Ten truths about tariffs

Matthew Stern

 

One of the consequences of the global financial crisis and the resulting slowdown in economic growth has been a rise in protectionism. Prospects for export-led growth have diminished and countries are desperately looking to safeguard what they have left. Import duties, which seemed destined for the WTO waste-bin five years ago, are once again emerging as a policy option of choice. In South Africa, this trend was first evidenced by rising tariffs across the clothing sector, and it has since spread across a much wider range of manufactured items (from windscreens to taps to chickens). Questions have also been asked about the agricultural concessions made by South Africa in the free trade agreement with the EU, and whether these can somehow be clawed-back.

Whereas the benefits to specific firms from increased tariff protection are clear, the wider economic impact of tariff decisions are often misunderstood and easily neglected. Before leaping to the protection of an individual applicant, the following ten truths should be borne in mind by trade policy makers:

1. Tariffs are, in the end, just another tax. They raise the prices of goods, regardless whether produced domestically or imported, and the cost is paid for by consumers.

2. As far as taxes go, tariffs are horribly regressive. The burden falls disproportionately on poor consumers, and the benefits flow almost entirely to a small group of relatively wealthy workers and business people.

3. The actual amount of protection given by a tariff is much higher than it seems. Companies receive protection on the full price of the final product, regardless of their contribution (value-added). The effective rate of protection they receive on what they actually produce is a multiple of the simple tariff.

4. Tariffs subsidize smuggling and corruption. Tariffs create an incentive to misdeclare imports – through misclassification and underdeclaration of quantities and values. The higher and greater the variation in tariff rates across products the greater is the subsidy to such activities, and the greater the administrative and compliance burdens required to deal with them. This increases the cost of trade well beyond the burden of the tariff itself.

5. Tariffs are biased against exports. Tariffs only benefit domestic sales. They cannot provide any protection to goods sold in foreign markets. As a result, tariffs provide an additional incentive to local firms to sell into the domestic market at the protected price, and discourage firms from competing in foreign markets at the world price.

6. Tariffs do not help firms to become internationally competitive. Insulating companies from foreign competition, no matter how unfair this competition may seem, does not equip them to compete in international markets. It simply buys them additional comfort in the small domestic market. Moreover, tariffs on imported inputs raise domestic costs and reduce the competitiveness of exporters.

7. Tariffs are the wrong instrument to improve national competitiveness. If South African firms cannot compete internationally, then policy action should be directed at the underlying causes of this lack of competitiveness. If it is labour costs, then labour reforms are needed; if it is infrastructure or electricity constraints, likewise. Raising tariffs on one product is a blunt, costly and ineffectual way of dealing with such economy-wide problems.

8. Tariffs result in a net deadweight loss. Tariffs not only redistribute income from users of taxed goods to protected domestic producers of these goods. By distorting incentives and causing us to produce goods in which we are not competitive and buy goods from higher cost sources than necessary, they also impose a net burden on the economy. This is what economists call the deadweight loss due to tariffs.

9. Just because other countries use them, does not make it right. Tariffs have been and are still used by many countries to protect their own industries. The cost of them doing so is largely carried by their own consumers, not by us. Our policies should be determined by what works best for us, not what others may choose to do (or not to do).

10. Most of the economy is not protected by tariffs and does just fine. South Africa retains tariffs across very few industries, but where these tariffs do exist, they can be high. In most cases they are designed to protect a handful of inward-looking firms. The vast majority of the economy receives no such protection and is expected to compete on a level playing field in domestic and international markets.

Firms will always ask for protection. One cannot blame them for that – business is in the business of finding new ways to scupper the competition and raise prices. But in considering such requests, Governments need to align themselves with the public interest, and not just the interests of the few. This requires a clear understanding of what tariffs can and cannot do. In truth (ten times over), tariffs offer policy makers a ready and easy way out in their engagements with industry, but they are seldom the right response to any particular economic challenge.