Barriers to Free Trade

Trade Policy Instruments

• Passive protection policy, includes policy instruments that aim to protect the home economy from foreign imports

• Active protection policy, includes policy instruments that aim to increase exports thereby protecting the home economy in the foreign markets (this primarily includes instruments and policies enchancing the competitivness of home firms abroad).

Division of Trade Policy Instruments

PASSIVE PROTECTION ACTIVE PROTECTION

tariffs export subsidies

import taxes and advance deposit requirements

production subsidies

quotas devaluing local currency

value quotas technical assistance

government procurement dumping

formalities of customs clearance

technical, safety, health and other regulations

tied aid

embargo

state trading

Concept of Protection

• Competitiveness and protection of the home economy have an inverse relationship

• Conflict between an efficient economic development/growth (the goal) and protection policy (as one of the instruments) because protection policy instruments:

1. divert commodity flows from more efficient (foreign) to less efficient (domestic) supply sources

2. divert flows of production factors (capital and labor) from less protected to more protected (and hence more privileged) sectors.

• Trade protection represents a social cost and will in the end run always burden the home economy and public regardless of whether the cost is covered by domestic (more efficient sectors) or foreign sources (foreign debt).

• Increasing the protection of certain sectors should become a norm only in cases when the sector has potential given cheaper production factors and other sources to become internally and externally competitive after a given period of time.

Tariff Protection – Efficiency Analysis

Assumptions –

• the analysis only includes a partial equilibrium: effects of a tariff are analyzed only in the market of the good directly affected by the imposition of the tariff. All other effects (on other markets) are disregarded.

• Assumption of perfect competition: foreign exporters of a good affected by the imposition of the tariffs will not react on the change in import prices by lowering the price of their exports.

Economic Effects of tariffs

• Consumption effect – domestic consumption of the commodity decreased by q3q4;

• Production (or protective) effect – domestic output increases by q1q2;

• Import effect – imports decrease by an amount equal to the sum of the two previous effects, that is for q3q4+q1q2;

• Fiscal revenue effect – fiscal revenue for the government of the levying country calculated by multiplying the per unit tariff by the imposed quantity, that is t*q2q3, which equals area c;

• Redistribution effect – since price has increased, there is a redistribution of income from consumers to producers.

Social Effect of Tariff

• Consumer surplus decreases for area AEFH (sum of a+b+c+d)

• Increase in fiscal revenue (area c)• Increase in producer surplus JGH - JBA = ABGH, which

equals area a

• Net costs of imposing a tariff:

1. production costs: area b represents social costs of inefficient allocation of production factors caused by the imposition of tariffs

2. consumer costs: the imposition of the tariff causes an increase in the relative price of the imported goods, this causes consumers to relinquish a part of their consumption (d) of the good.

Price Based Barriers

• Addition of tariff to the price of the good. [ Tariff is a tax on goods that are shipped internationally. It can be import tariff or a transit tariff]

• A specific duty is a tariff based on units & the ad-valorem duty is a tariff based on a percentage of the value of the item

• A compound duty is a tariff consisting of both a specific & an ad-valorem duty

• These taxes decrease the demand for the product while raising their respective prices.

The Effective Rate of Protection [ ERP]

• The Effective Rate of Protection measures the percentage effect of the entire tariff structure on the value added per unit of output in each industry.

• Tariff structure refers to the relationship among tariffs in related industries.

• Value added is the difference between the selling price and the cost of intermediate goods.

• ERP = ( V’- V ) / V

V’ = Value Added with tariff

V = Value added with free trade

ERP = (tf – ati) / (1 – a)

Where tf is the nominal tariff on the imported finished good

a is the value of imported inputs as a share of the value of the final good under free trade, and

ti is the tariff on imported inputs used by the domestic producers.

International Price Fixing

Cartels – A group of international firms that collectively agree to fix prices or quantities sold in an effort to control price.

Exchange Controls

Controls that restrict the flow of foreign currency through –

1. Blocked Foreign currency accounts for exports.2. Using fixed exchange rates that are favourable for the

home country rather than the importer.

Foreign Investment Controls

Controls may take the following forms –

1. Requiring foreign investors to take a minority ownership position [ 49% or less ]

2. Limiting profit Remittances for example, to 15% of accumulated capital per year

3. Prohibiting royalty payments to parent companies, thus stopping the latter from taking out capital.

Quantity Limits

• Quotas – restrict the number of units that can be imported or the market share that is permitted.

• Embargo – It is a quota set at zero level, which completely prevents the importation of the involved products.

• Orderly Marketing Agreements [ OMA] - International compacts negotiated between two or more governments, in which the trading partners agree to restrain the growth of trade in specified "sensitive" products, usually through the imposition of export quotas.

* Voluntary Export Restraint [ VER] - Arrangements through which exporters voluntarily restrain certain exports, usually through export quotas, to avert the possible imposition of mandatory import restrictions.

In General business, would rather be protected by quotas than by tariffs because –

• Under quotas, if future domestic demand is known, businesses can determine their future production level.

• Under tariffs, domestic producers must estimate the elasticity of demand curve for imported products & the future movement in world prices, which is a more difficult challenge.

Technical Barriers to Trade

• Product & process standards for health, welfare, safety, quality, size, measurements can create trade barriers by excluding products that do not meet the standards.

• Absence of an acceptable infrastructure for calibration, testing, certification, accreditation, quality assurance and standardization. Consequently, products are often re-tested in the importing country, leading to large cost penalties for exporters, while conversely - substandard products are being dumped in developing country.

• Customs Administrative Rules – Valuation systems of duties, tariff classifications, documentation requirements.

Country Item Details of NTM

United States

Marine products Increased inspections under the Bio-Terrorism Act, Customs Bond requirement, Mandatory labeling discriminating “farm raised” and “wild” with punitive fines and non-recognition of EIC certification.

United States

Paper products Non scientific quarantine restrictions, customs surcharges, eco labeling stipulations and food safety/ health standards exist on paper products exports.

United States

Tobacco A TRQ regime restricts imports.

Russia Meat products Standards for bovine meat are more stringent than the OIE  Terrestrial Animal Health Code, EIC Conformity certificates are not recognized and Certification with respect to swine fever and FMD are insisted upon for poultry exports which are not relevant..

European

Community

Chemicals The Registration, Evaluation and Authorisation of Chemicals (REACH) legislation increases cost of compliance by € 85,000 to € 325,000 per chemical.