6. The Path of Tariff Reduction
158. The Review identified a number of adjustment considerations that should inform the tariff reduction path. It weighed adjustment costs - including regional employment effects - with the longer term benefits associated with tariff reduction. The Review also took into account the TCFC Strategy and the Government's broader objective to see New Zealand firms continue their transformation to becoming internationally competitive.
6.1 Adjustment Theory
159. Adjustment costs are a wide variety of potentially negative short-term outcomes that may result from tariff reduction. These outcomes may include a reduction in output and employment, the loss of industry-specific and firm-specific (human) capital, and macroeconomic implications that may result from, for instance, reductions in government revenue (Matusz and Tarr 1999).
160. Virtually all studies have found that, relative to the overall long-term benefits of tariff reduction, adjustment costs are very small. This is because:
- employment adjustment costs are typically short term as dislocated workers generally find new employment opportunities as the benefits from tariff reform grow the economy;
- unemployment for workers in most industries is not long-term;
- normal labour turnover in many industries exceeds shocks from tariff reduction; and
- much of the resource allocation brought about by tariffs is within industries rather than between industries meaning many workers are able to find jobs with the same skill set. (Matusz and Tarr 1999)
161. In assessing the path of tariff reduction then, adjustment costs should not be disregarded, but should be viewed in conjunction with the medium and longer term benefits of tariff reduction. Adjustment pressures related to tariff changes should also be seen in the context of continual structural change and pressures within industries and the economy generally, such as exchange rate movements, energy prices, changes in demand in export markets or changes in technology.
162. Adjustment pressures will be minimised if tariff reduction programmes:
- are announced well in advance so existing capital stock is not prematurely junked and firms have time to prepare and reorganise;
- allow time for firms to adjust to increasing international competition while still providing strong incentives to change and innovate; and
- provide a certain and limited period of adjustment for firms.
6.2 Key Adjustment Issues
163. In considering the appropriate tariff reduction path across New Zealand's remaining tariff lines, the Review needed to balance a number of considerations:
- the need to identify tariff reduction paths that provided for substantial incentives to encourage further efficiency and productivity gains following a six-year moratorium;
- the need not to undermine key infrastructural linkages within industries that would be critical to firms' transitions to higher productive and higher value activity;
- the importance of ensuring that domestic market share is not eroded too quickly, but is able to provide a continuing foundation for firms to develop new international markets and consolidate and expand in existing markets; and
- the need to provide for effective employment transition at the regional and industry levels.
164. Many submissions expressed concern that any tariff reduction path be gradual because further productivity gains and product and process innovations will be more difficult to achieve than under the initial tariff reduction programmes. Further gains are more likely to come from innovation, R&D and the development of new markets than simple cost cutting. The development of new products and markets is not straightforward and will require appropriate adjustment periods.
165. Many firms, including those benefiting from tariffs at or below 7.5 per cent, stressed the importance of the domestic market and the difficulty in overcoming trade barriers in export markets. The domestic market very often serves as the necessary foundation for global market development by many firms. Consequently, many firms identified a substantive threat to their operations if tariffs were changed without adequate adjustment periods. Given sufficient time to adjust, however, they could handle the transition to becoming more export oriented. This argument was supported by a number of high performing, internationally competitive companies.
TCFC Adjustment Issues
166. The GE modelling work by Infometrics supports the view that tariff removal will not significantly affect TCFC employment under an appropriate adjustment path. Indeed, Infometrics anticipated that the effect of tariff removal would be simply to lower the rate of employment growth in these industries. The Review anticipates that, in the light of the transformation that is already taking place, the dynamic benefits of restructuring within the TCFC industries will result in a stronger, higher-value sector. Notwithstanding the transformation of the sector, however, there will still be some firms that close down as a direct result of tariff removal with subsequent costs for employees.
167. As outlined in Section 4.4, the clothing and footwear industries employ a high proportion of female, Asian and Pacific peoples and unskilled workers. Workers with limited skills sets will find it comparatively difficult to find alternative employment. Employment adjustment costs for displaced workers in the TCFC industries, therefore, are likely to be higher than for workers in other industries.
