Introduction 
What is Tariff Escalation? 
A Tax on Sustainability 
Environmental Effects 
Tariff Escalation—Direct Evidence   
Bias Against Developing Countries   
Bias Re-visited   
Tariff Escalation—Indirect Evidence  
Is It Optimal to Exports Raw Materials?  
Tariff Escalation and the Balance of Trade   
A Natural Question   
The Political Economy   
The Devil and the Deep Sea   
No-win!   
Win-win   
Conclusions   
Recommendations

The reduction in overall tariff rates during the successive rounds of the General Agreement on Tariffs and Trade (GATT), including the Uruguay Round, seems to have created a sense of complacency among trade activists, especially from the developed countries.  

However, the issue is not that of average tariff rates, but that of escalation in the existing structure of tariffs. Tariff escalation is said to occur when relatively high rates of tariffs are applied to imports of processed commodities compared to those on unprocessed commodities or raw materials. The issue is whether or not the prevailing escalated tariff structure in most of the developed countries is in fact a hindrance to sustainable development—a tax on sustainability. 
  
This Briefing Paper examines various issues regarding tariff escalation, including the political economy. In particular, it argues that the removal of tariff escalation will lead to a win-win situation for both developing as well as developed countries. 

What is Tariff Escalation? 

A tariff is a tax, or a duty, on the imports of a country. They are often imposed by a government in order to save the domestic producer from foreign competition. Tariff escalation is defined as that process by which relatively higher rates of tariffs are applied to successive stages of production--raw materials to final product. For instance, a country may choose to impose no tariff on the import of raw leather, but positive tariffs on the import of leather manufactures such as shoes, garments or accessories. 

When an exporter faces an escalated tariff structure, s/he will find it easier to export unprocessed goods or raw materials only. Thus, tariff escalation has the potential of hindering the growth of manufacturing industries in the exporting countries (see Box 1). 
 

A Tax on Sustainability 
The question is a debatable one--whether or not the prevailing escalated tariff structure in most of the developed countries is in fact a hindrance to sustainable development? The answer is yes, because it prevents: 

• the possibility of achieving a new era of growth in which developing countries play a larger role and reap large benefits;
• the formation of an open multilateral trading system which makes possible more efficient allocation and use of resources and to lessen demand on environment; and
• the optimal use of world’s resources seeking both to protect and preserve the environment and enhance the means for doing so.

This view of sustainable development is expressed by the Brundtland Commission’s famous report: “Our Common Future”, which reads thus: 

“Sustainable development seeks to meet the needs and aspirations of the present without compromising the ability to meet those of the future. Far from requiring the cessation of economic growth, it recognises that the problems of poverty and underdevelopment cannot be solved unless we have a new era of growth in which developing countries play a larger role and reap large benefits.” [Emphasis added]

Environmental Effects 
There are many possible ways in which tariff escalation may hurt the environment. First, if a country is forced to export primary goods alone, it is likely to cause over-depletion of natural resources and disturb the ecological balance of the region. Second, the slower rate of growth of income will leave less resource available for efficient environmental management in developing countries. Third, not only does it result in inequities in world trade, but also undermines the novelty of the notion—growth with equity.  Fourth, if processing is only done in developed countries, it may be carried out with relatively capital intensive techniques (and hence, misallocation of resources), compared to developing countries where the level of mechanisation is generally lower. 

On the other hand, the reverse is true if processing is allowed to be done in developing countries, and with labour intensive techniques which are relatively environmental friendly.  Another important reason for why the removal of tariff escalation can benefit the environment is that environmental controls are more effective on processing industries compared to the non-processing sector. 
 In other words, the removal of tariff escalation can potentially bring about a relative increase in processing activities and thus bring a larger share of economic activities under the purview of environmental legislation in the country. 

Furthermore, tariff escalation prevents specialisation according to natural comparative advantage. The basic postulate of international trade theory is that world income is maximised when countries produce what they are best at, i.e. where they have a comparative advantage. From this basic postulate tariff itself is distortionary, and by definition, reduces total income by pushing the global economic system into the “second-best” world (global allocation of resources). An escalated tariff structure is even worse, for it results in so-called “third-best” allocation of resources. In short, when countries defy the natural forces of comparative advantage, income and hence welfare is reduced, for developing as well as developed countries. 

