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A paper prepared by the Economic Division of the Ministry of Foreign Affairs and Trade, Wellington, New Zealand in August 2002.
Tariff escalation takes place when further processed goods face higher import duties at the borders of our markets than those levied on the base raw material. The objective of this paper is to examine the issue of tariff escalation as it potentially impacts on the export from New Zealand of value-added products in the forestry sector. We find that logs are generally imported duty-free while processed products such as veneers and plywood face higher duties. This inhibits further processing in New Zealand. A methodology is developed to demonstrate just how serious this issue is.
The New Zealand radiata pine plantation harvest of 18.6 million cubic metres in the year to June 2001 is forecast to increase by 24 percent by 2005 and grow a further 56 percent by 2020 to reach 36 million cubic metres. Due to the limited size of the New Zealand market most of the increase in production needs to be exported. The forest industry is important to New Zealand, as it is currently providing around 4 percent of New Zealand’s GDP and is the largest earner of non-agricultural merchandise export returns. To maximise benefits to the New Zealand economy, a major co-ordinated effort is required to develop current export markets and to find new ones for those value-added wood products that provide a higher return.
The Ministry of Foreign Affairs and Trade (MFAT) recently published a report of the significance of the Uruguay Round (UR) for New Zealand’s merchandise exports, with an emphasis on the analysis of tariff reductions[1]. This study was limited to those countries that were founding members of the WTO, and the “gains” were measured as reductions in duties actually paid during 2000 compared with those which would have been paid that year had the pre-Uruguay Round duties still been in place. During the December 2000 year, forestry exports totalled $3.26 billion. Fifty eight percent or $1.88 billion has been included in the original WTO member market analysis. “Gains” of $27.8 million were recorded to New Zealand exporters over that 2000 December year, while remaining tariffs were calculated to be $31.5 million or 1.7 percent.
The data was updated for the December 2001 trade year, and the applied tariffs on exports worth $3,015 million were analysed. This represented exactly 90 percent of the total forestry exports over the period, with the “missing” ten percent being exports in lines of less than one million dollars at the HS 8 digit level. Duties of $37.8 million were levied on these exports, with the average duty rate at 1.25 percent (this analysis includes Australia, our CER partner, and the duty-free destinations of Singapore and Hong Kong). Thus, we can say that the overall level of tariffs faced by our exporters of forestry products is not high, although of course the current trade patterns may hide some “trade chilling” or prohibitive tariffs. Other MFAT analysis and review work suggests also that non-tariff barriers to forestry exports are important. While these problems are a serious impediment to trade, the relevant authorities are generally addressing them.
Paragraph 16 of the Doha ministerial declaration commits WTO members to negotiate the reduction, or where appropriate, elimination of tariff barriers (including tariff peaks, high tariffs, and tariff escalation) and non-tariff barriers to trade in non-agricultural products. As with other negotiating areas, negotiations on non-agricultural market access are to be concluded by 1 January 2005. The first stage will be for WTO members to decide how the negotiations should be conducted (this is called agreeing on “modalities”). Possible modalities for tariff reductions include percentage cuts, formula cuts (for example, a formula which aims for proportionately greater reductions for the highest existing tariffs), initiatives that aim to reduce all tariffs in certain sectors to zero (as happened in the Uruguay Round), and bilateral request/offer negotiations. New Zealand’s objectives for non-agricultural market access under the Doha Development Agenda are to:
The objective of this paper is to examine the concept of tariff escalation in the forestry sector and the extent to which this escalation may be inhibiting current trade flows. The paper is therefore set against this introductory background.
Most general issues about tariffs are well known. There is the concept of tariff peaks, whereby tariffs on some products are set at an extremely high level, particularly in relation to other tariffs on similar products. There is the concept of “water in the tariff”, whereby a tariff is set at a level much higher than is needed to inhibit trade, and in fact ends up prohibiting that trade. There are issues between an ad valorem and a specific tariff rate (where the tariff is levied at a per unit amount and the tariff’s effect will vary with world price and currency changes). There is the WTO concept of bound versus applied tariff rates, and there are issues on whether these rates are applied on fob or cif values (i.e., does the tariff include freight etc – in New Zealand it does not, while for many other countries it does). There are also issues on “tariff add-ons”, whereby special additions are made to the tariffs charged (the Indian Tariff Schedule includes a number of these).
