Tariffs in global business: concept, processes, and case examples.
This manuscript examines the concept and processes of tariffs in global business. In the flowing sections is a review of the market-entry literature, an examination of purposes and types of tariffs, a critical analysis of four case examples of tariffs in global business involving the steel, lumber, automobile, and textile industries, and a discussion of the use of foreign trade zones in managing a firm's tariff exposure. The manuscript features a comprehensive literature review that may be of value to global business practitioners and researchers.
After a month at sea in a container aboard a cargo ship, a product lands at a port in a host country. Then begins the process of moving the product through the various host-country governmental offices related to country entry and customs. Priced conservatively on export from its home country, the product must be competitive in the host-country market. A recent market research study indicates that the host-country promises to be a profitable market for the exporting firm, but it is a price-sensitive market and the product's price, therefore, must be competitive with local products.
The market-entry process moves smoothly at the port. The firm's host-country distributor adroitly handles the documentation for country entry. All is going well with the processing activities at the port until the host-country government levies a tariff of 60% on the specific product type and country-of-origin locale of the product imported to the host country. At the imposition of the tariff, the landed cost of the product increases from (X) in host-country currency to [(X) + 0.60(X)]. At a tariff-imputed landed cost of [(X) + 0.60(X)], the product likely will not be competitive, particularly in the host country's price-sensitive market.
The opening vignette typifies an unfortunate experience of some managers in international market-entry transactions. A foreign market is selected, a product is shipped, and upon arrival a higher than anticipated tariff is levied. While it is possible to request "advanced tariff classification" from a country to which a product is being exported to know the likely amount of tariff beforehand, tariff schedules in a host country sometimes will change without prior notification. The change more often than not is an increase in tariff. This results in the landed cost of a product increasing significantly as the result of an increase in tariff, thereby affecting a product's price competitiveness within a host-country market.
Nations affect market-entry behaviors of home-country firms seeking entry to host-country markets through trade policies, the mix of national customs, laws, procedures, rules, and tariffs that govern international trade (Strange, 1988; Behrman & Grosse, 1990; Brewer, 1993; Shleifer & Vishny, 1994; Aswicahyono & Hill, 1995; Loree & Guisinger, 1995; Markusen, 1995; Braunerhjelm & Svensson, 1996; Barrell & Paine, 1997; Kehoe, 1998, Rugman & Verbeke, 1998; Globerman & Shapiro, 1999; Editorial, 2003; Cellich & Jain, 2004; Kahn, 2004; Kehoe, 2004, Griffin & Pustay, 2005). In addition to trade policies, market-entry behavior is influenced by variables such as the market-entry decision processes and managerial motivations at work in a firm, a firm's level of export intensity, the interplay of host-country culture and market-entry processes, and the international experiences of a firm's management.
The actions of governmental and non-governmental institutions impact the market-entry decision processes and affect a firm's market-entry strategies. For example, market-entry policies and rules (e.g., tariffs and quotas) within a host country drive decisions whether to ship a product in complete form to a host county or to ship in component parts for assembly within the country.
Similarly, country-of-origin policies of a host country affect decisions whether or not to ship directly from home to a host country or to transship through another country. Literature describing and modeling these and other considerations in the market-entry decision process is complex and robust. Among the more interesting research about managing market-entry decision processes of multinational firms are articles and books by Tookey (1964), Kindleberger (1969), Horst, (1972), Stopford and Wells (1972), Hymer (1976), Johanson and Vahlne (1977), Killing (1983), Root (1983) Thomas and Araujo (1985), Beamish and Banks, 1987; Gomes-Casseres (1987), Roehl and Truitt (1987), Kogut (1988), Anderson and Narus (1990), Kim and Hwang (1992), Lei and Slocum (1992), Erramilli and Rao (1993), Haverman (1993), Parkhe (1993), Smith and Zeithaml (1993), Inkpen and Birkenshaw (1994), Dalli (1995), Li (1995), Buckley (1996), Duffy (1996), Quelch and Klein (1996), Gomes-Casseres (1997), Buckley and Casson (1998a), Buckley and Casson (1998b), Davis, Desai and Francis (2000), Pan and Tse (2000), Meyer and Estrin (2001), Leonidou, Katsikeas and Samiee (2002), Muralidharan (2003), Harris (2004), Oum, Park, Kim and Yu (2004).
