Global Value Chains and Tariff Policy: Effective Protection in an Inter-Connected World Economy

1. Global Value Chains and Tariff Policy: Effective Protection in an Inter-Connected World Economy Antonia Diakantoni Hubert Escaith WTO WIOD CONSORTIUM MEETING, 25-26 MAY 2011 Sevilla, Spain.

2. Effective Protection Theory • Nominal tariffs affect the domestic price of traded goods • The higher the tariff, the higher the: • Benefits for domestic firms producing the good • Costs for domestic firms using the good as input • Effective Protection for any given industry: • Weights additional production costs against the additional benefits determined by nominal tariffs Effective Protection Rate (EPR) • Tariff Escalation: • Nominal tariffs increase with the degree of processing • Effective Protection is low for producers of intermediate goods and high for producer of final goods

3. Global Value Chains, Tariff Escalation and Trade in Tasks • Steep Tariff Escalation was a key feature of import substitution industrialization policies • Low nominal tariffs on intermediate inputs or capital goods • High tariffs on manufactured final (consumer) goods • But since the end-1980s, industrialization of developing countries is increasingly export-led • Processing imported inputs as part of international supply chains • Trade in final goods displaced by trade in processed intermediates embedding the domestic value added (trade in tasks)

4. Trade in Tasks and Effective Protection Rate • From an input-output perspective, high sectorial EPR protects primary factors in this industry and increases the “price” of the value added (compared to a “free market” situation) • It is an incentive for moving productive factors (labour and investment) to the protected sector • But reduces international price competitiveness as GVCs blur the dichotomy between tradables vs. non-tradables (trade in tasks=trade in value added) • Expectations : • The smaller the domestic economy, the lower the incentive for high EPRs • Because trade within GVCs is very responsive to transaction costs, we expect a reduction in EPRs peaks during the 1990s for manufactured goods • The higher the incidence of GVCs and the length of supply chains, the flatter the nominal protection ditribution (lower EPR)

5. Research Proposal • Analyse the evolution of sectorial EPRs • From 1995 to 2005 • For a selection of developed and developing countries: USA and 9 Asian economies • Using IDE-JETRO Asian Input-Output data base • To disentangle the role of changes in tariff policy from the changes in production structure and technology • Explore specific patterns related to the specificity of industries or the length of international supply chains (in particular, vulnerability to a supply shock affecting prices) • Relate stylised facts with the recent literature/ discussion on GVCs

6. Research Proposal (2) • Descriptive and Exploratory Data Analysis … to establish stylized facts • Counterfactuals to separate the role of tariffs from the changes in production structure: • Controlling for technical coefficients and changing tariffs • Controlling for tariffs and changing technical coefficients • Relating observation with the incidence of price shocks in a “trade in tasks” framework (production networks) • Approximating the length of international supply chains through Average Propagation Length

7. Some preliminary results: EPR 1995-2005Simple average of countries and sectors

8. Comparison of China's nominal and EPR rates(2005)

9. Average propagation length of a supply shockindex 100 = highest sectoral value, 2008 Length weighted by size of shock (Ghosh) from industrial and electronic products, non-domestic effects only.

10. Caveats (besides numerous data issues):EPR is a descriptive more than a normative tool • Positive theory: tariffs affect the allocation of resources (the «raison d’être» of protectionism) … But they also eventually affect consumption and (potentially at least) terms of trade • EPR is a partial equilibrium tool, but • Indirect effects (e.g. substitution) would need to be modelled through General Equilibrium Models. • Comparative statics (e.g. 2005 vs. 1995)controlling separately for changes in tariffs and changes in production structure: • Will shed some light on substitution effects • But cannot isolate them from other changes in the institutional and economic environments.

11. Thank you Global Value Chains and Tariff Policy: Effective Protection in an Inter-Connected World Economy Antonia Diakantoni Hubert Escaith WTO The “Made in the World” initiative has been launched by the WTO to support the exchange of projects, experiences and practical approaches in measuring and analysing trade in value added.