copyright © 2010 pearson addison-wesley. all rights reserved. chapter 7 nontariff barriers and...

Copyright © 2010 Pearson Addison-Wesley. All rights reserved.

Chapter 7

Nontariff Barriers and Arguments for Protection

Copyright © 2010 Pearson Addison-Wesley. All rights reserved.7-2

Topics to be Covered

• Quota and its Effects• Quota vs. Tariff• Customs valuation practices• Government procurement policies• Technical barriers to trade• Health and safety standards• Intellectual property rights• Export subsidy• Dumping• Valid and Invalid Arguments for Protection


Quota

• A government imposed limit on the quantity or value of a good traded between countries

• Example: U.S. imposed an import quota of no more than 1.25 million tons of sugar from 1993 to 1994. Quota on milk, cream, cheese, butter and various products containing sugar, cotton….etc.


• The quota is one of the more restrictive forms of protectionism.

• Quotas limit imports of a good to a certain number of units on an annual basis.

• It is considered so extreme they are banned by the (WTO).

• However, there are different reasons why they still exist in various forms,

QUOTAS


1. Not all countries are members of the WTO.2. New members of the WTO are allowed to

maintain their previously existing quotas for a specified period of time.

3. Some countries implement quotas in defiance of WTO rules.

4. Agricultural products have not previously been covered by WTO standards.

QUOTAS


QUOTAS

Number of Import Quotas in the Major Industrialized Countries

CountryTotal Number of Import Quotas

Quotas on Agricultural Products

Quotas on Industrial Products

United States 7 1 6

Canada 5 4 1

United Kingdom 3 1 2

France 46 19 27

Germany 4 3 1

Italy 8 3 5

Benelux 5 2 3

Japan 27 22 5


Types of Quotas

• Tariff Rate Quota (TRQ)—allows a certain quantity of a good into a country at low or zero tariff rate, but applies higher tariff to quantities exceeding the quota.

• In Jan 2005, I T law allows countries to impose quotas to provide temporary protection to aid locally distressed industries, or when they have balance of payment problems. Faced with sharply rising imports of textiles & cloth from China, in summer 2005 the EU negotiated a three years agreement with china to limit the growth of Chinees exports of this product, USA in November 2005 reached similar agreement with China.


Quota License

• A license which gives the bearer the right to import into a country a specific amount of a good during a specific time period.

• Licenses may be sold or given away.

• The recipients of the licenses may be domestic or foreign, the welfare impact of this quota system depends on who get the licenses and how much was paid to obtained them.


Welfare Effects of a Quota (Consider Figure 7.1)

• Domestic price effect• Import effect• Consumption effect• Production or Protection effect• Redistribution effect• Consumer surplus effect• Producer surplus effect• Deadweight costs• QUOTA RENT


Welfare Effects of a Quota


TABLE 7.1 Welfare Effects of a Quota Auctions Licenses


Quota Rent

• Profit that accrues to whoever has the right to bring imports into the country and sell these goods in the protected market.

• Who Gets the Quota Rent?• Government• Domestic producers or importers• Foreign producers


Government Auctions Licenses

• When the government sells or auctions quota licenses, the welfare effects are identical to those of a tariff which raises the product price by the same amount (refer to Table 7.1).

• Studies estimate that the U.S. government loses between $3.7 billion to $6.8 billion yearly by not holding auctions.


Domestic Firms Get Licenses

• When government gives the quota licenses to domestic producers or importers, the latter group effectively gets the quota rent.

• Profits to domestic firms rise by $(a+c) while government revenue is unaffected (Refer to Figure 7.1).


.

Government Gives Licenses to Foreigners

• A voluntary export restraint works like an import quota, except that the quota is imposed by the exporting country rather than the importing country.

• However, these restraints are usually requested by the importing country.

• The profits or rents from this policy are earned by foreign governments or foreign producers.

– Foreigners sell a restricted quantity at an increased price.


Voluntary Export Restraint - VERThe most notable example of VERs is when Japan imposed a VER on its auto exports into the U.S. as a result of American pressure in the 1980s. The VER subsequently gave the U.S. auto industry some protection against a flood of foreign competition.

