International Business

Chapter Seven

Governmental Influence on Trade

Reported by: Alianah A. Pacma

Chapter Objectives
To realize the rationales for government policies that enhance and restrict trade To interpret the effects of pressure groups on trade policies To understand the comparison of protectionist rationales used in high-income countries with those used in lowincome countries economies To comprehend the potential and actual effects of government 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 government trade policies
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Introduction
Protectionism refers to those government restrictions and incentives specifically designed to help a county s domestic firms compete with foreign competitors at home and abroad.
Governments intervene in the trade process to attain economic, social, and/or political objectives. Whenever governments impede the flow of imports and/or encourage the flow of exports, they simultaneously provide direct and/or indirect subsidies for their domestic firms.
Protectionist measures are likely to lead to retaliation by affected stakeholders.
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CONFLICTING RESULTS OF TRADE POLICIES

While governments intervene in trade in order to attain economic, social, and/or political objectives, they also pursue political rationality when they do so. Officials enact those trade policies they feel will best protect their nations and citizens and perhaps their personal political longevity. However, aiding struggling constituencies without penalizing those who are well off is often impossible. Thus, protectionist actions not only spark fierce debate among competing parties, but they can also lead to retaliation by affected stakeholders.

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Rationales for Government Intervention in Trade

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Rationales for Governmental Intervention in Trade

ECONOMIC RATIONALES NONECONOMIC RATIONALES

Maintenance of Essential Industries Infant-Industry Argument Prevention of Shipments to Unfriendly Countries Industrialization Argument Maintain or Extension of Spheres of Influence Economic Relationships with Protecting Activities that Other Countries Help Preserve the National Identity
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Unemployment

Rationales for Government Intervention in Trade

ECONOMIC RATIONALES FOR GOVERNMENTAL INTERVENTION

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Economic Rationales for Government Intervention:

A.

Unemployment

Persistent unemployment pushes many groups to call for protectionism; one of the most effective is organized labor. By limiting imports, local jobs are retained as firms and consumers are forced to purchase domestically produced goods and services. However, unless the protectionist country is relatively small, such measures usually do little to limit unemployment. On the other hand, they may result in a decline in export-related jobs because of (i) price increases for components or (ii) lower incomes abroad. Further, such measures are likely to lead to retaliation unless either the protectionist or the affected country is relatively small. Thus, governments must carefully balance the costs of higher prices with the costs of unemployment and the displaced production that would result from freer trade when enacting such measures.

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Economic Rationales for Government Intervention:

B.

Infant-Industry Argument

First presented by Alexander Hamilton in 1792, the infant-industry argument holds that a government should temporarily shield emerging industries in which the country may ultimately possess a comparative advantage from international competition until its firms are able to effectively compete in world markets. Eventual competitiveness will result from movement along the learning curve plus the efficiency gains from achieving the economies of large-scale production. Two basic problems associated with the above argument are the assumptions that (i) governments can in fact identify those industries that have a high probability of success and (ii) firms within those industries should receive government assistance. Infant-industry protection requires some segment of the economy (typically local consumers) to incur the initial higher cost of inefficient local production. Ultimately, the validity of the argument rests on the expectation that the future benefits of an internationally competitive industry will exceed the costs of the associated protectionist measures.
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Economic Rationales for Government Intervention:

C. Industrialization Argument
Industrialization Argument: The development of national industrial output should be supported, even though domestic prices may not be competitive on the world market, reasons to support it are as follows:
1. 2. 3. 4. 5. 6. Use of Surplus Workers. Promoting Investment Inflows. Diversification. Greater Growth for Manufactured Products. Import Substitution versus Export Promotion. Nation Building.

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Economic Rationales for Government Intervention:

C. Industrialization Argument
1. Use of Surplus Workers.
Surplus workers can more easily be used to increase manufacturing output than agricultural output. However, this shift may also lead to (i) increasing demand for social services because of the rural to urban migration and (ii) decreasing agricultural output. In this instance, improved agriculture practices may be a better means of achieving economic success.

