Governmental Influence on TradeChapter seven

Members

K.A.S. Navarathne PGIA 07-6906

W.A.Wasantha PGIA 07-6970

R.G.M.S.Perera PGIA 07-6931

J.R. Nanayakkara PGIA 07-6949

P.K.T.K. Wimalarathne PGIA 07-6902

OBJECTIVES

To realize the rationales of governmental policies that enhance and restrict trade

To interpret the effect of pressure groups on trade policies

To understand the comparison of protectionist rationales used in high-income countries with those used in low –income countries’ economies

To comprehend the potential and actual effect of governmental intervention on the free flow of trade

To understand the major means by which trade is restricted and regulated

To grasp the business uncertainties and business opportunities created by governmental trade policies

INTRODUCTION

• This chapter begins by reviewing the economic and the non economic rationales for trade protectionism ,followed by an explanation of the major forms of trade controls and their effects on companies’ operating decisions.

Protectionism –

Government restrictions on imports and occasionally on exports that frequently give direct or indirect subsidies to industries to enable them to compete with foreign production either at home or abroad.

PHYSICAL AND SOCIETAL INFLUENCES ON PROTECTIONISM

AND COMPANIES’ COMPETITIVE ENVIRONMENT

CONFLICTING RESULTS OF TRADE POLICIES

Governments intervention in trade to attain

• Economic, • Social or• Political objectives.

Governmental officials apply trade policies

• To benefit the nation and its citizens• Their political longevity

Conflicting objectives

Determining the best way to influence trade is complicated Reason - frequent conflicts in the effects of policies.

Government would also like to help struggling companies and industries without penalizing those who doing well

This goal is often impossible –especially if other countries retaliate against their protectionist actions

Eg :- U.S. gave tax breaks to aid its exporters, but the 25-nation EU

related with import taxes that hurt such U.S. companies’ export sales as Al-Edmonds for shoes and Northland Forest Products for specialty lumber

Proposals for trade regulation reform often spark fierce debate among people and groups that believe they will be affected

Stakeholders/Interest groups – Those that are most directly affected (Workers, Owners, Suppliers, and Local politicians) Eg :- U.S. stakeholders whose livelihood depends on a U.S. base of

clothing production are fighting the elimination of import-restricting quotas

Individual consumers often misinterpret how much retail prices rise because of import restrictions

Eg :- EU restrictions on banana imports cost EU consumers about $2

billion a year because of higher banana costs, a significant amount in total but trivial for each banana or for each consumer

RATIONALES FOR GOVERNENT INTERVENTION IN TRADE

EONOMIC RATIONALES

- Prevent unemployment

- Protect infant industries

- Promote industrialization

- Improved position compared to other countries

NONECONOMIC RATIONALS

- Maintain essential industries

- Deal with unfriendly countries

- Maintain or extend spheres of influence

- Preserve national identity

ECONOMIC RATIONALES FOR GOVERNMENTAL INTERVENTION

1. Unemployment

2. Infant-Industry Argument

3. Industrialization Argument

4. Economic Relationships with other Countries

1. UNEMPLOYMENT

• The most effective pressure group for import restrictions

- Time and incentive to picket companies - Contact governmental representatives and confront

organizations

• Eg:- Unemployed U.S. steelworkers pressured U.S. lawmakers to apply tariffs and quotas to restrict steel imports in order to preserve their jobs and pensions

Retaliation -

Two factors can ease the effects of retaliation• Small trading countries are less important in the retaliation

process• Retaliation that decreases employment in a capital-incentive

industry may not affect employment as much as the value of the trade loss would imply

Even if no country retaliates, the restricting country may gain jobs in one sector only to lose jobs elsewhere.

Eg. Lower imports – Lower import handling jobs

Possible Costs of Import Restrictions If import restrictions do increase domestic employment, fellow

citizens will have to bear the cost of• Higher prices• Higher taxes

Government officials should compare the,- Costs of higher prices with the cost of unemployment and displaced production that would result from free trade

& - Costs of policies to ease the plight of displaced employees,

such as for unemployment benefits or retraining

Efforts to reduce unemployment through import restrictions are usually ineffective.

