Trade Policy and Tariffs

The most basic function of a tariff is to increase the price of imported goods. This makes domestically produced goods more competitive. For example, if India imposes a 20% tariff on imported steel, Indian steel manufacturers can sell their steel at a slightly lower price than the imported steel and gain a competitive advantage.

Tariffs can generate revenue for the government. This revenue can be used to fund public services or reduce other taxes. However, the revenue generated from tariffs is often relatively small compared to other sources of government revenue. The primary goal is usually protection, not revenue.

Trade policies are often used to protect infant industries. The idea is that new industries need time to develop and become competitive before they can face foreign competition. Tariffs can provide this protection. For example, in the early years of its automobile industry, South Korea used tariffs to protect its domestic car manufacturers from foreign competition.

Trade policies can be used as a tool for retaliation. If one country imposes unfair trade practices on another, the affected country may retaliate by imposing tariffs on goods from the offending country. The US-China trade war under the Trump administration is a prime example of this.

A key concept is Most Favored Nation (MFN) treatment under the WTO. This means that any trade advantage (like a lower tariff) granted to one WTO member must be extended to all other members. There are exceptions, such as for regional trade agreements.

Regional Trade Agreements (RTAs), like free trade agreements, are an exception to the MFN principle. Countries in an RTA can offer preferential tariff rates to each other without having to offer the same rates to all WTO members. Examples include the European Union and the ASEAN Free Trade Area.

Trade policies can be used to achieve non-economic objectives, such as promoting human rights or environmental protection. For example, a country might impose tariffs on goods from countries with poor labor standards or weak environmental regulations.

The WTO's dispute settlement mechanism is a crucial part of the global trade system. It provides a forum for countries to resolve trade disputes peacefully and according to agreed-upon rules. If a country violates WTO rules, it may be authorized to impose retaliatory tariffs on the offending country.

A common misconception is that tariffs always benefit domestic producers. While tariffs can protect domestic industries, they also raise prices for consumers and can harm downstream industries that rely on imported inputs. For example, a tariff on steel can hurt the automobile industry, which uses steel to manufacture cars.

India's trade policy is guided by the principles of promoting economic growth, protecting domestic industries, and ensuring fair trade practices. India has been actively pursuing free trade agreements with various countries and regions to boost its exports and attract foreign investment.

UPSC often tests your understanding of the impact of trade policies on different sectors of the economy. Be prepared to analyze the winners and losers from specific trade policies and to evaluate the overall impact on economic growth and development.