How Import Tariff can Affect Your Business?

Jayden William

Import Tariff is the tax imposed on imported goods can affect the business. In most countries, the
governments impose this import tariff and the general purpose behind them is to limit (or
sometimes totally ban) the imports of some specific product. By imposing trade barriers, the
governments are looking to achieve some or all of these economic targets. The sweep of import
duties is quite wide.

Goods as well as services bought from the foreign countries are subjected to import duties in
India. Recently, the special duty exemption scheme has released the importers from the burden
of paying import duties for those import items which will facilitate production of export goods.

Import Customs can be considered to be a type of tax levied by the Govt. of India on all goods
exported/imported to/from India. In India, the Central Board of Excise & Customs (CBEC) is the
apex body that governs all customs-related matters.

Import customs in India also includes tariffs that are applied to foreign goods. Tariffs are
charged by customs official to allow the landing of the imported goods in the port. The purpose
behind levying tariffs is mainly to protect the domestic industries from foreign competition.
Tariffs serve to protect the domestic industries through-the revenue tariffs and the protective
tariff. The revenue tariffs contain certain set rates to apply on the imports to increase the revenue
earning of the government. Whereas protective tariffs serve to superficially amplify the cost of
the imported goods so that the buyer has to pay more money for the purchase of an imported
good which can be purchased at a lesser price from an indigenous manufacturer.

In most cases the tax is collected at the moment some shipment arrives at ports. Governments
normally force tariffs (or import duties) to protect local industries and to raise their revenues,
although many economists have debated against it. According to them these methods are faulty,
because in the end it's the consumer who suffers at the hand of high prices and inflation. As an
exporter it would be better off going for some country with minimum tariffs because you will
loose the low cost advantage once you have to pay these taxes. Tariff allows local manufacturers
to offer lower prices as compared to the imported items.
Import Quotas
From lawbrain.com

Import quotas are a form of protectionism. An import quota fixes the quantity of a particular
good that foreign producers may bring into a country over a specific period, usually a year. The
U.S. government imposes quotas to protect domestic industries from foreign competition. Import
quotas are usually justified as a means of protecting workers who otherwise might be laid off.
They also can raise prices for the consumer by reducing the amount of cheaper, foreign-made
goods imported and thus reducing competition for domestic industries of the same goods.

The general agreement on tariffs and trade (GATT) (61 Stat. A3, T.I.A.S. No. 1700, 55 U.N.T.S.
187), which was opened for signatures on October 30, 1947, is the principal international
multilateral agreement regulating world trade. GATT members were required to sign the
Protocol of Provisions Application of the General Agreement on Tariffs and Trades (61 Stat.
A2051, T.I.A.S. No. 1700, 55 U.N.T.S. 308). The Protocol of Provisions set forth the rules
governing GATT and it also governs import quotas. This agreement became effective January 1,
1948, and the United States is still bound by it. GATT has been renegotiated seven times since
its inception; the most recent version became effective July 1, 1995, with 123 signatories.

Import quotas once played a much greater role in global trade, but the 1995 renegotiation of
GATT has made it increasingly difficult for a country to introduce them. Nations can no longer
impose temporary quotas to offset surges in imports from foreign markets. Furthermore, an
import quota that is introduced to protect a domestic industry from foreign imports is limited to
at least the average import of the same goods over the last three years. In addition, the 1995
GATT agreement identifies the country of an import's origin in order to prevent countries from
exporting goods to another nation through a third nation that does not have the same import
quotas. GATT also requires that all import quota trade barriers be converted into tariff
equivalents. Therefore, although a nation cannot seek to deter trade by imposing arbitrary import
quotas, it may increase the tariffs associated with a particular import.

In the United States, the decade from the mid-1980s to the mid-1990s saw import quotas placed
on textiles, agricultural products, automobiles, sugar, beef, bananas, and even under-wear—
among other things. In a single session of Congress in 1985, more than three hundred
protectionist bills were introduced as U.S. industries began voicing concern over foreign
competition.

Many U.S. companies headquartered in the United States rely on manufacturing facilities outside
of the country to produce their goods. Because of import quotas, some of these companies cannot
get their own products back into the United States. While such companies lobby Congress to
change what they consider to be an unfair practice, their opposition argues that this is the price to
be paid for giving away U.S. jobs to foreign countries.

Nearly every country restricts imports of foreign goods. For example, in 1996—even after the
new version of GATT went into effect—Vietnam restricted the amount of cement, fertilizer, and
fuel and the number of automobiles and motorcycles it would import. The import quotas of
foreign countries can adversely affect U.S. industries that try to sell their goods abroad. The U.S.
economy has suffered because of foreign import quotas on canned fruit, cigarettes, leather,
insurance, and computers. In a market that has become overcrowded with U.S. entertainment, the
European Communities have chosen to enforce import quotas on U.S.-made films and television
in an effort to encourage Europe's own industries to become more competitive.

More on tariffs vs. import quotas

Atlantic Economic Journal, June, 1995 by Yeong-Her Yeh

It has been shown by Pelcovits [1976] and Walter [1971] that with a given tariff or static-
equivalent quota, rising import demand will increase the amount of imports under the tariff but
will increase the domestic price of the import good under the static-equivalent quota. In this case,
the tariff is superior to the static-equivalent quota from a welfare standpoint. On the other hand,
with a given tariff or static-equivalent quota, falling import demand will reduce the amount of
imports under the tariff but will decrease the domestic price of the import good under the static-
equivalent quota. In this case, the tariff is inferior to the static-equivalent quota from a welfare
standpoint.

The above proposition is based on the assumption that the country concerned is small and faces a
given international price line. The purpose of this paper is to show that the above proposition
does not hold when the country concerned is a large country, and the terms of trade are not
constant. It will be shown that a tariff and the static-equivalent quota cannot be ranked from a
welfare standpoint whether the country experiences an increase or a decrease in its import
demand.

The offer-curve approach [Meade, 1952] will be used in this study in contrast to the partial
equilibrium approach used in the previous studies. It is assumed that neither the exportable good
nor the importable good is an inferior good. This paper is divided into two sections. The case
where the country concerned is a small country is analyzed in Section I. Then, Section II deals
with the case where the country concerned is a large country.

I. Section I

In Figure I, the vertical axis and horizontal axis measure the home import good Y and home
export good X, respectively. OA is the free-trade offer curve of the home country A. Country A
faces a perfectly-elastic foreign offer curve OB under the assumption that country A is a small
country. Suppose that country A imposes a tariff. The tariff-distorted offer curve [OA.sub.t]
intersects OB at F. Point F is the trade equilibrium point after the tariff. The welfare of country A
is represented by the trade indifference curve I. Next, suppose that country A imposes the static-
equivalent quota OM, which is the amount of imports under the tariff. Country A's offer curve
after the quota is OGM which also intersects OB at F. Like the tariff case, country A's welfare is
represented by the trade indifference curve I.(1)
Now, assume that country A's import demand is increased.(2) This means that, given any
international price line, country A wants to export more good X and import more good Y.(3)
OA[prime] and [OA[prime].sub.t] are the free-trade offer curve and tariff-distorted offer curve,
respectively, after the increase in import demand. Point H is the new trade equilibrium point
under the tariff. The amount of imports is increased from OM to Oh after the increase in import
demand. The welfare of country A is represented by the dashed-trade indifference curve [I.sub.t].
(4)

However, under the static-equivalent quota, the amount of imports remains the same as OM after
the increase in import demand. The new offer curve is OG[prime]M which intersects OB at F.
The welfare of country A is represented by the dashed-trade indifference curve [I.sub.q]. Since
[I.sub.t] lies above [I.sub.q], the tariff is superior to the static-equivalent quota.

Next, consider the case where there is a decrease in import demand. In Figure II (the notations
used in Figures II and III are the same as those in Figure I), country A initially reaches point F by
imposing a tariff or imposing the static-equivalent quota OM. The welfare of country A is
represented by the trade indifference curve I under both the tariff and the static-equivalent quota.

Now, suppose that there is a decrease in import demand. This means that, given any international
price line, country A would like to export less good X and import less good Y.(5) After the
decrease in import demand, the free-trade offer curve will shift from OA to OA[prime], and the
tariff-distorted offer curve will shift from [OA.sub.t]t to [OA[prime].sub.t]. The trade
equilibrium point will move from F to H under the tariff and the amount of imports is decreased
from OM to Oh. However, the trade equilibrium point will remain at F under the static-
equivalent quota (the new offer curve is OG[prime]M which intersects OB at F).(6)

After the decrease in import demand, country A reaches the welfare level represented by the
dotted-trade indifference curve [I.sub.t] under the tariff whereas it reaches the welfare level
represented by the dotted-trade indifference curve [I.sub.q] under the static-equivalent quota.
Since [I.sub.t] lies below [I.sub.q], the tariff is inferior to the static-equivalent quota.

