978-0134200057 Chapter 7 Lecture Notes

Unlock access to all the studying documents.

View Full Document

CHAPTER SEVEN

GOVERNMENTAL INFLUENCE ON TRADE

OBJECTIVES

7-1 Recognize the conflicting outcomes of trade protectionism

7-2 Assess governments’ economic rationales and outcome uncertainties with

international trade intervention

7-3 Assess governments’ noneconomic rationales and outcome uncertainties with

international trade intervention

7-4 Describe the major instruments of trade control

7-5 Classify how companies deal with governmental trade influences

CHAPTER OVERVIEW

This chapter reviews the economic and noneconomic rationales for trade protectionism,

the major forms of trade controls, and trade control’s effects on companies’ operating

decisions.

CHAPTER OUTLINE

OPENING CASE: THE U.S.-VIETNAMESE CATFISH DISPUTE [See Map 7.1.]

This case is a great example of attempts to protect a national industry against

international competition. Catfish are farmed in the southern U.S. and Vietnam. The

Vietnamese production has some competitive advantages including a more conducive

climate, lower governmental restrictions, and lower labor rates. So even with

transportation costs, Vietnam exports catfish to the U.S. The U.S. catfish growers fought

back using a variety of means. They tried to limit the use of the name catfish and

petitioned for increased taxes on imported fish and even tried to bring into question the

safety of overseas fish. The U.S. producers have not been successful in limited imports

and have even been caught up by their own efforts. A key point is that trade between

nations cannot be viewed just by one industry. Vietnam is the third largest export market

for U.S. beef. So, if we successfully limit the imports of catfish, will Vietnam retaliate

by limiting beef imports?

INTRODUCTION

In principle, no country permits a totally unregulated flow of goods and services

across its borders. Likewise, governments may choose to enable the global

competitiveness of their own domestic firms. Protectionism refers to those

government restrictions and incentives that are specifically designed to help a

country’s domestic firms compete with foreign competitors at home and abroad. The

rationale for such policies can be economic or noneconomic in nature. Whenever

governments choose to impede the flow of imports and/or encourage the flow of

7-1

exports, they simultaneously provide direct and/or indirect subsidies for their

domestic firms.

I. CONFLICTING OUTCOMES OF TRADE PROTECTIONISM

All countries seek to influence trade and respond to their economic, social, and

political objectives. Despite free-trade benefits, governments intervene in trade to

attain economic, social, or political objectives. Officials enact trade policies that they

reason will have the best chance to benefit their nation and its citizens—and, in some

cases, their personal political longevity. Their decisions are complicated because

outcomes are uncertain and affect groups of their citizens differently.

A. The Role of Stakeholders

Proposals on trade regulations often spark fierce debate among people who

believe they will be affected—the so-called stakeholders. Of course, those most

directly affected are most apt to speak out, such as workers, owners, suppliers,

and local politicians whose livelihoods depend on the actions taken. Consumers

generally purchase products with little thought as to where the product was

produced. Import barrier costs are often spread out so that the effect is not

noticed by the consumer.

II. ECONOMIC RATIONALES FOR GOVERNMENTAL TRADE

INTERVENTION AND OUTCOME UNCERTAINTIES

Governmental intervention in the trade process may be either economic or

noneconomic in nature. [See Table 7.1.]

A. Fighting Unemployment

Probably no pressure group is more effective than the unemployed; no other

group has more time and incentive to protest publicly and contact government

representatives. Import-displaced workers are often the least able to find

alternative work, especially if large numbers are concentrated in small company

towns where there are virtually few alternative employment opportunities

1. What’s Wrong with Full Employment as an Economic Objective?

Nothing! However, creating domestic employment by limiting imports may

not fully work as expected. It may lead to retaliation by other countries,

affect large and small economies differently, reduce import handling jobs,

may decrease jobs in another industry, and may decrease export jobs

because of lower incomes abroad.

B. Protecting “Infant Industries”

The infant-industry argument holds that a government should shield an emerging

industry from foreign competition by guaranteeing it a large share of the

domestic market until it

1. Underlying Assumptions. The infant-industry argument presumes that

early operating costs within a newly producing country may be too high to

compete in world markets and that sufficient cost reductions will occur over

time.

