5. The Case for Further Tariff Reduction
107. This section assesses the costs and benefits of reducing tariffs after 1 July 2005. It examines efficiency arguments, including dynamic and allocative effects of tariffs, the employment impacts of reducing tariffs and the relationship between tariff policy and the Government's industry and regional development initiatives. The section also considers what is happening internationally and assesses the arguments for and against adopting a policy of reciprocity. Section 6 addresses the path of tariff reduction based on an analysis of adjustment issues.
5.1 Analytical Framework
108. The underlying principle that governed the Review was the objective to ensure that tariff policy supports improved productivity across the economy in the interest of improving New Zealand's economic growth performance. While not as important as it once was, tariff policy remains a key domestic economic policy instrument to achieve this end. Changing New Zealand's tariff regime will impact on different sectors and groups in the economy in different ways. There will be those that benefit and those that experience real costs in the short term.
109. The Review's analytical framework addressed the following:
- the dynamic effects associated with firm behaviour;
- efficiency gains to be made through further allocative efficiency, including gains to consumers and exporters;
- the employment effects and regional implications;
- the interrelationship between tariff policy and broader industry and regional development policies in promoting productivity growth;
- whether tariffs should compensate New Zealand manufacturers for relatively higher cost structures;
- the implications of pursuing a policy of reciprocity; and
- the merits of tariff alignment with Australia.
5.2 Dynamic Effects
110. The key driver of the reforms of the mid-1980s was the general shift to opening up New Zealand's economy to international price signals and increasing competition. The removal of import licensing and phasing down of tariffs were a fundamental component of this policy change.
111. The process of opening the New Zealand economy to international competition was not painless. Many firms did not adapt, went out of business, were taken over, or faced stiff competition as new firms entered the market place (NZIER 1998a). Many other firms, however, did adapt to the new environment and went on to be successful. Case study research has shown it has been a difficult process for firms to become more efficient and develop new technologies, products and processes, but substantial productivity gains have been achieved by many firms which have allowed them to compete successfully in new global markets.
112. Continued insulation from full international competition results in domestic industry being less outwardly focussed than under a fully open economy. Reducing tariffs increases competition, and the threat of competition, thereby forcing firms to extract efficiencies and innovate. Innovation includes developing new business practices and models, improving quality and services, developing new products and markets and becoming more customer focussed. Both consumers and producers benefit from this. In addition, a more open business environment allows for higher rates of capital accumulation in the economy overall29 and increased technology diffusion. Firms are able to import new technologies at competitive world prices. Increased technology uptake by firms builds their capability and spurs innovation. In turn, exports increase as they become more competitive, of higher value and less price sensitive.
113. Further productivity gains can be expected from further tariff reduction and should be captured. Further competitive pressure on firms is likely to increase the incentives for firms to innovate and encourage the emergence of more globally competitive firms. As a small isolated economy, New Zealand will only maximise its potential to extract further productivity gains by achieving a fully competitive environment. Tariff reduction will help to ensure New Zealand businesses are exposed to as much international competition, a key driver of economic growth, as possible. In line with the Government's Growth and Innovation Framework, tariff reduction will provide a strong incentive on firms to focus on adding value to their products and services through innovations and developing new global connections. In addition, tariff reduction will reinforce the message that world-class, innovative performance is necessary to compete and grow in the global marketplace.
5.3 Allocative Effects
114. Prices are the most important determinant of resource allocation between and within firms, industries and sectors. The less distortion there is in prices, the better firms will be at allocating scarce resources. Tariffs, in raising the price of foreign goods relative to domestically produced goods, introduce a price distortion. Tariff schedules are furthermore often characterised by arbitrary rates of duty with disparate rates for similar goods. New Zealand is no exception to this and the alternative specifics regime is a case in point (see Appendix E). These price signals distort efficient investment decisions by consumers and producers.
