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I. Introduction and General Topics



Instruments of Protection and their
Economic Impact

José María Caballero, Geraldo Calegar and Carlo Cappi
Policy Assistance Division



This module reviews the main trade policy instruments used by governments to protect farmers from external competition. It also identifies and interprets the main economic impacts of these interventions and their welfare effects, and explains how to measure the scope of protection using protection indicators.


3.1 Instruments of protection

3.2 Economic impacts of protection

3.3 Indicators of protection

3.4 Summary and conclusions



Direct and indirect instruments

Governments intervene in agricultural trade by means of direct and indirect instruments (see Box 1) with various objectives, the most common being to raise tax revenue, to support producers' incomes, to reduce consumers' food costs, to attain self-sufficiency and to counter interventions from other countries. These instruments are analysed in the following sections.

Box 1: Main instruments of protection

Direct interventions Indirect interventions
Tariffs Exchange rate management
Import and export quotas Commodity programmes
Export subsidies Marketing supports
Sanitary and phytosanitary restrictions Input subsidies and tax exemptions
  Long-term investment assistance


3.1.1 Direct protection instruments

Direct protection instruments affect commodities as they enter international trade either as imports or exports. The most common ones are tariffs, import and export quotas and export taxes and subsidies.


Different types of tariffs

A tariff is a tax levied on an imported good. Specific tariffs are levied as a fixed charge per unit of the import good, for example US$3 per barrel of oil. Ad valorem tariffs are levied as a percentage of the CIF price (see Box 2) of an import good, for example a 20 percent charge on the CIF price of a tractor. Tariffs may be fixed (a given charge per physical unit or a given percentage of the CIF price) or variable (charges vary according to the CIF price). The variable import levies used by the European Union (EU) on imported foodstuffs were an example of a variable tariff1.

Tariffs are the simplest and oldest form of trade policy instrument. Traditionally, they were used as a source of government revenue but they are mostly used today to protect particular home sectors from international competition by artificially increasing the domestic price of the imported good.

Box 2: CIF and FOB prices

CIF stands for COST, INSURANCE AND FREIGHT. It is the landed cost of an import good on the dock or other entry point in the receiving country. It includes the cost of international freight and insurance and usually also the cost of unloading onto the dock. It excludes any charge after the import touches the dock such as port charges, handling and storage and agents' fees. It also excludes any domestic tariffs and other taxes or fees, duties or subsidies.

FOBstands for FREE ON BOARD. It is the cost of an export good at the exit point in the exporting country loaded in the ship or other means of transport in which it will be carried to the importing country. It is equal to the CIF price at the port of destination minus the cost of international freight and insurance and the unloading onto the dock.

In the balance of payments and other trade statistics, imported goods are always valued at their CIF price and exported goods at their FOB price.


A tariff raises the price of imports to home consumers, increases government revenue, and tends to increase the price for domestic producers of the import-competing commodity, thus providing an incentive for them to increase production and replace imports. Tariffs, therefore, increase the income of producers and government at the expense of consumers, and tend to make the domestic production of the good greater than it would have been in the absence of the protective measure.


Different types of quotas

Quotas are limits imposed by government on the physical quantity of either imports or exports. They can be unilaterally imposed by government or they can be negotiated with exporting or importing countries, which "voluntarily" agree to restrict exports or imports (see Box 3).

Box 3: Voluntary restraint agreements

A voluntary restraint agreement is a promise by government "A" to government "B" to limit exports from country "A" to country "B" of a certain commodity (e. g. meat or cotton textiles) to a specified annual level. The trade effect is equivalent to that of an import quota, although the distribution of the quota rent may differ.

Exchange controls, which limit the amount of foreign exchange made available to importers or to citizens travelling abroad, are a special kind of quota with the characteristic that they restrict imports in general rather than imports of a particular commodity.

Quotas are usually enforced by governments through the issuing of licenses, which are property right documents allowing the holder to import or export specific quantities of the particular good. Government either sells or auctions the licenses to interested importers or exporters or distributes them free of charge according to some administrative criteria. For example, the United States has a quota on imports of foreign cheese. Only certain trading companies are allowed to import cheese, each of which is allocated the right to import (license) a maximum number of pounds of cheese each year. Individual quotas are based on the amount of cheese imported by the firm in the past.

Quotas give rise to quota rents

Like tariffs, import quotas tend to raise the domestic price of the commodity and to increase the income of import-competing producers at the expense of consumers. The main contrast with tariffs is in the distribution of the revenue deriving from the difference in the selling price of the imported good with and without the protective measure. While in the case of tariffs this revenue is collected by government, in that of quotas it may go in part or totally to license holders, who are allowed to buy imported goods and resell them at a higher price in the home market. The gains thus made are known as quota rents and may to some extent be collected by government if the licenses are sold or auctioned.