II. Section II

This section deals with the case where the country concerned is a large country, which faces a
less-than-perfectly elastic foreign offer curve. In Figure III, country A initially reaches point F by
imposing the optimum tariff or imposing the static-equivalent quota OM. The welfare of country
A is represented by the trade indifference curve I, which is tangent to OB at F, under both the
tariff and the static-equivalent quota.

Now, assume that there is an increase in import demand. After the increase in import demand,
the free-trade offer curve will shift from OA to OA[prime], and the tariff-distorted offer curve
will shift from [OA.sub.t] to [OA[prime].sub.t]. Country A will reach the new trade equilibrium
point H under the tariff. However, it will remain at F under the static-equivalent quota (the new
offer curve OG[prime]M intersects OB at F). The welfare of country A is represented by the
dashed-trade indifference curve [I.sub.t] at H under the tariff, whereas it is represented by the
dashed-trade indifference curve [I.sub.q] at F under the static-equivalent quota.(7)
The trade indifference curve [I.sub.t] could lie above, below, or coincide with the trade
indifference curve [I.sub.q]. Figure III shows the case where [I.sub.t] lies above [I.sub.q]. If
[OA[prime].sub.t] intersects OB at S (the intersection point between [I.sub.q] and OB), then
[I.sub.q] and [I.sub.t] would coincide. If [OA[prime].sub.t] intersects OB at a point above S, then
[I.sub.t] would lie below [I.sub.q]. This means that a tariff and the static-equivalent quota can not
be ranked from a welfare standpoint when a country experiences an increase in import demand.

On the one hand, after the increase in import demand, country A increases its imports from OM
to Oh under the tariff whereas it still imports the same amount OM under the static-equivalent
quota. Country A is better off from importing more because the price of the importable good is
higher at home than abroad. On the other hand, after the increase in import demand, the terms of
trade are measured by line OH (not drawn) under the tariff whereas they are still measured by
line OF (not drawn) under the static-equivalent quota. In other words, the terms of trade
deteriorate under the tariff after the increase in import demand. Thus, due to these conflicting
forces, the tariff and the static-equivalent quota cannot be ranked from a welfare standpoint. The
result will be the same for the case where country A initially imposes a non-optimum tariff.

The above analysis can be applied to the case where there is a decrease in import demand.
Obtained will be the same result, that a tariff and the static-equivalent quota cannot be ranked
from a welfare standpoint.

In conclusion, this paper uses a general equilibrium approach to analyze the welfare effects of a
tariff and of the static-equivalent quota in a country which experiences changes in its import
demand. For a small country, a tariff is always superior to the static-equivalent quota when it
experiences an increase in its import demand. On the other hand, a tariff is always inferior to the
static-equivalent quota when the country experiences a decrease in its import demand. However,
the results are different for a large country. We cannot rank a tariff and the static-equivalent
quota from a welfare standpoint. This is true whether the country experiences an increase or a
decrease in its import demand.

1 It is assumed that the government raises import quota revenues by selling import licenses
through competitive auctions. Then, like tariff revenues, import quota revenues are redistributed
to the private sector in the form of lump-sum transfers. It is also assumed that the import quota
always remains binding.

2 A change in import demand could be due to a change in consumer preferences, a change in

technology, or a change in factor endowments. For this study, it does not matter what factor
causes a change in import demand [Johnson, 1958].

3 The dashed-trade indifference curves represent the new trade indifference curves after the
increase in import demand. A trade indifference curve before the increase in import demand is
tangent to OB at point a whereas a dashed-trade indifference curve after the increase in import
demand is tangent to OB at point a[prime]. This means that, given an international price line
(OB), country A would like to export more and import more at point a[prime] after the increase
in import demand than at point a before the increase in import demand.
5 The dotted-trade indifference curves represent the new trade indifference curves after the
decrease in import demand.

6 OA[prime] cannot lie to the left of [OA.sub.t]. Otherwise, the static-equivalent quota OM
cannot remain binding after the decrease in import demand.

7 On the one hand, the tariff rate is the same before and after the increase in import demand. On
the other hand, the international price line OH after the increase in import demand is less steep
than the international price line OF before the increase in import demand. Therefore, the slope of
[I.sub.t] at H should be less steep than the slope of I at F.

8 This study can be used to analyze the welfare effects of a tariff and of the static-equivalent
quota in a country which faces a change in the foreign offer curve. For a small country, a tariff is
always superior to the static-equivalent quota when it faces a decrease in the world price of its
import good. However, a tariff is always inferior to the static-equivalent when it faces an
increase in the world price of its import good. On the other hand, for a large country, a tariff and
the static-equivalent quota cannot be ranked from a welfare standpoint in the presence of a
change in the foreign-offer curve.

REFERENCES

Johnson, Harry G. International Trade and Economic Growth, George Allen and Unwin, 1958,
Ch. 3.

Meade, James E. A Geometry of International Trade, George Allen and Unwin, 1952, Chs. 2-3.

Pelcovits, Michael D. "Quotas vs. Tariffs," Journal of International Economics, 6, 4, November

1976, pp. 367-8.

Walter, Ingo. "On the Equivalence of Tariffs and Quotas: A Comment," Kyklos, 24, 1, 1971, pp.
111-2.

Yeong-Her Yeh, University of Hawaii - Honolulu. The author is grateful to an anonymous

referee for his valuable comments, but is responsible for any error which remains.

COPYRIGHT 1995 Atlantic Economic SocietyThis paper uses the offer-curve approach to
analyze the welfare effects of a tariff and of the static-equivalent quota in a country which
experiences changes in its import demand. For a small country, a tariff is always superior to the
static-equivalent quota when it experiences an increase in its import demand. On the other hand,
a tariff is always inferior to the static-equivalent quota when it experiences a decrease in its
import demand. However, one cannot rank a tariff and the static-equivalent quota from a welfare
standpoint in a large country. This is true whether the large country experiences an increase or a
decrease in its import demand. (JEL F13)
COPYRIGHT 2008 Gale, Cengage Learning
Causality tests of export-led growth: the case
of Mexico
Atlantic Economic Journal, June, 1995 by Mary McCarville,
Emmanuel Nnadozie

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I. Introduction

By examining the incidence of export-led development in Mexico, this paper tests whether
exports cause growth, using the Granger causality test, which takes into consideration the time
series properties of the data.(1) Previous tests have attempted to discern causality by regressing
output growth against export growth and other relevant variables.(2) Ni et al. [1990] demonstrate
that such studies are inherently weak in that they are based on an a priori assumption that export
growth causes economic growth. In the past, the Granger causality test has been utilized on time
series data for exports and GDP.(3) However, as Ni et al. point out, these tests are likewise of
limited use in their failure to account for time-series properties of the data. Ni et al. suggest
application of the Dickey-Fuller test to detect stochastic trends in the data and utilization of
Granger causality tests on newly stationary, detrended values. The methodology utilized in the
tests on Mexico differs slightly from that of Ni et al., but the theory is the same.

II. Model Selection

The Dickey-Fuller unit root test confirmed the presence of a unit root; consequently, both data
sets were first-differenced. Candidate ARIMA models were selected through the calculation of
SBC (Schwartz's Bayesian Criterion) and AIC (Akaike's Information Criterion) values.(4)
Finally, the optimal ARIMA model was selected using the Hannan-Rissanen criterion. The best
candidate model for real exports (XT) according to the Hannan-Rissanen criterion was ARIMA
(1,1,1), and the best model for real GDP (YT) was likewise ARIMA (1,1,1). Finally, the Godfrey
Lagrange Multiplier test verified that the ARIMA (1,1,1) models which follow are appropriate
for both data sets:

[X.sub.t] = .51078[x.sub.t-1] - .45915[[Epsilon].sub.t-1] [[Epsilon].sub.t]

[X.sub.t] = .78845[y.sub.t-1] - .66206[[Epsilon].sub.t-1] [[Epsilon].sub.t].

III. The Granger Causality Test

The test procedure is to conduct two separate hypothesis tests and to discern causality or lack of
causality through consideration of the results of both tests. Specifically, the first hypothesis test
conducted consists of the null hypothesis that export growth does not cause GDP growth, as
opposed to the alternative hypothesis that export growth does cause GDP growth. The restricted
model regresses YT against lagged values of YT; whereas the unrestricted model regresses YT
against lagged values of YT and XT.

