IB 303: Chapter 6. Governmental Influence on Trade
Terms in this set (18)
Governmental restrictions and support to influence international trade competitiveness are known as protectionism.
Conflicting results of trade policies
Despite free-trade benefits, governments intervene in trade to attain economic, social, or political objectives.
Sometimes, trade policies may have conflicting results (catfish limitations helped the workers, but also brought higher prices to the workers) (helping struggling companies without penalizing the ones that are doing well) (countries limiting their imports in retaliation)
Conflicting results of trade policies: the role of stakeholders
* stakeholders: the people who will be affected by a decision (i.e. trade regulation)
- stakeholders may object, especially displaced workers
- role of consumers: typically buy the best product they can find for the price, regardless of origin. even if they knew about the price addition due to import restrictions, they probably would not make efforts to rectify them.
Economic rationales for governmental intervention
Governmental trade intervention can be either economic or noneconomic.
Economic rationales for governmental intervention: Fighting Unemployment
1. Fighting Unemployment
- workers displaced because of imports are often the least able to find work (unskilled), and when they do, they generally earn less than before
1) Using trade policy to achieve full employment is problematic, since gaining jobs by limiting imports is not guaranteed and the potentially high costs of success must be borne by someone.
2) Limiting imports to gain jobs in one sector means losing jobs in another sector:
- fewer imports mean fewer jobs in the importing industry
- global complexity of production: import restrictions in one industry will drive up the costs in another, which will cause lower sales.
- imports stimulate exports by increasing foreign income and foreign exchanged earnings
* Analyzing trade-offs
- government must weigh the possible costs of import restrictions (higher prices and higher taxes) with costs of unemployment.
- evidence suggests that efforts to reduce unemployment through import restrictions are usually ineffective. Unemployment is better dealt with through fiscal and monetary policies.
Economic rationales for governmental intervention: Protecting "infant industries"
* The infant-industry argument
- one of the oldest arguments for protectionism
- holds that a government should shield an emerging industry from foreign competition by guaranteeing it a large share of the domestic market until it can compete on its own
- says that production becomes more competitive over time because of:
1. increased economies of scale
2. greater worker efficiency
and that the government needs to protect it until it reaches this stage, and will be paid back through higher domestic employment, lower social costs, and higher tax revenues.
- the prices may never actually fall enough to create internationally competitive products.
1. Determining probability of success
- security of governmental protection may discourage managers from innovating, necessary for global competition
- if the costs aren't reduced due to lack of success, it will lead to a rally to block importation of lower-priced goods
2. Who should bear the cost?
- consumers may have to pay higher prices or taxpayers may have to pay subsidies for the protected products/company
- governments can spend less elsewhere, such as infrastructure and education, which increase overall global competitiveness
Economic rationales for governmental intervention: Developing an Industrial Base
Countries with a large manufacturing base generally have higher per capita GDP than those that do not (ex: Japan and U.S.), because they have developed an industrial base while largely restricting imports.
They all operate under these assumptions:
1. Surplus workers can increase manufacturing output more easily than agricultural output.
2. Inflows of foreign investment in the industrial sector promote sustainable growth.
3. Prices and sales of agricultural products and raw materials fluctuate widely, which is a detriment to economies that depend heavily on just one or a few commodities.
4. Markets for industrial products grow faster than markets for commodities.
5. Industrial growth reduces imports and/or promotes exports.
6. Industrial activity helps the nation-building process.
1. Surplus workers:
* Industrialization argument: presumes that that the unregulated importation of lower-priced manufactures prevents the development of a domestic industry.
1) In rural areas, underemployed may lose the safety net of their extended families, and those who move to urban areas may not have enough housing, social services, or suitable jobs.
2) improved agriculture practices may be a better means of achieving economic success than a drastic shift to industry.
2. Investment Inflows:
* Import restrictions may also increase FDI, which provides capital, technology, and jobs.
* Import restrictions keep out foreign goods = foreign companies may invest to produce in the restricted area.
* fluctuation in prices of agricultural products due to uncontrollable factors such as the weather or changes in demand.
* ISSUE: a greater dependence on manufacturing good does not guarantee diversification of export earnings, since the population is small and the industrial shift will focus on one or two manufactured products, which face competitive risks and potential obsolescence.
