembled in the US were not counted as part of the export restriction - only complete
autos exported from Japan were restricted. Thus, after the VERs were implemented,
Honda, Mazda, Toyota, Mitsubishi, and Nissan all opened assembly plants in the US. A
quicker circumvention was accomplished by shipping knockdown sets (unassembled
autos) to Taiwan and South Korea, where they were assembled and exported to the US
market.


Textile VERs


Trade 10-3b
Another interesting effect of VERs occurred in the textile industry beginning in the
1950s. In the mid 50s, US cotton textile producers faced increases in Japanese exports of
cotton textiles which negatively affected their profitability. The US government
subsequently negotiated a VER on cotton textiles with Japan. Afterwards, textiles began
to flood the US market from other sources like Taiwan and South Korea. The US
government responded by negotiating VERs on cotton textiles with those countries. By
the early 1960s, other textile producers in the US, who were producing clothing using the
new synthetic fibers like polyester, began to experience the same problem with Japanese
exports that cotton producers faced a few years earlier. So VERs were negotiated on
exports of synthetic fibers from Japan to the US. During this period European textile
producers were facing the same pressures as US producers and the EEC negotiated
similar VERs on exports from many southeast Asian nations into the EEC.

This process continued until its complexity led to a multilateral negotiation between the
exporters and importers of textile products around the world. These negotiations resulted
in the Multi-Fiber Agreement (MFA) in the early 1970s. The MFA specified quotas on
exports from all major exporting countries to all major importing countries. Essentially it
represented a complex arrangement of multilateral VERs. The MFA provided an assured
upper limit (ceiling) to the extent of competition that import-competing firms could
expect in the US and the EEC. This type of arrangement has sometimes been called an
orderly market arrangement. It is also a reasonable example of what has been referred to
as managed trade.

The MFA was renewed periodically throughout the 70s, 80s and 90s. However, the
Uruguay round of the GATT, completed in 1994, renamed the MFA to the Agreement on
Textiles and Clothing (ATC) and specified a ten year transition period during which the
ATC will be eliminated.


Export Taxes


Trade 10-4
An export tax is a tax collected on exported goods. As with tariffs, export taxes can be
set on a specific or an ad valorem basis. In the US, export taxes are unconstitutional
since the US constitution contains a clause prohibiting their use. This was imposed due
to the concerns of Southern cotton producers who exported much of their product to
England and France.

However, many other countries employ export taxes. For example, Indonesia applies
taxes on palm oil exports; Madagascar applies them on vanilla, coffee, pepper and
cloves; Russia uses export taxes on petroleum, while Brazil imposed a 40% export tax on
sugar in 1996. In December 1995 the EU imposed a $32 per ton export tax on wheat.


Export Subsidies


Trade 10-5
Export subsidies are payments made by the government to encourage the export of
specified products. As with taxes, subsidies can be levied on a specific or ad valorem
basis. The most common product groups where export subsidies are applied are
agricultural and dairy products.

Most countries have income support programs for their nation's farmers. These are often
motivated by national security or self-sufficiency considerations. Farmers' incomes are
maintained by restricting domestic supply, raising domestic demand, or a combination of
the two. One common method is the imposition of price floors on specified commodities.
When there is excess supply at the floor price, however, the government must stand
ready to purchase the excess. These purchases are often stored for future distribution
when there is a shortfall of supply at the floor price. Sometimes the amount the
government must purchase exceeds the available storage capacity. In this case, the
government must either build more storage facilities, at some cost, or devise an
alternative method to dispose of the surplus inventory. It is in these situations, or to avoid
these situations, that export subsidies are sometimes used. By encouraging exports, the
government will reduce the domestic supply and eliminate the need for the government
to purchase the excess.

One of the main export subsidy programs in the US is called the Export Enhancement
Program (EEP). Its stated purpose is to help US farmers compete with farm products
from other subsidizing countries, especially the European Union, in targeted countries.
The EEP's major objectives are to challenge unfair trade practices, to expand U.S.
agricultural exports, and to encourage other countries exporting agricultural commodities
to undertake serious negotiations on agricultural trade problems. As a result of Uruguay
round commitments, the US has established annual export subsidy quantity ceilings by
commodity and maximum budgetary expenditures. Commodities eligible under EEP
initiatives are wheat, wheat flour, semolina, rice, frozen poultry, frozen pork, barley,
barley malt, table eggs, and vegetable oil.

In recent years the US government has made annual outlays of over $1 billion in its
agricultural Export Enhancement Program (EEP) and its Dairy Export Incentive Program
(DEIP). The EU has spent over $4 billion annually to encourage exports of its
agricultural and dairy products.


