If the exporter categorizes the product incorrectly, a common error, the importing country’s custom agent may reclassify the goods — often resulting in a higher duty rate. This could change the terms of the deal and cause the importer to reject it. Consequently, it is important that the exporter and banker understand the challenges, be familiar with the barriers to trade, and limit the risks from the beginning.

Tariff Barriers

Tariff barriers are taxes or duties levied on imports of foreign products. Originally, U.S. tariffs were established to provide revenue for the federal government, predating income or property taxes. Today, however, they are viewed differently. In effect, tariffs increase the product price which discourages its demand and thereby insulates, to a degree, domestic producers from foreign competition. Each country places higher tariffs on goods determined to be import sensitive.

The most common form of duty or tariff is the ad valorem: a tax assessed on merchandise value. If not specified, the duty or tariff applied is usually ad valorem. In many countries, ad valorem taxes are applied to the value of merchandise, plus the cost of insurance and freight. As a result, when issuing an invoice to the foreign buyer, it is important to itemize these individual costs.

In addition to ad valorem duties, other types exist. Specific duties are those charged by weight, volume, length or any other unit (e.g., charging 10 cents per square yard on fabric). If the duty is assessed by weight, it is important to know if the packaging weight is included in that figure. If so, packaging weight must be kept to a minimum. Compound duties call for both an ad valorem and a specific duty on the same product. Alternative duties are those in which the custom official calculates the ad valorem duty and the specific duty and applies whichever is higher.

Countries apply tariffs in different ways. In Mexico, for example, additional taxes are assessed on top of the duties. These include a processing fee and a value-added tax (VAT). The customs processing fee is similar to the U.S. customs user fee, also referred to as a merchandise processing fee. The VAT is similar to the Canadian Goods and Services Tax (GST). The United States does not assess a VAT. The following example illustrates how a 10 percent ad valorem duty and a customs processing fee are calculated, and their effect on the final U.S. exporter’s price to Mexico versus a local Mexican manufacturer’s price in the Mexican market. It is important to note that a Mexican customs processing fee is assessed on the cost, insurance and freight (CIF) value of the good. A national VAT of 15 percent is typically applied to the CIF value, duty and customs processing fee. In the past, Mexico has applied a VAT of 0 percent on basic foodstuffs, 6 percent on certain food items in specific regions, 20 percent on luxury goods and a general rate of 15 percent on all other goods.

The following compares the costs of U.S. exports to Mexico and Mexican domestic goods before and after tariffs:

  • Invoice value (including CIF on export): $ 10,000(U.S.), $ 10,000(Mexico)
  • Ad valorem duty (10%): $ 1,000 , n/a
  • Customs processing fee (.8%): $80, n/a
  • VAT (15%): $ 1,662, $ 1,500
  • Total cost: $ 12,742, $ 11,500

In addition to the above fees, an import processing fee, harbor tax, and other taxes, if assessed further, will increase the exporter’s costs. Also, it is wise to be careful when calculating the VAT, as the foreign customs service is likely to assess the VAT on top of the duty, effectively increasing the VAT rate.

Non-Tariff Barriers

Non-tariff barriers are often hidden, and are not necessarily quantifiable or measurable. They typically include quotas, boycotts, licenses, standards, local content requirements, restrictions on foreign investment, domestic government purchasing policies, exchange controls and subsidies. Non-tariff barriers often are used to inhibit the importation of products. In many sectors, it is predicted that environmental, labor, competitive policy and investment issues increasingly will be used in an abusive manner to discourage imports.

At a time when it appears that foreign government subsidies for industry are decreasing, assistance by other means may be increasing. According to Ron Brown, the late Secretary of the U.S. Department of Commerce, the Europeans, Japanese, and even the emerging markets are investing more and more of their resources to do battle with U.S. companies. In a sampling of about 200 overseas competitive projects tracked during an eight year period, it was estimated that U.S. firms lost approximately one-half of these due in part to government pressure — a hidden and non-quantifiable barrier to trade. And foreign governments may increase their efforts whenever they wish.