2. Promoting Investment Inflows.

Import restrictions encourage foreign direct investment by foreign firms that want to avoid the loss of a lucrative or potential market. FDI inflows in turn lead to increased local employment, an attractive outcome for policy makers.
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Economic Rationales for Government Intervention:

C. Industrialization Argument
3. Diversification.
Price variations can wreak havoc on economies that rely on just a few commodities for job creation and export earnings. Contrary to expectations, however, unless a country s industrial base is truly expanded, a move into manufacturing may simply shift that dependence from a reliance on the basic commodities to the downstream manufactured goods produced from them.

4. Greater Growth for Manufactured Products.

Terms of trade refers to the quantity of imports that a given quantity of a country s exports can buy. Many emerging nations have experienced declining terms of trade because the demand for and prices of raw materials and agricultural commodities have not risen as fast as the demand for and prices of finished goods. In addition, changes in technology have reduced the need for many raw materials. Cost savings realized from manufactured products go mainly to higher profits and wages, thus fueling the industrialization process.
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Economic Rationales for Government Intervention:

C. Industrialization Argument
5. Import Substitution versus Export

Promotion.
Import substitution represents an economic development
strategy that relies on the stimulation of domestic production for local consumption by erecting barriers to imported goods. If the protected industries do not become globally competitive, however, local customers will continually be penalized by high prices. On the other hand, export-led development, i.e., export promotion, encourages economic development by harnessing a country-specific advantage (e.g., low labor costs) and building a vibrant manufacturing sector through the stimulation of exports. In reality, when effectively crafted, import substitution policies eventually lead to the possibility7-13 of export promotion as well.

Economic Rationales for Government Intervention:

C. Industrialization Argument
6. Nation Building.
The industrialization process helps countries build infrastructure, advance rural development, enhance the quality of peoples lives, and boost the skills of the workforce.

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Economic Rationales for Government Intervention:

D. Economic Relationships with Other

Countries
Countries track their own performance as compared to other nations to determine whether to impose trade restrictions as a means of improving their competitive positions. Primary motivations are four:

1. 2. 3. 4.

Balance of Payments Adjustments. Comparable Access or Fairness. Restrictions as a Bargaining Tool. Price-Control Objectives.

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Economic Rationales for Government Intervention:

D. Economic Relationships with Other Countries

1. Balance of Payments Adjustments.
The trade account (the current account) is a major part of the balance of payments for most countries. If balance-of-payments difficulties persist, a government may restrict imports and/or encourage exports in order to balance its trade account. If it chooses to devalue its currency, the value of all transactions will be affected. If, however, it wishes to target certain products, then protectionist measures (both tariffs and nontariff barriers) will be more effective.

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Economic Rationales for Government Intervention:

D. Economic Relationships with Other Countries

2. Comparable Access or Fairness.
The comparable access argument promotes the idea that a country s firms are entitled to the same access to foreign markets as foreign firms have to its market. Economic theory reasons that producers operating in industries where increased production leads to economies of scale but which lack equal access to foreign competitors markets will struggle to become cost-competitive. However, restricting trade, even on the grounds of fairness, may lead to higher prices for domestic customers.
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Economic Rationales for Government Intervention:

D. Economic Relationships with Other Countries

3. Restrictions as a Bargaining Tool.
Import restrictions may be levied as a means to try to persuade other countries to lower their import barriers. The danger, however, is that each country will, in turn, retaliate by escalating its own restrictions. To successfully use restrictions as a bargaining tool requires that they be (i) believable and (ii) important to the targeted parties.

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Economic Rationales for Government Intervention:

D. Economic Relationships with Other Countries

4. Price-Control Objectives
Countries may withhold products from international markets in an effort to raise world prices and thus improve export earnings and/or favor domestic customers. (Organization of Petroleum Exporting Companies (OPEC) is a case in point.) The practice of pricing exports below cost, or below their homecountry prices, i.e., below their fair market value, is known as dumping. Most countries prohibit imports of dumped products, but enforcement usually occurs only if the product disrupts domestic production. The optimum-tariff theory claims that a foreign producer will lower its prices if the destination country places a tariff on its products. So long as the foreign producer reduces its price by any amount, some shift in revenue goes to the importing country, and the tariff is deemed an optimum one.
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Rationales for Government Intervention in Trade

NONECONOMIC RATIONALES FOR GOVERNMENTAL INTERVENTION

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Non-Economic Rationales for Government Intervention:

A. Maintenance of Essential Industries

The essential industry argument states that a government applies restrictions to protect essential domestic industries (particularly defense) so that the country is not dependent on foreign sources of supply. Protecting an inefficient industry, however, will lead to higher costs and possibly political consequences as well.

