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CHAPTER 6
POLITICAL ECONOMY OF TRADE
LEARNING OBJECTIVES:
6.1 Explain why governments sometimes intervene in trade.
6.2 Outline the instruments that governments use to promote trade.
6.3 Describe the instruments that governments use to restrict trade.
6.4 Summarize the main features of the global trading system.
CHAPTER OUTLINE:
Why Do Governments Intervene in Trade?
Political Motives
Protect Jobs
Preserve National Security
National Security and Imports
National Security and Exports
Respond To “Unfair” Trade
Gain Influence
Economic Motives
Protect Infant Industries
Pursue Strategic Trade Policy
Benefits of Strategic Trade Policy
Drawbacks of Strategic Trade Policy
Cultural Motives
Cultural Influence of the United States
Instruments of Trade Promotion
Subsidies
Drawbacks of Subsidies
Export Financing
Foreign Trade Zones
Special Government Agencies
Instruments of Trade Restriction
Tariffs
Protect Domestic Producers
Generate Revenue
Quotas
Reason for Import Quotas
Reasons for Export Quotas
Voluntary Export Restraints
Tariff-Quotas
Embargoes
Local Content Requirements
Administrative Delays
Copyright © 2016 Pearson Education, Inc.
Currency Controls
Global Trading System
General Agreement on Tariffs and Trade (GATT)
Uruguay Round of Negotiations
Agreement on Services
Agreement on Intellectual Property
Agreement on Agricultural Subsidies
World Trade Organization (WTO)
Dispute Settlement in the WTO
Dumping and the WTO
Subsidies and the WTO
Doha Round of Negotiations
WTO and the Environment
Bottom Line for Business
A comprehensive set of specially designed PowerPoint slides is available for use with Chapter 6.
These slides and the lecture outline below form a completely integrated package that simplifies the
teaching of this chapter’s material.
Lecture Outline
This chapter explores business–government trade relations, considers why nations implement
barriers to trade, and explores the cultural, political, and economic motives for such barriers. It
also examines the instruments countries use to restrict imports and exports, and how the global
trading system promotes trade.
I. WHY DO GOVERNMENTS INTERVENE IN TRADE?
Free trade is the pattern of imports and exports that would result in the absence of trade
barriers. Governments impose restrictions on free trade for political, economic, and cultural
reasons.
A. Political Motives
1. Protect jobs
Short of an unpopular war, nothing will oust a government faster than high
unemployment. All governments become involved when trade threatens jobs at
home.
2. Preserve national security
Industries essential to national security receive government-sponsored protection
for both imports and exports.
a. Imports
Governments restrict imports to guarantee domestic supply, which
preserves national security. Many countries fiercely protect their
agricultural sector for national security reasons because a nation that
imports its food supplies could face starvation in times of war.
b. Exports
Governments have national security motives for banning certain defense-
related goods from export to other nations. Agencies review requests to
export technologies or products that have dual uses—meaning they have
both industrial and military applications.
3. Respond to “unfair” trade
Many argue that it makes no sense for one nation to allow free trade if others do
not. Governments threaten to close their ports or to impose high tariffs if another
nation does not concede on a certain trade issue.
4. Gain influence
Governments of the largest nations may become involved in trade to gain
influence over smaller nations. The United States wishes to maintain control
over Central, North, and South America and the Caribbean basin. For example,
in 1962, the United States banned all trade and investment with Cuba in the hope
of exerting political influence against its communist leaders.
B. Economic Motives
1. Protect infant industries
The infant industry argument says that emerging industries need protection from
international competition during development until they become competitive
internationally. Protection can be removed after it gains the knowledge to
become innovative, efficient, and competitive.
a. Drawbacks
Governments may make errors in distinguishing between industries
worth protecting and those that are not. Protection can cause domestic
firms to grow complacent toward innovation and limit their
competitiveness and increase consumer prices. Small promising ventures
today can get private funding.