Market-Entry Decision Processes and Managerial Motivations
While describing and modeling market-entry decision processes is interesting, at a deeper level of abstraction is a need to understand the motivations of managers for entering the international business arena. Horst (1972), Grubaugh (1987), Zitta and Powers (2003) and Samli (2004) suggest that managers enter host-country markets seeking growth, profits, technology enhancement, and to satisfy a desire for a global presence. Doukas and Lang (2003) posit a need for diversification as a managerial driver of foreign direct investment, while Hejazi and Pauly (2003) argue that domestic capital formation is a significant motivator of international market entry. Muralidharan (2003) suggests the exploitation of "arbitrage opportunities in product, financial and other resources markets that may exist across various country operations" motivates international market entry decisions. Claggett and Stutzman (2003) posit managers move to international diversification in order to increase revenues and to lower volatility, thereby enhancing overall firm performance. Bruner (2004) says managers seek to increase returns, reduce risks, or both in entering foreign markets. Tyson (2004) suggests managers seek "low-wage production platforms" to serve domestic and global markets as a motivation for international-market entry. Wilson (1980), Yip (1982), Woodcock, Beamish and Makino (1994), and Uhlenbruck (2004) explore international market entry through a lens of acquired foreign subsidiaries. Knight and Cavusgil (2004) argue that managers in some firms aspire to be a "born-global firm" by entering foreign markets at or near to a firm's founding.
In addition to understanding managerial motivations for engaging in international business, another interesting area of literature focuses on describing the control of an international-market entry. Initially of a descriptive nature, but of late more empirically based, the control-related literature is rich in content and managerially relevant. It includes research by scholars such as Kindleberger (1969), Dunning (1981), Davidson (1982), Root (1983), Jain (1989), Yip (1992), Dunning (1993), Root (1994), Bengtsson (1998), Cheng and Kwan (2000), Keegan and Green (2000), Dunning (2003), Kim, Park and Prescott (2003); Safarian (2003), Sundaramurthy and Lewis (2003), Choi and Beamish (2004), and Samli (2004). Particularly managerially relevant is an Import Handbook by Feinschreiber and Crowley (1997). Focusing primarily on importing to the United States, the book is a useful resource about importing to any country as well as exporting.
Market-Entry and Export Intensity
A subset of studying reasons for market entry involves developing an understanding of the drivers of export intensity. Among determinants of export intensity are such factors as the relationship of export intensity to firm size and governance structure (Kaynak & Kothari, 1984; Beamish & Munro, 1986; Miesenbock, 1988; Namiki, 1988; Cuplan, 1989; Holzmuller & Kasper, 1991; Bonaccorsi, 1992; Chetty & Hamilton, 1993; Filatotchev, Dyomina, Wright & Buck, 2001; Samli, 2004). A desire to achieve first mover advantages (Lieberman & Montgomery, 1988; Quelch & Deshpande, 2004; Samli, 2004; Griffin & Pustay, 2005) also affects export intensity, as does a manager's ability to marshal the appropriate resources required for market entry (Madsen, 1989; Louter, Ouwerkerk & Bakker, 1991; Chang, 1995; Aulakh, Kotabe & Teegen, 2000; Samli, 2004). Likewise affecting export intensity are prior international experiences, motivation, orientation and skills of management (Johnston & Czinkota, 1982; Levitt, 1983; Welsh & Luostarinen, 1988; Aaby & Slater, 1989; Dichtl, Koeglmayr & Mueller, 1990; Andersson & Svensson, 1994; Leonidou, Katsikeas & Piercy, 1998; Quelch & Deshpande, 2004; Samli, 2004).
Characteristics of a product, a brand's global reputation, and the channels of distribution in use all impact export intensity (McGuinness & Little, 1981; Anderson & Coughlan, 1987; Peng & Ilinitch, 1998; Anderson & Narus, 1990; Steenkamp, Batra & Alden, 2003; Johansson & Ronkainen, 2004; Quelch & Deshpande, 2004). Home-country location relative to host-country markets (Davidson, 1980; Caves & Mehra, 1986; Agarwal & Ramaswamy, 1991; Aulakh, Kotabe & Sahay, 1996; Gwin & Kehoe, 1999; Jeannet & Hennessey, 2004; Samli, 2004) affects export intensity through the availability and quality of global logistics resources. Finally, such micro managerial aspect as pricing in international markets (Piercy, 1981a; Samiee & Anckar, 1998; Griffin& Pustay, 2005), buyer and seller relationships (Egan & Mody, 1992; Dyer, 1996; Piercy, Katsikeas & Cravens, 1997; Peng & Ilinitch, 1998; Peng & York, 2001), and transaction cost (Anderson & Gatigon, 1986; Erramilli & Rao, 1993; Kahn, 2004) affect export intensity.
