In recent months, growing evidence has shown that there seems to be an apparent trend for backsliding or reversal of the government policy on tariff reduction. Why is this happening? And what is its implication? The authors claim that backsliding in the government's tariff policy can do more harm than good--this Notes explains why.trade liberalization, trade reforms, tariff reduction, tariff policy

Aldaba, Rafaelita M.

Medalla, Erlinda M.

English

Research Papers in Economics

Policy Notes
September 2003 No. 2003-10
PHILIPPINE INSTITUTE
FOR DEVELOPMENT STUDIES
Surian sa mga Pag-aaral
Pangkaunlaran ng Pilipinas
“No” to policy reversal...
Backsliding in Tariff
Policy Can Do More
Harm than Good
Erlinda M. Medalla and Rafaelita M. Aldaba*
_______________
*The authors are Senior Research Fellow and Research Associate,
respectively, at the Philippine Institute for Development Studies (PIDS).
rade liberalization has been widely implemented
in the Philippines in the last 10 to 20 years.
And while the trade reforms initiated in the
1980s were not sustained, the reforms in the
1990s were carried out with much vigor. This is seen in the
drop of the average tariffs from over 40 percent in 1980 to
eight percent in 2000. Average tariffs will have also fallen
to four–five percent in 2004.
The trade reforms had resulted in changes in the
country’s output structure and export orientation. In the
manufacturing industry, for instance, there has been a shift
from consumer goods like food processing and beverages
to intermediate goods like chemicals and petroleum refiner-
ies. The share of capital goods in our production output has
risen due to the growing importance of electrical machinery
and professional and scientific equipment. In terms of ex-
port orientation, meanwhile, the share of manufactured
goods to total exports increased from 25 percent in 1981-
1985 to 90 percent in 1996-2001.
T
Doubts linger...
Despite these improvements in trade and overall domestic
resource allocation brought about by the trade liberalization
measures, however, certain quarters still remain skeptical
and are concerned about the “subdued” effects of said re-
forms on the domestic economy. They raise doubts about
the slow growth of the manufacturing value added vis-à-vis
the fast growth in manufactured exports. One potential ex-
planation for this is the continued dependence of our manu-
factured exports on imported inputs and the lack of back-
ward linkages with domestic output. Still, albeit the continu-
ous decline of manufacturing value added during the 1980s,
there are signs of gradual improvement in the 1990s as the
share of manufacturing increased from 21 percent in 1990
to 24 percent in 2000.
Another source of concern among certain quarters that
raises doubts on the benefits of the trade reforms is the
lack of growth in total factor productivity. This poor perfor-
mance has been attributed to both adverse domestic and
international shocks that hit the country as well as the ad-
justment lags that have accompanied our trade reforms.
Nonetheless, in the more recent period of 1996-2001, some
small positive contribution in factor productivity has been
observed. It remains to be seen though on whether this
gain could be sustained or not.
Sustaining trade reforms being made difficult
The transition from a highly distorted trade regime in the
1960s and 1970s to a more liberal one in the 1980s and
thereafter is a long and difficult process. In reducing protec-
tion to high-cost firms, trade liberalization results in the low-
ering of domestic prices and in forcing such kind of firms to
PIDS Policy Notes are observations/analyses written by PIDS research-
ers on certain policy issues. The treatise is holistic in approach and
aims to provide useful inputs for decisionmaking.
The views expressed are those of the author and do not necessarily
reflect those of PIDS or any of the study's sponsors.September 2003 2
Policy Notes
either trim their fat or exit the market. Firms adjust by mov-
ing labor and capital, and one-time adjustment costs are
incurred in terms of worker retraining, machinery, unem-
ployment and bankruptcy.
But more often than not, powerful domestic produc-
ers put up a strong resistance. They engage in cartel and
lobbying activities for the government to reimpose protec-
tionist measures, particularly when they are unable to adapt
quickly to new market conditions and find themselves vul-
nerable to competition from more efficient foreign produc-
ers. Because of such activities, tariff distortions that are
supposed to be corrected by trade reforms continue to per-
sist. This is evident, for instance, in the petrochemicals
sector—a major input to a lot of industries—which receives
