How an Export Tariff Works as Protection

Malaysia, the world’s second-largest palm oil producer, raised its tax on crude palm oil (CPO) exports from 5% to 5.5% in April due to the price spike in the world market. However, according to traditional trade theories, an increase in the world price would bring larger net gain to the country; therefore, palm oil exports should have been encouraged. But why does Malaysia set up barriers and run totally counter to the theoretical behavior?

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Before we dig into the story behind the tariff policy, let’s first look at how the export tariff works and what impact it might have. To facilitate understanding, assume that Malaysia is a small country and its actions will not influence the world price of CPO, Pw. If Malaysian producers continue to export CPO, the price they receive will decrease by the amount of the export tariff,Pw-z, as illustrated in the diagram below.

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A lower price of Pw-z leads to an increase in domestic consumption, QD(z)- QD, and a decline in domestic production, QS– QS(z) . The gap between the supply and demand represents Malaysia’s CPO exports, and the narrowed gap indicates shrinking exports. Now, let’s focus on the welfare impact. Consumer surplus increases by A due to a lower price, and producer surplus decreases by (A+B+C+D). Government gains revenue of C by charging the export tariff. Therefore, the total welfare loss is (B+D). 

In light of the welfare cost of the tariff, why would Malaysia impose a higher export tariff? Firstly, CPO is not only a strong export commodity, but also an indigenous raw material to food and oleochemical industries in Malaysia. Therefore, the export tax structure is aiming to favor export of palm oil products instead of CPO. Since the El Nino weather pattern returned and curbed the yields of crude palm oil, the domestic downstream manufactures is facing a short supply of raw materials. To prevent the negative effects from manifesting itself through the industrial chain, Malaysia imposes higher taxes on exports and keeps the supplies inside to ensure sufficient quantity of CPO available for domestic manufacturers. As a result, the export tariff can be seen as a protection for downstream industries.

Another reason for raising the export tariff may be the concerns of Dutch Disease, a problem usually occurring in a country where the economy heavily relies on just a few export products. It says that when the price of the primary export product rises, the country’s competitiveness will fall, and domestic manufacturers of other sectors will suffer as a whole. As the world prices of CPO increase, Malaysia will get more dollar-dominated revenues from its exports. The needs to convert dollars into local currency will give rise to the demand for local currency, leading to the appreciation of Ringgit. Consequently, Malaysia’s competitiveness will deteriorate. Decreasing exports by higher export tariffs can relieve the pressure on home currency appreciation, thus lowering the risk of Dutch Disease, and ensuring Malaysia’s competitiveness. 

In fact, the issue of export restrictions is not new, and has been played out throughout the history of trading in all corners of the world. For example, in a purpose of increasing government revenue, Argentina imposed high export tariffs on almost all raw materials and agricultural exports since 2002. To alleviate the environmental problems caused by over-mining (e.g. water pollution) and protect depleted resources, China imposed a high export tariff on its rare earth metals, which invited criticism from Japan, the U.S. and the European Union. 

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As can be seen from the above discussion, countries employ export restrictions to serve different purposes—conserving natural resources (e.g. metals, minerals), supporting downstream processing industries, preventing exports of hazardous products, increasing government revenues, or limiting domestic price increases. However, just as all other trade barriers, export restrictions can lead to market disorders, and even social unrest (e.g. the 2008 countrywide strikes against high export tariffs in Argentina). Therefore, the trade-off between the benefits and the underlying risks calls for more prudent use of export restrictions. 


References

1. Official Portal of Malaysian Palm Oil Board: http://www.mpob.gov.my/

2. Gan Peck Yean, Li ZhiDong, A study on Malaysia’s Palm Oil Position in the World Market to 2035,    http://eneken.ieej.or.jp/data/4362.pdf

3. Benefits of trade liberalization, WTO: http://www.oecd.org/trade/benefitlib/exportrestrictionsonrawmaterials.htm

4. Export restrictions and taxes, WTO: http://www.wto.org/english/tratop_e/agric_e/negs_bkgrnd09_taxes_e.htm

5. Mei Xinyu, WTO ruling not end of road for China, China Daily, http://usa.chinadaily.com.cn/opinion/2011-07/20/content_12940288.htm

6. Steven Husted, Michael Melvin, International Economics 9th edition

 

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