Culture and Market Entry
An interesting and well-conceptualized literature concerns culture and market entry. Part of the literature is descriptive in nature as typified by the work of Kluckhohn and Strodtbeck, 1961; Converse, 1972; Hofstede, 1980; Redding, 1980; Hamilton and Biggart, 1988; Kogut and Singh, 1988; Clark, 1990; Kanungo, 1990; Kale and McIntyre, 1991; Shane, 1992; Shane, 1994; Barkema, Bell and Pennings, 1996; Meschi, 1997; Thomas and Mueller, 2000; Gannon, 2001; and Ferraro, 2002. Another aspect of the literature is pragmatic and perhaps more managerially relevant. That literature seeks to analyze the impact of cultural distance in the market-entry decision. Evidence suggests that as perceptions of country risk and cultural distance increase, managers are less likely to use wholly-owned approaches to market entry, rather instead to use strategic alliances and joint ventures so as to dampen the country risk and cultural distance factors (Agarwal, 1994; Sutcliffe and Zaheer, 1998; Brouthers and Brouthers, 2001; Oum, Park, Kim and Yu, 2004).
The depth and variety of international experiences of management arguably influence a firm's approach to international market entry (Pavord & Bogart, 1975; Piercy, 1981b; Welsh & Luostarinen, 1988; Andersen, 1993; Leonidou & Katsikeas, 1996; Leonidou, 1998; Samli, 2004). These experiences impact such factors as the need for collaboration (Kogut 1989; Ring & Van de Ven, 1992; Dyer, 1997; Sundaramurthy & Lewis, 2003; Griffin & Pustay, 2005), for control (Gupta & Govindrajan, 1991; Sohn, 1994; Fladmoe-Lindquist & Jaque, 1995), for flexibility (Kogut, 1985; Cellich & Jain, 2004), and for trust (Geringer, 1991; Sako, 1992; Sako & Helper, 1997; Zaheer, McEvily & Perrone, 1998) in an international market-entry venture.
CONCEPT AND TYPES OF TARIFFS
Winston Churchill reportedly understood the power of tariffs. At the conclusion of an international visit, he advised his hosts as follows. "You young gentlemen have entertained me royally, and in return I will give you a priceless secret. Tariffs! These are the politics of the future, and of the near future. Study them closely and make yourselves masters of them, and your will not regret your hospitality to me." (Churchill, 1902)
A tariff is a tool used by government to affect market-entry behavior. It is the most common type of governmental control imposed on global trade (Daniels, Radebaugh & Sullivan, 2002; Samli, 2004). Tariffs are part of a government's trade-control infrastructure (Globerman & Shapiro, 2003), the mix of institutions, laws, policies, procedures, and regulations that impact on global trade operations. Tariffs and other trade controls signal the extent of market openness in a host-country market and thereby influence investment decisions of global firms. Nations uses tariffs to discourage imports to the country, to protect home-country industries, to penalize other counties for imposing tariffs on a home-country's products, to penalize other countries not aligned politically with a home country, and to generate revenues for the home country (Lascu, 2003).
A nation may levy a tariff as an export tariff when a product leaves its home country, levy as a transit tariff when a product passes through a country enroute to its destination, or levy as an import tariff when a product enters a host-county. The United States constitutionally prohibits export tariffs (Jeannet & Hennessey, 2004), while other countries allow them. The use of import tariffs is routine in international trade and, as such, this research focuses particularly on import tariffs.
An import tariff, simply described, is a tax. It is a tax or customs duty imposed on goods crossing international boundaries from a country-of-origin to host-country markets (Horst, 1971; Brewer, 1993; Daniels, Radebaugh & Sullivan, 2002; Jeannet & Hennessey, 2004; Griffin & Pustay, 2005). An import tariff is applied either as a specific amount of host-country currency per unit of product imported to a host-country (i.e., a specific tariff) or as a percentage of value of an imported good (i.e., an ad valorem tariff).
A nation may levy an import tariff as a specific tariff as a specific amount of host-country currency per unit based either on weight of a product, volume, cubic dimensions, length, height, or other measures decided by the country to which the product is being imported. An example is a nation levying a specific tariff as so many importing-country currency units per pound, or per liter, or per linear foot, or per pair. On importing a liquid product to the United Kingdom, a specific tariff might be 2.00 [pounds sterling] per liter. On importing lumber, a specific tariff might be 0.85 [pounds sterling] per board foot of lumber. If footwear, a specific tariff might be expressed at 4.00 [pounds sterling] per pair of shoes. In each of these examples, the tariff is a specific amount of host-country currency per unit of product.
Specific tariffs often disproportionably restrict importation of inexpensive products as opposed to relatively more expensive products. For example, if the cost of a pair of shoes landed on a dock in a host country is 25 [pounds sterling]/pair, a 4 [pounds sterling]/pair tariff has a greater import restrictive impact than if the landed cost is 150 [pounds sterling]/pair of shoes. A public policy implication for a host-country government to consider is that a specific tariff often restricts products less expensive, rather than those that are more expensive. If the policy goal is to restrict less expensive imports, a specific tariff is appropriate. If this is not a policy goal, a host-country government may want to consider a different approach to tariffs, possibly an ad valorem tariff.