168. Displaced workers are most likely to be working in marginal or fading firms. Fading firms will be less likely to have utilised new technologies or engaged in upskilling their workforces. On the other hand, growing firms will be likely to be using new technologies requiring workers with a higher skill base. Workers who exit fading firms may be unlikely to have gained the necessary experience to be employed immediately by growing firms. In addition, these displaced workers will be in competition with increasing numbers of students from design courses.
Table 6: Clothing and Footwear Employment by TLA
| | Clothing | Footwear | Percentage of clothing and footwear employ-ment34 | Clothing and footwear employ-ment as % of manu-facturing employ-ment | Unemploy-ment Rate35 |
| | | | % | % | % |
| Carterton | 48 | 3 | 0.6 | 11.7 | 5.2 |
| Horowhenua | 186 | 3 | 2.1 | 10.7 | 9.3 |
| South Wairarapa | 45 | 0 | 0.5 | 10.6 | 6.4 |
| Waitakere City | 876 | 180 | 11.9 | 8.7 | 8.3 |
| Auckland City | 1,164 | 174 | 15.1 | 7.0 | 7.9 |
| Kapiti Coast | 84 | 9 | 1.1 | 6.3 | 7.1 |
| Waimakariri | 174 | 6 | 2.0 | 5.9 | 4.4 |
| Selwyn | 102 | 3 | 1.2 | 5.9 | 3.3 |
| Christchurch City | 1,278 | 60 | 15.1 | 5.7 | 6.8 |
| Wellington City | 240 | 21 | 2.9 | 5.7 | 6.2 |
| Wanganui | 138 | 18 | 1.8 | 5.5 | 9.7 |
| Banks Peninsula | 21 | 0 | 0.2 | 5.3 | 4.8 |
| Mackenzie | 3 | 0 | 0.0 | 5.3 | 3.0 |
| Porirua City | 90 | 6 | 1.1 | 5.0 | 10.3 |
Source: March 2001 Census of Population and Dwellings
169. Employment adjustment may be further limited in some regional areas where overall employment growth may be slow and/or where manufacturing employment is declining. This is likely to have greater implications for females, Asians and Pacific peoples. Adjustment is likely to be further impeded by the fact that the clothing and footwear industries have a high proportion of very small firms that employ disproportionate numbers of unskilled workers. A further impediment is that the TCFC industries employ a higher proportion of workers over 40 than both manufacturing and the total economy. Many older women provide a second-income for their household meaning that relocation to other areas will be very limited.
170. Of the four TLAs likely to be affected by employment impacts of tariff removal (see Table 6), Horowhenua District is the only TLA to have suffered an employment decline since 1986. With an unemployment rate of 9.3 per cent36 further work to assess impacts on Horowhenua and possibly the two Wairarapa TLAs of Carterton and South Wairarapa may need to be considered. See also paragraphs 99-102.
171. In addition to the adjustment impediments and risks identified above, the Department of Labour (2002) identified several further risks. A particular area of concern is that a short term rise in unemployment may become persistent and have long term effects because:
- unemployment may reduce attachment to the workforce;
- new employment opportunities may be generated outside of regions with a concentration of TCFC firms and individuals and families may have a number of reasons for not being able to move; and
- it may lead to a depreciation in the skills of unemployed workers.
172. Because of the impediments and risks to efficient adjustment in the TCFC industries, identified above, employment assistance programmes may need to be considered. Determining a causal link between employment loss and tariff reduction, however, is difficult. While there are not expected to be significant dislocation costs due to the low levels of tariffs and the gradual phase-out of tariffs, it may be appropriate for the government to consider and further assess any disproportionate impacts on the particular regions and social groups identified earlier in this report. Some short-term adjustment assistance for affected employees could be warranted in some circumstances where that assistance could shorten the duration of unemployment. Assistance programmes may lessen the impact on those unemployed and in regions where unemployment is already high and where protected industries are significant employers.
