21 Commercial Policy and its Instruments

Vishal Kumar

1. Learning Objective

After completing this module, you will be able to:

i. Understand the meaning and concept of Commercial Policy

ii. Understand the Tariffs and Quotas

iii. Know about the reasons for implementing tariffs

iv. Understand the Non-Tariffs barriers

v. Know about the Types of Non-Tariff Barriers to Trade

2. Introduction

‘Commercial Policy’ which is also referred to as a trade policy or international trade policy, is a set of rules and regulations that are intended to change international trade flows, particularly to restrict imports. Every nation has some form of ‘trade policy’ in place, with public officials formulating the policy which they think would be most appropriate for their country. Their aim is to boost the nation’s international trade. The purpose of trade policy is to help a nation’s international trade run more smoothly, by setting clear standards and goals which can be understood by potential trading partners. In many regions, groups of nations work together to create mutually beneficial trade policies.

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Trade policy can involve various complex types of actions, such as the elimination of quantitative restrictions or the reduction of tariffs. According to a geographic dimension, there is unilateral, bilateral, regional, and multilateral liberalization. According to the depth of a bilateral or regional reform, there may be free trade areas (wherein partners eliminate trade barriers with respect to each other), ‘‘custom unions’’ (whereby partners eliminate reciprocal barriers and agree on a common level of barriers against no partners), and free economic areas (or deep integration as in, for example, the European Union, where not only trade but also the movement of factors has been liberalized, where a common currency has been instituted, and where other forms of integration and harmonization have been established). The most common barriers to trade are tariffs, quotas, and non-tariff barriers. A tariff is a tax on imports, which is collected by the government and which raises the price of the good to the consumer, also known as duties or import duties. Tariffs usually aim first to limit imports and second to raise revenue. A quota is a limit on the amount of a certain type of good that may be imported into the country. A quota can be either voluntary or legally enforced.

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The effect of tariffs and quotas is the same i.e. to limit imports and protect domestic producers from foreign competition. A tariff raises the price of the foreign good beyond the market equilibrium price, which decreases the demand for and, eventually, the supply of the foreign good. A quota limits the supply to a certain quantity, which raises the price beyond the market equilibrium level and thus decreases demand.

Non-tariff barriers include regulations regarding product content or quality, and other conditions that hinder imports. One of the most commonly used nontariff barriers are product standards, which may aim to serve as “barriers to trade.” Other non-tariff barriers include packing and shipping regulations, harbour and airport permits, and onerous customs procedures, all of which can have either legitimate or purely anti-import agendas, or both. These are explained in detail as follows:

3. Tariffs and Tariff Rate Quotas

Tariffs, which are taxes on imports of commodities into a country or region, are among the oldest forms of government intervention in economic activity. They are implemented for two clear economic purposes. First, they provide revenue for the government. Second, they improve economic returns to firms and suppliers of resources to domestic industry that face competition from foreign imports.

Tariff is a tax levied on goods traded internationally. When imposed on goods being brought into the country, it is referred to as an import duty. Import duty is levied to increase the effective cost of imported goods in order to increase the demand for domestically produced goods. Another type of tariff, less frequently imposed, is the export duty which is levied on goods being taken out of the country, to discourage the export of those goods.

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This may be done if the country is facing a shortage of that particular commodity or if the government wants to promote the export of that good in some other form, for example, a processed form rather than in raw material form. It may also be done to discourage exporting of natural resources. When imposed on goods passing through the country, the tariff is called transit duty.

Tariffs are widely used to protect domestic producers’ incomes from foreign competition. This protection comes at an economic cost to domestic consumers who pay higher prices for import competing goods and to the economy as a whole through the inefficient allocation of resources to the import competing domestic industry. Therefore, since1948, when average tariffs on manufactured goods exceeded 30 percent in most developed economies, those economies have sought to reduce tariffs on manufactured goods through several rounds of negotiations under the General Agreement on Tariffs Trade (GATT). Only in the most recent Uruguay Round of negotiations were trade and tariff restrictions in agriculture addressed. In the past, and even under GATT, tariffs levied on some agricultural commodities by some countries have been very large. When coupled with other barriers to trade they have often constituted formidable barriers to market access from foreign producers. In fact, tariffs those are set high enough can block all trade and act just like import bans.