Ad Valorem Tariff
A nation levies an import tariff as an ad valorem tariff on the landed cost of a product--that is, levies on a product's landed CIF basis (Cost, Insurance and Freight) at a port of entry. An example is levying a 60% ad valorem tariff on a product whose landed CIF cost basis (X) in the United Kingdom is 480 [pounds sterling]. That product will have a tariff-imputed landed cost basis of [(X) + 0.60(X)] or [(480 [pounds sterling]) + 0.60(480 [pounds sterling])] or 768.00 [pounds sterling]. Hence, in this example, a product with a CIF landed cost basis of 480 [pounds sterling] upon entering a host country, leaves the port of entry with a cost basis of 768 [pounds sterling]. At the tariff-imputed landed cost of [(X) + 0.60(X)], such a product may not be competitive in a host-country market, particularly, as in the case of the opening vignette, if host-country consumers are price sensitive.
A compound tariff is both ad valorum and specific in its configuration. For example, levying a shipment of imported liquor at a $3.00/liter specific tariff and a 10% ad valorum tariff is a compound tariff. If the shipment contains 10,000 one-liter bottles at a landed CIF cost basis of $25.00/liter, the compound tariff is the specific tariff plus the ad valorum tariff or [(10,000 one-liter bottles x $3.00/liter) + (10,000 one-liter bottles x $25.00/liter x 10%)] = [$30,000 + $25,000] = $55,000 compound tariff.
PURPOSES OF TARIFFS
Among the purposes of tariffs are being protective and/or revenue generative. If a 60% ad valorem tariff has as its purpose to keep a product out of a country, the tariff is a protective tariff. If a tariff's primary purpose is to generate tax revenue for a country, it is a revenue tariff. In many cases, a tariff will have both protective and revenue objectives.
A protective tariff generally is levied at a higher rate than is a revenue tariff. The reason is that a protective tariff is designed to protect a country's domestic products and industries and, therefore, will be of a relatively high magnitude to make prices of imported products noncompetitive against domestic products. An important policy question for government is how high should be a protective tariff? The answer is that it depends whether a host-country government is seeking a partial or a complete restriction of imports of a particular product. The determination of the type of restriction, whether a partial or a complete restriction, often is a function of the amount of pressure brought on a government by domestic industry.
For example, the U.S. steel industry lobbied the U.S. government for a protective tariff against imported steel. The pressure intensified given that 27 U.S. steel manufacturers went bankrupt since 1997, including the third and fourth largest U. S. steel manufacturers (Kahn, 2001; Matthews, 2001a; Matthews 2001b; Berner, 2002; Arndt, 2003). This situation brought pressure from industry on government to enact a protective tariff and to do so at a level approaching a complete restriction of steel imports.
A country generally levies a revenue tariff at a lower rate than a protective tariff. Levying at a lower rate does not keep a product out of a country, but allows entry to apply and collect the tariff. Keeping a tariff relatively low maximizes collection of tax. Government seeks to find a tariff's point of elasticity in order to maximum tax revenue. Too high a revenue tariff will result in loss of tax revenue due to a reduction in imports. Conversely, a revenue tariff set too low also results in loss of tax revenue because the tariff is too low to generate acceptable tax revenues. The policy issue for a government regarding a revenue tariff is to discover the point of elasticity where a tariff is not too high or too low, thereby maximizing revenue.
Whether a tariff is primarily protective or primarily revenue in its objective, its classification may be a single-column tariff or a two-column tariff. Under a single-column tariff schedule, a country levies the same duty on a product no matter its country-of-origin, while a double-column schedule allows differential tariffs rates on imports of the same product from different countries. Countries develop two-column tariff rates through bilateral negotiations. A particularly interesting type of a two-column tariff regime is a preferential tariff in a free trade area, a customs union, or a common market. For example, countries in a common market may reduce tariffs against each other by using a double-column schedule, while maintaining higher tariffs, through a single-column schedule, against countries not members of the common market.
ENABLING LEGISLATION FOR U.S. TARIFFS
The United States Department of Commerce and the U. S. International Trade Commission administer tariffs. Enabling legislation is in the Tariff Act of 1930, particularly in Section 337 prohibiting unfair methods of competition by importers to the United States if the effect of the competition is to injure substantially or to destroy a domestic industry (Keegan & Green, 2000). Other enabling legislation is in the Trade Expansion Act of 1962, the Trade Act of 1974, the Trade and Tariff Act of 1984, the Omnibus Trade and Competitiveness Act of 1988, and the Trade Act of 2002. The Trade Act of 2002 reestablished fast-track authority under which Congress either votes to approve or to disapprove proposed trade agreements without amending them (Czinkota & Ronkainen, 2004). The Trade Act of 2002 also includes (Zoellick, 2002) "a large, immediate downpayment on open trade for the neediest (countries), cutting tariffs to zero for an estimated $20 billion in American imports from the developing world."