The second hypothesis test consists of the null hypothesis that GDP growth does not cause
export growth as opposed to the alternative hypothesis that GDP growth does cause export
growth. The restricted model consists of a regression of XT against the lagged values of XT. The
unrestricted model regresses XT against lagged XT and also lagged YT.

In general, the results of the hypothesis tests can result in four possible outcomes which are as
follows:

(1) Accept both null hypotheses, meaning that causality runs neither from X to Y nor from Y to
X, though the variables appear to be correlated.

(2) Accept the null hypothesis that X does not cause Y but reject the null hypothesis that Y does
not cause X, meaning that unidirectional causality runs from Y to X.

(3) Reject the hypothesis that X does not cause Y but accept the hypothesis Y does not cause X,
meaning that causality runs unidirectionaily from X to Y.

(4) Reject both null hypotheses, meaning that there exists a feedback causal relation between X
and Y.

Application and Results

In this specific case, both models have been identified as ARIMA (1,1,1). Since there exists an
MA component in both models identified, both series can be represented as infinite order AR
processes. Since it is impossible to conduct a causality test for AR of degree infinity, the authors
limit the AR order by selecting and utilizing the order of the pure AR model which had the
lowest AIC value. For both models, this is AR(1).

The test, then, proceeds as follows. For the null hypothesis that X does not cause Y, the authors
run the restricted and unrestricted models and the test statistic:

[Mathematical Expression Omitted],

where

[Mathematical Expression Omitted].

ESS = error sum of squares; n = number of observations; P = the difference between degrees of
freedom of [ESS.sub.R], [ESS.sub.UR], and k = number of parameters estimated in the equation.
The test statistic (tau) is distributed as a chi-square variable with q degrees of freedom, where q
equals the number of restrictions. For the first hypothesis, the computed test statistic (tau) =
4.357956. At the five percent level of significance, the chi-square critical value is 3.841. The
critical value is less than the calculated value; the null hypothesis is rejected. At the 1 percent
level of significance, the chi-square critical value is 6.635; the null hypothesis is accepted. This
ambiguity arises from the fact that there is a data set of limited size. This ambiguity is discussed
in the subsequent part of this paper.

For the second hypothesis that GDP growth does not cause export growth, the same procedure
and test statistic are used. The chi-square critical value at 5 percent remains 3.841, and the
critical value at 1 percent remains 6.635. For this hypothesis test, the test statistic calculated is
2.42006. This value is less than the critical value at both the 5 percent and 1 percent levels of
significance, which results in acceptance of the null hypothesis. The authors conclude that GDP
growth does not cause export growth.

In this case, the authors have a very puzzling result. At the 5 percent level of significance, the
hypothesis that export growth does not cause GDP growth is rejected, but the hypothesis that
GDP growth does not cause export growth is accepted. This indicates that there is unidirectional
causality running from X to Y; or in other words, export growth is causing GDP growth, as
export-led development theories posit. On the other hand, though, at the 1 percent level of
significance, the authors accept the null hypothesis that export growth does not cause GDP
growth, and also accept the null hypothesis that GDP growth does not cause export growth. This
means that causality runs neither from X to Y nor Y to X. That is, export growth is not
contributing to GDP growth, and GDP growth is not leading to export growth.

What the authors can say without doubt is that GDP growth does not cause export growth, either
at the 5 percent or the 1 percent level of significance. The empirical result only shows that export
growth is causing GDP growth at the 5 percent level, not at the 1 percent level of significance.

This ambiguous result of the chi-square test is likely due to an insufficient number of
observations. That is, the sample size may be too small for application of the chi-square test,
since the chi-square distribution is asymptotically normal. With an insufficient number of data
points, the chi-square test gives ambiguous and thus unreliable results, so one must consider an
F-test.

First, the authors test the null hypothesis that export growth does not cause GDP growth. The
unrestricted model which regresses YT against LAG1YT and LAG1XT is utilized to generate
the necessary statistics for the test. The null hypothesis, more specifically, is that the coefficient
of LAG1XT = 0, and the alternative hypothesis is that the coefficient does not equal zero. The
test statistic is:

[Mathematical Expression Omitted],

where RSS = regression sum of squares; ESS = error sum of squares; and k = number of
parameters estimated in unrestricted equation.
The F-statistic calculated is 8.0375. The critical F-value with one degree of freedom in the
numerator and 57 degrees of freedom in the denominator is approximately 4.00 at the 5 percent
level of significance and 7.08 at the 1 percent level of significance. Thus, one can see that the
calculated value exceeds the critical value at both levels of significance. The authors may
unambiguously reject the null hypothesis, concluding that export growth does indeed lead to
GDP growth.

Next the F-test is applied to the second hypothesis that GDP growth does not cause export
growth. The test procedure and test statistic are the same as those above. The computed F-
statistic is 1.5179, which is less than the critical value at either 5 percent (4.00) or 1 percent
(7.08). The authors thus accept the null hypothesis that GDP growth does not cause export
growth, confirming the previous result of the chi-square test.

Application of the F-test resolves the ambiguity of the chi-square test. Results show that export
growth does contribute to GDP growth, and that GDP growth does not contribute to export
growth.

IV. Conclusions

The Granger causality test confirms the relationship between export growth and GDP growth in
the Mexican case as posited by development theory. However, this is by no means a standard
result since a time series-based Granger causality test will not support development theory in
every case. Given the nature of the Mexican economy, the results of the test are not surprising.
Petroleum and coffee exports contribute substantially to Mexico's GDP. Since the mid-1970s, the
Mexican petroleum industry has undergone rapid expansion. As of 1985, Mexico ranked fifth in
the world in terms of petroleum reserves, and it was the largest petroleum supplier to the United
States. Petroleum provided significant export revenues until a decline in international petroleum
prices in 1985. Due to declines in prices and volume of exports, the petroleum industry was
adversely affected causing major revenue loss for the country. This trend continued in 1986.
Coffee, the other significant export commodity, became the most valuable export crop in 1986.
In 1987, however, international prices fell causing a substantial decline in the value of exports.

Tariffs, import quotas, and customs unions

Atlantic Economic Journal, Dec, 1992 by Yeong-Her Yeh

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The differences between tariffs and import quotas in their economic effects have been
extensively discussed the literature |Bhagwati and Srinivasan, 1983; Marksen and Melvin,
1988~. The purpose of this paper is to demonstrate another difference between them. It has been
known that the welfare of a tariff-imposing country could increase, decrease, or remain the same
after it joins a customs union. The outcome depends on the welfare-reducing trade diversion
effect and welfare-improving trade creation effect of the customs union |Bhagwati, 1971;
Chacholiades, 1990; Lipsey, 1960~. It will be shown in this paper that the welfare of a quota-
imposing country will always increase after it joins a customs union. The partial equilibrium
approach is used in this study. It is assumed that there are no inferior goods.

In Figure I, D and S denote the demand curve and supply curve of the home country A,
respectively. |OP.sub.B~ and |OP.sub.C~ measure the prices of good X in foreign countries B
and C, respectively. |OP.sub.B~ and |OP.sub.C~ remain constant under the assumption that
country A is a small country. Suppose that country A imposes a tariff before it forms a customs
union with country B. Since |OP.sub.C~ is less than |OP.sub.B~, country A would import good X
from country C. The domestic price of good X is equal to |Mathematical Expression Omitted~,
which is greater than |OP.sub.C~ by the full amount of the tariff, t. The amount of imports is
equal to ad and the tariff revenue is measured by amnd.

Next, suppose that country A and country B form a customs union. Country A's tariff on imports
from country B will be eliminated. However, the same tariff, t, is still imposed on imports from
country C after the customs union. After the customs union, the domestic price of good X is
equal to |OP.sub.B~ and country A would import bf of good X from country B.