Export taxes

Export taxes benefit consumers and taxpayers at the expense of producers

Export taxes are levies on the export of commodities. Like tariffs on imports, they can be exacted per physical unit or as a percentage of the FOB price. Export taxes are normally used by governments as a means to raise revenue. Although their use has decreased in recent years, they were common in pre-structural adjustment days in countries where export production of primary commodities offered the easiest and surest way to collect fiscal revenue. Export taxes reduce the price received by the producers of the export commodity and also lower the selling price of the commodity in the domestic market. Thus, for instance, the taxation in the past by Argentinean governments of wheat and meat exports had the effect of reducing the price received for these products by Argentinean farmers as well as that paid for them by Argentinean consumers. Because of this effect on prices, export taxes tend to discourage domestic production and encourage domestic consumption of the exported commodity, thus reducing over time the quantity exported. Export taxes benefit domestic consumers and the government budget at the expense of export producers.

Export subsidies

Export subsidies benefit producers at the expense of taxpayers and consumers

An export subsidy is a payment to a firm or individual that ships a good abroad. Like a tariff or an export tax, it can be either specific or ad valorem. Export subsidies give producers and traders an incentive to export, making it more profitable to sell abroad and hence pushing up the price of the good in the home market. When a government subsidizes the export of a commodity, traders will tend to go on exporting the commodity up to the point when the home price exceeds the foreign price by the amount of the subsidy. Export subsidies benefit export producers and traders at the expense of domestic consumers and taxpayers.

Sanitary and phytosanitary restrictions

Non-tariff barriers

Sanitary and phytosanitary restrictions applied to imports are not in themselves trade measures but can easily be turned into them. They have been increasingly used with the deliberate purpose of shielding domestic producers from international competition. It is not rare that nations introduce such restrictions not to prevent health hazards on the basis of scientific evidence but in response to public activism from interested parties. It is in recognition of this that sanitary and phytosanitary restrictions are high on the agenda of trade negotiations.

3.1.2 Indirect protection instruments

Two different types of instruments are included here. The first is the management of the exchange rate which, although directly oriented to affect trade flows, has general (as opposed to commodity-specific) effects, since it applies equally to all imports and exports across the board. Because of this we have classified it as an indirect instrument. We also include measures oriented to support certain producers, notably farmers, such as commodity programmes, marketing supports, input subsidies, tax exemptions, and long-term investment assistance. These measures focus on domestic production rather than trade and tend to support producers as such, not simply as exporters or import-competitors. They have, however, definite trade implications, since they affect the competitive position of home producers vis-à-vis international competitors.

Exchange rate management

An undervalued exchange rate benefits producers at the expense of consumers, and vice versa

The exchange rate, which is the price of the domestic currency in relation to foreign currencies, determines the amount of domestic currency received by exporters for a certain value of exports and paid by importers for a certain value of imports. By raising this price, currency devaluation increases the value in domestic currency received by exporters as well as that paid by importers. Devaluation, hence, encourages exports and discourages imports; raising this one price provides generalized incremental protection to all domestic exporters and import competitors. The opposite is true of overvaluation; an overvalued exchange rate discourages exports and encourages imports, because it works as a subsidy on imports and a tax on exports.

While devaluation can take place overnight as a consequence of a policy decision, overvaluation develops over time as a result of failures to adjust the exchange rate (i.e. to devalue) in situations in which domestic inflation is higher than that of the country's trading partners. Since devaluation pushes up the domestic price of exportable and importable commodities, it tends to have an inflationary impact. The fear that devaluation will feed the inflationary process often deters monetary authorities from devaluing in the face of creeping domestic inflation, notwithstanding the potential positive effect of devaluation on the trade balance.

Commodity programmes

Non-market support programmes are growing in importance in developed economies

Commodity programmes are the major agricultural protection instruments used by the United States, the EU, Japan and other countries to aid local producers. These programmes are designed to support farm incomes, and often result in restricting imports or subsidizing exports. Commodity programmes include direct payments made to farmers in the form of subsidies to crop prices, as well as supply control programmes aimed at reducing the harvested area.

An example of direct payments to subsidize crop prices was the deficiency payment system practised in the United States to support grains and oilseeds, which granted farmers the difference between the market price for these commodities and a guaranteed or fixed target price, if higher. An example of a supply control programme are the payments made to farmers to keep land uncultivated under the set aside policy of the EU. The United States had a similar acreage reduction programme in the past, where producers were required to cut back the area sown to a particular crop by a prescribed percentage of the historic base, in order to be entitled to receive the corresponding payment2. The latter programmes aim at reducing the domestic production of certain crops so as to sustain their market price while avoiding or reducing the creation of export surpluses.