A tariff-rate quota (TRQ) combines the idea of a tariff with that of a quota. The typical TRQ will set a low tariff for imports of a fixed quantity and a higher tariff for any imports that exceed that initial quantity. In a legal sense and at the WTO, countries are allowed to combine the use of two tariffs in the form of a TRQ, even when they have agreed not to use strict import quotas. In the United States, important TRQ schedules are set for beef, sugar, peanuts, and many dairy products. In each case, the initial tariff rate is quite low, but the over-quota tariff is prohibitive or close to prohibitive for most normal trade. Explicit import quotas used to be quite common in agricultural trade. They allowed governments to strictly limit the amount of imports of a commodity and thus to plan on a particular import quantity in setting domestic commodity programs. Various types of tariff barriers are:

4. Technical Barriers

Countries generally specify some quality standards to be met by imported goods for various health, welfare and safety reasons. This facility can be misused for blocking the import of certain goods from specific countries by setting up of such standards which deliberately exclude these products. The process is further complicated by the requirement that testing and certification of the products regarding their meeting the set standards be done only in the importing country. These testing procedures being expensive, time consuming and cumbersome to the exporters, act as a trade barrier. Under the new system of international trade, trading partners are required to consult each other before fixing such standards. It also requires that the domestic and imported goods be treated equally as far as testing and certification procedures are concerned and that there should be no disparity between the quality standards required to be fulfilled by these two. The importing country is now expected to accept testing done in the exporting country.

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Procurement Policies

Governments quite often follow the policy of procuring their requirements (including that of government owned companies) only from local producers, or at least extend some price advantage to them. This closes a big prospective market to the foreign producers.

International Price Fixing

Some commodities are produced by a limited number of producers scattered around the world. In such cases, these producers may come together to form a cartel and limit the production or price of the commodity so as to protect their profits. OPEC (Organization of Petroleum Exporting Countries) is an example of such cartel formation. This artificial limitation on the production and price of the commodity makes international trade less efficient than it could have been

Exchange Controls

Controlling the amount of foreign exchange available to residents for purchasing foreign goods domestically or while traveling abroad is another way of restricting imports.

Direct and Indirect Restrictions on Foreign Investments

A country may directly restrict foreign investment to some specific sectors or up to a certain percentage of equity. Indirect restrictions may come in the form of limits on profits that can be repatriated or prohibition of payment of royalty to a foreign parent company. These restrictions serve to discourage foreign producers from setting up domestic operations. Foreign companies are generally interested in setting up local operations if they foresee increased sales or reduced costs as a consequence. Restrictions against foreign investment, thus, act as an impediment to international trade by giving rise to inefficiencies.

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Customs Valuation

There is a widely held view that the invoice values of goods traded internationally do not reflect their real cost. This gave rise to a very subjective system of valuation of imports and exports for levy of duty. If the value attributed to a particular product would turn out to be substantially higher than its real cost, it could result in affecting its competitiveness by increasing the total cost to the importer due to the excess duty. This would again act as a barrier to international trade. This problem has now been considerably reduced due to an agreement between various countries regarding the valuation of goods involved in cross-border trade.

Transportation Costs

These costs act as another trade barrier. The cost of moving goods from one market to another has the same effect as tariffs. While tariffs are imposed by governments, transportation costs act as natural barriers to trade.

5. Reasons for Implementing Tariffs

Tariffs are often created to protect infant industries and developing economies, but are also used by more advanced economies with developed industries. Here are five of the top reasons for implementing tariffs are:

1. Protecting Domestic Employment

The levying of tariffs is often highly politicized. The possibility of increased competition from imported goods can threaten domestic industries. These domestic companies may fire workers or shift production abroad to cut costs, which means higher unemployment and a less happy electorate. The unemployment argument often shifts to domestic industries complaining about cheap foreign labour, and how poor working conditions and lack of regulation allow foreign companies to produce goods more cheaply. In economics, however, countries will continue to produce goods until they no longer have a comparative advantage.

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2. Protecting Consumers

A government may levy a tariff on products that it feels could endanger its population. For example, South Korea may place a tariff on imported beef from the United States if it thinks that the goods can be tainted with disease.

3. Infant Industries

The use of tariffs to protect infant industries can be seen by the Import Substitution Industrialization (ISI) strategy employed by many developing nations. The government of a developing economy will levy tariffs on imported goods in industries in which it wants to foster growth. This increases the prices of imported goods and creates a domestic market for domestically produced goods, while protecting those industries from being forced out by more competitive pricing. It decreases unemployment and allows developing countries to shift from agriculture.

Criticisms of this sort of protectionist strategy revolve around the cost of subsidizing the development of infant industries. If an industry develops without competition, it could wind up producing lower quality goods, and the subsidies required to keep the state-backed industry.

