Unit II: The Instruments of Trade Policy | Financial Management & Economics Finance: CA Intermediate (Old Scheme) PDF Download

 Page 1


4.28 ECONOMICS FOR FINANCE 
UNIT II: THE INSTRUMENTS OF TRADE 
POLICY 
 
 
LEARNING OUTCOMES 
 
International Trade
The Instruments of 
Trade Policy
Tariffs
Non-Tariff Measures 
(NTMs)
Export-Related 
Measures
At the end of this unit, you will be able to: 
? Define trade policy and describe its objectives  
? Distinguish between different types of trade policy 
measures  
? Evaluate the use of tariffs as a trade policy instrument  
? Describe the ‘trigger price mechanisms’ for protection of 
domestic industry 
? Outline the different Non-Tariff Measures adopted by 
countries 
UNIT OVERVIEW 
Page 2


4.28 ECONOMICS FOR FINANCE 
UNIT II: THE INSTRUMENTS OF TRADE 
POLICY 
 
 
LEARNING OUTCOMES 
 
International Trade
The Instruments of 
Trade Policy
Tariffs
Non-Tariff Measures 
(NTMs)
Export-Related 
Measures
At the end of this unit, you will be able to: 
? Define trade policy and describe its objectives  
? Distinguish between different types of trade policy 
measures  
? Evaluate the use of tariffs as a trade policy instrument  
? Describe the ‘trigger price mechanisms’ for protection of 
domestic industry 
? Outline the different Non-Tariff Measures adopted by 
countries 
UNIT OVERVIEW 
4.29 
 
THE INSTRUMENTS OF TRADE POLICY 
 2.1 INTRODUCTION 
Before we go into the subject matter of this unit, we shall take a quick look into a 
few recent developments in the international trade arena.  
21 June 2020: China has lost a dispute to the European Union at the World Trade 
Organization (WTO) for a market economy status, as the former allowed the 
dispute to lapse. According to the EU, China subsidizes its industries to a great 
extent, particularly steel and aluminium, making their sales prices in the 
international market unfair. 
21 June 2020: India argues against farm tariff concessions to ease Covid-19 woes 
and proposes that only a balanced, inclusive and calibrated response is needed to 
tackle temporary crisis. 
2
nd
July 2020; China sees India's ban on 59 apps with Chinese links as 
'discriminatory', and calls for reversal of the move as it has been discriminatory 
and selective, and may have violated World Trade Organization (WTO) rules.  
8
th
 July 2020:  India asked Japan to lower the entry barriers in agricultural and 
pharmaceutical sectors.  
19th July 2020:  The WTO to set up dispute panels against India on request from 
Japan and Taiwan.  The panels will look into the request against import duties on 
mobile phones and ICT products imposed by New Delhi. 
15
 th
 September 2020: The WTO ruled that the tariffs the USA imposed on Chinese 
goods in 2018, triggering a trade war, were inconsistent with international trade 
rules.  
The above vignettes are just a few of the multitudes of episodes that arise almost 
on a daily basis when countries engage in trade.  A glance at similar newspaper 
reports makes it obvious that governments do not conform to free trade despite 
the potential efficiency and welfare outcomes it will generate; rather, they employ 
different devices for restricting the free flow of goods and services across their 
borders.  
As we know, under free trade, buyers and sellers from separate economies 
voluntarily trade with minimum of state interference. The free interplay of market 
forces of supply and demand decides prices. Protectionism, on the other hand, is 
a state policy aimed to protect domestic producers against foreign competition 
through the use of tariffs, quotas and non-tariff trade policy instruments. Trade 
Page 3


4.28 ECONOMICS FOR FINANCE 
UNIT II: THE INSTRUMENTS OF TRADE 
POLICY 
 
 
LEARNING OUTCOMES 
 
International Trade
The Instruments of 
Trade Policy
Tariffs
Non-Tariff Measures 
(NTMs)
Export-Related 
Measures
At the end of this unit, you will be able to: 
? Define trade policy and describe its objectives  
? Distinguish between different types of trade policy 
measures  
? Evaluate the use of tariffs as a trade policy instrument  
? Describe the ‘trigger price mechanisms’ for protection of 
domestic industry 
? Outline the different Non-Tariff Measures adopted by 
countries 
UNIT OVERVIEW 
4.29 
 