Finally, there is the issue of tariff escalation. Tariff escalation refers to the situation whereby a tariff on a product increases as that product moves through the value-added chain. An example would be a five percent tariff on coffee beans but a ten percent tariff on ground coffee. The general purpose of that tariff would be to protect the domestic industry by enabling them to import the basic raw material tariff-free or at low rates to enable the value-adding process to go on behind these tariff walls.
There are two ways of measuring this tariff escalation effect. The first and easiest measure is just the simple nominal tariff escalation, or the difference on tariff rates between the raw material and the processed product. In our coffee example below, the difference between five percent and ten percent is five percent; therefore the nominal tariff escalation is five percent. This is easy to use, and especially so if the processed product is derived mainly (or entirely as in the coffee example) from the one raw material (coffee beans). It tells us little however about the real trade impact of the tariff escalation, and to look more closely at the trade effect we need to examine the “effective tariff rate”, or ETR.
This ETR is analogous to the better-known Effective Rate of Protection (ERP), a measure that has been applied to measuring the actual rate of protection to the domestic industry from the domestic perspective. This ERP is defined as “The effective rate of protection of an individual industry the percentage by which the entire set of a nation’s trade barriers raises the industry’s value added per unit of output”[2]. The effective rate of protection will be higher than the nominal tariff protection levels when the final product is more heavily protected than base inputs. The effective rate of protection looks at the protection given to the domestic industry sheltering behind those tariff walls, and uses the domestic cost structure to calculate the final rate. In this case we are trying to find a similar rate of protection, but this time from the exporter perspective. The ETR is therefore a mirror image of the ERP, but this time using the exporting nation’s cost structure and with the protection in the final market expressed as “tariff equivalents” or the ETR.
Let us take the coffee bean/ground coffee example further. The nominal tariff escalation was five percent, as discussed above. Now, let us say that coffee beans represent one half of the costs of producing ground coffee. Let us also assume that there is no difference in transport costs between beans and ground coffee from the exporter to the foreign market place - we could relax this assumption, although the current paper on forestry exports does not because of data limitations. Table 1 shows that for $100 worth of ground coffee the exporter is faced with a tariff bill of $10 at the border. This is the 10 percent ad valorem tariff rate. Had the exporter sent just coffee beans, the tariff bill would have been $2.50 on the $50 worth of beans. In the meantime there has been value of $50 added to the beans, but an additional $7.50 in tariffs has been levied. Thus, the ETR on the final product is 15 percent and not 10 percent. The exporter must pay this 15 percent duty ($7.50) on top of whatever other costs were entailed in grinding the coffee beans in order to access the foreign market. Tariffs will greatly erode the final profit margin, and at some point it will not be profitable to grind beans for that market. This is shown diagrammatically in Table 1 below. The crucial question is: are we adding value or merely adding cost?
Value $ |
Value-added $ |
Duty rate % |
Duty value $ |
|
| (1) Nominal | ||||
Coffee beans |
$50 |
na |
5% |
$2.50 |
Ground coffee |
$100 |
$50 |
10% |
$10 |
| (2) ETR | Value-added $ | Extra tax $ | Therefore ETR becomes | |
Ground coffee |
$50 |
$7.50 (10-2.50) |
15% ($7.50 tax on $50) |
|
| It has cost $7.50 in order to obtain an extra $50 in the foreign market | ||||
If the nominal tariff escalation increases, perhaps by increasing the tariff on ground coffee to 15 percent, then the ETR will also increase (to 25 percent in this case, another $12.50 on the $50 value-added processing). Similarly, a change in the percentage that beans make up of the final cost of ground coffee will alter the ETR. This change could come about through technological change (a new process to grind coffee) or a change in the relative prices of the inputs into the value-added process, including a change in the price of beans.
