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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
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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
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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
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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.
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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
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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
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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
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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.
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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.
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