THE INSTRUMENTS OF TRADE POLICY 
 2.1 INTRODUCTION 
Before we go into the subject matter of this unit, we shall take a quick look into a 
few recent developments in the international trade arena.  
21 June 2020: China has lost a dispute to the European Union at the World Trade 
Organization (WTO) for a market economy status, as the former allowed the 
dispute to lapse. According to the EU, China subsidizes its industries to a great 
extent, particularly steel and aluminium, making their sales prices in the 
international market unfair. 
21 June 2020: India argues against farm tariff concessions to ease Covid-19 woes 
and proposes that only a balanced, inclusive and calibrated response is needed to 
tackle temporary crisis. 
2
nd
July 2020; China sees India's ban on 59 apps with Chinese links as 
'discriminatory', and calls for reversal of the move as it has been discriminatory 
and selective, and may have violated World Trade Organization (WTO) rules.  
8
th
 July 2020:  India asked Japan to lower the entry barriers in agricultural and 
pharmaceutical sectors.  
19th July 2020:  The WTO to set up dispute panels against India on request from 
Japan and Taiwan.  The panels will look into the request against import duties on 
mobile phones and ICT products imposed by New Delhi. 
15
 th
 September 2020: The WTO ruled that the tariffs the USA imposed on Chinese 
goods in 2018, triggering a trade war, were inconsistent with international trade 
rules.  
The above vignettes are just a few of the multitudes of episodes that arise almost 
on a daily basis when countries engage in trade.  A glance at similar newspaper 
reports makes it obvious that governments do not conform to free trade despite 
the potential efficiency and welfare outcomes it will generate; rather, they employ 
different devices for restricting the free flow of goods and services across their 
borders.  
As we know, under free trade, buyers and sellers from separate economies 
voluntarily trade with minimum of state interference. The free interplay of market 
forces of supply and demand decides prices. Protectionism, on the other hand, is 
a state policy aimed to protect domestic producers against foreign competition 
through the use of tariffs, quotas and non-tariff trade policy instruments. Trade 
  
 
4.30 ECONOMICS FOR FINANCE 
liberalization refers to opening up of domestic markets to goods and services 
from the rest of the world by bringing down trade barriers. 
In unit 1, we have seen that there are clear efficiency benefits from trade in terms 
of economic growth, job-creation and welfare. The persuasive academic 
arguments for open trade presuppose that fair competition, without distortions, is 
maintained between domestic and foreign producers. However, it is a fact that 
fair competition does not always exist and unobstructed international trade also 
brings in severe dislocation to many domestic firms and industries on account of 
difficult adjustment problems. Therefore, individuals and organisations continue 
to pressurize policy makers and regulatory authorities to restrict imports or to 
artificially boost up the size of exports.  
Historically, as part of their protectionist measures, governments of different 
countries have applied many different types of policy instruments, not necessarily 
based on their economic merit, for restricting free flow of goods and services 
across national boundaries. While some such measures of government 
intervention are simple, widespread, and relatively transparent, others are 
complex, less apparent and frequently involve many types of distortions.  
In this unit, we shall describe some of the most frequently used forms of 
interference with trade. Understanding the uses and implications of the common 
trade policy instruments, will enable formulation of appropriate policy responses 
and more balanced dialogues on trade policy issues and international trade 
agreements. 
Trade policy encompasses all instruments that governments may use to promote 
or restrict imports and exports. Trade policy also includes the approach taken by 
countries in trade negotiations. While participating in the multilateral trading 
system and/or while negotiating bilateral trade agreements, countries assume 
obligations that shape their national trade policies. The instruments of trade 
policy that countries typically use to restrict imports and/ or to encourage exports 
can be broadly classified into price- related measures such as tariffs and non-
price measures or non-tariff measures (NTMs).  
In the following sections, we shall briefly touch upon the different trade policy 
measures adopted by countries to protect their domestic industries.  
  
