Massell, Benton F.

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INSTITUTE FOR DEVELOPMENT STUDIES 
UNIVERSITY COLLEGE.; NAIROBI 
Discussion Paper No. 43 
SOME REMARKS ON THE THEORY OF EFFECTIVE PROTECTION 
Eenton F. Massell 
January 1967 
Any views expressed in this paper are those of the author. They 
should not be interpreted as reflecting the views of the_Institute 
for Development Studies or of the University College, Nairobi. 
Some Remarks on the Theory of Effective Protection 
Benton F. Massell 
A number of recent articles have made a distinction between 
nominal and effective tariff rates, and have held the latter to be relevant 
for an analysis of the protective implications of tariffs. A particularly 
lucid exposition of the theory of effective protection is contained in a 
- _ 1 paper by U. M.; Corden / K J . In Corden's jwcrds, 
i i 
Ordinary nominal tariffs apply to commodities, 
but resources move as between economic activities . 
Therefore, to discover the resource-allocation 
effects of a tariff structure one must calculate 
the protective rate for each activity, that is, 
the effective protective rate. 
The present paper examines some aspects of the theory of effective protection. 
SP RATES AND RESOURCE ALLOCATION 
The theory of effective protection is based on two points. First, 
in considering the EP rate for an industry., it is relevant to take into 
account not only the tariff rate of the industry's output but also taxes 
cum subsidies on inputs used in producing this output. Second, the level of 
protection is related not to the industry's gross output but to its value-added. 
This can be demonstrated in a simple model. Consider an economy with 
a single primary factor (capital), and a single tradable input (materials). 
Further assume that the foreign demand for and supply of all traded goods 
is infinitely elastic; that the production of all goods is characterized by 
fixed production coefficients;, and that all tariffs are nonprohibitive, so 
that the local price of any protected good equals the world market price plus 
the tariff. 
Then, the effective protective rate, gj, on the production of 
industry j's output, is given by 
1 Corden / , page 222. 
2 The argument is readily extendable to the n factor and m input case. 
- l . a • 3 3 (1) 
where t. = the nominal tariff rate on industry i's output, t.! = the 
J 3 
nominal tariff rate on materials; and a. - the share of materials in the i 
cost of j in the absence of a tariff. 
Consider next the rate of return on capital in industry j. 
This is given by 
[ - ': '? ( ; V > J = Vj [ 1 + -- a^ ( 1 + t..') I (2) 
where r^ . = the post-tar iff rate of return, and v.. = the output-capital 
ratio. Now it can be seen that an alternative expression for c is : 
r t 
J _ J _ (3) 
where r.! = the pre-tariff rate of return. In other words, the EP rate 
is simply the relative increase in the rate of return to capital resulting 
from the tariff. 
Corden is correct., that it is relevant to consider taxes cum 
subsidies on inputs. An appropriate measure of protection must consider5 
in the example above3 a tax levied on materials. If an import duty is levied 
on materials used to produce industry j's output, the protection accorded 
to the production of this output is decreased accordingly. 
However5 there is some question whether EP rates measure the 
resource-allocation effects of a tariff. What Corden appears to be saying 
is that the percentage rate of increase in the return on capital will 
2 determine the interindustry flow of capital, For example. 
If we have calculated that tradable industry X has 
10 per cent effective protection and tradable 
industry Y has 20 percenta we should be able to 
conclude that resources will be drawn from X to Y 
and into both from non-protected industries and from 
those non-traded industries where prices stayed constant, 
1 
•1"n a more general model« g. is the rate of increase in value-added, as 
a result of the tariff. ^ 
Corden A / , page 227 . 
Surely this is an oversimplification . Capital will only flow from 
industry X to industry Y if the post-tariff rate of return is higher in Y 
than in X. And this will not necessarily be the case in Corden?s example 
unless the pre-tariff rates of return are identical in the two industries. 
A sufficient (but not necessary) condition for the two pre-tariff rates of 
return to be equal is (1) there is competitive factor pricing., and (2) both 
industries are economic in the pre-tariff situation. Although the first 
assumption is in the spirit of E? theory, the second is not, for it requires 
that tariffs are imposed only on industries that are economic anyhow --a 
somewhat stringent requirement. 
In the more eeneral case, r ® will not be the same in all 
3 
industries. Consider the following example. The pre-tariff return on 
capital is 2 percent in industry Y and 4 percent in industry X. The going 
rate on capital is G percent. Thus neither industry produces. Now assume 
a tariff is levied, so as to provide an EP rate of 100 percent in industry Y 
and 50 percent in industry X. Then, contrary to what the EP theory would 
predict, capital will flow into industry X but not into industry Y.^ " 
There are two points relevant here. First, capital will be 
influenced by the absolute and not the relative increase in the rate of 
2 j-return. Thus a better measure of the resource allocation effects or a 
tariff would be given by 
h. = p r (4) 1 "j j 
But even this is not enough, for the value of r r is relevant as Well as 
j 
the value of h. . In our example above, h must be 2 percent to make 
3 -
