PART 2
THE ENVIRONMENT OF INTERNATIONAL BUSINESS
CHAPTER 7
GOVERNMENT INTERVENTION AND REGIONAL ECONOMIC INTEGRATION
Instructor’s Manual by Marta Szabo White, Ph.D.
I. LECTURE STARTER/LAUNCHER
■ Governments have long intervened in international business, hindering the free flow of
trade and investment.
■ Intervention can take many forms- tariffs and quotas, restrictions on international
investment, bureaucratic procedures and red tape, regulations that restrict value-chain
activities. Governments can also provide subsidies and financial incentives intended to
sustain or develop domestic firms and industries.
■ Although studies have found a strong association between market openness
(unimpeded free trade) and economic growth, as well as the fact that market
liberalization and free trade are robust contexts for fostering economic growth and
national living standards, in reality:
There is no such thing as unimpeded free trade.
■ Ask your students to think about government intervention- what are the pros and
cons? Make two lists, pros on one side and cons on the other. Why is there no such
thing as unimpeded free trade? That is, what is the justification for government
intervention? By contrast, why is free trade good? (The answer can be found in Chapter
5: Theories of International Trade and Investment.)
■ To better understand regional integration, think of international business as existing
along a continuum where, at one extreme, the world operates as one large free-trade
area in which there are no tariffs or quotas, all countries use the same currency, and
products, services, capital, and workers can move freely among nations without
restriction.
■ At the other extreme of this continuum is a world of prohibitive barriers to trade and
investment where countries have separate currencies and have very little commercial
interaction with each other.
■ It is useful to draw this continuum on the board or screen, featuring the two extremes.
Then ask the students where their country falls on this continuum and why. Then ask
the students for examples of countries or regions that might fall at the opposite
extremes of this continuum. Ask them to justify their answers.
■ Ask your students if they know one of the major motives in creating the European
Community (the precursor to the EU).
● Members sought to strengthen their mutual defense against the expanding
influence of the former Soviet Union.
■ The European Union is the most advanced economic bloc. Describe the
characteristics of the EU.
■ The CIA World Factbook provides additional details of the EU:
https://www.cia.gov/library/publications/the-world-factbook/geos/ee.html
■ Ask students whether their favorite country is a member of an economic bloc- which
one. Ask them what advantages/disadvantages being in this bloc brings to their country.
[1] YOUTUBE
William Spaniel
International Relations 101 (#9): Tariffs and the Barriers to Free Trade
Published on Jul 11, 2012
Modeling free trade as a prisoner’s dilemma provides an explanation. Although
everyone is collectively better off with free trade, individual incentives tell states to place
tariffs on imported goods. Thus, although the result is collectively crazy, it is individually
rational.
https://www.youtube.com/watch?v=Kc-bgKyPDz4
8.33 Minutes
[2] TED TALK
George Papandreou: Imagine a European democracy without borders
Published on Jun 12, 2013
Greece has been the poster child for European economic crisis, but former Prime
Minister George Papandreou wonders if it’s just a preview of what’s to come. “Our
democracies,” he says, “are trapped by systems that are too big to fail, or more
accurately, too big to control” — while “politicians like me have lost the trust of their
peoples.” How to solve it? Have citizens re-engage more directly in a new democratic
bargain.
https://www.youtube.com/watch?v=y9ALB39wRKo
20.06 Minutes
[3] PBS NewsHour
Is NAFTA a success story or damaging policy?
Published on Feb 20, 2014
A one-day summit in Mexico between President Obama and his North American
counterparts marked the 20th anniversary of NAFTA, a trade agreement designed to
eliminate cross-border duties and other barriers. What’s the legacy, effect and the future
of NAFTA? Jeffrey Brown gets debate from former U.S. Trade Representative Carla
Hills and Lori Wallach of the Public Citizen’s Global Trade Watch.