Marketing support

Marketing support instruments aim at reducing the marketing costs of home producers through different programmes such as transportation and storage subsidies and subsidized marketing credit.

Input subsidies and tax exemptions

Input subsidies more widespread in developing countries

Input subsidies aim at reducing the cost of production by lowering the price of inputs. They usually take the form of subsidies directly applied to inputs (e.g. fertilizer subsidy, say a 10 percent reduction in the price of fertilizer), exemptions from indirect taxes on inputs (e.g. tax exemptions for fuel used by agricultural machinery), concessionary domestic credit for production loans (e.g. subsidized interest rate for seasonal loans to farmers), government special insurance programmes for farmers (e.g. crop insurance), free or subsidized extension services, no or partial cost recovery of irrigation water, and others. Another way of supporting farmers' incomes is by exempting farms from profit taxation or giving them a special tax treatment more favourable than that of other businesses.

Long-term investment assistance

Long-term investment supports aim at increasing the productivity and profitability of the farming sector. The main components are investments in agricultural research and in farm-related infrastructure, such as irrigation and drainage systems. Many countries subsidize these investments to a smaller or greater extent. Other long-term investments include the improvement of roads, ports, storage facilities, and information systems.


The partial equilibrium method is used to analyse the effects of protection

In this section we analyse the main economic impacts of the protection instruments surveyed above using what is known as the partial equilibrium method. This method consists of the analysis of a particular market in isolation, without attention to how events in that market may affect those in other markets, and these may in turn affect the situation in the original market. The partial equilibrium method can be used to trace the impact of shocks on the relationship between quantities (produced, imported, exported and consumed) and prices of a single commodity or group of commodities. Thus, for instance, we may assess how an increase in the protection of cereals affects production and consumption in the cereals market, without considering how changes in cereal production and consumption will impact on, say, land use or the demand for farm labour or the consumption of other foods, and how these will in turn affect conditions in the cereals market.

3.2.1 Market equilibrium in a closed economy

The behaviour of a certain market, say for rice, is first examined in the absence of international trade, i.e. in a closed economy. This is graphically shown in Box 4, where the demand and supply curves for rice are drawn.

Box 4: Market equilibrium in a closed economy

Box 4: Market equilibrium in a closed economy


The demand curve "D" shows the quantities of rice that consumers are willing to buy at different prices. In general, other factors being constant (income, prices of other products, tastes, etc.), the demand curve slopes downward, since the lower the price of rice, the larger the quantity consumers will normally be willing to buy.

Similarly, the supply curve "S" shows the quantities of rice producers are willing to supply at different prices. In general, other things being constant (prices of factors of production, state of technology, etc.), the supply curve slopes upwards, since the quantity that producers will be able and willing to supply will normally increase as the price received increases.

Concept of market equilibrium

If it is not possible to import or export rice, i.e. in a closed economy, "A" will signal the equilibrium position in the rice market, since at price pe the quantity of rice that producers are willing to supply (qs) is equal to that which consumers are willing to buy (qd). Price pe will hence clear the market.

3.2.2 Market equilibrium in an open economy

We examine now what happens to the domestic rice market when the country opens to trade. To do this we must adjust the price of rice in the international market so that we can compare it meaningfully with the domestic price received by farmers. International prices thus adjusted are called financial parity prices3. The adjustment method is explained in Box 5.

Box 5: Calculation of financial parity prices

We start from the border price, which for imports is the CIF price expressed in local currency, i.e. multiplied by the going exchange rate, and for exports the FOB price also expressed in local currency.

Exports: We calculate the financial export parity price by deducting from the border price (FOB in this case) all transport and marketing costs from the farm to the port, any export taxes or subsidies, and all local port charges including taxes, storage, loading agents' fees, etc., so as to be left with the farm-gate price. If the exported crop undergoes some industrial transformation, such as milling, the raw crop equivalent of the exported product, i.e. the paddy equivalent in our example, is calculated using the conversion rate of paddy into milled rice, and the cost of milling is deducted.

Imports: We calculate the financial import parity price by first choosing a domestic wholesale reference market, for instance the wholesale market of the capital city, where imported goods are supposed to enter into competition with locally produced equivalent goods. We then add to the border price (CIF in this case) all port charges after the import touches the dock, any domestic tariffs and other taxes or fees, duties or subsidies, and the transport and marketing costs from the port to the market of reference. The result is the import parity price at the market of reference. If we further want to obtain the import parity price at the farm-gate, we subtract the transport and marketing costs that farmers have to pay to put their produce in the market of reference. If there is any industrial transformation, we calculate the raw crop equivalent as in the export parity case.

Source: Gittinger (1982).

When we make this comparison three situations are possible in a free market economy where agents can freely decide to import, export and domestically sell goods. These situations are graphically illustrated in Box 6.

