As the globalization and liberalization emerged in the international economy and trade, there have been many policies formulated, and restructured over the years to make trade easier for the countries. The era has progressed from free trade to the era with trade barriers and tariffs and duties. As the world trade grew steadily since 1950s, after the liberalization in the global economy during 1990s, the world trade grew very rapidly upward. The reason behind this growth can be attributed to the following factors: high level of economic growth in the developing countries and improved trade between the wealthier and developed nations (Bartlett 2012).
Over the years, all the countries are becoming wealthier; their production is increasing, transportation costs and trade barriers are decreasing and comparative advantage is also increasing. Hence, the level of international trade is also increasing. When the global trade started, the policy of free trade was introduced. Over the years, the tariffs and import duties were imposed on trade and trade barriers were created to reduce the unfair practices by some wealthier nations. World Trade Organization was established to formulate and keep a check on the rules and regulations of international trade. Multilateral trade agreements were designed to give equal rights to all the countries as per their wealth and production capabilities. The free trade policies are restricted to limit the exports of the natural resources. The tariffs and import duties are forms of trade barrier (Balassa 2014).
A tariff is also known as the customs duty. It is a type of tax, which is levied on the goods when they cross national boundaries. It is generally imposed by the government of the importing nation. Import duty is also the tax imposed on the imported goods. It is generally based on the value of the imported goods. The terms tariff and import duty usually refer to the same tax, but depending on the context, one term is used (Moffatt 2016).
Tariffs and import duties are generally levied for two reasons: to raise the revenue of the local government and protecting the domestic industries by giving them an advantage to the locally produced goods, which are not under any import duty. Sometimes, higher tariffs are also imposed to penalize any particular country if it follows unfair practices (Viner 2014).
It can be said that the tariff, which is imposed mainly to earn revenue, sometimes it exerts protection, while the tariff, which is imposed for protection may also generate revenues. According to the theory of international trade, the best measure to differentiate between protective tariffs and revenue tariffs was to make a comparison of their effects on the domestic and international producers.
A tariff can be said to be protective when the locally produced goods do not bear the same taxation similar to the imported goods, or when the demand for imported goods is diverted towards any locally produced substitute goods due to imposition of tariff. A duty is purely protective when the duty shifts the production away from the export industries and pushes the production level upwards in the protected domestic industry or towards the substitute producing industries for which the demand has increased. On the other hand, purely revenue duties are imposed for yielding revenues for the government. A duty is purely revenue earning, when it diverts the resources of the country towards the production of goods on which additional spending can happen, from the production of taxed goods or substitutes for taxed goods (Matsushita et al. 2015).
In the context of revenue generation, a nation can impose an equal amount of tax on the domestic production for avoiding protection. Or, it can select a comparatively smaller number of the imported products for general consumption and levy low duties on them, so that the resources do not have the inclination to shift to the industries producing taxed goods or substitute goods (Encyclopedia Britannica 2017). On the other hand, if the country wants to protect the domestic industries, the list of protected goods would be long and tariffs would be very high.
Import duty is the most common and most important type of the custom duties. It is levied for either revenue generation or protection of the industries, or for both. However, tariffs are not a sufficient measure for revenue generation. This is due to the fact that, these duties generally encourage the domestic productions, which are economically inefficient. If the imports comprises of the bulk of available revenue bases, then also it is advised to impose tax on the entire consumption, than only on the imports consumption for avoiding uneconomical protection (Salvatore 2014).
To protect the domestic jobs: If the consumers buy less costly imported goods, then the workers of the domestic industry have the risk of losing their jobs.
For protecting infant industries: If a nation wishes to develop its own industries producing any particular product, then it would impose tariffs for making the imported product more expensive. This would discourage the consumers from purchasing the imported version, and they would prefer to buy the local good and help the domestic industry grow (Ascarza, Lambrecht and Vilcassim 2012).
For retaliating against a trade partner: When a nation does not follow the terms and conditions of the trade agreements with any other country, then to punish that rule breaking partner, the other country might impose high tariff on the goods imported. The high tariff would make the products more costly, hence, its exports would fall.
For protecting the consumers: when the government feels that a particular imported good is harmful for the people, it imposes high tariff to make the product costly, which would discourage the consumers from buying it (Bhagwati 2014).
Tariffs and import duties are barriers to free trade. The tariffs have a protective effect on the domestic industries. Import duties are the indirect tax levied on the imported goods. Since, it is an indirect tax, the producers shift the burden of the tax on the consumers. The consumers have to pay tax inclusive price for buying the imported goods. The tariffs and duties comprise of a scheduled list of goods along with the tax inclusive prices as per the government rules and regulations (Balassa 2014).