Thus, the ETR is a function of the tariffs assessed on the component parts and the final product, the technological process involved, and the relative prices of all inputs into the final product. It is purely and simply a tax on value-added processes. In some (rare) cases this can actually be negative, as the tariff on the final product may be less than the tariff on the raw material, but this is very much the exception[3]. If the tariff rate is the same for both the raw material and the final product, then the ETR is zero. Note that that same rate may or may not be zero. Note also that there are cases when the raw product itself represents the highest value that can be obtained from that product. A case in point is a crayfish, where the greatest value that New Zealand can obtain from that crayfish is to take it live and place it in a tank in an overseas (generally North Asian) restaurant. Nothing more can be done to increase that crayfish’s value to New Zealand, and in fact any attempts at further processing reduces it value.
It has generally been speculated that the ETR is high in some forestry products into New Zealand’s markets, and this paper will examine that hypothesis
Technical data for this section of the study was obtained from the report “Wood Processing Comparative Model”, a report prepared for Investment New Zealand by Jaakko Poyry in September 2001. Special thanks are due to its author, Marcel Vroege, for helpful comments and advice in the preparation of this current paper.
The technical data as shown in Table 2 has been used in this paper. The values are expressed in US dollars, but the same final outcome is valid for New Zealand dollars or any other currency units. Let us work through the example of Mouldings, HS code 4407108, in Table 2. Wood costs at $220 per cubic metre are the main costs, with energy etc (i.e., all non-labour costs of processing) at $21 and labour at $99 per cubic metre. This gives an end value of $340 per cubic metre for mouldings, with added value past the log stage of $120. It is this $340 (plus freight difference, discussed below) that the final tariff is levied on, and not the value-added of $120.
HS |
Product |
wood |
energy |
labour |
added |
Final |
|
|
etc |
|
value |
value |
|
4403 |
Logs* |
|
||||
4407108 |
Clear wood |
70 |
25 |
17 |
42 |
112 |
440910 |
Mouldings |
220 |
21 |
99 |
120 |
340 |
9403 |
Furniture |
220 |
25 |
199 |
224 |
444 |
440810 |
Veneers |
300 |
22 |
202 |
224 |
524 |
441219 |
Plywood |
40 |
56 |
45 |
101 |
141 |
44112/3 |
Fibreboard |
20 |
76 |
15 |
91 |
111 |
44103 |
Particleboard |
10 |
61 |
38 |
99 |
109 |
4701 |
Mechanical pulp |
63 |
106 |
22 |
128 |
191 |
Source: Jaakko Poyry Report.
*Logs are introduced into the table because they represent the base material.
Two qualifying points need to be discussed. One is the three-step process needed for manufacturing furniture, while the second is the question of freight. In the first case, that of furniture, the three steps are from logs to clear wood (sawn timber) and then to furniture. The manufacturing process has been compressed down to a two-step process for this paper, so therefore the ETR for furniture will be an approximation. Freight is another complicating factor. Logs are exported as a bulk commodity and as such face low per unit freight costs. Processed products require more sophisticated and therefore more costly handling than logs. An accurate assessment of the full impact of freight costs would require a detailed analysis of the differences in these costs by product to each individual market, whereas the costs in Table 2 are invariant as to destination. The freight costs will therefore increase the ETR, and the values seen below in Table 4 are an under-estimate. The general point remains valid for both furniture ETR values and the overall ETR estimates in the absence of the freight costs.
Tariffs for the main forestry products as outlined in Table 2 are shown below in Table 3. These are the applied tariffs, and they are sourced from the relevant country Tariff Schedules. Rates shown for Taiwan are the WTO final tariff rates, although this makes a difference in only one tariff line.
Korea |
US |
Taiw |
China |
Japan |
Malay |
Indon |
Phil |
Thai |
|
Product |
|
||||||||
Logs |
2 |
0 |
0 |
0 |
0 |
0 |
0 |
0 |
10 |
Clear wood |
5 |
0 |
0 |
0 |
4.8 |
0 |
0 |
10 |
10 |
Mouldings |
8 |
0.3 |
0 |
9.4 |
5 |
20 |
0 |
7 |
20 |
Furniture |
8 |
0.5 |
0 |
11 |
0 |
30 |
15 |
20 |
20 |
Veneers |
5 |
0 |
0 |
4 |
5 |
20 |
5 |
10 |
20 |
Plywood |
8 |
10.4 |
0 |
8.4 |
15 |
35 |
15 |
20 |
20 |
Fibreboard |
8 |
6 |
0 |
7.5 |
2.6 |
20 |
5 |
20 |
20 |
Particleboard |
8 |
8 |
0 |
9.6 |
5 |
20 |
5 |
20 |
20 |
Mechan pulp |
0 |
0 |
0 |
0 |
0 |
0 |
5 |
3 |
5 |
Table 4 combines Tables 2 and 3 to produce the ETR for the main forestry products. Taiwan stands out with all zeros, as the applied rate is zero (or will be soon) on all the forestry products of interest to this study.