2. INFANT-INDUSTRY ARGUMENT- Alexander Hamilton in 1972

Infant-Industry Argument The government should shield an emerging industry from

foreign competition by guaranteeing it a large share of the domestic market until it is able to compete on its own.

The infant-industry argument says that production becomes more competitive over time due to,- Increased economies of scale - Greater worker efficiency

• The economies of scale and employees’ higher productivity will enable a company to manufacture efficiently, thereby positioning it to compete internationally

• The government can recoup the costs of trade protection through,

- Higher domestic employment

- Lower social costs

- Higher tax revenue

Risk - Although it is reasonable to expect production cost to decrease overtime, they may never fall enough to create internationally competitive products.

Which creates 2 problems,1. Some industries grow to be competitive because of

governmental protection

2. There are companies, which are early losses & lately gained benefits without any public help.

• Infant-industry protection requires government to make subsidies to lower the product prices of protected companies.

1. Subsidized companies to keep price levels– Tax payers

2. Production subsidies – Reduce the amount that that government can spend elsewhere.

3. INDUTRIALIZATION ARGUMENTCountries seek protection to promote industrialization because that type of production

• Brings faster growth than agriculture - Surplus workers can more easily increase manufacturing out put than agriculture

• Brings in investment funds- If import restrictions keep out foreign-made goods, foreign companies may invest to produce in the restricted area

• Diversifies the economy- Export prices of agricultural products fluctuate very much, which is detriment to economies that depend on few of them

• Brings more income than primary products- The terms of trade for emerging economies may deteriorate because,

Demand for primary products grow slowly & Production cost savings for primary products will be passed on to consumers

• Reduces imports and promotes exports

- Import substitution and export promotion

- Import substitution is not the best approach to develop new industries due to higher prices and taxes

• Helps the nation-building process

- Build infrastructure

- Advance rural development & enhance rural social life

- Boost the skills of the workforce

When a country shifts from agriculture to industry,

• Demands on social and political services in cities may increase

• Output increases if the marginal productivity of agriculture worker is very low – Need to adopt improved agricultural practices

• Development possibilities in the agriculture sector may be overlooked

4. ECONOMIC RELATIONSHIPS WITH OTHER COUNTRIES

There are four main motivations to promote domestic producers

• Balance of Payments Adjustments

- A trade deficit creates problems for nations with low foreign exchange rates

- Governments improve their balance of payments by improving their balance of trade

Eg. Devaluation of currency & import restriction

• Comparable Access or “Fairness”- Domestic producers may be disadvantaged if their access to foreign market is less than foreign producers’ access to their market

• Restrictions as a Bargaining Tool

- The imposition of import restrictions may be used as a means to persuade other countries to lower their import barriers

• Price-Control Objectives- Keep up word prices

- Lead to substitute

- Keep domestic prices down by increasing domestic supply

- Give purchasers less incentive to increase output

- Shift foreign production and sales

- To penetrate foreign market, Eg. Dumping

Rationales for government intervention

• Economic Rationales for government intervention

• Non-economic Rationales for government intervention

Non-economic rationales for government intervention

• Maintenance of essential industries

• Prevention of shipments to unfriendly countries

• Maintenance or extension of spheres of influence

• Protecting activities that help preserve the national identity

Maintenance of essential industries

• The essential-industry argument – (Governments apply trade restrictions to protect essential domestic industries during peacetime so that a country is not dependent on foreign sources of supply during war.)

e.g.: U.S. government subsidize the domestic silicon production.

• Determine which ones are essential

• Consider cost & alternatives

• Once an industry receives protection, it is difficult to remove it because the protected companies, their employees, trade unions and politicians demand for continue protection even though the rational is not exists.

e.g.: U.S continues to subsidize its mohair producers more than 20 years since mohair was no longer essential for military uniforms.

Prevention of shipments to unfriendly countries

• Prevent the export of strategic goods that might fall in to the hands of potential enemies (even to friendly countries) or that might be in short supply domestically.

e.g.: U.S. government prevented export of data-encryption.

e.g.: Nine Chinese companies and an Indian businessman sold technology to Iran regarding the chemical and conventional weapons programmes. Then, US forbade to export goods in to US and prevented US companies from exporting to them.