Definition of non-tradables

Definition of exportables

Box 6: Classification of goods according to their tradability

a) Non-tradables b) Exportables c) Importables
Non-tradables Exportables Importables


Definition of importables

3.2.3 Economic effects of trade policy instruments

Significance of the small country assumption

We use now the above partial equilibrium framework to examine the effect of protection instruments. It should be mentioned that the results presented here are valid only when the variation in the quantities traded internationally as a result of the introduction of the policy measures are sufficiently small not to affect international prices. In our example, we assume that the changes in the quantity of rice imported or exported by the country in question following, say, the introduction of a tariff or an export subsidy are not big enough to change the basic conditions in the international market for rice and hence to affect the world price. This is usually called the small country assumption. We also assume a competitive situation where, through free trading, in the absence of policy measures, domestic prices of tradable goods become equal to the international price. For simplicity of presentation, we assume that the import and export parity prices are equal to the world price, which we denote as "Pw".

Tariffs and import quotas

In Box 7 we analyse the effects of an ad valorem tariff, "t". We assume that rice is an importable and we start from the situation of equilibrium with trade and no protection. The domestic price will be equal to the international price Pw. We assume next that a tariff "t" is introduced as a percentage payment on the value of rice imports, say 20 or 30 percent.

The tariff will generate a series of reactions over time from rice producers, consumers and traders until a new equilibrium is reached in the domestic rice market. Comparing the initial and final situations, shown in Box 7, the effects of the tariff are as follows:

Tariffs benefit producers and taxpayers at the expense of consumers

Box 7: Effects of tariffs and import quotas

Box 7: Effects of tariffs and import quotas


Similar trade effects can be expected if a government imposes an import quota equal to d1-s1. However, the effects of a quota on the distribution of income can differ from a tariff depending on the destination of the quota rent. This is the difference between the offer price of the exporting country and the selling price on the domestic market. For example, if the country's international trade is controlled by state-operated enterprises, the government can fix directly the amounts to be imported by each enterprise and decide whether the quota rent should be retained by each enterprise or centrally collected. This can be done with a simple administrative action. On the contrary, if international trade is left to the private sector, the implementation of import quotas is more complex and, as indicated before, is done through the issuing of licenses. In this situation, the quota rents will be obtained by those who receive the licenses.

Export subsidies, taxes and quotas

The analysis of export subsidies is similar to that of import tariffs. In Box 8 we illustrate the case when a subsidy consisting of a percentage "s" of the international market price is paid by government to rice exporters.

Export subsidies have the opposite effect to import tariffs

Box 8: Effects of an export subsidy and a quota

Box 8:  Effects of an export subsidy and a quota


Impact of an export quota or export tax

The effect of an export quota limiting the amount that can be exported of rice, say to protect domestic consumers, will be to lower the domestic price, since by restricting exports more output will be available in the local market pushing down prices. The same diagram in Box 8 can be used to illustrate this, simply assuming that the initial price, i.e. the price before imposing the quota, is that shown in the diagram as Pw (1+s). If the export quota is equal to (s1 - d1), the domestic price will fall to that shown as Pw in the diagram. The quota-rent is the darker part of the shaded area. Export taxes will have the reverse effects of export subsidies, similar to the effects of quotas.

Measures in support of domestic producers

Domestic support measures also have trade effects

Policy measures to support producers, not directly designed as trade interventions, can take two forms; either they can add to the revenues received by producers (direct payments) or they can reduce costs to producers (input subsidies). Both types of subsidy have the effect of allowing producers to supply more at the same price, thus shifting to the right the supply curve4. Box 9 illustrates a situation where these measures move a country from being a net importer (S1) to being self-sufficient (S2) and eventually becoming a net exporter (S3) in the case of a tradable commodity.

Box 9: Effects of domestic support measures

Box 9:  Effects of domestic support measures


More precisely, producers' subsidies will bring about the following effects:

A similar type of analysis to that in Box 9 can be applied to taxes or subsidies on food consumption. In this case, it will be the demand curve that will shift to the left (in the case of taxes) or to the right (in the case of subsidies). In case of non-tradable commodities, prices as well as demanded and supplied quantities will change.

3.2.4 Welfare effects of trade measures

As indicated earlier, trade protection measures give rise to winners and losers, thus having a welfare impact on society. The extent of this impact can be estimated using the concepts of consumer and producer surplus, explained below5. We illustrate this for an import tariff.

The concepts of consumer and producer surplus

Definition of consumer surplus

The consumer surplus measures the difference between the amount a consumer is willing to pay for a unit of a good and the amount actually paid. If, as normally assumed, consumers have a decreasing marginal willingness to pay (i.e. they are willing to pay less for new units as they go on consuming the good), but they pay for all units an amount equal to what they are willing to pay for the last unit, there will be a positive consumer surplus. The consumer surplus concept applies not only to individual consumers but also to consumers of the commodity as a whole.