As a result, when calculating the total exporting costs, which is necessary to price a product, it is essential to consider the resources necessary to ensure that any non-tariff barriers applied to the exporter’s product are satisfied. If not, the exporter’s ability to perform may be adversely affected.

Quotas are a very common non-tariff barrier which are used extensively under the Multi-Fiber Arrangement (MFA). The importation of a product is limited to a specific quantity over a designated time period, usually a year. This method artificially stimulates consumption of the domestic substitute that may be more expensive and/or of lower quality. The domestically produced substitute becomes more attractive, preserving or attaining a greater share of the domestic market.

Three types of quotas exist: absolute quotas, tariff-rated quotas, and voluntary restraint agreements (VRAs). Absolute quotas effectively cut off further importation of a product into the host country when a specific quantity is reached. Quotas may apply to imports from all countries or certain countries. Tariff-rated quotas allow for a specific quantity of a product to be imported at a reduced duty rate. Once this quantity is reached, a higher duty becomes applicable. VRAs are informal bilateral or multilateral agreements in which exporting countries voluntarily limit the quantity of exports of a certain product to a particular country. This avoids the imposition of import restrictions, but effectively acts as a quota.

Government or industry boycotts against imports from particular countries have been implemented for political or economic reasons. For example, U.S. imports from Cuba are banned on political grounds; in the 1980s, the U.S. steel industry urged users to purchase domestic steel products and terminate imports. Licenses are required by importers in many countries prior to product importation. In the past, Mexico maintained license requirements on virtually every product; however, with the advent of the North American Free Trade Agreement (NAFTA), these demands have been drastically reduced or eliminated.

Standards are used to ensure a degree of quality in accordance with national regulations, including standards to protect health, safety and product quality. However, they are sometimes used in an unduly stringent or discriminating way for the sole purpose of restricting trade. The United States, Canada and Mexico all require many foreign products to meet the requirements set forth by each country’s respective regulatory bodies. For example, foreign electrical equipment requires authorization from the U.S. Underwriters Laboratory (UL), Canadian Standards Association (CSA), and Norma Oficial Mexicana (NOM) of Mexico prior to its importation.

Local content requirements dictate that a product must embody a particular percentage of local material or components prior to its importation. For example, under NAFTA rules of origin, a minimum product content requirement must exist in order for the good to be considered of U.S., Canadian or Mexican origin and enter with free trade status. If this content level is not obtained, the product normally will be allowed entry under a higher duty applicable to the newly defined country of origin.

Many countries inherently favor domestic suppliers over foreign suppliers. “Buy domestic” policies have been prevalent in many countries for years. In fact, as previously noted, in a sampling of about 200 overseas competitive projects tracked during an eight year period, it is estimated that U.S. firms lost approximately one-half of potential foreign contracts due partially to government pressure favoring non-foreign firms.

Subsidies are indirect forms of consideration granted by national governments to domestic producers for various reasons, which effectively enhance their product price competitiveness vis-à-vis foreign producers. Subsidies may be extended in the form of outright cash disbursements, reduced interest rates on bank loans, tax exemptions, preferential exchange rates, governmental contracts with special privileges, or any other form of favorable treatment.

The Case of Brazil

In some countries, the government may deny importers access to foreign currencies, effectively creating a non-tariff barrier for the purpose of reducing imports. Thus, when a country experiences either a temporary or prolonged severe balance of trade problems, its government has several options to remedy the situation. Three very effective measures include a gradual or abrupt devaluation of the currency in order to make imports more expensive, the tightening up on the issuance of import licenses, or the raising of duties. Brazil, which had been experiencing imbalances in its external trade for some time, decided on a different course of action. In an attempt to restrict Brazilian imports, in March 1997, the Brazilian government implemented measures that required Brazilian importers to provide advance payment for imports financed on credit terms of 360 days or less. Shipments to Brazilian importers on terms of up to 180 days required full payment in local currency upon arrival of the goods. Shipments on credit terms from 181 days to 360 days were required to be paid in local currency to a designated commercial bank 180 days prior to the instrument’s maturity date. At that time, a foreign exchange contract would be issued and foreign currency would be made available to pay the foreign creditor on the due date. Exemptions to these regulations included imports with repayment terms in excess of 360 days, oil imports, oil by-products, and imports valued at less than $10,000.