Prevention of shipments to unfriendly countries cont..

Facts not in favor of sanctions

•Trade sanctions against Cuba were supposed to topple the Castro

regime but four decades later he was still in power

•Who really suffers? Political leaders still get whatever they need, so that the costs of sanctions are borne by innocent people. eg: sanctions against Iraq

•Use of trade sanctions has been controversial (pp 233)

Facts not in favor of sanctions cont..

• Sometimes impose trade sanctions based on one issue rather than countries overall record. eg: suggested sanctions against brazil to restrict the cutting of Amazon forest.

Prevention of shipments to unfriendly countries cont…

Facts in favor of sanctions

• It can refuse products used child slaves eg: Cocoa production in ivory cost

• Sanction succeeded• US & UK sanctions against Zimbabwe•Indian sanction against Nepal

Prevention of shipments to unfriendly countries cont…

Maintenance or extension of spheres of influence

• Governments give aid and credits to, and encourage imports from, countries that join a political alliance or vote a preferred way within international bodies

• Eg: The UE has given preferential treatment of bananas from certain former colonies.

• Eg; China delayed permission for Allianz, a German Insurance Group, to operate in china after Germany gave a reception for Dalai Lama.

Protecting activities that help preserve the national identity

• To protect the collective identity, countries limit foreign products and services in certain sectors.

• Eg: For many years Japan, South Korea and

China maintained an almost total ban on rice

imports, largely because rice farming has been

a historically cohesive force in each nation.

• Eg: Canada relies on a ‘cultural sovereignty’ argument to prohibit foreign ownership or control of publishing, cable TV and book selling.

• Eg: France protects its cinema industry out of fear

that invasion of English language and Anglo Saxon

culture will weaken its cultural identity.

• Eg: Korea requires theaters to show Korean films at least 146 days per year

P1

Quantity

Price

DS

Q1

P2

Q2

Direct price influence

Tax – Increased the price & decrease the quantity sold

Tariffs

Governments charges tariffs when on a good when it crosses the an official boundaries of a country

Source of Government income

Export tariffs Tariffs collected by the exporting country Use by the countries which are exporting raw

materials

Transit tariffCollected by the country through which the goods have passed the border

Eg: Singapore

Import tariffsTariffs collected by the importing country

Increase the price of the imported goods

Make the price advantage for domestically produced goods

Protective even though there is no domestic production in direct competition (Curtail demand on imported goods – Political)

Tariffication methods Specific duty

Charge per unit basis

Ad Valorem duty

Charge as a % of value of the item

Compound duty

Charge both the specific duty & Ad valorem duty on the same good

Tax controversy – Industrial countries No tariffs on importation of raw materials but

tax on processed materials Ad valorem tax on based on total value (raw

materials + processing cost)

Emerging economies argue that the Effective tax rate on manufactured goods more than the published rate.Eg: Assume; Duty on coffee beans = 0

Duty on instant coffee = 10%; If price of coffee jar $5 (Beans – $2.50 + Process - $ 2.50). The effective duty on manufacturing portion is 20% - ( ($0.5/$5)*100)

Price

Quantity

P2

P1

Q2 Q2

DS1

S

Direct quantity influences

Import restriction causes quantity sold to fall

SubsidiesDirect payments to domestic companies to

compensate them for losses incurred from selling abroad

Eg: US subsidies to cotton exporters Sri Lanka – Subsidies to tea exporter

Provide business developments such as market information, trade expositions & foreign contacts

Overcomes market imperfections rather than creating

Aid & LoansGovernments grants loans & aids to other

countriesTied aid – Recipient required to spend the

funds in donor country

Common with large contracts in emerging economies such as infrastructure developments, Telecommunication, railway & electric power projects

Customs Valuation Importers/exporters declare a low price on

invoice in order to enjoy low ad valorem tariffs

Use declared invoice value

Value based on identical goods / Similar goods

Value based on final sales value Reasonable cost

If no invoice value/ doubt

If not possible

Sometimes use the discretionary power to assess the value too high – prevent importation of foreign products

Sometimes misclassify a product & its corresponding tariff

Eg: IC Vs “Chemical Silicon”

