Chapter 07 – The Political Economy of International Trade
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The Political Economy of 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 developments of the
world trading system and the
current trade issues.
• Explain the implications for
managers of developments in the
world trade 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 US 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 battle over tariffs imposed
on Chinese tires exported to the United States and whether
the tariffs violate trade agreements. The closing case
explores the effect of the recent global financial crisis on
the volume of world trade as well as the implications of
the protectionist measures some countries have taken in an
effort to protect jobs and provide a competitive edge for
domestic companies.
7
Chapter 07 – The Political Economy of International Trade
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OUTLINE OF CHAPTER 7: THE POLITICAL ECONOMY OF
INTERNATIONAL TRADE
Opening Case: U.S. Tariffs on Tires from China
Introduction
Instruments of Trade Policy
Tariffs
Subsidies
Import Quotas and Voluntary Export Restraints
Local Content Requirements
Administrative Policies
Antidumping Policies
Country Focus: Subsidized Wheat Production in Japan
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
The Revised Case for Free Trade
Retaliation and Trade War
Domestic Politics
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
Implications for Managers
Trade Barriers and Firm Strategy
Policy Implications
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Chapter Summary
Critical Thinking and Discussion Questions
Closing Case: The Global Financial Crisis
CLASSROOM DISCUSSION POINT
Ask students whether the United States promotes free trade. Jot their responses on the
board.
Next, ask students similar questions about the European Union (EU dairy farms receive
$15 billion a year in subsidies).
OPENING CASE: The Global Financial Crisis and Protectionism
The opening 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 the case can revolve around the following questions:
1. Do you agree with the decision to impose tariffs on tires imported from China? What
benefits does the new policy bring to the industry in the U.S.? What problems could the
tariffs create? Why should firms be concerned?
2. How might the tariffs imposed by the United States actually harm some U.S.
companies and workers? What might happen when the tariffs expire? Why should firms
be concerned?
3. Discuss the implications of the tariffs for U.S. consumers. What impact do the tariffs
have on tires prices for U.S. buyers?
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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.
Slides 7-3 What is the Political Reality of Free Trade?
Free trade refers to a situation where a government does not attempt to restrict what its
citizens can buy from another country or what they can sell to another country.
Slide 7-4-7-10 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
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.
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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.
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 7-12-7-16 Political Arguments for Intervention
Political arguments for government intervention include:
• protecting jobs
• protecting industries deemed important for national security
• retaliating to unfair foreign competition
• protecting consumers from “dangerous” products
• furthering the goals of foreign policy
• protecting the human rights of individuals in exporting countries
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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
Slide 7-17-7-20 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
argument: protection of manufacturing from foreign competition does no good unless the
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
intervention in industries with possibly large economies of scale. Such intervention
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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.
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.
Slide 7-21-7-25 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
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,
machine tools, semiconductors, steel, and textiles, and the resulting unemployment gave
rise to renewed demands in the U.S. Congress for protection against imports.
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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
Slides 7-26-7–27The 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).
Another Perspective: To see current issues at the WTO, go to {http://www.wto.org} and
click on “News.” In addition, consider {http://www.businessweek.com/news/2011-05-
20/doha-talks-on-trade-face-unbridgeable-gaps-apec-ministers-say.html}.
Slides 7-28-7-29 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.
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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
matter of personal opinion, in stating their opinions, students should consider the
following points. Trade with the U.S. is very important to China, as China views the U.S.
as an important market. The U.S. is also an important source of certain products. Thus,
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,
each of whom may be negatively impacted by only a few dollars, are less motivated and
effective lobbyists than are a few producers who may have a great deal at stake. While in
some instances it may be argued that domestic consumers will be better off if world-class
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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 U.S. 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
the U.S. government introduces a specific ad valorem tariff on Thai computer imports, it
forces manufacturers to get around these restraints by developing other strategies,
QUESTION 5: Reread the Management Focus feature on U.S. Magnesium Seeks
Protection. Who gains most from the anti-dumping 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
Russia are the employees and investors of U.S. Magnesium. Some students may suggest
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CLOSING CASE: The Global Financial Crisis and Protectionism
Summary
The closing case describes the changes in the volume of world trade and levels of
protectionism that have occurred in the wake of the recent global recession. After the
financial crisis that began in the United States in 2008 and then spread to other countries
around the world, the volume of world trade fell prompting countries to impose various
protectionist policies. As the global economy began to recover, some of these policies
were retracted, however there is concern that many protectionist measures are still in
place. Discussion of this case can revolve around the following questions:
QUESTION 1: Why do you think calls for protectionism are greater during sharp
economic contractions than boom periods?
