International_Economics_Tenth_Edition (1)

The benefits and costs of protecting domestic producers from foreign competition, as discussed earlier in this chapter, are based on the direct effects of an import tariff. Import-competing businesses and workers can benefit from tariffs through increases in output, profits, jobs, and compensation. A tariff imposes costs on domestic consumers in the form of higher prices of protected products and reductions in consumer surplus. There is also a net welfare loss for the economy because not all of the loss of consumer surplus is transferred as gains to domestic producers and the government (the protective effect and consumption effect).

A tariff carries additional burdens. In protecting import-competing producers, a tariff leads indirectly to a reduction in domestic exports. The net result of protectionism is to move the economy toward greater self-sufficiency, with lower imports and exports. For domestic workers, the protection of jobs in import-competing industries comes at the expense of jobs in other sectors of the economy, including exports. Although a tariff is intended to help domestic producers, the economy-wide implications of a tariff are adverse for the export sector. The welfare losses due to restrictions in output and employment in the economy's export industry may offset the welfare gains enjoyed by import-compet- ing producers.

Becausea tariff is a tax on imports, the burden of a tariff falls initially on importers, who must pay duties to the domestic government. However, importers generally try to shift increased costs to buyers through price increases. There are at least three ways in which the resulting higher prices of imports injure domestic exporters.

First, exporters often purchase imported inputs subject to tariffs that increase the cost of inputs. Because exporters tend to sell in competitive markets where they have little ability to dictate the prices they receive, they generally cannot pass on a tariff-induced increase in cost to their buyers. Higher export costs thus lead to higher prices and reduced overseas sales.

export revenues and ability to import. The decline

in foreign export revenues results in a smaller demand for a nation's exports and leads to falling output and employment in its export industries.

If domestic export companies are damaged by import tariffs, why don't they protest such policies more vigorously? One problem is that tariffinduced increases in costs for export companies are subtle and invisible. Many exporters may not be aware of their existence. Also, the tariffinduced cost increases may be of such magnitude that some potential export companies are incapable of developing and have no tangible basis for political resistance.

Steel-Using Industries Oppose Restrictions on Steel Imports

In 2002, John Jenson, chairman of the Consuming Industries Trade Action Coalition, testified before the u.s. Senate Finance Committee regarding restrictions on steel imports.' He indicated that he voiced concerns of millions of American workers in steel-consuming industries regarding restrictions on steel imports.

'D.S. Senate Finance Committee, Tesrimony ofJohnJenson, February 13,

2002.

According to Jenson, restrictions on steel imports would be harmful to U.S. steel-using industries that employ 12.8 million workers compared to less than 200,000 workers employed by American steel producers. In our global economy, steel users must compete with efficient foreign manufacturers of all types of consumer and industrial installations, machines, and conveyances-everything from automobiles and earth movers to nuts and bolts. Forcing U.S. manufacturers to pay considerably more for steel inputs than their foreign competitors would deal U.S. manufacturers a triple blow: (1) increase raw material costs; (2) threaten access to steel products not manufactured in the United States; and (3) increase competition from abroad for the products they make. It would simply send our business offshore, devastating U.S. steel-using businesses, most of them small businesses.

Jenson's statement highlighted the main reasons for the opposition of steel-using industries to restrictions on steel imports:

•Import restraints do not address the most serious problem facing certain U.S. steel producers; that is, high and relatively inflexible costs such as wages and retirement benefits. If the United States restricts steel imports, it will not provide any lasting relief to U.S. steel mills because it won't solve the real problem.

•The U.S. market needs imports. The total production of steel in the United States, even at peak capacity, is not enough to satisfy domestic demand. Further, American steelusing manufacturers need imported steel meeting specifications that U.S. producers cannot or do not supply. Imports are necessary in many instances to allow U.S. manufacturers to compete globally.

•Import restrictions would jeopardize tens of thousands of Americans who work for steelusing manufacturers and U.S. exporters. Every state would lose more jobs than trade restrictions would save-even steel-intensive states like Indiana and West Virginia.

Jenson concluded that steel is an important industry to the U.S. economy. It is not the only industry,

however, and the costs of saving the steel industry should not outweigh the benefits.