4. National Security

Barriers are also employed by developed countries to protect certain industries that are deemed strategically important, such as those supporting national security. Defense industries are often viewed as vital to state interests, and often enjoy significant levels of protection. For example, while both Western Europe and the United States are industrialized, both are very protective of defense-oriented.

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5. Retaliation

Countries may also set tariffs as a retaliation technique if they think that a trading partner has not played by the rules. For example, if France believes that the United States has allowed its wine producers to call its domestically produced sparkling wines “Champagne” (a name specific to the Champagne region of France) for too long, it may levy a tariff on imported meat from the United States. If the U.S. agrees to crack down on the improper labeling, France is likely to stop its retaliation. Retaliation can also be employed if a trading partner goes against the government’s foreign policy objectives.

6. Non-Tariff Barriers to Trade (NTB)

Non-tariff barriers are trade barriers that restrict imports but are not in the usual form of a tariff. Some common examples of NTB’s are anti-dumping measures and countervailing duties, which, although they are called “non- tariff” barriers, have the effect of tariffs once they are enacted. Their use has risen sharply after the WTO rules led to a very significant reduction in tariff use. Some non-tariff trade barriers are expressly permitted in very limited circumstances, when they are deemed necessary to protect health, safety, or sanitation, or to protect depletable natural resources. In other forms, they are criticized as a means to evade free trade rules such as those of the World Trade Organization(WTO), the European Union (EU), or North American Free Trade Agreement (NAFTA) that restrict the use of tariffs.

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Some of non-tariff barriers are not directly related to foreign economic regulations, but nevertheless they have a significant impact on foreign-economic activity and foreign trade between countries. Trade between countries is referred to trade in goods, services and factors of production. Non-tariff barriers to trade include import quotas, special licenses, unreasonable standards for the quality of goods, bureaucratic delays at customs, export restrictions, limiting the activities of state trading, export subsidies, countervailing duties, technical barriers to trade, sanitary and phyto-sanitary measures, rules of origin, etc. Sometimes in this list they include macroeconomic measures affecting trade.

7. Types of Non-Tariff Barriers to Trade

The following are the types of Non Tariff Barriers to trade:

1. Quotas

Import Licensing requirements
Proportion restrictions of foreign to domestic goods (local content requirements)
Minimum import price limits

2. Embargoes

Customs and Administrative Entry Procedures
Valuation systems
Antidumping practices
Tariff classifications
Documentation requirements
Fees

3. Standards

Standard disparities
Intergovernmental acceptances of testing methods and standards
Packaging, labeling, and marking

4. Government Participation in Trade

Government procurement policies
Export subsidies
Countervailing duties
Domestic assistance programs

5. Charges on imports

Prior import deposit subsidies
Administrative fees
Special supplementary duties
Import credit discriminations
Variable levies
Border taxes

6. Others:

Voluntary export restraints
Orderly marketing agreements

Examples of non-tariff Barriers to trade

Non-tariff barriers to trade can be:

Import bans
General or product-specific quotas
Rules of Origin
Quality conditions imposed by the importing country on the exporting countries
Packaging conditions
Labeling conditions
Product standards
Complex regulatory environment
Determination of eligibility of an exporting country by the importing country
Determination of eligibility of an exporting establishment (firm, company) by the importing country.
Additional trade documents like Certificate of Origin, Certificate of Authenticity etc.
Occupational safety and health regulation
Employment law
Import licenses
State subsidies, procurement, trading, state ownership
Export subsidies
Fixation of a minimum import price
Product classification
Quota shares
Foreign exchange market controls and multiplicity
Inadequate infrastructure
Buy national” policy
Over-valued currency
Intellectual property laws (patents, copyrights)
Restrictive licenses
Seasonal import regimes
Corrupt and/or lengthy customs procedures

Thus, there are several different variants of division of non-tariff barriers. Some scholars divide between internal taxes, administrative barriers, health and sanitary regulations and government procurement policies. Others divide non-tariff barriers into more categories such as specific limitations on trade, customs and administrative entry procedures, standards, government participation in trade, charges on import, and other categories. We choose traditional classification of non-tariff barriers, according to which they are divided into 3 principal categories.

