The Instruments Of Trade Policy – Chapter Notes
CA Foundation Business Economics notes on Instruments of Trade Policy: tariffs, non-tariff measures, anti-dumping duties, quotas, safeguards and export-related measures.
Contents
This unit explains how governments interfere with international trade. In theory, free trade allows countries to specialise, reduce costs and improve consumer welfare. In practice, governments often intervene because domestic firms, workers and strategic sectors may suffer when foreign competition becomes too strong or unfair.
Price-related measures. They increase the price of imported goods by adding a tax or duty at the border.
Rules, restrictions, standards, quotas and procedures that influence trade without directly imposing an ordinary customs tariff.
Policies used to encourage exports or sometimes restrict exports depending on domestic priorities.
Under free trade, buyers and sellers from different countries trade with minimum government interference. Prices are decided by demand and supply. Protectionism is different. It is a government policy used to protect domestic producers against foreign competition by using tariffs, quotas and non-tariff instruments.
Free trade means international trade with minimum state interference, where market forces decide prices and quantities.
Protectionism means government action to protect domestic producers from foreign competition through trade barriers.
Trade policy includes all instruments that governments use to promote or restrict imports and exports, and also the approach taken by countries in trade negotiations.
Trade policy is shaped by domestic priorities as well as international commitments. When a country enters bilateral, regional or multilateral trade agreements, it accepts obligations that influence what trade restrictions it can or cannot use.
Objectives of Trade Policy
- Protect Domestic Industries — Industries facing strong or unfair import competition may need protection to survive.
- Generate Government Revenue — Import duties are a source of revenue, especially in developing economies.
- Reduce Import Dependence — Trade barriers can reduce excessive dependence on foreign suppliers.
- Promote Exports — Export incentives help domestic firms compete in international markets.
- Correct Trade Distortions — If foreign firms dump goods or receive subsidies, the importing country may respond with duties.
- Protect Health, Safety and Environment — Standards and quality rules prevent entry of unsafe or harmful products.
A tariff is a financial charge in the form of a tax imposed at the border on goods moving from one customs territory to another.
Tariffs are the most visible trade policy instrument. In this unit, the word tariff mainly refers to import duty because import duties are far more common than export duties.
The government earns revenue on goods imported into the country.
Domestic firms receive protection because imported goods become relatively expensive.
Specific Tariff
A fixed amount of duty charged per physical unit, weight or measurement of the commodity imported.
The weakness of a specific tariff is that its protective value falls when import prices rise. If the duty remains fixed but the product price rises, the duty becomes a smaller percentage of the product value.
Ad Valorem Tariff
A duty charged as a fixed percentage of the value of the imported commodity.
Ad valorem tariffs preserve the protective value of tariffs because the duty rises with the value of the imported product. However, importers may try to undervalue goods in invoices to reduce the duty burden.
Mixed and Compound Tariffs
The duty may be based either on value or on quantity, depending on which generates the required amount. Example: 5% ad valorem or ₹3,000 per tonne, whichever is higher.
A combination of ad valorem and specific tariff. Example: 5% ad valorem plus ₹100 per kilogram.
Other Important Tariffs
Calculated on the basis of specific contents or components of the imported product.
Imports within a quota face low tariff; imports beyond the quota face higher tariff.
Tariff rate charged among WTO members unless a preferential agreement applies.
Lower tariff charged to countries receiving preferential treatment under trade agreements.
Maximum tariff level a WTO member legally commits not to exceed.
The actual tariff charged on imports. It can be lower than the bound tariff but not higher.
Tariff increases as the product moves from raw material to finished goods.
A tariff set so high that imports practically stop entering the country.
Specific Tariff vs Ad Valorem Tariff
| Basis | Specific Tariff | Ad Valorem Tariff |
|---|---|---|
| Meaning | Fixed amount per unit | Fixed percentage of value |
| Depends On | Quantity, weight or measurement | Monetary value of import |
| Effect of Inflation | Protective effect falls | Protective effect is maintained |
| Valuation Issue | Customs valuation not important | Customs valuation is important |
| Risk | May become weak when prices rise | Importers may undervalue goods |
Sometimes foreign firms or foreign governments create distortions in trade. They may sell goods at unfairly low prices or support exporters through subsidies. Importing countries respond through special duties that are triggered when unfair trade practices are identified.
Anti-Dumping Duty
Dumping occurs when manufacturers sell goods in a foreign country below their domestic market price or below full average cost of production.
Dumping can be used as a predatory strategy. A foreign exporter may sell at very low prices to destroy domestic competition and later capture the market. Anti-dumping duty is imposed to offset this unfair price advantage.
Countervailing Duty
A countervailing duty is imposed to offset the advantage received by foreign exporters through subsidies or tax concessions from their home government.
