International marketing management lesson 02

LESSON BARRIERS IN INTERNATIONAL MARKETING MANAGEMENT CONTENTS 2.0 Aims and Objectives 2.1 Introduction 2.2 Tariffs 2.3 Kinds of Tariffs 2.4 Non-Tariff Barriers 2.5 Quotas 2.6 What are the Costs Associated with Quotas? 2.7 Implications of Tariffs 2.7.1 Consumption Effect 2.7.2 Revenue Effect 2.7.3 Redistributive Effect 2.7.4 Terms of Trade Effect 2.7.5 Employment/Income Effect 2.7.6 Balance of Payments Effect 2.7.7 Competition Effect 2.8 Non-Tariff Measures to Regulate Trade 2.9 Differences between Tariff and Non-Tariff Barriers 2.10 Commodity Agreements 2.11 Bilateral Agreements 2.12 Let us Sum up 2.13 Lesson End Activity 2.14 Keywords 2.15 Questions for Discussion 2.16 Suggested Readings 28 International Marketing Management 2.0 AIMS AND OBJECTIVES After studying this lesson, you will be able to: Distinguish between tariff and non-tariff barriers Understand the application of tariff and non-tariff barrier in international trade Describe non-tariff measures to regulate trade Distinguish between quantitative restrictions on import and import through licensing 2.1 INTRODUCTION Every country has to regulate its own international trade mainly due to the following specific reasons: (i) improving its balance of trade and balance of payments position Most of the developing countries face balance of payments problem and, therefore, they struggle hard to maintain the balance in their imports and exports; (ii) protecting its own industries against competition in the international market or in domestic markets from foreign products; and (iii) exploiting its manpower and natural resources to the maximum extent possible so that the country’s economic development may proceed at a faster pace In order to attain these objectives, almost every country imposes certain restrictions on its international trade, i.e., imports and exports These restrictions may be called trade barriers Trade barriers may be (i) tariff barriers and (ii) non-tariff or protective barriers 2.2 TARIFFS Tariffs have been one of the classical methods of regulating international trade They may be referred to as taxes levied on imports They aim at restricting the inward flow of goods from other countries to protect the country’s own industries by making the goods costlier in that country Sometimes the duty on a product is so steep that it does not become worthwhile to import it In addition, the duties so imposed provide a substantial source of revenue to the importing country In India, customs duty form a significant part of total revenue and, therefore, is an important element in preparing the budget Some countries use this method of imposing tariffs and customs to balance their balance of trade A nation may also use this method to influence the political and economic policies of other countries It may impose tariffs on certain imports from a particular country as a protest against tariffs imposed by that country on its goods In order to ensure that the system of imposing custom duties is not discriminatory, a multilateral association, comprising a number of countries of the world, has been formed to help formulate trade policies of the member countries This association is popularly known as General Agreement on Tariff and Trade (GATT) and its main objective is to reduce duties and other import levies systematically through mutual negotiations It ensures that every member country enjoys a status of Most Favoured Nation (MFN) and a member country must charge the tariffs and customs duties at the lowest rate unless otherwise settled bilaterally 2.3 KINDS OF TARIFFS Tariffs may be classified according to (i) the purpose of taxes, and (ii) how they are levied i As far as the purpose of taxes is concerned, tariffs may be classified into two categories (a) revenue tariff and (b) protective tariff Revenue Tariffs are basically intended to raise government revenue without intending to protect any industry of the country It is levied at a fairly low rate and does not obstruct the free flow of imports Protective Tariffs, on the other hand, aim at protecting the domestic industries and are generally levied at a very high rate and, therefore, obstruct the free flow of imports Its main purpose is not to increase revenue but to provide a safeguard to the domestic industries against foreign competition in the local market Tariffs, sometimes, are levied to discriminate between countries, e.g., tariffs are imposed on certain goods having certain specifications, which are imported, from a particular country ii On the basis of how tariffs are computed, tariffs may be put into two categories (a) specific tariffs and (b) ad valorem tariffs Specific Duties or Tariffs are imposed on the basis of per unit of any identifiable characteristics of merchandise such as per unit of weight, volume, length, number or any other unit of quality of goods The duty schedules so specified must specify the rate of duty as well as the determining factor such as weight, number, etc and the basis of arriving at determining factor such as gross weight, net weight or fair weight, etc Ad valorem Tariffs are based on the value of imports and are charged in the form of a specific percentage of the value of goods The schedule should specify how the value of the imported goods would be arrived at Most of the countries follow the practice of charging tariffs on the basis of c.i.f cost of a product or f.o.b cost mentioned in the invoice As tariffs, under this method, are levied on c.i.f or f.o.b prices, sometimes unethical practices of under invoicing are adopted whereby the custom revenue is affected In order to eliminate such malpractices, some countries adopt a fair value (given in the schedule) or the current domestic value of the goods as the basis for the computation of customs duty In order to protect the domestic industries against competitions, some other tariffs are also imposed Among them, two are important (a) Anti-dumping duty and (b) Counteracting duties a Anti-dumping duty: Very often, exporters from developed countries are eager to sell their products in foreign markets with a view to capture a large market, at a very low price not proportionate to their cost of production This attempt to introduce their products in a large quantity into foreign market at a very low price, even lower than cost, is called ‘dumping’ This naturally will adversely affect the domestic industries The government of the importing country, therefore, imposes customs duty on such goods at a very high rate to counteract this unfair competition This duty is known as ‘anti-dumping duty’ Such duties are charged in addition to the normal customs duty on the product This additional charge would cover at least the difference between the export price and the normal price or market price in the exporting country b Counteracting duties: These are similar to the anti dumping duties and are charged on goods imported from countries where the manufacturer exporter is paid, directly or indirectly, a subsidy as an incentive for export The amount of duty normally does not exceed the estimated amount of subsidy 29 Barriers in International Marketing Management 30 International Marketing Management Check Your Progress 1 Define Ad-valorem Tariffs What you understand by Anti-dumping duty? 2.4 NON-TARIFF BARRIERS Over the last few years, GATT has been endeavouring to achieve a reduced and rationalised tariff structure for trade among its member countries As per terms of GATT, every member country will accord MFN treatment to all other member countries while importing goods from them At the same time, importing countries are also concerned with the development of their own industries and trade They will have to protect them against unfair competition with a view to giving the domestic industry a fair chance for survival To meet the challenges, more and more countries are adopting non-tariff measures to regulate their imports Such measures may be called ‘non-tariff barriers’ Some of these non-tariff measures are: a Quantitative restrictions, quotas and licensing procedures b Foreign exchange restrictions c Technical and administrative regulations d Consular formalities e State trading and f Preferential arrangements We shall discuss these measures in brief hereunder a Quantitative (QR) restrictions, quotas and licensing procedures: Under quantitative