173. Textiles New Zealand has expressed a concern at the reduction of off-farm R&D funding as a result of the restructuring of the wool industry. They argue that changes in the wool industry and associated R&D funding reductions and the removal of tariffs at the same time would pose considerable strain on the TCFC industries and hinder the adjustment to a lower tariff environment. While there may be short-term effects associated with the changes in the wool industry for some industries within the TCFC sector, this issue is better addressed through other government initiatives. A Textiles New Zealand proposal for R&D funding is being examined separately from the Tariff Review.
6.3 The TCFC Strategy
174. The TCFC Strategy for the textile, clothing, footwear and carpet industries is a joint industry and government partnership. The strategic vision is to "transform the TCFC industries so that they grow profitably and sustainably in the global marketplace and to ensure that growth opportunities are available for small, medium and large TCFC companies". The five-year targets focus on becoming globally competitive with exports valuing $1,000 million in 2008 (see Appendix C for the individual industry targets), annual export growth of 12.6 per cent and the creation of five internationally recognised New Zealand-based product categories/niches. Three action agendas of customer focus, business performance and enabling strategies are the basis for implementing the Strategy.
175. The TCFC Strategy's underlying objective is to position the industries to compete in an increasingly competitive global marketplace. This is to be achieved through placing greater emphasis on customer focus, improvement in management practices and investment, reorientation of production and marketing towards niche markets, seeking new markets beyond Australia, building inter-firm cooperation and international distribution channels, and improved skills and productivity.
176. The Review has sought to ensure that tariff policy does not undermine this objective. Previous tariff reduction has clearly assisted the TCFC industries in becoming more innovative and internationally competitive. Further tariff reduction will apply more pressure on firms in the TCFC industries to continue to innovate and develop export markets beyond Australia which currently takes around 80 per cent of TCFC exports (see Appendix C). The value of trans-Tasman preferences is declining and New Zealand TCFC firms must position themselves for increased competition in both the Australian market and other global markets.
177. Those firms in the TCFC industries that are producing more standardised product will find it difficult to survive, no matter what the level of tariff protection. Competition from developing countries, particularly China, is increasing and will continue to increase. This will continue to erode the protective effect of the current tariff regime. On the other hand, those firms that have developed particular niche markets should continue to perform well.
178. An important focus of the Review has been to understand the nature of important infrastructural linkages with a view to ensuring that they are not undermined under a tariff reduction programme. With respect to the TCFC industries, there is some concern that tariff removal will adversely affect many apparel manufacturers with upstream effects on textile producers. This may impact on the TCFC industries, as a whole, in terms of its network structures and its ability to export. However, while some firms may downsize or shut down production, resources are freed for those firms in the industries that are not dependent on protection and who have developed or are developing their own brands and niches for export. In addition, it is not clear that there is a group of firms that is vital to the sustainability of the TCFC industries. Many New Zealand TCFC firms, for example, are becoming increasingly connected with overseas suppliers.
179. The design/fashion end of the apparel industry has stated in submissions that there are important infrastructural linkages between the design end of the market and the mainstream textile and clothing industry that could be put at risk (see also Blomfield 2002). Previous tariff reduction, for instance, impacted on quilting and pleating to the extent that no commercial capability remains today. There are few fabric suppliers remaining in New Zealand and sewing technicians and garment dyers are in very short supply. Beyond the fashion industry, those apparel manufacturers specialising in niche markets (such as outdoor wear) have stressed the importance of the more basic lines in developing and sustaining niche products.
180. Future tariff policy needs to ensure, in particular, that tariff reduction does not undermine the infrastructure that supports the transformation of the TCFC industries to the high value-added end of the market. It will continue to be some time before the design and niche ends of the apparel industry can generate enough critical mass alone to support the existing infrastructure.
6.4 Alternative Specific37 Tariffs
181. Of the 7450 Tariff items in the New Zealand Tariff, 195 Tariff items carry alternative specific rates. This means that the duty paid is calculated either by way of the alternative specific rate (expressed in dollars and cents per unit) or the associated ad valorem rate - whichever rate returns the highest level of duty. Except for two Tariff items concerning ballpoint pens, alternative specific rates are confined to clothing. They were retained for apparel in 1992 because it was recognised the clothing industry faced particular pressure from very low cost garments from a range of sources and also experienced particular difficulties in taking successful anti-dumping actions.