The effects of the customs union on country A's welfare can be shown as follows. The consumer
surplus is increased by |Mathematical Expression Omitted~. However, the producer surplus is
decreased by |Mathematical Expression Omitted~, and the tariff revenue is reduced by amnd.
The welfare of country A could increase, decrease, or remain the same after the customs union,
depending on whether (abc def) is greater than, less than, or equal to cmne, respectively. (abc
def) measures the welfare-improving trade creation effect, whereas cmne measures the welfare-
reducing trade diversion effect of the customs union.(1)

Now consider the case where country A imposes an import quota instead of a tariff before it
forms a customs union with country B. Suppose that the import quota(2) is equal to ad, the
amount of imports under the tariff. Country A will import ad of good X from country C. The
domestic price of good X in country A is equal |Mathematical Expression Omitted~ and amnd
measures the import quota revenue.(3)

Next suppose that countries A and B form a customs union. Country A's import quota on imports
from country B is eliminated. However, the same import quota (ad of good X) is still imposed on
imports from country C after the customs union. After the customs union, the domestic price of
good X is decreased to |OP.sub.B~, and the amount of imports is increased to bf However, unlike
the tariff case, only (bc ef) of good X is imported from country B. ce of good X (which is the
import quota) is still imported from country C. After the customs union, country A still could
import from country C at the price equal to |OP.sub.c~ so long as the amount of imports does not
exceed the import quota.
The effects of the customs union on country A's welfare can be shown as follows. The consumer
surplus is increased by |Mathematical Expression Omitted~. However, the producer surplus is
decreased by |Mathematical Expression Omitted~, and the import quota revenue is decreased by
aced. Like the tariff case, (abc def) measures the welfare-improving trade creation effect of the
customs union. There will be no welfare-reducing trade diversion effect of the customs union.
This is because country A still imports the same amount of good X from country C even after the
customs union. Thus, the welfare of country A in this case always increases after it joins a
customs union.

In conclusion, it has been shown above that there is another difference between tariffs and import
quotas in their economic effects. The welfare of a tariff-imposing country could increase,
decrease, or remain the same after it joins a customs union. However, the welfare of a quota-
imposing country will always increase after it joins a customs union.

1 The diversion of initial trade from a lower-cost source to a higher-cost source is the trade
diversion effect of a customs union. The creation of new trade between the home country and the
partner country is the trade creation effect of a customs union |Chacholiades, op. cit., p. 235~.

2 It is assumed that an import quota is always binding and fully utilized.

3 It is assumed that the home government raises the import quota revenue by selling import
quota licenses through competitive auctions.

Tariffs, import quotas, voluntary export

restraints and immiserizing growth
American Economist, Spring, 1999 by Y.H. Yeh

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The differences among tariffs, import quotas and voluntary restraints in their economic effects
have been discussed extensively in the literature (1, 3, 5). The purpose of this paper is to show
another difference among them. It will be shown that a country may or may not experience
immiserizing growth in the presence of a trade restriction. The outcome depends on whether the
country restricts its trade with tariffs, import quotas or voluntary export restraints. The offer
curve approach (4) is used in this study. It is assumed that neither the exportable good nor the
importable good is an inferior good.
In Figure 1, the horizontal axis and the vertical axis measure the exportable good X and the
importable good Y of the home country A, respectively. OA is the free trade offer curve of
country A before growth. OB is the free trade offer curve of the foreign country.

Now assume that country A wants to reduce the amount of imports to, say, OQ of good Y.
Country A can attain this goal by imposing a tariff. O[A.sub.t] is the offer curve after the tariff
which intersects OB at E. The welfare of country A will be represented by the trade indifference
curve I or its corresponding consumption indifference curve c, which is tangent to the pregrowth
production possibility curve MN.

Country A also could attain the same goal by imposing an import quota equal to OQ of good Y.
The offer curve after the import quota is OGQ, which intersects OB at E. Like the tariff case, the
welfare of country A is represented by the trade indifference curve I?

Lastly, country A also could restrict its imports by using a voluntary export restraint. In this case,
country A will reach point G where the foreign offer curve after the voluntary export restraint,
OEG, intersects OA. The welfare of country A will be represented by the trade indifference
curve [I.sub.v].(2)

Next suppose that there is an increase in import demand (or export supply) due to growth (2).
Country A's free trade offer curve will shift to [Mathematical Expression Omitted]. This is
because given any international price line, country A would like to export more and import more
after the increase in import demand.

After growth, the offer curve of country A under the import quota becomes [Mathematical
Expression Omitted], which intersects OB at E. The welfare of country A is now represented by
the dashed trade indifference curve [Mathematical Expression Omitted] or the corresponding
consumption indifference curve [Mathematical Expression Omitted] which is tangent to the
postgrowth production possibility curve [Mathematical Expression Omitted]. This means that the
welfare of country A always increases after growth. Growth will lead (1) to an increase in
welfare as the production possibility curve shifts outwards. However, it might also lead (2) to a
change in the terms of trade which might benefit or hurt the country. Moreover, it might lead (3)
to a change in the volume of trade and thus enhance or reduce the gains from trade. In the
presence of an import quota, the last two effects are absent. Hence, growth unambiguously
makes the country better off.

On the other hand, under the tariff, the tariffdistorted offer curve after the increase in import
demand is [Mathematical Expression Omitted] which intersects OB at F. The welfare of country
A is represented by the dashed trade indifference curve [Mathematical Expression Omitted].(4)
Since both I and [Mathematical Expression Omitted] represent a lower welfare level than
[Mathematical Expression Omitted], the welfare level represented by [Mathematical Expression
Omitted] could be lower than the welfare level represented by I. This means that immiserizing
growth can arise under the tariff.(5)

Unlike the import quota case where the terms of trade and the amount of imports remain the
same after growth, the amount of imports increases and the terms of trade deteriorate after
growth under the tariff. Thus, when the gains from growth and the increase in imports are more
than offset by the loss from the deterioration in the terms of trade, the welfare of country A
decreases.

Lastly, under the voluntary export restraint, country A will reach point [Mathematical Expression
Omitted] (where the foreign offer curve [Mathematical Expression Omitted] intersects
[Mathematical Expression Omitted]) after growth. The welfare of country A will be represented
by the dashed trade indifference curve [Mathematical Expression Omitted] at [Mathematical
Expression Omitted].(6) The welfare level represented by [Mathematical Expression Omitted]
can be lower than the welfare level represented by the trade indifference curve [I.sub.v] before
growth.(7) This is because the gain from growth could be more than offset by the loss from the
deterioration in the terms of trade after growth.

Figure 2 shows the case where there is a decrease in import demand (or export supply) after
growth. After the decrease in import demand, the free trade offer curve of country A shifts to
[Mathematical Expression Omitted].(8) This is because given any international price line,
country A would like to import less and export less after the decrease in import demand.

Under the import quota, country A's offer curve becomes [Mathematical Expression Omitted]
after growth which intersects OB at E. The welfare of country A after growth is represented by
the dotted trade indifference curve [Mathematical Expression Omitted](9) or the corresponding
consumption indifference curve [Mathematical Expression Omitted], which is tangentto the
postgrowth production possibility curve [Mathematical Expression Omitted]. Since the
consumption indifference curve c after growth always lies above the consumption indifference
curve c before growth, immiserizing growth never arises.

Under the tariff, the tariff-distorted offer curve shifts to [Mathematical Expression Omitted],
after the decrease in import demand. [Mathematical Expression Omitted] intersects OB at U. The
welfare of country A is now represented by the dotted trade indifference curve [Mathematical
Expression Omitted].(10) Since both I and [Mathematical Expression Omitted] represent a lower
welfare level than [Mathematical Expression Omitted], the welfare level represented by
[Mathematical Expression Omitted] could be lower than the welfare level represented by I. This
means that immiserizing growth could take place under the tariff. This is because the gains from
growth and the improvement in the terms of trade can be more than offset by the loss from the
reduction in imports.(11)

Lastly, under the voluntary export restraint, country A will reach point [Mathematical Expression
Omitted] (where the foreign offer curve [Mathematical Expression Omitted] intersects
[Mathematical Expression Omitted]) after growth. The welfare of country A will be represented
by the dotted trade indifference curve [Mathematical Expression Omitted] at [Mathematical
Expression Omitted]. The welfare level represented by [Mathematical Expression Omitted] will
be always higher than the welfare level represented by the trade indifference curve [I.sub.v]
before growth.(12) This is because country A gains from growth and the improvement in the
terms of trade after growth.
In conclusion, this paper shows another difference among tariffs, import quotas and voluntary
export restraints. Immiserizing growth never arises in the presence of import quotas. This is true
whether there is an increase in import demand or a decrease in import demand after growth. On
the other hand, immiserizing growth can occur in the presence of tariffs. This is true whether
growth leads to an increase in import demand or a decrease in import demand. Lastly,
immiserizing growth never arises in the presence of voluntary export restraints if there is a
decrease in import demand after growth. However, immiserizing growth could take place in the
presence of voluntary export restraints if there is an increase in import demand after growth.

The author is grateful to an anonymous referee for valuable comments, but is responsible for any
error which remains.

Notes

1. It is assumed that the government of country A raises import quota revenues by selling import
licenses through competitive auctions. Then, like tariff revenues, import quota revenues are
redistributed to the private sector. Draw line Og which has a slope equal to the slope of I at E.
Line Og intersects OA at h. The tariff revenue (or the import quota revenue) is spent on fh of
good X and fE of good Y.

2. Under a voluntary export restraint, the import restriction is administered by the exporting
country. Therefore, the revenue from the import restriction is captured by the exporting country.
EG measures the revenue captured by country B.

3. The dashed trade indifference curves represent the new trade indifference curves after the
increase in import demand. They are derived with a new production possibility curve after
growth.

4. On the one hand, the tariff rate is the same before and after growth. On the other hand, the
international price line OF (not drawn) after growth is less steep than the international price line
OE (not drawn) before growth. Therefore, the slope of [Mathematical Expression Omitted] at F
(which measures the domestic price ratio after growth) is less than the slope of I at E (which
measures the domestic price ratio before growth).

5. Immiserizing growth, however, never takes place if [Mathematical Expression Omitted]

intersects OB at W (where [Mathematical Expression Omitted] intersects OB) or at a point
between E and W.

6. After the increase in import demand in country A, country B's exports remain the same as OQ
of good Y. However, the revenue captured by country B is increased from EG to [Mathematical
Expression Omitted].

7. Since both [I.sub.v] and [Mathematical Expression Omitted] represent a lower welfare level
than [Mathematical Expression Omitted], it is possible that [Mathematical Expression Omitted]
represents a lower welfare level than [I.sub.v].
8. [Mathematical Expression Omitted] cannot lie to the left of O[A.sub.t]. Otherwise quota OQ
cannot remain binding after the decrease in import demand.

9. The dotted trade indifference curves represent the new trade indifference curves after the
decrease in import demand. They are derived with a new production possibility curve after
growth.

10. On the one hand, the tariff rate is the same before and after growth. On the other hand, the
international price line OU (not drawn) after growth is steeper than the international price line
OE (not drawn) before growth. Therefore, the slope of [Mathematical Expression Omitted] at U
(which measures the domestic price ratio after growth) is greater than the slope of I at E (which
measures the domestic price ratio before growth).

11. Immiserizing growth, however, cannot arise if [Mathematical Expression Omitted], intersects
OB at S (where [Mathematical Expression Omitted] intersects OB) or at a point between E and
S.

12. [Mathematical Expression Omitted] represents a higher welfare level than [Mathematical
Expression Omitted], which in turn represents a higher welfare level than [I.sub.v].

Why Are Tariffs Preferable to Quotas?

Tariffs vs. Quotas

From Mike Moffatt, former About.com Guide

See More About:

• tariffs
• quotas
• economic growth

[Q:] Why are tariffs preferred to quantitative restrictions as a means of

controlling imports?

[A:]Thanks for your question!

Tariffs and quantative restrictions (commonly known as import quotas) both serve the purpose of
controlling the number of foreign products that can enter the domestic market. There are a few
reasons why tariffs are a more attractive option than import quotas.
Three Reasons Why Tariffs Are Preferable to Quotas

1. Tariffs Generate Revenue for the Government: If the U.S. government

puts a 20% tariffs on imported Indian cricket bats they will collect $10 million
dollars if $50 million worth of Indian cricket bats are imported in a year. That
may sound like small change for a government, but given the millions of
different goods which are imported into a country, the numbers start to add
up. The Progressive Policy Institute has found that the United States collects
20 billion dollars a year in tariff revenue. This is revenue that would be lost to
the government unless their import quota system charged a liscencing fee on
importers. Which brings me to point 2.
2. Import Quotas Can Lead to Administrative Corruption: Suppose that
there is currently no restriction on importing Indian cricket bats and 30,000
are sold in the U.S. each year. For some reason the United States decides
that they only want 5,000 Indian cricket bats sold per year. They could set an
import quota at 5,000 to achieve this objective. The problem is: How do they
decide which 5,000 bats get in and which 25,000 do not? The government
now has to tell some importer that their cricket bats will be let into the
country and tell some other importer than his will not be. This gives the
customs officials a lot of power as they can now give access to favored
corporations and deny access to those who are not favored. This can cause a
serious corruption problem in countries with import quotas as the importers
chosen to meet the quota are the ones who can provide the most favors to
the customs officers.

A tariff system can achieve the same objective without the possibility of corruption. The
tarriff is set at a level which causes the price of the cricket bats to rise just enough so that
the demand for cricket bats falls to 5,000 per year. Although tariffs control the price of a
good, they indirectly control the quantity sold of that good due to the interaction of
supply and demand.

3. Import Quotas Are More Likely to Cause Smuggling: Both tariffs and
import quotas will cause smuggling if they are set at unreasonable levels. If
the tariff on cricket bats is set at 95% then it's likely that people will try to
sneak the bats into the country illegally, just as they would if the import
quota is only a small fraction of the demand for the product. So governments
have to set the tariff or the import quota at a reasonable level. But what if
the demand changes? Suppose cricket becomes a big fad in the United States
and everybody and their neighbour wants to buy an Indian cricket bat? An
import quota of 5,000 might be reasonable if the demand for the product
would otherwise be 6,000. Overnight, though, the demand has now jumped
to 60,000. With an import quota there will be massive shortages and
smuggling in cricket bats will become quite profitable. A tariff does not have
these problems. A tariff does not provide a firm limit on the number of
products that enter. So if the demand goes up, the number of bats sold will
go up, and the government will collect more revenue. Of course, this can also
be used as an argument against tariffs as the government cannot ensure that
the number of imports will stay below a certain level.
For these three reasons, tariffs are generally considered to be preferrable to import
quotas.

Tariffs - The Economic Effect of Tariffs

How Tariffs Effect The Economy

From Mike Moffatt, former About.com Guide

See More About:

• tariffs
• quotas
• economic growth

In my article The Softwood Lumber Dispute we saw an example of a tariff

placed on a foreign good. A tariff is simply a tax or duty placed on an imported good
by a domestic government. Tariffs are usually levied as a percentage of the
declared value of the good, similar to a sales tax. Unlike a sales tax, tariff rates are
often different for every good and tariffs do not apply to domestically produced
goods.

The upcoming book Advanced International Trade: Theory and Evidence by Robert Feenstra
gives three situations in which governments often impose tariffs:

• To protect fledgling domestic industries from foreign competition.

• To protect aging and inefficient domestic industries from foreign competition.
• To protect domestic producers from dumping by foreign companies or
governments. Dumping occurs when a foreign company charges a price in
the domestic market which is "too low". In most instances "too low" is
generally understood to be a price which is lower in a foreign market than the
price in the domestic market. In other instances "too low" means a price
which is below cost, so the producer is losing money.

The cost of tariffs to the economy is not trivial. The World Bank estimates that if all
barriers to trade such as tariffs were eliminated, the global economy would expand
by 830 billion dollars by 2015. The economic effect of tariffs can be broken down
into two components:

• The impact to the country which has a tariff imposed on it.

• The impact to the country imposing the tariff.

In almost all instances the tariff causes a net loss to the economies of both the
country imposing the tariff and the country the tariff is imposed on.
Impact to the economy of a country with the tariff imposed on it.
It is easy to see why a foreign tariff hurts the economy of a country. A foreign tariff
raises the costs of domestic producers which causes them to sell less in those
foreign markets. In the case of the softwood lumber dispute, it is estimated that
recent American tariffs have cost Canadian lumber producers 1.5 billion Canadian
dollars. Producers cut production due to this reduction in demand which causes jobs
to be lost. These job losses impact other industries as the demand for consumer
products decreases because of the reduced employment level. Foreign tariffs, along
with other forms of market restrictions, cause a decline in the economic health of a
nation.

The next section explains why tariffs also hurt the economy of the country which imposes them.

Except in all but the rarest of instances, tariffs hurt the country that imposes them,
as their costs outweigh their benefits. Tariffs are a boon to domestic producers who
now face reduced competition in their home market. The reduced competition
causes prices to rise. The sales of domestic producers should also rise, all else being
equal. The increased production and price causes domestic producers to hire more
workers which causes consumer spending to rise. The tariffs also increase
government revenues that can be used to the benefit of the economy.

There are costs to tariffs, however. Now the price of the good with the tariff has increased, the
consumer is forced to either buy less of this good or less of some other good. The price increase
can be thought of as a reduction in consumer income. Since consumers are purchasing less,
domestic producers in other industries are selling less, causing a decline in the economy.