As a result, it was assumed that most Brazilian importers would have to come up with cash in advance. To achieve this, they likely would have to borrow from local Brazilian banks — an unlikely scenario for most Brazilian importers since local financing costs were often prohibitive.

The Impact of Trade Barriers

As foreign markets are liberalized, allowing firms to export more goods and services, domestic markets generally incur greater foreign competition. As this occurs, the tendency to protect an industry becomes heightened. Although this is beneficial in some instances for certain periods of time, numerous studies have indicated that this approach does have severe negative consequences.

Commenting on a report released in August 1993 by the General Agreement on Tariffs and Trade (GATT) depicting the true costs to consumers of protectionism, Peter Sutherland, former Director General of GATT, stated, “It is high time that governments made clear to consumers just how much they pay — in the shops and as taxpayers — for decisions to protect domestic industries from import competition. Virtually all protection means higher prices. And someone has to pay; either the consumer or, in the case of intermediate goods, another producer. The result is a drop in real income and an inability to buy other products and services.”

Mr. Sutherland continued, “Maybe consumers would feel better about paying higher prices if they could be assured it was an effective way of maintaining employment. Unfortunately, the reality is that the cost of saving a job, in terms of higher prices and taxes, is frequently far higher than the wage paid to the workers concerned. In the end, in any case, the job often disappears as the protected companies either introduce new labor-saving technology or become less competitive. A far better approach would be to use the money to pay adjustment costs, like retraining programs and the provision of infrastructure.”

To a large extent, the U.S. textile and apparel industry has been protected on a global basis by the Multi-Fiber Arrangement (MFA). Now being phased out, the MFA established quotas on behalf of industrialized countries and directed against textile and apparel exports from developing countries. The Institute for International Economics estimated that in 1986, the MFA raised textile and apparel costs in the United States by an average of 28 percent and 53 percent, respectively, with annual consumer losses of $2.8 billion and $17.6 billion. The net welfare cost to the nation, after subtracting the benefits to producers and workers, exceeded $8 billion. The consumer costs to maintain each U.S. textile and apparel manufacturing job, the study contended, were $135,000 and $82,000, respectively. As a result, the lowest 20 percent of U.S. households, ranked according to income, experienced a decline of 3.6 percent in their standard of living.

According to the GATT report released in August 1993, studies conducted during the 1980s indicated that protection costs a four-person household an additional $200-$420 per year in the United States, $130 per year in the U.K. and $220 per year in Canada.

Many leaders of industry and scholars alike have argued that even if protectionism were implemented to a greater extent, low technology jobs would still disappear. Robert Reich, former U.S. Secretary of Labor, stated that “Even if millions of workers in developing nations were not eager to do these jobs [low-technology jobs] at a fraction of the wages of U.S. workers, such jobs would still be vanishing. Domestic competition would drive companies to cut costs by installing robots, computer integrated manufacturing systems, or other means of replacing the work of unskilled Americans with machinery that can be programmed to do much the same thing.”

This appeared as Chapter Six in the book Trade and Finance For Lenders, 1999.

John Manzella
About The Author John Manzella [Full Bio]
John Manzella, founder of the ManzellaReport.com, is a world-recognized speaker, author of several books, and a nationally syndicated columnist on global business, trade policy, and economic trends. His latest book is Global America: Understanding Global and Economic Trends and How To Ensure Competitiveness.

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