**KH8 (revised)**IV. Various Costs of Trade and Trade Arrangements

Direct and indirect costs of trade [Head, 59-90]

The costs associated with international trade (exporting, importing) include:

(i)costs of transportation, insurance, finance and spoilage, (ii)costs of crossing borders (clearing customs, tariffs, antidumping duties, countervailing duties,..),(iii)costs of arranging for trade contracts (financing, letter of credit,..)

Here we continue to focus on (i)costs of transportation and (ii)costs of crossing borders. We will discuss (iii) later.

Summary of what follows in this slide:(i)costs of transportation, insurance, finance and spoilage e.g. FOB, CFR/CIF, … Also (*) Fij = G [(MiMj) / Dij] (Meaning, implications)

(ii)costs of crossing borders (clearing customs, tariffs, antidumping duties, countervailing duties,..). These costs are explained below.

I) VISIBLE BARRIERSA. tariff (duty): a specific tariff (duty), e.g. $5 tariff per barrel of oil; an ad valorem tariff (duty), e.g. 25% U.S. tariffs on imported light trucks from Japan in the 1980s and 1990s; special import measures (antidumping & countervailing duties, measures of safeguards)B. Subsidies to domestic producers in various formsC. quantity restrictions of imports: C1. import quotas; C2. voluntary export restraint (VER)D. local content requirement

II) INVISIBLE BARRIERS E. administrative policies: careful inspection, etc. to limit importsF. foreign business practicesG. foreign culture

GENERAL LESSON LEARNED FROM THE TRADE WARS AROUND THE 1930S: “trade can stimulate economic activity.” This lesson lead to promotion of freer trade after World War II

GATT ESTABLISHED IN 1947: to liberalize trade by eliminating tariffs, subsidies, import quotas, etc.WTO recently replaced GATT

IMPLICATIONS FOR BUSINESS FIRMS

The following figure shows the breakdown of typical trade costs.

Transportation-related costs can be very large.

(Vertical axis shows the extent of seller’s (exporter’s) responsibility.)

Trade costs and the INCO Terms

INCO (International Commercial) terms

(See posted slide. Also: www.jus.uio.no/lm//icc.incoterms.1990/doc.html )

EXW (... named place): “Ex works” means that the seller fulfils his obligation to deliver when he has made the goods available at his premises (i.e. works, factory, warehouse, etc.) to the buyer...The buyer bears all costs and risksinvolved in taking the goods from the seller’s premises to the desired destination.

FAS (... named port of shipment): “Free Alongside Ship” means that the seller fulfils his obligation to deliver when the goods have been placed alongside the vessel on the quay or in lighters at the named port of shipment. This means that the buyer has to bear all costs and risks of loss of or damage to the goods from that moment. The FAS term requires the buyer to clear the goods for export. It should not be used when the buyer cannot carryout directly or indirectly the export formalities. This term (and FOB) can only be used for sea or inland waterway transport.

FOB (... named port of shipment): “Free on Board” means that the seller fulfils his obligation to deliver when the goods have passed over the ship’s rail at the named port of shipment. This means that the buyer has to bear all costs and risks of loss of or damage to the goods from that point.

CFR (... named port of destination): “Cost and Freight” Seller has responsibility to deliver the goods to the buyer’s port and to turn over two documents: the invoice (cost) and the bill of lading (freight).

CIF (... named port of destination): “Cost, Insurance and Freight” means that the seller has the same obligations as under CFR but with the addition that he has to procure marine insurance against the buyer’s risk of loss of or damage to the goods during the carriage. The seller contracts for insuranceand pays the insurance premium. This term can only be used for sea and inland waterway transport. When the ship’s rail serves no practical purposes such as in the case of roll-on/roll-off or container traffic, the CIP (Cost and Insurance Paid to...named place) term is more appropriate to use.

DEQ (... named port of destination): “Delivered Ex Quay (duty paid)” means that the seller fulfils his obligation to deliver when he has made the goods available to the buyer on the quay (pronounced “kee”, it is a synonym of wharf) at the named port of destination, cleared for importation. The sellerhas to bear all risks and costs including duties, taxes and other charges of delivering the goods thereto (unless otherwise specified).

DDP (... named place of destination): “Delivered duty paid” means that the seller fulfils his obligation to deliver when the goods have been made available t the named place in the country of importation. The seller has to bear the risks and costs, including duties, taxes and other charges of delivering the goods thereto, cleared for importation. This term may be used irrespective of the mode of transport.

