Trade Protectionism: Impact of Tariffs and Trade Barriers on International Trade

There are benefits to free trade, but some parties could lose out as well; that is why governments may feel the need to interfere and regulate certain aspects of the trade. Let’s understand why governments control trade and identify methods governments use to control trade.

Introduction to Trade Tariffs

Tariff refers to taxes or duties levied on imports which results in raising the prices of imported goods. Government add taxes to raise prices of imported goods so that it becomes expensive to the end user.

The taxes owed on imports are paid by the domestic consumers and are usually paid to the customs authority of the country imposing the tariff. Often, imported goods are cheaper because they use cheaper capital or labor costs, but if those goods become more expensive, consumers are likely to switch.

There are several reasons why a country may decide to apply taxes/trade tariffs on imports.

Currently, it is the most widely used method to regulate flow of trade, and certain free trade agreements allow member states to use only tariffs for trade regulation and that too under special circumstances.

More importantly, this method of levying tariffs uses price mechanism which forms the core of modern economic theory; the theory of production and trade is influenced by how tariffs effects wages.

Tariffs make imported products expensive and give a price advantage to locally-produced goods over similar goods which are imported, this helps raise revenues for governments and also make the locals happy.

Freer trade can hurt domestic firms, and workers working for these less-efficient industries are likely to lose jobs. Government levy tariffs if it wants to protect some of its domestic industries which may not be yet ready to compete with the more efficient and large foreign companies.

If its industries are in an infant stage; barriers are also commonly employed to protect certain strategic industries such as the defense.

A government may also levy a tariff on products that it feels could endanger its population. For example, a country may place a tariff on imported food from other country if it thinks that the goods could be tainted with a disease.

While tariffs can be used to protect a few domestic sectors, most economists are of the view that free trade policies are best suited in a global market as it creates jobs elsewhere and promotes economic growth for all the countries involved.

The levying of tariffs is often highly politicized, but in pure economics term, countries will continue to produce goods until they no longer have a comparative advantage.

Tariff and Non-Tariff Barriers

Tariff

• are direct taxes and charges imposed on imports
• are a barrier to trade
• are visible and known in quantity
• can be accounted for when a company develops its marketing strategy
• are generally simple, straightforward and easy for a country to administer
• can be used by government’s as a way to make revenue
• are useful for politics to show the home manufacturers that they are actively trying to protect their home market

Most common Forms of Tariffs

• Specific: charges are imposed on particular products by either weight or volume.
• Ad Valorem: the charge is a straight percentage of the value of goods (the import price)
• Discriminatory: the tariff is charged against goods coming from a particular country, either because of a trade imbalance or for political purposes

Non-Tariff Barrier

• are much more elusive and can be more easily disguised
• In the last 50 years the world has seen a gradual reduction in tariff barriers in the most developed countries
• In parallel, non-tariff barriers have substantially increased

Most common Forms of Non-Tariffs

• Quotas: A restriction on the amount (measured in units or weight) of a good that can enter or leave a country during a certain period of time is called a quota.
• Embargoes: A complete ban on trade (imports and exports) of one or more products with a particular country is called an embargo; can be decreed by nations or by supranational organizations such as the United Nation; usually political reasons

Reasons for Trade Protectionism

Free trade between nations permits international specialization. Efficient firms increase their output thus permitting economies of scale.

While countries have many reasons for wishing to trade with each other, it is also true to say that all too frequently an importing nation will take steps to inhibit the inward flow of goods and services.

Each nation or trading bloc establishes laws that favour their own companies and discriminate against foreign one. Protectionist legislation tends to take the form of tariff and non-tariff barriers.

Two main reasons why countries set up trade restrictions

1. Tariffs Protect Domestic Producers

• Import tariffs might enhance the attractiveness of domestic products by raising the effective costs of imported goods.
• In this way, domestic producers gain a protective barrier against imports.
• The tariff protection can provide a price advantage but can also keep producers from increasing efficiency in the long run.

2. Tariffs Generate Revenue

• Using tariffs to generate government revenues is most common among relatively less developed nations which usually lack the capability to formally and accurately record domestic transactions.
• The lack of accurate record keeping makes the collection of sales taxes within the country difficult.
• Nations solve the problem by simply raising their needed revenue through import and export tariffs.
• Those nations obtaining a greater portion of their total revenue from taxes on international trade are mainly the poorer nations.