Countervailing duties restore fair competition. They prevent subsidised foreign goods from entering the domestic market at artificially low prices.
Tariffs create barriers to trade and reduce the quantity of imports entering the country.
Imported goods become expensive. Consumers pay higher prices and consume less than under free trade.
Local firms can sell more at higher prices because foreign competition becomes weaker.
Protected domestic industries may increase output and employment in the short run.
The importing country collects tariff revenue on imported goods.
Tariffs protect inefficient domestic producers and reduce gains from comparative advantage.
NTMs are policy measures other than ordinary customs tariffs that can affect international trade in goods by changing quantities traded, prices, or both.
Non-tariff measures have become more important because tariff reduction through WTO negotiations and free trade agreements has reduced the role of traditional tariffs. NTMs are often less visible and more complex than tariffs.
NTBs are discriminatory non-tariff measures imposed with protectionist intent to favour domestic suppliers over foreign suppliers.
Measures related to product characteristics, technical specifications, safety, health and production processes.
Measures related to licensing, quotas, finance, procurement, distribution and administrative procedures.
Practical problems such as delays in testing, certification, transport, customs clearance and documentation.
Sanitary and Phytosanitary Measures (SPS)
Measures applied to protect human, animal or plant life from risks arising from additives, pests, contaminants, toxins or disease-causing organisms.
SPS measures are generally justified on health and safety grounds. But if used excessively, they can become hidden barriers to trade.
Technical Barriers to Trade (TBT)
Mandatory standards and technical regulations relating to product size, shape, design, labelling, packaging, functionality, performance and production methods.
TBT measures cover both food and non-food products. They include testing, inspection and certification procedures to verify whether products meet required standards.
| Basis | SPS | TBT |
|---|---|---|
| Main Purpose | Protect human, animal and plant life | Ensure product standards and technical compliance |
| Applies To | Food safety, animal health, plant health | Food and non-food products |
| Examples | Pesticide limits, disease restrictions | Labelling, packaging, quality standards |
Import Quotas
An import quota is a direct restriction specifying the physical amount of a good that can be imported during a given period.
Import quotas are usually set below the free trade level of imports. They are enforced through licences. The licence holders earn quota rents because they can buy imports and sell them at higher domestic prices.
Imports are limited to a fixed quantity during a specified time period.
Restrictions are imposed only during a particular season to protect domestic producers.
Restrictions are imposed for a temporary period to deal with a specific situation.
Quota is divided among specific exporting countries.
Other Non-Technical Measures
Used to influence import prices and support domestic prices. These include para-tariff measures such as additional taxes and charges.
Imports are allowed only after discretionary approval from the government.
Increase import costs by controlling foreign exchange availability or payment terms.
Special rights are given to selected operators, state agencies or canalising agencies.
Government gives preference to domestic suppliers in public purchases.
Trade-related investment measures such as local content requirements for producers.
Imported goods may be sold only through specified channels or approved agents.
Foreign producers may be restricted from providing after-sales service directly.
Lengthy documentation, red tape and customs delays increase transaction costs.
Criteria used to determine the national source of a product for applying duties and restrictions.
Tariff vs Quota
| Basis | Tariff | Quota |
|---|---|---|
| Nature | Tax on imports | Direct quantity restriction |
| Effect on Price | Raises import price directly | Raises price indirectly by reducing supply |
| Government Revenue | Government earns revenue | No automatic revenue to government |
| Importer Benefit | Limited | Licence holders earn quota rents |
| Control Over Quantity | Indirect and uncertain | Direct and certain |
Safeguard Measures
Temporary measures used to restrict imports when a sudden increase in imports causes or threatens serious injury to domestic industry.
Safeguards are emergency actions. They are not meant to permanently block imports. Their purpose is to give domestic industries time to adjust.
Trade policy is not only about restricting imports. Governments also use export-related measures to increase foreign exchange earnings, support domestic producers and improve global market access.
Financial assistance given to exporters to reduce costs and make domestic products competitive abroad.
Exporters may receive exemptions, rebates or refunds to reduce the cost of exporting.
Export promotion councils and trade bodies help firms with market information, promotion and compliance support.
Sometimes governments restrict exports to maintain domestic availability of essential goods.
| Instrument | Meaning | Main Effect |
|---|---|---|
| Tariff | Tax on imports | Raises import price |
| Quota | Quantity restriction | Limits imports directly |
| Anti-Dumping Duty | Duty against unfair low pricing | Protects domestic producers |
| Countervailing Duty | Duty against subsidised exports | Neutralises foreign subsidy advantage |
| SPS | Health and safety measure | Protects life and health |
| TBT | Technical standards | Ensures product compliance |
| Safeguard Measure | Temporary emergency protection | Protects against import surge |