ITariff Examples

The previous section analyzed the welfare effects of import tariffs from a theoretical perspective. Now let us turn to some examples of import tariffs and examine estimates of their costs and benefits to the nation.

Bush's Steel Tariffs Buy Time for Troubled Industry

In spite of opposition from domestic steel-using industries, in 2002 President George W. Bush

imposed tariffs ranging from 8~; .

In 1950, U.S. steelmakers dominated the world market. Accounting for half of global steel output, they produced almost 20 times as much steel as Japan and more steel than all of Europe combined. However, the market dominance of U.S. steelmakers gradually declined as they became complacent and insensitive to changing market conditions. By the 1960s, foreign steelmakers had made significant inroads into the American market, turning the United States into a net importer of steel. Since that time, sales and profits of U.S. steel mills have declined, and thousands of American steelworkers have lost their jobs.

Big U.S. integrated steel companies have lugged around outdated technology, high fixed costs, and enormous capacity. They also face tough competition from minimills that convert scrap directly into finished steel products. Minimills use modern technology to produce steel with about a 20 percent cost advantage over the integrated mills. Another problem facing big U.S. steelmakers is legacy costs, including pension and health-care benefits, which are owed to hundreds of thousands of both current and retired employees and add more than $9 to the cost of producing a ton of steel.

Since the 1960s, big integrated U.S. steelmakers have argued that they need import restraints because unfairly traded (dumped and subsidized) imports deprive them of a chance.to modernize as quickly as foreign rivals have. In response to pressure from U.S. steelmakers, in 2001 President Bush requested the U.S. International Trade Commission (USITC) to launch an investigation to determine whether the steel industry was seriously injured or threatened with serious injury from imports. After reviewing the facts, the USITC decided in 2002 that U.S. steelmakers in 16 out of 33 product categories were injured by imports, making those products eligible for trade restraints. The USITC especially noted excess steel in the world market producing the lowest prices in 20 years and the 30 bankruptcies of American steel companies.

The Bush remedy was a program in which 30 percent tariffs were initially imposed on imported steel that competes with the main products of most of the big integrated mills. The tariffs were scheduled to decrease to 24 percent the second year and to 18 percent the third year,and were then to expire. Other steel products faced tariffs from 15 percent to

8 percent. In return for granting steelmakers protection from imports, President Bush insisted that they bring their labor costs down and upgrade equipment.

Critics of the steel tariffs argued that the big integrated companies suffered from a lack of competitiveness due to previous poor investment decisions, diversion of funds into nonsteel businesses, and a reduction of investment during previous periods of import protection. They also noted that protecting steel would place a heavy burden on American steel-using industries such as automobiles and earth-moving equipment. Although the tariffs would temporarily save roughly 6,000 jobs, the cost to U.S. consumers and steel-using firms of saving these jobs was between $800,000 and $1.1 million per job. Moreover, the steel tariffs would cost as many as 13 jobs in steel-using industries for every 1 steel job protected:

'Robert W. Crandall, The Futility of Steel Trade Protection, Criterion Economics, 2002. See also U.s. International Trade Commission.

Steel-Consuming Industries. Competitive Conditions with Respect to Steel Sakquard Measures, September 2003.

The Bush tariffs did provide some relief to U.S. steelmakers from imports. Also, some cost-cutting occurred among steelmakers during 2002-2003: Producers merged and labor contracts were renegotiated, though often at considerable cost to the approximately 150,000 workers still employed in an industry that is just a shadow of its former self. However, the tariffs aroused heavy opposition among a large number of u.s. companies that use steel to make everything from auto parts to tin cans and washing machines. In numerous lobbying trips to Washington, chief executives of these firms noted that the tariffs drove up their costs and imperiled more jobs across the manufacturing belt than they saved in the steel industry. Indeed, President Bush found himself in a difficult political situation given the opposing interests of steel producers and steel users.