Economic Rationales

Fight unemployment/ Protecting domestic employment.
Most countries aim for 100 percent employment, protecting against foreign competition is one way to achieve this.

To protect infant industries
Protect new manufacturing industries where there is a comparative advantage (good if it makes the industry efficient) 
Brazil auto-makers became 10th largest in the world due to tariff barriers and quotas (how long can protection continue?)

Promoting industrialization
Develop industrial base to increase GDP: It brings faster growth than agriculture, attracts investment, diversifies the economy, more income than primary products, reduces imports- increases exports, helps nation building

However this assumes that the domestic industry becomes efficient over time. Other countries have taken an export-led industrial approach. e.g. Japan, South Korea, Taiwan

Improving comparative position
Countries try to get regional power, eg. Brazil, India, South Africa

The 1930 Smoot-Hawley act raised  U.S. tariffs on over 20,000 imported goods. This effectively removed foreign competition from the US market for many products. Other countries retaliated and stopped importing US products. It is believed the Act helped reduce American exports and imports by more than half during the Depression.

Political Rationales

Maintaining essential industries, Dealing with unfriendly countries, Maintaining or extending spheres of influence, Preserving national identity

• Protecting national economy
  Jobs, industries, heritage (Agricultural subsidies in EU and USA), political and economic consequences?

• National security
  Defense-related industries (aerospace, semiconductors)
  Read how ISIS get their weapons

• Protecting consumers 
  GM food, hormone treated beef, drugs, horse meat

• Retaliation and Punitive sanctions
  China and USA ‘trade wars’ read about it here

• Furthering foreign policy objectives
  South Africa during Apartheid
  Watch this video about the 2017 sanctions on Qatar

• Protecting human rights
  Impose trade barriers to countries that do not respect human rights. Eg. North Korea

• Tariffs: Specific and Ad-valorem
  Brazil and car industry

• Quotas, Voluntary Export Restraints and Embargoes

• Local Content Requirement (certain %age must be local)

• Administrative and bureaucratic procedures (delays to increase costs and uncertainty)

• Regulations and technical standards (export license)

• Countervailing and Anti-dumping policies (Steel)

• Government Subsidy (e.g. Cash grants, low-interest loans, equity participation)

• Foreign direct investments and ownership restraints (China and JV)

Impact of Tariffs

Effects of US-China Trade War on Auto Industry

In recent years, Tariffs have been making headlines as the US has initiated trade tariffs on China and other countries in order to reduce the U.S trade deficit. The U.S. Congress is the only body authorized to impose tariffs. Most of the U.S. deficit results from American enthusiasm for imported consumer products and automobiles.

The spiraling US-China trade war has impacted several industries, including the auto industry.

Decreased import of vehicles from US to China which will impact the top automakers in the US.

• Increase in production costs for US auto makers as parts are sourced from China; China is the second biggest exporter of vehicle parts to the US, after Mexico (Bermingham and Behsudi, 2019).
• China is also at the center of the global supply chains for most auto companies. US automakers will now spend more on auto parts that are sourced from China.
• China is also at the center of the global supply chains for most auto companies. So due to increased tariffs, US automakers will now spend more on auto parts that are sourced from China because they are taxed at a higher rate.

Increase in production costs for US auto makers as parts are sourced from China.

China does not sell a lot of cars to the United States but it is the second biggest exporter of vehicle parts to the US, after Mexico. China is also at the center of the global supply chains for most auto companies. So due to increased tariffs, US automakers will now spend more on auto parts that are sourced from China because they are taxed at a higher rate.

Both US and Chinese consumers will bear higher costs for imported cars. Increased auto tariffs will result in higher vehicle purchasing cost for the Chinese consumers. However, it may not affect the majority of the population as locally produced vehicles comprise 96% of Chinese vehicle consumption.

In general, the combined tariffs are likely to reduce profits and increase manufacturing costs for several businesses in the automotive industry. This is because no one is just a seller today, most suppliers are also buyers of some other things.

The US-China trade war threatens to affect other countries as well; the conflict is hurting the Chinese auto industry but because China also happens to be a key market for the German auto industry, even the German car industry is getting impacted by the US-China trade war. Global Automakers and OEMs may consider localizing a great portion of their operation in China.