Tariff Escalation—Direct Evidence 
We know that the post Uruguay average tariff rates are only between 3.5 to 4.0 percent? So why bother about tariff escalation? 
The above rhetoric is commonly heard today (especially in the government as well as academia of developed countries), but is completely misguided. The issue is not that of average tariff rates, but that of escalation in the existing structure of tariffs. That calls for an investigation, not merely of tariff rates on a final commodity but that of tariff rates at different stages of production of the commodity. 
 
Consider a simple arithmetic reality. If the tariff rate on a final product is even as low as, say, 0.001 percent, but that on an earlier (unprocessed or semi-processed) stage is zero percent, the rate of escalation between the two stages is still infinite! Thus, the fact that post Uruguay average tariff rates are as low as 4.0 percent, is, in itself, no guarantee whatsoever that tariff escalation is no longer a problem. 
 
Although absolute tariff rates have gone down after the Uruguay Round, the prevailing rates are still remarkably higher for higher levels of processing for almost every commodity except tobacco (see Table 1 for data on selected commodities). In all other groups, the tariff rates continue to be higher for finished products even after the Uruguay Round adjustments. 
 
In leather, for instance, there is no tariff on the import of raw leather in developed countries, but a 4.1 percent tariff on the import of finished products. In rubber, wood, jute and tin the same pattern prevails, viz., no tariff at the raw material stage but positive tariffs at the final stages. As noted above, in arithmetic terms, these sectors exhibit infinite tariff escalation. 
 

Bias Against Developing Countries 

In Table 2, columns 2, 3 and 4 report average tariff rates at different stages of production on total imports in three developed country markets, the US, the European Common Market and Japan. Column 5 reports the average tariff rate at semi and processed stages of imports from developing countries alone. The table reveals that not only there is escalation of tariffs (the rates in columns 2, 3 and 4 are progressively higher), they are also biased against developing countries on the whole (the figures in column 5 are higher than any other figure in the corresponding row). 
 

Even further, Table 3 bears additional testimony to the tariff escalation problem. It shows the pattern of tariff rates on imports to developed countries from developing countries alone. The commodity group includes all industrial products. First of all, tariff rates continue to be progressively higher at higher stages of processing even after the Uruguay Round. The change in tariff escalation (after the Uruguay Round) between the raw materials and semi-manufactures stages is -38% compared to only a -23% change between the semi-manufactures and finished product stages. Thus, the bias against finished industrial products from developing countries has only deepened in the developed country markets. The absolute rate of tariff is disturbingly high, 6.2%, on finished products, compared to 2.8% on the earlier stage. 
 
Tariff Escalation—Indirect Evidence 

It is to be noted that the escalation of tariff rates is only one of several methods that can be employed by a country to restrict access to its final goods market by foreign producers. Some of these other methods are not as visible as tariff rates that are recorded and published in systematic ways. These other methods can be broadly classified as “non-tariff barriers”. Non-tariff barriers can, and do, reveal escalation as well. That is, these barriers are deployed more heavily in manufacturing industries rather than raw materials. Thus, the effect on the growth process of a developing country will be the same as those outlined before. 
 
It is almost impossible to provide a direct account of every possible non-tariff barrier in every industry. Like tariff rates, non-tariff barriers do not necessarily lend themselves to easy numerical representation. However, since in the final analysis, the effect of such barriers will be reflected in the pattern of exports and imports of the countries involved, it makes sense to examine those in light of this possibility. The analysis of trade flows reported below brings out this ‘indirect’ evidence of escalation of both tariff as well as non-tariff barriers. The basic premise is simple: 
 
Countries that impose escalated trade barriers will tend to import less of finished goods, relative to unfinished goods, in a particular commodity group. Also, countries that face escalated trade barriers from their trading partners, will tend to export more unfinished products or raw materials in order to make up for their loss of export earnings in the final goods category. 
 
In order to prove the first part of the premise above, one can look at the pattern of imports in the “food and beverages” category of a set of  developed as well as developing countries. The import of food and beverages is sub-divided into two sub-categories, primary and processed. On the basis of the relative magnitudes of primary versus processed imports in this category it may be concluded that the access of developing countries to the processed market in developed countries is severely restricted. 
 
