Unit 2 Essay: International Economics
BBA 4351, International Economics 1
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Course Learning Outcomes for Unit II Upon completion of this unit, students should be able to:
3. Analyze the effects of trade restrictions on the economy. 3.1 Define specific tariff, ad valorem tariff, and compound tariff. 3.2 Explain how a tariff affects the welfare of a small importing country and a large importing
country.
Course/Unit Learning Outcomes
Learning Activity
3.1
Unit II Lesson Chapter 3 Chapter 4 Unit II Essay
3.2
Unit II Lesson Chapter 3 Chapter 4 Unit II Essay
Reading Assignment Chapter 3: Sources of Comparative Advantage Chapter 4: Tariffs
Unit Lesson Tariff Every country would like to engage in international trade because of the benefits it would bring to their country. However, uncontrolled international trade could lead to a disaster in domestic industries. For example, unlimited imports of dairy products could kill domestic dairy industries in terms of jobs and competitiveness of market prices for domestic dairy products. A tariff could serve as an effective economic policy tool to prevent perverse outcomes. There are thousands of products that are subject to tariffs. A tariff represents the amount of a tax levied on imported goods or services when they cross national boundaries. The tariff levied may depend on the type of product or even the season of the year for agricultural products. There are two different types of tariffs—an ad valorem tariff and a compound tariff. Ad Valorem Tariff Ad valorem tariffs are imposed to manufactured goods or services in terms of a percentage of the final values of final goods. Suppose that a country imports an item that is worth $30,000. Then this imported item will be subject to a higher base tariff rate than an imported item that is worth $28,000.
Tariffs
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Imposing an ad valorem tax can protect domestic firms when prices are constantly changing. Suppose that an ad valorem tariff rate is 10%, and the final market value of an imported item is $3,000, then a country can impose $300 in the form of tariff tax. If the market value of the same item rises to $4,000, then the tariff rate increases to $400; accordingly, if the final value of the same item falls to $2,000, then the amount of tariff being imposed on the same item would drop to $200. In that sense, an ad valorem tariff can be thought of as a proportional tax since it does not increase when there is a change in the base tariff rate. In global economy where inflation rate is rising over time and the role of trading
manufactured goods is becoming more important, importing countries have been adopting ad valorem tariff taxes more frequently than specific duties. Although determination of ad valorem tax rates seems to be quite simple, complex issues arise when putting it into practice from a policy perspective. The most challenging issue lies in determining the final value of an imported item, which is conventionally assessed by customs appraisers. In addition, the market value or final value of an imported item varies over time. Both factors combined lead to significant challenges in setting up standards for determining the optimal market values. Ad Valorem Taxes An ad valorem tariff is where the tax base is the appraised value of property, goods, or services. There are three different types: property taxes, income taxes, and consumption taxes. The most common form of ad valorem tax is the property tax. Suppose the property tax rate in your region is 1.5% and your property value is $300,000. You would then pay $4,500 (0.015 x $300,000) per year to the city or to the county in the form of annual property taxes. There are also different types of property taxes such as a special assessment. This tax is imposed on residents benefiting from improvement of neighborhoods (e.g., good school districts, amenity parks, community pools, proximity to commercial centers). The second type of ad valorem tax is income tax. This is pretty straightforward. You are paying taxes to state and/or federal governments proportionate to your annual income. If you make $85,000 per year and the tax rate is 25%, then you pay $21,250 in income tax. Finally, there is the consumption tax (or sales tax). This is also known as the excise tax and is generally applied to a wider variety of items such as toothpaste, alcohol, tobacco, milk, and oranges, just to name a few. In general, the federal government does not impose sales tax on most products, although certain types of products such as tobacco and alcohol are federally taxed. Most sales taxes are imposed by states or local governments. Compound Tariff Compound tariff is simply a combination of an ad valorem tariff, which is based on the value of imported goods or services and a specific tariff, which is a fixed amount of tax. Think of it as a two-part tariff where one is dependent on the appraised value of goods and services, and the other is dependent on the fixed amount. The former belongs to the category of ad valorem tax while the latter belongs to the category of a specific tax. Let us say that for imported bananas the United States imposes 3% per kg and 5% of the product price. That would be a good example of compound tariff. Other Types of Tariffs Sometimes, a country will impose a mixed tariff where it can use either a specific or an ad valorem rate. The rationale for using one over the other depends on which yields the most revenue. Suppose the United States
