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
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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
2. Preserve national security
Industries essential to national security receive government–
sponsored protection for both imports and exports.
a. Imports
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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
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.
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
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4
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.
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
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
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
2. Customs duties increase production costs and the time it takes to
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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
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
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.
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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
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.
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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,
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
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
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3. Subsidies and the WTO
a. Governments retaliate when the competitiveness is
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
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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.
Quick Study Questions
Quick Study 1
1. Q: Free trade is the pattern of imports and exports that occurs in the what?
2. Q: For what political reasons does a government intervene in trade?
A: (1) Practically every government restricts imports that threaten jobs in the
threatens to restrict imports coming from a nation that restricts its own imports.
(4) The largest nations may get involved in trade to gain influence over smaller
3. Q: What are some economic reasons why a government intervenes in trade?
A: One economic motive for a nation to intervene in trade is protection of young
(infant) industries from competition. According to the infant industry argument, a
country’s emerging industries need protection from international competition
during their development phase until they become sufficiently internationally
Another economic motive for intervention is pursuit of a strategic trade
policy. The new trade theorists believe government intervention can help
companies take advantage of economies of scale and be first movers in their
Copyright © 2019 Pearson Education, Inc.
4. Q: Some people see the products of what country as the greatest threat to local
cultures around the world?
Quick Study 2
1. Q: Financial assistance from a government to domestic producers is called what?
A: Governments employ the use of subsidies to assist domestic companies in
2. Q: What are the hoped-for outcomes of a foreign trade zone?
A: A foreign trade zone (FTZ) is a designated geographic region in which
merchandise is allowed to pass through with lower customs duties (taxes) or
3. Q: What are some of the ways that governments provide export financing?
A: Export financing can help a nation increase exports. A government can offer
Quick Study 3
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1. Q: Why might a government impose a tariff on a product?
2. Q: Why might a government impose a quota on a product?
3. Q: A stipulation that a portion of a product be sourced domestically is called
what?
A: A local content requirement is a law that stipulates a specified amount of a
Quick Study 4
1. Q: The first system of multilateral agreements to promote free trade was called
what?
A: The GATT was designed to promote free trade by reducing both tariff and
nontariff barriers to trade. The GATT was formed in 1947 and early success
2. Q: What are the main goals of the World Trade Organization?
A: The WTO is the international organization regulating trade among nations.
WTO agreements are essentially contracts among member nations that commit
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3. Q: Exporting a product at a price that is lower than that normally charged
domestically or one that is lower than production costs can expose a firm to
charges of what?
A: Dumping is when a company exports a product at a price that is either lower
Ethical Challenge
The National Foreign Trade Council (NFTC), a nonprofit trade and industry group
based in Washington DC, won a court battle against the state of Massachusetts. In a
unanimous decision, the U.S. Supreme Court sided with the NFTC and struck down a
Massachusetts law that was designed to deny state contracts to any company doing
business in Myanmar. The Court ruled that the Massachusetts law intruded on the federal
government’s authority and was preempted by federal law regarding Myanmar. In fact,
the U.S. Constitution states that “foreign policy is exclusively reserved for the federal
government.” The NFTC says that it shares concern over human rights abuses in
Myanmar but believes that a coordinated, multinational effort would be most effective at
instilling change.
6-5 Do you think that companies should be penalized domestically based on where
they do business abroad? Explain.
A: Students will have opinions on this question, however, in addition to laws
abroad, there are some US laws that govern the conduct of activities of US
companies in foreign countries. The following list is intended to highlight some of
the more significant ones that you need to consider when conducting an activity
individuals and entities with which one may not engage.
6-6 Do you foresee potential problems when the WTO gets involved in such political
matters?
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15
Students should look at the material covered in this chapter, and then people able
to formulate and present an opinion.
Practicing International Management Case
Down with Dumping
6-19 Q: People love finding a bargain on their favorite items while shopping. But few
people would likely want those items made in the home market (and expanding
employment) if it meant paying a higher price for them. Do you agree with this
sentiment? Explain.
A: Many people would agree with the sentiment expressed in this statement. The
6-20 Q: Do you think that people from different cultures would respond differently to
the above question? If so, identify which cultures.
A: People from individual-oriented cultures would probably be more likely to
agree with the statement than would people from very group-oriented cultures.
6-21 Q: The WTO cannot punish individual companies, but can only direct the actions
toward governments of countries. Why do you think the WTO was not given
authority to charge individual companies with dumping? Explain.
A: The task of investigating the actions of individual companies would no doubt