industry X economic, but 4- percent to make Y economic. 
1 
Because the post-tariff rates of return will be 5 percent in industry X 
and only 4- percent in Y. 
o ' • If r.® is zero then g is infinite for any value of t., certainly an 
^ j 3 
absurd result. And if r®_. is negative, the results are equally 
absurd. Soligo and Stern / 6 7 obtain such results. 
VALUE-ADDED 
Corden's definition of value-added also deserves some attention. 
He begins by distinguishing between primary factors and tradable inputs. 
He then considers nontradable inputs., noting that if these are available to 
the industry in question in infinitely elastic supply9 they should be 
treated like tradable inputs, and otherwise should be grouped together with 
primary factors. Finally, he argues that any primary factor available in 
infinitely elastic supply should also be grouped with the tradable inputs. 
In particular, capital might be in some cases internationally mobile, and 
available at the going rate. And labor in an LDC might be available accordi 
to ?. A. Lewis assumptions, a horizontal supply curve at the prevailing 
wage rate. Basevi, in his study of protection in the U. S. /~2 does in 
fact treat capital as a tradable input, and calculates the effective protect 
rate on labor alone. 1 
According to Corden, then, the denominator in equation (1) 'consist 
of value-added by finitely-supplied., nontradable., primary factors. Corden Ss 
distinction between infinitely and finitely elastically supplied factors 
(inputs) raises some questions. First, if one groups together selected 
primary factors and selected nontradable inputs.then effective protection 
is being related to a congeries of factors, and it is not entirely clear 
what the measure means. Second,and more disturbing, Corden is attributing 
a great deal of significance to the difference between (1) infinite and (2) 
finite (although possibly large) elasticities. As infinite means "arbitrari 
larse," then how large in practice mast an elasticity be to be regarded as 
infinite? Surely the limiting case is not sufficiently dissimilar to form 
the basis of a qualitative distinction between groups of factors. 
This incidentally gives some nonsense results, in that the labor-intensity 
of an industry is inversely correlated with the effective protective 
rate, for each of two years, and is significant at the 1 percent level 
for one of these years. That is, industries with a lower rate of effectiv 
protection on labor tend to have a higher labor-output ratio. 
2 Selected on the basis of supply elasticity. 
Another problems is that, in a LDC, labor and capital may both be 
infinitely elastically available, or nearly so. Many LDCs depend heavily on 
foreign capital, and industries are frequently protected primarily to attract 
capital from abroad. Surely the capital supply curve must look nearly 
horizontal to economic planners. Similarly, labor is in many cases Lewis-
available. But if both factors are horizontally supplied, then both must 
be treated like tradable inputs. Then what is in the denominator? It may 
be zero, in which case the theory of effective protection breaks down. Or 
perhaps there is some finitely elastically supplied factor: entrepreneurship 
electricity? An EP rate calculated on some such factor is likely to be of 
little interest. 
From the point of view of a sufficiently small industry, all inputs 
are available at the going rate, unless there is some factor specific to 
the industry. If protection is provided for producing paper clips, the 
paper clip industry's demand for factors will not have a noticeable effect 
on the return to: any factor, except possibly some type of skilled labor or of 
experienced management. In principle,• then, the EP rate should be calculated 
on the basis of value-added by these few specific factors: and this would 
produce some odd results. 
CONCLUSION 
This paper has examined the contention that EP rates indicate the 
resource-allocative effects of a tariff. It was found that EP rates do not 
in themselves indicate into which industries resources will flow: it is 
necessary also to have information on the pre-tariff profitability of the 
different industries. 
The EP rate relates the nominal tariff to value-added by primary 
factors, defined as domestic, nontradable inputs whose supply is less than 
perfectly elastic. Our argument above suggests that this concept of primary 
factor — and therefore the corresponding concept of value-added -- is 
ambiguous. Accordingly, the concept of effective protection may be mis-
leading. 
... s -
R e f e r e n c e s 
1- 3ela Balassa, !iRariff Protection in Industrial Countries: An 
Evaluation," Journal of Political Economy, December 1965. 
2. G. Basevi, "The U. S. Tariff Structure; Estimate of Effective Rates 
of Protection of U. S. Industrial and Industrial Labor," Review of 
Economics and Statistics, August 1965. 
3. W. M. Corden, "Protection/' Economic Record, March 1966. 
4-. W. M. Corden, "The Structure of a Tariff System and the Effective 
Protective Rate," Journal of Political Economy, June 1965. 
5. G. K. Helleiner, "Agricultural Export Pricing Strategy in Tazania," 
Paper prepared for Social Science Conference, University of East Africa, 
December 1956. 
6. Ronald Soligo and Joseph J. Stern, "Tariff Protection, Import 
Substitution, and Investment Efficiency," The Pakistan Development 
Review, Volume V- Summer 1965, No. 2. 
7. Finius Zilch, '''Estimating Effective Protective Rates for Queen 
Maud Land," Review of Antarctic Political Economy, February 1936. 


Some remarks on the theory of effective protection

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