In the past, governments mostly protected local markets by using tariff barriers. Tariffs, which act like a tax on imports, can raise the cost of foreign goods. If the tariff level is set high enough, foreign companies will simply avoid shipping goods across a customs border since it can be impossible to remain competitive with domestic goods in the face of high tariff levels.
Countries have reduced tariffs after multiple rounds of reductions at the global level. In fact, many people argue that tariffs are no longer an especially big issue. In ongoing free trade agreements (FTAs), the focus has largely shifted from goods to other chapters and different kinds of “sexier” market commitments like services, investment, e-commerce, or intellectual property rights.
Yet tariffs continue to matter. For some sectors—like agriculture—tariff rates charged at the border can be 100%, 330% (some dairy into Canada) or as high as 1400% (for a particular kind of potato into Japan).
Even in sectors where tariffs are generally low or set to zero, such as electronic goods, tariffs can still be important. For example, while global commitments in the Information Technology Agreement (ITA) have eliminated tariffs entirely on some classes of goods, many of the raw materials, parts and components used in the manufacture of more complex electronic goods may continue to be charged tariffs at the border.
Research shows, in fact, that the cumulative effect of even very low tariffs can be quite high—as semi-finished parts and components go back and forth across borders in supply chains, a 2, 5 or 10% tariff can add up quickly.
Tariffs are leveled on the gross value of the good and not on the value-added amount. Firms with long international chains can face significant costs from very low tariffs. Ferrantino showed that a 10 percent tariff across a five stage chain results in a tariff equivalent of 34 percent—and doubling the chain again drives tariff levels up to the equivalent of 75 percent.
Robert Koopman, now chief economist at the WTO, and his colleagues have reported that the effective tariff rate for the United States is 17 percent higher than the nominal rate, 71 percent higher in Hong Kong and 171 percent higher in Mexico. Developing countries, overall, include more intermediate goods into final products, making the impact of tariffs more significant.
Free trade agreements do not entirely solve this problem either. Sebastien Miroudot and colleagues have shown how the amplification of tariffs still takes place under free trade agreements.
The continuing importance of tariffs makes some of the news coming out of regional talks in the Regional Comprehensive Economic Partnership (RCEP) particularly worrying. At the ministerial meeting last month, leaders agreed to cut tariffs on 65% of goods at the launch of the agreement and raise this level to 80% by the time the deal is fully implemented in 10 years.
This news could also be presented another way—RCEP officials have agreed to leave 35% of tariffs untouched at the introduction of the agreement and not address 20% of tariffs even when the agreement is finished.
I am trying to get research underway to determine the actual impact of such policies. I suspect that trade between many RCEP members is currently limited to a small set of tariff lines. If these lines are part of the “excluded” groups of tariff lines, the net impact of RCEP cuts will be modest indeed.
The example I frequently give is to say that snow removal equipment will undoubtedly be “fully liberalized” across RCEP. Given the tropical nature of many RCEP countries, such a concession is basically meaningless—they do not produce, sell, buy, export or import many snow shovels, snowplows, or even snow boots. However, things that are actually traded, including many key agricultural items, will surely be left off, or “carved out,” of the final agreement.
More disturbing still, India has apparently won permission to continue with a “3 tier” offer in tariff cuts. Under the tiered approach, ASEAN countries will receive the 65/80 offer (start at 65% coverage and increase to 80%). South Korea and Japan, in tier two, will be stuck at 65%. Finally, China, Australia and New Zealand will receive tariff cuts on only 42.5% of tariff lines at the outset into India.
Think about that for a moment. India is promising to cut tariffs on less than half of tariff lines. Snow shovels and boots are in. Most commercially meaningful goods are not.
New Zealand, in particular, is trying to fight back and require that India's offer include goods tariff lines that account for 55% of the value of goods traded between the two members. This is more helpful, but still complicated and of less value to businesses than greater liberalization across the board.
Note that India’s coverage levels are not automatically reciprocal. Apparently, China will offer India 42.5% of its domestic market, but Australia is going to be more generous at 80% coverage and New Zealand will start at 65% coverage.
Tariff cuts have to be viewed in tandem with rules of origin (ROOs). It is possible to have relatively modest cuts, but easy-to-use rules of origin and broad cumulation. This makes it more likely that firms will take advantage of RCEP in the future since items produced with content from across the 16 member countries can be more easily included and often receive reduced tariff benefits into RCEP members. A future post will consider where officials seem to be heading in the ROO chapter.
On the bright side, if these provisions remain for trade in goods, the Asian Trade Centre and a host of other consulting firms across the region are likely to have enormous demand in the coming years as companies come to grips with the potential benefits arising from RCEP commitments. To successfully use an RCEP agreement with modest tariff cuts, different levels of commitment, and at least a 10 year phase in period, firms will need very savvy advice and support.
We are standing by to help.
***Talking Trade is a blog post written by Dr. Deborah Elms, Executive Director, Asian Trade Centre, Singapore***