115. Tariffs, because they are a matter of government policy and therefore subject to change, create uncertainty in the economy. This uncertainty may result in firms delaying investment decisions and making decisions with unintended outcomes if tariff levels change. Of the 26 firms case studied, two were critical of the sudden announcement of the tariff freeze as forward contracts had been signed on the basis of the planned tariff reduction programme of the time. While in general tariffs are a low priority for firms, the postal survey showed that firms which compete with imports see the uncertainty associated with tariff protection as significant enough to affect investment plans. Firms are now looking for certainty about the post-2005 regime.
116. Case study research showed that the tariff freeze has generally been regarded as a helpful pause in the steady squeeze on margins that firms have had to manage over the past 15 years. A number of firms made the point that a period of stability has been valuable in allowing/encouraging them to think longer term. This has led some firms to undertake investment and expansion they probably would not otherwise have embarked on. However, despite this increased investment and employment in some firms, the current tariff regime is still resulting in inefficient firms continuing to tie up resources that could be more efficiently used in other firms within the same industry or in another manufacturing industry. In addition, domestic consumers and other producers continue to pay inflated costs for tariff-affected products - notably final goods. The export sector, in particular the agriculture sector, continue to see tariffs as a tax on their exports.
117. A reduction in tariffs lowers producers' cost structures, thereby increasing the profitability of those firms, industries and sectors not assisted by tariffs. This in turn results in higher rates of capital accumulation, increased investment and demand which generates employment opportunities and further exports. These benefits for producers, however, should not be overstated. New Zealand's tariff schedule exhibits a high degree of tariff escalation with higher tariffs on highly processed or final goods. The postal survey showed that, of fifteen issues which might affect their business, tariffs on inputs were ranked last. Benefits are therefore much more likely to accrue to consumers rather than firms as firms' inputs (raw materials and intermediate goods) are now almost entirely duty free.
118. Reducing tariffs raises consumers' disposable income, particularly for lower socioeconomic groups that benefit relatively more as a higher percentage of their income is spent on high tariff items such as clothing and footwear. Tariff reduction allows for increased consumption of those goods that become cheaper. Increased purchasing power frees up money to spend on other goods and services increasing consumer welfare.
119. Tariffs impose an administrative cost on government. Given the fixed costs associated with maintaining a tariff regime, administrative costs become disproportionately high the lower tariffs become.
5.4 Tariffs and Employment
120. Employment throughout the economy, beyond the short-term, is not determined by tariff policy, but by broader macroeconomic settings such as monetary and fiscal policy and labour market policy settings. New Zealand's relatively flexible labour market along with recent high employment growth, high labour force participation rates and widespread labour shortages should mitigate shorter term employment adjustment effects associated with further tariff reduction.
121. A frequent justification for maintaining tariffs is that tariffs help maintain employment of unskilled workers, female employees, ethnic minorities, and contribute to maintaining employment in many regional areas. Section 4 showed that the clothing and footwear industries, as the two industries projected to be noticeably affected by tariff removal, are comparatively significant employers of unskilled workers, females, Asian and Pacific peoples and are important in several regions. The question is whether tariffs are necessary to maintain employment of these groups.
122. Section 3 showed that, since 1992, employment has grown and unemployment rates have fallen despite continued tariff reduction. This demonstrates that the economy overall has generated employment opportunities and that, in aggregate, labour has moved to fill these positions.
123. A report by the New Zealand Institute of Economic Research showed that, as a whole, those sectors where exports exceed imports are more intensive in the use of unqualified labour, especially females (NZIER 1999c). These sectors included most service industries, most primary industries, food processing and textiles, apparel and leather. Export sectors typically benefit from tariff reduction through lower cost structures and growth in these sectors will result in more opportunities opening for unskilled labour and females. In addition, the proportion of female hours worked has risen substantially to nearly 40 per cent in 2001, from under 35 per cent in 1986 (Infometrics).
124. Between 1986 and 1991 there were sharp employment effects across all ethnic groups, particularly amongst non-European/non-Pākehā. Since 1991, however, employment has increased and unemployment rates have fallen across all ethnic groups at differing rates.
