Who Killed Tariffs? Modern Trade

Economic Times, July 23, 2011
By Bipul Chatterjee
With most products now commoditised,what matters is trade logistics and amount of output

Although tariffs are trade-distorting, they are part-and-parcel of the international trading system. But do they matter much in today’s emerging regime of international trade where global and regional value chains and associated factors determining trade costs are gaining more importance?

Trade is about relative competitiveness of competing products produced by different firms. Suppose an Indian clothing product is facing 10% tariff in an export market and a Bangladeshi producer of a similar product is facing 0% tariff in that market. These tariffs are over the base price they would charge for their products. Even in that case, the Indian product could be more competitive if its other factors of competitiveness capital cost, labour cost and other costs, including trade logistics can offset this difference in tariff.

This is particularly relevant in today’s world because countries have considerably reduced their import tariffs. Since the formation of the General Agreement on Tariffs and Trade (Gatt), most developed countries have reduced their tariffs on most products to single digit. Successive Gatt-round negotiations helped that process. In fact, till the Tokyo Round that was launched in 1979,Gatt negotiations were all about tariff cuts. With the advent of the Uruguay Round of Gatt negotiations in 1986 and its conclusion in 1994,developing countries started following a similar path. For instance, India’s average applied tariff on agricultural products is reduced to about 40% and that on industrial goods to about 15%.This is a huge fall as compared to tariffs imposed in 1990s and earlier.

Given the low levels of applied tariffs, it is no longer impossible to counter trade-distorting effects of tariffs through other means of generating greater competitiveness. Some countries do it by simply manipulating their exchange rates regime. There are many other means, including camouflaging subsidies in a manner that either they cannot be detected easily or they are non-actionable as per relevant rules of the World Trade Organization (WTO).

In today’s world, non-tariff barriers (NTB) are much more trade-distorting since they add to trade costs. Various efforts are being made to address the menace of NTBs, including converting them to tariff-equivalence. Why do countries practice NTBs? To favour one producer – often an indigenous producer – over another – mostly a foreign competitor.

While there are efforts at bilateral, regional and multilateral level to harmonise and minimise NTBs by adhering to a rules-based system, the emerging nature of international trade has a built-in mechanism to reduce them.

The world has moved on from simple intra-industry trade to a complex web of regional and global value chains. Given that producers in a value chain collaborate with each other to reduce trade costs, there is a possibility that they nurture their governments to reduce NTBs.

A recent study by the WTO and the Tokyo-based Institute of Developing Economies (IDE), Trade patterns and global value chains in east Asia: From trade in goods to trade in tasks, highlighted this point by stating, “The integrated factory floor, which had dominated manufacturing since the 19th century, has been replaced with a network of individual suppliers specialising in specific services or phases of production.”

Professor Richard Baldwin of the Graduate Institute of International Studies in Geneva described this as the second great unbundling where production is sliced and diced into separate fragments that can be spread around the globe. Indeed, it is so: the Boeing 787 Dreamliner is assembled – not produced – in the US; its parts are sourced from at least six other countries.

Over the last two decades, not only that many east Asian producers got integrated into regional and global value chains but also, and more importantly, they are facing less tariffs and non-tariff barriers as reflected in growing intra-regional and inter-regional trade vis-à-vis east Asia. Their average share of vertical specialisation increased considerably as shown in the WTO-IDE study.

In computers and electronic equipment, the share of import contents of the US increased considerably, domestic content decreased and, yet, there was an increase in their export value. That led this study to look at bilateral trade balance differently. In 2005, the value added – including China processing trade – figure of US-China trade balance was 53% less than traditional statistics; in 2008, it was 42%.

If this is so, then why so much negotiating capital is being invested in bilateral or preferential and multilateral trade negotiations. While bilateral or preferential trade agreements are more due to political – as against economic – reasons, multilateral trade regime under the aegis of the WTO has other virtues. A major virtue of the rules-based multilateral trade regime is its ability to reduce differences between bound and applied tariffs – called water in tariff – so that there is less uncertainty in the system. It will reduce further once the Doha Round is concluded.

These virtues are best exploited by east Asian countries to raise their share in vertical specialisation. This is the lesson that south Asian countries should draw to raise their share in vertical specialisation – fortunately, regional value chains are getting more academic and political interests in south Asia.

In future, the multilateral trade regime should devise rules in a manner that further encourages vertical specialisation. Tariffs are related to prices of products and they matter less in this new scenario because products – in vertical specialisation – are so specific that there is hardly a scope for product differentiation and, therefore, price competition. What matters most is quantity of production – economies of scale through technological advancement and otherwise – and reduction in trade logistics.

(The author is Deputy executive director of CUTS International. Views are personal)

This article can also be viewed at: