Chapter 07 – The Political Economy of International Trade
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The Political Economy of International Trade
Learning objectives
• Understand why governments
sometimes intervene in
international trade.
• 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.
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.
raise prices outside of the country. Foreign countries (and
global companies) have cried foul and the WTO is
conducting its own investigation. The closing case
explores the battle over tariffs imposed on Chinese tires
exported to the United States and whether the tariffs
violate trade agreements.
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Chapter 07 – The Political Economy of International Trade
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OUTLINE OF CHAPTER 7: THE POLITICAL ECONOMY OF
INTERNATIONAL TRADE
Opening Case: China Limits Exports of Rare Earth Metals
Introduction
Instruments of Trade Policy
Tariffs
Subsidies
Country Focus: Are the Chinese Illegally Subsidizing Auto Exports?
Management Focus: U.S. Magnesium Seeks Protection
The Case for Government Intervention
Political Arguments for Intervention
Economic Arguments for Intervention
Country Focus: Trade in Hormone-Treated Beef
Country Focus: Estimating the Gains from Trade for America
Focus on Managerial Implications
Trade Barriers and Firm Strategy
Policy Implications
Chapter 07 – The Political Economy of International Trade
Chapter Summary
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 some current trade barriers in mind such as the
Next, ask students similar questions about the European Union (EU dairy farms receive
$15 billion a year in subsidies).
OPENING CASE: China Limits Exports of Rare Earth Metals
The opening case explores China’s decision to limit the export of rare earth metals, which
are a crucial ingredient in the manufacture of a wide range of hi-tech products (e.g.,
iPhones, wind turbines, batteries used in hybrid cars) around the globe. The country
claims the reason for the export quota is that several of its mining operations did not meet
environmental standards and had to be shut down. Other countries believe it is an attempt
by China to give its domestic manufacturers a cost advantage. Discussion of the case can
revolve around the following questions:
1. Do you agree with China’s reasoning for limiting exports of rare earth metals? What
problems do the quotas create for China? For other countries?
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3. Discuss the implications of the export quotas for U.S. consumers. What impact do the
quotas have on prices for iPhones or hybrid cars?
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
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
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
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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
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.
Dumping is defined as selling goods in a foreign market at below cost of production or at
below “fair” market value.
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
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The most common political reason for trade restrictions is “protecting jobs and
industries.”
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.
Slides 7-17 through 7-20 Economic Arguments for Intervention
Protecting infant industries and strategic trade policy are the main economic reasons for
trade restrictions.
The infant industry argument has been considered a legitimate reason for
protectionism, especially in developing countries. Many economists criticize this
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Strategic trade policy – where the existence of substantial scale economies suggests that
the world market will profitably support only a few firms, and may justify government
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
Special interest groups may influence governments.
Slides 7-21 through 7-25 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.
Calls for protectionism were motivated by 3 factors:
1. Japan’s success in such industries as automobiles and semiconductors coupled with the
2. The world’s largest economy, the United States, was plagued by a persistent deficit.
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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
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.
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.
Chapter 07 – The Political Economy of International Trade
CRITICAL THINKING AND DISCUSSION QUESTIONS
QUESTION 1: Do you think that governments should consider human rights when
granting preferential trading rights to countries? What are the arguments for and against
taking such a position?
ANSWER 1: China is frequently cited as a violator of human rights, and can form the
basis for a discussion of this question. While the answer to the first question clearly is a
QUESTION 2: Whose interests should be the paramount concern of government trade
policy—the interests of producers (businesses and their employees) or those of
consumers?
ANSWER 2: The long-run interests of consumers should be the primary concern of
governments, based on a utilitarian approach (the most good). Unfortunately consumers,
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QUESTION 3: Given the arguments relating to the new trade theory and strategic trade
policy, what kind of trade policy should business be pressuring government to adopt?
ANSWER 3: According to the textbook, businesses should urge governments to target
technologies that may be important in the future and use subsidies to support
development work aimed at commercializing those technologies. Government should
QUESTION 4: You are an employee of an U.S. firm that produces personal computers
in Thailand and then exports them to the United States and other countries for sale. The
personal computers were originally produced in Thailand to take advantage of relatively
low labor costs and a skilled workforce. Other possible locations considered at that time
were Malaysia and Hong Kong. The U.S. government decides to impose punitive 100%
ad valorem tariffs on imports of computers from Thailand to punish the country for
administrative trade barriers that restrict U.S. exports to Thailand. How do you think
your firm should respond? What does this tell you about the use of targeted trade
barriers?
ANSWER 4: As long as the manufacturing requirements have not changed significantly,
looking at Malaysia or Hong Kong again for production would appear obvious. When
QUESTION 5: Reread the Management Focus, “U.S. Magnesium Seeks Protection.”
Who gains most from the antidumping duties levied by the United States on imports of
magnesium from China and Russia? Who are the losers? Are these duties in the best
national interests of the United States?
ANSWER 5: Many students will probably argue that the only clear winners from the
antidumping duties imposed by the United States on magnesium imports from China and
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CLOSING CASE: U.S. Tariffs on Tire Imports from China
Summary
The closing case explores the dispute over tariffs imposed by the United States on tires
imported from China. China more than tripled its share of the U.S. market from 2004 to
2008 prompting U.S. steelmakers to lobby for protection. Their efforts were rewarded by
the decision to impose a three-year tariff. China immediately complained that the policy
violated WTO agreements, but ultimately the WTO ruled in favor of the United States.