https://www.youtube.com/watch?v=DGeTZ4u2jbg
11.55 Minutes
[4] YOUTUBE
The Big Picture with Thom Hartmann
Why TPP Will Be A Disaster for Americans
Published on Mar 13, 2015
Neil Sroka, Democracy for America joins Thom Hartmann. Just like every other
so-called free trade deal – the Trans Pacific Partnership is a raw deal for the American
people. So why is Congress doing everything in its power to make this bad deal a
reality as soon as possible?
https://www.youtube.com/watch?v=bTrPsFTGmYI
11.46 Minutes
II. LEARNING OBJECTIVES AND THE OPENING VIGNETTE
LEARNING OBJECTIVES
After studying this chapter, students should be able to:
7.1 Understand the nature of government intervention
7.2 Know the instruments of government intervention
7.3 Explain the evolution and consequences of government trade intervention
7.4 Describe how firms can respond to government trade intervention
7.5 Understand regional integration and economic blocs
7.6 Identify the leading economic blocs
7.7 Understand the advantages and implications of regional integration
Key Themes
■ In this chapter, there are eight themes:
[1] The nature of government intervention
[2] Instruments of government intervention
[3] Evolution and consequences of government intervention
[4] How firms can respond to government intervention
[5] Regional integration and economic blocs
[6] The leading economic blocs
[7] Advantages and implications of regional integration
■ The focus of this chapter is government intervention and regional economic
integration in international business.
■ Despite the value of free trade, governments often intervene in international business.
■ Key concepts to familiarize yourself with:
◘ Protectionism refers to national economic policies designed to restrict free
trade and protect domestic industries from foreign competition.
◘ Government intervention arises typically in the form of tariffs (e.g. duty),
nontariff trade barriers (e.g. quota), and investment barriers (target FDI).
■ Rationale for government intervention
■ Governments impose trade and investment barriers to achieve political, social, or
economic objectives. Such barriers are either defensive or offensive:
◘ Defensive barriers safeguard industries, workers, special interest groups,
protect infant industries and to promote national security (export controls).
◘ Offensive barriers pursue a strategic or public policy objective, such as
increasing employment or generating taxes.
■ Instruments of government intervention
■ Governments also impose regulations and technical standards, as well as
administrative and bureaucratic procedures.
■ Countries may also impose currency controls to minimize international withdrawal of
national currency.
■ FDI and ownership restrictions ensure that the nation maintains partial or full
ownership of firms within its national borders.
■ Governments also provide subsidies, a form of payment or other material support.
■ Foreign governments may offset foreign subsidies by imposing countervailing duties.
■ With dumping, a firm charges abnormally low prices abroad.
■ A government may respond to dumping by imposing an antidumping duty.
■ Governments support domestic firms by providing investment incentives and biased
government procurement policies.
■ Consequences of government intervention:
◘ Economic freedom – the extent of government intervention in the national
economy, assessed using the Heritage Foundation’s Index of Economic Freedom.
◘ Government intervention and trade barriers may disproportionately impact
developing economies and low-income consumers because countries in for example
Africa, Bangladesh, Pakistan, and India are taxed at relatively unjustly higher levels.
◘ Government intervention can also offset such harmful effects (e.g. subsidies).
■ Evolution of government intervention: Intervention has a long history.
◘ 1800s- (late) many countries imposed substantial protectionism.
◘ 1930s- countries reduced trade barriers worldwide.
◘ Import substitution -Latin America- delayed countries’ eventual transition to
free trade.
◘ Industrialization- Following World War II, Japan embarked on export-led
development.
◘ Protectionist policies– India
◘ 1980s – China had limited foreign involvement until then.
◘ General Agreement on Tariffs and Trade (GATT) – the most important
development for reducing trade barriers of the last several decades
◘ 1995– replaced by the World Trade Organization (WTO)
◘ The 150 members of the WTO account for nearly all world trade.
■ Intervention and the global financial crisis
◘ Crisis impetus- inadequate regulation in the banking/ finance sectors
◘ Response- new government regulations and increasing protectionism to
safeguard jobs, wages, and protect domestic industries via subsidies
◘ Ripple Effect- Government reforms transcend beyond the banking and financial
areas.
■ How should firms respond to government intervention?
