International Trade

Effective Rate of Protection

So far, we have only considered the nominal rate of protection offered by a tariff - in other words, the level of protection offered to producers by imposing an import tariff on their good.

Now we look at the effective rate of protection, which considers the entire tax structure.

Definition

The effective rate of protection is the percentage by which a country's trade barriers increase the value added per unit of output (considering the fact that tariffs on inputs matter as well as tariffs on outputs).

One-Input Model

First we consider the case where there is only one input i into the production of a good j. Consider these parameters:

P_j Price of a unit of j

C_j Cost of a unit of j

a_ij Share of input i in cost of j

t_i Tariff rate on i

t_j Tariff rate on j

In the absence of a tariff, V_j, which is the value added per unit of output j, is:

  Vj = Pj - Cj
     = Pj(1 - aij)

Suppose tariffs are imposed on the output (t_j) and input (t_i). Then the new value added V'_j is:

  V'j = Pj[(1 + tj) - aij(1 + ti)]

By definition, the effective rate of protection g_j is:

  gj = (V'j - Vj) / Vj
    = (tj - aijti) / (1 - aij)

From this, we can draw a number of conclusions:

Example

Consider a simplified example where steel is considered to be the only input to produce automobiles. Under free trade, assume that the price of a car is $10000 and the price of steel required to produce a car is $8000.

Then the value added (under free trade) is $10000 - 8000 = $2000.

1. How much is the value added if a 10% tariff is imposed on cars? How much is the ERP?

        V'  = 10000 (1 + 0.1) - 8000 = 3000
        ERP = (3000 - 2000) / 2000 = 0.5
   

   As we can see, although the tariff is only 10%, the effective rate of protection is 50%.

2. How much are the value added and ERP if a 10% tariff is imposed on steel (only)?

       V'  = 10000 - 8000 (1 + 0.1) = 1200
       ERP = (1200 - 2000) / 2000 = -0.4
   

   In this case, the 10% tariff on steel (which is a cost to producers) is effectively a 40% tariff.

3. How much are the value added and ERP if a 10% tariff is imposed on cars and steel both?

       V'  = 10000 (1 + 0.1) - 8000 (1 + 0.1) = 2200
       ERP = (2200 - 2000) / 2000 = 0.1
   

   As expected, this is the same as either of the tariffs.

4. How much are the value added and ERP if there is a 20% tariff on cars and a 10% tariff on steel?

       V'  = 1000 (1 + 0.2) - 8000 (1 + 0.1) = 3200
       ERP = (3200 - 2000) / 2000 = 0.6
   

   As in the first case, this is effectively more protection for producers.

Multiple Inputs

We have considered the case where there is only one input for the given output. This is a special case of the more general situation where there are n inputs.

In the more general case, the effective rate of protection can be derived in a similar way, and we get the following:

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[Topic] Tariffs

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Copyright © 1997-2003 Dr MoonJoong Tcha
[mtcha@ecel.uwa.edu.au]

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