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  • <International Trade and Finance> Topic: Suppose that a country reduces import tariff on raw materials and intermediate products but not on finished products. What effect will this have on the rate of effective protection? Explain.

<International Trade and Finance> Topic: Suppose that a country reduces import tariff on raw materials and intermediate products but not on finished products. What effect will this have on the rate of effective protection? Explain. Essay Example

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Effects of reducing Tariffs on Raw Materials and Intermediate goods on Effective Rate of protection9

Effects of reducing Tariffs on Raw Materials and Intermediate goods

Introduction

Governments are usually concerned about their economic performance. While participating in the international markets, they usually come up with various measures that would protect their industries in the verge of enhancing an effective Balance of Payment. One of the commonly used methods is reduction of tariffs (Salvatore, 2010). A tariff is usually described as a tax duty which a country tends to levy on products as part of its economic trade practices. This is a method that is often used in order to protect young industries especially in the developing countries. Third world countries are often concerned in enhancing an effective rate of protection (ERP) (Krugman & Obstfeld,2009).

ERP usually measures the percentage outcome of the whole tariff framework on the value added per unit of output in every industry (Ruffin, 2002).
Effective rate of protection is statistically used in economics to measure the real protection yielded by import duties or tariffs. In most cases the effective rate tends to measure the total increase in domestic production that the tariff makes possible based on the rate applied to finished product and imported inputs, compared to free trade (Nickell, 1996). Effective rate of protection measures the total effect of entire tariff structure on the value added per unit of the output in each industry when both intermediate and final goods are imported. It is used to measures the real amount of protection afforded to a particular industry by import duties, tariffs and other trade restrictions levied by the country. In calculating the overall effects of tariffs imposed on a country it is always important to consider the effect of tariffs on the final price of a good and the effects of tariffs on the costs of inputs used in production. In most cases the actual protection provided by a tariff is normally not equal to the tariff rate if the imported intermediate goods are used in the production of the protected good (Salvatore, 2010).

The calculation of effective rate of protection usually differs considerably when domestic producers use various imported inputs as well as intermediate goods subject to various tariffs. The effective rate of protection is used in economics to estimate the protection afforded to domestic producers a each stage of production (Tybout, 2003; Gagnon & Ihrig, 2004).The effective rate of protection therefore shows how much extra producers can charge and still be competitive with imported goods. Trade policies exhibited by nations have an effect on the domestic prices of goods and services are able to make adjustments. The policies usually alter the link between the domestic and international market prices (Salvatore, 2010). Import duties usually raise the local prices whereas the export taxes lower domestic prices. Traditionally, imposition of tariffs was meant to be a means through which a country can raise its revenue and also makes importation of final products difficult in order to safeguard domestic industries (Arndt, 1997).

Effect of reducing import tariffs on raw materials and intermediate goods on effective rate of protection

When a country imposes low tariffs on raw materials and intermediate goods or components but high on the final or finished goods, the effective tariff rate on finished goods is usually much higher than it appears from the nominal rate which is a tariff rate applied to value of finished product(Salvatore, 2010). This therefore implies that when a country reduces the import tariffs on its raw materials and intermediate goods but not on finished goods it leads to higher degree of tariff escalation. When the degree of tariff escalation is higher, the effective rate of protection enjoyed by the final –good industry is normally greater (Giovannini, 1988).

In such a situation the ERP will be positive and greater than the nominal tariffs on output. Tariff escalation is used in economics to refer to a situation where import duties on components or raw materials are lower but the imposed tariffs move progressively higher on semi-finished goods upwards to the finished goods ((Krugman & Obstfeld,2009). When tariffs on products escalate with various stages of product processing, the effective rate of production always increases. This usually creates a situation where the effective rate of protection of value added in the processing industry in the specific importing country is higher than the nominal tariff on the product of that industry (Salvatore, 2010).

Tariff escalation therefore in most cases potentially is a signal of a country’s higher rates of protection for value –added or processed products hence in most cases it usually inhibits international trade as far as these goods are concerned(Krugman & Obstfeld,2009). According to research if the total value of the tariffs on importable inputs exceeds that on the output, the effective rate of protection will be negative. In such cases the industry is usually discriminated against others in comparison with the imported product since tariffs tends too raise the price of goods in the local market by an equivalent value (Salvatore, 2010).

The effective rate of protection reveals the extremely adverse effect of tariffs that rise from low rates on raw materials to high rates on intermediate inputs and yet higher rates on the final product. When a country reduces tariffs on imported raw materials and intermediate goods it usually impedes a particular country’s access to developed countries markets (Salvatore, 2010). Tariff escalation usually encourages the final processing of imported inputs in developed countries though on other hand it discourages the processing of intermediate products into final goods in the foreign country where the goods are being produced or manufactured (Van, 2005). Primarily, this is usually used as an incentive for developing nations to expand production of raw materials. On other hand it acts as a disincentive for developing nations to compete in the market for finished goods. When the effective protection rate increases, a persistent of generations of profound alterations that arise from inefficient production processes as well as prices for the final goods that are above the international prices ensue (Treer, 2004).

A country is also able to enjoy preferential treatment as well as anti-export bias (Krishna, Pravin and Devashish, 1999).Reducing tariffs on imported raw materials usually enhances trade creation. Trade creation comes as a result of switching consumption from the high cost production to low cost production (Oladipo, 2007). As a result of reduction of import tariffs on the raw materials, a country is able to increase the region’s competitiveness since it would now compete with other countries which are within the free trade areas as well as those that have a zero tariff floor. Industries are therefore able to increase production and even if there is no adjustment in the prices for its final commodities, it is able to produce quality products that would be more marketable in the international market(Salvatore, 2010). The measure also stimulates production by lessening industries’ production costs and this makes it possible for the industries to acquire hard technologies as a reduced cost. This therefore enhances production and the end result is increased exports (Hummels, Jun and Kei-Mu, 2001).

On other hand when a country imposes higher tariffs on imported raw materials and intermediate goods, the imposed tariffs usually increase the product price as the tariffs will in most cases increase the manufacturing cost using these imported materials making the firm’s less competitive (Pavcnik, 2002).Tariffs usually elevate the prices of imported goods as well as raw materials. As a result, domestic producers are not able to reduce prices of their products even in the presence of high competition in the international market. On the other hand, domestic consumers are not able to access cheaper goods and services since the domestic industries cannot lower the prices for their goods due to high production cost (Schor, 2004).

Tariff imposition on the raw materials usually hurts a country’s economy. This is usually translated in the domestic prices since imposition of tariff has an effect of raising cost of production and hence domestic prices increases(Krugman & Obstfeld,2009). This means that consumers opt to import foreign goods and services since they are cheaper than locally manufactured products. High domestic prices discourage domestic production and as a consequence, exports decline (Tybout, Jaime and Vittorio, 1991).

Conclusion

Tariff importation is a common form of protection that is used by various countries. It is often put in place with an aim of increasing government revenues as well as protecting the local industries. However, tariffs usually compromise both the raw materials and the intermediate products (Hummels, Jun and Kei-Mu, 2001). Countries therefore prefer reducing the tariffs on imported raw materials and intermediate goods as a way of encouraging domestic production in the verge of improving terms of trade. Reducing import tariffs on intermediate goods and raw materials usually increases the rate of effective protection due to a higher degree of tariff escalation. Adoption of tariff reduction system has both positive and negative effects on the economy. One paramount aspect is that it reduces the cost of production for the industries in the importing country on other hand it (Krishna, Pravin and Devashish, 1999).

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