Tariffs are imposed on top of the price. Hence, with imposition of tariff, the price increases by that amount. Hence, the custom duties refer to the collected earning from the tariff taxes.
Figure 1: Impact of tariff on industries
(Source: Author)
Figure 1 depicts the effects on tariff on the industries. The price and quantity of a particular product in the domestic economy is at PE and QE at the equilibrium point E. At world price P, the supply of the product in the local market is QS1 and demand is QC1, which is also greater than the equilibrium supply. There is excess demand in the market. Thus, there will be imports in the economy to meet the domestic demand. To regulate the imports for protecting the domestic industry, the government imposes tariff T on the price P. Thus, the price rises to PT = P + T. At the higher price PT, the supply increases to QS2 and demand decreases to QC2. The consumers bear the tax burden by paying the tax inclusive price. Due to the tariff, the government earns tax revenue, denoted by the area ABGC. Hence, the imports level is controlled. Domestic industry becomes competitive and produces more to meet the market demand.
The effects of tariff on the industries of the nation can be classified in the following categories.
From figure 1, it is seen that, when the price of the product increases due to imposition of tariff, the consumption decreases to QC2 from QC1, as the buyers of the product move up the demand curve due to higher prices. This effect is called consumption effect. This indicates that, the buyers feel the pinch in their pockets from the tariff. After the tariff, T is imposed, the buyers have to pay PT, which is the tariff inclusive price. Thus, the tariff on the product makes the buyers to reallocate some of their expenses for other products (Schroeder and Traber 2012).
The major benefit of the tariff on the domestic producers is that, it enables the producers to sell their products at a higher price than the free trade price, that is, P. When the market price increases further due to imposition of tariff, the producers would produce more and supply more of the product and would move up the supply curve S. This is called production effect. In figure 1, at the tariff inclusive price PT, the producers increase the market supply from QS1 to QS2. It is derived from the increase in the supply of the product is that, some of the scarce resources of the country would shift away from the production in some other industries (Torres 2012).
Tariffs have positive effect on the economy of a country. These help in the earning of the revenue for the government; and thus help in increasing the GDP of the country. The protective tariffs help in the growth of the nation’s noncompetitive and the underdeveloped domestic industries. These get the incentives and encouragement to compete. The tariffs also determine and control the terms of trade between two countries.
The tariffs and duties are often imposed on the imported goods and rarely on exported goods. These are indirect taxes, hence, costing extra money to the customers. With the imposition of tariffs and duties, the government of a nation regulates the volume and type of foreign goods entering the local markets of the economy (Scm.ncsu.edu 2017).
Tariffs and import duties have significant effect on the exporting country. The trade partner country would not get the benefit of higher price of the product. The benefit of the tariff is gained by the government of the importing country in terms of customs duty or tax (Lambrecht et al. 2012). For the exporting country, the price would remain at P. However, as the price in the domestic market increases due to tariff, the local production increases to QS2 from QS1, but the local consumption falls from QC1 to QC2. Hence, the quantity of imports falls after imposition of the tariff as shown in figure 1. This is called the trade effect of tariff and import duties.
Tariffs and import duties have another significant effect for the government as well as for the economy. Due to the imposition of tariff, the amount that the buyers pay extra is the revenue for the government. In figure 1, the area ABGC shows the amount of revenue that the government earns from the tariff (Darby and Pisica 2013).
With the revenue effect on the economy, the important question arises that if the welfare of the economy increases with the imposition of tariff and import duties. The answer lies in the fact that, the revenue generated from the tariff or import duty is essentially the transfer of income from the buyers to the government. It does not reflect any net changes in the total wealth of the nation, along with the wellbeing of the nation. In other words, the loss of the consumers is the gain of the government (McGee and Yoon 2016).
Another effect of tariff or import duty is the misallocation of resources. Due to the imposition of this duty, the exports of the good would fall in the exporting country. Hence, production of that particular good also falls, in which the country has comparative advantage. With the fall in production, the scarce resources would shift to another inefficient industry, in which it does not have comparative advantage. Hence, it can be said that imposition of tariff results in misallocation of resources (Graham 2015).
There are various cost and benefits on imports from the economic tariffs. The various effects have been analyzed.
The price of the commodity is increased when the importer imposes the entire tariffs on the consumers.
The offer of exports for imports for a country is considerably reduced by tariffs. This is because a part of the imports needs to be surrendered to the customs authorities in the form of tariff.
The benefits of tariff are as follows:
Revenue is earned by countries by imposing tariffs.
The domestic price of the imported commodity tends to increase due to tariffs. This reduces the demand of the commodity in the domestic market, which helps to stimulate the production in the domestic country (Graham 2015).