Discussion of this case can revolve around the following questions:
QUESTION 1: Which groups benefited from the imposition of U.S. tariffs on Chinese
tire imports? Which groups suffered? What does this tell you about tariffs in general?
ANSWER 1: In the short-term, U.S. workers in the manufacturing sector benefitted from
QUESTION 2: How do you think that the United States would have reacted if the
Chinese had raised tariff rates on the importation of certain goods from the United States?
ANSWER 2: The United States would raise a protest to the WTO about increased taxes,
QUESTION 3: What does the rise of tire imports from Thailand, Indonesia, and Mexico
during 2010 and 2011 tell you about the value of this kind of trade policy?
ANSWER 3: Tariffs on one country provide opportunities for other countries to take
QUESTION 4: Do you think that the policy was in the best interests of the United
States? Justify your answer.
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ANSWER 4: Students’ answers will vary. In the short run, U.S. production increased
after the tariffs were imposed; however, many U.S. sales jobs were lost because small-
INTEGRATING iGLOBES
There are several iGLOBE video clips that can be integrated with the material presented
in this chapter. In particular, you might consider the following:
Title: Are Chinese Business Partnerships a Good Deal for U.S. Companies?
Run Time: 8:19
Abstract: In the wake of the new Oriental DreamWorks joint venture and a visit to the
Key Concepts: joint ventures, market entry, foreign direct investment, technology
transfer, property rights protection, national trade policy, globalization, World Trade
Organization, firm strategy, rational for foreign direct investment, political economy
Notes: The challenges faced by U.S. companies in partnerships with Chinese companies
were recently explored in a lively discussion between Stephen Orlins of the National
According to Navarro, DreamWorks has been forced into taking a minority stake in a
joint venture in which the company’s proprietary animation technology will be
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The two do agree on a few points. In particular, both are concerned with the level of
access U.S. companies have to China, and feel that the market should be more open and
that restrictions currently imposed by China should be lifted. In addition, both are uneasy
with China’s policies, or lack thereof, regarding intellectual property rights, and feel that
there should be more effort to protect proprietary information. Regardless of these
concerns though, Stephen Orlins believes that the relationship between the two countries
is interdependent – neither can prosper unless the other is prosperous too.
Discussion Questions and Answers:
1. Compare and contrast joint ventures and wholly owned subsidiaries. What are the
advantages and disadvantages of each form of market entry? Why might a company
choose one over the other?
Answer: Most students will probably recognize that the choice between a wholly owned
subsidiary versus a joint venture may in fact be dictated by the government as in the case
2. Reflect on the issues raised by Peter Navarro regarding the Oriental DreamWorks deal.
Do you agree with him? How does Stephen Orlins view the partnership? In your
opinion, should DreamWorks have gone ahead with the partnership? Why or why not?
Answer: Peter Navarro claims that the Oriental DreamWorks deal reflects the high level
of protectionism in China. He feels that China’s policy of demanding a joint venture in
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3. Consider the allegations by Peter Navarro that China is responsible for the economic
problems that currently challenge the United States. In your opinion, is he on the right
track?
4. Why does the World Trade Organization allow countries to maintain restrictions on
media? How do these restrictions affect how companies operate?
Answer: Restrictions on media have been around for decades, in fact, most countries
have some sort of media restrictions. The reasons for these policies range from
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INTEGRATING VIDEOS
There are also several longer video clips that can be integrated with the material
presented in this chapter. In particular, you might consider the following from
International Business DVD Volume 6:
Title: Morocco Solar Power
Learning Objectives
The purpose of this video is to help you:
❖ Explain Porter’s theory of competitive advantage and how it pertains to Morocco.
Key Words
❖ Comparative advantage
❖ Levels of economic and social development
Synopsis
Near the village of Ain Beni Mathar in Morocco, a new energy plant was recently
launched. The plant produces solar energy using a unique combination of two types of
technology that integrate a solar field with natural gas based power. Morocco hopes that
this new plant will be just the first step in its goal to replace existing energy sources with
clean sources. Morocco is committed to reducing its dependency on foreign sources of
energy, and also wants to protect the environment. It is expected that the Beni Mathar
plant will help the North African country achieve those goals by producing a more
environmentally friendly, safer energy.
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Discussion Questions
1. Using Michael Porter’s theory of competitive advantage, discuss the factors of
production that are contributing to Morocco’s success in the production of solar energy.
What makes the country uniquely positioned to produce solar power?
2. Discuss the notion of strategic trade policy. How does the concept apply to
Morocco’s efforts to become a leader in the production of solar power? How is Morocco
leading the global effort to develop renewable sustainable sources of energy?
INCORPORATING globalEDGE™ EXERCISES
Exercise 1
You work for a pharmaceuticals company that hopes to provide products and services in
New Zealand. Yet management’s current knowledge of this country’s trade policies and
Exercise 2
The number of member nations of the World Trade Organization (WTO) has increased
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Also, examine the list of current observer countries. Do you notice anything in particular
about the countries that have recently joined or have observer status?
Answers to Exercise Questions
Exercise 1
The database can be accessed by searching the term “Market Access Database” at
source that primarily focuses on statistical data, the resource is found under the
globalEDGE category “Research: Multi–Country”. Be sure to click on the Resource Desk
link to search this area of the globalEDGE website.
Search Phrase: “Market Access Database”
Exercise 2
Search Phrase: “Global International Organization”