Taxes and subsidies on domestic consumption and production distort trade patterns. Most attempts to quantify their impact have calculated average subsidies weighted by production or consumption shares. Such indices lack theoretical foundation and have obvious practical limitations, since highly taxed commodities obtain low weights whereas they should be heavily weighted in assessing overall trade restrictiveness. In Discussion Paper No. 786, James Anderson and Research Fellow Peter Neary extend their previous work in developing a Trade Restrictiveness Index (TRI), which aggregates the trade effects of complicated patterns of tariffs and quotas, to encompass domestic distortions. This Index corresponds to the uniform tariff that would exert the same effects on welfare and trade as a given structure of taxes and subsidies. The TRI improves upon the standard ad hoc producer and subsidy equivalent indices because it uses marginal rather than average weights and also aggregates consumer and producer distortions. The TRI may also be extended to incorporate taxes and subsidies in the markets for non-traded goods or factors of production.

Anderson and Neary then apply the TRI to study changes in Mexican agricultural policy during the late 1980s, finding that large increases in restrictiveness in 1986 and especially 1987 were followed by even larger reductions in 1988 and 1989, yielding a cumulative fall in restrictiveness of 40.9%. Disaggregating the TRI's components reveals that changes in producer subsidies, especially to the major crop, maize, accounted for most of this change. These trends are not captured by changes in the conventional consumer and producer subsidy-equivalent indices; indeed, in some years at least one of these moved in the opposite direction.

Domestic Distortions and International Trade
James E Anderson and J Peter Neary

Discussion Paper No. 786, June 1993 (IT)