The above is illustrated in Box 10, where consumers in society are assumed to be willing to pay P1 for the first unit of the good, P2 for the second unit, P3 for the third, and so on up to P7. If the market price is P7, consumers will have a surplus of P1-P7 on the first unit purchased, since their willingness to pay exceeds by that amount what is actually paid. Similar but declining increments of surplus (P2-P7, P3-P7, P4-P7, P5-P7, and P6-P7) will be obtained on all other units consumed. The entire consumer surplus is hence equal to the shaded area in Box 10. If we reduce the increments (by dividing more finely the units), in the limit the consumer surplus will be the whole area under the demand curve D and above the price line P7.

Box 10: Deriving the consumer surplus from the demand curve

Box 10:  Deriving the consumer surplus from the demand curve


Definition of producer surplus

The producer surplus is a symmetrical concept to that of the consumer surplus. Here, the marginal willingness to sell is assumed to be increasing as shown by the supply curve "S" in Box 11. In the case of produced goods, the reason is that the marginal cost is normally increasing (i.e. new units are more expensive to produce, at least in the short run, as we go on increasing production), so that higher prices are needed in order to bring more supply into the market, and the supply curve is hence upward sloping. Under these conditions, if producers receive for all units an amount equal to that for which they are willing to sell the last unit (which would normally be the marginal cost), there will be a positive producer surplus.

Box 11: Deriving the producer surplus from the supply curve

Box 11:  Deriving the producer surplus from the supply curve


The concept is illustrated in Box 11, where we show the willingness to sell different units of a good, indicated by P1, P2, and so on up to P5. Using the same reasoning as in the case above, the total area above the supply curve "S" and below the price line P5 is the producer surplus.

Changes in consumer and producer surplus are a measure of changes welfare

The consumer surplus is usually interpreted as reflecting the satisfaction or welfare gain derived from consumption. Similarly, the producer surplus is normally interpreted as the gain or accumulated profit that producers obtain from different levels of production. The welfare analysis of trade interventions consists, therefore, in examining, and if possible measuring, how these interventions will increase or decrease the consumer and producer surplus, as well as generate fiscal revenues or costs and quota rents. This is illustrated below in the case of a tariff.

Welfare effects of a tariff

In Box 12 we have reproduced the diagram of Box 7 but we have labelled with lower-case letters from "a" to "g" the various areas in the diagram relevant to our analysis. As explained before, the effect of the tariff will be to increase the domestic price "Pd" above the world level "Pw" by the amount of the tariff "t", with the consequence of a decrease in consumption and imports and an increase in production. These effects are indicated with arrows in the diagram.

Box 12: Welfare effects of a tariff

Box 12:  Welfare effects of a tariff

The welfare consequences of the tariff, which are summarized in Box 13, are the following:

Deadweight loss triangles

Box 13: Summary of the welfare effects of a tariff

Indicators Without Tariff With Tariff Change
Consumer surplus b+c+d+e+f+g f+g -(b+c+d+e)
Producer surplus a a+b +b
Tariff revenue none d +d
Total surplus a+b+c+d+e+f+g a+b+d+f+g -(c+e)

The monetary magnitude of the welfare gains and losses of various groups and the net welfare effect to society will depend on the elasticities of the supply and demand curves, the import price of the good, the quantities produced, consumed and imported, and the size of the tariff. With suitable information on the above variables the welfare effects can be estimated under the restrictive partial equilibrium and small country assumptions.


Protection indicators measure distortions due to trade policy interventions

The instruments of trade protection discussed earlier modify market prices and quantities in comparison to what they would be in the absence of these interventions. To that extent protection instruments are said to introduce distortions in the markets. The concept of market distortions is discussed in Box 14.

Box 14: The concept of market distortions

By distortions economists refer to deviations between the actual set of prices in an economy and a set of ideal long-term equilibrium prices for that economy. There are two different reasons why these two sets of prices may differ: (i) market failures, i.e. the inability of markets to operate properly due to factors such as monopolistic elements, asymmetric information, transaction costs, externalities, and to a certain extent uncertainty and risk; and (ii) policy interventions. Protection indicators are designed to measure the effect of policy interventions. Measuring policy interventions requires establishing a benchmark against which to compare domestic prices. For traded goods, the normal practice is to use the international price (adjusted as needed) as the benchmark (see Box 15 on Economic parity prices). The magnitudes estimated as distortions due to policy interventions indicate the extent to which domestic prices diverge from international prices.

