International Business: Fourth Edition

International Business Fourth Edition

CHAPTER 5 The Political Economy of International Trade

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Chapter Focus The political reality of free trade is that while nations are nominally committed to it, they intervene and take actions to protect the interests of politically important groups. This chapter explores the political and economic reasons for intervention; to restrict imports and expand exports, but, more recently, for ‘social’ reasons. The chapter describes the range of intervention instruments used by governments and considers the case for free trade in light of government actions.

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The 7 Instruments of Trade Policy

Tariffs

Subsidies

Voluntary Exports Restraints Import Quotas

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Local Content Requirements

Antidumping Duties

Administrative Policies

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Tariffs Specific Fixed charge per unit

Tariffs  Oldest form of protection.  Good for the Government.  Good for producers.  Leads to inefficiency.  Bad for consumers.

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Ad Valorem Charge is a proportion of the goods value

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Subsidies Tax Breaks

Cash Grants

Government payment to a domestic producer

Low Interest Loans

Government Equity Participation

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Subsidies Paid by taxing individuals Agriculture 1.Keeps inefficient farmers in business. 2.Encourages production of subsidized products. 3.Produce products grown more cheaply elsewhere. 4.Reduces agriculture trade.

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Helps domestic producers to compete internationally.

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Import Quotas and Voluntary Export Restraints Import Quotas

Quota rent

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Helps producers

Direct restriction on the quantity of a good that can be imported into a country.

VERs

Quota on trade imposed by the exporting country at the request of the importing country’s government.

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Local Content Requirements A specific A specific fraction of a fraction of a good must be good must be domestically domestically produced. produced. Physical amount

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Value

Widely used by developing countries to develop their manufacturing base. Used by developed countries to protect local jobs and industry from foreign competition.

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Administrative Policies Bureaucratic rules designed to make it difficult for imports to enter a country. Japanese ‘masters’ in imposing rules.

Tulip bulbs. Federal Express.

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Antidumping Policies Selling goods into a foreign market below production costs, or Selling below “fair market value”. Used to unload excess production. Or, predatory pricing.

Antidumping policies are used to punish foreign firms. Protect local industry from “unfair” practices. Impose “countervailing” duties.

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Political Arguments for Intervention Protect Industry and Jobs.

National Security

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Protect Human Rights

Retaliation Further Foreign Policy Objectives Protect Consumers

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Protect Industry and Jobs.

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Most common political argument.

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Retaliation

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Risky strategy. If government fails to heed warnings and imposes its own higher tariffs, the result is higher tariffs all around and a corresponding economic loss.

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Retaliation US Trade Sanctions Partial List 25 20 15 New Sanctions

10 5 0 1993 95 McGraw-Hill/Irwin

97

Afghanistan Italy Burma Libya Canada Nigeria China N. Korea Cuba Pakistan India Saudi Arabia Iran Sudan Iraq Syria Yugoslavia

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Protect Consumers

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Battleground for biotechnology such as hormone-treated beef and genetically altered crops.

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Further Foreign Policy Objectives

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Used to build relations with another country or punish it (so-called rogue states). Policy is unilateral and easily defeated by other countries ignoring it.

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Protect Human Rights

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Basis for the use of “Most Favored Nation” status to persuade China to change its positions on human rights.

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Economic Arguments for Intervention Infant Industry Strategic Trade Policy

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 Infant industry is the oldest economic argument for government intervention, dating to 1792 and Alexander Hamilton.  Protect developing country’s new industry from developed countries better established industries. Recognized by GATT.

 Strategic trade policy can help a firm gain ‘first mover’ advantages or overcome barriers created by a different (foreign) first mover.

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Revised Case for Free Trade Paul Krugman, MIT economist, argues that strategic trade policies can lead to trade wars. The best way to handle disputes is to work to establish rules that minimize trade-distorting subsidies - a function of the World Trade Organization. He also argues that government intervention usually favors special interest groups that distort the subsidy to their own ends. Therefore, “a blanket policy of free trade, with exceptions granted only under extreme pressure … may be the best policy that the country is likely to get.” McGraw-Hill/Irwin

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Development of the World Trading System Intellectual arguments for free trade: Adam Smith and David Ricardo.

Free trade as government policy: Britain’s (1846) repeal of the Corn Laws.

Britain continued free trade policy. Fear of trade war.

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World War I to World War II 1918 - 1939 Great Depression US stock market collapse Smoot-Hawley Act (1930) US had positive trade balance with world Act imposes tariffs to protect U.S. firms. Foreign response was to impose own barriers US exports tumbled

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General Agreement on Tariffs and Trade WWII allies want international organization in trade arena similar to UN in political arena. GATT proposed by US in 1947 as step toward ITO. 1948: Havana Conference. Failed charter for the International Trade Organization. GATT 19 original members grew to 120 nations by the time it was superceded by the WTO. GATT members agree not to raise tariffs above negotiated rates.

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GATT Negotiating Rounds %

Geneva 1947 Annecy 1949 Torquay 1950-51 Geneva 1956 Dillon 1960-62 Kennedy 1964-67 Tokyo 1973-79 Uruguay 1986-94

23 13 38 26 45 62 99 117

Annual Growth Under GATT

9.0 8.5 8.0 7.5 7.0 6.5 6.0 5.5 5.0 4.5 4.0 1953-63

1963-73

World Trade World Income

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Average Reduction in US Tariff Rates 1947 - 85 120

Index Pre-Geneva Tariff = 100

100 80 60 40 20

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GATT Negotiating Rounds © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

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1980-1993: Disturbing Trends Pressures for greater protectionism: Japan’s economic success. World’s second largest economy. World’s largest exporter.

The U.S.’s persistent trade deficit. Many countries had found ways to avoid GATT restrictions.

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Uruguay Round Most comprehensive trade agreement in history. Created the World Trade Organization. Impacted: Agriculture subsidies (stumbling block: US/EU). Applied GATT rules to services and intellectual property. Strengthened GATT monitoring and enforcement.

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World Trade Organization Umbrella organization for: GATT Services Intellectual property 154 Rue de Lausanne, Geneva Responsibility for trade arbitration: Reports adopted unless specifically rejected. After appeal, fail to comply can result in compensation to injured country or trade sanctions.

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WTO 141 members (China) and 28 candidates. Between 1995 and 2000, 213 disputes brought before the WTO. Significant victories: Telecommunications 68 countries (90%) of world telecommunications revenues Pledged to open their markets to fair competition Financial Services 95% of financial services market 102 countries will open, to varying degrees, their markets.

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Failure of Countries to Agree on Goals

WTO

Seattle

Private Groups & Unions Oppose “faceless” Organization

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