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Measuring International Trade Policy: a Primer on Trade Restrictiveness Indices

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Measuring International Trade Policy: a Primer on Trade Restrictiveness Indices Measuring International Trade Policy: A Primer on Trade Restrictiveness Indices Cletus C. Coughlin Measuring the overall restrictiveness of a country’s international trade policies is important and, in fact, essential for estimating the effects of trade policies and for negotiations to reduce trade barriers. A good measure is also difficult to produce: Trade restrictiveness indices are construct ed by combining the actual structure of trade restrictions, which is generally quite different across goods, into a single number. Under certain assumptions, this single number is the uniform tariff that would produce the same trade restrictiveness as the actual differentiated structure of restric - tions. In this paper, the economic intuition underlying the construction of these indices is pre - sented and estimates of these indices and the resulting insights are summarized. (JEL F00, F13, C43) Federal Reserve Bank of St. Louis Review , September/October 2010, 92 (5), pp. 381-94. ountries commonly use tariffs and if applied to every imported good, would gener - other barriers to deter the importa tion ate the same result for a nation’s economic well- of foreign-produced goods. Such trade being as the actual set of trade barriers. 1 Trade policies affect economic activity and restrictiveness indices are valuable for many pur - Ceconomic well-being not only in the country poses, such as assessing the impact of trade pol icy enacting these policies but in other countries as on economic and social outcomes and providing well. A fundamental question when assessing useful information for trade negotiations. Because these policies is how restrictive overall a coun - of the importance of trade restrictiveness indices, try’s trade policies actually are. Ideally, one would an elementary introduction to these indices should like to have a measure that provides insights con - be of value for researchers, policymakers, and cerning not only how a country’s restrictiveness students. has changed over time, but also how it com pares Unlike trade restrictiveness indices, more with its trading partners’. common measures of trade restrictiveness can The present paper focuses on the measure ment be characterized as ad hoc and, thus, flawed. of trade restrictiveness. Particular attention is given There fore, studies using these less-rigorous meas - ures of the impacts of trade policy on economic to measures that are termed trade restrictiveness welfare and performance should be viewed with indices . Such indices are produced by combin ing skepticism. actual trade restrictions, which are generally quite Beginning with the pioneering efforts of James different across goods, into a single number. This Anderson and Peter Neary in the early 1990s, single number is the uniform tariff factor equiva - lent that would produce the same trade restric tive - 1 ness as the actual structure of restrictions. In the As discussed later, trade restrictiveness indices can also be con - structed relative to other measures of economic activity, such as case of a specific index discussed later, this tar iff, the volume of imports. Cletus C. Coughlin is a vice president and deputy director of research at the Federal Reserve Bank of St. Louis. The author thanks Mariana Spatareanu, Vlad Manole, and Silvio Contessi for comments on an earlier draft. Lesli Ott provided valuable research assistance. © 2010, The Federal Reserve Bank of St. Louis. The views expressed in this article are those of the author(s) and do not necessarily reflect the views of the Federal Reserve System, the Board of Governors, or the regional Federal Reserve Banks. Articles may be reprinted, reproduced, published, distributed, displayed, and transmitted in their entirety if copyright notice, author name(s), and full citation are included. Abstracts, synopses, and other derivative works may be made only with prior written permission of the Federal Reserve Bank of St. Louis. FEDERAL RESERVE BANK OF ST . LOUIS REVIEW SEPTEMBER /OCTOBER 2010 381 Coughlin much progress on the measurement of trade faced by domestic producers and consumers prior restrictiveness indices has occurred, including to the imposition of the tariff. Thus, the quantity developments in economic theory and estima tion of imports is M W. that will be discussed here. 2 The theoretical Now assume a tariff is imposed that raises advances use general equilibrium analysis, an the price faced by domestic producers and con - approach that examines all markets in an econ omy sumers to P T. As a result of the higher price, at the same time. Thus, changes in one market imports would decrease to M T. The deadweight can affect many other markets, and the determi - loss caused by the tariff is represented by the nation of all equilibrium prices and quantities