Market distortions related to the type of trade interventions discussed above can be assessed by means of various indicators6. Here we consider nominal and effective protection coefficients, the producer and consumer support estimates, the nominal assistance coefficient and the WTO aggregate measure of support. It is worth noting that in most cases these indicators can be calculated at different points in the commodity chain. According to the point chosen, the definition and calculation method will slightly change. Here, the coefficients refer to the farm-gate level. It is also worth indicating that the basic procedure for the calculation of these measures is to take economic parity prices (explained in Box 15) as benchmarks of "undistorted" prices and compare them with actual domestic prices.

3.3.1 Nominal Protection Coefficient (NPC)

NPC measures protection given to a product

The NPC is the simplest coefficient used to assess the level of protection resulting from market distortions. It measures the ratio between the domestic price actually received by farmers and the economic parity price of a commodity, both taken at the farm-gate level. The NPC can be applied to both exportables and importables. The calculation procedure of economic parity prices is explained in Box 15.

If, for example, the price that producers receive for a certain export or import-competing commodity at the farm-gate is US$2 000 per ton, while the farm-gate economic parity price is US$1 500 per ton, the NPC would be US$2 000/US$1 500, which is equal to 1.33. This means that, due to market distortions, there is an implicit subsidy to the producers of the commodity equal to 33.3 percent of the price of the product.

Box 15: Economic parity prices

Economic parity prices are derived from financial parity prices. Like them, they are based on the international CIF or FOB price, but they do not include those elements of market distortions present in financial parity prices. There are three ways in which market distortions may affect financial parity prices, which need to be taken into account in calculating the economic price. First, the exchange rate used to convert the international CIF or FOB price into the border price may be distorted. Second, the fiscal or trade policies (taxes, subsidies, tariffs and quotas) used to make transfers to producers may affect the price of the commodity. Finally, there may be market failures or income transfers (like indirect taxes and subsidies) that alter the transport and marketing costs of the commodity from the border point to the farm-gate level.

In practice, the calculation of economic parity prices is made using the same method shown in Box 5 for the calculation of financial parity prices, but with the following differences:

  • the FOB (CIF) price paid by (to) the foreign client is converted into a domestic currency price not at the official exchange rate but at the exchange rate corrected for the eventual overvaluation or undervaluation of the currency;
  • all relevant government tariffs, taxes and subsidies as well as the rents originating in quantitative restrictions (like quotas) are eliminated;

3.3.2 Effective Protection Coefficient (EPC)

EPC measures the protection given to a production activity

Notwithstanding its usefulness, the NPC has two serious limitations. First, it does not recognize the protection or implicit tax impact that distortions in the markets of the inputs entering into the production process of a commodity may have on the production of that commodity. Second, in order to predict the behaviour of producers, what is of interest is not so much how protection affects the price of a commodity as how it affects the incomes of factor owners involved in the production of the commodity (as labourers, land owners, and suppliers of capital and entrepreneurial services), i.e. the consequences on value added. The concept of value added is explained in Box 16.

Box 16: The concept of value added

Value added is the difference between the value of final production and the value of the intermediate inputs entering into production. The concept applies equally to the production of a single commodity, to an economic sector or to the macroeconomy. The depreciation of machinery and other capital goods entering production is also deducted when value added is net. Value added, hence, is what is left to share as payment for the services of primary factor owners in the form of rents, interest, profits, wages and salaries.

Using our previous example, to assess the degree of protection to the rice production activity we should consider the negative effect of an artificially high price of fertilizer or of high yielding variety (HYV) seeds, compared to the economic import parity price benchmark due to, say, a tariff on the import of these inputs or oligopolistic pricing by distributors. The behaviour of rice producers (e.g. their decision to increase or decrease output or to change to other crops or to invest in other businesses) depends not on the price received for their paddy but on what is left in their hands as net farm income, i.e. on value added, considering what they receive for the paddy they produce and what they pay for the inputs they use. It depends, hence, on the distortions present in the paddy market as well as on those present in the markets of the inputs used in the production of rice, such as fertilizer and HYV seeds.

The EPC overcomes the above limitations of the NPC, measuring the degree of protection as the ratio between the value added in the presence of market distortions, i.e. the net income actually received by farmers, and the value added in the absence of market distortion, i.e. when inputs and outputs are valued at their economic parity prices7.

The calculation of effective protection coefficients often results in negative figures for a number of commodities or sectors. This is not surprising since there are cases where the protection offered by a tariff on the final product is more than compensated by the negative impact of the tariffs on intermediate inputs. A positive consequence of the introduction of the effective protection concept was a new focus on the protection provided by the structure of a country's tariff regime, as opposed to the average level of the tariff regime.