Where below the seller’s responsibility ends and the buyer’s responsibility begins depends on the contract.

1. EXW is the sum of production costs and the markup.

2. FAS adds the cost of transporting the good from the manufacturer’s premises

to the port of export to the EXW price.

3. FOB adds the cost of loading the goods on board to the FAS price.

4. CIF adds the cost of shipping over water, including insurance of goods to

the FOB price.

5. DEQ (duty paid) adds the cost of the duties to the CIF price.

6. DDP adds the cost of inland transport to the buyer’s premises to the DEQ.

In some situations it makes difference which term is used in quoting a price for trade transactions.

We will discuss more on this in detail later in trade finance.

Transportation cost in international trade

Examples of transportation costs: freight carrier costs, marine insurance costs

Newton’s “Law of Universal Gravitation (1687)”: the attractive force between two objects i and j is given by the product of the two masses divided by the square of the distance between them.

Dutch economist Jan Tinbergen (1962) proposed that the same functional form could hold for international trade flows.

(*) Fij = G [(MiMj) / Dij]

• Fij is the“flow” from origin i to destination j, or, in some cases, it represents the sum of the flows in both directions. [Note: i and j = countries, provinces, states, etc.]• Mi and Mj are the relevant economic sizes (GDP) of the two locations i and j.• Dij is the distance between the locations.• G is the “gravitational constant” which depends on such things as national borders, free trade agreements, and common languages. (G>0.)

(*) means that: (1)given G and D, there’s more trade between bigger economies; (2)given G, Mi and Mj, there’s more trade between economies which are closer; and (3)doubling of distance will decrease trade by one half.For appropriately measured Mi,Mj and Dij, the above law predicts trade flows very well.See the following figure.

A “gravity” law for Canadian exports

Examples. How do firms overcome the costs of distance?

- How do automakers deal with the cost of transportation over land (domestic market) or over the ocean (foreign market)?

- How do manufacturers of high-value added products deal with transporting their products to overseas locations? (E.g. expensive electronics products.)

Costs of crossing borders

There are different types of barriers for crossing borders.

Example. Exchange rates with volatility risks discussed earlier.

Another source of barrier: trade policy barriers (customs duties, etc.) to be discussed here.

What does the following figure tell us?

Assume: [the distance between Ontario and BC] = [the distance between Ontario and Washington state] = [the distance between BC and Michigan]

The Border Effect on Canada-US Trade in 1995

The figure shows the border still matters!

Despite FTA and NAFTA, the flows of trade between Canada and The United States are much smaller than the flows between their domestic jurisdictions.

Instruments of trade policy I) VISIBLE BARRIERS 

A. tariff (duty)  

(i) a specific tariff (duty): fixed $per unit, e.g. $5 tariff per barrel of oil

 • an ad valorem tariff (duty) levied on a proportion of the value of the imported

good: 25% U.S. tariffs on imported light trucks from Japan in the 1980s and 1990s

(This policy may have prompted Japanese car makers to shift some of their production capacity to the U.S. )

(iii) special import measures: antidumping & countervailing duties, etc. (to be discussed later)

Canada’s Customs Duty Schedule

HS6 CCRA# Description MFN GPT LDCT+FTAs

95.06.11 1000 Downhill skis 0% 0% 0%

9010 Cross-country skis 7.5% 5% 0%

9020 Snowboards 7.5% 5% 0%

95.06.12 0000 Ski bindings 7% 5% 0%

95.06.19 0010 Ski poles 6.5% 3% 0%

95.06.21 0000 Sailboards 9.5% 6% 0%

95.06.29 0010 Water skis 7.5% 5% 0%

95.06.29 0090 Other (inc. surfboards) 7.5% 5% 0%

95.06.70 1100 Ice skates w/ boots 18% 18% 0%

95.06.70 2010 Ice skates w/o boots 5.5% 3% 0%

95.06.99 9089 Other (inc. skateboards) 7.5% 5% 0%

Classification: “Harmonized” System

First 6 digits are same for all countries9506.11: Skis9506.21: Sailboards9506.99: Other outdoor sport equipment

Last 4 digits specific to each importer 9506.11.1000 (downhill skis in Cda, duty: 0%)9506.11.9010 (cross-country skis in Cda, duty: 7.5%)9506.11.1000 (cross-country skis in US, duty: 0%)9506.11.4010 (other skis in US, duty: 2.6%)

First 8 digits (HS6+2) determine the tariff item

Definitions

HS6: 6-digit Harmonized System codes.

