Tariff Policy
Marissa Maricosa A. Paderon
Assistant Professor, Economics Dept.
Ateneo de Manila University
1
Common features of tariff policy
Preferential duty – applied to an import good
according to its geographical source; a
country that is given preferential treatment
pays a lower tariff.
A preferential duty is geographically
discriminatory in nature
Most-favoured-nation (MFN) - non-
discriminatory. Import tariff applies to all its
trading partners.
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Common features of tariff policy
Offshore assembly provisions (OAP) – tariff in
practice is lower than that listed in tariff schedule.
e.g. US imports cordless telephone set from Taiwan at
$80/set, t=15%. Pay import tax of $12.
Assume price to US consumer = $92; US components
made by Taiwan = $52.
Under the OAP, applied value of final product = ($80 -
$52)= $28 x 15%= $4.20 import tax. For US consumer:
$80 + $4.20= $84.20 which is 5.25% (4.20/80) instead of
15%
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Measurement of Tariff
One issue concerns the height of a country’s
average tariff (how much price interference
exists in a country’s tariff schedule.
2 Measurements:
Unweighted average tariff – average of nominal
rates.
e.g. 3 imported goods A,B,C with tariffs = 10%, 15%,
20%, respectively
tUA= (10 + 15 +20)/3 = 15%
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Measurement of Tariff
Note: unweighted average tariff does not take into
account the relative importance of imports. For example,
country A imports mostly good A, then tUA tend to
overstate height of the country’s average tariff.
Weighted Average Tariff – each good’s tariff rate is
weighted by the importance of the good in the total
bundle of imports.
Example: Given: good A: $500,000 tariff = 10%; good B:
$200,000, tariff = 15%; good C:$100,000, tariff = 20%
tWA= [(10% x 500,000) + (15% x 200,000) + (20% x
100,00)]/(500,000+200,000+100,000) = 12.5%
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Measurement of Tariff
Weighted average tariff is biased downward.
Assume similar demand elasticities across all goods,
purchases of goods with high tariffs tend to decline
because of tariff imposition while those with low
tariffs decline lesser.
Prohibitive tariff- import tariff that is so high that
keeps imports from coming into the country.
To avoid bias of weighted average rate, use weights of
goods in world trade, not the country’s trade.
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Nominal vs effective rate of protection
Nominal rate – the rate listed in a country’s
tariff schedule, whether it is an ad valorem tariff
or a specific duty.
Effective rate of protection (ERP) –measures
protection enjoyed by firms or industries. It is
the percentage excess of domestic value added
at protected prices over value added at free
trade prices.
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Measuring protection & efficiency
Nominal rate of protection (NRP) – measures
the amount by which the price of a good is
raised by government policies. It is the excess
of actual domestic price of the good over its
free trade price, expressed as the percentage
of the free trade price.
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Measuring protection & efficiency
If the good is non-traded, its free trade price
is the price that would prevail in the
absence of government intervention.
If the good is traded, its free trade price is
the domestic currency value of its world
price if the country is small in the world
market.
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Measuring protection & efficiency
Without NTBs, the NRPs are the tariff rates for
imported goods and the subsidy rates for exported
goods.
When there are NTBs, the NRPs are calculated by
comparing the difference between domestic &
foreign prices (with transportation costs).
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Measuring protection & efficiency
EPR = value added under protection – value added with free trade
value added with free trade
Assume that the country is a small country (which can’t influence
the world prices) and given the data below:
Price Tariff Tariff protected prices
Final good P1,000 10% PF 1,000 + 0.10 (1,000) = P1,100
Inputs: A 500 5% PA 500 + 0.05(500) = 500 + 25 = 525
B 200 8% PB 200 + 0.08(200) = 200 + 16 = 216
VA (protected prices) = 1,000 + 0.10(1,000) = 1,000 + 100= 1,100
– (525 + 216) = 1,100 – 714 = 359
VA (free trade prices) = 1,000 – (500 + 200) = 1,000 – 700 = 300
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Measuring protection & efficiency
ERP = 359 – 300 = 19.6%
300
means that the effective rate of protection given to the
firm resulting from the protection structure is 19.6%.
What about the efficiency of the firm?
have to compare if the protection is justified given the
efficiency/inefficiency of the firm or industry.
85.6 < EPR => high protection
42.8 < EPR < 85.6 => medium protection
0 < EPR < 42.8 => low protection
EPR < 0 => penalty
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Nominal vs effective rates of
protection
ERPj = (tj – Σiaijti)/(1-Σiaij)
Rules:
If nominal tj > wt. ti=> ERP > nominal tj
If nominal tj < wt ti => ERP < nominal tj
If nominal tj = wt ti => ERP = nominal tj
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Optimum tariff
For a large country, there is an optimum tariff
(tariff rate that maximizes national welfare,
resulting from improvement in the terms of
trade)
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Measuring protection & efficiency
Domestic resource cost (DRC) – this is a cost-benefit
analysis which measures the sector’s allocative efficiency
in the use of domestic resources. When divided by the
shadow exchange rate (DRC/SER), it measures the social
cost of domestic resources used per unit of net foreign
exchange saved from the production of a tradable good.
DRC/SER Efficiency Classification
0 < DRC/SER < 1.0 Highly efficient
1.0 < DRC/SER < 1.2 Efficient
1.2 < DRC/SER < 1.5 Mildly inefficient
1.5 < DRC/SER < 2.0 Inefficient
DRC/SER > 2.0 Highly inefficient
DRC/SER < 0 Negative foreign exchange
earner/dissaver 15
Tariff in a Large country
Consider 2 countries: Home (exports manufactures
& imports food, offer curve M), trading partner
Foreign country (offer curvc OF).
Suppose Home country imposes a tariff. How would
its trade change if there were no change in its terms
of trade?
From a small country analysis: given a world price, tariff
reduces imports, If world relative price remains at
(Pm*/Pf*)1, Home’s offer shifts from point 1 to point 2. in
general, Home’s offer curve shrinks to a curve Om2.
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Tariff in a Large country
The shift in Home’s offer curve will change the
equilibrium TOT at pt. 3, with relative price of
manufactures (Pm*/Pf*)2 > (Pm*/Pf*)1. Hence,
tariff improves the country’s TOT. The gains
from improved TOT may offset the losses from
the distortion of production and consumption,
which reduce welfare at any given TOT.
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