3.3.3 The Producer Support Estimate (PSE)

PSE is a more comprehensive measure of support

Definition of PS

The Producer Support Estimate (previously referred to as the Producer Subsidy Equivalent) has been adopted by the OECD to measure agricultural support. The PSE is an aggregate measure of support to farmers designed to include, alongside the taxes or subsidies (explicit or implicit) on the final product, all subsidies or indirect taxes on inputs as well as any other form of direct support to producers. The PSE is equal to the monetary value of all policy transfers to producers derived from trade barriers, price supports, exchange rate management, commodity programmes, marketing supports, input subsidies, tax exemptions, and long-term investment assistance, including both product- and non-product-specific support measures. In order to make comparisons of support levels across countries, the total monetary value of these forms of support is usually expressed as a percentage of the gross value of farm receipts calculated at market prices (and including the value of direct payments to producers). The resulting indicator is referred to as the percentage PSE. Both PSE measures are calculated for individual commodities and can be aggregated to derive the total PSE or total percentage PSE for a country's whole farm sector.

PSE is an indicator of support not of trade distortion

Note that the PSE is a measure of the transfers to producers arising from government interventions. It should not be interpreted as the amount farmers would lose from the termination of all forms of producer supports. For one thing, the existence of support tends to depress the world prices used as reference prices to measure market price support; if support were removed or reduced, producers would receive some compensation in the form of higher world market prices. It should also be noted that the PSE includes all types of support to farmers irrespective of whether they distort prices or affect international trade flows or not. Hence, the PSE is an indicator of the support to producers but not of the trade distortion effects of this support.

PSE amounts in both absolute and percentage terms are shown in Box 17 for some of the developed countries. Transfers to EU farmers in 1996-98 exceeded US$100 billion while they amounted to US$36 billion in the United States and US$56 billion in Japan. In percentage terms, Japan had the highest rate of producer support in that period at 63 percent, followed by the EU at 39 percent and the United States at 17 percent.

3.3.4 The Consumer Support Estimate (CSE)

Definition of CSE

The Consumer Support Estimate is an indicator parallel to the PSE. It was previously called the Consumer Subsidy Equivalent by the OECD. The CSE measures all domestic policy transfers (direct and indirect) to consumers, and can be expressed as a percentage of the cost of food to consumers calculated at market prices. The CSE can be calculated for groups of commodities or for all market consumption in a country.

Box 17: PSE, CSE and NAC measures for the EU, United States and Japan

    1986-88 1991-93 1996-98
Producer support estimate (PSE) US mn 99,619 131,028 116,271
Percentage PSE % 46 47 39
Producer NAC % 1.86 1.88 1.65
Consumer support estimate (CSE) US mn -81,077 -85,378 -56,146
Percentage CSE % -42 -38 -25
Producer support estimate (PSE) US mn 41,428 34,981 35,838
Percentage PSE % 26 19 17
Producer NAC % 1.35 1.24 1.20
Consumer support estimate (CSE) US mn -9,322 -1242 1,612
Percentage CSE   -8 -1 1
Producer support estimate (PSE) US mn 52,073 55,628 55,639
Percentage PSE % 65 58 63
Producer NAC % 2.85 2.40 2.69
Consumer support estimate (CSE) US mn -64,314 -76,224 -79,107
Percentage CSE % -58 -51 -51

Source: OECD (1999). Politiques Agricoles des Pays de l'OCDE: Suivi et Evaluation. Table III.12.

Box 17 shows the CSE to consumers in some developed countries over the past decade. In the EU, for example, consumer costs exceeded US$80 billion in the early 1990s but due to both the shift in EU agricultural policy to greater reliance on direct payments to farmers and to higher world market prices, the burden fell to US$56 billion in 1996-98. Differences in the support mechanisms used in the US and Japan are also clearly evident, where the average percentage CSE in Japan has exceeded 50 percent throughout the period while in the US, where market price support arrangements are not as important, the percentage CSE is close to zero or even negative.

3.3.5 The Nominal Assistance Coefficient (NAC)

Definition of NAC

The Nominal Assistance Coefficient (NAC) is defined as the value of total production at farm gate prices plus budgetary support to the value of total production at world prices. It is thus analogous to the Nominal Protection Coefficient except that the top line of the ratio, the numerator, encompasses all forms of assistance and not just that provided through market price support. It can also be compared to the percentage PSE. The latter measures the value of support as a ratio to the value of farm receipts including support. It measures the percentage of farm revenues which are due to the protection instruments in place. The NAC can be interpreted as a comparison of the effective price which farmers receive with the border price. Like the PSE, however, caution must be exercised in interpreting the NAC as a measure of trade distortion. The trade effects of policies in two countries with the same NAC could be quite different, depending on how coupled the budget transfers are to the level of production on farms.

Box 17 shows that the NAC and the PSE measures of support move closely together. The 1.65 figure for the EU in 1996-98 is interpreted as showing that, on average, effective prices (including the value of direct budget support) received by EU farmers were 65 percent above world prices in that year.

