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Chapter 07 – Government Policy and International Trade
Government Policy and International Trade
Learning objectives
Identify the policy instruments used by governments to influence international trade
flows.
Understand why governments sometimes intervene in international trade.
Summarize and explain the arguments against strategic trade policy.
Describe the development of the world trading system and the current trade issue.
Explain the implications for managers of developments in the world trading system.
This chapter focuses on the political systems and tools of trade policy. The major
objective of this chapter is to describe how political realities shape the international
trading system.
With an introduction to tariffs, subsidies, and the development of the world trading
system, the chapter describes the evolution of the World Trade Organization and its
impact on the global business environment.
While in theory many countries adhere to the free trade ideal outlined in Chapter 5, in
practice most have been reluctant to engage in unrestricted free trade.
The United States continues to restrict trade in technological and militarily sensitive
products as well as in textiles, sugar, and other basic products in response to domestic
political pressures.
The opening case explores the decision by the United States and members of the
European Union to levy tariffs on solar panels imported from China. China has been
accused of subsidizing its solar panel industry in order to gain an unfair advantage and
“dump” (export at below-market prices) panels in the United States and elsewhere. The
tariffs, however, did not produce the expected results of protecting domestic
manufacturing jobs in the United States or the EU. Instead, they resulted in driving global
production to Malaysia. The closing case explores the economic effects of the
longstanding U.S. policy to support the sugar industry.
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Chapter 07 – Government Policy and International Trade
OUTLINE OF CHAPTER 7: GOVERNMENT POLICY AND
INTERNATIONAL TRADE
Opening Case: U.S. Tariffs on Chinese Solar Panels Benefit Malaysia
Introduction
Instruments of Trade Policy
Tariffs
Country Focus: Are the Chinese Illegally Subsidizing Auto Exports?
Subsidies
Import Quotas and Voluntary Export Restraints
Local Content Requirements
Administrative Policies
Antidumping Policies
Management Focus: Protecting U.S. Magnesium
The Case for Government Intervention
Political Arguments for Intervention
Country Focus: Trade in Hormone-Treated Beef
Economic Arguments for Intervention
The Revised Case for Free Trade
Retaliation and Trade War
Domestic Policies
Development of the World Trading System
From Smith to the Great Depression
1947–1979: GATT, Trade Liberalization, and Economic Growth
1980–1993: Protectionist Trends
The Uruguay Round and the World Trade Organization
WTO: Experience to Date
The Future of the WTO: Unresolved Issues and the Doha Round
Country Focus: Estimating the Gains from Trade for America
Focus on Managerial Implications
Trade Barriers and Firm Strategy
Policy Implications
Chapter Summary
Critical Thinking and Discussion Questions
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Chapter 07 – Government Policy and International Trade
Closing Case: Sugar Subsidies Drive Candy Makers Abroad
CLASSROOM DISCUSSION POINT
Ask students whether the United States promotes free trade. Jot their responses on the
board.
Then try to dig a little deeper by asking why, if the United States promotes free trade, it
still maintains some trade barriers. (Have in mind some current trade barriers, such as the
$14.9 billion in farm subsidies provided by the U.S. Department of Agriculture in 2012).
Write the responses of students on the board using the basic arguments for intervention
framework presented in the text.
Next, ask students similar questions about the European Union. (For example, EU dairy
farms receive $15 billion a year in subsidies.)
Another Perspective: At the WTO’s Doha Round in 2001, many nations—including
Brazil, China, and India—opposed agricultural subsidies in the United States and the EU.
Twelve years later, these countries, and others, have grown their own agricultural
subsidies rapidly. See the article
{http://www.theguardian.com/sustainable-business/agricultural-subsidies-reform-govern
ment-support} for another view.
LECTURE OUTLINE
This lecture outline follows the Power Point Presentation (PPT) provided along with this
instructor’s manual. The PPT slides include additional notes that can be viewed by
clicking on “view,” then on “notes.” The following provides a brief overview of each
Power Point slide along with teaching tips, and additional perspectives.
Slide 7-3 What Is the Political Reality of Free Trade?
Free trade refers to a situation in which a government does not attempt to restrict what
its citizens can buy from another country or what they can sell to another country.
Slides 7-4 through 7-10 Instruments of Trade Policy
The main instruments of trade policy are:
tariffs
subsidies
import quotas
voluntary export restraints
local content requirements
antidumping policies
administrative policies
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Chapter 07 – Government Policy and International Trade
Tariffs are the oldest form of trade policy. The principal objective of most tariffs
is to protect domestic producers and employees against foreign competition.