The U. S. International Trade Commission (USITC, 2004), created in 1916, is an independent federal agency charged broadly with monitoring international trade and tariffs. Comprised of six Commissioners appointed by the President, the Commission oversees all aspects of international trade policies of the United States, including investigating complaints of unfair trade practices and monitoring the impact of imports on domestic businesses. The Commission holds public hearings, engages in research on trade practices, publishes tariff summaries, and administers the Harmonized System (2004) of three classification codes for goods and services in international trade. The three codes include:
* U. S. Standard Industrial Classification (SIC), a code classifying goods and services.
* United Nation's Standard Industrial Trade Classification (SITC), a code developed by the United Nations for products shipped in international commerce.
* Harmonized System (HS) Commodity Number, a ten-digit code entered on a Shipper's Export Declaration for any shipment greater than US$2500 in value. Also called a Schedule B number (its earlier name), a HS number enables an exporter to identify the type and amount of any tariff levied on a product category in a host country. Another use of a Shipper's Export Declaration with a HS number is to track exports and compile export data.
Four cases elucidate the use of tariffs in global business. In the first case, the U. S. steel industry lobbies for tariff protection against steel imports from other countries. The second case finds the United States applying a tariff against lumber from Canada. In the third case, the United States relaxes tariffs levied against automobiles imported from South Africa. The fourth case involves the U. S. textile industry seeking additional tariff protection. The significance of the first and second cases is that to date these are the only industries (steel and lumber) in which the Bush administration has levied tariffs against imports. The third case demonstrates the impact of a tariff reduction on corporate growth and profits. The final case is about an industry in distress and its need for tariff relief.
Tariff On Steel
With bankruptcy of 27 manufacturers since 1997, including the third and fourth largest manufacturers (Kahn, 2001; Matthews, 2001a; Matthews 2001b; Berner, 2002; Matthews, 2002; Arndt, 2003; Loomis, 2004), the U.S. steel industry reacted by lobbying for a tariff as high as 50% on imported steel. The industry estimated that a 50% tariff would improve industry profits by approximately $10 billion (Kahn, 2001; Matthews, 2001c; Magnusson, 2002a; Czinkota & Ronkainen, 2004). The U. S. International Trade Commission did not support a 50% tariff, but recommended tariffs of 5% to 40% on 16 imported steel product lines (Kahn, 2001; Pearlstein, 2001; Czinkota & Ronkainen, 2004).
While the U. S. International Trade Commission supported a tariff on steel, others argued it is not necessary and would only prolong problems in the industry. Barro (2002) typifies the arguments against steel tariffs in pointing out that "since 1950, Big Steel has been reluctant to make the investments needed to match the new technologies introduced elsewhere. It was slow to replace open-hearth furnaces with basic oxygen furnaces and was late in introducing continuous casting. Big Steel also acquiesced to high wages for its unionized labor force. Hence, the companies have difficulty competing not only with more efficient producers in Asia and Europe but also with technologically advanced U.S. mini-mills."
On March 5, 2002, President Bush, acting on the unanimous recommendation of the U.S. International Trade Commission, authorized a three-year regime of tariffs ranging from 8 to 30% on a variety of imported steel (Allen & Pearlstein, 2002; Magnusson, 2002a; Pearlstein, 2002; Will, 2002; Czinkota & Ronkainen, 2004). These tariffs will impact approximately U.S.$ 8 billion of imported steel originating from Europe, Japan and South Korea or about 10% of the world market for steel (Economist Article, 2002a, 2002b, 2002c).
Arguably, a tariff on imported steel offers protection to the industry and may preserve jobs. Additionally, because steel is a basic industry, national defense considerations arise. So too do domestic political considerations arise. In the muck of politics lies a reality that as many as six seats in the U. S. House of Representatives were from areas in which steel mills might cease operating without the benefit of tariff protection (Blustein, Kessler & Phillips, 2002; Will, 2002). For all of these reasons, the United States levied a tariff on imported steel on March 5, 2002. The steel tariff has benefits and cost, as does any tariff. The public-policy calculus in a tariff decision involves ensuring the benefits outweigh the cost.
In an analysis of the potential cost to consumers of a 20% tariff on imported steel, Hufbauer (2001) found that a 20% tariff on imported steel would cost consumers about $7.0 billion in increased prices over a four-year period. Other economists predict that domestic prices of products containing steel may increase by 6% to 8% in the first year of the tariff (Czinkota & Ronkainen, 2004). The benefits rest largely in the number of jobs saved in the steel industry, which Hufbauer (2001) estimates as approximately 7,300 jobs, at a cost to American consumers of $326,000 for each job saved.