Korea |
US |
Taiw |
China |
Japan |
Malay |
Indon |
Phil |
Thai |
|
Product |
|
||||||||
Clear wood |
10.0 |
0 |
0 |
0 |
12.8 |
0 |
0 |
26.7 |
10.0 |
Mouldings |
19.0 |
0.85 |
0 |
26.6 |
14.2 |
56.7 |
0 |
19.8 |
38.3 |
Furniture |
13.9 |
1.0 |
0 |
21.8 |
0 |
59.5 |
29.7 |
39.6 |
29.8 |
Veneers |
9.0 |
0 |
0 |
9.4 |
11.7 |
46.8 |
11.7 |
23.4 |
33.4 |
Plywood |
10.4 |
14.5 |
0 |
11.7 |
20.9 |
48.9 |
20.9 |
27.9 |
24.0 |
Fibreboard |
9.3 |
7.3 |
0 |
9.2 |
3.2 |
24.4 |
6.1 |
24.5 |
22.2 |
Particleboard |
8.6 |
8.8 |
0 |
10.6 |
5.5 |
22.0 |
5.5 |
22.0 |
21.0 |
Mechan pulp |
-2.0 |
0 |
0 |
0 |
0 |
0 |
7.5 |
4.5 |
2.5 |
Where the country codes are as in Table 2.
The highest ETRs are those displayed in Table 4 for Malaysia, followed by the fellow ASEAN members of Thailand and the Philippines, and a feature of the data is the variability, both between countries and products and even within countries across the different final products. Analysis of the differences between the four North Asian destinations shown in Table 4 and the four ASEAN destinations highlights just how much higher these ASEAN ETRs are. In most cases they are, on average, at least double those for the North Asian markets, and up to 4.4 times the average North Asian ETR for furniture.
Some of these ASEAN countries are major exporters of forestry products. In 1999 Malaysia exported US$980 million worth of lumber[4] compared to New Zealand’s US$380 (and Indonesia’s US$241) according to the UN statistics. Similarly, over the same period Indonesia exported veneers and plywood worth US$2,916 million and Malaysia US$1,389million compared to New Zealand’s US$94 million over the same period. Importantly, these ASEAN exports are almost all tropical hardwoods, and these are most likely to have been harvested in a non-sustainable manner. Thus, a reduction in the ETRs for forestry exports to ASEAN would produce a global win-win outcome: both economic efficiency and environment sustainability would be enhanced.
Table 5 gives a glimpse of the trade impacts of these ETRs by examining the December 2001 exports from New Zealand (expressed in NZ dollar millions). If we were to visualise an overlay of the trade data in Table 5 with the same cells showing the ETR values in Table 4, we would see that only in the case of Japan’s clear wood and plywood trade (and possibly the lesser exports of clear wood, veneers and fibreboard into the Philippines) is there significant trade taking place where there is an ETR in that cell of above 10 percent. This provides good evidence that tariff escalation inhibits trade flows in value-added products.
Korea |
US |
Taiw |
China |
Japan |
Malay |
Indon |
Phil |
Thai |
|
Product |
|
|
|
|
|
|
|
|
|
Logs |
410 |
3 |
11 |
89 |
188 |
2 |
0.02 |
25 |
7 |
Clear wood |
10 |
362 |
34 |
34 |
95 |
6 |
11 |
8 |
|
Mouldings |
50 |
1.3 |
0.2 |
||||||
Furniture |
0.1 |
4 |
1 |
|
|||||
Veneers |
2 |
1 |
2 |
0.01 |
0.1 |
9 |
|
||
Plywood |
2.3 |
0.04 |
109 |
|
|||||
Fibreboard |
21 |
38 |
13 |
29 |
124 |
2 |
10 |
4 |
0.2 |
Particleboard |
0.04 |
0.08 |
48 |
0.1 |
|
||||
Mechan pulp |
6 |
7 |
40 |
76 |
13 |
0.02 |
0.2 |
Where the country codes are as in Table 2.