2. Risks in Designating Industries. However, production costs may never fall

enough to create internationally competitive products. Inherently, there are

7-2

problems. First, governments must identify those industries that have a high

probability of success, and this is hard. Even if policymakers choose the

right industries, some economic segment must absorb the high early cost

before domestic production becomes internationally viable. This burden

may fall on consumers who pay higher prices for the protected products or

on taxpayers who pay for subsidies.

C. Developing an Industrial Base

Many of today’s emerging economies emulate historical practices and use

protectionism to spur local industrialization. They operate under the

assumptions outlined below.

1. Surplus Workers. The industrialization argument purports that the

development of national industrial output (and hence economic growth)

should be supported, even though domestic prices may not be competitive

on the world market. Surplus workers can more easily be used to increase

manufacturing output than agricultural output. Shifting people out of

agriculture, however, can create at least two problems: 1) when moving to

urban areas they leave behind the safety net of their extended families and

rely on the social services in the cities, and 2) improved agriculture

practices may be a better means of achieving economic success.

2. 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.

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. Growth in Manufactured Goods. 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.

5. Import Substitution and Export-Led Development. 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 or higher taxes. On the other hand, export-led development

encourages economic development by harnessing a country-specific

advantage (e.g., low labor costs) and building a vibrant manufacturing sector

7-3

through the stimulation of exports. In reality, when effectively crafted,

import substitution policies eventually lead to the possibility of export

promotion as well.

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. The four primary motivations for doing so are outlined

below.

1. Balance-of-Trade 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. It has two

options that affect its competitive position broadly: (i) depreciate or devalue

its currency, an action that makes all of its products cheaper in relation to

foreign products, or (ii) rely on fiscal and monetary policy to bring about

lower price increases in general than those in 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. There are at least two reasons for rejecting

the idea of fairness. First, tit-for-tat market access can lead to restrictions

that may deny one’s own consumers lower prices. And second, 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. Import 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.

4. Export Restrictions. Countries that hold a near-monopoly of certain

resources sometimes limit their international sale in an effort to raise prices

abroad. However, this policy often encourages smuggling, the development

of technology, or different means to produce the same product. Export

controls are especially ineffective for digital products because they are so

easily copied abroad. A country may also limit exports of a product that is in

short supply worldwide to favor domestic consumers. Typically, a greater

supply drops domestic prices beneath foreign ones. However, favoring

domestic consumers disfavors domestic producers, so they have less

incentive to maintain production when prices are low.

7-4

5. Affecting Exporters’ Prices. 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 home-country 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.

III. GOVERNMENTS’ NONECONOMIC RATIONALES AND OUTCOME FOR

TRADE INTERVENTION

Governments may choose to intervene in the trade process for noneconomic reasons

such as the maintenance of essential industries (especially defense), the promotion of

acceptable practices abroad, the maintenance or extension of spheres of influence,

and the preservation of national culture.

A. Maintaining Essential Industries

The essential industry argument states that a government applies restrictions

to protect essential domestic industries during peacetime so that the country is

not dependent on foreign sources of supply during war. Protecting an inefficient

industry, however, will lead to higher costs and possibly political consequences

as well.

B. Promoting Acceptable Practices Abroad

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 or that might be in short supply domestically. 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.

POINT—COUNTERPOINT:

Should Governments Impose Trade Sanctions?

POINT: Many argue that although not all trade sanctions are successful, many have at

least been influential in achieving their objectives. Further, when a nation breaks an

international agreement and/or acts in unacceptable ways, punitive actions such as

removing diplomatic recognition, boycotting events, or eliminating foreign aid or loans

may be ineffective without the addition of trade sanctions.

COUNTERPOINT: Others argue against the use of sanctions on the grounds that they

are ineffective. Further, even if sanctions are successful at weakening the targeted

countries’ economies, the costs are borne not by government officials, but by innocent

7-5

people. Finally, it appears that governments sometimes impose sanctions based on just a

single issue, rather than on a country’s overall record, which is really counterproductive.

