Executive Summary
[Released under the Official Information Act]
This research was undertaken for the Ministry of Economic Development, which is co-ordinating the officials review of post-2005 tariffs. The objective of the research is to recommend what should happen to import tariffs when the current freeze on further reductions ends in 2005. The recommended tariff regime beyond 2005 should be informed by the expected medium to long term benefits of one regime versus another and the transition costs associated with moving to a regime which is different from the current one.
The research has four main components:
- An historical assessment of the effect of tariff changes on manufacturing industry employment, from the perspectives of region, ethnicity, gender, household type and income.
- A postal survey of companies in industries which currently enjoy tariff protection, to establish the relative significance of tariffs to firms.
- A series of case studies to better understand the micro-economic adjustments associated with tariff changes, both past and future.
- General equilibrium modelling to analyse the macro-economic and industry effects of various tariff change scenarios.
These sections are preceded by an Overview discussion on where tariff changes sit within the context of broader economic reform, dealing with issues such as the capture of economic rents, reciprocation and dislocation costs.
Our main findings are summarised below.
Historical Impact of Tariff Changes on Industry
- Past tariff reductions on clothing and footwear have led to noticeable changes in the relative share of these industries in total manufacturing, as measured by employment shares. This translates into observable effects by region, by ethnic group, by gender and by household type.
- Beyond these industries, however, there is little evidence of a consistent relationship between tariff changes and changes in industry employment. It is likely that the effects of other economic events such as changes in monetary policy and the terms of trade have outweighed the effects of tariff changes.
- Nevertheless the data suggests that a few communities might merit some assistance if tariffs are reduced quickly in future. This is because the consumer benefits of lower tariffs are much more widely dispersed than the industry dislocation effects.
Postal Survey
- The results of the survey confirm the inferences drawn from the case studies in most instances. Most notably, tariffs are not a amongst the most important issues for most companies. This is primarily true for companies which either are or have become less labour intensive, more export oriented, and more innovative in terms of product development, sourcing of materials and production processes.
- Nonetheless there are a few companies, mostly in the clothing and footwear industries, for whom tariffs provide a significant degree of protection to their margin.
Case Studies
- A combination of lower tariffs, increased competition, high real interest rates, a floating exchange rate, changes in labour market conditions, and business failures has forced manufacturers to shift from a cost-plus (1980s) to a cost-down (1990s) business approach.
- Of the 26 firms interviewed we would classify at least three firms as being subsistence businesses - they provide a cash surplus, they have some valuable assets on their balance sheets (mainly buildings), but they are vulnerable to imports eating away at what is left of their customer base.
- There are around four or five firms that are indifferent to what happens to tariffs. Their businesses are financially sound and they have product that would continue to compete effectively with lower priced imports. Quality, customisation, speed, design, and a significant level of natural protection are important ingredients to the commercial robustness of these businesses.
- The majority of firms occupy the middle ground on tariffs. They benefit from their existence but would survive or adapt to the introduction of lower tariffs.
- The tariff freeze is generally regarded as a helpful pause in the steady squeeze on margins that firms have had to manage over the past decade or more. A number of firms made the point that a period of stability has been very valuable in allowing/ encouraging them to think longer term. The increased certainty has led some firms to undertake investment and expansion they probably would not otherwise have embarked on.
General Equilibrium Analysis
- Moving from the current tariff regime to free trade generates only a small gain in welfare, as measured by changes in private consumption or gross domestic product (GDP). Thus it is reasonable to infer that partial reductions in tariffs would yield even smaller effects.
- Even on the assumption that there would be some dynamic efficiency gains, the macroeconomic gains from free trade are unlikely to exceed 0.1% of GDP. That is, the level of GDP would permanently be higher by less than 0.1%.
- The simple point is that New Zealand has secured most of the gains from lower import protection already; firstly by the removal of import licensing, secondly by bringing down the "tall poppies" and thirdly by lowering the entire tariff profile to the point where the mean price of goods imports is about 1% higher than what it would be without tariffs. The additional gains from a possible fourth stage - free trade - are small by comparison, even allowing for some additional increase in variety and quality; attributes which are difficult to measure, but which increase the consumer gain from lower border protection.
- The industries which would incur the greatest losses in output under free trade are clothing and footwear, with the reductions in output being about 8% in each case. Small gains accrue to industries such as forestry, dairy and meat processing, base metals, and machinery and equipment.
Recommendations
While the macroeconomic gains from further reductions in tariffs are likely to be small, considerations such as market signalling and rent seeking behaviour lead us to the view that all tariffs should eventually be abolished. Furthermore, the weight of evidence collected from industries demonstrates that few companies benefit significantly from tariff protection, while for many companies the tariff regime has an adverse effect on profitability, either by raising input costs or compliance costs. In addition, those companies for whom tariffs are important tend to be those with relatively poor productivity, with low foreign exchange earnings and with mediocre future viability.
Of course this is a generalisation; many would be viable without tariff protection if given enough time to adjust. A reasonable adjustment period would also minimise the economic losses associated with transition costs, although historical evidence suggests that these costs are unlikely to be substantial and would probably be unobservable within the usual year to year variation in economic growth, even in specific regions.
For these reasons we advocate a phased reduction of tariffs over the next 5-10 years:
- After the current freeze ends, all tariffs should be progressively reduced to zero.
- Before the freeze ends and preferably as soon as possible, the path of tariff reductions should be announced. A multi-party accord, although difficult, would add credibility to the policy, provide business certainty and would minimise the chances of more deferrals through industry lobbying against future reductions.
- The path of tariff reductions should ensure that the cost of delays does not exceed the loss from accelerated depreciation of productive capital stock.
- In addition, the process of reduction should begin by simplifying the tariff regime so that tariffs are expressed in multiples of 5%.
- Given these criteria, we recommend the following path:
- 2003: Announce future path of tariff reform.
- Immediately post freeze: All tariffs drop to the next lowest multiple of 5%.
- Thereafter: every two years tariffs drop by a further five percentage points until they reach zero. Given the current tariff structure, most tariffs would be zero by 2010, in line with the Bogor goals of "free and open" trade and investment by 2010 for developed countries. (Developing countries have until 2020.) Most protected companies would have an adjustment period of at least seven years.
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