4. Growth in manufactured goods:
* terms of trade: the quantity of imports that a given quantity of a country's exports can buy
* over time, it takes more low-priced primary products to buy the same amount of high-priced manufactured goods.
* demand for primary products grows more slowly due to:
1) producers must compete on price, whereas the prices of manufactured goods can stay high due to differentiation
2) as income rises, people spend more money on technologies instead of food
5. Import substitution and export-led development
- developing countries have promoted industrialization by restricting imports, but it becomes an ISSUE if it does become efficient.
- South Korea and Taiwan have achieved rapid economic growth by promoting the development of industries to distinguish between import substitution and export-led development.
6. Nation building
- strong relationship between industrialization and aspects of the nation-building process.
- industrialization helps build infrastructure, advance rural development, and boost workforce skills. (Ecuador and Vietnam: improved food security and export competitiveness)
Economic rationales for governmental intervention: Economic Relationships with Other Countries
Every nation wants to improve its relative position for economic welfare through four practices:
1. Balance-of-trade adjustments:
- a trade deficit causes problems for nations with low foreign exchange reserves (funds that finance the purchase of priority foreign goods and maintain the trustworthiness of a currency).
- government may act to reduce imports or encourage exports to balance its trade account. This can be done in two ways:
1) Depreciating or devaluing its currency, which makes it products relatively cheaper
2) Relying on fiscal and monetary policy to bring about lower price increases than those in other countries
2. Comparable access or "fairness"
- Comparable access argument: holds that companies and industries are entitled to the same access to foreign markets as foreign industries and companies have to theirs.
- Two practical reasons for rejecting the idea of fairness:
1) tit-for-tat market access can lead to restrictions that may deny lower prices to one's own consumers.
2) Governments would find it impractical to negotiate and monitor separate agreements for each of the many thousands of different products and services that might be traded.
3. Restrictions as a Bargaining Tool
- Countries levy trade restrictions to coerce other countries to change their policies.
- danger: each country may escalate its restrictions to create a trade war that has a negative impact on all their economies.
- to use restrictions successfully as a bargaining tool, you must consider two criteria:
1) Believability: you either have access to alternative sources for the product or your consumers can do without it.
2) Importance: exports of the product you're restricting are significant to certain parties in the producer country, significant enough to prompt changes.
4. Price-Control Objectives:
- Countries may withhold goods from international markets to raise prices abroad.
1) encourages smuggling and the development of technology or different means to produce the same product.
2) people will seek substitutes
- country may also limit exports to favor domestic consumers.
- favoring domestic consumers usually disfavors domestic producers of the product, so they have less incentive to maintain production when prices are low.
3) fear that foreign producers will price their exports so artificially low that they will drive producers out of business in the importing economy.
* Dumping: companies sometimes export below cost or below their home-country price.
- only disrupted if it disrupts domestic production; otherwise, country consumers can enjoy lower prices.
- may dump to introduce them and build a market abroad
- companies can afford to dump if they charge high prices in their home market or if their home-country government subsidizes them
* Optimum-tariff theory: states that a foreign producer will lower its prices if the importing country places a tax on its products.
- benefits importing country because the producer lowers its profits on the export sales and the importing country receives the tax.
- criticism: developing country exporters reduce payment to their workers rather than absorbing the full impact through a lower profit margin, causing severe hardships.
Noneconomic Rationales for Government Intervention
Major noneconomic rationales:
1. Maintaining essential industries (especially defense)
2. Promoting acceptable practices abroad
3. Maintaining or extending sphere of influence
4. Preserving national culture
Noneconomic Rationales for Government Intervention: Maintaining essential industries
Essential-industry argument: governments apply trade restrictions to protect essential domestic industries during peace-time so the country is not dependent on foreign supplies during war.
- Ex: U.S. subsidizing domestic production of silicon so domestic computer-chip makers won't need to depend on foreign suppliers.
- Nationalism rallies support.
- high cost: essential-industry argument should not be accepted without a careful evaluation of costs, real needs, and alternatives.
- governments also buy and stockpile supplies of essential raw materials that might be in future short supply.
Noneconomic Rationales for Government Intervention: Promoting acceptable practices abroad
- Governments use national defense arguments to prevent the export, even to friendly countries, of strategic goods that might fall into the hands of potential enemies.
