THE Effective RATE OF Protection PDF

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THE Effective RATE OF Protection...

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THE EFFECTIVE RATE OF PROTECTION Thus far we have assumed that a given commodity is wholly produced in one country. We have ignored the case in which some of the inputs are imported  we have ignored the large and important trade in intermediate products. For analysing the protective effect of tariffs, the treatment of intermediate products makes a great deal of difference. Key point  when a producer has the option of importing some of the material inputs required for the production of a given product, the ad valorem tariff on that product may not accurately indicate the protection being provided to the producer  a distinction needs to be drawn between the nominal tariff rate, which is just the usual ad valorem tariff or its equivalent, and the effective rate of protection (ERP). ERP  the level of protection being provided to a particular process of production by the given nominal tariffs on a product and on material inputs used in its production. We are particularly interested in how a set of tariffs affects the firm’s value-added or what is available to cover primary factor costs, and also the net profit of the firm. ERP  the percentage increase in an industry’s value added per unit of output that results from a country’s tariff structure. The standard of comparison is value added under free trade. Example  World price of shoes is $20 and it takes $12 worth of leather at the free-trade world price to make a pair of shoes  value-added at world price is $8. Country A levies a nominal tariff of 30 percent on shoe imports but allows leather to be imported duty free  price of shoes in country A would rise to $26  the value-added is now $14 instead of $8  they could incur factor costs of $14 and still be competitive with a foreign firm whose factor costs were $8.  Value-added in country A can be 75 percent larger than the value-added at the free trade price [(14-8)/8 = 75%]  the ERP is 75 percent, while the nominal tariff is only 30 percent. Firm in country A Free-Trade Competitor Shoe price $26 $20 Leather input $12 $12 Value-added $14 $8 We expect that high effective rate of protection will attract resources into industries where a country has production costs much higher than abroad; where it has a comparative disadvantage  the country’s economic efficiency falls. Note that a tariff on leather would reduce the effective rate of protection for shoes  a tariff on leather increases the price of leather in country A and raises A firms’ costs of production  value-added must be smaller for A firm to continue selling shoes at $26. A 20% nominal tariff on leather would lead to the following result: Firm in country A Free-trade competitor Shoe price $26 $20 Leather price $14.40 $12 Value-added $11.60 $8 The effective tariff rate on shoes has fallen from 75% to 45% [(11.60-8)/8 = 45%]. Shoe producers in country A will tend to favour tariffs on shoes but oppose tariffs on leather. Formula for calculating the effective tariff rate:

t j−∑ aij∗t i e j=

i

1−∑ a ij i

ej = the effective rate f protection in industry j, shoe production tj = the nominal tariff rate in industry j = 30 percent tariff on shoes ti = the nominal tariff rate in industry i = 20 percent tariff on leather aij = the share of inputs from industry I in the value of output of industry j at free trade prices = (12/20) = 0.60. Plugging this all in yields an effective rate of protections for shoes of 45%.

Actual practice  a given product has many intermediate inputs, each with its own nominal tariff rate  the formula uses the share of each input (a ij) to weight the nominal tariff rates in forming the sum (∑aijti). The tariff structures of many countries show a systematic pattern in which nominal tariff rates increase as the stage of production advances  tariff rates are low on raw materials, higher on semi-finished products, and highest on finished manufactures. This pattern is even greater in effective tariff rates  very high protection being accorded to the higher stages of manufacture. ERPs could also turn negative  if the nominal rate on leather were increased to 60%, the ERP for shoes would be -15%  the economic meaning is that a firm must pay such high nominal tariffs on its imported inputs that it is actually at a disadvantage in comparison to its free-trade competitors in the outside world; its value-added margin must be less than that of a free-trade competitor: Firm in Country A Free-Trade Competitor Shoe price $26 $20 Leather input $19.20 $12 Value-added $6.80 $8 To compete with a foreign firm whose factor costs are $8, the firm in country A must hold its factor costs to $6.80. Negative effective tax rates often turn up among a nation’s export products  the nominal tariff applicable for an export is zero because it is being sold in foreign countries at the world market price. Therefore, if firms producing the export item use any imported inputs at all that are subject to tariff, their effective tariff rate is negative  there is an implicit tax on exports. Many developing countries have strong comparative advantages in final products, nevertheless, they are not exported  because they impose a tariff or otherwise restrict imports of inputs where they have a comparative disadvantage  partial response to this problem  free trade zones which allw producers to claim a rebate for duties paid on imported inputs if the producers export their final product. Potential problem in calculating ERPs  we assume that the input coefficients are fixed constant, unaffected by changes in prices  however, international trade causes changes in relative prices and shifts in the allocation of resources. These changes will also affect the amounts of various inputs used to produce a particular product.  ERP calculations do not allow for this influence....