Other important factors in public-policy calculus is an evaluation of potential retaliatory responses by other nations (Economist Article, 2002a; Kantor, 2002, Magnusson, 2002a, 2002b; Powell, 2002) and consideration of the impact of a tariff on a nation's global status (Matthews & King, 2002; Stevenson, 2002; Zoellick 2002). In the case of the steel tariff, the United States expected a retaliatory response from several nations. To offset a retaliatory response, the United States made diplomatic initiatives toward Brazil (Krugman, 2002), Canada (Baglole, 2002), China (Krugman, 2002; Wonacott, 2002), the European Union (Matthews, 2001c; Blustein, 2002; Winestock, 2002), Japan (Krugman, 2002; Zaun, 2002), and South Korea (Krugman, 2002).
Despite ongoing diplomatic initiatives, other nations did not well tolerate the steel tariff, particularly the European Union nations. When the World Trade Organization sided with an EU complaint and ruled the steel tariff illegal, the EU announced plans to impose more than $2 billion of tariffs on U.S. imports unless the steel tariff was rescinded (Becker, 2003a). If the U.S. ignored the WTO ruling and maintained its steel tariff, it would have to accept over $2 billion in European sanctions, in addition to possible sanctions by China, Japan, and South Korea (Becker, 2003b; King & Tejada, 2003).
Organized labor, as might be expected, did not support lifting the steel tariff, no matter the EU objections and the WTO ruling. In a letter to President Bush, AFL-CIO President John J. Sweeney (2003) argued for the tariff as follows: "A report issued by the International Trade Commission in September validates the effectiveness of the tariffs. Bankruptcies and layoffs in the domestic steel industry have slowed. Steel prices have stabilized and many domestic producers are returning to profitability. The steel industry is in the midst of a major consolidation and restructuring. Labor unions and steel companies have negotiated agreements to reduce costs, improve productivity and profitability, and help facilitate industry consolidation. The costs to steel consumers have been largely negligible. Steelworkers and steel companies are doing what you asked them to do in 2002--make painful decisions to increase their competitiveness. Now is not the time to pull the rug from under their feet, setting back these efforts that have so far been successful. Bowing to international pressure from the World Trade Organization, the European Union, and Japan to end the tariffs would send a disturbing signal that the United States is unwilling to defend its domestic workers and industries besieged by heavily subsidized foreign competitors. America's working families are fighting for their economic survival. Manufacturing employment is at its lowest point in over forty years. I urge you not to alter the steel tariffs. Doing so would only hinder the recovery of the steel industry, which is so vital to our economic future and our national security."
Despite objections by organized labor, President Bush lifted the steel tariff in early December 2003. The administration argued that the tariff achieved its purpose as a temporary trade restriction to assist the steel industry while consolidating in the face of aggressive foreign competition. The EU withdrew its threat of retaliatory tariffs after the announcement of lifting the steel tariff (Koff & Krouse, 2003; Stevenson, 2003).
Tariff on Lumber
Perhaps not as controversial as the steel tariff, another tariff emerged as the result of industry pressure. U.S. timber companies argued that Canada's provincial governments unfairly subsidized logging and production processes, resulting in artificially low prices for exported lumber, with Canadian timber companies allegedly paying as much as 60% less for standing trees than U.S. lumber companies. Because of industry pressure, the U.S. government in August 2001 levied a temporary 19.3% tariff on Canadian softwood lumber, a lumber used primarily in home construction (Crutsinger, 2001). Then, in March 2002, the government announced an intention to increase to a 29% tariff. That tariff adds about $1500 to the construction cost a typical new home (Economist Article, 2002d).
On June 3, 2004, after reviewing lumber shipments between the time of the initial levy and March 31, 2003, the Commerce Department proposed cutting the tariff from its current 27.2% to 13.2%. The decision has no immediate impact because the Commerce Department will not make a final ruling until it completes its final review in December 2004. Canadian officials welcomed relief from what they term punitive duties averaging 27.2%. The Commerce Department emphasized that the recommendation is preliminary and reflect a change in the methodology in setting tariff rates. The Commerce Department still holds that tariffs are necessary to counter Canadian government subsidies of softwood lumber (Editorial, 2004). The Coalition for Fair Lumber Imports commented that the methodology used by Commerce "is way undervaluing timber across Canada" and objects to reducing the tariff rate. The development results from favorable rulings in Canada's legal challenges to the tariff before the WTO and a North American Free Trade Agreement appeal panel (Daly, 2004). The American Homeowners Grassroots Alliance (2004) opposes the lumber tariff and provides opposition information on its website, including its Congressional testimony opposing the tariff.