125. Māori, Pacific peoples and Asians experienced more rapid employment growth than Europeans/Pākehā since 1991 - primarily attributable to higher working-age population growth rates. With respect to unemployment rates, Māori unemployment rates have almost fallen to 1987 levels. However, unemployment rates are still significantly higher than 1987 levels for Pacific peoples and Asians (refer to paragraph 65). A recent report suggests that the industrial distribution of Pacific workers is changing, with increasing proportions working in the services sector and fewer working in secondary industries, including manufacturing. This trend may see Pacific peoples' unemployment rate continue to fall - perhaps to 1987 levels (SNZ and MPIA 2002).
126. Tariff reduction has been one of a number of factors to affect regional employment. The Infometrics report showed that the majority of regions experienced employment growth between 1986 and 2001. Several regions' employment levels, however, have not yet recovered to 1986 levels (see paragraph 57).
127. In summary, analysis of the employment impacts of previous tariff reduction based on employment figures, the analysis of Census data by Infometrics and Infometrics' GE modelling demonstrates that further tariff reduction will not affect employment across the whole economy, in aggregate, in the medium to long term. However, analysis of previous tariff reduction confirms that employment effects from further tariff reduction will be uneven. Past experience would suggest that further tariff reduction may affect employment beyond the short-term in certain regions and amongst Pacific peoples and Asians. These potential negative employment effects will, however, depend on the rate of tariff reduction and the adjustment path.
128. It is important to note that those ethnic groups who have suffered the largest unemployment effects have also benefited the most from the income effects of lower consumer prices. This is because these ethnic groups have lower incomes than Europeans/Pākehā on average.
129. In addition, the Māori economic base is twice as export intensive as the New Zealand economy on average (TPK, p.18). To the extent that tariffs are a tax on exports, tariff reduction will benefit Māori relatively more than other groups.
5.5 Tariffs and Industry and Regional Development
Industry Development
130. Ad valorem tariffs are an acceptable policy tool for industry assistance under WTO rules and are a favoured alternative to other protective measures such as quotas, licences and other non-tariff trade barriers. Tariffs that are consistent with WTO rules are predictable, transparent, do not discriminate between suppliers or exclude imports of lower-cost goods, and do not completely insulate markets from price signals.
131. Tariffs are, however, a blunt instrument for targeting many of the specific challenges facing New Zealand firms. These challenges include lifting exports through developing higher value-added products, developing management capability and increasing R&D investment. More targeted programmes are being run by New Zealand Trade and Enterprise, Technology New Zealand and the Foundation of Research, Science and Technology to address specific capability issues identified as a constraint to New Zealand businesses. These programmes provide a more efficient and effective means of addressing specific sectoral or firm problems. They should be supported by appropriate tariff policy designed to promote further productivity gains and industry adjustment to compete in an increasingly competitive international environment.
Regional Development
132. The impacts of tariff changes will not be uniform across regions. Even allowing for appropriate adjustment periods it is possible that there may be medium term employment effects in some small regional areas due to the closure of significant firms. The opportunity for employment shifts within industries and to other industries in some regions may be limited. There is a risk that reducing tariffs too fast could cause strain on some districts (notably Horowhenua and Wairarapa) or individual towns that are seeking to either diversify or move into areas with a long term competitive advantage. The costs associated with these regional impacts, however, will not outweigh the overall benefits of tariff reduction under appropriate adjustment paths.
133. The key principles that underpin the government's involvement in regional development are:
- making the most of what a region has to offer rather than making transfers from prosperous regions to less prosperous regions; and
- partnering with local communities to facilitate the development of local strategies that respond to local opportunities and that integrate social, environmental and economic concerns.
134. Further tariff reduction does not conflict with these principles, but broader economic policy will need to be consistent with encouraging regions to focus on areas where they have a long term, sustainable competitive advantage. Any adverse regional impacts of tariff removal may be better addressed through more targeted economic development tools under current policy instruments.
135. Currently the government funds a range of programmes which assist regions to pursue particular projects or to meet other regional objectives such as increasing skills. One of these programmes is the Regional Partnerships Programme which provides guidance and funding to assist regions identify and develop sustainable, economic growth strategies and put those strategies into action. Other initiatives include the Regional Initiatives Fund, the Sector Initiatives Fund and the regional polytechnic programme.