◘ Firms should first undertake research to understand the extent and nature of
trade and investment barriers abroad.
◘ When trade barriers are substantial, FDI or joint ventures to produce products
in target countries are often the most appropriate entry strategies.
◘ Where importing is essential, the firm can take advantage of foreign trade
zones, areas where imports receive preferential tariff treatment.
◘ Management should try to obtain a favorable export classification for the firm’s
exported products- being familiar with the harmonized code schedules, which provide
a standardized directory for applicable tariffs.
◘ Government assistance in the form of subsidies and incentives helps reduce
the impact of protectionism.
◘ Firms sometimes lobby the home and foreign governments for freer trade and
investment.
■ Regional integration involves groups of countries forming alliances to promote free
trade, cross-national investment, and other mutual goals.
■ This integration results from economic blocs, in which member countries agree to
eliminate tariffs and other restrictions on the cross-national flow of products, services,
capital, and, in more advanced stages, labor, within the bloc.
■ Stages of regional integration:
◘ Free trade area, in which tariffs and other trade barriers are eliminated
◘ Customs union, a free trade area in which common trade barriers are
imposed on nonmember countries
◘ Common market, a customs union in which factors of production move freely
among the members
◘ Economic union, a common market in which some economic policies are
harmonized among the member states
◘ Political union does not yet exist
■ There are roughly 200 economic integration agreements in the world.
■ The European Union (EU) is the most advanced of these, comprising 28 countries in
Europe.
■ The most notable bloc (free-trade-area) in the Americas is the North American Free
Trade Agreement (NAFTA) – consisting of Canada, Mexico, and the U.S.
■ Countries pursue regional integration because:
◘ It contributes to corporate and industrial growth, economic growth, better living
standards, and higher tax revenues for the member countries.
◘ It increases market size by integrating the economies within a region.
◘ It increases economies of scale and factor productivity among firms in the
member countries and attracts foreign investors to the bloc.
◘ It also increases competition and economic dynamism within the bloc, and
increases the bloc’s political power.
■ Success factors for regional integration:
◘ Countries that are relatively similar in terms of culture, language, and economic
and political structures.
◘ Countries that are geographically close to each other.
■ Ethical dilemmas of regional integration:
◘ Regional integration simultaneously leads to trade creation, whereby new trade
is generated among the countries inside the bloc, and trade diversion, in which member
countries discontinue some trade with countries outside the bloc.
◘ It can reduce global free trade, particularly when member countries form a
customs union that results in substantial trade barriers to countries outside the bloc.
◘ When economic blocs involve many countries of various sizes, regional
integration can concentrate power into large firms and large nations inside the bloc.
◘ Regional integration results in economic restructuring, which may harm
particular industries and firms.
◘ When a country joins an economic bloc, it must relinquish some of its
autonomy and national power to the bloc’s central authority. Individual countries risk
losing some of their national identity
■ Consequences of regional integration:
●Regional integration can concentrate power into large firms and large nations
inside the bloc.
●Regional integration results in economic restructuring, which may harm particular
industries and firms.
●When a country joins an economic bloc, it must relinquish some of its autonomy to
the bloc’s central authority.
●Regional integration leads to increased internationalization by firms inside their
economic bloc.
●Firms reconfigure value-chain activities and rationalize their operations.
●The formation of economic blocs also leads to mergers and acquisitions.
●Managers revise marketing strategies by standardizing products and developing
regional brands.
●Regional integration also leads firms from outside the bloc to invest into the bloc.
Teaching Tips
■ The challenge for this chapter is how to get students excited about something that is a
macro-environmental force, over which businesses have little or no control.
Corporate-level strategic decisions that firms can control concern whether to compete or
not to compete in a particular business/market. Before such a decision can be crafted,
management should conduct a country-specific analysis of barriers to entry in the form
of intervention, regulations, and restrictions, vs. market openness and degree of
economic freedom. This would be part of Due Diligence.
