978-1259578113 Chapter 7 Lecture Notes

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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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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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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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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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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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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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