restrictions, the maximum quantity of different commodities, which would be allowed to be imported over a period of time from various countries, is fixed in advance The quantity allowed to be imported or quota fixed normally depends upon the relations of the two countries and the need of the importing country There is, therefore, no effect of price level changes in foreign or domestic markets and the government is in a position to restrict the imports to a desired level Quotas are very often combined with licensing system to regulate the flow of imports over the quota period as also to allocate them between various importers and supplying countries Under this system, a licence or a permit is to be obtained from the government to import the goods specifying the quantity and the country from which to import, before concluding the contract with the supplier b Foreign exchange restrictions: Exchange control measures have been widely used by a number of developing countries in the post-war period to regulate their imports and to keep the balance of payments in controllable limits Under this system, the importer must be sure that adequate foreign exchange would be made available to him for the import of goods by obtaining a clearance from the exchange control authorities of the country before concluding the contract with the supplier c Technical and administrative regulations: Another measure to regulate imports is the imposition of certain standards of technical production, technical specifications, etc to which an importing commodity must conform Such types of technical restrictions are impressed in case of pharmaceutical products, etc and the importing commodities must satisfy them before their import is permitted Besides technical restrictions, administrative restrictions such as adherence to certain documentary procedure are adopted to regulate imports These technical and administrative measures impede the free flow of trade to a large extent d Consular Formalities: A number of countries demand that shipping documents must accompany the consular documents such as certificate of origin, certified invoices, import certificates, etc Sometimes, it is also insisted that such documents should be drawn in the language of importing countries In case the documentation is faulty or not drawn in the language of importing country, heavy penalties are imposed Fees charged for such documentation are quite heavy e State trading: In most socialistic countries, foreign trade, i.e., import and export transactions, are exclusively handled or canalised by certain state agencies Separate state agencies are set up for each class of products These agencies carry on international trade strictly according to the government policies A few other countries of the world follow state trading in a restricted sense to achieve certain desired results especially where bulk imports are needed and the government wants to maintain price stability India is a good example where state trading is followed in a restricted sense Some articles, as decided by the government, are imported only through the State Trading Corporation (STC) Likewise, exports of raw materials such as iron ore, mica, etc are canalised only through Minerals and Metals Trading Corporation (MMTC) f Preferential arrangements: With due evolvement of the multilateral trading system, a few member countries agree to a small advantageous group for their mutual benefit The member countries of the group negotiate and arrive at a settlement of preferential tariff rate to carry on trade amongst them These rates are much lower than ordinary tariff rates and applicable only to the member nations of the small group Such type of preferential arrangements are outside the purview of the GATT Some of the small groups are EEC, ASEAN, LAFTA, etc 2.5 QUOTAS In the preceding chapter, we analysed the basis of international trade and the advantages expected to be gained by each country specialising in the manufacture of products for which its factor endowment gives it comparative advantage over other countries Such an argument implies free trade between nations However, free trade is not the commercial policy of most nations of the present-day world in which a variety of measures are undertaken by different countries to regulate their imports and exports in keeping with certain economic objectives so that they can all benefit It is admitted that free trade advances the welfare of all people of all the trading countries equally While free international trade would, other conditions being equal, help attain maximum world production of goods and services, it may also hurt the welfare of certain groups in every country because of income-redistribution effects But it is difficult to set off the gains of one group against the losses of another, because of the difficulties of making meaningful interpersonal comparisons Groups, which are likely to suffer as a result of free international trade, are likely to pull their weight in favour of restrictive trade Another motive for imposing restrictions lies in a country’s (especially economically weak country’s) desire for gains, which it may not achieve under free trade conditions Additionally, while considering economic welfare, we are concerned with marginal social costs rather than 31 Barriers in International Marketing Management 32 International Marketing Management marginal private costs, which may diverge quite considerably from each other Prices and costs could also diverge from each other if there is a production subsidy on some products but not others Alternatively, differential rates of internal taxation could also lead to similar divergence In such circumstances, price ratios will not accurately reflect marginal ratios, causing distortion of trade Neither production nor consumption will be optimised Thus, the question of evolving an equitable commercial policy to regulate export/import of trade becomes vital Several policy instruments are adopted to regulate trade in the national interest Apart from tariffs, a country may adopt quantitative quota systems, exchange control methods, commodity agreements, state trading and certain policies either to encourage or discourage trade A quota may be defined as the imposition of an ‘absolute limit on the physical quantity of value of goods or services that may be traded over a set period of time’ Quotas can be imposed on imports as well as exports Import and export quotas may be global (universal, non-discriminatory) if they apply to all countries in respect of any commodity or group of commodities; or they may be selective (discriminatory), if the restrictions imposed relate to some of the exporting countries and not to others Such quotas may be the result of traditional and historical factors, e.g., the quota arrangements between a colonial country and the imperial regime which may continue even after independence because they find them mutually advantageous Again, there may be a “tariff quota” wherein the rate of tariff imposed increases when the total quantity imported exceeds a certain amount and, at some later point, further imports may be completely prohibited If the supply and demand curves of a country are not inelastic, and if the quota is set at the volume of imports which would result from a given tariff duty, the protective, consumption and redistribution effects of the quota will be similar to those of the tariff The following figures illustrate the quota effects COUNTRY A (Exporting) P R I C E P SA DA O A B C QUANTITY (a) Figure 2.1 In the above figure, P is the equilibrium price line for both countries A and B At this price, demand is OA and supply is OC, in country A Thus, it exports AC amount of the commodity traded, to country B, whose imports, ad, just equal to it, and make up the gap between its supply Oak and demand Do then, for whatever reason, country B, decides to limit its imports of the commodity to a smaller quantity equal to B and so imposes a quota restriction, which may be global This has the effect of raising the equilibrium price from P to P1, domestic production (supply) from Oa to Ob, and domestic demand is reduced from Od to Oc In the exporting country A, as may be expected, production (supply) decreases from OC to OB There is no change in price because supply is elastic COUNTRY B (Importing) P R I C E SB P1 Q b P g O a h b c d QUANTITY (b) Figure 2.2 Thus, it can be seen from the second part of the figure (relating to country B) that, like tariffs, quotas raise the domestic price of the commodity, reduce imports and the quantity demanded, increase domestic production (supply) and redistribute real incomes from consumers to producers But the revenue effect of a quota may be different In the case of a tariff, a revenue equal to the area of gh will accrue to the government But in the case of a quota, the outcome is not so certain There are four distinct possibilities Firstly, if the imports are well organised and have a monopoly of the trade, they may capture this revenue Contrarily, the exporters may capture it, if they are organised and strong enough to raise the price and compel weak and disorganised importers to pay it Third possibility is that the government, say, by auctioning the import licences, takes away the excess value due to scarcity In this case the revenue effect of a quota is similar to that of a tariff But, fourthly, in the actual marketing situation, it is unlikely that any of the three parties involved will be able to monopolise the entire revenue, which may be shared in some ratio amongst them The actual outcome will depend on the market structure facing the country, which imposes the quota, and how the parties involved react to that structure Thus, the revenue effect is unpredictable and might, most likely, be shared by the three parties involved The possibility of improvement in the terms of trade, as a result of the imposition of quota, depends upon the foreign (exporting) country’s elasticity of supply and retaliatory action, if any, that it may take There are a variety of reasons for the prevalence of quota system Quotas are usually preferred in respect of those commodities in which the foreign supply position is quite 33 Barriers in International Marketing Management 34 International Marketing Management inelastic In such a case, tariff is likely to be absorbed fully by the exporting country and as such would not lead to a rise in price for the importing country or a decline in the quantity of imports Thus, tariff would not succeed in restricting imports This is usually the situation with regard to agricultural products However, the elasticity of external supply of any commodity is generally not precisely known Hence, it is difficult to calculate precisely the several effects of a tariff and the magnitude by which the price would rise is an open guess It may be even more difficult if foreign markets are riddled In such circumstances, quota systems give more determinate results Similarly, if domestic demand for a certain imported commodity is inelastic and if it is considered desirable to reduce the imports of that commodity, then fixation of import quotas may be the only way of curtailing imports Tariffs, in such cases, are ineffective because demand is unresponsive to rise in price From the administrative point of view, quotas are easy to administer and more flexible instruments of commercial policy because they can be quickly adjusted — raised, lowered or removed Since they are more definite, they are less speculative And since they are usually seen as short-term measures, they not lead to the creation of vested interests — an important drawback with tariffs Additionally, since quotas are better related to internal demand and supply situation than a tariff, they can be used more effectively to insulate the domestic economy from external disturbances owing to cyclical fluctuations In such circumstances, the gains from economic stability may far outweigh the costs associated with quotas 2.6 WHAT ARE THE COSTS ASSOCIATED WITH QUOTAS? Firstly, quotas are more arbitrary than tariffs, in as much as they violate the market mechanism and the price mechanism The danger is greater when non-economic motives induce quota policy and insufficient and/or dishonest administration implements it This may not only distort the price and market mechanisms but also open the floodgates of graft, which may introduce irrationality in economic decision making in unpredictable ways Secondly, being an administered system of allocation of imported resources, the quota systems might lead to collusion among importers, which may spread to other related areas of economic power This, however, is a drawback quotas have in common with tariffs There are a variety of other import control measures prevalent in different countries but these are of minor significance, and as such may be dealt with en passant A policy to buy the product of a domestic industry, so as to promote development, employment, or other defined economic and non-economic objectives is very popular In India, Mahatma Gandhi once campaigned for swadeshi with nationalist zeal and raised bonfires of foreign textiles to promote Indian handloom industry, which gives employment to millions of indigent people Such sentiments are very common and useful to certain times, especially, wars — cold or shooting Many countries also insist that others trading with them should avail of their shipping, airlines, insurance and other services which add to their invisible earnings from trade Government may make the use of indigenous products and services compulsory for its own agencies as well as other organisations Various countries also prohibit the import of certain categories of products (e.g meat, vegetable products) for health reasons, others impose regulations regarding packaging and labelling and other administrative measures to restrict imports by imposing costs on the exporting country Finally, exchange control measures may be used to influence trade Since, generally, importers have to pay in foreign currencies, this requires conversion of domestic currency into foreign currency, e.g Indian rupees into British pounds or US dollars Governments strictly regulate conversion of currencies Therefore, denial or liberalisation of conversion facilities can influence the course of trade Similarly, the terms on which currencies are exchanged (rate of exchange) can be altered either to favour or adversely affect the flow of goods or services from one country to another The principles covering the determination of foreign exchange rates and their implications for trade between countries will, however, be dealt with in another lesson We turn now to consider commercial policies for control of exports These export controls may be subdivided into two parts: (i) those imposed by any foreign country on its exports to the home country and (ii) those imposed by the home country itself on its exports to the rest of the world As regards the first category, it has a family resemblance with import controls imposed by the home country The terms of trade of the home country move against it and whatever revenue accrues goes to the foreign country, except when the foreign market for the commodity in question is competitive and there is no collusion amongst exporters These export controls may not affect the export prospects of the home country if they are global (non-discriminatory) but they will if they are selective (discriminatory) However, they may be inflationary, if they apply to a commodity which is an essential input for a number of commodities or which is widely used in the economy The second type of export controls are more involved in their effect Inelastic foreign demand will raise the price of the exported commodity and hence improve the terms of trade in favour of the home country Thus, it will increase receipts from a given amount of exports because fall in exports will be accompanied with rise in prices of exports Since exports are limited, it makes possible increased supplies for domestic consumption, which, in turn, would lead to lower prices for the consumers Thus, the more elastic the domestic demand, more favourable will be the consumption effect Similarly, export controls could be used with favourable effects to deal with an inelastic domestic supply situation If domestic supply is restricted, producers benefit at the expense of the consumers via rise in prices There is, thus, a redistributive effect in their favour However, policies and measures which bank on restricting supplies are bedevilled by tensions and conflicts and are difficult, if not, unworkable In practice, such a policy would lead to collusion and monopolistic practices among the producers, if they