The first category includes methods to directly import restrictions for protection of certain sectors of national industries: licensing and allocation of import quotas, antidumping and countervailing duties, import deposits, so-called voluntary export restraints, countervailing duties, the system of minimum import prices, etc.
Under second category follow methods that are not directly aimed at restricting foreign trade and more related to the administrative bureaucracy, whose actions, however, restrict trade, for example: customs procedures, technical standards and norms, sanitary and veterinary standards, requirements for labeling and packaging, bottling, etc.
The third category consists of methods that are not directly aimed at restricting the import or promoting the export, but the effects of which often lead to this result. The non-tariff barriers can include wide variety of restrictions to trade.

8. TARIFFS Vs QUOTAS

The differences between tariffs and quotas will be clear by the following way of comparison: Let us first examine the superiority of quotas to tariffs:

As a protective measure, a quota is more effective than the tariff. A tariff seeks to discourage imports by raising the price of imported articles. It however fails to restrict imports when the demand for imports is price inelastic.
When compared to tariffs, quotas are much precise and their effects much more certain. The reactions or responses to tariffs are not clear and accurately predictable; but the effect of quotas on imports is certain.
It has been argued that quotas tend to be more flexible; more easily imposed and more easily removed instruments of commercial policy than tariffs. Tariffs are often regarded as relatively permanent measures and rapidly build powerful vested interests, which make them all the more difficult to remove. Quotas have many characteristics of a more temporary measure, are designed to deal only with a current problem, and removable as soon as circumstances warrant.

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Quotas, however, suffer from certain effects. Tariffs in some respects are superior to quotas:

The effects of quotas are more rigorous and arbitrary and they tend to distort international trade much more than the tariffs. That is why GATT condemns quotas and prefers tariffs to quotas for controlling imports.
Quotas tend to restrict competition much more than tariffs by helping importers and exporters to acquire monopoly power. If import quotas are allocated only to a few importers, they may enable them to amass fortunes by exploiting the market. Similarly, quotas tend to promote the concentration of economic power among foreign exporters.
Quotas may support inflationary pressures within the country by restricting supply. Tariffs also suffer from the same defect.
Quotas offer greater scope for corruption than tariffs.

9. The Transition from Tariffs to Non-Tariff Barriers

One of the reasons why industrialized countries have moved from tariffs to NTBs is the fact that developed countries have sources of income other than tariffs. Historically, in the formation of nation-states, governments had to get funding. They received it through the introduction of tariffs. This explains the fact that most developing countries still rely on tariffs as a way to finance their spending. Developed countries can afford not to depend on tariffs, at the same time developing NTBs as a possible way of international trade regulation. The second reason for the transition to NTBs is that these tariffs can be used to support weak industries or compensation of industries, which have been affected negatively by the reduction of tariffs. The third reason for the popularity of NTBs is the ability of interest groups to influence the process in the absence of opportunities to obtain government support for the tariffs.

10. Summary:

In this module we have learnt about Tariffs, Non-Trade barriers and Quotas used in the International Trade barriers means any hurdle or road block that hampers the smooth flow of goods, services and payments from one destination to another. These obstacles arise from rules and regulations governing trade from either home or host country. Trade barriers are an integral part of international trade. The most common barriers to trade are tariffs, quotas, and non-tariff barriers. A tariff is a tax on imports, which is collected by the government and which raises the price of the good to the consumer, also known as duties or import duties. Tariffs usually aim first to limit imports and second to raise revenue. Non-tariff barriers include quotas, regulations regarding product content or quality, and other conditions that hinder imports. One of the most commonly used non-tariff barriers are product standards, which may aim to serve as “barriers to trade.”

Suggested Readings:

Sundharam K.P.M. and Datt Ruddar (2010). Indian Economy, S. Chand & Sons, New Delhi.
Sharan Vyptakesh (2003). International Business: Concept, Environment and Strategy. Pearson Education, New Delhi
Cullen. (2010). International Business. Routledge.
Bennett Roger (2011). International Business. Pearson Education, New Delhi
Paul Justin (2010). Business Environment-Text and Cases. Tata McGraw Hill, New Delhi.
Cherunilam Francis (2010). International Business. Prentice Hall of India Private Limited. New Delhi.
Cherunilam Francis (2013). Global Economy and Business Environment. Himalaya Publishing House, New Delhi.
Levi MauriceD. (2009). International Finance. Routledge.
Conklin David w. (2011). The Global Environment of Business. Sage Publications.
Mithani D M. (2009). Economics of Global Trade and Finance. Himalaya Publishing House New Delhi.
Cherunilam Francis (2011). International Business Environment. Himalaya Publishing House, New Delhi.
Saleem Shaikh (2010). Business Environment. Pearson Education, New Delhi.