Tariff on Automobiles
Unlike the case example involving the steel industry, the situation in the automobile industry selected for examination is somewhat different. This case situation involves automobiles imported to the United States from South Africa. These automobiles now enter the U.S. duty-free, under a preferential trade agreement, the African Growth and Opportunity Act of 2001 (AGOA), to stimulate African economies (Itano, 2003).
Bavarian Motor Works (BMW) operates a factory in Rosslyn, South Africa that produces BMW 3 Series automobiles. Itano (2003) reports that of approximately 50,000 BMW 3 Series cars produced each year, 80 percent (40,000 cars/year) are for export, and 25,000 of these cars are destined for the United States. Prior to the 2001 AGOA trade agreement between the U.S. and South Africa, each automobile carried a 2.5% import tariff. The AGOA, in effect until 2008, enables automobiles imported from South Africa to enter the United States duty free.
Since the elimination of tariffs on automobiles from South Africa, BMW-South Africa quadrupled its business, with exports to the United States accounting for half of its business growth. Production at the BMW Rosslyn, South Africa plant in 2002 was 55,600 3 Series automobiles (BMW Annual Report, 2002), a significant increase of 43,600 automobiles above the 12,000 automobiles reportedly produced at the plant in 1998 (Itano, 2003). Firms enter host-country markets seeking business growth and profit (Dunning, 1973; Ajami and Ricks, 1981; Dunning, 1993; Gwin and Kehoe, 1999; Kehoe and Whitten, 1999; Zitta and Powers, 2003). BMW is no exception to these desires, with exports to the United States accounting for half of the business growth in its South African plant.
Tariff on Textiles
The textile industry, in a few words, is competitive and is distressed. Consumer prices of apparel products have fallen significantly in recent years. A study by the U. S. Department of Labor found consumer prices of apparel products decreased from a base index of $100 in 1993 to $74 in 2002 (Economist Article, 2003). A study by the consulting firm of A. T. Kearney reports a jacket retailing at $100 in 1992 is $68 in 2003 (Economist Article, 2003). Such retail price erosion obviously impacts negatively the revenue and profit of U. S. based textile firms.
Because of erosion in retail prices, retailers, as a result, demand lower prices from manufacturers, which, in turn, cause manufacturers to consider producing offshore (Ansberry, 2003). Such is the case with U. S. based textile firms, increasingly moving production offshore to low-wage host countries. Producing in a low-wage host country reduces the cost basis of the textile products and, as retail prices erode, enables textile firms to protect profit margins by lowering manufacturing cost. Another reaction to retail price erosion, as well as to an influx of low-cost import clothing, is an emergent increase in alliances and mergers in the textile industry as U.S. firms join forces to compete against low-cost (but often higher quality) imported textiles.
In addition to alliances and mergers, U.S. textile manufacturers are seeking additional tariff protection and import quotas, particularly against textile imports from China, the number one source of imported clothing, and Mexico, the number two source of clothing imports (Rushford, 2003). The American Textile Manufacturers Institute (ATMI, 2003) estimates 2.6 million U.S. manufacturing jobs, including almost 300,000 U.S. textile and apparel jobs, have been lost since January 2001. In July 2003, ATMI estimates 18,200 lost jobs, of which 4,800 were at the Pillowtex plant in North Carolina, the largest single job loss in the state's history. This situation may worsen when textile import quotas expire on December 31, 2004 (WSJ Report, 2003). ATMI predicts that expiration of textile quotas may result in a loss of 630,000 textile jobs by 2006.
ARGUMENTS FOR AND AGAINST TARIFFS
The four case studies presented above embed arguments against and arguments favoring tariffs. Compelling arguments are possible in either direction.
Making an argument for tariffs and accepting that a utopian world of no tariffs is unattainable, the reasons for tariffs are many. The arguments vary depending on the strength of the economies of the countries involved. Is the country a major economic power or a developing nation? The United States may argue, as in the case of the steel industry, that national defense demands the existence of a domestic steel industry. How could the U.S. be dependent on foreign steel for a vital need? This argument may not apply to a developing country struggling to maintain a quality of life for its citizens. That country may impose a tariff on an import that competes with local manufacturers in order to protect jobs, particularly if the local operation has inefficient processes and older production machinery. This machinery may be all that the local company can afford, it is the best they can do and it puts people to work. The local company cannot afford to compete in the global market. Rather, it is providing jobs and products and need protection from larger, well-financed, and technologically advanced global competitors.