- They also limit trade to promote changes in a foreign country's policies or capabilities.
Noneconomic Rationales for Government Intervention: Maintaining or extending spheres of influence
- Governments use trade to support their spheres of influence, giving aid and credits to, and encouraging imports from, countries that join a political alliance or vote a preferred way within international bodies.
- Ex: EU + 77 members of African, Caribbean, and Pacific Group of States signed the Cotonou Agreement
- Ex: Venezuela can export oil at low cost with long-term financing to targeted Latin American countries to gain influence in the region.
Noneconomic Rationales for Government Intervention: Preserving national culture
Governments prohibit exports or arts and historical items that they deem to be part of their national heritage.
- They also limit imports of certain foreign products and services that may either conflict with their dominant values, such as morality, or replace domestic sources of production that uphold these traditional values.
Instruments of Trade Control
The choice of trade control is crucial because each type may incite different responses from domestic and foreign groups.
Two types that differ in their effects:
1. Those that indirectly affect the amount traded by directly influencing export or import prices
2. Those that directly limit the amount of a good that can be traded
Instruments of Trade Control: Tariffs
Tariff barriers directly affect prices, and nontariff barriers may affect either price of quantity.
* Tariff (also called a duty):
- the most common type of trade control
- tax levied on a good shipped internationally
* Export tariff: tariffs collected by the exporting country
* Transit tariff: tariff collected by a country through which the goods pass
* Import tariff: tariff collected by the importing country (THE MOST COMMON)
- raise the price of imported goods by placing a tax on them and gives domestically produced goods a relative price advantage, discourages imports
* Tariffs as sources of revenue:
- source of governmental revenue
- import tariffs are of little importance to developed countries because they cost more to collect, but in developing countries they are a major source of revenue.
- mostly collected on imports, some countries charge export tariffs on raw materials.
- Transit tariffs were a major source once, but governmental treaties have nearly abolished them.
* Criteria for Assessing Tariffs
- a specific duty: a government assess a tariff on a per unit basis
- ad valorem duty: a percentage of the item's value as tariff
- compound duty: on both the unit and the value
* Effective tariff
Instruments of Trade Control: Nontariff Barriers; direct price influences
- Subsidies are a form of direct assistance to companies to boost competitiveness.
- Controversy: commercial aircraft.
(EU & Airbus Industrie: U.S. subsidize Boeing through R&D contracts for military aircraft that also have commercial applications and tax breaks to secure employment from Boeing's facilities.
U.S.: EU subsidizes Airbus through low-interest government loans.)
* Agricultural Subsidies:
- one area in which everyone agrees that subsidies exist is agricultural products in developed countries
- food supplies are too critical to be left to chance
- U.S. subsidies for cotton production disadvantages Brazilian production.
- In U.S., Japan and the EU, rural areas have a disproportionately high representation in government decision making. (internal politics)
- Effect: developing countries are disadvantaged in serving the developed countries with competitive agricultural products. Surplus is sold to developing countries at low prices, distorting trade and knocking out local competition.
* Overcoming market imperfections:
- business development services including market information, trade expositions, foreign contacts.
- more justifiable than tariffs because they seek to overcome, rather than create, market imperfections.
- gov. can spread the cost of collecting information among many users
2. Aid and Loans
- Tied aid or tied loans: recipient is required to spend the funds in the donor country; helps win contracts for infrastructure, telecommunications, railways, and electric power projects
- donor country suppliers
3. Customs valuation
- tariffs for imported merchandise depend on the product, price, and origin, which tempts exporters and importers to declare these wrongly on invoices to pay less duty.
- agents sometimes use their discretionary power to assess the value too high, thereby preventing the importation of foreign-made products such as occurred on Philippine cigarettes imported into Thailand.
* Valuation problems:
- new products are coming on the market all the time and must be classified within existing tariff categories
- easy to misclassify a product and its corresponding tariff
- classification of differences may result in millions of dollars in duties
4. Other Direct-Price Influences
- special fees (consular and customs clearance and documentation)
- requirements that customs deposits be placed in advance of shipment
- minimum price levels at which goods can be sold after they have customs clearance
Nontariff Barriers: Quantity Controls
- the most common type of quantitative import or export restriction, limiting the quantity of a product that can be imported or exported in a given time frame, typically per year.