Page 4


4.28 ECONOMICS FOR FINANCE 
UNIT II: THE INSTRUMENTS OF TRADE 
POLICY 
 
 
LEARNING OUTCOMES 
 
International Trade
The Instruments of 
Trade Policy
Tariffs
Non-Tariff Measures 
(NTMs)
Export-Related 
Measures
At the end of this unit, you will be able to: 
? Define trade policy and describe its objectives  
? Distinguish between different types of trade policy 
measures  
? Evaluate the use of tariffs as a trade policy instrument  
? Describe the ‘trigger price mechanisms’ for protection of 
domestic industry 
? Outline the different Non-Tariff Measures adopted by 
countries 
UNIT OVERVIEW 
4.29 
 
THE INSTRUMENTS OF TRADE POLICY 
 2.1 INTRODUCTION 
Before we go into the subject matter of this unit, we shall take a quick look into a 
few recent developments in the international trade arena.  
21 June 2020: China has lost a dispute to the European Union at the World Trade 
Organization (WTO) for a market economy status, as the former allowed the 
dispute to lapse. According to the EU, China subsidizes its industries to a great 
extent, particularly steel and aluminium, making their sales prices in the 
international market unfair. 
21 June 2020: India argues against farm tariff concessions to ease Covid-19 woes 
and proposes that only a balanced, inclusive and calibrated response is needed to 
tackle temporary crisis. 
2
nd
July 2020; China sees India's ban on 59 apps with Chinese links as 
'discriminatory', and calls for reversal of the move as it has been discriminatory 
and selective, and may have violated World Trade Organization (WTO) rules.  
8
th
 July 2020:  India asked Japan to lower the entry barriers in agricultural and 
pharmaceutical sectors.  
19th July 2020:  The WTO to set up dispute panels against India on request from 
Japan and Taiwan.  The panels will look into the request against import duties on 
mobile phones and ICT products imposed by New Delhi. 
15
 th
 September 2020: The WTO ruled that the tariffs the USA imposed on Chinese 
goods in 2018, triggering a trade war, were inconsistent with international trade 
rules.  
The above vignettes are just a few of the multitudes of episodes that arise almost 
on a daily basis when countries engage in trade.  A glance at similar newspaper 
reports makes it obvious that governments do not conform to free trade despite 
the potential efficiency and welfare outcomes it will generate; rather, they employ 
different devices for restricting the free flow of goods and services across their 
borders.  
As we know, under free trade, buyers and sellers from separate economies 
voluntarily trade with minimum of state interference. The free interplay of market 
forces of supply and demand decides prices. Protectionism, on the other hand, is 
a state policy aimed to protect domestic producers against foreign competition 
through the use of tariffs, quotas and non-tariff trade policy instruments. Trade 
  
 
4.30 ECONOMICS FOR FINANCE 
liberalization refers to opening up of domestic markets to goods and services 
from the rest of the world by bringing down trade barriers. 
In unit 1, we have seen that there are clear efficiency benefits from trade in terms 
of economic growth, job-creation and welfare. The persuasive academic 
arguments for open trade presuppose that fair competition, without distortions, is 
maintained between domestic and foreign producers. However, it is a fact that 
fair competition does not always exist and unobstructed international trade also 
brings in severe dislocation to many domestic firms and industries on account of 
difficult adjustment problems. Therefore, individuals and organisations continue 
to pressurize policy makers and regulatory authorities to restrict imports or to 
artificially boost up the size of exports.  
Historically, as part of their protectionist measures, governments of different 
countries have applied many different types of policy instruments, not necessarily 
based on their economic merit, for restricting free flow of goods and services 
across national boundaries. While some such measures of government 
intervention are simple, widespread, and relatively transparent, others are 
complex, less apparent and frequently involve many types of distortions.  
In this unit, we shall describe some of the most frequently used forms of 
interference with trade. Understanding the uses and implications of the common 
trade policy instruments, will enable formulation of appropriate policy responses 
and more balanced dialogues on trade policy issues and international trade 
agreements. 
Trade policy encompasses all instruments that governments may use to promote 
or restrict imports and exports. Trade policy also includes the approach taken by 
countries in trade negotiations. While participating in the multilateral trading 
system and/or while negotiating bilateral trade agreements, countries assume 
obligations that shape their national trade policies. The instruments of trade 
policy that countries typically use to restrict imports and/ or to encourage exports 
can be broadly classified into price- related measures such as tariffs and non-
price measures or non-tariff measures (NTMs).  
In the following sections, we shall briefly touch upon the different trade policy 
measures adopted by countries to protect their domestic industries.  
  