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Non-Economic Rationales for Government Intervention:

B. Prevention of Shipments to Unfriendly Countries

Groups concerned about security use national defense arguments to prevent the export, even to friendly countries, of strategic goods that might fall into the hands of potential enemies. Trade controls on non-defense goods may also be used as a foreign policy weapon to try to prevent another country from meeting its political objectives. However, retaliation often renders such protectionist measures ineffective.
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Non-Economic Rationales for Government Intervention:

C. Maintenance or Extension of Spheres of Influence

To maintain their spheres of influence, governments may give aid and credits to and encourage imports from countries that join a political alliance or vote a preferred way within international bodies. Further, trade restrictions may coerce governments to take certain political actions or punish firms whose governments do not comply.

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Non-Economic Rationales for Government Intervention:

D. Protecting Activities that Help Preserve the National Identity

Countries are partially held together through a unifying sense of cultural and national distinctiveness. To sustain this collective identity, governments may limit the presence of foreign products in certain sectors.

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INSTRUMENTS OF TRADE CONTROL

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Instruments of Trade Control

Instruments of trade control can: -directly limit the amount that can be traded -indirectly affect the amount traded by directly influencing prices Tariffs (also called duties) are taxes levied on (internationally) traded products. Nontariff barriers (NTBs) represent administrative regulations, policies, and procedures, i.e., quantitative and qualitative barriers, that directly or indirectly impede international trade.
While tariff barriers directly affect prices and subsequently the quantity demanded, nontariff barriers may directly affect price and/or quantity.
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Fig. 7.4: Comparison of Trade Restrictions

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Instruments of Trade Control: Tariffs

Tariffs, i.e., taxes levied on (internationally) traded products, include:
exports tariffs, levied by the country of origin on exported products transit tariffs, levied by a country through which goods pass en route to their final destination import tariffs , levied by the country of destination on imported products
A tariff increases the delivered price of a product, and, at the higher price, the quantity demanded will be less.
[continued]

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A specific duty is a tariff that is assessed on a per unit basis. An ad valorem tariff is assessed as a percentage of the value of an item.
If both a specific duty and an ad valorem tariff are assessed on the same product, it is known as a compound duty.
While raw materials frequently enter industrial countries tariff free, an ad valorem tariff is often applied to the total value of manufactured goods. Critics argue that the effective tariff on the manufactured portion, i.e., the value-added portion, is higher than the published tariff.
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Instruments of Trade Control:

Nontariff Barriers Direct Price Influences
Subsidies: direct or indirect financial assistance from governments to their domestic firms to help them overcome market imperfections and thus make them more competitive in the marketplace. Aid and loans: tied aid and loans require that the recipient spend the funds in the donor country Customs valuation: determining the true value and/or origin of traded products Other direct price influences: special fees, deposits, minimum price levels
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Instruments of Trade Control:

Nontariff Barriers Quantity Controls
Quota: a numerical limit on the quantity of a

product that may be imported or exported in a given period of time

Voluntary export restraints (VERs): negotiated limitations of exports from one country to another Embargo: an outright ban on imports from or exports to a particular country
Because of the increase in the equilibrium price, a quota may increase per unit revenues for participants within the protected market.
[continued]

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Buy local legislation Specific permission requirements

Import and export licenses Foreign exchange controls

Administrative delays Reciprocal requirements

Barter Offset

Restrictions on services
Essentiality Professional standards Immigration
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DEALING WITH GOVERNMENT INTERVENTION

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Dealing with Government Intervention

Firms can deal with trade restrictions by:

moving operations to lower-cost countries concentrating on market niches that attract less international competition adopting internal innovations that lead to greater efficiency and/or superior products trying to secure government protection
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CONCLUSIONS

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Implications/Conclusions
When governments choose to impede the flow of imports and encourage the flow of exports, they simultaneously provide direct and/or indirect subsidies for their domestic industries. It is difficult to determine the real effects of trade barriers due to the likelihood of retaliation and the fact the imports and exports can both have positive effects.
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Much government interference in the international trade process is motivated by political rather than economic factors. A company s particular international strategy will determine the extent to which it might benefit from protectionist measures.
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THANK YOU!!
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