Generally the benefit caused by the increased domestic production in the tariff protected industry
plus the increased government revenues does not offset the losses the increased prices cause
consumers and the costs of imposing and collecting the tariff. We haven't even considered the
possibility that other countries might put tariffs on our goods in retaliation, which we know
would be costly to us. Even if they do not, the tariff is still costly to the economy. In my article
The Effect of Taxes on Economic Growth we saw that increased taxes cause consumers to alter
their behavior which in turn causes the economy to be less efficient. Adam Smith's The Wealth
of Nations showed how international trade increases the wealth of an economy. Any mechanism
designed to slow international trade will have the effect of reducing economic growth. For these
reasons economic theory teaches us that tariffs will be harmful to the country imposing them.

That's how it should work in theory. How does it work in practice?

Empirical Evidence on the Effect of Tariffs on the Country Imposing Them

Study after study has shown that tariffs cause reduced economic growth to the
country imposing them. A few of examples:

1. The essay on Free Trade at The Concise Encyclopedia of Economics looks at

the issue of international trade policy. In the essay, Alan Blinder states that
 "one study estimated that in 1984 U.S. consumers paid $42,000 annually for
each textile job that was preserved by import quotas, a sum that greatly
exceeded the average earnings of a textile worker. That same study
estimated that restricting foreign imports cost $105,000 annually for each
automobile worker's job that was saved, $420,000 for each job in TV
manufacturing, and $750,000 for every job saved in the steel industry."
2. In the year 2000 President Bush raised tariffs on imported steel goods
between 8 and 30 percent. The Mackinac Center for Public Policy cites a
study which indicates that the tariff will reduce U.S. national income by
between 0.5 to 1.4 billion dollars. The study estimates that less than 10,000
jobs in the steel industry will be saved by the measure at a cost of over
$400,000 per job saved. For every job saved by this measure, 8 will be lost.
3. The cost of protecting these jobs is not unique to the steel industry or to the
United States. The National Center For Policy Analysis estimates that in 1994
tariffs cost the U.S. economy 32.3 billion dollars or $170,000 for every job
saved. Tariffs in Europe cost European consumers $70,000 per job saved
while Japanese consumers lost $600,000 per job saved through Japanese
tariffs.

These studies, like many others, indicate that tariffs do more harm than good. If these tariffs are
so bad for the economy, why do governments keep enacting them? We'll discuss that question in
the next section.

Study after study has shown that tariffs, whether they be one tariff or hundreds, are bad for the
economy. If tariffs do not help the economy, why would a politician enact one? After all
politicans are reelected at a greater rate when the economy is doing well, so you would think it
would be in their self interest to prevent tariffs.

Recall that tariffs are not harmful for everyone, and they have a distributive effect. Some people
and industries gain when the tariff is enacted and others lose. The way gains and losses are
distributed is absolutely crucial in understanding why tariffs along with many other policies are
enacted. To understand the logic behind the policies we need to understand The Logic of
Collective Action. My article titled The Logic of Collective Action discusses the ideas of a book
by the same name, written by Mancur Olson in 1965. Olson explains why economic policies are
often to the benefit of smaller groups at the expense of larger ones. Take the example of tariffs
placed on imported Canadian softwood lumber. We'll suppose the measure saves 5,000 jobs, at
the cost of $200,000 per job, or a cost of 1 billion dollars to the economy. This cost is distributed
through the economy and represents just a few dollars to every person living in America. It is
obvious to see that it's not worth the time and effort for any American to educate himself about
the issue, solicit donations for the cause and lobby congress to gain a few dollars. However, the
benefit to the American softwood lumber industry is quite large. The ten-thousand lumber
workers will lobby congress to protect their jobs along with the lumber companies that will gain
hundreds of thousands of dollars by having the measure enacted. Since the people who gain from
the measure have an incentive to lobby for the measure, while the people who lose have no
incentive to spend the time and money to lobby against the issue, the tariff will be passed
although it may, in total, have negative consequences for the economy.
The gains from tariff policies are a lot more visible than the losses. You can see the sawmills
which would be closed down if the industry is not protected by tariffs. You can meet the workers
whose jobs will be lost if tariffs are not enacted by the government. Since the costs of the
policies are distributed far and wide, you cannot put a face on the cost of a poor economic policy.
Although 8 workers might lose their job for every job saved by a softwood lumber tariff, you
will never meet one of these workers, because it is impossible to pinpoint exactly which workers
would have been able to keep their jobs if the tariff was not enacted. If a worker loses his job
because the performance of the economy is poor, you cannot say if a reduction in lumber tariffs
would have saved his job. The nightly news would never show a picture of a California farm
worker and state that he lost his job because of tariffs designed to help the lumber industry in
Maine. The link between the two is impossible to see. The link between lumber workers and
lumber tariffs is much more visible and thus will garner much more attention.

The gains from a tariff are clearly visible but the costs are hidden, it will often appear that tariffs
do not have a cost. By understanding this we can understand why so many government policies
are enacted which harm the economy.

Top Ten Management on Voluntary Export Restraints: An Overview of Why Limiting

Exports Can Help Keep The Economy Strong

by David Wyld

his overview of the concept of Voluntary Export Restraints was prepared by Brant Dill
while an Accounting major in the College of Business at Southeastern Louisiana
University.

Introduction

In this article, I will discuss what a Voluntary Export Restraint (VER) is and how it is used. We
will look into where and why this was first started and how it affects countries both positively
and negatively. Also we will look at a few key facts about this topic and a video to help explain
it.

The Idea in a Nutshell

Voluntary Export Restraint or Restrictions (VER) is a government imposed limit on the quantity
of goods that can be exported during a certain period. These restraints are usually agreed upon
by the importing country and exporting country to keep everyone happy. VERs have been
around since at least the 1930s, and can be applied to textiles, steel, tools, automobiles, etc. In
1981, the U.S. auto industry was threatened by Japanese vehicles. So, a VER agreement was
made to allow Japan to export 1.68 million cars to the U.S. annually.

The Top Ten Things You Need to Know About Voluntary Export Restraints
1. VERs are agreed upon by importers and exporters. A bilateral basis is used to
control the amounts of goods that are transferred from one country to another country.

2. As a result of the Japanese/American VER agreement to limit the number of

cars exported to America, American buyers suffered. They were forced to buy less
economical vehicles made by American auto-makers. Those consumers who still opted
to buy Japanese vehicles had to pay higher prices.

3. Textiles were also regulated by VERs between the United States and Japan.
The VER was agreed upon to decrease the amount of cotton that Japan was sending to the
U.S. This VER turned into the Multi-Fiber Agreement in the 1970’s and was phased out
in 2004.

4. Because a VER is not usually a voluntary decision by the exporting country, the
WTO decided to phase out all VERs over a four year time period. This was a result of
the Uruguay round of the GATT (General Agreement on Tariffs and Trade) in 1994.

5. Foreign producers agree to VERs because they fear that harsher restrictions will
be placed on their trading abilities. They fear damaging tariffs and import quotas will
follow if they do not agree to the VER. A VER is used to make the best out of a bad
situation.

6. VERs do not benefit consumers because they have to pay more. When VERs
are implemented, the domestic producers benefit because it limits the import competition.

7. A VER was used to control the number of raw and processed tuna being
imported to the U.S. by Japan. Tuna was the second largest Japanese import behind raw
silk. The VER implemented unilateral restraints on tuna exports to the U.S. from April
1952 to March 1953. This was the first VER post World War II.

8. A VER on cotton textiles left a legacy of bitterness between the United States
and Japan. Between 1956 and 1960, Hong Kong’s imports of cotton increased from $7
million to $63.5 million. The United States increased their profits during this period and
the Japanese experienced a great loss.

9. VERs became a topic of interest during the Kennedy administration. Some

people felt that VERs were used inappropriately and that they should be issued less
frequently. This led to many changes in the International Trade Policy.

10. In 1967 the Trade Expansion Act, accelerated the use of VERs. This created a
right to equal compensation for those countries that were affected by the United States’
decisions to issue so many VERs.

My Take
I believe that VERs are still relevant because when used properly they can keep prices and the
economy in balance. Trading between countries can be kept satisfied by the use of VERs. By
agreeing to limit the amount of goods exported to a country you can successfully keep that trade
barrier open. Importing and exporting are a huge part of everyday business and VERs help keep
possible feuds between nations at a minimum. VERs are like that quick an easy fix that lasts
long enough to find a permanent solution.