a tariff of 15 percent while finished goods only receive be-
tween 5-10 percent tariff protection. In the cement sector,
meanwhile, firms that operated like a cartel are able to
receive additional protection against competing imports.
In light of these conditions, it therefore becomes very
difficult to sustain trade reforms. Especially given our weak
institutional and regulatory framework, the government sim-
ply tends to be inconsistent and soon after, a policy rever-
sal becomes apparent. Nowhere is this clearer than early
this year when the government froze tariffs at their 2002
levels instead of following the supposed schedule of de-
creasing their rates. Very recently, the government also an-
nounced that tariff rates would be increased to their 1998
applied levels to strengthen domestic industries. Clearly,
this is an indication that in response to pressures, the gov-
ernment has reversed its trade policy.
Indeed, there may be some valid reasons, in particu-
lar, social concerns for temporary protection to preserve
employment. But it should be emphasized that substantial
care must be taken in identifying domestic industries where
competition from imports has been too fierce to allow the
transition process to be socially sustainable. Protection may
be awarded as long as import growth is the cause of serious
injury to domestic import-competing industries but it must be
temporary and strictly related to a restructuring program.
It should also be noted that using tariffs in the preser-
vation of jobs as a social policy often results in tremendous
costs to consumers. A tariff artificially increases prices and
reduces imports. And while it increases domestic produc-
tion, it also leads to a decline in consumption. It may also
affect the competitiveness of the export industries. If, how-
ever, the costs are disproportionate relative to the expected
benefits, then the social policy embodied in protectionism
should be addressed in a more efficient manner. This could
be through, for instance, direct government assistance to
individuals who lose their jobs as imports increase or through
tax relief to firms that are less efficient than foreign com-
petitors.
Backsliding or policy reversal is not the answer
Given the above circumstances and the accompanying quali-
fying cases, it must therefore be stressed that reversing
the present policy on tariff reduction or having a policy back-
sliding is not the answer. It will just dampen firms’ incen-
tives to become efficient and foster rent-seeking behavior.
Backsliding also substantially reduces the credibility of trade
reforms.
Dani Rodrik1 points out that a primary need for a gov-
ernment engaged in trade liberalization is to establish and
bolster its credibility. Allowing the possibility of providing
protection amidst the transition process thus sends a sig-
nal to firms that the government will not commit itself to a
given policy reform. This can negatively affect the perfor-
mance of firms and can lead to so-called time-inconsistency
problems. The firms do not adjust because they expect to
obtain further protection in the future and it may not be politi-
cally optimal for the government not to grant such protection.
In short, reversing tariff reform at this time when firms
have already started to respond to reforms will create a lot
of uncertainty and instability that can easily swamp the gains
earned from previous reforms. Thus, it can do more harm
than good. Particularly damaging would be the high inflation
and low growth. Increasing tariff rates will lead to a large
degree of variability in relative prices that goes hand in hand
with high inflation. With low growth, the firms’ ability to ad-
just to changes in relative prices diminishes. Finally, a policy
reversal could reduce the government’s credibility that will
make investors and lending institutions doubt government’s
commitment to render well-meaning reforms.      
For further information, please contact
The Research Information Staff
Philippine Institute for Development Studies
NEDA sa Makati Building, 106 Amorsolo Street
Legaspi Village, 1229 Makati City
Telephone Nos: 892-4059 and 893-5705
Fax Nos: 893-9589 and 816-1091
E-mail: emedalla@pidsnet.pids.gov.ph; afita@pidsnet.pids.gov.ph;
jliguton@pidsnet.pids.gov.ph
The Policy Notes series is available online at http://www.pids.gov.ph.
_______________
1Rodrik, D. 1989. The credibility of trade reforms – a policy
maker’s guide. The World Economy 12:1-17.

"No" to Policy Reversal: Backsliding in Tariff Policy Can Do More Harm than Good

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"No" to Policy Reversal: Backsliding in Tariff Policy Can Do More Harm than Good

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