4.31 
 
THE INSTRUMENTS OF TRADE POLICY 
 2.2 TARIFFS  
Tariffs, also known as customs duties, are basically taxes or duties imposed on 
goods and services which are imported or exported. Different tariffs are generally 
applied to different commodities. It is defined as a financial charge in the form of 
a tax, imposed at the border on goods going from one customs territory to 
another. They are the most visible and universally used trade measures that 
determine market access for goods. Instead of a single tariff rate, countries have a 
tariff schedule which specifies the tariff collected on every particular good and 
service. Import duties being pervasive than export duties, tariffs are often 
identified with import duties and in this unit, the term ‘tariff’ would refer to 
import duties. 
Tariffs are aimed at altering the relative prices of goods and services imported, so 
as to contract the domestic demand and thus regulate the volume of their 
imports. Tariffs leave the world market price of the goods unaffected; while 
raising their prices in the domestic market. The main goals of tariffs are to raise 
revenue for the government, and more importantly to protect the domestic 
import-competing industries. 
2.2.1 Forms of Import Tariffs  
(i) Specific Tariff: Specific tariff is the fixed amount of money per physical unit 
or according to the weight or measurement of the commodity imported or 
exported. This tariff can vary according to the type of good imported. 
Example, a specific tariff of `1000/ may be charged on each imported 
bicycle. The disadvantage of specific tariff as an instrument for protection of 
domestic producers is that its protective value varies inversely with the price 
of the import. For example: if the price of the imported cycle is `5,000/- and  
the rate of tariff is 20%; then, if due to inflation, the price of bicycle rises to 
`10,000, the specific tariff is still only 10% of the value of the import. Since 
the calculation of these duties does not involve the value of merchandise, 
customs valuation is not applicable in this case. 
(ii) Ad valorem tariff:  When the duty is levied as a fixed percentage of the 
value of the traded commodity, it is called as valorem tariff. An ad valorem 
tariff is levied as a constant percentage of the monetary value of one unit of 
the imported good. A 20% ad valorem tariff on any bicycle generates a 
`1000/ payment on each imported bicycle priced at `5,000/ in the world 
market; and if the price rises to `10,000, it generates a payment of `2,000/. 
Page 5


4.28 ECONOMICS FOR FINANCE 
UNIT II: THE INSTRUMENTS OF TRADE 
POLICY 
 
 
LEARNING OUTCOMES 
 
International Trade
The Instruments of 
Trade Policy
Tariffs
Non-Tariff Measures 
(NTMs)
Export-Related 
Measures
At the end of this unit, you will be able to: 
? Define trade policy and describe its objectives  
? Distinguish between different types of trade policy 
measures  
? Evaluate the use of tariffs as a trade policy instrument  
? Describe the ‘trigger price mechanisms’ for protection of 
domestic industry 
? Outline the different Non-Tariff Measures adopted by 
countries 
UNIT OVERVIEW 
4.29 
 