References

Benjamin, D. K. (1999). Voluntary Export Restraints on Automobiles. Retrieved September 22,

2010, from Property and Environment Research Center:
http://www.perc.org/articles/article416.php

McClenahan, W. (1991). The Growth of Voluntary Export Restraints and American Foreign
Economic Policy. Retrieved September 20, 2010, from h-net: http://www.h-
net.org/~business/bhcweb/publications/.../p0180-p0190.pdf

Suranovic, S. M. (2006, June 2). Textile VERs. Retrieved September 20, 2010, from International
Trade Theory and Policy: http://internationalecon.com/Trade/Tch10/T10-3B.php

Voluntary Export Restraint. (2010, September 8). Retrieved September 17, 2010, from
Wikipedia: http://en.wikipedia.org/wiki/Voluntary_Export_Restraints

The Basics Of Tariffs And Trade Barriers

by Brent Radcliffe

International trade increases the number of goods that domestic consumers can choose from,
decreases the cost of those goods through increased competition, and allows domestic industries
to ship their products abroad. While all of these seem beneficial, free trade isn't widely accepted
as completely beneficial to all parties. This article will examine why this is the case, and how
countries react to the variety of factors that attempt to influence trade. (To start with a discussion
on trade, see What Is International Trade? and The Globalization Debate.)

What Is a Tariff?
In simplest terms, a tariff is a tax. It adds to the cost of imported goods and is one of several
trade policies that a country can enact.

Why Are Tariffs and Trade Barriers Used?

Tariffs are often created to protect infant industries and developing economies, but are also used
by more advanced economies with developed industries. Here are five of the top reasons tariffs
are used:
 1. Protecting Domestic Employment - The levying of tariffs is often highly politicized. The
possibility of increased competition from imported goods can threaten domestic
industries. These domestic companies may fire workers or shift production abroad to cut
costs, which means higher unemployment and a less happy electorate. The
unemployment argument often shifts to domestic industries complaining about cheap
foreign labor, and how poor working conditions and lack of regulation allow foreign
companies to produce goods more cheaply. In economics, however, countries will
continue to produce goods until they no longer have a comparative advantage (not to be
confused with an absolute advantage).

2. Protecting Consumers - A government may levy a tariff on products that it feels could
endanger its population. For example, South Korea may place a tariff on imported beef
from the United States if it thinks that the goods could be tainted with disease.

3. Infant Industries - The use of tariffs to protect infant industries can be seen by the Import
Substitution Industrialization (ISI) strategy employed by many developing nations. The
government of a developing economy will levy tariffs on imported goods in industries in
which it wants to foster growth. This increases the prices of imported goods and creates a
domestic market for domestically produced goods, while protecting those industries from
being forced out by more competitive pricing. It decreases unemployment and allows
developing countries to shift from agricultural products to finished goods.

Criticisms of this sort of protectionist strategy revolve around the cost of subsidizing the
development of infant industries. If an industry develops without competition, it could
wind up producing lower quality goods, and the subsidies required to keep the state-
backed industry afloat could sap economic growth.

4. National Security - Barriers are also employed by developed countries to protect certain
industries that are deemed strategically important, such as those supporting national
security. Defense industries are often viewed as vital to state interests, and often enjoy
significant levels of protection. For example, while both Western Europe and the United
States are industrialized, both are very protective of defense-oriented companies. This
can be seen in the special treatment of Boeing (NYSE:BA) by the United States and
Airbus by Europe.

5. Retaliation - Countries may also set tariffs as a retaliation technique if they think that a
trading partner has not played by the rules. For example, if France believes that the
United States has allowed its wine producers to call its domestically produced sparkling
wines "Champagne" (a name specific to the Champagne region of France) for too long, it
may levy a tariff on imported meat from the United States. If the U.S. agrees to crack
down on the improper labeling, France is likely to stop its retaliation. Retaliation can also
be employed if a trading partner goes against the foreign policy objectives of the
government.

The next section will cover the various types of trade barriers and tariffs.
Types of Tariffs and Trade Barriers
There are several types of tariffs and barriers that a government can employ:

• Specific tariffs
• Ad valorem tariffs
• Licenses
• Import quotas
• Voluntary export restraints
• Local content requirements

Specific Tariffs - A fixed fee levied on one unit of an imported good is referred to as a specific
tariff. This tariff can vary according to the type of good imported. For example, a country could
levy a $15 tariff on each pair of shoes imported, but levy a $300 tariff on each computer
imported.

Ad Valorem Tariffs - The phrase ad valorem is Latin for "according to value", and this type of
tariff is levied on a good based on a percentage of that good's value. An example of an ad
valorem tariff would be a 15% tariff levied by Japan on U.S. automobiles. The 15% is a price
increase on the value of the automobile, so a $10,000 vehicle now costs $11,500 to Japanese
consumers. This price increase protects domestic producers from being undercut, but also keeps
prices artificially high for Japanese car shoppers.

Non-tariff barriers to trade include:

Licenses - A license is granted to a business by the government, and allows the business to
import a certain type of good into the country. For example, there could be a restriction on
imported cheese, and licenses would be granted to certain companies allowing them to act as
importers. This creates a restriction on competition, and increases prices faced by consumers.

Import Quotas - An import quota is a restriction placed on the amount of a particular good that
can be imported. This sort of barrier is often associated with the issuance of licenses. For
example, a country may place a quota on the volume of imported citrus fruit that is allowed.

Voluntary Export Restraints (VER) - This type of trade barrier is "voluntary" in that it is created
by the exporting country rather than the importing one. A voluntary export restraint is usually
levied at the behest of the importing country, and could be accompanied by a reciprocal VER.
For example, Brazil could place a VER on the exportation of sugar to Canada, based on a request
by Canada. Canada could then place a VER on the exportation of coal to Brazil. This increases
the price of both coal and sugar, but protects the domestic industries.

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.
In the final section we'll examine who benefits from tariffs and how they affect the price of
goods.

Who Benefits?
The benefits of tariffs are uneven. Because a tariff is a tax, the government will see increased
revenue as imports enter the domestic market. Domestic industries also benefit from a reduction
in competition, since import prices are artificially inflated. Unfortunately for consumers - both
individual consumers and businesses - higher import prices mean higher prices for goods. If the
price of steel is inflated due to tariffs, individual consumers pay more for products using steel,
and businesses pay more for steel that they use to make goods. In short, tariffs and trade
barriers tend to be pro-producer and anti-consumer.

The effect of tariffs and trade barriers on businesses, consumers and the government shifts over
time. In the short run, higher prices for goods can reduce consumption by individual consumers
and by businesses. During this time period, businesses will profit and the government will see an
increase in revenue from duties. In the long term, businesses may see a decline in efficiency due
to a lack of competition, and may also see a reduction in profits due to the emergence of
substitutes to their products. For the government, the long-term effect of subsidies is an increase
in the demand for public services, since increased prices, especially in foodstuffs, leaves less
disposable income. (For related reading, check out In Praise Of Trade Deficits.)

How Do Tariffs Affect Prices?

Tariffs increase the prices of imported goods. Because of this, domestic producers are not forced
to reduce their prices from increased competition, and domestic consumers are left paying higher
prices as a result. Tariffs also reduce efficiencies by allowing companies that would not exist in a
more competitive market to remain open.

Figure 1 illustrates the effects of world trade without the presence of a tariff. In the graph, DS
means Domestic Supply and DD means Domestic Demand. The price of goods at home is found
at price P, while the world price is found at P*. At a lower price, domestic consumers will
consume Qw worth of goods, but because the home country can only produce up to Qd, it must
import Qw-Qd worth of goods.
 Figure 1. Price without the influence of a tariff

When a tariff or other price-increasing policy is put in place, the effect is to increase prices and
limit the volume of imports. In Figure 2, price increases from the non-tariff P* to P'. Because
price increases, more domestic companies are willing to produce the good, so Qd moves right.
This also shifts Qw left. The overall effect is a reduction in imports, increased domestic
production and higher consumer prices. (To learn more about the movement of equilibrium due
to changes in supply and demand, read Understanding Supply-Side Economics.)

Figure 2. Price under the effects of a tariff

Tariffs and Modern Trade

The role tariffs play in international trade has declined in modern times. One of the primary
reasons for the decline is the introduction of international organizations designed to improve free
trade, such as the World Trade Organization (WTO). Such organizations make it more difficult
for a country to levy tariffs and taxes on imported goods, and can reduce the likelihood of
retaliatory taxes. Because of this, countries have shifted to non-tariff barriers, such as quotas and
export restraints. Organizations like the WTO attempt to reduce production and consumption
distortions created by tariffs. These distortions are the result of domestic producers making
goods due to inflated prices, and consumers purchasing fewer goods because prices have
increased. (To learn about the WTO's efforts, read What Is The World Trade Organization?)

Since the 1930s, many developed countries have reduced tariffs and trade barriers, which has
improved global integration, as well as brought about globalization. Multilateral agreements
between governments increase the likelihood of tariff reduction, and enforcement on binding
agreements reduces uncertainty.

