International Business 9e

By Charles W.L. HillMcGraw-Hill/Irwin Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 7The Political Economy of International Trade

7-*

What Is The Political Reality Of International Trade?Free trade occurs when governments do not attempt to restrict what citizens can buy from another country or what they can sell to another country many nations are nominally committed to free trade, but intervene to protect the interests of politically important groups

7-*

How Do Governments Intervene In Markets?Governments use various methods to intervene in markets including Tariffs - taxes levied on imports that effectively raise the cost of imported products relative to domestic products Specific tariffs - levied as a fixed charge for each unit of a good imported Ad valorem tariffs - levied as a proportion of the value of the imported good

7-*

How Do Governments Intervene In Markets?Tariffs increase government revenuesforce consumers to pay more for certain importsare pro-producer and anti-consumerreduce the overall efficiency of the world economy

7-*

How Do Governments Intervene In Markets?Subsidies - government payments to domestic producersSubsidies help domestic producerscompete against low-cost foreign importsgain export marketsConsumers typically absorb the costs of subsidies

7-*

How Do Governments Intervene In Markets?Import Quotas - restrict the quantity of some good that may be imported into a country Tariff rate quotas - a hybrid of a quota and a tariff where a lower tariff is applied to imports within the quota than to those over the quota A quota rent - the extra profit that producers make when supply is artificially limited by an import quota

7-*

How Do Governments Intervene In Markets?Voluntary Export Restraints - quotas on trade imposed by the exporting country, typically at the request of the importing countrys governmentImport quotas and voluntary export restraintsbenefit domestic producers raise the prices of imported goods

7-*

How Do Governments Intervene In Markets?Local Content Requirements - demand that some specific fraction of a good be produced domestically benefit domestic producersconsumers face higher pricesAdministrative Policies - bureaucratic rules designed to make it difficult for imports to enter a country polices hurt consumers by limiting choice

7-*

How Do Governments Intervene In Markets?Antidumping Policies aka countervailing duties - punish foreign firms that engage in dumping and protect domestic producers from unfair foreign competitiondumping - selling goods in a foreign market below their costs of production, or selling goods in a foreign market below their fair market value enables firms to unload excess production in foreign markets may be predatory behavior - producers use profits from their home markets to subsidize prices in a foreign market to drive competitors out of that market, and then later raise prices

7-*

Why Do Governments Intervene In Markets?There are two main arguments for government intervention in the market Political arguments - concerned with protecting the interests of certain groups within a nation (normally producers), often at the expense of other groups (normally consumers) Economic arguments - concerned with boosting the overall wealth of a nation benefits both producers and consumers

7-*

What Are The Political Arguments For Government Intervention?Protecting jobs - the most common political reason for trade restrictions results from political pressures by unions or industries that are "threatened" by more efficient foreign producers, and have more political clout than consumers

7-*

What Are The Political Arguments For Government Intervention?Protecting industries deemed important for national security - industries are often protected because they are deemed important for national securityaerospace or semiconductors

7-*

What Are The Political Arguments For Government Intervention?Retaliation for unfair foreign competition - when governments take, or threaten to take, specific actions, other countries may remove trade barriersif threatened governments do not back down, tensions can escalate and new trade barriers may be enactedrisky strategyProtecting consumers from dangerous products limit unsafe products

7-*

What Are The Political Arguments For Government Intervention?Furthering the goals of foreign policy - preferential trade terms can be granted to countries that a government wants to build strong relations with trade policy can also be used to punish rogue statesthe Helms-Burton Act and the DAmato Act, have been passed to protect American companies from such actions

7-*

What Are The Political Arguments For Government Intervention?Protecting the human rights of individuals in exporting countries through trade policy actionsthe decision to grant China MFN status in 1999 was based on this philosophyProtecting the environment international trade is associated with a decline in environmental qualityconcern over global warmingenforcement of environmental regulations

7-*

What Are The Economic Arguments For Government Intervention?The infant industry argument - an industry should be protected until it can develop and be viable and competitive internationally accepted as a justification for temporary trade restrictions under the WTO

7-*

What Are The Economic Arguments For Government Intervention?Question: When is an industry grown up ?Critics argue that if a country has the potential to develop a viable competitive position, its firms should be capable of raising necessary funds without additional support from the government

7-*

What Are The Economic Arguments For Government Intervention?Strategic trade policy - first mover advantages can be important to successgovernments can help firms from their countries attain these advantages governments can help firms overcome barriers to entry into industries where foreign firms have an initial advantage

7-*

When Should Governments Avoid Using Trade Barriers?Paul Krugman argues that strategic trade policies aimed at establishing domestic firms in a dominant position in a global industry are beggar-thy-neighbor policies that boost national income at the expense of other countriescountries that attempt to use such policies will probably provoke retaliationKrugman argues that since special interest groups can influence governments, strategic trade policy is almost certain to be captured by such groups who will distort it to their own ends

7-*

How Has The Current World Trading System Emerged?Until the Great Depression of the 1930s, most countries had some degree of protectionismSmoot-Hawley tariff (1930)After WWII, the U.S. and other nations realized the value of freer tradeestablished the General Agreement on Tariffs and Trade (GATT) - a multilateral agreement to liberalize trade

7-*

How Has The Current World Trading System Emerged?In the 1980s and early 1990s protectionist trends emergedJapans perceived protectionist (neo-mercantilist) policies created intense political pressures in other countriespersistent trade deficits by the U.Suse of non-tariff barriers increased

7-*

How Has The Current World Trading System Emerged?The Uruguay Round of GATT negotiations began in 1986 focusing onServices and intellectual propertygoing beyond manufactured goods to address trade issues related to services and intellectual property, and agriculture The World Trade Organizationit was hoped that enforcement mechanisms would make the WTO a more effective policeman of the global trade rules