C. Maintaining or Extending 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.

D. Preserving National Culture

Countries are partially held together though a unifying sense of cultural and

national distinctiveness. To sustain this collective identity, governments may

limit the presence of foreign products in certain sectors. Consumers still seek

out the best products and services for the least price.

IV. MAJOR INSTRUMENTS OF TRADE CONTROL

Governments use many rationales and seek a range of outcomes when they try to

influence the international trade process. The choice of instrument(s) is crucial

because each type of control may incite different responses from both domestic and

foreign groups. While some instruments directly limit the amount that can be traded,

others indirectly affect the amount traded by directly influencing prices, i.e., while

tariff barriers directly affect prices and subsequently the quantity demanded,

nontariff barriers may directly affect price and/or quantity.

A. Tariffs: Direct Price Influences

A tariff (also called a duty) is a tax levied on (internationally) traded products.

Export tariffs are levied by the country of origin on exported products; a

transit tariff is levied by a country through which goods pass en route to their

final destination; import tariffs are 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.

1. Import Tariffs. Unless they are optimum tariffs, import tariffs raise the price

of imported goods by placing a tax on them that is not placed on domestic

goods, thereby giving domestically produced goods a relative price

advantage. Tariffs may also serve as a major source of revenue in developing

countries. 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. A tariff controversy concerns the treatment of

manufactured exports to industrialized nations. While raw materials

frequently enter industrial countries tariff-free, when an ad valorem tariff is

applied to manufactured goods, it is generally applied to the total value of

the product. Critics argue that the effective tariff on the manufactured

portion, i.e., the value-added portion, is higher than the published tariff.

B. Nontariff Barriers: Direct Price Influences

7-6

Nontariff barriers (NTBs) represent administrative regulations, policies, and

procedures, i.e., quantitative and qualitative barriers that directly or indirectly

impede international trade.

1. Subsidies. Subsidies consist of 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.

Recently we have seen government intervention shoring up floundering

companies and industries. One of the most popular forms of government

subsidy can be seen in the agriculture industry. From the standpoint of

market efficiency, subsidies are more justifiable than tariffs because they

seek to overcome, rather than create, market imperfections. However, many

international frictions result from disagreements about the definition of a

subsidy.

2. Aid and Loans. Governments may give aid and loans to other countries but

require that the recipient spend the funds in the donor country; this is known

as tied aid or tied loans. In this way some donor products that might

otherwise be noncompetitive may find limited international markets.

However, there is growing skepticism about the value of tied aid because it

can slow down the development of local suppliers in developing countries

and shield suppliers in the donor countries from competition.

3. Customs Valuation. Because of the temptation to declare a low invoice

price in order to pay a lower ad valorem tariff, it is sometimes difficult to

determine the true value of traded products. Due to the many different

products traded and the differences being minute in some cases, it is easy to

misclassify a product and receive a lower tariff. First, customs officials

should use the declared invoice price. If there is none, or if the authenticity

of the value is in doubt, then customs agents may assess the shipment on the

basis of the value of identical (preferable) or similar (acceptable) goods

arriving at about the same time. Further, because countries often impose

different import barriers on products sourced from different countries,

customs officials must also determine a product’s true origin.

4. Other Direct Price Influences. Other means that countries may use to

affect prices include establishing special fees for consular and customs

clearance and documentation, requirements that customs deposits be made

in advance of shipment, and minimum price levels at which products can be

sold after they receive customs clearance.

C. Nontariff Barriers: Quantity Controls

Governments use a variety of nontariff barriers to directly affect the quantity of

imports and exports. When the quantity of imports is limited, the resulting shift

in the supply curve means that the equilibrium price will then be higher.

1. Quotas. A quota represents a numerical limit on the quantity of a product

that may be imported or exported in a given period of time. (Because of the

increase in the equilibrium price, quotas may increase per-unit revenues for

firms that participate in the market.) Voluntary export restraints (VERs)

are negotiated limitations of exports from one country to another and, as in

7-7

the case of a quota, may result in higher prices to customers. An embargo

represents an outright ban on imports from or exports to a particular

country.