136. There are also employment-related programmes, including the Community Employment Group of the Department of Labour and Work and Income New Zealand which would assist adjustment. The Community Employment Group has developed expertise in assisting communities to respond to plant closures by making use of its community networks to assist transition. The group discusses what support can be provided and may fund the establishment of a resource centre to act as a coordination and information point. Work and Income provides assistance to unemployed job seekers through a number of measures for situations of local labour market shocks. Under further tariff reduction, however, it may be necessary for the government to consider specific assistance programmes on top of existing schemes.
Tariff Concession Policy
137. Cabinet paper FIN Min (01) 30/4 required that the Tariff Review "review tariff concessions policy relating to the non-withdrawal of tariff concessions".
138. Up until 1989 concession policy provided for the automatic withdrawal of a concession i.e. reimposition of a tariff, if local manufacture of a suitable alternative product commenced. There were changes to the policy in 1989 and 1991 and in 1998 it was decided that the provision for discretionary withdrawal of tariff concessions would be removed altogether.30
139. The Review recommends the continuation of existing tariff concessions policy. Reinstatement of tariffs where a concession has applied would result in a clear disruption to firms that have come to rely on access to duty free imports. It would also result in an effective increase of tariff rates which is out of line with the Review's recommendations on Part I of the Tariff.
5.6 Tariffs as an Equaliser of Costs
140. The Review addressed the argument that tariffs should be maintained to equalise costs between trading partners so that one country does not have an "unfair" advantage over another. These costs include capital and labour inputs and costs associated with the need to meet environmental standards, health and safety regulations or other regulatory compliance costs such as ACC. Many manufacturing firms with both high and low tariffs argue that tariffs - no matter how low - go some way in compensating for the higher costs New Zealand firms face. Many also argue that it is unfair to import goods which are produced by low-wage labour in developing countries. This, they maintain, not only disadvantages producers in New Zealand - a high-wage economy - but also supports the exploitation of cheap labour overseas.
141. The Review rejected these arguments on the grounds of the well-established principle of comparative advantage where a country exports those products it can produce relatively inexpensively and imports those goods that it can produce only at relatively greater cost. The huge gains from trade that both developed and developing countries have enjoyed, as tariffs have come down globally, directly reflect this principle. In addition, tariff policy is a poor means of addressing fundamental issues over human rights or the environment.
5.7 Reciprocity
142. The Terms of Reference required the Review to "assess the implications of pursuing a policy of reciprocity in the context of tariff reduction". The Review was also cognisant of various government policy statements reflecting a desire to no longer lead the way on tariff reduction.
143. A common theme in submissions and in direct consultations was that New Zealand should only provide for tariff reductions on the basis of other countries reducing their tariffs in turn.
144. Business concern about reciprocity, however, is also closely interrelated with a broader concern about the need for adequate adjustment periods to operate in an unprotected, fully open environment. The reduction of tariffs and other barriers to trade in key trading partners' economies clearly would assist the adjustment process for firms as it would open up new market opportunities to compensate for the loss of market share in the domestic market.
145. The Review weighed these concerns about reciprocal fairness, including a belief that New Zealand should not lead the world in tariff reduction. It concluded that tariff policy remains a key instrument of domestic economic policy and should not be constrained by the actions of others. A decision to move ahead on tariff policy based solely on the principle of reciprocity would be to undermine the scope for achieving further productivity and efficiency gains as well as consumer welfare benefits within the economy. It would also create a high degree of uncertainty for business. The Review concluded, therefore, that reciprocity could not be the underpinning principle for the development of policy options. New Zealand should, however, continue to give the highest priority to achieving reciprocal trade access gains at the multinational level under the Doha Round of trade negotiations (see Box 1) and in bilateral trade policy endeavours.
146. The principle of reciprocity underpins expectations for the achievements of the APEC Bogor Goals. Reciprocal benefits under the APEC framework, however, can be achieved under a framework of unilateral tariff removal as well as through FTAs and CEPs.
