2 Module 4

Module 4

Objectives of the module • Tariffs • Subsidies • Local content requirements, • Administrative Policies • Anti-dumping policies • Political and economic argument for intervention

• Classical Theories supporting Free trade • Government intervention due to political interests

Trade policy uses seven main instruments

– – – – – – –

Tariffs Subsidies Import Quotas Voluntary export restraints Local content requirements Administrative policies Antidumping duties

TARIFFS • A tax levied on imports • Two categories – Specific tariff & Ad valorem tariffs

• Specific Tariffs – are levied as a fixed charge for each unit of a good imported

• Ad valorem tariffs – are levied as a proportion of the value of the imported good

• A tariff raises the cost of imported products. • In most cases tariffs are put in place to protect domestic producers from foreign • • They also raise revenues for the government • Domestic producers gain, because the tariffs affords them some protection against foreign competitors by increasing the costs of imported goods • Consumer may lose because they must pay more for certain imports

Conclusion • Tariffs are unambiguously proproducer and anti-consumer • Tariffs reduce the overall efficiency of the world economy

Subsidies • A Subsidy is a government payment to a domestic producer • Forms of Subsidy – – – –

Cash grants Low interest loans Tax-breaks Government equity participation

Issues with Subsidies • Subsidies tend to protect the inefficient and promote excess production • E.g., Agriculture subsidies

– Allow inefficient farmers to stay in business – Encourage countries to overproduce the subsidized product – Encourage countries to produce products that could be grown more cheaply elsewhere and imported – Therefore, reduce international trade in agriculture

Import Quotas • An import Quota is a direct restriction on the quantity of some good that may be imported into a country • This restriction is enforced by issuing import license to a group of individuals or firms

Voluntary Export Restraint • A quota on trade imposed by the exporting country, typically at the request of the importing country’s government. • The extra profit that producers make when supply is artificially limited by an import quota is referred to as a quota rent.

Local content requirements • A requirement that some fraction of a good can be produced domestically • This requirement can be expressed in terms either in physical terms (75% of component parts should be produced locally) or in value terms (75% of the value of this product must be produced locally )

Administrative Policies • Bureaucratic rules that are designed to make it difficult for imports to enter a country

Anti-dumping policies • Dumping is defined as selling the goods in a foreign market at below their costs of production or below fair market value • Anti-dumping policies are designed to punish foreign firms that engage in dumping • The objective is to protect domestic producers from the unfair foreign competition

Government Intervention • Political reasons • Economic reasons

Political Arguments for government Intervention • Protecting jobs and industries • National Security • Retaliation • Protecting customers • Furthering foreign policy objectives • Protecting human rights

National Security • Strategic industries are run by the government • Defense, aerospace, electronics, semiconductors, posts, railways • Indian government exclusively reserved eight industries for public sector operation from the national security point of view

Protecting Industries • From foreign competition • Most of the sick small scale units have become mortal • The small & medium enterprises have become sick after the entry of foreign industries • Cheap products from China & east asian countries

Protecting Jobs • Economic liberalization lead to closure of many small industries • Downsizing of large industries • Outsourcing of employees • Privatization of public sectors • All this reduced the number of jobs

Retaliation • Foreign business need to be dealt with tough approach • Only governments can deal in such a manner • Otherwise, the foreign business control the domestic business firms

Economic Arguments for intervention • The Infant industry argument • Strategic Trade Policy

Infant Industry Argument • When the industry is in the infant stage, it needs protection from the foreign competition • Private industrialists cannot invest heavily during infant stage • Govt. should interfere in business to provide capital and infrastructural facilities

Strategic Trade Policy • In the form of subsidies