2. Pursue strategic trade policy
New trade theorists believe government intervention helps firms take advantage
of economies of scale and enjoy first-mover advantages. First-mover advantages
result because economies of scale limit the number of companies in an industry.
a. Benefits
Companies earn profits if they obtain first-mover advantages and
solidified market positions. The chaebol helped companies survive poor
economic times because of the wide range of industries in which they
competed; policies had spin-off effects on industries such as
transportation.
b. Drawbacks
Government assistance to domestic companies caused inefficiency and
high costs for South Korean and Japanese companies in the late 1990s.
Government support is subject to political lobbying and special-interest
groups could capture gains with no benefit for consumers.
C. Cultural Motives
Exposure to people and products of other countries slowly alters cultures.
1. Unwanted cultural influence causes great distress and can force governments
to block imports.
2. Many countries have laws that protect their media programming for cultural
imperialism.
3. The United States is seen as a threat to national cultures because of its global
strength in consumer goods, entertainment, and media.
II. INSTRUMENTS OF TRADE PROMOTION
A. Subsidies
A subsidy is financial assistance to domestic producers in the form of cash payments,
low-interest loans, tax breaks, product price supports, or some other form intended to
help domestic companies fend off international competitors.
1. Drawbacks of subsidies
Some say subsidies cover costs that competitive industries should absorb, thus
encouraging inefficiency and complacency. Because governments pay for
subsidies with tax income, it is felt that subsidies benefit companies but harm
consumers. Although subsidies provide short-term relief, the idea that subsidies
are helpful in the long term is questionable.
B. Export Financing
1. Governments promote exports by helping companies finance their export
activities through loans or loan guarantees.
2. Two agencies help U.S. companies to obtain export financing: Export-Import
Bank and the Overseas Private Insurance Corporation (OPIC). OPIC insures
against losses due to: (1) expropriation, (2) currency inconvertibility, and (3)
war, revolution, and insurrection.
3. Financing is often crucial to small businesses just beginning to export.
4. Critics say subsidizing large multinational companies at taxpayer expense is
corporate welfare.
C. Foreign Trade Zones
1. A foreign trade zone (FTZ) is a designated geographic region in which
merchandise is allowed to pass through with lower customs duties (taxes) or
fewer customs procedures. Goals are jobs and trade.
2. Customs duties increase production costs and the time it takes to get a product to
market. Companies can reduce such costs and time by establishing a facility
inside a foreign trade zone.
3. A common purpose of such zones is final product assembly. Lower customs
duties are offset by the jobs created in the United States.
4. China established very large foreign trade zones to reap the benefits.
5. Mexico’s maquiladora zone: import materials from the United States without
duties, process them, and re-export them to the United States, which charges
duties only on the value added in Mexico.
D. Special Government Agencies
1. Governments have special agencies responsible for promoting exports. Such
agencies organize trips for trade officials and businesspeople to visit other
countries and open trade offices in other countries.
3. Governments not only promote exports but also may encourage imports.
4. Although finding out about government regulations in other countries can be
daunting, information access is now easier on the Web.
III. INSTRUMENTS OF TRADE RESTRICTION
A. Tariffs
1. A tariff is a government tax levied on a product as it enters or leaves a country:
(1) export tariff, (2) transit tariff, and (3) import tariff.
2. Types of import tariff: An ad valorem tariff is levied as a percentage of the
stated price of an imported product. A specific tariff is levied as a specific fee for
each unit (by number or weight) of an imported product. A compound tariff is
calculated partly as a percentage of the stated price of an imported product, and
partly as a specific fee for each unit.
3. Protect domestic producers
Because import tariffs raise the cost of an imported good, domestically produced
goods appear more attractive to buyers. But protection may cause domestic
producers to become lax in increasing efficiency.
4. Generate revenue
Tariffs are a source of government revenue. Less-developed nations have less
formal domestic economies that lack the capability to record domestic
transactions accurately. Because this makes collection of sales taxes difficult,
nations raise needed revenue through import and export tariffs. As countries
develop, they generate a greater portion of their revenues from taxes on income,
capital gains, and other economic activities. Tariffs exact a cost on countries
because they lessen the gains from trade.