* Import quotas raise prices for two reasons:
1) To limit supply
2) to provide little incentive to use price competition to increase sales.
- companies sometimes convert the item into something for which there is no quota. ex: sugar into candy.
* Export quotas: assure domestic consumers a sufficient supply of goods at a low price, prevent depletion of natural resources, and attempt to raise export prices by restricting supply in foreign markets
* Voluntary Export Restraint: a country asks another county to voluntarily reduce its companies' exports to it.
- much easier to switch off than an import quota
- less damage to political relations than an import quota
* Embargoes: prohibits all trade
- used to achieve political goals
- U.S. imposed embargo on Cuba to induce the people to overthrow the communist regime.
2. "Buy Local" Legislation
- governments may specific a domestic content restriction: certain percentage of the product must be of local origin.
- U.S. recession-driven economic stimulus package of 2009 requires the funded project to us only U.S. made steel, iron, and manufactured goods.
- price mechanisms: permits agency to buy a foreign product only if it's some predetermined margin below the price of a domestic competitor.
- domestic purchase indirect favoritism: prohibiting foreign Medicare payments unless it's an emergency, preventing medical tourism.
3. Standards and Labels
- arbitrary standards of rejecting shipments citing health reasons
4. Specific permission requirements
- some countries require that potential importers or exporters secure governmental permission (an import or export license) before transacting trade
- restricting imports directly: denying permission
- indirectly: cost, time, and uncertainty involved
* foreign exchange control: requires an importer to apply to a government agency to secure the foreign currency to pay for the product.
5. Administrative delays
- intentional administrative delays or those caused by inefficiency
- create uncertainty and raise the cost of carrying inventory
- protect domestic producers but also political reasons: Japan and China fighting over ownership of island in the East China Sea.
6. Reciprocal requirements
- exporters must sometimes take merchandise or buy services in lieu of receiving cash payment
- common in the aerospace and defense industries
- Thailand has bought military equipment from China and Russia in exchange for dried fruit and frozen chickens
- governmental requirements in the importing country whereby the exporter, usually in sales to a foreign government, must provide additional economic benefits such as jobs or technology as part of the transaction.
7. Restrictions on Services
- service is the fastest growing sector in international trade
- countries consider four factors to decide whether to restrict service:
- do they serve strategic purposes or provide social assistance to citizens?
- do we feel that the services should be sold for profit?
- price controls or subsidize government-owned service organizations that create disincentives for foreign private participation.
- often excluded: media, communications, banking, utilities, and domestic transport. India has excluded multi-brand retailers because of the disruption they may cause to local retail establishments
2) not-for-profit services:
- few foreign firms compete in mail, education, and hospital health services.
3) standards: governments limit entry into many service professions to ensure practice by qualified personnel accountants, actuaries, architects, electricians, engineers, gemologists, hairstylists, lawyers, medical personnel, real estate brokers, and teachers.
4) immigration: governmental regulations often require an organization to search for locals before it can apply for work permits for personnel from abroad.
Dealing with Governmental Trade Influences
When companies face possible losses because of import competition, they have several options:
1. Move operations to another country
2. Concentrate on market niches that attract less international competition.
3. Adopt internal innovations, such as greater efficiency or superior products.
4. try to get governmental protection.
* Tactics for dealing with import competition:
- ask governments to restrict import markets or open export markets
* Convincing decision makers:
- governments cannot help every company
- convince officials that your situation warrants particular policies
- identify key decision makers and convince them by using the economic and noneconomic arguments
- convey to the public officials that voters and stakeholders support their position.
* Involving the industry and stakeholders
- odds of success increase with an ally domestic companies in the same industry
- involving taxpayers and merchants in the communities where it operates
- lobby decision makers and endorse the political candidates that are sympathetic to the situation.
* Preparing for changes in the competitive environment
- Those that depend on freer trade and/or have integrated their production and supply chains among countries tend to oppose protectionism
- those with single or multi-domestic production facilities, such as a plant in Japan to serve the Japanese market and a plant in Taiwan to serve the Taiwanese market, may support protectionism.
- companies have different self-perceptions of being able to compete against imports. At least one company in an industry may oppose protectionism, commanding competition competitive advantages in terms of scale economies, supplier relationships, or differentiated products.