tri angle ABC. 5 The restrictiveness of this tariff of all goods and services occurs simultaneously. is simply the height of the tariff, which is the Without question, such an analysis provides strong difference between P T and P W. Trade restrictive - foundations for trade restrictiveness indices. How - ness increases the larger the difference between ever, to increase reader understanding of the key the domestic price and the price in world mar kets. points in this paper, the following discussion of This simplicity vanishes, however, when assess - trade restrictiveness indices relies on partial ing trade restrictiveness with two or more goods equilibrium analysis, an approach that considers and tariffs. only part of an economy, such as the market for a specific good. Problems with Existing Measures Let’s begin with a case of two goods that are subjected to different tariffs. One approach could MEASURES OF TRADE be to construct a measure of trade restrictiveness RESTRICTIVENESS: by computing the simple (i.e., unweighted) aver - CONSTRUCT WITH CAR E3 age of the two tariff rates. An obvious problem here is that all goods are treated identically. Intuitively, To show how difficult it is to measure a the goods should be weighted in terms of their country’s trade restrictiveness, I examine a num ber importance. 6 One common weighting approach of situations that illustrate problems with exist ing is to use actual import volumes as weights. Unfor - measures and provide the foundation for under - tunately, such an approach is flawed. standing the advances associated with trade When a uniform tariff is imposed on all the restrictiveness indices. goods in question, the calculation of an average tariff weighted by import volumes generates a A Very Simple Case reasonable index: that a higher average tariff accu - The measurement of trade restrictiveness is straightforward when there is only one imported because it is derived from the country’s supply and demand curves good and a tariff is applied. Figure 1 illustrates for the good. Using prices less than the price associated with the intersection of the supply and demand curves, the import demand this simple case. The import demand for this curve is the difference between quantity demanded and quantity good is represented by D M.4 The price in world supplied. 5 markets for this good is P W, which is the price The deadweight loss stems from the distortion of consumption and production decisions resulting from the wedge between the domestic price and the world price caused by the tariff. The fact 2 See Anderson and Neary (1992, 1994, 1996, 2003, and 2007) and that domestic consumers and producers face a price that exceeds Anderson (1998). A compilation of their work is presented in the world price leads to inefficiencies associated with consump tion Anderson and Neary (2005). as well as production. First, some would-be purchasers whose marginal benefits would exceed the world price are not buying— 3 A more thorough discussion of the ideas in this section can be and, therefore, not consuming—the good because of the addi tional found in Anderson and Neary (2005). costs imposed by the tariff. Second, some domestic producers whose marginal costs exceed the world price are producing the good. 4 To be consistent with the underlying theory, this demand curve is a compensated net import demand curve. A compensated demand 6 As pointed out by Mariana Spatareanu in personal correspon dence, function, also known as a Hicksian demand function, reflects the simple average can be easily manipulated. To reduce its aver age demand for a bundle of goods that minimizes expenditure while tariff rate, a country may simply create a large number of cate gories providing a fixed level of utility. The curve is characterized as “net” of goods with zero or very low tariffs. 382 SEPTEMBER /OCTOBER 2010 FEDERAL RESERVE BANK OF ST . LOUIS REVIEW Coughlin Figure 1 One Imported Good Subject to Tariff Price C PT A PW B DM 0 M T MW Imports rately indicates a more restrictive policy. How - demand for M1 is represented by D M1 and the ever, with a differentiated tariff structure, goods demand for M2 is represented by D M2 . Note that subject to high tariffs will tend to receive lower the quantity of M1 increases with leftward move - weight than goods subject to low tariffs. The rea son ments along the horizontal axis and that the quan - is that the price of a good with a high tariff will tity of M2 increases with rightward movements tend to rise relative to a good with a low tariff, so along the horizontal axis. To simplify, but with out consumers will tend to substitute the good with losing any generality, the price in world markets the low tariff for the one with the high tariff. As for both goods is assumed to be P W. Prior to the a result, in the calculation of the import- weighted imposition of a tariff, P W is the price faced by average tariff, goods with high tariffs will tend to domestic producers and consumers for both goods.
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