Impact of Trade Policy on Economies

This assignment delves into the multifaceted effects of trade policy on economies. It examines how factors like tariffs, non-tariff barriers (NTBs), and trade agreements shape economic outcomes. Students are expected to analyze the impact of these policies on various aspects such as economic growth, productivity, job creation, consumer prices, and international competitiveness. The assignment encourages critical thinking about the complexities of global trade and its implications for national development.

Running head: INTERNATIONAL TRADE AND ENTERPRISE
International trade and enterprise
Name of the student
Name of the University
Author note

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Executive summary:
This report has analyzed the international trade and economic implication of tariff in the
economy. Besides this, the report has studied the various empirical evidences to trace out how
tariff affects the economies depending upon its nature. Moreover, it has highlighted the facts that
how tariff has performed for different economy from different perspective. The report gas given
a brief on the costs and benefits of a tariff and to conclude it has provided idea regarding trade
liberalization by reducing the tariff. Analyzing the various aspects of import tariff and its
economic implications, the report has found that imposing tariff on the importable introduce gap
between the producer surplus, consumer surplus and government revenue that leads to
deadweight loss. The report concludes with a view that, it is better to reduce the import tariff
because it can provide better sustainability of the economy and increase the competition among
the firms.

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Table of Contents
Introduction:....................................................................................................................................3
Different types of tariff and reason for implying it:........................................................................4
Protect Infant industry:................................................................................................................4
Enhance domestic employment:..................................................................................................5
Protect market from dumping:.....................................................................................................5
Protect the market from collapsing:.............................................................................................5
Protect environment:....................................................................................................................5
Economic implication of tariffs:......................................................................................................5
Effect of tariff on small open economy:......................................................................................6
Effect of tariff on large open economy:.......................................................................................7
Empirical evidence of tariff on different countries and its effect:...................................................9
Costs and benefits of a tariff:.........................................................................................................10
Price effect:................................................................................................................................10
Revenue effect:..........................................................................................................................10
Consumption effect:...................................................................................................................11
Effect on competition:...............................................................................................................11
Employment and income effect:................................................................................................11
Removing tariff:.............................................................................................................................12
Conclusion:....................................................................................................................................12
Reference:......................................................................................................................................14

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Introduction:
Tariff or import duties are the economic tools that government use to control and regulate
the flow of international trade. These are kind of taxes that are imposed in both the cases of
export and import of goods and services. Among many alternatives to control the trade flow
tariff is the only one, which is permitted by the General Agreement on Tariffs and Trade (GATT)
(Javorcik and Narciso 2017). Owing to its simple structure and easy to apply framework, often it
is being used by the governments who are indulged in the international trading. In present day’s
trade liberalisation among the players of international trade, however in case of deteriorating
trade balance, countries used to apply the tariff or duties. Main aim of the imposing tariff is to
raise the price of goods and services, which will reduce the aggregate demand of the
consumables (Francois et al. 2015). Thus, by reducing the aggregate demand respective
countries can check their trade balance and lead the economy away from recession. In most of
the cases, tariffs are imposed on imports rather than export in order to check the Balance of
Trade of economy. Government of the countries tariff as the trade barriers and it effectively
helps the economy to move away from the declining trade balance.
This report is meant to analyze the various aspects of the tariff and import duties and it
will try to find out how these instruments affects the different industries and the economies. In
addition, it will describe help the government to check their economy. Analyzing the implication
of tariff on the various economies, the report will try to find out the importance of the tariff for
the international trade. Moreover, it will highlight the facts that how tariff has performed for
different economy from different perspective. The report will give a brief on the costs and
benefits of a tariff and to conclude it will provide idea regarding trade liberalization by reducing
the tariff.