Voluntary Import Expansions (VIEs)


Trade 10-6
A Voluntary Import Expansion (VIE) is an agreement to increase the quantity of
imports of a product over a specified period of time. In the late 1980s, VIEs were
suggested by the US as a way of expanding US exports into Japanese markets. Under the
assumption that Japan maintained barriers to trade that restricted the entry of US exports,
Japan was asked to increase its volume of imports on specified products including
semiconductors, automobiles, auto parts, medical equipment and flat glass. The intention
was that VIEs would force a pattern of trade that more closely replicated the free trade
level.


Other Trade Policy Tools


Trade 10-7
Government Procurement Policies
A Government Procurement Policy requires that a specified percentage of purchases by
the federal or state governments be made from domestic firms rather than foreign firms.

Health and Safety Standards
The U.S. generally has more regulations than other countries governing the use of some
goods, such as pharmaceuticals. These regulations can have an effect upon trade patterns
even though the policies are not designed based on their effects on trade.

Red-Tape Barriers
Red-tape barriers refers to costly administrative procedures required for the importation
of foreign goods. Red-tape barriers can take many forms. France once required that
videocassete recorders enter the country through one small port facility in the south of
France. Because the port capacity was limited, it effectively restricted the number of
VCRs that could enter the country. A red-tape barrier may arise if multiple licences must
be obtained from a variety of government sources before importation of a product is
allowed.


Trade Questions Jeopardy 10-1

DIRECTIONS: As in the popular TV game show, you are given an answer to a question and you
must respond with the question. For example, if the answer is "a tax on imports," then the
correct question is "What is a tariff?"

1. An arrangement in which a country agrees to limit the quantity of a good it
exports to another country.
2. A payment made by a government to encourage exports.
3. The schedule of tariffs charged in all import commodity categories in the US.
4. A tax levied as a dollar charge per unit of imports.
5. A government policy which favors domestic firms over foreign firms with respect
to government purchases.
6. Costly or annoying administrative procedures which make it difficult to import
goods into a country.
7. The international organization that maintains the Harmonized Commodity Coding
and Classification System for imported goods.
8. A type of quota that allows a specified quantity of a good to be imported at a
reduced tariff rate during a specified period.
9. The new name for the multi-fiber agreement.
10. A tax levied as a percentage of the value of an imported good.


by Steven M. Suranovic, The George Washington University

Chapter 20
Trade History and Trade Law


FROM THE WTO WEBSITE LEVEL 1: Basic Definitional
What is the WTO? LEVEL 2: Basic Intermediate
20-0
LEVEL 3: Advanced
The WTO in Brief Intermediate

Understanding the
WTO
LEVEL 1

20-1 Measuring Protectionism: Average Jeopardy 20-1
Tariff Rates Around the World Internet Qs 20-1A
20-2 US Trade Policy Highlights Internet Qs 20-1B
20-2a Customs Duties in Government Internet Qs 20-1C
Revenue: Britain, France and Internet Qs 20-1D
Brazil Problem Set 20 1-1
20-3 US Tariff Policy: Historical Notes Problem Set 20 1-2

20-4 US Trade Law Highlights

Answer Keys
DOWNLOAD Chapter 20 in PDF format.
Center

Answer keys to the problem sets are for
sale in Adobe Acrobat PDF format for
easier viewing and printing. Purchases
must be made using a recent Internet
Explorer browser. Revenues from these
sales will help us to expand and improve
the content at this site.

Related Links
r WTO Trade Policy Reviews r International Trade Law: An
Trade Policy Reviews are conducted Overview
periodically by the WTO for every from the Legal Information Institute
member country. The secretariat at Cornell University.
report provides a comprehensive
summary of each country's trade r About the US Trade Representative
policies.
r The WTO Agreements
r About Import Administration at the
A description of some of the details
US International Trade Admin.
behind WTO rules on antidumping
measures, subsidies and
countervailing measures and r About the US International Trade
safeguards. Commission

property laws. The content is owned by Steven M. Suranovic. You MAY make a local copy of
the work, a printed copy of the work and you MAY redistribute up to 2 copies of the work

Suranovic, Steven, "International Trade Theory and Policy: Trade History and Trade Law,"
The International Economics Study Center, © 1997-2006, http://internationalecon.com/v1.0/
ch20/ch20.html.