not exist already It can be seen from the above, that export quotas are beneficial when foreign demand and domestic supply are inelastic in contrast with import quotas which are advantageous when domestic demand and foreign supply are inelastic However, export controls and quotas are generally less successful than import controls The reason simply is that knowledge about demand and competitive conditions in foreign markets is far from perfect As such it is difficult to fix suitable prices and quotas Whatever success the export quotas achieve is generally a short-run phenomenon because in the long-run demand is more elastic, substitutes can be found, alternative sources of supplying the demand can be developed and the monopoly of a country can be broken 35 Barriers in International Marketing Management 36 International Marketing Management 2.7 IMPLICATIONS OF TARIFFS A tariff may be defined as a charge levied on goods as they enter a country by crossing the national customs frontier Tariffs are thus intended to regulate imports Whether they seek to collect revenue (known as revenue tariff) or to protect domestic industry (known as protective tariff), tariffs function within the price system But they modify the terms of trade between the domestic economy and the rest of the world Unless the duty is very high, it need not completely shut out the products of other countries A tariff duty can be specific or ad valorem The specific duty is based upon the quantity of the product howsoever measured The ad valorem duty is based on the value of the product and is expressed as a proportion or percentage of the total value (w.e.f) of the imported quantity The protective effect of a specific tariff is eroded under inflationary pressure but not so the effect of ad valorem duty There are, in addition, export duties on goods being sent out of the country and in-transit duties on entrecote trade The effects of a tariff are manifold CP Kindle Berger classifies them into eight categories The protective effect The consumption effect The revenue effect The redistribution effect The terms of trade effect The employment income effect The balance of payments effect and The competitive effect A tariff achieves these effects by limiting imports and invariably all these effects can be analysed as part of the total impact of a tariff upon the economy A tariff reduces imports that can be easily seen because a duty on imports will raise its price, so its demand will fall, thus, compelling a reduction in import of the commodity subjected to such a duty If the duty equalises import and domestic prices and if domestic supply is adequate, then, in the absence of qualitative differences, imports will cease If a tariff duty is levied on a finished product, it has the effect of raising the import price of that commodity If we know the elasticities of domestic and foreign demand and supply, we can calculate how effective the tariff duty would be in reducing the imports However, if the tariff duty is on an input required to make the final product, its impact will be on the costs of production It will raise the selling price of the product and thus reduce the gap in the prices of the imported and the domestic product An import duty on the finished product achieves the same result by raising the price of the imported product Thus, to assess the total impact of tariffs on a product, we must take into account, not merely the individual tariffs on different commodities but also the tariff structure of the country as a whole Only then can the effective rate of protection be assessed We can assess the effect of a tariff by examining its implication for a product or the effect of a general duty on all (or most) imports 37 Barriers in International Marketing Management Y D P R I C E S E P11 P1 F P A B C D G D S O Q Q1 Q2 Q3 QUANTITY Figure 2.3: Effect of a Tariff on Production (Protective); Consumption, Revenue and Income Distribution Figure 2.3 analyses the effects of a tariff in partial equilibrium context DD and SS represent the demand and supply curves OP represents the pre-tariff price level, at which OQ is produced domestically and quantity QQ3 is imported from abroad to meet the total demand (consumption), which is OQ3 Then tariff is levied which raises price level from O to P This has the effect of raising domestic output from OQ to OQ1 But this output is raised by diverting resources from other firms Area A represents gain to the industry due to protection (redistribution effect), the area B represents a dead loss due to transference of resources at a higher cost and perhaps decreasing return It is known as the protective effect On the other hand, the consumption effect is seen as the fall of domestic consumption from (OQ3 to OQ2) Thus area D, like B, is also a dead loss to the economy Import duties yield revenue to the government which are equal to the product of the tariff and the quantity imported, i.e PP1 × Q1Q2 – which corresponds to the rectangle marked C in the above diagram and is known as the revenue effect of the tariff Thus, in sum, (A +C) accounts for the positive effects of the tariff and (B + D), the negative aspect The balance of these would indicate the net benefit/loss from a tariff If, however, the tariff is raised as high as OP, it will prove to be prohibitive for imports The domestic supply will equal domestic demand but the cost in terms of consumption and protective effects will increase and the revenue to the state from imports will fall to zero It may also be noted that the magnitude of the protective and consumption effects of a tariff depend upon the elasticity of the supply and demand functions respectively The more elastic are these functions, the greater will be these costs and vice versa If any or both of these functions become completely inelastic, the related cost falls to zero Protective effects of a tariff are uncertain It is true that it helps to stabilise and enable the development of an industry faced with unequal, if not unfair, foreign competition; it also often breeds inefficiency, retards technical change and encourages combinations in restraint of trade Thus, the impact of a protective tariff is quite unpredictable 38 International Marketing Management 2.7.1 Consumption Effect The consumption effect of a tariff is invariably to reduce aggregate consumption, except when the intent of the tariff is to protect a nascent industry, which has the potential to grow but would not otherwise, due to market imperfections, lack of external economies or difficulties, lack of natural resources endowment In such cases, imposition of a tariff may be a necessary precondition for the development of the industry, which may ultimately be able to without protection, thus, increasing production and consumption both at the same time 2.7.2 Revenue Effect Government raises revenue in a variety of ways for a variety of purposes Even in economically advanced countries, import duties play more significant role in fiscal policy and planning It is necessary for these countries to regulate imports according to a certain order of planned priorities to correct imbalance in their balance of payments accounts, to curb certain undesirable types of consumption and to raise revenue for financing development and other expenditure Thus import duties play a varied role They are administratively convenient because it is easy to check goods at entry points into any country Besides, if it is desired to avoid protective and redistributive effects of a tariff, it can be done by imposing a tax on domestic supply by an equivalent amount and bring in additional revenue However, the adverse consumption effects of a tariff cannot be avoided except in the rare circumstances when its entire burden is borne by the exporting country, which absorbs it in its price 2.7.3 Redistributive Effect In Figure 2.3, DPG represents consumers’ surplus in the pre-tariff period, when price is OP After tariff price rises to OP1, and consumers’ surplus is reduced to DPF, the consumers’ surplus, represented by the area PP1 PG, is redistributed among producers, and as such, indicates the magnitude of redistribution effect in the economy However, Figure 2.3 shows the redistribution of consumers’ surplus among the producers of a single commodity in the economy Thinking of the economy as a whole, HeckscherOhlin theory, dealt with in the