ANNEX. Graphical Presentation of a Tariff Reduction
The first round effects of a tariff cut can be captured in a simple diagram where P represents the world price of an imported good, Q quantity, S a horizontal import supply curve, based on the assumption that a small importing countries (small markets) do not influence world prices, and D a downward sloping import demand curve to represent consumers response to changes in the domestic price of the imported good:49
The left hand side of the diagram highlights the initial situation before the tariff is cut from t0. The intersection with the demand curve of Q0 and P+t0 shows quantity demanded of the imported good at the domestic price (world price plus tariff). The triangle labeled CS0 represents consumer surplus50 while the triangle DWL0 shows dead weight welfare loss to the economy due to the tariff. TR0 represents initial tariff revenue. If the tariff is lowered to t1, as shown on the right hand side, the domestic price drops to P+t1 and quantity demanded increases to Q1. The distance Q0-Q1 along the horizontal axes represents trade creation . Importantly, the dead weight loss to the economy has decreased to DWL1 and consumer surplus has increased to CS1( triangle from top of demand curve to b to P+t1). Increased consumer surplus can be broken into an increase in overall welfare ( triangle a-b-e ), and a transfer of revenue from the government to consumers Δt*Q0( rectangle P+t0 -a-e-P+t1). The overall welfare gain to the economy is equivalent to the are a-b-c-d.
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Prepared by Greetje Everaert, Axel Palmason, and Yuri Sobolev.
There are 36 ‘sensitive’ products at the HS8 classification level where the EAC countries charge tariffs in excess of 25 percent. For about one-third of these products, the special tariff rates are the same for the three countries, while for the other two-thirds the EAC members apply different duty levels. In addition, Uganda and Tanzania, which are still at a lower level of industrial development, chose to gradually liberalize sensitive imports from Kenya by 2010.
The UNCTAD Trade Policy Simulation Model, Laird and Yeats (1986); refined by the World Bank under the name SMART.
The survey of literature on trade, growth and poverty reduction by Berg and Krueger (2003) concludes that trade liberalization is an important determinant of growth, which in turn leads to poverty reduction as average incomes grow. An OECD study on dynamic gains from trade (TD/TC/WP(2006)34) points to a robust relationship between openness to trade and the level of productivity and GDP per capita.
As noted in a recent World Bank study (Agricultural Trade Reform and the Doha Development Agenda, 2005), if only two percent of agricultural tariff lines in developed countries (and four percent in developing countries) are classified as ‘sensitive’, and thereby subject to only a 15-percent tariff cut, the welfare gains to developing countries from global agricultural reform would virtually disappear. This points to the importance of not exempting sensitive products from liberalization.
The relatively low value of imports recorded under the high tariff categories is due in part to the endogenous response to high protection rates and in part to customs duty evasion as noted later.
Given limited data availability to date since the introduction of the CET, it is too early to establish robust empirical evidence of trade diversion.
Capping tariffs as opposed to reducing them progressively across all tariff bands (whereby higher tariffs are reduced by more than lower ones) has the advantage of reducing the potential for reclassification of goods from low to high-tariff categories, which would keep effective tariffs high despite the tariff rates reduction.
For example, based on the 2004 data, the estimated ratio of revenue collected from trade taxes to revenue calculated by the model is about 80 percent for Kenya, 60 percent for Tanzania, and 40 percent for Uganda.
Kenya is not separately identified in the GTAP model and the latest available data is for 2001, which does not capture most recent development, including the introduction of the CET.
The simulation results also depend on the elasticities used in the calculations. In line with the literature, elasticities vary by product but not by country. Elasticity of demand across all products is on average around negative 2.15 (standard deviation 1.3), elasticity of substitution is held constant at 1.5, while elasticity of supply is infinite (constant at 99) corresponding to the price taker notion (Source: World Bank WITS-SMART). The point estimates in Table 8 are sensitive to the elasticity assumptions, which are on the conservative side. Due to the linearity of the model, if the elasticity of demand were doubled, trade creation would double and, if the elasticity of substitution were doubled, trade diversion would double.
Moreover, according to Kee et al. (2004), the export tax equivalent increases substantially when NTBs are taken into account.
The size of Tanzania’s imports from South Africa requires careful implementation of EAC rules of origin to prevent re-exportation, primarily to Kenya, of Tanzania’s imports effected under SADC preferential tariffs.
According to Yang and Gupta (2005), the limited success of Africa’s RTAs in promoting trade and investment could in part be attributed to the problems associated with overlapping memberships.
The EAC partner countries agreed on rules of origin that represent a negotiating compromise between the prevailing arrangements in COMESA and SADC, and do not correspond to either of these preexisting arrangements.
Confusion over which rules of origin apply at borders and their enforcement is one of the main concerns related to the overlapping membership of countries in regional integration initiatives in Southern and Eastern Africa expressed by the private sector (Charalambides (2005)).
COMESA’s stated objective is to establish a customs union by 2008.
Study on the Post-Effects of Tanzania Withdrawal from COMESA on Tanzania Business Developments with COMESA Member States, May 2005.
This could exert further pressure on Tanzania to rejoin COMESA.
Lower elasticity of demand would result in a steeper demand curve. Elasticity of import supply is infinite.
Producer surplus is not considered.