Southeast Toyota at JAXPORT’s Talleyrand Marine Terminal receives a shipment of Toyota vehicles. (Jaxport, 2008)
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imposes an ad valorem tariff at 10% or a specific tariff of $4 per kg of product A. If the 10% generates the most revenue, then the United States would choose the ad valorem tariff, but they would choose the specific tariff of $4 per kg if it generated the most revenue. The Impact of Free Trade Under free trade, domestic industry will likely be negatively affected by foreign competition due to the massive influx of cheaper imported foreign goods and the domestic industry being unable to compete. This is why U.S. economists have argued that the government should impose a tariff or compound tariffs to protect domestic industries and jobs. Field (2011), however, points out that the free trade agreement (FTA) could also increase trade and benefit the U.S. economy in many ways. To get an idea of the potential impact of FTA, Field (2011) posits that FTA countries accounted for approximately $96 billion in U.S. goods exported in 2010 and $71 billion in U.S. goods imported in the same year. Unlike the widespread belief that free trade could harm the U.S. economy and the trade balance, he makes the point that in trading manufactured goods with FTA countries, the United States had a $17 billion net surplus, but a $190 billion deficit in trading those same goods with non-FTA countries. On the other hand, some economists believe it is tricky to measure the impact of the FTA on jobs with accuracy. For instance, U.S. companies relocate a production facility to Mexico to take advantage of the North American Free Trade Agreement (NAFTA) duty provisions. The parts they once used for final production in the United States are now shipped as intermediate goods to plants in Mexico and used for final production. Those are jobs initially created in the domestic industries, and now they transition to jobs created from exports. This, in turn, indicates the FTA is not creating new jobs through these new exports.
References
Carbaugh, R. J. (2017). International economics (16th ed.). Boston, MA: Cengage Learning. Field, A. M. (2011). Free trade’s net worth. Journal of Commerce, 12(28), 10-14. Gaida, M. [MichaelGaida]. (2016). Port, inland port, Rhine, crane, Düsseldorf [Photograph]. Retrieved from
https://pixabay.com/en/port-inland-port-rhine-crane-1569694/ Jaxport. (2008). Vehicle shipment | Southeast Toyota at Jaxport’s Talleyrand Marine Terminal receives a
shipment of Toyota vehicles in October | Flickr [Photograph]. Retrieved from https://www.flickr.com/photos/jaxport/3026760273/in/photolist-5BsWnX-5Bxdos-aXrzZ-bwwuQ4- 8zJEoJ-5mb3hw-5mb4Pd-jMuQNg-boVRUc-5m6LCp-ahZRdG-4o7Sc7-4AcBbV-d3Jj8N-ciZHPf- ubwDn-5wBq3U-nwP5AK-chEftd-buhVYZ-ntm4eT-qTnakA-5US5tz-7Pewa1-qyxMwu-gWxkN6- 6id6xn-5m6LVg
Freight ready to be shipped overseas (Gaida, 2016)
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Suggested Reading The video below will help you to understand the pros and cons of free trade and protectionism. The video will also help you understand how each country protects its domestic industries using trade barriers. Films for Humanities & Sciences (Producer). (2007). Global exchange: Free trade and protectionism [Video
file]. Retrieved from https://libraryresources.columbiasouthern.edu/login?auth=CAS&url=http://fod.infobase.com/PortalPla ylists.aspx?wID=273866&xtid=34992
The primary objective of the PowerPoint presentation below is to explore and analyze various approaches to more fully understanding the sources of comparative advantage and to assess the ability of comparative advantage theory to explain actual trade patterns among nations. Click here to access the Chapter 3 PowerPoint presentation. (Click here to access a PDF version of the presentation.) The primary objective of the PowerPoint presentation below is to consider the impact of a tariff, one of the most common barriers to international trade. Simply put, a tariff is a tax on international trade, and you will learn more about tariffs in the following presentation. Click here to access the Chapter 4 PowerPoint presentation. (Click here to access a PDF version of the presentation.)
