The Theory of Effective Protection

Why do countries impose tariffs? The main objective of the tariff-imposing country, apart from curbing imports and possibly capturing the advantage of its natural monopoly power in trade, is to encourage the domestic production of the import-competing industries whose survival is threatened by foreign competition. Until recently, the protective effects of a tariff on the imports of a final good were taken for granted. It was generally believed that a higher rate of tariff or a higher nominal rate of protection would lead to a higher output level for the protected commodity. With the recognition by trade theorists of the importance of trade in intermediate goods, a new measure of protection, widely known as the effective rate of protection (E.R.P.), has been evolved to take into account the implications of the entire tariff structure, rather than tariffs on individual imported commodities, for the pattern of output in the economy. In contrast to the theory of nominal protection, which analyses the impact of tariffs on the total value of final goods, the E.R.P. measures the percentage change in the contribution of the domestic primary factors or, what is the same thing, in the value-added of an industry as the economy moves from a free trade situation to one of protected trade.