Conclusion
Free trade benefits consumers through increased choice and reduced prices, but because the
global economy brings with it uncertainty, many governments impose tariffs and other trade
barriers to protect industry. There is a delicate balance between the pursuit of efficiencies and the
government's need to ensure low unemployment.

by Brent Radcliffe (Contact Author | Biography)

Brent Radcliffe is an analyst with a publishing company based in Washington, DC. He is a

graduate of the University of Florida with a degree in International Economics, with minors in
both French and International Relations. Radcliffe is a freelance writer covering topics related to
economics, trade and investing.

How Globalization Affects Developed

Countries
by Nicolas Pologeorgis
The phenomenon of globalization began in a primitive form when humans first settled into
different areas of the world; however, it has shown a rather steady and rapid progress in the
recent times and has become an international dynamic which, due to technological
advancements, has increased in speed and scale, so that countries in all five continents have been
affected and engaged.

What Is Globalization?
Globalization is defined as a process which, based on international strategies, aims to expand
business operations on a worldwide level and was precipitated by the facilitation of global
communications due to technological advancements, and socioeconomic, political and
environmental developments. The goal of globalization is to provide organizations a superior
competitive position with lower operating costs, to gain greater numbers of products, services
and consumers. This approach to competition is gained via diversification of resources, the
creation and development of new investment opportunities by opening up additional markets,
and accessing new raw materials and resources. Diversification of resources is a business
strategy that increases the variety of business products and services within various organizations.
Diversification strengthens institutions by lowering organizational risk factors, spreading
interests in different areas, taking advantage of market opportunities and acquiring companies
both horizontal and vertical in nature.

Industrialized or developed nations are specific countries with a high level of economic
development and meet certain socioeconomic criteria based on economic theory such as gross
domestic product (GDP), industrialization and human development index (HDI) as defined by
the International Monetary Fund (IMF), the United Nations (UN) and the World Trade
Organization (WTO). Using these definitions, some industrialized countries in 2010 were:
Austria, United Kingdom, Belgium, Denmark, Finland, France, Germany, Japan, Luxembourg,
Norway, Sweden, Switzerland, and the United States. (The WTO sets the global rules of trade.
But what exactly does it do and why do so many oppose it? Read What Is The World Trade
Organization?)

Components of Globalization
The components of globalization include GDP, industrialization and the Human Development
Index (HDI). The GDP is the market value of all finished goods and services produced within a
country's borders in a year and serves as a measure of a country's overall economic output.
Industrialization is a process which, driven by technological innovation, effectuates social
change and economic development by transforming a country into a modernized industrial, or
developed, nation. The Human Development Index comprises three components. Specifically, a
country's (a) population's life expectancy, (b) knowledge and education measured by the adult
literacy and (c) income.

The degree to which an organization is globalized and diversified has bearing on the strategies
that it uses to pursue greater development and investment opportunities.

The Economic Impact on Developed Nations

Globalization compels businesses to adapt to different strategies based on new ideological trends
that try to balance rights and interests of both the individual and the community as a whole. This
change enables businesses to compete worldwide and also signifies a dramatic change for
business leaders, labor and management by legitimately accepting the participation of workers
and government in developing and implementing company policies and strategies. Risk
reduction via diversification can be accomplished through company involvement with
international financial institutions and partnering with both local and multinational businesses.
(Investing overseas begins with a determination of the risk of the country's investment climate,
read Evaluating Country Risk For International Investing.)

Globalization brings reorganization at the international, national and sub-national levels.

Specifically, it brings the reorganization of production, international trade and the integration of
financial markets, thus affecting capitalist economic and social relations via multilateralism and
microeconomic phenomena, such as business competitiveness, at the global level. The
transformation of the production systems affects the class structure, the labor process, the
application of technology and the structure and organization of capital. Globalization is now seen
as marginalizing the less educated and low-skilled workers. Business expansion will no longer
automatically imply increased employment. Additionally, it can cause high remuneration of
capital due to its higher mobility compared to labor.

The phenomenon seems to be driven by three major forces: globalization of all product and
financial markets, technology and deregulation. Globalization of product and financial markets
refers to an increased economic integration in specialization and economies of scale, which will
result in greater trade in financial services through both capital flows and cross-border entry
activity. The technology factor, specifically telecommunication and information availability,
have facilitated remote delivery and provided new access and distribution channels while
revamping industrial structures for financial services by allowing entry of non-bank entities such
as telecoms and utilities.

Deregulation pertains to the liberalization of capital account and financial services in products,
markets and geographic locations. It integrated banks by offering a broad array of services,
allowed entry of new providers and increased multinational presence in many markets and more
cross-border activities.

In a global economy, power is the ability of a company to command both tangible and intangible
assets that create customer loyalty, regardless of location. Independent of size or geographic
location, a company can meet global standards and tap into global networks, thrive and act as a
world class thinker, maker and trader, by using its greatest assets: its concepts, competence and
connections.

Beneficial Effects
Some economists have a positive outlook regarding the net effects of globalization on economic
growth. These effects have been analyzed over the years by several studies attempting to
measure the impact of globalization on various nations' economies using variables such as trade,
capital flows and their openness, GDP per capita, foreign direct investment (FDI) and more.
These studies examined the effects of several components of globalization on growth using time
series cross sectional data on trade, FDI and portfolio investment. Although they provide an
analysis of individual components of globalization on economic growth, some of the results are
inconclusive or even contradictory. However, overall, the findings of those studies seem to be
supportive of the economists' positive position instead of the one held by the public and non-
economist view.

Trade among nations via the use of comparative advantage promotes growth, which is attributed
to a strong correlation between the openness to trade flows and the affect on economic growth
and economic performance. Additionally there is a strong positive relation between capital flows
and their impact on economic growth.

Foreign Direct Investment's impact on economic growth has had a positive growth effect in
wealthy countries and an increase in trade and FDI resulted in higher growth rates. Empirical
research examining the effects of several components of globalization on growth using time
series and cross sectional data on trade, FDI and portfolio investment found that a country tends
to have a lower degree of globalization if it generates higher revenues from trade taxes. Further
evidence indicates that there is a positive growth-effect in countries which are sufficiently rich as
are most of the developed nations.

The World Bank reports that integration with global capital markets can lead to disastrous effects
without sound domestic financial systems in place. Furthermore globalized countries have lower
increases in government outlays, as well as taxes, and lower levels of corruption in their
governments.

One of the potential benefits of globalization is to provide opportunities for reducing

macroeconomic volatility on output and consumption via diversification of risk.

Harmful Effects
Non-economists and the wide public expect the costs associated with globalization to outweigh
the benefits, especially in the short-run. Less wealthy countries from those among the
industrialized nations may not have the same highly-accentuated beneficial effect from
globalization as more wealthy countries measured by GDP per capita etc. Free trade, although
increases opportunities for international trade, it also increases the risk of failure for smaller
companies that cannot compete globally.

Additionally it may drive up production and labor costs including higher wages for more skilled
workforce. Domestic industries in some countries may be endangered due to comparative or
absolute advantage of other countries in specific industries. Another possible danger and harmful
effect is the overuse and abuse of natural resources to meet the new higher demand in the
production of goods. (Learn what both the supporters and critics have to say about this growing
global trend The Globalization Debate.)

The Bottom Line

One of the major potential benefits of globalization is to provide opportunities for reducing
macroeconomic volatility on output and consumption via diversification of risk. The overall
evidence of the globalization effect on macroeconomic volatility of output indicates that,
although in theoretical models the direct effects are ambiguous, financial integration helps in a
nation's production base diversification, leads to an increase in specialization of production.
However, the specialization of production based on the concept of comparative advantage can
also lead to higher volatility in specific industries within an economy and society of a nation. As
time passes, successful companies, independent of size, will be the ones that are part of the
global economy. (Read Does International Investing Really Offer Diversification?)

by Nicolas Pologeorgis (Contact Author | Biography)

Dr. Nicolas Pologeorgis has been an assistant provost, dean, MBA director, associate director for
a Center for Economic Education, full-time faculty and part-time instructor in colleges and
universities in both traditional and online settings for the past 15 years. He has participated and
served on accreditation teams as a chair and/or mentor and is now the lead consultant for higher
education assessment, evaluation and accreditation for the Center for Assessment and
Accreditation. Additionally, Pologeorgis teaches online for a number of institutions of higher
education and mentors students in their pursuit of their masters' or doctoral degrees in the
capacity of dissertation committee member or chair or external reviewer in the areas of business,
economics and finance. Prior to working in academia, Pologeorgis spent 10 years in the financial
service industry.