Tariffs also raise revenue for the government. Domestic producers gain, because
tariffs afford them some protection against foreign competitors by increasing the
cost of imported foreign goods. Consumers lose because they must pay more for
certain imports. Tariffs reduce the overall efficiency of the world economy.
Subsidies take many forms (cash grants, low-interest loans, tax breaks, and government
equity participation in domestic firms). By lowering production costs, subsidies help
domestic producers in two ways: they help them compete against foreign imports and
they help them gain export markets. Subsidy revenues are generated from taxes.
Governments typically pay for subsidies by taxing individuals. Therefore, whether
subsidies generate national benefits that exceed their national costs is debatable.
Subsidies encourage overproduction, inefficiency and reduced trade. In practice, many
subsidies are not very successful at increasing the international competitiveness of
domestic producers. Rather, they tend to protect the inefficient and promote excess
production.
Quotas and Voluntary Export Restraints (VER) are direct restrictions on the quantity
of some good that may be imported into a country. The quota restriction is usually
enforced by issuing import licenses to a group of individuals or firms. A VER is a quota
on trade imposed by the exporting country, typically at the request of the importing
country’s government.
Local content regulations have been widely used by developing countries to shift their
manufacturing base from the simple assembly of products whose parts are manufactured
elsewhere into the local manufacture of component parts. They have also been used in
developed countries to try to protect local jobs and industry from foreign competition.
From the point of view of a domestic producer of parts going into a final product, local
content regulations provide protection in the same way an import quota does: by limiting
foreign competition. The aggregate economic effects are also the same; domestic
producers benefit, but the restrictions on imports raise the prices of imported components.
Governments sometimes use informal or administrative policies to restrict imports and
boost exports. Administrative trade policies are bureaucratic rules that are designed to
make it difficult for imports to enter a country.
Another Perspective: Information about U.S. trade is readily available on government
sites. Visit {www.business.gov} to access an array of links. You can also review the
current U.S. tariffs at the U.S. Office of Tariff Affairs and Trade Agreements at
{www.usitc.gov/tata/index.htm}.
Dumping is defined as selling goods in a foreign market at below cost of production or at
below “fair” market value.
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Chapter 07 – Government Policy and International Trade
Slide 7-11 The Case for Government Intervention
There are two types of arguments for government intervention, political and economic.
Slides 7-12 through 7-16 Political Arguments for Intervention
Political arguments for government intervention include:
protecting jobs
protecting industries deemed important for national security
retaliating for unfair foreign competition
protecting consumers from “dangerous” products
furthering the goals of foreign policy
protecting the human rights of individuals in exporting countries
The most common political reason for trade restrictions is “protecting jobs and
industries.”
Countries sometimes argue that it is necessary to protect certain industries because they
are important for national security. Defense-related industries often get this kind of
attention (e.g., aerospace, advanced electronics, semiconductors).
Government intervention in trade can be used as part of a "get tough" policy to open
foreign markets.
Consumer protection can also be an argument for restricting imports. Since different
countries do have different health and safety standards, what may be acceptable in one
country may be unacceptable in others.
Sometimes, governments use trade policy to support their foreign policy objectives.
Governments sometimes use trade policy to create pressure for improving the human
rights policies of trading partners. For years the most obvious example of this was the
annual debate in the United States over whether to grant most favored nation (MFN)
status to China. MFN status allows countries to export goods to the United Status under
favorable terms. Under MFN rules, the average tariff on Chinese goods imported into the
United States is 8 percent. If China’s MFN status were rescinded, tariffs would probably
rise to about 40 percent.
Another Perspective: In the United States, the Bureau of Export Administration enhances
the nation's security and its economic prosperity by controlling exports for national
security, foreign security, foreign policy, and short supply reasons. To learn more, go to
{http://www.bis.doc.gov/} and click on Export Administration regulations.
Slide 7-17 Think Like a Manager: Government Intervention and Job Creation
Slides 7-18 through 7-21 Economic Arguments for Intervention
Protecting infant industries and strategic trade policy are the main economic reasons for
trade restrictions.
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Chapter 07 – Government Policy and International Trade
The infant industry argument has been considered a legitimate reason for
protectionism, especially in developing countries. Many economists criticize this
argument: protection of manufacturing from foreign competition does no good unless the
protection helps make the industry efficient. Brazil built up the world’s 10th largest auto
industry behind tariff barriers and quotas. Once those barriers were removed in the late
1980s, however, foreign imports soared and the industry was forced to face up to the fact
that after 30 years of protection, the Brazilian industry was one of the most inefficient in
the world.