However, there are ways in which a company can avoid a VER. For example, the exporting country's company can always build a manufacturing plant in the country to which exports would be directed. By doing so, the company will no longer need to export goods, and should not be bound by its country's VER.


What are the Welfare Effects of a VER?

TABLE 7.2 Welfare Effects of a Voluntary Export Restraint


Equivalence or Nonequivalence of Tariffs and Quotas

• They are similar in their effects on prices, output, and imports.

• Tariff revenue goes to government, while quota rent depends on who gets the license.

• With tariff, the domestic monopolist can only charge the world price plus tariff; with quota, the monopolist can charge higher price and produce less.


Equivalence or Nonequivalence of Tariffs and Quotas (cont.)

• With a tariff, an increase in demand will be met by a rise in imports; with a quota, no new imports are allowed in.

• Quotas are more difficult to administer because of the problem of how to give away licenses and the likelihood of graft and corruption.


Other NTBs

• Customs valuation practices• Government procurement policies• Technical barriers to trade• Health and safety standards• Intellectual property• Export subsidy


Customs Valuation Practices

• Countries wanting to raise government revenue may instruct customs officials to raise estimates of the value of imports via:

freight and insurance cost fees for processing paper work assembly charges other taxes• WTO Article VII requires the use of a

transactions basis (invoices) to value imports.


Government Procurement Policies

• “Buy American” policy—requires U.S. government agencies to purchase American products unless the domestic price is more than 12% higher than the foreign price.

• Effect: This policy raises the cost to government of providing public services, thus redistributing income from taxpayers to domestic producers.


Technical Barriers to Trade

• Technical regulations or standards may be imposed to protect the environment, insure consumer safety, promote national security, and guarantee product quality.

• WTO requires that such standards do not create unnecessary and discriminatory barriers to trade.


• Technical Barriers to Trade– Technical barriers refer to a country’s

national standards for safety, health, and product labeling

– They can distort international trade– Exported goods may have to meet different

labeling and technical standards– Differences in the degree of regulation can

affect services

Health and Safety Standards


• If the intent of the regulations is an expression of national preference and the adverse effects on foreign competitors are just a by-product of this, it is difficult to complain to the WTO

• If the regulations are intended to protect an industry, countries can complain to the WTO or threaten retaliation

• Intervention by the WTO in these disputes has not generally been successful




• These government standards help protect the health and safety of citizens.

• Examples: EU ban on U.S. beef containing growth hormones; Japanese ban on U.S. beef due to mad cow disease.

• Such standards also serve as an effective mechanism for protecting domestic firms from foreign competition.


Intellectual Property Rights

• Intellectual property—the innovative or creative ideas of inventors, artists, or authors.

• Laws which protect intellectual property include:– Patent– Copyright– Trademark


Problems with Intellectual Property Rights Protection

• Varying degrees of law enforcement in different countries

• Growing trade in counterfeit goods


Export Subsidy

• A direct or indirect payment by a country’s government to one or more of its export industries. An export subsidy can also be specific or ad valorem

– A specific subsidy is a payment per unit exported.

- An ad valorem subsidy is a payment as a proportion of the value exported.

• An export subsidy raises the price of a good in the exporting country, decreasing its consumer surplus (making its consumers worse off) and increasing its producer surplus (making its producers better off).

• Also, government revenue will decrease.


Effects of Export Subsidy

• Forms of export subsidies include:– They can be explicit as in direct payments of

money to an industry– They can be indirect as reduced taxes, lower

utility rates, or a lower level of business regulation

• Subsidy leads to a greater output of exportables than would otherwise occur.

• Resources are drawn away from import-competing sectors.


Countervailing Duty

* Consumers lose as they pay more taxes to finance the export subsidy.

* Internal prices of exportables rise.

• A tariff imposed by an importing country designed to offset the export subsidy and resulting low prices charged by exporters.


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Local Content Requirement

• A local content requirement is a regulation that requires a specified fraction of a final good to be produced domestically.

• It may be specified in value terms, by requiring that some minimum share of the value of a good represent domestic valued added, or in physical units.


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Local Content Requirement (cont.)