THE INSTRUMENTS OF TRADE POLICY 
 2.1 INTRODUCTION 
Before we go into the subject matter of this unit, we shall take a quick look into a 
few recent developments in the international trade arena.  
21 June 2020: China has lost a dispute to the European Union at the World Trade 
Organization (WTO) for a market economy status, as the former allowed the 
dispute to lapse. According to the EU, China subsidizes its industries to a great 
extent, particularly steel and aluminium, making their sales prices in the 
international market unfair. 
21 June 2020: India argues against farm tariff concessions to ease Covid-19 woes 
and proposes that only a balanced, inclusive and calibrated response is needed to 
tackle temporary crisis. 
2
nd
July 2020; China sees India's ban on 59 apps with Chinese links as 
'discriminatory', and calls for reversal of the move as it has been discriminatory 
and selective, and may have violated World Trade Organization (WTO) rules.  
8
th
 July 2020:  India asked Japan to lower the entry barriers in agricultural and 
pharmaceutical sectors.  
19th July 2020:  The WTO to set up dispute panels against India on request from 
Japan and Taiwan.  The panels will look into the request against import duties on 
mobile phones and ICT products imposed by New Delhi. 
15
 th
 September 2020: The WTO ruled that the tariffs the USA imposed on Chinese 
goods in 2018, triggering a trade war, were inconsistent with international trade 
rules.  
The above vignettes are just a few of the multitudes of episodes that arise almost 
on a daily basis when countries engage in trade.  A glance at similar newspaper 
reports makes it obvious that governments do not conform to free trade despite 
the potential efficiency and welfare outcomes it will generate; rather, they employ 
different devices for restricting the free flow of goods and services across their 
borders.  
As we know, under free trade, buyers and sellers from separate economies 
voluntarily trade with minimum of state interference. The free interplay of market 
forces of supply and demand decides prices. Protectionism, on the other hand, is 
a state policy aimed to protect domestic producers against foreign competition 
through the use of tariffs, quotas and non-tariff trade policy instruments. Trade 
  
 
4.30 ECONOMICS FOR FINANCE 
liberalization refers to opening up of domestic markets to goods and services 
from the rest of the world by bringing down trade barriers. 
In unit 1, we have seen that there are clear efficiency benefits from trade in terms 
of economic growth, job-creation and welfare. The persuasive academic 
arguments for open trade presuppose that fair competition, without distortions, is 
maintained between domestic and foreign producers. However, it is a fact that 
fair competition does not always exist and unobstructed international trade also 
brings in severe dislocation to many domestic firms and industries on account of 
difficult adjustment problems. Therefore, individuals and organisations continue 
to pressurize policy makers and regulatory authorities to restrict imports or to 
artificially boost up the size of exports.  
Historically, as part of their protectionist measures, governments of different 
countries have applied many different types of policy instruments, not necessarily 
based on their economic merit, for restricting free flow of goods and services 
across national boundaries. While some such measures of government 
intervention are simple, widespread, and relatively transparent, others are 
complex, less apparent and frequently involve many types of distortions.  
In this unit, we shall describe some of the most frequently used forms of 
interference with trade. Understanding the uses and implications of the common 
trade policy instruments, will enable formulation of appropriate policy responses 
and more balanced dialogues on trade policy issues and international trade 
agreements. 
Trade policy encompasses all instruments that governments may use to promote 
or restrict imports and exports. Trade policy also includes the approach taken by 
countries in trade negotiations. While participating in the multilateral trading 
system and/or while negotiating bilateral trade agreements, countries assume 
obligations that shape their national trade policies. The instruments of trade 
policy that countries typically use to restrict imports and/ or to encourage exports 
can be broadly classified into price- related measures such as tariffs and non-
price measures or non-tariff measures (NTMs).  
In the following sections, we shall briefly touch upon the different trade policy 
measures adopted by countries to protect their domestic industries.  
  