This assertion rests on the fact that there is a clear bias against the import of processed food and beverages in most of the developed countries including the U.S., Spain, France, Germany, Italy, Finland, Korea, Japan and even Mexico. Primary imports of food and beverages in these countries were consistently higher than processed imports over the period 1988-94. On the other hand, countries such as India, Bangladesh, China, Pakistan, Tonga, New Zealand, Australia as well as Brazil had shares of processed imports of food and beverages that far exceeded the corresponding shares of the primary category. 
 
 

Is It Optimal to Exports Raw Materials? 

Table 4 clearly indicates that many developing countries have been forced to increase their exports of raw materials in the past decade. Furthermore, it has been argued in trade and economics literature that increasing the export of raw materials is optimal when a country faces escalated tariffs. But is it really so? It may be a stop gap arrangement to make up for the loss of foreign currency earnings, but such a policy cannot be sustained in the long run. The difficulties with it are as follows: 

• the sources of most raw materials are bound to be exhausted sooner or later. If a country fails to develop a strong manufacturing base, what does it do at that point?;
• over-depletion of natural resources have serious environmental consequences;
• dependence on the export of raw materials often puts a country at the mercy of unpredictable climatic conditions. Foreign exchange earnings are thus subject to lot of uncertainty;
• even favourable climate in a particular year, leading to a great harvest, can harm a country by drastically reducing the world price of the particular crop; and

value added is lowest in raw materials. Therefore, if most of the economic activity of a country is centred around that sector, the rate of growth of its income is bound to slow down. 

Today, none of the few existing studies on tariff escalation has made an explicit reference to its relationship with the trade balance. That is surprising, since any manipulation of tariffs rates is bound to affect the trade balance by changing the relative price between traded and non-traded goods. In fact, in principle, the practice of tariff escalation goes back to the days of colonial imperialism. 
 
Colonial imperialism created a scenario where, in stage one, the centre used to import raw materials from the peripheries. In stage two, these raw materials were processed into industrial products at the centre. In the final stage, the industrial products were exported to the peripheries themselves. 
 
Since the price of the raw materials that the peripheries exported was not commensurate with the price of the manufactured goods that they were forced to import, enormous amounts of gold and other precious metals found their way out of the peripheries and into the coffers of the centre. In modern day lingo, this reflects nothing but a severe balance of trade deficit for the peripheries. Thus, one of the major motivation behind imposing the colonial pattern of trade was to boost the trade surplus of the centre. 

A Natural Question 

A natural question to ask, therefore, is whether tariff escalation, which is nothing but a legacy of the colonial pattern of trade, can boost the trade balance of developed as well as developing countries? 
 
The theoretical findings in this respect are reported below, and are based on an analytical model (the model has been fully explained in the appendix to CUTS-CITEE Research Report, No. 9707, 1997): 

• if the main exports of a country are labour intensive, it should choose (optimally) uniform or no tariffs on its imports;
• if the main exports of a country are less capital intensive compared to its non-traded goods, it can improve its own trade balance by removing escalated tariffs; and
• for optimal allocation of a country’s resources (both developing as well as developed), it is necessary as well as sufficient for the country to remove tariff escalation.

If the existence of tariff escalation results in so-called “third-best” allocation of global resources, and when it is true that the removal of tariff escalation will result in improvement of trade balance of developing as well as developed countries, then the question is what prevents its removal. The answer lies in the geo-politics of international trade which is influenced by domestic political considerations. 
 
The very existence of tariff escalation undermines the basic pillars of the GATT system: non-discrimination between trading nations and liberalisation of tariffs. 
 
However, mere questioning of the system does not answer the political economy behind tariff escalation. This answer lies at the existence and functioning of different coalitions within the domain of global political economy. The only rational answer is the existence of a coalition of interests between the producers of processed (import substitutable) goods of developed countries and their governments. This coalition is further strengthened by powerful transnational corporation’s lobby. 
 
In short, the difference between costs and benefits for different groups in the society, along with the difference in sizes of various groups, does explain the political economy behind the existence of tariff escalation. 
 
In such a situation, what are the choices of developing countries? 