Measuring Protectionism:
Average Tariff Rates Around the World


Trade 20-1 One method used to measure the degree of protectionism within an economy is the
average tariff rate. Since tariffs generally reduce imports of foreign products, the higher
the tariff, the greater the protection afforded to the country's import-competing
industries. At one time, tariffs were perhaps the most commonly applied trade policy.
Many countries used tariffs as a primary source of funds for their government budgets.
However, as trade liberalization advanced in the second half of the twentieth century,
many other types of non-tariff barriers became more prominent.

The table below provides a list of average tariff rates in selected countries around the
world. These rates were all taken from the WTO's trade policy review summaries. More
details about the trade policies of these countries can be found at the WTO's website at:
http://www.wto.org/wto/reviews/tp.htm.

Generally speaking, average tariff rates are less than 20% in most countries, although
they are often quite a bit higher for agricultural commodities. In the most developed
countries, average tariffs are less than 10%, and often less than 5%. On average, less
developed countries maintain higher tariff barriers, but, for many countries that have
recently joined the WTO, tariffs have recently been reduced substantially to gain entry.

Average Tariff Rates

Japan (1997) 9.4%

European Union (1997)
4.9%
Industrial Goods
20.8%
Agriculture

Norway (1996) 5.6%

Canada (1996)
6.6%
Overall
1.0%
with US

Brazil (1996) 12.5%

Mexico (1997)

13.2%
Overall
4.2%
With US

Chile (1997) 11.0%

El Salvador (1995) 10.1%

Cyprus (1996)
16.4%
Overall
7.2%
with EU
37.6%
Agriculture

Morocco (1995) 23.5%

Benin (1997) 13.0%

Zambia (1996) 13.6%

Malaysia (1997) 8.1%

Thailand (1994) 30.0%

Problems Using Average Tariffs as a Measure of Protection

The first problem with using average tariffs as a measure of protection in a country is
that there are several different ways to calculate an average tariff rate and each method
can give a very different impression about the level of protection.

Most of the tariffs above are calculated as a simple average. To calculate this rate, one
simply adds up all of the tariff rates and divides by the number of import categories. One
problem with this method arises if a country has most of its trade in a few categories with
zero tariffs, but has high tariffs in many import categories in which it would never find
advantageous to import. In this case the average tariff may overstate the degree of
protection in the economy.

This problem can be avoided, to a certain extent, if one calculates the trade-weighted
average tariff. This measure weights each tariff by the share of total imports in that
import category. Thus, if a country has most of its imports in a category with very low
tariffs, but has many import categories with high tariffs but virtually no imports, then the
trade-weighted average tariff would indicate a low level of protection. The standard way
of calculating this tariff rate is to divide total tariff revenue by the total value of imports.
Since this data is regularly reported by many countries this is a common way to report
average tariffs.

However, the trade-weighted average tariff is not without flaws. As an example, suppose
a country has relatively little trade because it has prohibitive tariffs (i.e. tariffs set so high

as to eliminate imports) in many import categories. If it has some trade in a few import
categories with relatively low tariffs, then the trade-weighted average tariff would be
relatively low. After all, there would be no tariff revenue in the categories with
prohibitive tariffs. In this case, a low average tariff could be reported for a highly
protectionist country. Note also that, in this case, the simple average tariff would register
a higher average tariff and might be a better indicator of the level of protection in the
economy.

Of course the best way to overstate the degree of protection is to use the average tariff
rate on dutiable imports. This alternative measure, which is sometimes reported, only
considers categories in which a tariff is actually levied and ignores all categories in
which the tariff is set to zero. Since many countries today have many categories of goods
with zero tariffs applied, this measure would give a higher estimate of average tariffs
than most of the other measures.(1)

The second major problem with using average tariff rates to measure the degree of
protection is that tariffs are not the only trade policy used by countries. Countries also
implement quotas, import licenses, voluntary export restraints, export taxes, export
subsidies, government procurement policies, domestic content rules, and much more. In
addition, there are a variety of domestic regulations which, for large economies at least,
can and do have an impact on trade flows. None of these regulations, restrictions or
impediments to trade, affecting both imports and exports, would be captured using any of
the average tariff measures. Nevertheless these non-tariff barriers can have a much
greater effect upon trade flows than tariffs themselves.

The Ideal Measure of Protectionism

Ideally, what we would like to measure is the degree to which a government's policies
(both domestic and trade policies) affect the flow of goods and services (on both the
import and export side) between itself and the rest of the world. Thus, we might imagine
an index of protectionism (IP) defined as follows:

Where the numerator represents the sum of all exports and imports across all N trade
categories given the current set of trade policies, and the denominator represents the
sum of all exports and imports that would obtain if the government employed a set of
domestic policies that had no impact on trade of goods and services with the rest of the
world. If IP = 1, it would indicate that current government policies are completely non-
restrictive and the economy could be characterized as being in a pure state of "free
trade." If IP = 0, then government policies would be so restrictive as to force the
economy into a state of isolation or autarky.