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Different types of tariff and reason for implying it:
Tariff is one of the most widely utilized trade barriers, which is used by several
economies around the world. It is basically charged either on export or in the case of imports;
however, empirically it has been seen that countries use this tool in the case imports in higher
number compared to the exports. Since 1789, tariff was being started to impose on the
international trade in order to check the country’s Balance of Trade and since then, there has
been various development in the case of tariff imposition (Lindert and Williamson 2016).
However, due to lack of proper implication, it was exhausted from practice until GATT
introduced it again in the year 1947 with a aim to liberalize the trade among trading partners.
Successor of GATT, World Trade Organisation (WTO) since its introduction tried to reduce the
implication of tariff with certain exceptions; however, trading countries still use to imply this in
case of any dwindling situation in the balance of trade (Davis and Wilf 2017). Depending upon
the mode of duty, tariffs can be classified in two types, which are Ad valorem tariff and Specific
tariff. Ad valorem tariff is levied on the trading of goods and services as a percentage of total
value; whereas, Specific tariff is imposed at fixed quantity on per unit of commodity traded
(Orefice 2017). There are various reasons for implying these various types of tariffs, which are
as follows:
Protect Infant industry:
According to the infant industry argument, if the new entrants or infant industries
compete with the players from world market, then it is hard to survive. Thus, government use
tariff as protection mechanism to let the infant industries sustain and transform them into a
potent firm that can withstand against the international competition (Graham 2015).

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Enhance domestic employment:
Government often uses the tariff in order to enhance the demand of the domestic products
by effectively enhancing the price of the imported goods and services through taxation. It helps
the ailing industries to face higher aggregate demand leading to higher employment.
Protect market from dumping:
International players often try to dump their excess goods in the world market, reducing
the price of certain commodity. This reduces the price and hence enhances the import of that
specific goods and services that deteriorate the balance of trade (Blonigen 2016). In such cases,
government uses the tariff and import duties to control the excess import.
Protect the market from collapsing:
International trade is an important part of every economy and without better trading;
countries cannot grow its Gross Domestic Product (GDP). In case of poor economic condition, if
the country indulge itself into trading, then the scope of higher import is much high. It can lead
the country further into a dwindling situation and ultimately leading towards breakdown (Aghion
et al. 2015). Thus, to protect the country’s interest, government use the tariff as the trade barrier.
Protect environment:
Import of certain goods and services can be harmful for an economy as well as the
environment too. Thus, to control the import of those products, government impose tariff or
import duty that enhance the price and reduce the demand.
Economic implication of tariffs:
One of the most basic reasons for implying the import tariff is to increase the aggregate
demand of the domestic produces through increasing the price of importable. However,

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depending upon the economic condition of the country, which is imposing tariff, economic
implication changes (Egger et al. 2015). In this report two generalised economic framework has
been chosen, which are small open economy and large open economy. Economic implication of
tariff on these different types of economies is as follows:
Effect of tariff on small open economy:
Small open economies are those economies which have small economic performance
compared to its trading partners and cannot alter its Terms of Trade. For the small open
economy, prices are given and it can afford any volume of importable at a given price. Any
imposition of tax can lead the price of importable to a higher level, which can reduce the demand
(Cosar, Guner and Tybout 2016). This reduction in demand of the importable will be substituted
by the domestic goods and services leading to a higher aggregate demand.
According to the figure 1, Sh is the domestic supply and Dh is the domestic demand of the
goods and services and AB represents the amount of imports in equilibrium condition. Price of
the importable is Pw. Now imposing if government decides to impose a tax of t1 amount, then it
would lead the price to Pw (1+t1), which will reduce the aggregate demand of the importable.
From figure 1, it can be seen that, in post taxation period quantity of importable falls to CD
amount, but it fails to prohibit the imports. However, if government imposes a tariff of t2 amount,
then it would have stop the import leading though rising the price to a higher level as represented
by the Pw (1+t2).

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Figure 1: Effect of tariff on small open economy
Source: (Cosar, Guner and Tybout 2016)
Tariff is an indirect tax, thus it will fall upon the consumer leading to a loss of consumer
surplus as represented by the figure 1 through the area (a+b+c+d). C part in the figure 1
represents the government revenue and (b+d) is the deadweight loss due to imposing tariff.
However, there is a rise in producer surplus, which is represented by the part a in the diagram.
Thus it can be said that, if tariff is imposed on the importable in a small open economy, then it
causes distribution of welfare from consumer to producer and the government (Mbaye et al.
2015).