182. Specific tariffs are an inefficient and non-transparent form of tariff protection as:
- it is impossible to know precisely the actual protection they afford at any given time. Specific rates of duty are therefore not transparent and are not a favoured form of tariff protection under the WTO. The WTO's Trade Policy Review of New Zealand stated that New Zealand's alternative specific regime added "a degree of complexity (and therefore opacity) as well as unpredictability to the tariff" (WTO 2003, p. ix);
- unlike ad valorem tariffs, they do not keep pace with inflation. Unless the specific rates are increased to keep in line with cost increases in exporting countries, specific tariffs will increasingly be less effective as a protection mechanism and will eventually afford no protection;
- protection fluctuates with exchange rate movements creating unpredictability for importers and retailers. Protection decreases as the exchange rate depreciates and increases as the exchange rate appreciates; and
- they often result in markedly disparate rates of protection for similar items of goods. This increases tariff dispersion and the distortion associated with the tariff regime.
183. Because of the negative effects of specific tariffs, officials have reviewed the alternative specific tariff regime and have calculated ad valorem equivalents (AVEs) of all specific rates (see Appendix E) to determine the level of tariff protection they are currently affording. Of those imports that may attract an alternative specific, 22 per cent (by value) paid the alternative specific rate of duty.
184. The calculations showed that across all 195 Tariff items, the existence of the alternative specific raises the ad valorem rate by an average of 1.7 percentage points. This 1.7 percentage points is on top of the ad valorem rate of duty. The highest adjusted AVE is 33.7 per cent - 14.7 percentage points higher than the ad valorem tariff rate of 19 per cent.38 The alternative specifics regime, therefore, is generally providing very little extra protection, although there appears to be fairly significant protection in one or two very narrow segments of the apparel industry.39
185. It is proposed that the alternative specifics be removed for the following reasons:
- specific tariffs (including alternative specific tariffs) are an inefficient and non-transparent means of protection;
- the present alternative specifics regime encourages capital to be retained in low value-added products. Maintaining alternative specifics for remaining manufacturers who benefit from the regime acts as a disincentive to these firms to move up the value chain;
- the New Zealand apparel industry has undergone major transformation over the last 15 years. Removal of alternative specifics would therefore impact on fewer manufacturers. The dumping concerns of the early 1990s appear to be of less importance to the apparel industry given the industry's move away from production which competes directly with low cost imports; and
- the removal of alternative specific tariffs would result in approximately 20 per cent of low-cost garments paying less duty which should flow through to price reductions for consumers. Removal would be of particular benefit to lower socioeconomic groups who disproportionately bear the cost of the specific tariff - a higher percentage of the price paid for a clothing garment is the duty proportion.
186. Both options outlined in Section 7 involve the removal of alternative specific tariffs, in one step, on 1 July 2005.40 All clothing imports (except used clothing) would consequently pay duty by way of the applicable ad valorem tariff only.
6.5 Administrative Simplicity
187. Tariff reduction programmes must reflect administrative simplicity. In the context of the Review this primarily means that there should be identical annual percentage point cuts where possible, i.e. 2.5 percentage points. It also means that tariff rates should be simplified or standardised (such as to 5, 10 or 15 per cent). It is not, therefore, practical or desirable for each manufacturing industry to have individual tailored reduction programmes. In addition, a key principle of trade policies internationally is that they be transparent. Differing reduction programmes for each industry would add unnecessary complexity to the Tariff.
6.6 Tariff Preferences
188. New Zealand maintains a number of tariff preferences for imports from various countries that satisfy the relevant rules of origin criteria. All imports from Australia, Singapore and Pacific Forum Island countries enter duty free and New Zealand's GSP provides preferential treatment to imports from 102 LDCs and 49 LLDCs. On 1 July 2001 New Zealand was among the first in the world to remove all tariffs on imports from LLDCs.