Citing an improving economy and cost-cutting efforts by domestic steel companies, President Bush removed the steel tariffs in December 2003. He noted that his tariffs provided domestic steelmakers time to restructure and regain competitiveness. However, his removal of the tariffs was primarily in response to the World Trade Organization's ruling that the tariffs were illegal (see Chapter 6). The World Trade Organization said the United States erred in seeking protectionism nearly four years after the industry suffered from a surge of imports during the meltdown of Asian economies. This decision gave the European Union and several other steel-exporting countries the authority to impose retaliatory tariffs of up to 30 percent on more than 2 billion dollars' worth of u.s. exports unless Bush eliminate his steel tariffs. Bowing to this pressure, Bush removed the tariffs. His action infuriated domestic steelmakers, who felt that they needed more time to regain competitiveness.

Lamb Tariffs Fleece

U.S. Consumers

In 1999, the U.S. government imposed stiff tariffs on imports of Iamb from Australia and New Zealand to protect high-cost U.S. producers and provide stability to the domestic market.' U.S.sheep

'This example is drawn from Douglas A. Irwin, "Lamb Tariffs Fleece U.S. Consumers. The Wall Street Journal, July 12, 1999, p. A2S.

producers have long been dependent on government. For more than half a century, until Congress enacted farm-policy reforms in 1995, they received subsidies for wool. Having lost that handout, burdened with inefficiencies and high costs, and facing domestic competition from pork, beef, and chicken, sheep producers attempted to reduce foreign competition by filing for import barriers.

Almost all U.S. Iamb imports come from Australia and New Zealand, major agricultural producers with a comparative advantage. New Zealand has less than 4 million people but as many as 60 million sheep, compared with about 7 million sheep in the United States. New Zealand's farmers have invested substantial resources in effectivemarketing and new technology, making them highly efficient producers. New Zealand also wiped out domestic agricultural subsidies in the free-market reforms of the 1980s and is on track to eliminate all import tariffs by 2006.

Rather than copy this example, the American sheep producers requested temporary import relief to allow them time to become competitive in the future. The U.S. government at first appeared to be considering only modest amounts of protectionism. Australia and New Zealand even offered financial assistance to the U.S. producers. However, the government relented to the demands of the sheep industry and its advocates in Congress and enacted stiff import barriers. On top of existing tariffs, the government imposed a 9 percent tariff on all imports in the first year (declining to 6 percent and then 3 percent in years two and three), and a whopping 40 percent tariff on imports above the levels of 1998 (dropping to 32 percent and 24 percent).

The American Sheep Industry Association's president declared that the policy will restore stability to the market. However, the decision outraged farmers in Australia and New Zealand. Moreover, consumer groups in the United States noted that whenever sheep producers speak of bringing stability to the market, you know that consumers are getting fleeced.

Harley-Davidson Revs Up

Sales with Tariffs

There have been approximately 150 manufacturers of motorcycles in the United States since the

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U.S. dealerships and warehouses, estimated to be a year-and-a-half supply of new motorcycles, led to heavy price cuts and intense product promotion.

By 1982, Harley was rapidly approaching bankruptcy and layoffs were mounting. Harley turned to the U.S. government for import relief. The government concluded that rising motorcycle imports from Japan were a substantial cause of a threat of serious injury to Harley and that temporary protectionism was justified to permit Harley to recover from its injuries and provide it time to complete a comprehensive program to fully compete with the Japanese.

In 1983, the U.S. government implemented a 5- year tariff program for heavyweight motorcycles (700 cc engines and larger). During the first year, the import tariff was raised from 4.4 percent to 49.4 percent; during the second year, the tariff was reduced to 39.4 percent; in the next three years, the tariff was cut by 15 percent, 5 percent, and 5 percent. After the fifth year, the tariff was to revert to 4.4 percent. The tariff hikes did not apply to motorcycle imports from Italy, Germany, and the United Kingdom, which accounted for less than 20 percent of U.S. imports of heavyweight motorcycles in 1982. The 5-year tariff program was intended to allow Harley sufficienttime to eliminate its excess inventories and to benefit from improved economies of scale obtained from increased sales and production.

But the substantial tariff looked much better on paper than it worked out in reality. Stung, Japanese motorcycle manufacturers reacted promptly to circumvent the tariff policy. They quickly downsized their 750-cc motorcycle engines to 699 cc, thus evading the tariff that applied to motorcycle imports having engines of 700 cc or more. The press dubbed these downsized models "tariff busters." The downsized engine wiped out approximately half of the tariff's value to Harley. Also, Kawasaki and Honda quickly increased production of heavyweight motorcycles in their U.S. plants. That left only Suzuki and Yamaha motorcycles, with engines over 1,000 cc, subject to the tariff. These manufacturers were permitted to ship 7,000 to 10,000 of these heavyweight motorcycles to the United States before they had to start paying the extra import duty.

