Tariff:

As you have  read  in  the  theory of protection in Unit 4,  tariff  has three functions: (i) it provides revenue to  the  government, (ii) it protects the domestic product  from  competition with the imported product as the latter becomes more costly because of  the tariff and (iii)  it  is an  instrument  in development policy for discouraging non-priority import e.g., luxury goods, and  encouraging priority imports,  e.g.,  capital goods  and  industrial intermediates.

Normally tariff  is fixed as  a percentage  of  the price of a product. Thus when we say that  the  tariff on a product  in  a country is  15 percent,  it means that the government charges customs duty at the rate of  15 percent of the price. This type of charging  of  tariff is called "ad  valorem" tariff, signifjlng  that it is based on  the value of  the product. There are some  instances of another form of charg- ing of  tariff which is called "specific"  tariff. In this method,  the  tariff is fixed at the rate  of some amount per unit  of quantity, for example, Rupees  10  per kilogram. Now there is a decision in the WTO that all tariffs must be fixed on ad valorem basis. The c ustoms  duty is charged at  the time  of  entry of  the tariffs have been substantially reduced over  the several rounds of multilateral trade negotiations (MTN) in the GATTIWTO system. Generally the developed countries have  low  tariffs; on an  average about 4 percent. The developing countries have comparatively high tariffs, on an average about 27 percent. The developed countries, however, have retained tariffs much higher  than  their average on the products which are of main export interest to the developing countries.

The developing countries have reasons for maintaining higher tariff. For them, it is an important and convenient source of  revenue. It also helps them to ration their scarce foreign exchange among competing imports; for example as mentioned earlier,  they  can discourage the import of luxury products and encourage the import of industrial raw materials by having high tariffs on the former and low tariffs on the latter. More importantly, tariffs are virtually the only instrument for protecting their industries from competing imports.

In the course of the multilateral trade negotiations (MTN), countries undertake obligations not  to raise tariffs on specified products beyond specified limits. These  tariffs are said  to be "bound". A country may apply a tariff lower  than the bound level on that product, but it cannot generally go beyond the bound level, except as a temporary measure under some contingency provisions that will be explained  later. \hen  it wants to raise the bound tariff level on a regular basis, it has to negotiate with other countries and has to offer compensation in the form of reducing its tariffs on certain other products of interest to other coun- tries.

There are two contingency situations in which the tariff can be raised higher than the bound level and a country can also put quantitative limits to the  import of particular products. These situations are: firstly, providing "safeguard" to the domestic industry against sudden surge of imports, and secondly, tiding over the problem of the shortage of inflow and reserve of foreign exchange, technically called the "balance of payment (BOP)" problem.