International Business

Chapter Seven

Governmental Influence on Trade

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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 low-income 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 simul-taneously 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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Fig. 7.2: Physical and Societal Influences on Protectionism and

Companies’ Competitive Environment

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Fig. 7.1: Import Market Shares of Clothing in the U.S. before and after the Multifiber Arrangement

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Rationales for Government Intervention in Trade

ECONOMIC RATIONALES NONECONOMIC RATIONALES

Prevent unemployment Maintain essential industries

Protect infant industries Deal with unfriendly countries

Promote industrialization Maintain or extend spheres of influence

Improve position com-pared to other countries

Preserve national identity

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Economic Rationales for Government Intervention:

Prevent UnemploymentBy limiting imports, local jobs are retained as firms

and consumers are forced to purchase domestically produced goods and services.

• Unless the protectionist country is relatively small, such measures are usually ineffective.

• Such measures are likely to lead to retaliation unless either the protectionist or the affected country is relatively small.

• Such measures may decrease export-related jobs because of (i) price increases for components or (ii) lower incomes abroad.

Governments must carefully balance the costs of higher prices with the costs of unemployment and the displaced production

that would result from freer trade.

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Economic Rationales for Government Intervention:

Protect Infant IndustriesInfant Industry Argument [Alexander Hamilton, 1792]:

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 compete in world markets. Hamilton reasoned that eventual competitiveness would result from: • movement along the learning curve

• the efficiency gains from achieving the economies of large-scale 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:

Promote IndustrializationIndustrialization Argument:

The development of national industrial output should be supported, even though domestic prices may not be competitive on the world market.

• Terms of trade describes the quantity of imports that a given quantity of a country’s exports can buy.

• Export-led development encourages national economic development by harnessing a country-specific advantage and building a vibrant manufacturing sector through the stimulation of exports.

Many of today’s emerging economies emulate historical practices and use protectionism to spur local industrialization.

[continued]

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Supporters of the industrialization argument claim that:

• surplus workers can more easily increase manufacturing output than agricultural output

• foreign investment inflows promote sustainable growth• fluctuating prices are a major detriment to those

economies that depend on just a few commodities• demand for and prices of raw materials and agricultural

commodities do not rise as fast as the demand for and prices of finished goods

• export promotion, and possibly import substitution, lead to sustainable economic development

• industrialization helps the nation-building process

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Economic Rationales for Government Intervention:

Improve Relative Economic PositionCountries may impose trade restrictions to

improve their relative competitive posi-tions. Their primary motivations are:

• balance-of-payments adjustments

• comparable access, i.e., “fairness”

• leverage as a bargaining tool

• price-control objectives [continued]

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• The comparable access argument, i.e., “fairness,” promotes the idea that a country’s firms are entitled to the same access to foreign markets as foreign firms have to its market.

• Dumping refers to the practice of pricing exports below cost, or below their home-country prices, i.e., below their “fair market value.”

• 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 price is reduced by any amount, some shift in revenue goes to the importing country, and the tariff is deemed an optimum one.

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Noneconomic Rationales for Government Intervention

• Maintenance of essential industriesEssential industry argument: a government

applies restrictions to protect essential domestic industries (particularly defense) so that the country is not dependent on foreign sources of supply

• Prevention of shipments to “unfriendly” countries• Maintenance or extension of spheres of

influence• Preservation of national identity

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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: Comparisonof 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

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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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.