B. Quotas
A quota is a restriction on the amount (measured in units or weight) of a good that can
enter or leave a country during a certain period of time. Governments administer quota
systems by granting quota licenses to other nations’ companies or governments (import
quotas) and domestic producers (export quotas).
1. Reason for import quotas
a. Protects domestic producers by placing a limit on the amount of goods
entering the country. This helps domestic producers maintain market
shares and prices by retraining competition.
b. Domestic producers win because of market protection, but consumers
lose because of higher prices and limited selection. Other losers include
domestic producers whose production requires the import subjected to a
quota; companies relying on imported intermediate goods find the final
cost of their own products increase.
2. Reasons for export quotas
a. A country may wish to maintain supplies in the home market. This is
common for countries that export natural resources that are needed in the
domestic market.
b. A country may restrict supply on world markets to increase the
international price.
3. A voluntary export restraint (VER) is a unique version of export quota that a
nation imposes on its exports, usually at the request of an importing nation. If
domestic producers do not curtail production, consumers benefit from lower
prices due to a greater supply. Export quotas hurt consumers in the importing
nation because of reduced selection and higher prices. Export quotas might retain
jobs if imports threaten to put domestic producers out of business.
4. Tariff-Quotas
A tariff-quota is a lower tariff rate for a certain quantity of imports and a higher
rate for quantities that exceed the quota (e.g., agricultural trade).
C. Embargoes
a. An embargo is a complete ban on trade (imports and exports) in one or more
products with a particular country. It may be placed on one or a few goods or
completely ban trade in all goods. It is the most restrictive nontariff trade barrier
and often has political goals.
b. Embargoes can be decreed by individual nations or by supranational
organizations such as the UN.
D. Local Content Requirements
a. Local content requirements are laws stipulating that producers in the domestic
market must supply a specified amount of a good or service. Designed to force
companies from other nations to employ local resources in their production
processes—particularly labor.
b. May help protect domestic producers from the price advantage of companies
based in other, low-wage countries. Developing countries use them to boost
industrialization.
E. Administrative Delays
a. Administrative delays are regulatory controls or bureaucratic rules designed to
impair the rapid flow of imports into a country.
b. Can include government actions such as requiring international air carriers to
land at inconvenient airports, requiring inspections that damage the product,
understaffing customs offices to cause delays, and requiring special licenses that
take time to obtain.
c. Objective is protectionism.
F. Currency Controls
a. Currency controls are restrictions on the convertibility of a currency into other
currencies.
b. Governments reduce imports by stipulating an exchange rate that is unfavorable
to potential importers. Also, can give exporters favorable rates to encourage
exports.
IV. GLOBAL TRADING SYSTEM
World trade volume peaked in the late 1800s. U.S. Smoot-Hawley Act in 1930 shifted nation
from free trade to protectionism. Smoot-Hawley, and the global trade wars it ushered in,
crippled industrialized nations and helped spark the Great Depression.
A. General Agreement on Tariffs and Trade (GATT)
The GATT was a 1947 treaty designed to promote free trade by reducing both tariff and
nontariff barriers to international trade. Success in GATT’s early years began to wane in
the 1980s. (See Table 6.2 for listing of the completed Rounds of GATT)
1. Uruguay Round of Negotiations
The Uruguay Round made significant progress in reducing trade barriers by
revising and updating GATT.
2. Services
The General Agreement on Trade in Services (GATS) extended the principle of
nondiscrimination to cover international trade in all services. The GATS
identify four forms of services: Cross Border Supply, Consumption
abroad, Commercial presense and Presence of natural persons.a.