The Jaakko Poyry report contains valuable data on international costs of production. Of particular interest is the New Zealand/Chilean comparison, as although this is not directly related to the present study it is relevant in the wider sense. It would however become especially relevant should Chile gain preferential access to competing markets. Table 6 outlines the production costs from Jaakko Poyry, with all costs being in US dollars per cubic metre to enable a direct comparison. In all cases except fibreboard Chilean wood costs are higher, while the other costs are lower. By virtue of the lower labour (and other input) costs Chile is able to produce product cheaper than New Zealand, as the table shows. No production data is available for Chile for particleboard and mechanical pulp.
| Product | Wood Costs | Added value Costs | Final Costs | |||
NZ |
Chile |
NZ |
Chile |
NZ |
Chile |
|
Clear wood |
70 |
80 |
42 |
30 |
112 |
110 |
Mouldings |
220 |
240 |
120 |
76 |
340 |
316 |
Furniture |
220 |
240 |
224 |
90 |
444 |
330 |
Veneers |
300 |
350 |
224 |
133 |
524 |
483 |
Plywood |
40 |
42 |
101 |
78 |
141 |
120 |
Fibreboard |
20 |
16 |
94 |
83 |
111 |
99 |
Source: Jaakko Poyry Report
One impact of the lower cost structure for Chile is that, despite having higher raw material costs, their ETR is higher than New Zealand’s by virtue of the lower percentage of final product represented by other input costs. This highlights an assumption made in the current paper; namely that the final production costs represent the market value of the product.
The objective of this section is to examine the implications of CER for the New Zealand’s forestry exports to Australia. Table 7 details the Australian tariff data, with the “Book” tariff being the MFN rate that New Zealand would have paid in the absence of the CER agreement, the ETR again being the tariff on the extra value-added component demonstrating the tariff escalation (or the escalation that New Zealand would have faced in the absence of CER) and finally the exports from New Zealand to Australia in the December 2001 year. Australia has zero MFN tariffs on both logs and mechanical pulp, and an even MFN “book” tariff of 5 percent levied on all the value-added products under scrutiny in this study. Thus, the ETRs are relatively low and even, as shown in Table 7.
The natural consequence of CER is that the ETRs do not apply to New Zealand. This will alter the trading patterns, and that change is clearly shown in Table 7 below. In stark contrast to most entries in Table 5, forestry exports to Australia are almost entirely value-added products. While of course Australia is not a representative market and we cannot draw a conclusive linkage from these patterns and the lack of ETRs to what may happen in Asian markets should the high Asian ETRs be neutralised, we can at least regard the different trade patterns as indicative of what may happen. The other case study that is of interest is the Taiwanese market, but it must be recognised that the ETRs have only gone to zero with the new tariff schedule adopted by Taiwan as a result of their recent WTO accession. Consequently, there has not been enough time to reflect possible changes to established trading patterns.
Logs |
0 |
0 |
0.1 |
Furniture |
5 |
9.9 |
53 |
Product |
Book Tariff |
ETR |
NZ Exports, Dec 01, $m |
Logs |
0 |
0 |
0.1 |
Clear wood |
5 |
13.3 |
197 |
Mouldings |
5 |
14.2 |
33 |
Furniture |
5 |
9.9 |
53 |
Veneers |
5 |
11.7 |
1 |
Plywood |
5 |
7.0 |
20 |
Fibreboard |
5 |
6.1 |
26 |
Particleboard |
5 |
5.5 |
11 |
Mechanical pulp |
0 |
0 |
0.4 ($96m chemical pulp) |
[1] “The Uruguay Round: Significance for New Zealand’s merchandise Exports with an Emphasis on the Analysis of Tariff Reductions”
[2] “International Economics”, Peter Lindert and Thomas Pugel, 10th Edition, 1996. Irwin Publishers. Page 123.
[3] Table 4 later in the paper shows an example of this, where the duty on logs into Korea is 2 percent but further processed mechanical pulp enters duty-free.
[4] This data is by SITC classification and not the HS classification used in the current paper.