■ One strategy to induce interest in this chapter and the topic of government
intervention might be to assign students to analyze the Index of Economic Freedom,
published by the Heritage Foundation (www.heritage.org) that measures economic
freedom in 186 countries. Hong Kong, Singapore and New Zealand are the top three
countries in terms of Economic Freedom as measured by the ten freedoms comprising
this index.
■ Note: Economic freedom flourishes when government supports those institutions that
foster freedom and provide an appropriate level of intervention and regulation. In 2010
for the first time, the U.S. slipped into the second highest category, due to increased
U.S. federal government intervention following the global financial crisis.
■ An assignment (for credit) might be to select two countries at opposite ends of the
spectrum and create an argument why entry into country A makes more sense than
country B- then reverse the case by now arguing the opposite. Entry modes (which one
is optimal and why) should be included as required components for both sides of the
argument. The entire class may be involved if students present their positions to the rest
of the class, and reactions from other students are encouraged with participation points.
■ Regional integration is an attempt to achieve freer economic relations.
■ Two of the most well-known examples of this trend are the European Union (EU) and
the North American Free Trade Agreement area (NAFTA). The EU is composed of 28
member countries in Europe. NAFTA is composed of Canada, Mexico, and the United
States.
■ Free trade agreement (less advanced economic blocs- NAFTA) – formal
arrangement between two or more countries to reduce or eliminate tariffs, quotas, and
other barriers to trade in products and services
■ More advanced economic blocs (EU) permit the free flow of capital, labor,
technology and the harmonization of monetary and fiscal policies.
Commentary on the Opening Vignette:
INDIA’S EVOLUTION TO A LIBERAL ECONOMY
Key message
■ India is a paradox- it is the world’s leading emerging economy in information
technology and e-business, and simultaneously, a bureaucratic nightmare- trade
barriers, business regulations, import taxes, and controls on foreign investment are
substantial- with tariffs averaging over 15% on many products, compared to less than
4% in Europe, Japan, and the United States.
■ Hundreds of commodities, from cement to household appliances, can be imported
only after receiving government approval. Licensing fees, testing procedures, and other
hurdles can be very costly to importers.
■ India is plagued with poor infrastructure- inadequate roads, bridges, airports, &
telecommunications
■ 1980s (early) – India has been liberalizing regulations:
◘ Abolished/minimized import licenses
◘ Reduced tariffs substantially
◘ Privatization incentives- numerous state enterprises have been “privatized” –
sold to the private sector and to foreign investors.
■ 10 million ‘mom-and-pop’ shops scattered across 500,000 cities/villages.
■ 2012- Indian government yielded to political pressure and denied Walmart, Carrefour,
and other foreign retailers the opportunity to participate in India’s huge retailing sector.
In a joint venture with the Indian firm Bharti Enterprises, Walmart had planned to open
numerous stores nationwide.
■ India’s entrepreneurial potential is significant
■ Special Economic Zones (SEZs) introduced- territories that offer foreign firms the
benefits of India’s low-cost, high-skilled labor, are exempt from trade barriers, sales and
income taxes, licensing requirements, FDI restrictions, and customs clearance
procedures.
■ Example-
◘ The Mahindra City SEZ, an 840-acre development, is focusing on a $277
million software development complex constructed by Infosys Technologies, India’s
leading IT firm.
◘ However, Europe and North America aim to minimize outsourcing of jobs to
India; therefore demand protectionism—trade barriers and defensive measures
intended to minimize the export of jobs abroad.
Uniqueness of the situation described
■ India is a study in contrasts.
■ The world’s leading emerging economy in IT and e-business vs. its saturation in trade
barriers and business regulations- at the federal and 28 state levels.
■ Trade barriers and government bureaucracy in India vs. protectionism demands in
Europe and the U.S. exemplify the complex world of government intervention.
Classroom discussion
■ Define outsourcing and offshoring
Outsourcing is the purchase of a value-creating activity from an external supplier.
Offshoring is the relocation of manufacturing and other value-chain activities to
cost-effective destinations abroad.
■ Should firms balance competitive advantages of value chain global sourcing
(offshoring) with the impact of domestic job displacement? Do firms have a greater
obligation to their stakeholders or shareholders?