CCRA#: 4-digit Canada specific codes.

MFN: Most Favoured Nation status; offered to all WTO members and most other countries, with rare exceptions such as North Korea and Libya.

GPT: General Preferential Tariff; offered to poorer countries including most of South America and Asia.

LDCT: Least Developed Countries tariff; covers a smaller group of the world’s poorest nations, including Haiti and most of Sub-Saharan Africa.

Example. Sailboards (9506.21.0000) originating from:WTO member or other MFN list country: 9.5%General Preferential Tariff country (e.g. Algeria, Brazil): 6%Least Developed Country (e.g. Mali): 0%FTA (U.S., Mexico, Costa Rica, Chile): 0%General rate (Libya?): 35%

Tariffs in Rich countries are mainly low, with exceptions

What do tariffs do?

----> tariffs raise the import price relative to the domestic price

Who gains and who loses? -domestic vs. foreign producers? -domestic consumers

Some examples of tariffs and other trade policy tools

Dumping: charging an export price that is below the normal value (called the “fair value” I the US)The normal value: equal to the price charged for comparable sales in the exporter’s home market during the ordinary course of trade.

Implementation of ADD:Import-competing firms complain to their government that imports are being “dumped”Customs-related agency determines the normal price, compares with export price.If “ordinary” & “comparable” home sales are not available, the normal price is calculated as price charged to other (3rd country) markets; “cost of production + normal profit”

Reasons for antidumping duties:pricing exports “unfairly” low; causing injury to suppliers in importing countryReasons for countervailing duties:producers receiving “unfair” assistance from government contingent on exporting, or, specific to an industry AND injury-causing.Measures of safeguards:temporary relief; injury, compensation requirements

Example (CV duties). Canada-U.S. soft lumber dispute

What is it?

"The dispute is centered on stumpage fees - set amounts charged to companies that harvest timber on public land. Many in the U.S. see Canadian stumpage fees as being too low, making them de facto subsidies.”

A U.S. coalition of lumber producers wants the provincial governments to follow the American system and auction off timber rights at market prices. The U.S. responded by levying tariffs on incoming Canadian lumber in May 2002.

Not all U.S. forestry firms support the U.S. position on soft lumber trade. E.g. Weyerhaeuser. Why?

Example (Anti dumping duties)

If preliminary finding supports dumping claim, then “suspension of liquidation,” accused firms must pay deposits equal to dumping margin.

Dumping margin is (Pn – Px)/Px, where Pn=normal price, Px=firm price.Dumping margin is usually firm-specific:

In the softwood lumber dispute, Weyerhauser pays 12.39% but Canfor pays 5.96%. “All other firms” rate of 8.43%.

Why does Weyerhauser (a U.S. firm) pay the fine at all?

After “dumping” (or LTFV= “less than fair value” ) determination, import government agency determines whether its domestic industry has been or is threatened by material injury caused by the dumped imports.

Injury can be measured by loss of market share, falling profits, laid off workers, etc.

Injury determination often negative, then duties refunded with interest.

Options for accused firms:exit (abandon the market); settle; litigate; circumvent, for example, by FDI.

Instruments of trade policy

I) VISIBLE BARRIERS (Continued)

B. Subsidies to domestic producers in various forms:grants, low interest loans, tax exemptions, … to which industries? Canadian softwood lumber industry case (more on this later).

C. quantity restrictions of imports

C1. import quotas ---> import quantity limited, the right to import licensed; sugar, textile products, cheese often subject to import quotas

C2. voluntary export restraint (VER)VER on Japanese auto exports to the U.S. and Canada in the 1980s and the EU more recently; EU’s current VER on Chinese textile exports  

VER is often agreed by the exporting countries to avoid very damaging punitive tariffs. VER sidesteps world trade rules (WTO, also GATT) since neither side files a complaint

Example. The U.S. imposed VER on Japanese auto producers in the 1980s and 1990s to limit their auto exports to the U.S., and Canada followed the same policy. Standard trade policy analysis asks the following questions about this VER:  

Intended beneficiaries of this policy: ???  Intended victims of this policy: ???

Reality: ? ? ? (So what has happened?)

(Added notes)Intended beneficiaries of this policy: ???

The Big Three (GM, FORD, CHRYSLER)Intended victims of this policy: ???

U.S. and Canadian consumers, Japanese car makersReality: ? ? ? (So what has happened?)