Although the outcome of the tariff was disappointing to Harley, its economic performance

improved throughout the 1980s. By 1987, Harley enjoyed record profits of almost $18 million. It also enjoyed a 40 percent market share in the super-heavyweight motorcycle class, 11 percentage points ahead of its closest rival, Honda, and 17 points above its 1983 low of 23 percent. In March 1987, Harley announced that it no longer needed special tariffs to compete with the Japanese motorcycle firms. Harley indicated that, given temporary relief from predatory import practices, it had become competitive in world markets."

I Tariffs and the Poor S~~

Empirical studies often maintain that the welfare costs of tariffs can be high. Tariffs also affect the distribution of income within a society. A legitimate concern of government officials is whether the welfare costs of tariffs are shared uniformly by all people in a country, or whether some income groups absorb a disproportionate share of the costs.

Several studies have considered the incomedistribution effects of import tariffs. They conclude that tariffs tend to be inequitable because they impose the most severe costs on low-income families. Tariffs, for example, are often applied to products at the lower end of the price and quality range. Basic products such as shoes and clothing are subject to tariffs, and these items constitute large shares of the budgets of low-income families. Tariffs thus can be likened to sales taxes on the products protected, and, as typically occurs with sales taxes, their effects are regressive. Simply put, U.S. tariff policy is tough on the poor: Young single mothers purchasing cheap clothes and shoes at Wal-Mart often pay tariffs rates 5 to 10 times higher than rich families pay when purchasing at elite stores such as Nordstrom."

'Daniel Klein, "Taking America for a Ride: The Polirics of Motorcycle Tariffs," Cato Institute Policy Analysis, No. 32, January 1984. See also U.S. International Trade Commission, Heavyweight Motorcycles. and Engines and PowerTrain Subassemblies Therefor (Washington. DC: U.S. Government Printing Office, February 1983). and Peter Reid, Well Madein America (New York: McGraw-Hill, 1989).

'Edward Gresser, "Toughest on the Poor: America's Flawed Tariff System," Foreign Affairs, November-December 2002, pp. 19-23, and Susan Hickok, "The Consumer Cost of U.S. Trade Restraints," Federal Reserve Bank of New York, Quarterly Review, Summer 1985. pp. 10-11.

126 Tariffs

International trade agreements have eliminated most U.S. tariffs on high-technology products like airplanes, semiconductors, computers, medical equipment, and medicines. The agreements have also reduced rates to generally less than 5 percent on mid-range manufactured products like autos, TV sets, pianos, felt-tip pens, and many luxury consumer goods. Moreover, tariffs on natural resources like oil, metal ores, and farm products like chocolate and coffee that are not grown in the United States are generally close to zero. However, inexpensive clothes, luggage, shoes, watches, and silverware have been excluded from most tariff reforms, and thus tariffs remain relatively high. Clothing tariffs, for example, are usually in the 10 percent to 32 percent range.

Tariffs vary from one consumer good to the next. They are much higher on cheap goods than on luxuries. This disparity occurs because elite firms such as Ralph Lauren, Coach, or Oakley, selling brand name and image, find small price advantages relatively unimportant. Because they have not lobbied the U.S. government for high tariffs, rates on luxury goods such as silk lingerie, silverhandled cutlery, leaded-glass beer mugs, and snakeskin handbags are very low. But producers of cheap water glasses, stainless steel cutlery, nylon lingerie, and plastic purses benefit by adding a few percentage points to their competitors' prices. So on the cheapest goods, tariffs are even higher than the overall averages for consumer goods suggest, as seen in Table 4.8. Simply put, U.S. tariffs are highest on the goods important to the poor. The U.S. tariffs system is not uniquely toughest on the poor. The tariffs of most U.S. trade partners operate in a similar fashion.