It is a neutral effect of tariffs. Rise in prices occur only because of tariffs and there is a fall in demand. Total outlay on the consumption of any commodity relies on whether the demand is inelastic or elastic.
Imports, in some cases become very much expensive. So the need to cut down expenses on them becomes evident. Money, accrued from imports of commodities, may be spent on goods produced domestically. When there is less than full-employment in a country, this condition is likely to raise income as well as employment there (Spearot 2013).
Balance of payment helps in the reduction of imports and increase in the export surplus of a country. There is a chance of rectification in the deficit of balance of payment (Marchand 2012).
The following two effects have both costs and benefits of tariffs
Price is increased due to tariffs that lead to the transfer of real income of the consumers to the producers. There has been a redistribution of wealth from one class to another.
Tariffs have another positive impact on the economy. It tends to protect the domestic industry from competition of the foreign markets. This helps to protect a new company, working for a longer period of time, and helps to grow into an industry that is economically very strong. The new company will be able to compete in the world market successfully. But this may not hold good for a lazy and sluggish market. This type of market will not be liking this form of competition and it remains inefficient even if protection is given by tariffs (Felbermayr, Jung and Larch 2012).
The price of the costs of a tariff is very high when it comes to consumers but part of this goes to the government as it is partly offset by the tariff revenue. The tariff revenue is considered as a benefit. It can be spent on goods or redistributed among the customers through which they can derive some sort of benefits. Other costs such as efficiency costs are also associated with the tariffs, which is popularly known as deadweight loss. Tariffs also take into account real costs which is due to the fact that the marginal cost of production never equals to the marginal benefit of the consumers (Cavusgil et al. 2014).
Revenue of the government is accrued from the sales of imports in the domestic market. Consumer surplus is the total number of consumers who are willing to pay for any product and they need not have to pay at the equilibrium price. It is also considered as a measure of consumer welfare. The market price of a product is raised due to the tariffs and the consumer surplus is reduced.
As per the book Advanced International Trade: Theory and Evidence, it has been observed that governments, on three different situations impose tariffs. Firstly, to protect the domestic industries that is fledgling, from the competition of foreign markets. Secondly, tariffs are needed in order to protect the domestic producers from the process of dumping by the foreign conglomerates or governments. This process is caused when foreign company in a domestic market charges a price, which is reasonably low. This low price generally means a price that is very less in the foreign market than that of the domestic market. This low price is basically below the cost. The producer has the chance of losing money (Bradley, Leach and Torriti 2013).
The economic effect of tariff is generally broken down into two parts. They are the impact of tariffs on the country, which is having its imposition. Another impact is on the country, which is imposing the tariff.
In some way or the other, the tariff causes some amount of loss to both types of country, imposing and on which it is imposed (Beghin et al. 2012).
Conclusion:
It can be concluded that, if the countries engage in specialized and unconstrained trade practices based on the comparative advantage, it would lead to efficient allocation of resources and the real output of the world would expand. The purpose as well as the effect of the protective tariffs is to decrease the world trade. The revenue tariffs result in transfer of income in the economy but those do not increase the well-being of the overall economy. Therefore, although tariffs have positive effects on the specific sectors of the economy, the overall effect of the tariffs and import duties is the fall in the real output level of the world.
References
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Balassa, B., 2014. Development Strategies’. International Economics and Development: Essays in Honor of Raúl Prebisch, p.159.
Bartlett, B., 2012. The Truth about Trade in History. [online] Cato Institute. Available at: https://www.cato.org/publications/commentary/truth-about-trade-history [Accessed 29 May 2017].
Beghin, J., Disdier, A.C., Marette, S. and Van Tongeren, F., 2012. Welfare costs and benefits of non-tariff measures in trade: a conceptual framework and application. World Trade Review, 11(03), pp.356-375.
Bhagwati, J.N. ed., 2014. Illegal transactions in international trade: theory and measurement (Vol. 1). Elsevier.
Bradley, P., Leach, M. and Torriti, J., 2013. A review of the costs and benefits of demand response for electricity in the UK. Energy Policy, 52, pp.312-327.
Cavusgil, S.T., Knight, G., Riesenberger, J.R., Rammal, H.G. and Rose, E.L., 2014. International business. Pearson Australia.
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Graham, F.D., 2015. Protective tariffs. Princeton University Press.
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Marchand, B.U., 2012. Tariff pass-through and the distributional effects of trade liberalization. Journal of Development Economics, 99(2), pp.265-281.
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Scm.ncsu.edu, 2017. Tariffs: Tariff and Tax in International Trade. [online] Scm.ncsu.edu. Available at: https://scm.ncsu.edu/scm-articles/article/tariffs-tariff-and-tax-in-international-trade [Accessed 29 May 2017].
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