The Big 3 and J-car makers gained; (???) lost -----> Stock price/returns movements before and after the VER indicates that Japanese auto makers including large parts suppliers benefited enormously; estimated loss to the U.S. (???): MANY $BILLIONS. This VER contributed in part to Japanese automakers' decisions to go ahead with FDI in the U.S.

Example. EU’s VER on Chinese textile exports

China averts clash with EU on textiles: An agreement is reached just hours before threatened export restrictions

SHANGHAI: Hoping to ease growing trade tensions with the European Union, China agreed early Saturday to place voluntary limits on the growth of its textile and apparel exports to Europe. The decision came just hours before the European Union was set to impose its own trade restrictions on China as a way to stem the flood of Chinese textile and apparel goods that have flowed into Europe this year.According to the agreement, China is expected to work with EU officials to manage and limit the growth of certain textile and apparel exports to Europe to about 10 percent a year through the end of 2008, in effect tempering the rise of some of its largest and fastest-growing exports.Chinese and EU officials did not disclose the precise details of the curbs or limits that are expected to be put into place. But according to a statement released by the European Commission, the two sides agreed that Chinese textile exports would be managed to allow for "reasonable growth" between 2005 and 2007.The agreement - which covers about 10 categories of textiles - comes at a time of growing trade friction that has erupted in the first months after the global system of country-by-country textile quotas were lifted Jan. 1. (International Herald Tribune, June 11, 2005)

D. local content requirement

- per cent of local content measured in physical or $value terms;

- used by developing and developed countries (e.g. the U.S.); - also required by the Canada-U.S. auto pact and NAFTA  II) INVISIBLE BARRIERS

No commonly accepted international rules on these exist. E. administrative policies: careful inspection, etc. to limit imports

F. foreign business practices

Example. The U.S. criticism of Japanese business practices impeding imports of U.S. auto parts into Japan

G. foreign culture  

- can be a barrier for selling your products (e.g......)- but protection of foreign culture can be a problem too

Examples -A French limit on imported U.S. movies-Canadian content law on Canadian TV networks

 

Protection of Canadian culture industry against the imports of U.S. culture industry products is currently in effect,

but Canadian demand for such U.S. products continues to be strong!

GENERAL LESSON LEARNED FROM THE TRADE WARS AROUND THE 1930S:

“trade can stimulate economic activity”

This lesson lead to promotion of freer trade after World War II

GENERAL AGREEMENT ON TARIFFS AND TRADE (GATT) ESTABLISHED IN 1947

To liberalize trade by eliminating tariffs, subsidies, import quotas, etc. Uruguay round lasted for 1986-1993

Multilateral tariff reduction rounds (from post-war 40% to current 4%).

Kennedy (60s), Tokyo (70s), Uruguay (86-94), …

Tariff reductions phased in after each round concludes.

Establishes rules that member countries must obey.

Settles disputes over implementation of rules. 

- many rounds of GATT have resulted in substantial reduction in tariffs between 1947 and 1994, resulting in good world economic growth during this period

- GATT was recently replaced by the World Trade Organization (WTO) which will implement the GATT agreement ratified by 117 countries

- GATT covers manufactured goods and commodities

- These GATT agreements are being extended by WTO to cover services (e.g. finance/banking), intellectual property (e.g. copyrights, patents and technology trade). This is important because the shares of services and intellectual property in international trade are rapidly increasing

- Current issues at WTO include:

IPR on software, recorded music and related products;

environment: WTO is responsible for the cost of environmental protection when international trade is involved

 

- Should Canada pay for the pollution control equipment in China, if pollution results from production of Canada-bound goods in China?

 

There is considerable empirical evidence for the following:the amount of international trade increases as the amount of tariff protection decreases

GATT, WTO, FTA between Canada and the U.S., NAFTA, and EU, among others, have contributed to the significant reduction in the trade barriers globally or in specific regions.

See the following figures.