189. Existing policy established in 1997 with respect to the LDC preferential rates of duty is that:
- LDC tariffs are frozen and do not reduce when MFN tariffs reduce. In other words, under a tariff reduction programme LDC margins of preference diminish and eventually disappear. At that point, LDC imports pay the MFN tariff; and
- countries graduate (are no longer eligible for existing LDC preferences) when their per capita GNI reaches 70 per cent of New Zealand's per capita GNI.
The Review recommends that the existing policy with respect to the GSP continue.
190. Fixed margins of preference apply to Canadian imports and to certain automotive component products from the United Kingdom. Existing policy is that these Canadian and United Kingdom preferences reduce in line with the MFN reductions, i.e. the fixed margins of preference remain. The Review recommends that this policy continue.
6.7 Summary
- Overall, there are not expected to be significant dislocation costs under gradual tariff reduction.
- It is important to signal a clear path of tariff reduction to all sectors and industries.
- The path should recognise key adjustment issues. It is important to consider adjustment costs in the context of the medium and long-term benefits of tariff reduction. Adjustment pressures should also be seen in the context of continual structural and dynamic change within industries and the economy generally.
- Manufacturing firms in general have stressed that further productivity gains, innovations and development of exports will not be easy to achieve. It appears that considerable time is required for these improvements to take place.
- Many firms, including those benefiting from tariffs at or below 7.5 per cent, stressed the importance of the domestic market and the difficulty in overcoming trade barriers in export markets. They identified a substantive threat to their operations if tariffs were changed without adequate adjustment time. Given adequate time to adjust, however, they could handle the transition to becoming more export oriented. This argument was supported by a number of top performing companies already operating at world class levels.
- The clothing and footwear industries face unique adjustment pressures. They employ a high proportion of females, Asian and Pacific peoples and unskilled workers and are significant employers in several regions.
- The textiles, clothing, footwear and carpet (TCFC) industries have entered into a strategic partnership with the government. Tariff policy must support the industry and government objective of positioning the industries to compete in an increasingly competitive global marketplace. An important consideration of the Review was to ensure that important infrastructural linkages are not undermined by a rapid tariff reduction programme.
- The protective effect of the tariff regime, particularly in relation to clothing, will continue to be eroded by the increasing competitive strength of emerging developing country producers.
- Eliminating alternative specific tariffs will lead to a more transparent and predictable tariff regime. It will ensure activity is not in low value-added products.
- In order to promote productivity gains, innovation and to manage any disproportionate impacts on particular regions and social groups, tariff policy needs to be complemented by other appropriate government initiatives. Further work to assess impacts on Horowhenua and Wairarapa may need to be considered.
6.8 Policy Conclusion
191. The Review concluded that given the low average tariff rate and the profile of the remaining tariffs, all remaining protection should be removed within a decade from announcement this year of the post-2005 regime. The pace of reduction will be a function of the relative weighting that is given to consumer welfare gains and allocative efficiency, versus adjustment issues.
192. Early notice and up to eight years to adjust from 2005 at a measured and predictable rate should provide adequate notice and scope for firms to respond to increased competition and to adjust their behaviour, to plan and to position their businesses. Consultation indicated that firms recognised their survival depended on their ability to adjust and operate in an unsupported environment. Many firms anticipated removal of tariffs by 2010, but not earlier than this.
193. The Review concluded that alternative specific tariffs be removed in one step on 1 July 2005 with only the applicable ad valorem tariff rate continuing to apply. All tariffs at or below 12.5 per cent should be removed by 2010. Tariffs above 12.5 per cent that apply to carpet, clothing, headgear, footwear and ambulances and motor homes would be removed, at the latest, by 2013.
194. The TCFC industries' peak tariffs mean that under a scenario of tariff removal by 2010, the TCFC industries would face annual 4 percentage point reductions on top of the immediate removal of alternative specific tariffs. This would be sharper cuts than for all other industries and would put these industries under considerable pressure. There are risks that infrastructural linkages may be undermined and that employment adjustment, exacerbated by the unique features of the clothing and footwear industries, may be sharp in several regional areas under a tariff programme of annual 4 percentage point reductions. Annual 2.5 percentage point cuts may be a more appropriate adjustment path for mitigating these risks.
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