7-*

How Has The Current World Trading System Emerged?The WTO encompassed GATT along with two sisters organizationsthe General Agreement on Trade in Services (GATS) working to extend free trade agreements to services the Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPS)working to develop common international rules for intellectual property rights

7-*

How Has The Current World Trading System Emerged?The WTO has emerged as an effective advocate and facilitator of future trade deals, particularly in such areas as services 153 members in 2011so far, the WTOs policing and enforcement mechanisms are having a positive effectmost countries have adopted WTO recommendations for trade disputes a magnet for various groups protesting free trade

7-*

What Is The Future Of The World Trade Organization?The current agenda of the WTO focuses on the rise of anti-dumping policiesthe high level of protectionism in agriculturethe lack of strong protection for intellectual property rights in many nationscontinued high tariffs on nonagricultural goods and services in many nations

7-*

What Is The Future Of The World Trade Organization?The WTO launched a new round of talks at Doha, Qatar in 2001 that were still going on in 2011The agenda includescutting tariffs on industrial goods and servicesphasing out subsidies to agricultural producersreducing barriers to cross-border investmentlimiting the use of anti-dumping laws

7-*

What Do Trade Barriers Mean For Managers?Managers need to consider how trade barriers affect the strategy of the firm and the implications of government policy on the firmTrade barriers raise the cost of exporting products to a countryVoluntary export restraints (VERs) may limit a firms ability to serve a country from locations outside that country

7-*

What Do Trade Barriers Mean For Managers?To conform to local content requirements, a firm may have to locate more production activities in a given market than it would otherwiseManagers have an incentive to lobby for free trade, and keep protectionist pressures from causing them to have to change strategies

The Opening Case: U.S. Tariffs on Tire Imports from China explores the implications of U.S. tariffs on imported tires. The tariffs were implemented after intense lobbying by union workers. However, not only did the WTO rule that the tariffs violated trade agreements, they also caused tire prices in the United States to rise significantly. LO1: Identify the policy instruments used by governments to influence trade flows.Tariffs are the oldest form of trade policy; they fall into two categories:Specific tariffs are levied as a fixed charge for each unitAd valorem tariffs are levied as a proportion of the value of the imported goodTariffs are good for government because they generate revenue. But, while they protect domestic producers but they reduce efficiency, and create higher prices for consumers.

Subsidies are government payments to domestic producers. They can be in the form of:Cash grantsLow-interest loansTax breaksGovernment equity participation in the companySubsidy revenues are generated from taxes.Subsidies encourage over-production, inefficiency and reduced trade.

Country Focus: Subsidized Wheat Production in Japan explores the subsidies Japan continues to pay its wheat farmers. Tens of thousands of Japanese farmers continue to grow wheat despite the fact that the wheat grown in North America, Argentina, and Australia is far cheaper and of superior quality. The Japanese farmers stay in business thanks to the hefty subsidies paid by the Japanese government. As a result, wheat prices in Japan are substantially higher than they would be if a free market were allowed to operate.

Management Focus: U.S. Magnesium Seeks Protection explores the dumping charged levied by U.S. Magnesium against Chinese and Russian producers. According to U.S. Magnesium, the sole American producer of magnesium, Russian and Chinese producers were selling magnesium significantly below market value in an effort to drive U.S. Magnesium out of business. The company failed a complaint with the International Trade Commission (ITC) which ultimately ruled in favor of U.S. Magnesium.

LO2: Understand why governments sometimes intervene in international trade.Country Focus: Trade in Hormone-Treated Beef describes the trade battle between the United States and the European Union over beef from cattle that have been given growth hormones. It outlines the basic issues that led to the dispute, and shows how the World Trade Organization has treated the case.

The U.S. has used trade policy against countries like Libya, Iran, Iraq, North Korea, and Cuba.

Oldest argument - Alexander Hamilton, 1792.Protected under the WTO.Only good if it makes the industry efficient. Brazil auto-makers - 10th largest - wilted when protection was eliminated.Requires government financial assistance.Today if the industry is a good investment, global capital markets would invest.

Oldest argument - Alexander Hamilton, 1792.Protected under the WTO.Only good if it makes the industry efficient. Brazil auto-makers - 10th largest - wilted when protection was eliminated.Requires government financial assistance.Today if the industry is a good investment, global capital markets would invest.

Strategic trade policy suggests that: government should use subsidies to protect promising firms in newly emerging industries with substantial scale economiesgovernments benefit if they support domestic firms to overcome barriers to entry created by existing foreign firms

LO3: Summarize and explain the arguments against strategic trade policy.LO4: Describe the development of the world trading system and the current trade issues. GATT - multilateral agreement established in 1948 under U.S. leadership.Objective is to liberalize trade by eliminating tariffs, subsidies, and import quotas.Nineteen original members grew to 120.GATT used rounds of talks to gradually reduce trade barriers.Uruguay Round GATT 1986-93Mutual tariff reductions negotiated.Dispute resolution only if complaints were received.GATT regulations could be circumvented using voluntary export restraints.

The WTO: had 153 members in 2011resolved more than 400 disputes between 1995 and 2010three fourths of the disputes are settled by informal consultationBecause members believe that the protection of intellectual property rights is an essential element of the international trading system, TRIPS obliges WTO members to grant and enforce patents lasting at least 20 years, and copyrights lasting 50 years.

Country Focus: Estimating the Gains from Trade for America explores the results of a study by the Institute for International Economics. The study, which estimated the gains to the American economy from free trade, found that Americas GDP was more than 7 percent higher as a result of reductions in trade barriers than it would have been if the barriers remained. The study also estimated that if tariffs were reduced to zero, significant gains would still result.

LO5: Explain the implications for managers of developments in the world trading system.