Thanks to the GATT/WTO:

 - Despite the multilateral WTO / GATT agreement on trade, bilateral agreements or unilateral trade sanctions are NOT uncommon -U.S. Super 301 = a clause in U.S.Tariff legislation permitting U.S.Trade negotiators to threaten more restrictive import regulations to get other countries to lower their restrictions against U.S.- Made products or services 

IMPLICATIONS FOR BUSINESS FIRMS

 - know the rules on tariffs, etc. for your products fully - intelligent decisions on participating in domestic protectionists movements and lobbying

- request your government for establishing new tariffs, the local content requirement, VER, ...to protect your business (???) -the economics of IB should include the additional trade costs of visible and invisible barriers given above

-these costs will all increase the cost of IB, particularly for the foreign exporters and also the domestic buyers of the affected imported foreign goods

-In some cases cultural similarity may reduce the negative effect on trade of physical distance (recall the “country similarity theory”) 

Summary of what we have discussed in this slide:

(i)costs of transportation, insurance, finance and spoilage e.g. FOB, CFR/CIF, … Also (*) Fij = G [(MiMj) / Dij] (Meaning, implications)

(ii)costs of crossing borders (clearing customs, tariffs, antidumping duties, countervailing duties,..). These costs are explained below.

I) VISIBLE BARRIERSA. tariff (duty): a specific tariff (duty), e.g. $5 tariff per barrel of oil; an ad valorem tariff (duty), e.g. 25% U.S. tariffs on imported light trucks from Japan in the 1980s and 1990s; special import measures (antidumping & countervailing duties, measures of safeguards)B. Subsidies to domestic producers in various formsC. quantity restrictions of imports: C1. import quotas; C2. voluntary export restraint (VER)D. local content requirement

II) INVISIBLE BARRIERS E. administrative policies: careful inspection, etc. to limit importsF. foreign business practices G. foreign culture

GENERAL LESSON LEARNED FROM THE TRADE WARS AROUND THE 1930S: “trade can stimulate economic activity.” This lesson lead to promotion of freer trade after World War II

GATT ESTABLISHED IN 1947: to liberalize trade by eliminating tariffs, subsidies, import quotas, etc.WTO recently replaced GATT

IMPLICATIONS FOR BUSINESS FIRMS

Optional reference below

30 April 2001

Text: Super 301, Special 301, Title VII Reports from USTR

The Bush administration has identified a number of unfair trade barriers in foreign countries and reissued a pledge to enforce trade agreements vigorously but has not initiated any new investigations that might lead to actions against governments responsible for the barriers. The occasion for the administration's announcements was the April 30 release by the Office of the U.S. Trade Representative (USTR) of the annual Super 301, Special 301 and Title VII reports.

First authorized by the 1988 Trade Act, Special 301 remains in force under that law while Super 301 and Title VII remain in force under a 1999 executive order, which expires this year.

Title VII aims to identify unfair trade barriers in government procurement. Super 301 aims to identify other unfair trade barriers. USTR could decide at any time to initiate investigations into any of these trade barriers under Section 301 of U.S. trade law. If a Section 301 dispute is not resolved bilaterally or in the World Trade Organization (WTO), then ultimately USTR could impose retaliatory trade sanctions.

The Super 301 report identified some unfair agricultural trade barriers, including non-transparent risk-assessment procedures for imports in Australia and safeguard actions in Japan on a wide range of products. It also listed agricultural export subsidies in Canada.

In the auto sector, the report identified barriers to U.S. exports in Japan and South Korea and barriers to investment in India, the Philippines and Malaysia. It also listed discriminatory retail store laws in the Philippines that require foreign retailers to source their inventory domestically.

The Title VII report identified discriminatory government procurement practices in the European Union (EU), Japan, Taiwan, Canada and Germany. On intellectual property, the Special 301 report identified significant concerns with the level of protection in 51 trading partners.

USTR placed the EU and 15 other trading partners on its Special 301 priority watch list, which entails a higher level of scrutiny. The 15 trading partners are: Argentina, Costa Rica, the Dominican Republic, Egypt, Hungary, India, Indonesia, Israel, South Korea, Lebanon, Malaysia, Philippines, Russia, Taiwan and Uruguay. New to the priority list in 2001 are Hungary, Indonesia, Lebanon, Philippines and Taiwan.

Dropped from the list this year are Greece, Guatemala, Italy, Peru, Poland and Turkey. In March USTR began a Section 301 investigation into the adequacy of Ukraine's intellectual property protection regime. "Together these reports underscore the Administration's strong commitment to ensuring that Americans reap the benefits of the trade agreements that we negotiate," U.S. Trade Representative Robert B. Zoellick said. Following is the text of a USTR press statement on the release of the reports and an executive summary of them:

The U.S. Super-301 law

The United States threatened to use S-301 to:

(1) increase the tariff by 100% on Japanese luxury car imports;

(2) impose trade sanctions against countries that do not adequately protect intellectual property;

(3) impose trade sanctions against India which had (has?) strict FDI regulations; …

Countries on the U.S. Super-301 list: many