earlier lesson, shows that free trade raises the price of the abundant factor and lowers that of the scarce factor As such, the producers/suppliers of the scarce factors generally favour tariffs and trade restrictions, but those of the abundant factors argue for wider and free markets The redistribution effects of tariffs are more involved It is often argued, especially by small-scale enterprises, that free trade favours large, monopolistic and multinational enterprises, which pose a great threat to free competition Likewise, less developed countries find that free trade would drain their resources and depress their economic development 2.7.4 Terms of Trade Effect The effect of a tariff on the terms of trade depends on whether its burden falls wholly on the exporting/importing country or is shared by both If the exporting country pays whole or a part of a tariff, the importing country will be able to get its supply ‘cheaper’ The following figures illustrate how it works: PRICE S S P1 } P P1 P D D Tariff COUNTRY A COUNTRY B QUANTITY Figure 2.4: Elastic Supply in Exporting Country S COUNTRY A COUNTRY B P1 P P P1 D D Tariff QUANTITY Figure 2.5: Inelastic Supply in Exporting Country In the above figures, line PP represents price before tariff and P1P1 after tariff has been imposed The elasticities of demand and supply in the two countries are such that the impact of tariff is shared by both the countries, but in different proportions The distance between the down portions of the dotted line P1P1 indicates the total impact on the price in which the two countries share the change in price In Figure 2.4, the supply in the exporting country A is elastic relative to demand in importing country B So the major proportion of the tariff is absorbed by the higher price But, a portion of the tariff is also absorbed by the exporting country A, which lowers its export price, in order to achieve a higher level of exports than would be possible at an even higher price which would prevail if the entire tariff duty is absorbed by the importing country B The burden of higher price, which the consumers have to pay in country B, is mitigated to the extent of the revenue effect, part of which is also borne by the exporting country In Figure 2.5, there is the opposite case in which supply in the exporting country A is inelastic relative to demand in the importing country B So the major portion of the tariff is absorbed by the exporting country, which lowers its price to achieve a higher level of 39 Barriers in International Marketing Management 40 International Marketing Management exports Since the exporting country is absorbing most of the tariff, the importing country will get its supplies cheaper but the protective effect of the tariff in such circumstances will be small or negligible It is possible to demonstrate this with the help of other curves also, as Marshall has done, in a general equilibrium framework But the conclusions are similar as analysed above with simpler technique 2.7.5 Employment/Income Effect In general, tariff duties reduce imports by raising their price This obliges consumers to transfer their demand to domestic substitutes for imported goods This will raise employment and incomes in the domestic economy This, however, assumes that exporting countries not retaliate But retaliation can take place, because increase in national income and employment is achieved at the expense of those countries whose exports are reduced To counteract such a situation, countries with a high level of imports combine a policy of high tariff with increased domestic expenditure, so as to leave the value of imports unchanged Such a policy avoids retaliation by other affected countries and, at the same time, ensures that increase in national income does not drain the country’s gold reserves 2.7.6 Balance of Payments Effect The relationship between balance of payments and tariffs is neither simple nor direct The simplest statement is that raising tariffs improves the balance of payments by reducing imports but leaving the exports unaffected By the same reasoning, if tariffs are reduced, they encourage imports This is why less developed countries argue for a reduction of tariffs by the more developed countries However, this is not always the case A sophisticated statement would imply that tariffs divert spending from foreign to domestic goods, thus, raising national income But, with increase in national income, even if the propensity to import is reduced, there will be more money to go round and so it is quite possible that the impact of a tariff may wear out and at the second stage, the balance of payment position may even be left unchanged Thus, the balance of payment effect is quite involved However, if there are no savings, no investment and no foreign repercussions, the balance of trade will be unaffected by the tariff 2.7.7 Competition Effect The competitive effect of a tariff is really an anti-competitive effect; competition is stimulated by tariff removal Formation of ECM (European Common Market) is said to have enlarged markets and economies of scale, some say that its most significant result was breaking of monopolies Before ECM, one or two large companies in France kept high prices over some inefficient firms since competition was limited When tariff came down, small firms merged with larger ones Big firms could have reduced prices to destroy small firms But this is against national benefits These several effects are closely interrelated with each other, as it apparent from Figure 2.3 But one should not form the impression that all the effects of a tariff operate with equal intensity at the same time in any given situation From the above analysis, it would seem that in the absence of retaliation, as a country raises its tariffs unilaterally, the terms of trade improve and the volume of trade declines The improvement in the terms of trade tends, initially, to more than offset the accompanying reduction in the volume of trade Hence, welfare is enhanced Beyond some point, however, it is likely that the detrimental effect of the successive reductions in trade volume will begin to outweigh the positive effects of further improvements in the terms of trades, so community welfare begins to decline Somewhere in between, there must be a tariff which optimises a country’s welfare even under these conditions Keeping in mind the above effects, let us discuss the economic and non-economic arguments which weigh with economists and governments in formulating an optimum tariff policy Later, we will discuss other non-tariff measures and methods adopted to regulate trade Tariff is imposed to protect domestic industry from import competition Assuming there is no discrimination or other impediments to trade, an industry’s inability to compete against imported product implies comparative disadvantage in that product So economic welfare will be maximised if the country transfers resources to manufacture some other production in which it is advantageously placed and use its increased output to import the former product Thus, there is an implicit conflict between the interest of an industry and the larger interests of the economy For, if trade is free, the concerned industry might even wither away, causing unemployment and loss to the investors On the other hand, a protective tariff will raise prices even if it does not shut out imports; ensure higher returns and survival of the industry In such cases, a country has to make a choice between the wider interests of the country/community and those of a section or of an industry However, these arguments would not be valid if the comparative disadvantage is the result of restrictive action by another country or restrictive trade practices adopted by a large and/or monopolistic organisation Nor would it be advisable to allow an industry to suffer or wither away if its comparative disadvantage is due to some remediable organisational, technical or financial difficulty or some other short-term factors Thus it is necessary to take a long-term view of the situation, the prospects for the industry and the international market structure facing it Tariff is sometimes used as a device to improve a country’s terms of trade and thereby secure a larger share of the gains from trade This argument is valid upto the point of the optimum level of tariff, subject to the assumption