Other price influencesSpecial fee

Eg: Consuler, custom clearance, documentation

Minimum price levels

Quotas

Quantitative restrictions on imports or exports

Import quotasProhibits or limit the quantity of products that

can be imported in a given yearIncrease the price of the imported goodGenerate revenue to the companies which

are in importing limited supplySometimes based on political or market

conditionsProtect domestic producers; But not allways

Eg: Japan

Voluntary export restrictions – Type of import quota Country A ask country B to limit exports to country A

voluntarily Not damage the political relations between those

countries as much as import quotas does

Export quotas Restrictions on exports to assure the availability of

goods for domestic consumers at lower price Prevent depletion of natural resources Attempt to raise export price by restraining supply in

foreign markets

Embargo – Prohibit all forms of trade (To achieve political goals)

“Buy Local” Legislations In Government purchases prefer domestic

producersSome times use the price mechanisms

Eg: Purchase from foreign companies if price is at some predetermined margin below that of domestic competitor

Standards & LabelsDevice classification, labeling & testing

standards to allow the sale of domestic products but obstruct that of foreign – made ones

Eg: GMO,GMF

Specific permission requirementsRequire that potential importers or exporters

secure permission from government authorities before conduct trade transactions

Eg: Import license

Foreign –Exchange control Require importer of a given product to

supply to a government agency to secure the foreign currency to pay for the product.

Administrative delaysSpecific permission requirements are

international administrative delaysCreate uncertainty & raise the cost of caring

inventory

Reciprocal requirementsGovernment sometimes require that

exporters to merchandise in lieu of money or that they promise to buy merchandise or service, in place of cash payments, in the country to which they export

Eg: McDonnell Douglas sold helicopters to British Government but had to be equip them with Rolls-Royse engines as well as transfer much of the technology & production work to the UK

Restrictions on serviceRestrictions on foreign sale of services such as Transportation, Insurance, Consulting & Banking. These service industries restricted due to ;

EssentialityConsider certain service industries to be

essential because they strategic purposes or provide social assistance to their citizens

Sometimes prohibit some sectors for private companies (Foreign or Domestic)

Eg: Health, Transportation

StandardsLimits service professions to ensure practice

by qualified personnel via licensing

Eg: Accountants, Architects, Lawyers, etc…

ImmigrationGovernment regulation to organizations to

hire employees locally, have to search qualified personnel extensively in domestic market before recruit from foreign country

DEALING WITH GOVERNMENTAL TRADE INFLUENCES

Governments’ intervention in trade affects the flow of imports and exports of goods between countries.

When companies face possible losses because of the import competition, they have several options to deal with this situation

1.Move operations to a lower-cost country.

2.Concentrate on market niches that attract less international competition.

3.Adopt international innovations-greater efficiency or superior products

4.Try to get governmental protection.

If they have the given options, there are costs and risks with each option.

• Companies may lack the managerial, capital or technological resources to shift production abroad.

• They may not be able to identify more profitable product niches.• Even if they try to improve their efficiency, their innovation may

be quickly copied by foreign competitors.

• In such situations, companies often ask some protection from their government ( to restrict imports or open export markets)

Example : When the Japanese automobiles compete in U.S. market, the U.S. industry sought and received protection from Japanese imports in the form of quotas.

Can the government help every company that faces tough international competition ?

• No, its impossible and helping one industry may hurt another.

Therefore the company should propose or oppose a particular protectionist measures that can convince government officials.

And the companies must identify the key decision makers, whether they are an official of the executive branch, a member of parliament, a career civil servant.

Example : Trade policies in the U.S. are often championed by members of Congress who are specially sensitive to employment and company conditions in their districts.

Its important to identify and get together the other companies and groups that have a common objective to convince the officials that a particular company’s problems are not due to its specific inefficiencies but the general challenge of imports.

Companies can take different approaches to deal with changes with the international competitive environment.

And the company’s attitudes toward protectionism are a function of investments they have made to develop their international strategy.

Generally the companies that depend on free trade and those that have integrated their production and supply chains among countries tend to oppose protectionism and companies with single or multi domestic production facilities (ex: plant in Japan to serve the Japanese market) tend to support protectionism.

THANK YOU…