An argument against tariffs posits that the world should strive for a true global economy and any country or company should be able to obtain goods and/or services from any available source regardless of country of location. Everything else equal (quality, delivery, etc.), acquisition of good and/or services would be from least-cost locations anywhere in the world. This argument benefits consumers with lower prices and potentially benefits the bottom line of a local company acquiring, manufacturing and selling the final product, for example, the textiles discussed previously. When using tariffs to protect an industry, e.g., steel, there can be a disincentive for a protected industry or company to improve operations, reduce cost and enhance efficiency. As put bluntly by Charles Powell (2002), the steel tariff is 'blatantly protectionist, as well as a setback for free trade and open markets. It won't save inefficient steel producers ... will only buy them more time to go on being inefficient." Given continued inefficiencies, savings, as a result, are not available to pass on to consumers and/or improve the bottom line of a company.
FOREIGN TRADE ZONES
In the opening vignette, a firm exports a product to a host-country that promises to be a profitable market for the exporting firm, but it is a price-sensitive market and the product's price, therefore, must be competitive with local products. When the product lands at the port, it receives a tariff of 60% based on its specific product type and country-of-origin locale. The tariff increases the landed cost of the product from (X) in host-country currency to [(X) + 0.60(X)]. At a tariff-imputed landed cost of [(X) + 0.60(X)], the product likely will not be competitive, particularly in the host country's price-sensitive market. What is a manager to do in facing such a situation?
The product is at the port, but with a cost basis of 60% more than anticipated. Among options for management's consideration are either withdraw the product back to its home country, ship the product to another country having no or lower tariffs, or stick it out in the initial host country by increasing marketing expenditures to support the product at its higher price. Likely, the product will remain in the initial host country, particularly if the product enters a Foreign Trade Zone area at the port of entry.
A Foreign Trade Zone (FTZ) is a secure site where goods receive preferential tariff treatment. It may be a site within a port of entry where imports are outside the jurisdiction of the host-country's Customs authority or it may be as large as an entire city, for example Shenzhen, China (FTZRC, 2004; Griffin and Pustay, 2005). Goods in a FTZ remain in international commerce while within the zone or until they depart the zone into the host-country market or exported from the host country to another country.
Using a Foreign Trade Zone provides financial and operating benefits for a firm, especially improved cash flow. This is because of a deferral of customs duties, tariffs, and taxes on products or materials while in a Foreign Trade Zone. In some situations, exporters ship a product unassembled into a host country, assemble into a final product within a FTZ, and thereby avoid a higher tariff than if the product entered the country in final form. To reduce tariffs even more, companies inspect products while in a FTZ and destroy or return any defective products to avoid paying a tariff on defective products. These activities all serve to delay and/or reduce a tariff and thereby improve a firm's cash flow. For other examples of benefits of a FTZ, see the Foreign Trade Zone Resource Center (FTZRC, 2004).
So, should the firm in the opening vignette pay the 60% tariff now or should management delay payment by using a FTZ? If the product enters a FTZ, payment of the tariff upon arrival at the dock is not required. Rather, entering a FTZ make it possible to delay paying the tariff and inspection, further processing, repackaging if necessary, and other activities to make the product ready for sale can be done. Only, when the product exits the FTZ is a tariff paid. The cash flow savings enable a firm to use the monies for marketing the product to enhance a firm's chances of successfully consummating the exchange process.
At its core, international business involves exchange. The concept of exchange (Bagozzi, 1975) implies freedom. Individuals have free access to information; products are free to move in a market, even to move freely across international boundaries. Indeed, freedom is at the core of globalization. Managers should be free to source production anywhere in the world in least-cost, high-quality venues and individuals should be free to purchase products from anywhere in the world. However, in reality, freedom in international business is constrained by the policies of governments, policies such as tariffs.
A tariff is a tax. Whether a specific tariff, in which a fixed amount of tax is levied on a product, or an ad valorem tariff, in which the tariff is a percentage of a product's value, a tariff increases the price of a product in host country currency from (X) to [(X) + tariff rate(X)]. Because a tariff yields a higher cost basis for an import, it, in theory, protects domestic industries and home-country jobs, as in the case of the steel tariff. However, as with the steel tariff, a tariff may provoke responses either in the form of an appeal to the World Trade Organization, or bilateral retaliatory tariffs, or a trade war. All of these things inhibit exchange and the free movement of goods in the global arena.
Many problems related to tariffs emerge from political incentive, resulting from addressing concerns of special interests. These concerns often result in protectionist tariffs. Is there possibly a middle ground for tariff legislation wherein a tariff can be set to create revenue, protect local jobs and industries, but not completely shut out foreign competition? Achieving the middle ground requires international open-minded cooperation. Pushing to protectionist extremes causes tariff problems and breakdowns in international trade and comity.
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William J. Kehoe, University of Virginia Lucien L. Bass, III, University of Virginia
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|Author:||Kehoe, William J.; Bass, Lucien L., III|
|Publication:||Journal of International Business Research|
|Date:||Jul 1, 2004|
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