• From the viewpoint of domestic producers of inputs, a local content requirement provides protection in the same way that an import quota would.

• From the viewpoint of firms that must buy domestic inputs, however, the requirement does not place a strict limit on imports, but allows firms to import more if they also use more domestic parts.


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Local Content Requirement (cont.)

• Local content requirement provides neither government revenue (as a tariff would) nor quota rents.

• Instead the difference between the prices of domestic goods and imports is averaged into the price of the final good and is passed on to consumers.


Local Content Requirement - Instead of placing a quota on the number of goods that can be imported, the government can require that a certain percentage of a good be made domestically. The restriction can be a percentage of the good itself, or a percentage of the value of the good. For example, a restriction on the import of computers might say that 25% of the pieces used to make the computer are made domestically, or can say that 15% of the value of the good must come from domestically produced components


CORRUPTION AND INTERNATIONAL TRADE

• For this discussion, corruption will mean the use of public office for private gain as it relates to international trade

• The passing of money from the private sector into the hands of some government employee

• Facilitation payments are common practice and have little impact on trade

• Bribes can influence a government employee to do something illegal

• This may involve tariffs or quotas


CORRUPTION AND INTERNATIONAL TRADE

• High tariffs and quotas tend to induce bribes• Lacking a profit motive, government officials

may be bribed to purchase higher priced or lower quality products that they would not have otherwise purchased

• Bribes are generally illegal in the country they are made

• Developed countries have also moved to make it illegal to bribe foreign officials with 35 countries committed to the principle


ECONOMIC SANCTIONS

• Sanctions frequently involve both international economics and international finance

• Economic sanctions are a government's deliberate withdrawal of normal trade or financial relationships in order to achieve foreign policy goals

• As the private sector would not withdraw from a profitable economic relationship, it takes the coercive power of a government to accomplish this


ECONOMIC SANCTIONS

• The government imposing the sanction is the called the sender and the country that is the object of the sanction is the target

• The concept is that the cost of the sanction will induce the target to change its policies

• It is necessary to distinguish between actual sanctions and the threat of sanctions, which may be as effective as actual sanctions


ECONOMIC SANCTIONS

• Sanctions can take on many forms• Sanctions does not usually end all trade

between countries, sanctions may be imposed on only the part of the trade that is important to the target country

• Sanctions may involve a suspension of imports or a suspension of exports

• Sanctions may be imposed on FDI• Sanctions may include movements of

portfolio capital


ECONOMIC SANCTIONS• Sanctions are attractive because they occupy the

middle ground between simple complaints and outright warfare

• However, sanctions usually fail to change a target country’s behavior• Sanctions may be too weak a response• Given globalization, sanctions may not be

effective• Sanctions may invoke support for the target

country from their population and allies• Costs imposed on the sender’s population may

weaken domestic support


ECONOMIC SANCTIONS

• Some sanctions have domestic political goals and the effect on the target country is less important

• Economic sanctions have become common in the world economy

• They are now an official part of world trade and will continue to be used as a foreign policy tool


Dumping

• Selling a product in a foreign country at a price lower than the price charged by the same firm in its home market or at a price below costs of production.

• How would the U.S. be affected by dumping? (Refer to Figure 8.2 Dumping)– Effect on U.S. consumers– Effect on U.S. producers– Net welfare effect


FIGURE 8.2 Dumping


Types of Dumping

• Sporadic dumping is the occasional sale of a product by a firm in a foreign market at a price below that sold in its domestic market.

• Predatory Dumping dumping aimed at driving foreign competitors out of the market so that the market can be monopolized.

• Persistent dumping is the sale of a product by a firm in a foreign market at a price below that sold in its domestic market over an extended period of time


Under What Situations Can Dumping Occur?

1. Foreign producers have market power in both domestic and foreign markets so that they can practice international price discrimination.

– International price discrimination refers to selling the same product in two different countries at two different prices.


Dumping Situations (cont.)

2. Dumping could occur if a foreign firm receives a production or export subsidy from its government.


Antidumping Law

• If a U.S. industry can show injury from dumping, it can have a special tariff imposed on the dumped imports called the dumping margin.