The Devil and the Deep Sea 

The theoretical findings point towards a very tricky situation. Suppose that a developed country imposes escalated tariffs on its imports from a developing country. We know that from the standpoint of political economy (low bargaining power), the developing country should not retaliate but continue to increase its exports of raw materials. Therefore, 
 
Choice 1 (the Devil): Export raw materials and fall into the trap of unsustainable development? 
 
However, the government of a developing country will find it hard, if not impossible, not to retaliate with escalated tariffs on its own imports. The main reason behind it will be political and lobbying pressures from various vested interest groups (political economy within the country). Therefore, 
 
Choice 2 (the Deep Sea): Retaliate with escalated tariffs and invite a balance of trade crisis? 

No-win! 

This is clearly a no-win situation for a small developing country that faces escalated tariffs. The evidence produced earlier suggests that a number of countries are indeed pursuing the first option at least partially (see Table 4). The present economic condition of India seems to indicate that the second evil is also becoming a reality. 
 
India opted for economic liberalisation in 1991. The currency was devalued in order to bring it closer to its market rate and tariff rates were greatly reduced. As a result, India witnessed a healthy improvement in its trade balance. Its foreign exchange reserves rose to an all time high. Then came the slowdown, which was caused partly by the increase in new trade barriers that Indian manufactures were forced to encounter in the developed world. As a result, trade deficit has raised its ugly head again. The currency has taken a beating and there is a call for a further devaluation. Thus, by retaliating ever so slightly, a poor country can trigger a new set of crises all together. 

Win-win 

Apparently, there is no choice for developing countries. However, that is a politically reactive way to approach the issue. The first choice suggests defeat even without playing ball, while the second one is overtly reactive. 
 
At the same time there is a politically pro-active way out. This is the, formation and strengthening of coalition of interests between developing countries, producers (of processed goods which are labour intensive) and developed countries consumers. The thread of formation of such a coalition is civil society at large, particularly the consumer and developmental (environmental) organisations of developed as well as developing countries. In that case only, it will be politically feasible for the developed countries' governments to remove tariff escalation and thus, create the base for a win-win situation. 

Conclusions 

It is obvious that in spite of widespread reductions in tariff rates in practically every country, the existing structure reveals escalation and is biased againsts the interest of developing countries. Tariff itself is distortionary, and by definition, reduces total income by pushing the global economic system into the “second best world". A distorted (escalated, for instance) tariff structure is even worse, for it results in so-called “third best” allocation of resources. 
 
The first and foremost effect of a distorted tariff structure is thus to reduce income in all countries. The reduction in income automatically makes less resources available for the protection of environment. It is widely recognised amongst environmentalists 
in developing as well as developed countries that resource crunch is the single most important obstacle in the launching of programs to protect the environment. Tariff escalation makes matters worse. 

Tariff escalation creates pressure on developing countries to export products that go through minimum amount of processing at home. These are inevitably raw materials or some very primitive manufactures that command low prices in the world market. It is impossible for a developing country to pay for its growing imports with the help of such limited exports. 
 
Developing countries often try to make up for the low prices that their exports command by increasing the volume of exports. This involves the cultivation of low quality or marginal lands as well as deforestation. Both these practices have disastrous consequences for the environment. 
 
From a theoretical angle it may be argued that developed countries, whose exports are largely capital intensive (non-traded goods are relatively more capital intensive), have an incentive to remove escalated tariff structure in order to improve their trade balances. At the same time, it is not optimal for developing countries also, whose exports are mainly labour or natural resource intensive, to retaliate with escalated tariffs. 
 
This creates a double dilemma for developing countries. If they do not retaliate, they fall into the trap of unsustainable development. If they do retaliate by slowing down tariff reforms, they stand the risk of deteriorating trade balances. The present scenario in India is a case in point. 
 
However, that is a reactive way of approaching the issue. The pro-active way out, can be found if there is a strong coalition of interests between developed countries consumers and developing countries' producers (of processed goods). 
 
Finally, it is to assert that the evils of tariff escalation are not just restricted to lower imports of processed goods, and thus deterioration of trade balance in both sets of countries. Even further, tariff escalation can trigger off economic, environmental as well as social crises of a much more serious nature, and in both sets of countries. And, thus the veritable—a tax on sustainability. 
 

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