of no retaliation by countries which may be adversely affected by the tariff But the optimum terms of trade, which can be so achieved, are certainly not the maximum terms of trade If the assumption of ‘no retaliation’ is dropped, then the argument becomes invalid, because with repetitive rounds of retaliation and counter retaliation, the resulting terms of trade are likely to be much inferior than under free trade Generally, it is likely that a small country may be able to improve its terms of trade without inviting retaliation from other countries because it concerns only a small proportion of the total worked trade in a commodity But it is seldom that a big country is able to adopt tariff, as a device for improving its terms of trade without retaliation even if the tariff involved is small, because a big country’s example is likely to be followed by others Tariffs may increase domestic real income and employment if the economy is working at less than full capacity and if exports can be maintained at previous levels, without retaliatory action by the other country Another argument favouring use of tariffs to support employment is commonly known as “pauper labour” argument According to this, tariffs are needed to protect domestic workers from low priced foreign competition, when it is due to lower wage rates prevailing abroad This reasoning is fallacious Firstly, labour is only one of the factors of production and real wages are not directly related to relative international competitiveness Secondly, real wages must necessarily differ substantially between nations as a result of differences in relative factor endowments and efficiency, which are the basis of comparative cost differences Thus, to accept this argument is to deny the very basis of international trade A more widely held argument favours protection to nascent industries It is often known as “infant industry” argument It concedes that tariffs are generally detrimental to 41 Barriers in International Marketing Management 42 International Marketing Management economic efficiency but maintains that industries in already developed countries have certain economies which are not available to nascent industries in underdeveloped and developing countries Unless, therefore, such industries are protected until they reach a certain level of development, they may not be able to develop at all There is force in this argument since conditions in the real world not conform to the classical ideal of perfect competition But this deal is also capable of being misused and stretched beyond its legitimate limits Given tariff protection, the productive units of an industry may be able to gain rapidly in size because they are allowed to supply the domestic market without competition from imports As plant size increases the domestic enterprises realise significant internal economies of scale and reductions in costs of production As the enterprises multiply, there are external economies, which improve efficiency and reduce costs At some stage in the growth process, the industry reaches a level when it can without the protective tariff and compete with the foreign industry in the national and international market Thus, the protection to the industry leads to its development as well as enlargement in the size of the national market In order that such protection may be successful, certain conditions must be fulfilled Firstly, the country must have the necessary resource endowment for the industry Secondly, the industry must be capable of developing to its optimum efficiency in a reasonable period and capable of facing import competition without protection; and thirdly, it should also be capable of competing in export markets of the world Judiciously employed, infant-industry tariff is quite consistent with potential comparative cost advantage and factor endowment approach However, such tariffs are open to certain abuses Foremost of these is the fact that once an industry gets used to protection, there is the temptation to carry it longer than necessary with consequent burden on the consumer and loss of welfare Secondly, the argument is often stretched to extend protection to old and decaying industries, which may not be able to withstand import competition because of organisational inefficiency or technical obsolescence These problems call for a different remedy than tariff protection Thirdly, tariff has often been the mother of monopoly American economic history is full of examples of monopolies growing in a protected domestic market behind tariffs This is not the place to discuss the implication of a monopoly for the efficiency and stability of the economy, but it is necessary to guard against the baneful effects of concentration of economic power The tariff question is often related to the main issue of economic growth — whether it will be better if all industries grow simultaneously at the same or near-equal rate or whether some industries with a high potential comparative cost advantage in international markets should be developed first, to generate a growth momentum through the economy The former represents “balanced” growth approach and the latter, an “unbalanced” growth approach Advocates of the former extend the infant-industry argument to help a broad-based social overhead investment programme, to stimulate balanced industrial growth But the second approach does not rely on infant industry tariffs as an instrument of growth, except in exceptional cases for short-terms Whatever the approach, we should accept that the use of tariff protection must be based an a careful appraisal of the country’s factor endowment, the potential cooperative cost of the industry and the costs and benefits of a tariff policy to the economy as a whole Before we conclude, we must discuss some non-economic arguments for extending tariff protection to industries Foremost is the argument that industries, which are indispensable for national defence, must be protected This argument really takes the question of protection outside the scope of economics There is no doubt that national security is vital for any economic activity to be carried out and such industries have to be protected and fostered irrespective of their cost to the community But this argument should not be extended to grant protection to other industries as well, on the specious plea that in war time almost every industry would be needed and so we must aim at national self-sufficiency Such an extension of the national security argument would amount to a denial of the very basis and advantages flowing from international trade Tariffs can be used to prevent the import and consumption of certain commodities, which are considered socially undesirable such as opium, or luxury goods, which may be considered wasteful for a poor country such as India This argument is self-evident Tariffs can be used to offset discriminatory practices on the part of foreign suppliers A related argument suggests the use of tariffs to improve our bargaining position vis-à-vis other countries Imposition of a retaliatory tariff can, of course, improve a country’s terms of trade provided there is no counter retaliation But, as we have argued earlier, a higher tariff will reduce the volume of trade whose effects will worsen the gains from the terms of trade; if there is counter retaliation, it may lead on to a stage when no further trade would be possible As a tool in bargaining, tariffs can be extremely useful, if deftly employed It is common knowledge that in international economic negotiations, there generally is a positive relationship between the height of a country’s tariffs and its strength at the bargaining counter It is also often noticed that countries with low tariffs raise them with the intention of international bargaining But such strength may equally be due to the country’s size, economic power and standing in the comity of nations However, there are other aspects of a tariff, already discussed, which should be taken into account, because it is easier to impose a tariff than to get rid of it after vested interests come into play Secondly, if the countries concerned are themselves dependent on imports for their basic requirements the impact of tariffs — whether bargaining or otherwise — may be inflationary and may distort the price structure, depress exports and retard development Check Your Progress Define