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Wednesday, March 07, 2012 |
The effective rate of protection
In the real world, output
goes through stages of production. At successive stages, primary factors of production
process intermediate inputs. The resulting output sells for more than the cost of
materials, and the difference is called value added:
Value added (VA) = Price of output (P) - Cost of materials (CM).
Nominal tariffs are applied to output prices, but the beneficiaries of
tariffs are the owners of the factors of production used to process inputs. The effective
rate of protection computes the tariff rate as a proportion of the value added by an
economic activity, so it is a much more accurate measure of how a particular stage of
production is affected by nominal tariffs.
Nominal tariff: tn = [(Pt - Pf)/Pf].100
Effective tariff: te = [(VAt - VAf)/VAf].100
Example: Consider purchasing intermediate inputs such as steel to manufacture a refrigerator:
| Situation | Tariff on refrigerators | Price of refrigerators (P) | Tariff on materials | Cost of materials (CM) | Value added (VA) | Effective rate of protection |
| Free trade | 0% | $1,000 | 0% | $600 | VAf = $400 | 0 |
| 10% tariff on refrigerators | 10% | $1,100 | 0% | 600$ | $500 | 25% = [(500-400)/400].100 |
| 10% tariff on materials | 0% | $1,000 | 10% | $660 | $340 | -15% = [(340-400)/400].100 |
| 10% tariff across-the-board | 10% | $1,100 | 10% | $660 | $440 | 10% = [(440-400)/400].100 |
Result 1: Effective
protection is usually higher than nominal protection.
Example: DCs often put tariffs on refined products, but not on raw
materials: coffee, sugar, metals.
| Effective protection of manufacturing in some developing countries (percent) | |
| Mexico (1960) | 26 |
| Philippines (1965) | 61 |
| Brazil (1966) | 113 |
| Chile (1961) | 182 |
| Pakistan (1963) | 271 |
Result 2: Tariffs at
successive stages result in escalating tariffs.
Example: The effective tariff rate in DCs rises with more advanced
stages of production: Raw materials: 0.8% / Semimanufactures: 2.8% / Finished products:
6.2%
Result 3: Effective
protection can be negative:
Example: The effective rate of protection on wood products in Japan is
-30.6%.