Chapter 12
Controversies in Trade Policy
◼ Chapter Organization
Sophisticated Arguments for Activist Trade Policy
Technology and Externalities
Imperfect Competition and Strategic Trade Policy
Box: A Warning from Intel’s Founder
Case Study: When the Chips Were Up
Globalization and Low-Wage Labor
The Anti-Globalization Movement
◼ Chapter Overview
Although the text has shown why, in general, free trade is a good policy, this chapter considers two
controversies in trade policy that challenge free trade. The first regards strategic trade policy. Proponents of
activist government trade intervention argue that certain industries are desirable and may be underfunded by
markets or dominated by imperfect competition and warrant some government intervention. The second
controversy regards the recent debate over the effects of globalization on workers, the environment, and
sovereignty. While the anti-globalization arguments often lack sound structure, their visceral nature
demonstrates that the spread of trade is extremely troubling to some groups.
64 Krugman/Obstfeld/Melitz • International Economics: Theory & Policy, Tenth Edition
that the private sector will tend to invest less in high-technology sectors than is socially optimal. Although
there may be some case for intervention, the difficulties in targeting the correct industry and understanding
the quantitative size of the externality make effective intervention complicated. To address this market
failure of insufficient knowledge creation, the first best policy may be to directly support research and
development in all industries. Still, although it is a judgment call, the technology spillover case for
industrial policy probably has better footing in solid economics than any other argument.
The next section of the chapter examines the anti-globalization movement. In particular, it examines the
concerns over low wages in poor countries. Standard analysis suggests that trade should help poor
countries and, in particular, help the abundant factor (labor) in those countries. Protests in Seattle, which
shut down WTO negotiations, and subsequent demonstrations at other meetings showed, though, that
protestors either did not understand or did not agree with this analysis.
Anti-globalization protestors were by no means united in their cause. There were also strong concerns that
export manufacturing in developing countries was bad for the environment. Again, the issue is whether these
concerns should be addressed by tying environmental standards into trade negotiations, and the open
question is whether this can be done without destroying the export industries in developing countries.
Chapter 12 Controversies in Trade Policy 65
The final section of the chapter examines the link between trade and the environment. In general,
production and consumption can cause environmental damage. Yet, as a country’s GDP per capita grows,
the environmental damage done first grows and then eventually declines as the country gets rich enough to
begin to protect the environment. As trade has lifted incomes of some countries, it may have been bad for
◼ Answers to Textbook Problems
1. The main disadvantage is that strategic trade policy can lead to both “rent–seeking” and beggar-thy-
neighbor policies, which can increase one country’s welfare at the other country’s expense. Such
2. If everyone knows that an industry will grow rapidly, private markets will funnel resources into the
industry even without government support. There is need for special government action only if there
is some market failure; the prospect of growth by itself is not enough.
3. The results of basic research may be appropriated by a wider range of firms and industries than
the results of research applied to specific industrial applications. The benefits to the United States
4. A subsidy is effective when the firm in the other country does not produce when the domestic firm
enters the market. As the text Tables 12-1 and 12-2 show, a subsidy may present a credible threat of
entry and deter production by the other firm: A subsidy encourages Airbus to produce and Boeing not
5. One argument you could make is the infant industry argument. Because U.S. software firms are already
established, European firms would not be able to compete given the relatively steep learning curve
in this industry. With protection, the European industry could develop into an efficient scale and
be globally competitive. Further, this is likely an industry characterized by external economies of scale,
so once the industry develops, it will generate additional gains by creating a local hub of software firms.
Of course this argument depends on European software firms eventually becoming competitive. If
U.S. firms have some natural competitive advantage, then the European industry may be perpetually
6. The main critique against the WTO with respect to environmental issues is that the WTO refuses to
impose environmental standards on countries, but rather does not allow countries to discriminate
7. The French may be following an active nationalist cultural policy as an economic or strategic trade
policy to the extent that cultural activities, such as art, music, fashion, and cuisine, are linked to other
French major industries. Indeed, the fashion industry is tied to the huge textile industry, as well as to
Chapter 12 Controversies in Trade Policy 67
8. The concern is seen clearly in the idea of the environmental Kuznets curve where environmental
damage increases as a country moves from very poor to middle income and declines as the country
gets subsequently richer. The problem comes if the fastest growing countries are the ones moving
9. Suppose that there were no tariffs on imports in a country that had value-added taxes. This would give
an incentive for domestic firms to locate their production abroad and export their goods to that country
to avoid the value-added tax. Thus, a tariff on imports is necessary to maintain the same relative