2. “Buy Local” Legislation. Buy local legislation represents laws that are

intended to favor the purchase of domestically sourced products over

imported products, particularly with respect to government procurement.

Local content requirements, i.e., costs incurred within the local country

(usually measured as a percentage of total costs), fall within this category.

3. Standards and Labels. The professed purpose of standards is to protect

the safety or health of the domestic population. However, countries may

also devise classification, labeling, and testing standards that facilitate the

sale of domestic products but obstruct the sale of foreign-sourced products.

4. Specific Permission Requirements. An import (or export) license

requires that firms secure permission from government authorities before

conducting trade transactions. Such procedures directly restrict trade when

permission is denied and indirectly restrict trade because of the cost, time,

and uncertainty involved in the process. A foreign exchange control

requires an importer of a given product to apply to a government agency to

secure the foreign currency to pay for the product.

5. Administrative Delays. Intentional administrative delays create

uncertainty and increase the cost of carrying inventory. However,

competitive pressures can motivate countries to improve inefficient

administrative systems.

6. Reciprocal Requirements. Governments may require that foreign

suppliers accept products in lieu of money. Offsets and countertrade (see

Chapter 13) are reciprocal requirements that are made between countries

with ample access to foreign currency that want to secure jobs or

technology as part of the transaction.

7. Restrictions on Services. Countries restrict trade in services such as

transportation, insurance, advertising, consulting, and banking for reasons

of essentiality, not-for-profit services, standards, and immigration.

a. Essentiality. Countries consider certain services industries to be

essential because they serve strategic purposes or provide social

assistance to citizens. Private companies of any sort may be prohibited,

and in other cases, price controls may be imposed by the government;

government-owned operations are often subsidized.

b. Not-for-Profit Services. Mail, education, and hospital health services

are often not-for-profit services and governments may preclude foreign

firms from competing in these areas.

c. Standards. Governments may limit foreign entry into particular

service professions in order to assure that practitioners are qualified.

Licensing standards vary by country and extend to a wide variety of

occupations. Prerequisites for taking certification examinations may be

lengthy.

7-8

d. Immigration. Government regulations often require that an

organization, whether domestic or foreign, demonstrate that the skills

needed for a particular job are not available locally before hiring a

foreigner.

V. HOW COMPANIES DEAL WITH GOVERNMENTAL TRADE INFLUENCES

Although there are risks and costs associated with each option, firms can deal with

trade restrictions by (a) moving operations to a lower-cost country, (b) concentrating

on market niches that attract less international competition, (c) adopting internal

innovations that lead to greater efficiency or superior products, or (d) trying to get

government protection.

A. Tactics for Dealing with Import Competition When the options of moving

operations abroad, concentrating on niches, and innovation fail or are not

practical, companies may turn to the government to restrict imports or open

export markets.

B. Convincing Decision Makers. Companies may want to find government

officials who are supportive of their case. Generally Congress is sensitive to the

employment effects of trade, especially in their jurisdictions.

C. Involving the Industry and Stakeholders. There is strength in numbers and

companies may want to join forces within the industry to gain more political clout.

Outside groups such as activists and the general public may be of help in promoting the

case for favorable trade policies for the firm.

D. Preparing for Changes in the Competitive Environment. Companies can take

different approaches to deal with changes in the international competition environment.

Frequently these different approaches are based on their strategies and abilities.

LOOKING TO THE FUTURE: Dynamics and Complexity of Future World Trade

Each time countries negotiate a trading agreement, new optimum production locations

emerge. Further, the international regulatory situation is in many ways becoming more

complex. While some groups and firms are pushing for freer trade, others clamor for

greater protection. Thus, it is likely that as barriers come down for some products in

some countries, they will go up for other products in other countries. Those who see

themselves as losers are not apt to accept their losses without a struggle. Support for

their positions may be garnered from alliances that cross national borders, as well as

within domestic countries, as economic positions continue to affect politics, and vice

versa.

7-9