3.3.6 The WTO Aggregate Measure of Support (AMS)

The AMS is based on negotiating realities rather than economic criteria

This measure was introduced by the UR Agreement and is used in multilateral trade negotiations. It is similar to the PSE but is less inclusive since it does not include a number of support programmes, notably those in the so-called "Green Box" and "Blue Box" of the UR Agreement, such as the compensatory payments and land set-aside programmes of the EU and the United States' direct payment scheme. Support measures below a certain level are also excluded on the basis of the "de minimis" principle of the UR Agreement. Possible positive or negative protection to producers deriving from distortions in the exchange rate are also not taken into account. While the previous policy indicators are based on analytical principles, the AMS is a measure based on negotiating realities, which includes or excludes support programmes on the basis of agreements reached during negotiations rather than on purely economic criteria. The AMS is studied in detail in other modules and in FAO (1998). Box 18 highlights the difference between the AMS and the PSE.

Box 18: A comparison of PSE and AMS measurements

PSE includes all monetary transfers to producers from consumers and taxpayers.

AMS excludes some of the transfers from both consumers and taxpayers.

PSE includes all direct payments to producers (i.e. monetary transfers from taxpayers).

AMS excludes some of these: e.g. direct payments (from taxpayers) of `green box' and `blue box' origin.

PSE includes implicit monetary transfers from consumers resulting from import barriers.

AMS does not: market price support is only defined when an administered price exists.

PSE uses current external prices (i.e. prices prevailing at time of the PSE calculation).

AMS uses a fixed reference price (1986-88) for all AMS calculations: Base and Current.

PSE varies according to changes in world prices and exchange rates as well as `volumes of support'.

AMS varies only according to the volume of support.

PSE can measure negative transfers to producers and these are netted out when calculating the total PSE for the agricultural sector.

AMS ignores negative transfers in calculating aggregate support

PSE allows for high support to feed cereals to be registered as negative support to livestock.

AMS does not allow for this.

PSE measured support exposes producers to changing world market conditions.

AMS measured support does not.

Source: FAO (1998), page 57.


  1. This module has presented the main policy instruments used by governments to protect domestic producers, particularly in agriculture. The impact of these instruments on the levels of production, consumption, imports and exports was discussed. Some instruments have direct influence on the prices of tradable goods, while others affect them indirectly, contributing to make domestic products more competitive in international markets. Governments usually use different sets of instruments depending on their macroeconomic policies as well as on practical considerations.
  2. A simple analysis of the effects of the various instruments of protection can be made using the partial equilibrium method, showing the effects of these instruments on domestic demand, supply and price in a single market. The analysis permits identification of the effects of the instruments on the prices of tradable goods and the winners and losers.
  3. By using the concept of producer and consumer surplus, the welfare effects of the various instruments on consumers, producers, taxpayers and society as a whole can also be estimated.
  4. The levels of protection can be assessed by using different indicators, each of which has its different limitations, calculation procedures and economic meaning. It is important to be aware of the differences involved.


de Janvry, A. & Sadoulet, E. 1995. Quantitative Development Policy Analysis. Baltimore and London, The John Hopkins University Press.

FAO. 1998. The Implications of Uruguay Round Agreement on Agriculture for Developing countries - a Training Manual. Training Materials for Agricultural Planning, No. 41. Rome.

Gittinger, P J. 1982. Economic Analysis of Agricultural Projects. Second Edition. Baltimore and London, John Hopkins University Press.

Josling, T. E., Tangermann, S. & Warley, T. K. 1996. Agriculture in the GATT. London, Macmillan Press.

Just, R., Hueth, D.L. & Schmitz, A. 1982. Applied Welfare Economics and Public Policy. Prentice-Hall, N.J.

Tsakok, I. 1990. Agricultural Price Policy: a Practitioner's Guide to Partial Equilibrium Analysis. Ithaca, New York, Cornell University Press.


1 A variable tariff was used by the EU as part of the Common Agricultural Policy. It was calculated as the difference between the access price to the EU market, i.e. usually the price established by the EU for domestic producers, and the lowest CIF import price. Under the Uruguay Round Agreement, the EU was required to replace its variable levies by fixed tariffs, although there are some exceptions.

2 Under the 1996 Freedom to Farm legislation, grain and oilseed payments were decoupled from current market conditions and no longer vary with the gap between target and market prices; at the same time the acreage reduction programme was abolished.

3 In contrast to economic parity prices, which are explained in section 3.3.1.

4 In the case of direct payments, this is true only where the payments are coupled (linked) to the amounts which farmers produce. In practice, however, it is very difficult to achieve a fully decoupled payment.

5 The explanation is inspired by Just et al (1982).

6 Our presentation of this subject is inspired by those of de Janvry and Sadoulet (1995), Tsakok (1990) and FAO (1998).

7 To simplify this presentation we assume that all inputs entering production are tradable.

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