From UPSC perspective, the following things are important :
Prelims level : Not much.
Mains level : Paper 3- How could higher import tariffs affect the Indian economy?
It is important to have a stable tariff policy which would help to link effectively to global value chains.
Why countries levy tariff?
- The tariff is a tax levied on an imported good at the border.
- Countries use tariffs to-
- Provide easy market access or restrict them to protect domestic industry.
- It also serves the purpose of revenue collection and-
- To achieve some strategic objectives by giving/denying tariff concessions to countries.
Harmonised System in international trade
- What is it? Goods are classified at 2, 4, 6, 8 digits and some countries have even up to 10 digits, depending upon the level of trade potential of a country.
- WCO’s system of codes: The classification of these codes is streamlined under an international coding system called ‘Harmonized System’ (HS) under World Customs Organization (WCO) to which 138 countries are contracting parties and about 200 customs authorities are signatories.
- India’s national tariff lines are about 11,000 at HS 8-digit.
Historic background of the tariffs
- Colonial-era: During the colonial era tariffs were heavily used to protect the domestic industry, enjoy unbridled access to the colonized markets and raise tariffs against competitors.
- Adam Smith’s advocacy of free trade: Adam Smith in 18th Century challenged this idea of regimented trade with his advocacy of free trade that was convincingly brought out in his seminal work ‘Wealth of Nations’.
- Theory of comparative advantage: Further, in the 19th Century, David Ricardo, building on this concept, propagated the ‘theory of comparative advantage’.
- The theory proposes that nations should remain focused on their specific areas of competence and allowed to trade freely with other countries.
- This theory is against import substitution and considers raising tariffs as a drag on economic growth.
- What proponents of high tariff said? Proponents of high tariffs assert that-
- Developed countries dominated global markets for decades with high tariffs, developing countries should continue to enjoy differential tariff treatment until they catch up with the rest.
How countries calibrate tariffs?
- Each country calibrates its tariffs taking into account its-
- Domestic production.
- Demand and
- Typically, tariff structures of a manufacturing country reveal a pattern:
- Low tariffs on raw materials and intermediate goods in the range of 0-5%.
- Slightly higher tariffs for finished goods in the range of 7-10%.
- Higher tariffs for agriculture products at above 15%, sometimes up to bound rates as allowed under WTO.
- As agriculture lines are politically sensitive, most countries zealously guard them with high tariffs.
Export-import linkage and effects of high tariffs
- How tariffs could harm export competitiveness: Availability of cheaper raw materials and intermediate products support making of competitively priced finished goods for export markets.
- The challenge for an entrepreneur is to find these cheaper inputs.
- If these inputs are not available domestically at competitive rates, they look to source them from outside.
- But as high tariffs act as barriers to sourcing cheaper inputs, they undermine export competitiveness of a product.
- Implications for MSMEs
- For MSMEs (micro, small and medium enterprises), this dependency linkage is even more critical, without which they might close down their operations under threat of persistent losses or low returns.
- Impact on jobs and economy: This would have consequential impact on jobs, income and consumer choices in an economy.
- Inefficiency and corruption at entry points: High tariffs could breed inefficiency and corruption at the entry points as it leaves much scope for discretion at the hands of officials, circumvention through under/over-invoicing and violation of rules of origin.
- Impairing demand: Overtime, high tariffs run the risks of impairing demand and paralyzing domestic manufacturing.
- Maintaining judicious balance: Leveraging tariffs for benchmarking domestic prices is not an uncommon practice in any country.
- But maintaining a judicious balance between the interests of primary producers and user industries is imperative, given that there exists an intimate link between imports and exports.
India and Global Value Chain (GVC)
- 80% trade through More than 80% of the global trade runs through Global Value Chains (GVCs) which have evolved extensively in various regions of the world.
- Low tariffs help GVCs to thrive, essentially for the purpose of sourcing and accessing foreign markets.
- Why stable tariff policy is important for India?
- For India to emerge as a global hub for “networked products” and make every district an ‘export hub’ for a specific item, as envisaged in this year’s Budget, it is important to have a stable and predictable tariff policy which would help to link effectively to GVCs.
- For investors: From an investor’s point of view a stable tariff policy is a huge motivation.
Free-trade agreements and hope of getting market access
- Market access: The assumption that tariff concessions under bilateral free trade agreements (FTAs) would help get market access is misplaced.
- Why the assumption is misplaced? In reality, this may not happen as same concessions can be offered by a country to other trading partners in a trade arrangement or throw open to all countries on an MFN (most favoured nation) basis.
- Inverted duties situation: Gradual tariff liberalization is a natural progression and failing to do so could result in a situation of inverted duties where finished products end up being cheaper than raw materials and intermediate goods
- Thus, calling for tariff correction in course of time.
Revenue Generation through tariffs
- Why it is not a good idea? The domestic consumers ultimately end up absorbing import duties as they get passed onto products they consume.
- Taxing own people: This is akin to taxing one’s own people in an indirect way by making them pay more for a product than in other markets.
- Revenue generation from enhanced activities: For these reasons, the idea of revenue collection from import duties is losing steam, and instead, revenue generation from enhanced economic activity is gaining wider acceptance as a dynamic process.
Increasing tariffs on the import can end up hurting the economy than benefitting it in the long run, so the government must reconsider the policy of tariff increase.