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Effect of tariff on large open economy:
When tariffs are imposed by the large open economy, then the economic implication is
drastic. A large open economy has ability to influence the Terms of Trade owing to the fact that
it has comparative advantage in production of exportable. If tariff is levied by the large open
economy, then it will lead to rise in price, resulting a perfectly elastic supply curve of the goods
and services (Bodenstein et al. 2017).
Figure 2: Effect of tariff on large open economy
Source: (Cosar, Guner and Tybout 2016)
Considering the figure 2, it can be seen that Sf is the supply of the importable and Dh is
the market demand of the importable. Now, if the large open economy implies a tariff of the
importable then it will shift the supply from Sf to Sft and the price will rise from Pw1 to Pt. This rise
in price will reduce the importable from AB to CD and it will lead to a drop in price of the
importable in the world market from Pt to Pw. Coming to the consumer surplus, figure 2, shows
that in case of tariff by a large open economy, the resultant effect depends upon the e part. If it is

10INTERNATIONAL TRADE AND ENTERPRISE
larger the (b+d), then tariff will enhance the economic performance and in reverse it will
deteriorate the economic performance of the nation (Halpern et al. 2015).
Empirical evidence of tariff on different countries and its effect:
Tariff is being used since 19th century widely by various countries as a mechanism of
trade barrier. Prior to the publication of The Wealth of Nations, by the Adam Smith in 1776,
countries used to levy higher tariffs in order to enhance their national income (Adam 2016).
However, theory of Adam Smith altered the idea of the international trade and countries, started
to liberalize their trade barriers for better economic growth According to estimation, it is being
used mostly by the developing nations; however, there are exceptions too.
According to the Powell (2016) import tariffs has manifested adverse effect on the
economies that has been drawn from the effect of import duty in US economy. Free Trade at the
Concise Encyclopaedia of Economics argued that import duties have caused 42,000 USD
annually for textile job, which has been preserved through import quotas. The figures were as
high as 105,000 USD annually for the automobile workers and it rose to 750,000 USD for the
steel industry workers (Graham 2015). All the figures are higher than the average wages of the
workers of their respective industries that hints that economy has lost too much wealth through
imposition of import duty. Besides this, Mackinac Center for Public Policy argues that, import
duties have caused the US economy loss of annual income by 0.5 to 1.4 billion USD (Hohman
and Cammenga 2016).
According to the World Bank data of 2016, countries which impose highest import tariff
are Bahamas, Gabon, Chad, Bermuda, Central African Republic and other developing nations. In
contrast to this, European Union countries has applied tariff on import by 1.6% in average on
their total imports leading towards the fact that developed nations tends to favour trade

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liberalisation rather than putting barriers (Burstein and Gopinath 2014). According to the data,
shockingly Singapore levies the lowest amount of import tariff and the economy is growing at a
stable rate of 2% annual change rate. This highlights the fact that trade barrier not only affects
the economy’s Balance of Trade, moreover, it affects the economic growth as well.
Tariffs of US during 1994 have caused the economy a loss of 32.3 billion USD for each
job saved and it has caused 70,000 USD in the case of European Union (Kaufman 2017).
According t the same source, the figures rose magnanimously to 600,000 USD in the case of
Japanese economy and it has caused a loss of national income to Australia too. However, in the
face of Global Financial Crisis, Australian economy has levied 10% import duty and it has
caused the country to have domestic industry growth.
Costs and benefits of a tariff:
Tariffs are imposed to control the flow of goods and services from the international
market to the domestic economy. Various benefits of imposing tariffs are as follows:
Price effect:
Tariff can effectively increase the price of goods and services and utilizing the tariff
framework governments control the Balance of Trade situation. For instance, if the government
observes that Balance of Trade is deteriorating, then it impose tax on the importable that sharply
increase the price leading to a reduction in the aggregate demand of that goods and service. With
higher price, demand will lower and import of the said commodity will also be lower, which will
help the economy to survive from the dwindling Balance of Trade situation (Hayakawa et al.
2016). However, it has been seen that tariff negatively affect the economy with