4.31 
 
THE INSTRUMENTS OF TRADE POLICY 
 2.2 TARIFFS  
Tariffs, also known as customs duties, are basically taxes or duties imposed on 
goods and services which are imported or exported. Different tariffs are generally 
applied to different commodities. It is defined as a financial charge in the form of 
a tax, imposed at the border on goods going from one customs territory to 
another. They are the most visible and universally used trade measures that 
determine market access for goods. Instead of a single tariff rate, countries have a 
tariff schedule which specifies the tariff collected on every particular good and 
service. Import duties being pervasive than export duties, tariffs are often 
identified with import duties and in this unit, the term ‘tariff’ would refer to 
import duties. 
Tariffs are aimed at altering the relative prices of goods and services imported, so 
as to contract the domestic demand and thus regulate the volume of their 
imports. Tariffs leave the world market price of the goods unaffected; while 
raising their prices in the domestic market. The main goals of tariffs are to raise 
revenue for the government, and more importantly to protect the domestic 
import-competing industries. 
2.2.1 Forms of Import Tariffs  
(i) Specific Tariff: Specific tariff is the fixed amount of money per physical unit 
or according to the weight or measurement of the commodity imported or 
exported. This tariff can vary according to the type of good imported. 
Example, a specific tariff of `1000/ may be charged on each imported 
bicycle. The disadvantage of specific tariff as an instrument for protection of 
domestic producers is that its protective value varies inversely with the price 
of the import. For example: if the price of the imported cycle is `5,000/- and  
the rate of tariff is 20%; then, if due to inflation, the price of bicycle rises to 
`10,000, the specific tariff is still only 10% of the value of the import. Since 
the calculation of these duties does not involve the value of merchandise, 
customs valuation is not applicable in this case. 
(ii) Ad valorem tariff:  When the duty is levied as a fixed percentage of the 
value of the traded commodity, it is called as valorem tariff. An ad valorem 
tariff is levied as a constant percentage of the monetary value of one unit of 
the imported good. A 20% ad valorem tariff on any bicycle generates a 
`1000/ payment on each imported bicycle priced at `5,000/ in the world 
market; and if the price rises to `10,000, it generates a payment of `2,000/. 
  
 
4.32 ECONOMICS FOR FINANCE 
While ad valorem tariff preserves the protective value of tariff on home 
producer, it gives incentives to deliberately undervalue the good’s price on 
invoices and bills of lading to reduce the tax burden. Nevertheless, ad 
valorem tariffs are widely used across the world.  
There are many other variations of the above tariffs, such as: 
(a) Mixed Tariffs: Mixed tariffs  are expressed either on the basis of the value 
of the imported goods (an ad valorem rate)  or on the basis of a unit of 
measure of the imported goods (a specific duty)  depending on which 
generates the most income( or least income at times) for the nation. For 
example, duty on cotton: 5 per cent ad valorem or ` 3000/per tonne, 
whichever is higher. 
 Compound Tariff or a Compound Duty is a combination of an ad valorem 
and a specific tariff. That is, the tariff is calculated on the basis of both the 
value of the imported goods (an ad valorem duty) and a unit of measure of 
the imported goods (a specific duty).  It is generally calculated by adding up 
a specific duty to an ad valorem duty. Thus, on an import with quantity q and 
price p, a compound tariff collects a revenue equal to t
s
q + t
a
pq, where t
s
 is the 
specific tariff and t
a
 is the ad valorem tariff. For example: duty on cheese at 5 
per cent advalorem plus 100 per kilogram. 
(b) Technical/Other Tariff: These are calculated on the basis of the specific 
contents of the imported goods i.e. the duties are payable by its 
components or related items. For example: `3000/ on each solar panel plus 
` 50/ per kg on the battery. 
(c) Tariff Rate Quotas: Tariff rate quotas (TRQs) combine two policy 
instruments: quotas and tariffs. Imports entering under the specified quota 
portion are usually subject to a lower (sometimes zero) tariff rate. Imports 
above the quantitative threshold of the quota face a much higher tariff. 
(d) Most-Favoured Nation Tariffs: MFN tariffs refer to import tariffs which 
countries promise to impose on imports from other members of the WTO, 
unless the country is part of a preferential trade agreement (such as a free 
trade area or customs union). This means that, in practice, MFN rates are the 
highest (most restrictive) that WTO members charge each other. Some 
countries impose higher tariffs on countries that are not part of the WTO. 
(e) Variable Tariff: A duty typically fixed to bring the price of an imported 
commodity up to level of the domestic support price for the commodity.