consumption effect Write a brief note on revenue effect 2.8 NON-TARIFF MEASURES TO REGULATE TRADE In the preceding section, we have dealt with tariffs and their several effects on international trade between countries Although tariffs are the most important tool of commercial policy, they are not the only instruments available to governments to enforce their regulatory policies While tariffs impose a tax or duty on the goods imported (and represent an attempt to change the terms of trade in favour of the importing country), there is no direct restriction on the amount of goods which can be imported But it is quite open to any government to control the physical flow of goods into or out of it These measures of quantitative control can be employed independently or in addition to tariffs Although these restrictions are different in character and quality, their effects are not so very dissimilar, because like tariffs, they also seek to influence the terms of trade in favour of the home country 43 Barriers in International Marketing Management 44 International Marketing Management 2.9 DIFFERENCES BETWEEN TARIFF AND NON-TARIFF BARRIERS The purpose of tariff and non-tariff barriers is to regulate the free flow of imports However, the following differences may be noted in their operation i With tariffs, the government receives the revenue whereas no revenue is received by the government by applying non-tariff measures However, it is favoured as an appropriate measure to meet the demand of the country and to protect the industry ii Non-tariff measures protect the producers and make them feel more secure than under a tariff Producers are inclined to produce more for domestic as well as for international market under non-tariff barriers Such incentives are not there under tariffs iii Customs classification and valuation procedures pose a problem before the customs authorities whereas under non-tariff measures no such problem arises iv Non-tariff barriers to trade induce the domestic producers to form monopolistic organisations with a view to keeping output low and prices high This is not possible under an imports duty If the prices of products continue to rise due to the operation of monopolistic tendencies, imports become attractive even after the import duty is paid Thus non-tariff barriers remain ineffective if monopolistic tendencies prevail in the country v Imposition of tariffs and amendments therein are subject to legislative enactment and therefore are more or less inflexible Further, in many cases, the scope for adjustments, especially an upward revision of tariffs, is very limited due to the commitment under GATT On the other hand, non-tariff measures are often more flexible than tariff because the grant of import licence or release of foreign exchange is a matter of official discussion in regard to their timing and quantity vi Under tariffs, price differences between the importing and exporting countries will be only equal to the costs of tariffs and transportation If differences are more than this, they will be eliminated by competition But the price differences will be greater in two countries if non-tariff measures are adopted because there is no free flow of imports vii The difference in prices of the product in two countries is more than the costs of tariffs and transportation under non-tariffs The importers earn huge profits and it makes the business of importing more lucrative But under the tariff system, there are no such complication because flow of goods is not restricted and therefore the price differences cannot be more than the costs of tariffs and transportation for long There are, therefore, no huge profits to imports viii From the point of view of administrative convenience, tariffs are simpler to operate Tariff rates, once fixed through legislation, require no individual allocation of licensing, quotas or exchange There are, however, a number of authorities for the administration of non-tariff measures It may result in some sort of political interference or corruption ix Tariffs particularly favour the efficient firms in the country because only they can bear the competition, whereas non-tariff measures benefit the established firms because they get quotas or import licences on the basis of their past representation and, therefore, non-tariffs discriminate against newcomers Thus, both the measures — tariffs and non-tariffs — are not free from defects and, therefore, it cannot be advantageous to adopt them individually Both the measures are to be operated simultaneously to eliminate the ill effects of each other and to get the best for the economy 2.10 COMMODITY AGREEMENTS In order to get over these problems, different countries enter into commodity agreements among themselves and undertake state trading But commodity agreements have not always been successful in solving the problem of trading countries Commodity agreements are induced by a desire to stabilise prices especially where small shifts in demand lead to large price changes due to inelastic demand and supply functions This is particularly so in respect of primary products Hence primary producing countries generally have a feeling that, left to the free play of demand and supply forces of a market economy, they will not be able to get their just and equitable share in world’s trade at a just and equitable price Additionally, they are keen to conserve their mineral wealth and improve their bargaining power and to get the best price for them But they have not been very successful either because of the inelasticity of world demand, or because the demand for the product is a derived demand, which fluctuates widely In these circumstances, commodity agreements may even be a hindrance to the stability of the economy, because by fixing price over a period they accentuate fluctuations in demand Thus, though price stability is the avowed object of commodity agreements, instability of balance of payments may often be the result Check Your Progress Mention the various types of tariffs What are the non-tariff barriers? What is the employment effect of tariff? 2.11 BILATERAL AGREEMENTS Another method adopted to regulate international trade is that of bilateral trade agreements between countries International trade of communist bloc countries is organised almost entirely on the basis of bilateral agreements with other countries because of the requirements of centralised planning Free world countries have also resorted to bilateral trade arrangements either because of problems connected with control and regulation of foreign currency reserves or to employ international trade as an instrument of economic development; to find sale outlets for surplus resources and to optimise the use of scarce resources However, the actual practice of working these agreements varies from economy to economy At one extreme, it may simply means the issuance of permits for export of specific commodities to exporters, who may procure the quantity from the 45 Barriers in International Marketing Management 46 International Marketing Management market at the best price they can Even within the same country, there may be one practice for some commodities and another for some others The policy of bulk buying and selling, implicit in bilateral arrangements, often leads to state trading which is discussed in a separate lesson Here we want to discuss it briefly as a protective device and as an instrument of international commercial policy Planning for economic development requires large-scale intervention in the economic process This may, in some cases, require establishment of state (monopoly) trading in certain products either because the product is an essential industrial input or a necessity of life or has high utility as a revenue getter It is obvious that when state takes over trade in a particular commodity, it can use its monopoly to achieve a variety of public purposes It can restrict the use of an imported article by raising its domestic market price — the difference between its import price and domestic market price being the state’s revenue Likewise, the state can reduce the domestic price even lower than the import price — the difference being a subsidy to encourage its consumption This is done when the commodity is an essential input of widespread industrial use or when it is a necessity of life Finally, the state could