12INTERNATIONAL TRADE AND ENTERPRISE
Revenue effect:
Imposing tax is a good strategy for the government to earn higher revenue. If there is rise
in import or if the government finds that import of certain goods and services is causing the
economy negatively, then it impose tax and enhance the revenue for the economy. However, it is
also true that in case of the tariff duty, there is deadweight loss and the economy faces lower
amount of consumer surplus (Caliendo et al. 2015).
Consumption effect:
Imposing tariff, enhance the price of the goods and services effectively and depending
upon the price elasticity of the commodity, consumption of the goods and services gets altered.
For instance, if the importable is necessary good, then tariff imposition will reduce the
consumption to a much lower level compared to the tax on luxury goods and services. However,
imposing tariff reduces the consumer surplus.
Effect on competition:
The report has earlier stated that the tariff is imposed in order to reduce the competition
for the infant industries and let them become competitive. Thus, if the government impose tariff
duty, then it would reduce the competition in the market for the domestic industries and enhance
the competition on behalf of the international players, due to loss of market (Acemoglu et al.
2016). As the cost of imposing tariff, it reduces the competitiveness among the domestic firms
and the infant industries never mature to become competitive.
Employment and income effect:
Government imposes tariff in order to enhance the scope of employment in the domestic
industries by providing barriers to the import of foreign goods and services. With tariff

13INTERNATIONAL TRADE AND ENTERPRISE
employment can be enhanced through rising the price of importable and keeping the price of
domestic products same. It enhances the demand of the domestic goods and services and lead to
a higher employment level (Meer and West 2015). However, increasing employment with the
help of the tariff causes the country in loss of national income.
Removing tariff:
Well, till now various aspects of the tariff and reason for imposing tariff have been
cultured; however, it has been seen that tariff affects the domestic economy adversely. It causes
loss of national income and reduces the competitiveness among the industries (Fan et al. 2015).
Thus, it has become evident to remove tariff. Besides the above mentioned reasons, there are
various other reasons to remove the tariff, which are as follows (Bas ad Strauss 2015):
21st century is the era of trade liberalisation and without imposing tariffs, economic
growth can be enhanced to a great degree
Using custom and Ad valorem tariffs, economies who are in union, can have better inter
and intra industry trading opportunity rather than common tariff mechanism
Reduction in tariff will reduce the price of importable
Without tariff, economies can provide better consumer benefit to their citizens
Reduced or no tariff will bring in more goods and services in front of the consumers,
which will lead the economy to have better sustainability index
Conclusion:
Tariff is being used during the early 1700s and since then it has been acknowledged as
the effective mechanism of controlling international trade. Previously governments used to imply
tariffs in order to enhance the revenue of the economy and control the flow of importable,
however as the time passed new economies surfaced, that highlights the negative effect of tariff

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on the country’s economy. The report has found that ideas regarding the tariff started to change
after the publication of Wealth of Nation by Adam Smith and since then, economists are arguing
against the tariff. During 1947, trend towards trade liberalisation has been started by the GATT
and in the year 1995, WTO followed the footprint to make the move stronger. In spite of these
attempts to liberalise the trade, has not yet been successful completely because still the countries
like Bahamas, Gabon, Chad, Bermuda, Central African Republic and other developing nations
imposes high tariff on the importable. The report has found that, it is empirically true that, those
countries which are still in developing stage imposes higher tariff in order to protect their
domestic interest. However, in the case of large economies, it possess marketing controlling
power and it imposition of tariff can effectively increase the total benefit. In addition, it can be
stated that cost and benefit of tariff cannot be determined in general; it changes depending upon
the nature of economy. Moreover, the report has found that imposing tariff on the importable
introduce gap between the producer surplus, consumer surplus and government revenue that
leads to deadweight loss. Thus, to conclude, it can be said that it is better to reduce the import
tariff because it can provide better sustainability of the economy and increase the competition
among the firms.

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