If we could calculate and compare the index across many countries, then we could say
that countries with a smaller value were more protectionist than countries with a higher

value. We could also monitor changes in the index over time for a particular country.
Increases in the index value would indicate trade liberalization, while decreases in the
index would indicate growing protectionism.

The problem with this index, however, is that although it is easy to define, it would be
virtually impossible to measure. At least, I know of no way of doing so without making
extreme leaps of faith. Nevertheless, the index definition is useful as a way of indicating
how far from ideal are any traditional measures of protection such as average tariff rates.

Endnotes:

1. It is often claimed that average tariffs in the US were raised to almost 60% by the
Smoot-Hawley tariff act of 1930. This figure, although correct, represents the average
tariff on dutiable imports only. Thus, the figure somewhat overstates the true degree of
protection. In comparison, the trade-weighted average tariff in subsequent years rose
only as high as 24.8% in 1932, after which tariff rates fell.


US Trade Policy Highlights


Trade 20-2 Article 1, section 8 of the US Constitution states clearly and succinctly: " the Congress
shall have the power ... to regulate commerce with foreign nations ..." This means that
decisions about trade policy must be made by the US Senate and House of
Representatives, and not by the US President.

This clause is rather interesting today because one of the key agencies involved in US
trade negotiations is the US Trade Representative's office. This office administers the
Section 301 trade cases, has negotiated free trade agreements such as NAFTA, and has
negotiated trade liberalization agreements such as the Uruguay round under the GATT.
All this from an Executive branch agency which acts as an agent for the President. It
would seem, then, that the President does indeed make trade policy. Is this a violation of
the constitution? Actually no.

The only reason an Executive branch agency, like USTR, can make trade policy is
because the US Congress has granted this agency the authority to do so. This issue was
in the news recently when the Clinton administration attempted, unsuccessfully (as of
Feb 1998), to acquire fast track negotiating authority for new free trade agreements with
other countries. Fast track authority would not only give the President and his agents
negotiating powers; it would also require the US Congress to vote on any trade
agreement presented by the President without amendment. This means that Congress
must vote "yea" or "nay" to the entire agreement and cannot make changes to it before
the vote. The purpose of fast track authority is to give more credibility to the President
and his agents in negotiations with other countries, and hence raise the likelihood that an
agreement can be reached.

Probably one reason that the framers of the US Constitution reserved trade policy
formation for the US Congress was because at the time of US independence and for well
over a century after that, tariff revenue was the primary source of funds for the federal
government. It must have been thought unwise for the purse strings of the government to
be controlled by the President.

The adjoining diagram shows US customs duties as a percentage of federal government
revenue from 1821 to 1996. Notice that in the early 1800s tariff revenue comprised more
than 90% of the federal government budget. This fell during and after the US Civil War
in 1860 as alternative sources of funds became necessary to finance the war. Another
major decline occurred in the early part of the 1900s shortly after the Constitution was
amended to allow the collection of personal income taxes. In the 1990s, more than 70%
of federal government revenue came from payroll taxes which consists of both personal
income taxes and social security taxes. In contrast, less than 1.5% of revenue came from
customs duties. Of course, due to the size of the US federal budget, that still amounts to
over $18 billion in tariff revenue.

Comparisons with Other Countries

Often it is informative to compare one country's experience with others during the same
period. Click on the country below to see graphs showing customs duties as a percentage
of government revenue in Britain (1821 - 1964), France (1847 - 1988), and Brazil (1937
- 1985).


Customs Duties in Government Revenue: Britain, France
and Brazil


Trade 20-2a These graphs depict customs duties as a percentage of federal government revenue in
Britain (1821 - 1964), France (1847 - 1988), and Brazil (1937 - 1985). Note that both
Britain and France collected a much smaller percentage of government revenue from
customs duties in the 1800s compared with the US. In France it was significantly lower
and not much different from what prevails in there today. The pattern is Brazil is very
similar to the path followed by the US after 1940.

Intl trade suranovic-2006

Recommended

Recommended

More Related Content

Similar to Intl trade suranovic-2006

Similar to Intl trade suranovic-2006 (20)

More from Thorat Pravin

More from Thorat Pravin (16)

Intl trade suranovic-2006