Intellectual property
i. Intellectual property refers to property that results from people’s
intellectual talent and abilities and is legally protected by
copyrights, patents, and trademarks.
ii. Uruguay Round took a step toward getting intellectual property
under control; it created the Agreement on Trade-Related Aspects
of Intellectual Property (TRIPS) to standardize intellectual-
property rules.
b. Agricultural subsidies
i. Popular barriers to protect agricultural sectors include import
quotas and subsidies paid to farmers.
ii. Uruguay Round increased exposure of national agricultural
sectors to market forces and increased predictability in
international agricultural trade.
iii. Forces countries to convert nontariff barriers to tariffs and calls
for cutting of agricultural tariffs significantly.
B. World Trade Organization
The World Trade Organization (WTO) is the international organization that regulates
trade among nations. The WTO replaced the institution of the GATT but absorbed the
GATT agreements (such as on services, intellectual property, and agriculture) into its
own agreements. Thus, the GATT institution no longer officially exists. The WTO
recognizes 160 members and 24 observers. Three main goals of the WTO are to: (1)
help free trade; (2) negotiate opening of markets; and (3) settle trade disputes. Key
component of the WTO is normal trade relations: WTO members must extend the same
favorable terms of trade to all members that they extend to any single members.
1. Dispute settlement in the WTO
a. WTO’s power to settle trade disputes sets it apart from the GATT. WTO
agreements are contracts among member nations that commit them to
maintaining fair and open trade policies.
b. When a member files a complaint, the Dispute Settlement Body of the
WTO renders a decision in less than one year. Offenders must realign
policies according to WTO guidelines or suffer financial penalties and
perhaps trade sanctions.
2. Dumping and the WTO
a. WTO gets involved in settling disputes that involve “dumping” and the
granting of subsidies. Dumping occurs when a company exports a
product at a price that is either lower than the price normally charged in
its domestic market, or lower than the cost of production.
b. Because dumping is an act by a company, not a country, the WTO cannot
punish the country in which dumping is based.
c. WTO allows a nation to retaliate against dumping if it proves dumping
charges, calculates the damage, and can show the damage is significant.
Nations retaliate by imposing an antidumping duty—an additional tariff
placed on an imported product that a nation believes is being dumped on
its market.
3. Subsidies and the WTO
a. Governments retaliate when the competitiveness is threatened by a
subsidy that another country pays domestic producers. A countervailing
duty is an additional tariff placed on an imported product that a nation
believes is receiving an unfair subsidy.
b. WTO regulates the actions of the government that reacts to the subsidy
and the one that imposes the subsidy.
4. New Round of negotiations
a. Negotiations began in Doha, Qatar, in late 2001. The new round was
expected to bring particular benefits for developing nations.
b. Negotiations in this round are ongoing but disappointingly slow. The
Doha round was to conclude by the end of 2004 but negotiations are
proceeding very slowly. By the middle of 2017 members had made
limited progress on a late 2013 deal to improve “trade facilitation” by
reducing red tape at borders and setting standards for customs and the
movement of goods internationally. Although the agreement marked the
first significant achievement for the Doha round, no agreement was
reached on agricultural trade issues, tariffs, or quotas.
5. WTO and the environment
a. Rapid industrialization in many developing and emerging economies has
generated environmental concerns among governments and special-
interest groups.
b. WTO has no separate agreement for environmental issues, but works
with international agreements on the environment.
c. But the WTO has a Committee on Trade and Environment to study the
relationship between trade and the environment and to recommend
changes in the WTO trade agreements.
d. WTO also takes explicit positions on some environmental issues related
to trade. It states that labeling requirements or policies cannot
discriminate against the products of other WTO members. It also
supports policies of the least-developed countries that require full
disclosure of potentially hazardous products for reasons of public health
and environmental damage.
V. BOTTOM LINE FOR BUSINESS
Despite the theoretical benefits of trade, nations do not simply throw open their doors to free
trade and force all their domestic businesses to sink or swim. This chapter has discussed reasons
why national governments continue to protect all or some of their industries and how they go
about it. The global trading system through the World Trade Organization tries to strike a
balance between national desires for protection and international desires for free trade, and also
serves to settle trade disputes between countries.