147. Some argue that reducing and removing tariffs unilaterally will reduce New Zealand's bargaining power or negotiating coin in multilateral and bilateral trade negotiations. New Zealand would have less to offer others by way of benefits under bilateral or regional trade arrangements and it would therefore be more difficult for New Zealand to attract trade partners.
148. Improved market access is one of the main objectives of CEPs and free trade agreements. The small size of the New Zealand market and its relatively low tariffs and open services sector realistically means that other countries' reasons for seeking to negotiate a CEP with New Zealand will be broader than the benefits associated with improved market access. Nevertheless, given that preferential tariff treatment is an important consideration in securing domestic support in other countries pursuing CEPs with New Zealand, unilateral tariff removal could impact on New Zealand's ability to attract CEP partners. But this by itself, is not a reason for New Zealand not to reduce or eliminate its own tariffs.
Figure 3: New Zealand's Simple Average Bound and Applied Tariff Rates by APEC Sector Groupings 2001
Source: APEC 2001 Individual Action Plan
149. New Zealand accords the highest priority to multilateral trade negotiations under the WTO. As a small country New Zealand can achieve maximum negotiating leverage in a multilateral context. New Zealand has a strong interest in global trade disciplines and dispute settlements procedures. New Zealand's influence is achieved by demonstrating its commitment to an open and transparent multilateral trading system.
150. The current Doha Round is scheduled to be completed by 2005. Some argue that decisions on the tariff regime should wait until the outcome of the Round. The Review concluded, however, that it was not in New Zealand's interest to delay tariff policy decisions on New Zealand's tariff regime until the conclusion of the Doha Round. To do so would constrain the government's ability to signal a clear course and commitment to the post-2005 tariff regime to allow firms to begin to plan and take efficient investment decisions.
151. Applied tariff rates provide for little direct negotiating coin in WTO multilateral negotiations where tariff reductions are negotiated on the basis of historical bound rates. Bound tariff rates are negotiated rates which WTO members are legally committed to not exceed. All but 0.3 per cent of New Zealand's tariff lines are bound at rates negotiated at the Uruguay Round. More than 40 per cent of tariff lines are bound at zero. For the remainder, bindings are generally set at levels well above current applied tariffs as is the case for almost all countries (see Figure 3). For example, where New Zealand's applied tariff rate is 19 per cent (clothing and footwear), the average bound rate is 37 per cent. At this stage it is not possible to predict the likely outcome in the WTO. While the Round is expected to result in substantial bound tariff reductions, it is likely to be some time before bound tariff reductions have any impact on applied rates resulting from this Tariff Review.
5.8 Tariff Alignment with Australia
152. Submissions and consultation highlighted an interest for aligning the New Zealand Tariff with that of Australia's. The reasons given for this were to:
- reduce transaction costs in doing business with Australia;
- facilitate more efficient decision making for trans-Tasman businesses;
- encourage greater integration with Australia; and
- eliminate problems with New Zealand producers meeting CERROO requirements.
153. Australia is New Zealand's top export destination with exports in the December year 2002 totalling NZ$6,217 million (SNZ 2002b). It is particularly important for manufactured goods: 90 per cent of carpet exports, 87 per cent of clothing exports, 65 per cent of footwear exports and 72 per cent of processed plastic products go to Australia.
154. Australia, like New Zealand, has lowered its tariffs considerably (see Table 5). As a result, the value of trans-Tasman preferences has declined and will continue to decline as Australia continues unilaterally reducing MFN tariffs and pursuing FTAs and CEPs. This means that New Zealand exporters will face ever stronger competition for Australian market share. In the face of this, New Zealand manufacturers must, therefore, continue their push to become more globally competitive and to look beyond the Australian market. This will position New Zealand manufacturers for an increasingly competitive international marketplace. It will also position New Zealand manufacturers ahead of other manufacturers and they will be more prepared for tougher competition in the Australian market.