Besides bearing down hard on the poor, U.S. tariff policy affects different countries in different ways. It especially burdens countries that specialize in the cheapest goods, noticeably very poor countries in Asia and the Middle East. For example, average tariffs on European exports to the United States-mainly autos, computers, power equipment, and chemicals-today barely exceed 1 percent. Developing countries such as Malaysia, which specializes in information-technology goods, face tariff rates just as low. So do oil exporters such as Saudi Arabia and Nigeria.

TABL.E 4.8

U.S. Tariffs Are High on Cheap Goods, low on luxuries

Source: u.s. International Trade Commission, Tariff Schedules of the United States (Washington, DC: U.S. Government Printing Office. 2004); http://www.usitc.gov/taffairs.htm.

However, Asian countries like Cambodia and Bangladesh are hit hardest by U.S. tariffs; their cheap consumer goods often face tariff rates of 15 percent or more, some 10 times the world average.

Arguments for Trade

Restrictions

The free-trade argument is, in principle, persuasive. It states that if each nation produces what it does best and permits trade, over the long run all will enjoy lower prices and higher levels of output, income, and consumption than could be achieved in isolation. In a dynamic world, comparative advantage is constantly changing owing to shifts in technologies, input productivities, and wages, as well as tastes and preferences. A free market compels adjustment to take place. Either

the efficiency of an industry must improve, or else resources will flow from low-productivity uses to those with high productivity. Tariffs and other trade barriers are viewed as tools that prevent the economy from undergoing adjustment, resulting in economic stagnation.

Although the free-trade argument tends to dominate in the classroom, virtually all nations have imposed restrictions on the international {low ofgoods, services, and capital. Often, proponents of protectionism say that free trade is fine in theory, but that it does not apply in the real world. Modern trade theory assumes perfectly competitive markets whose characteristics do not reflect real-world market conditions. Moreover, even though protectionists may concede that economic losses occur with tariffs and other restrictions, they often argue that noneconomic benefits such as national security more than offset the economic losses. In seeking protection from imports, domestic industries and labor unions attempt to secure their economic welfare. Over the years, a number of arguments have been advanced to pressure the president and Congress to enact restrictive measures.

Job Protection

The issue of jobs has been a dominant factor in motivating government officials to levy trade restrictions on imported goods. During periods of economic recession, workers are especially eager to point out that cheap foreign goods undercut domestic production, resulting in a loss of domestic jobs to foreign labor. Alleged job losses to foreign competition historically have been a major force behind the desire of most u.s. labor leaders to reject free-trade policies.

This view, however, has a serious omission: It fails to acknowledge the dual nature of international trade. Changes in a nation's imports of goods and services are closely related to changes in its exports. Nations export goods because they desire to import products from other nations. When the United States imports goods from abroad, foreigners gain purchasing power that will eventually be spent on U.S. goods, services, or financial assets. U.S. export industries then enjoy gains in sales and

"Linda Hunter. "U.S. Trade Protection: Effects on the Industrial and Regional Composition of Employment." Federal Reserve Bank of Dallas. Economic Review. January 1990. pp. 1-13.

help workers, and that workers departing from an industry facing foreign competition should be liberally compensated (subsidized) for moving to new industries or taking early retirement.

Protection Against

Cheap Foreign Labor

One of the most common arguments used to justify the protectionist umbrella of trade restrictions is that tariffs are needed to defend domestic jobs against cheap foreign labor. As indicated in Table 4.10, production workers in Germany, Switzerland, and the United States have been paid much higher wages, in terms of the U.S. dollar, than workers in countries such as Sri Lanka and Mexico. So it could be argued that low wages abroad make it difficult for U.S. producers to compete with producers using cheap foreign labor and that unless U.S. producers are protected from imports, domestic output and employment levels will decrease.

Indeed, there is a widely held view that competition from goods produced in low-wage countries is unfair and harmful to American workers. Moreover, it is thought that companies that produce goods in foreign countries to take advantage

Hourly Compensation Costs in U.S. Dollars for

Production Workers in Manufacturing, 2002

Source: U.s. Department of Labor. Bureau of Labor Statistics.

Foreign Labor Statistics: Hourly Compensation Costs in U.S. Dollars,

September 2003. at http://www.bls.gov.

of cheap labor should not be allowed to dictate the wages paid to American workers. A solution: Impose a tariff or tax on goods brought into the United States equal to the wage differential