• The dumping margin is the difference between the market price of a product and its fair market value.


Injury Test

• Injury Test—an investigation to determine whether unfair foreign trade practices have caused or threatens to cause harm to a domestic industry.

• Complaint is simultaneously filed with:– Department of Commerce (DOC) which

investigates whether dumping actually occurred

– International Trade Commission (ITC) which investigates the question of injury


U.S. Antidumping Cases: 1980–2006


Arguments for free & Protection

Argument for free trade are1- F T leads to the most economic utilisation of the

productive resources because of specialisation.2- Under F T, division of labor occurs on an

international scale leading to greater specialisation, efficiency and economy in production.

3- Because of competition under F T, inefficient producers will improve their efficiency or quit.

4- F T enables consumer to obtain goods from the cheapest source.



• There are a number of arguments put forward in favor of protection, some of these argument are very valid while others not.

• Infant Industry Argument, the argument advanced by Alexander Hamilton, Fredrick list & others assumed that new industries having a potential comparative advantage may not get started in a country unless its given a temporary protection against foreign competition.



• Diversification argument.• Improve Balance of payments argument.• Anti- Dumping argument.• Employment argument.• Keeping money at home argument.


Valid Arguments

• Government revenue• Income redistribution• Non-economic goals (national defense)• Infant industry• Domestic distortions• Environmental protection• Strategic trade policies


Government Revenue Argument

• Reasons for using tariffs as revenue-generators:

foreigners may pay the tariff tariffs are easy to collect• Refer to Table 7.3• Tariffs are an important source of revenue in

developing countries.


TABLE 7.3 Tariff and Trade Taxes as a Percentage of Government Revenue


TABLE 7.3 Tariff and Trade Taxes as a Percentage of Government Revenue (cont.)


Income Redistribution Argument

• Trade policy can be used to redistribute income from one sector of society to another:

from consumers to producers from one industry to another from the rich to the poor


Problems with National Defense Argument

• This argument is over-used.

• Defense needs may be better served by allowing or expanding imports rather than restricting them.

• A better policy for meeting defense needs is through a domestic production subsidy with free trade.


Effects of a Domestic Production Subsidy

• Shifts the domestic supply down by the amount of the subsidy.

• Domestic producers gain.• Taxpayers pay for the subsidy.• Cost to society is a production deadweight

cost.• With the subsidy and free trade, goods

sell at the world price, so there is no consumption deadweight cost (as compared to a tariff).


FIGURE 7.2 Welfare Effects of a Domestic Production Subsidy


Infant Industry Argument

• Argument that new industries may need temporary protection until they have mastered the production and marketing techniques necessary to be competitive in the world market


Problems with the Infant Industry Argument

• The argument presumes that the protected industry will grow up and mature.

• It assumes that the government is capable of picking winners than the private sector is.


Domestic Distortions

• Take, for example, an agricultural price support program (Refer to Figure 7.3).

• Effects of price support:– Guaranteed higher price (above equilibrium)– Excess supply of the product

• With free trade:– Importers buy the good at lower world price

and sell at the higher support price– Cost of the farm program increase– A second distortionary policy, i.e., protection,

becomes necessary


FIGURE 7.3 Price Supports and Tariffs


Pollution Havens Hypothesis

• This argues that developing or poor countries with lax environmental standards will attract foreign firms that want to escape environmental standards in their home countries.

• Discuss Global Insights 7.1


Strategic Trade Policy

• The strategic use of trade policy (e.g., tariff or quota) to increase domestic welfare

• Consider two examples:– Brazil and IBM (foreign monopoly)– Strategic game by two monopolies, Airbus and

Boeing


FIGURE 7.4 Trade Policy and Foreign Monopoly


TABLE 7.4 The Effects of a Hypothetical Strategic Trade Policy


Limitations of Strategic Trade Policy

• Types of situations where strategic trade policy should be applied are very specialized and depend on assumptions of firm behavior.

• Even if firm behavior is known, other assumptions may still be violated.

• Gains from strategic policy may depend on the reaction of foreign governments.

• Strategic policy may be a “second-best” policy.

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