Table 5: Australian Tariff Reductions 1990-2010
| | 1990 | 1996 | 2000 | 200531 | 201032 |
| Passenger motor vehicles | 40 | 25 | 15 | 10 | 5 |
| Apparel and certain finished textiles | 55 | 37 | 25 | 17.5 | na |
| Footwear | 45 | 27 | 15 | 10 | na |
| Carpet, woven fabrics | 40 | 25 | 15 | 10 | na |
| Sleeping bags, table linen | 25 | 15 | 10 | 7.5 | na |
| Other TCF (e.g. yarns and leather) | 15 | 5 | 5 | 5 | na |
| General manufacturing | 15 | 5 | 5 | 533 | na |
155. A common external tariff with Australia would have several advantages as outlined in paragraph 152. There would be costs, however, associated with such an approach:
- [Text deleted due to confidentiality];
- many tariff rates would have to be raised and the tariff structure would become more complex; and
- [Text deleted due to confidentiality].
156. Concern was expressed that, if New Zealand removed tariffs ahead of Australia, Australian manufacturing firms would gain a major advantage by no longer "having to meet" CERROO. Analysis of this viewpoint, however, suggests that New Zealand manufacturing firms would not be at a disadvantage if New Zealand removed tariffs ahead of Australia. While it is true that Australian manufacturers would no longer need to consider meeting the CERROO criteria and would continue to benefit from tariff protection in their home market, they would lose their margin of preference into New Zealand. This means that they would have to compete with all other countries' exports on an equal basis. On the other hand, New Zealand manufacturers would still retain their margin of preference into Australia if Australia did not remove its tariffs.
5.9 Summary
The case for further unilateral tariff reduction is supported by the following:
- Competition is central to producing outward looking, world-class innovative firms. The process of opening up the economy to import competition and exposing firms to increased competition has produced substantial efficiency gains and spurred innovation.
- The remaining tariffs represent a net cost on the economy as a whole. There are further efficiency and welfare gains to be captured.
- Tariff policy, while less important than in the past, still provides an instrument to strengthen the incentives on firms to innovate and become more internationally competitive and globally connected. The removal of remaining tariffs over an appropriate adjustment period will support further innovation and productivity gains, and thereby position New Zealand firms ahead of those in other developed economies fully to respond to open global competition.
- Tariffs continue to impose a distortion on the efficient use of scarce resources in the economy, both within and between firms, industries and sectors. The impact of these distortionary effects increases in the context of the shortages of skilled labour and capital that many regions are experiencing.
- Tariffs continue to impose additional costs on consumers, particularly those in lower socioeconomic groups, by denying them welfare gains. The remaining tariff profile, in particular the peaks in the TCFC industries, accentuates the disproportionate burden experienced by lower socioeconomic groups.
- Tariffs remain an administrative cost to government.
- The current uncertainty with respect to the post-2005 regime is affecting efficient investment planning by firms. Failure to signal a clear and certain post-2005 regime will result in continuing investment uncertainty.
- Tariff policy is one instrument among a broader suite of interventions to promote productivity growth and innovation. New Zealand's economic performance will depend on moving up the value chain and developing new competitive advantages.
- Tariff policy is an important instrument of domestic economic policy. There are still further gains to be made from further tariff reduction. These gains should be taken by New Zealand independent of other countries. A tariff policy based solely on reciprocity would deny New Zealand these benefits. New Zealand, however, should continue to give the highest priority to achieving reciprocal trade access gains within the multilateral trade negotiations under the WTO and through regional and bilateral trade policy initiatives.
- While Australia is an important export destination for manufactured goods, there is very little advantage to external tariff alignment with Australia. It is important that New Zealand firms continue to diversify beyond Australia and continue to innovate.
- Removing the remaining tariffs will have some effects on employment in the shorter term. A key objective should be to ensure that the tariff reduction path allows for the efficient transition of labour from lower value activity to high value activity both between and within firms, industries and sectors.
- To the extent that there are potential transitional costs associated with tariff reduction, these will need to be managed through efficient tariff adjustment paths.
5.10 Policy Conclusion
157. The Review concluded that the case for further tariff reduction was strong and that the key policy objective should be to unilaterally remove all remaining tariffs and that a clear path to zero tariffs which takes into account key adjustment considerations be signalled to businesses and consumers.
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