The protective effect of a tariff (import duty) is measured in nominal terms as follows:
NRP = Nominal rate of protection by tariff (import duty).
Ph – Domectic or home market price of the product including tariff.
Pw = World market price of the product excluding tariff.
Say, for instance, a CD player’s world market price is Rs. 10,000. The government imposes custom duty (ad valorem) of Rs. 2,000 on the imported price, so that, its domestic market price becomes Rs. 12,000.
Hence, the nominal rate of protection in this case is:
The effective rate of protection (BRP) is, however, measured by using the formula:
TRg = Norminal rate of tariff on imported product
= Ratio of the value of imported input component (c) to original world market price of the product (g) without tariff.
TRc = Tariff rate (%) on imported component.
Now, suppose in our illustration, the domestically produced CD player costs Rs. 10,000 of which the contribution of domestic factor cost is Rs. 5,000 and imported input component is Rs. 5000. Assuming, input components are duty-free, the effective rate of protection is measured as under:
If, however, there is some import duty say at 10% on imported components, then:
If, say, tariff on imported component is also 20 per cent. 0.2-(0.5 x 0.12) 1-0.5
This means, when nominal tariff rate on imported input components and the final product is the same, the effective rate of protection would be equal to the nominal rate of protection.
Further, only when nominal tariff rate on final product imported exceeds that on the imported input component, the effective rate of protection would tend to be higher than the nominal rate of protection.
Apparently, if the nominal tariff rate on imported component is higher than that on the final product, the effective rate of protection will tend to be less than the nominal rate of protection.
In our illustration, suppose nominal rate of tariff on imported component is 30 per cent, then:
That is to say, effective rate of protection in this case is 10% as against 20% nominal rate of protection.
From importers point of view, nominal rate of tariff is important for it affects the domestic price of the imported products. To a producer, however, effective rate of protection of tariff on imported input component is more important in taking its business decision. The resource-allocation effect of tariff structure, thus, largely depends on the effective protective rate of tariff and the gap between the nominal and effective protective rates of tariff. The government should also device its protection policy in the light of the effective rate of protection rather than mere consideration of the nominal rate of tariff. Usually, in tariff policy raw-materials and input components are allowed duty free or at lower tariff rates and the final product imports are heavily taxed to protect the domestic industries in manufacturing and electronic goods.
Data in relates to the average rate of protection (measured considering tariffs plus the tariff equivalent of import quota) for selected categories of developing countries.