buy the domestic product at a price higher than the price at which it can be imported from abroad — the difference being akin to a protective duty What then, is the best commercial policy that a country can follow to optimise the material welfare of its people? The question is not easy to answer in direct simple terms, for there can be different ways of looking at it For example, it is possible to build differing theoretic models based either on efficiency or on social welfare as the main criteria, which will indicate the best commercial policy under different assumed conditions But it is equally possible to think of divergence and conflict between the criteria of efficiency and social welfare As such the government must necessarily think in terms of reconciliation of conflict and of reducing the divergence to a minimum Such a solution may not be pragmatic one In general theoretic terms, social welfare and efficiency are optimised when marginal social value equals marginal social cost In theory, free trade is expected to bring about such a consumption, put in practice, there will often be a divergence between them, because firstly the above conditions imply an unrealistic assumption regarding perfectly competitive factor and product markets Secondly, governments are an important intervener in economic matters imposing all sorts of taxes, subsidies, grants and other public policy measures; and thirdly, there are external economies and diseconomies in production Under such conditions, free trade cannot be expected to bring about efficiency and welfare All that can be said with certainty is that in the highly imperfect markets of the real world ‘free trade’, however desirable, cannot be practised unilaterally by any single country, to its own disadvantage So a second best solution would be more pragmatic For this to be worked out realistically, it would be necessary to evaluate carefully, the social cost of specific commercial policies and their contribution to social welfare That policy should be considered best possible in given circumstances which minimises the divergence between marginal social cost and marginal social welfare 2.12 LET US SUM UP Every country has to regulate its own international trade mainly due to: (i) Improving its balance of trade and balance of payment position; (ii) Protecting its own industries against competition in the international markets or in domestic markets from foreign products; and (iii) Exploiting its manpower and natural resources to the maximum extent possible so that the country’s economic development may proceed at a faster speed In order to attain these objectives, almost every country imposes certain restrictions on its international trade These restrictions may be called trade barriers – tariff and nontariff or protective barriers For the purpose of taxes tariffs may be classified into two categories, Revenue tariffs and Protective tariffs Based on the method of computation, tariffs may be put into two categories, Specific tariffs, Ad valorem tariffs; and Anti-dumping duties Over the last few years, GATT has been endeavouring to achieve a reduced and rationalised tariff structure for trade among its member countries As per the terms of GATT, every member country will accord MFN treatment to all other member countries while importing goods from them At the same time, importing countries are also concerned with the development of their own industries and trade They have to protect them against unfair competition with a view to giving the domestic industry a fair chance for survival To meet the challenges, more and more countries are adopting non-tariff measures to regulate their imports Such measures may be called ‘non-tariff barriers,’ which are as under: Quantitative restrictions, quotas and licensing procedures Foreign exchange restrictions Technical and administrative regulations Consular formalities State trading Preferential arrangements In the end, it is essential that some non-economic arguments for extending tariff protection to industries be discussed A related argument suggests the use of tariffs to improve one’s bargaining position vis-à-vis other countries Imposition of a retaliatory tariff can, of course, improve a country’s terms of trade provided there are no counteractions Secondly, if the countries concerned are themselves dependent on imports for their basic requirements the impact of tariffs – whether bargaining or otherwise – may be inflationary and may distort the price structure, depress exports and retard development International trade of communist bloc countries is organised almost entirely on the basis of bilateral agreements with other countries because of the requirements of centralised planning It can restrict the use of an imported article by raising its domestic market price – the difference between its import price and domestic market price, being the state’s revenue Likewise, the state can reduce the domestic price even lower than the import price – the difference being a subsidy to encourage its consumption 2.13 LESSON END ACTIVITY Compare the effects of tariff and non-tariff barriers of international trade on an economy 2.14 KEYWORDS Tariff: A tax assessed on goods that are imported or exported from a country Quota: A specified amount of product that a government will permit to be imported Non-tariff Barriers: Government policies that create restrictions on imports without the use of tariffs Specific Duties: These are imposed on the basis of per unit of any identifiable characteristics of merchandise Ad valorem Tariff: These are imposed on the basis of value of imports 47 Barriers in International Marketing Management 48 International Marketing Management 2.15 QUESTIONS FOR DISCUSSION What are trade barriers? Explain these in detail with examples from the Indian scenario What is the difference between Anti-dumping duties and Ad-valorem duties? What is the significance of Quotas in the international marketing? What are the implications of Tariffs in the international marketing? Check Your Progress: Model Answers CYP 1 Ad valorem Tariffs are based on the value of the imports and are charged in the form of a specific percentage of the value of goods Anti-dumping duty is levied when exporters from developed countries are eager to sell their products in foreign markets with a view to capture a large market, at a very low price note proportionate to their cost of production CYP The consumption effect of a tariff is invariably to reduce aggregate consumption, except when the intent of tariff is protect a nascent industry, which has the potential to grow but would not otherwise, due to market imperfections, lack of external difficulties, lack of natural resources endowment Government raises revenue in a variety of ways for a variety of purposes It imposes certain duties on imports etc., which is known as revenue effect CYP Types of Tariffs: (i) Revenue Tariff (ii) Protective Tariff (iii) Specific Tariff (iv) Ad Valorem duty (v) Anti-dumping duties (vi) Counteracting duty Non-tariff Barriers: (i) Quantitative restrictions, quotas and licensing procedures (ii) Foreign Exchange restrictions (iii) Technical and Administrative regulations (iv) State Trading (v) Preferential Arrangements Employment Effect of Tariff: Tariff duties reduce imports by raising their price This obliges consumers to transfer their demand to domestic substitutes for imported goods This will raise employment and incomes in the domestic economy 2.16 SUGGESTED READINGS PKVasudeva, International Marketing, Excel Books, New Delhi, 2006 Shyam Shukla, International Business, Excel Books, New Delhi, 2008 Philip R Catero, International Marketing Keegan, Global Marketing Management 49 Barriers in International Marketing Management ... PKVasudeva, International Marketing, Excel Books, New Delhi, 2006 Shyam Shukla, International Business, Excel Books, New Delhi, 2008 Philip R Catero, International Marketing Keegan, Global Marketing Management. .. concerned with marginal social costs rather than 31 Barriers in International Marketing Management 32 International Marketing Management marginal private costs, which may diverge quite considerably... commodities in which the foreign supply position is quite 33 Barriers in International Marketing Management 34 International Marketing Management inelastic In such a case, tariff is likely to be absorbed