Strategic trade policy suggests that government intervention may be justified in an
industry when the world market will profitably support only a few firms because of the
existence of substantial scale economies. Such intervention reduces the competitive effect
of existing first-mover advantages held by foreign companies.
Revised Case for Free Trade: While strategic trade policy identifies conditions where
restrictions on trade may provide economic benefits, there are two problems that may
make restrictions inappropriate: retaliation and politics.
Paul Krugman argues that strategic trade policies aimed at establishing domestic firms in
a dominant position in a global industry are beggar-thy-neighbor policies that boost
national income at the expense of other countries.
Special interest groups may influence governments.
Slides 7-22 through 7-26 Development of the World Trading System
How has today’s world trade system evolved?
Up until the Great Depression of the 1930s, most countries had some degree of
protectionism. Great Britain, as a major trading nation, was one of the strongest
supporters of free trade.
Although the world was already in a depression, in 1930 the United States enacted the
Smoot-Hawley tariff, which created significant import tariffs on foreign goods. As other
nations took similar steps and the depression deepened, world trade fell further.
After WWII, the United States and other nations realized the value of freer trade, and
established the General Agreement on Tariffs and Trade (GATT).
The approach of GATT (a multilateral agreement to liberalize trade) was to gradually
eliminate barriers to trade. Over 100 countries became members of GATT, and worked
together to further liberalize trade.
Another Perspective: A full review of GATT, containing an actual copy of the agreement,
is available at {http://www.ciesin.org/TG/PI/TRADE/gatt.html}.
Calls for protectionism were motivated by 3 factors:
1. Japan’s success in such industries as automobiles and semiconductors coupled with the
sense that Japanese markets were closed to imports and foreign investment by
administrative trade barriers.
2. The world’s largest economy, the United States, was plagued by a persistent deficit.
The loss of market share to foreign competitors in industries such as automobiles,
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McGraw-Hill Education.
Chapter 07 – Government Policy and International Trade
machine tools, semiconductors, steel, and textiles, and the resulting unemployment gave
rise to renewed demands in the U.S. Congress for protection against imports.
3. Many countries found ways to get around GATT regulations.
The Uruguay Round wrote the rules governing:
the protection of intellectual property rights
the reduction of agricultural subsidies
the strengthening of GATT’s monitoring and enforcement mechanisms
Slides 7-27 and 7-28 The Future of the WTO: Unresolved Issues and the Doha Round
In addition to the impasse at the meetings over agricultural subsidies, the Seattle round
was a lightning rod for a diverse collection of organizations from environmentalists and
human rights groups to labor unions that opposed free trade. All these organizations
argued that the WTO is an undemocratic institution that was usurping the national
sovereignty of member states and making decisions of great importance behind closed
doors. They took advantage of the Seattle meetings to voice their opposition.
The Doha Round had several initiatives:
Cutting tariffs on industrial goods and services. In 2000, for example, the average tariff
rates on non-agricultural products were 4.4% for Canada, 4.5% for the European Union,
4.0% for Japan, and 4.7% for the United States. On agricultural products, however, the
average tariffs rates were 22.9% for Canada, 17.3% for the European Union, 18.2% for
Japan, and 11% for the United States.
Phasing out subsidies. Subsidies introduce significant distortions into the production of
agricultural products. The net effect is to raise prices to consumers, reduce the volume of
agricultural trade, and encourage the overproduction of products that are heavily
subsidized (with the government typically buying up the surplus).
Reducing anti-dumping laws. WTO rules allow countries to impose anti-dumping duties
on foreign goods that are being sold cheaper than at home, or below their cost of
production, when domestic producers can show that they are being harmed.
WTO on intellectual property should allow for health protection in poorer nations. Rich
countries have to comply with the rules within a year. Poor countries, in which such
protection generally was much weaker, have five years’ grace, and the very poorest have
ten years.
Another Perspective: To see current issues at the WTO, go to {http://www.wto.org} and
click on “News.”
Slides 7-29 and 7-30 Implications for Managers
Managers need to consider how trade barriers affect the strategy of the firm and the
implications of government policy on the firm.
Trade barriers are a constraint upon a firm’s ability to disperse its productive activities.
International firms have an incentive to lobby for free trade, and keep protectionist
pressures from causing them to have to change strategy.
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