Wilbur Ross on the Effective Rate of Protection
“In a can of Campbell’s Soup, there are about 2.6 pennies worth of steel. So if that goes up by 25 percent, that’s about six-tenths of 1 cent on the price on a can of Campbell’s soup,” Ross argued. “I just bought this can today at a 7-Eleven … and it priced at a $1.99. Who in the world is going to be too bothered?”
Ross is doing his best (I guess) to explain the Effective Rate of Protection:
The principle objective of a tariff is to dampen imports in order to encourage domestic production of the protected industry. Until recently, the protective effects of a tariff were measured in terms of nominal rate of tariff on the imports of final products. It was believed that a higher nominal rate tariff of would bring a larger increase in the output of the protected industry. But the various duties imposed by a country are not likely to give a true picture of the degree of production afforded by the nominal tariff rate. For the nominal tariff rate does not take into consideration the amount of the duty on imported intermediate products and raw materials which are used in domestic import competing industries. The theory of effective rate of protection takes into account duties levied on such raw material and intermediate products. It measures actual rate of protection that the nominal tariff rate provides to domestic import competing industry. The nominal tariff rate is the rate of duty on the value of the imported final product (as for example the ad valorem tariff). It is important to the consumer, because the nominal tariff rate affects the price of final goods which the consumers ultimately consume. The effective rate of tariff, on the other hand, is important to producers, because the degree to which their production activity is protected from foreign competition depends upon effective and not the nominal rate of tariff.
In cases where the percentage of the imported inputs in the locally produced good is very small, then maybe we should not be too bothered, but let’s consider another example:
Consider the following example. Suppose a locally manufactured car has a selling price of $ 10,000. And the selling price of an imported car, having similar specifications, is also $ 10,000 in the domestic market…Now we assume that the government imposes a nominal tariff duty of 20 per cent on the imported car. The amount of tariff duty per year levied at 20 per cent ad valorem would, come to $ 2,000…Suppose now that the local car industry uses imported inputs accounting for 50 per cent of the total cost of producing a car and the rate of duty on these imported inputs, on ad valorem basis is 40 per cent. What would then be the effective degree of protection enjoyed by the local car industry?
I will leave to the reader to consider the case where the tariff on imported cars is zero and the tariff on imported components is 25%. I just wish someone from the Price is Right would have driven up in “a new car” when Wilbur was talking about soup and soda.