ANSWER 1: Sharp economic contractions are of course directly linked to slowdowns in
demand forcing companies to adopt new strategies. One such strategy may be to lobby
QUESTION 2: Despite the sharp economic contraction during 2008-2009, the increase
in protectionist measures was fairly modest. Why do you think this was the case?
ANSWER 2: Thanks to the greater number of trade agreements in place today as well as
WTO rules, many countries found they had limited options when they tried to respond to
the recent global recession. In the past, countries had more freedom to implement
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QUESTION 3: During 2008-2009 many developed nations gave subsidies to their
automobile producers. How might this have distorted international trade? Was this a
reasonable thing to do given the circumstances?
ANSWER 3: The 2008-200 financial crisis prompted many countries including the
United States to provide subsidies to automakers. While the assistance helped companies
remain in business and protected jobs, it also created an artificial environment for them
and may have prompted some companies to shift production from more efficient
QUESTION 4: What might occur if renewed economic slowdown triggered a wave of
protectionist measures around the world? Would protectionism protect jobs, or would it
make things worse?
ANSWER 4: In mid-2011, the global economy was still unstable, and the threat of a
double-dip recession was very real. Many students will probably suggest that if the
economy fails to fully recover, many companies will continue to face low demand and
because of the protection they received in the past, may still be unprepared to deal with it
QUESTION 5: The volume of world trade rebounded sharply in 2010 on the back of a
fairly modest growth rate in the world economy. What does this tell you about the nature
of international production in today’s global economy? What does this tell you about the
vulnerability of the world economy to any future trade wars?
ANSWER 5: Most students will probably recognize that today’s economy is truly global
in nature. A modest increase in demand can result in a substantial increase in the volume
of world trade thanks to the global nature of production where parts for products may
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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: Europe’s Deadly E.Coli Outbreak a “Wake–Up” Call Over Global
Food Distribution
Run Time: 8:17
Abstract: This video explores the global challenges associated with resolving the
problems associated with a recent E.coli outbreak in Germany and the implications of
today’s international food system for consumers and producers.
Key Concepts: globalization, European Union, protectionism, exports,
global distribution, political economy, trade policy, global economy, globalization of
production
Notes: Europe, and in particular Germany, is still unsure of exactly what caused a
deadly E.coli outbreak that sickened or killed some 2,000 people in June. In fact,
government officials were struggling to explain what had happened and why it was not
possible to contain the disaster much sooner. The most likely explanation for the
devastation appeared to involve ingredients in a salad, but whether tomatoes, cucumbers,
or lettuce were the problem was anyone’s guess. This apparent confusion has drawn
criticism from the public and from government officials in other countries, particularly
those in the European Union. Now, amid accusations and finger-pointing some countries
have put limits on agricultural imports from certain countries. What is perhaps most
worrisome about the situation though, is that it is still unclear exactly what carried the
deadly bacterium nor how to trace it back to the real source, whether it is a farm or
processing center or some other stop in the global food distribution system.
The outbreak highlights some of the challenges of today’s global food system. Today, in
an effort to meet the demand for a diverse range of products as well as for products that
are out of season locally, an international food system has emerged in which ingredients
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and products are sourced around the world. In addition, the processes used to produce
and distribute the products from farm to market are likely to differ greatly by country.
And, unlike many other types of problems, all countries, developed or still developing,
are equally susceptible to outbreaks like the one that is currently devastating Germany.
Moreover, it seems that governments are ill-prepared to handle crises like the one in
Germany. According to William Marter, an expert on food borne illness cases, the
United States, for example, is completely unprepared to handle the type of outbreak that
has brought so much grief for Germany.
Still, with customers demanding more choice at the grocery store, the globalization of the
food system is likely to continue. There are some efforts to develop agencies or
organizations to oversee the process, but so far, there has been little agreement on exactly
what form should such an organization should take, what its responsibilities would be, or
what the standards it establishes should look like. The crisis in Germany has brought
renewed attention to the situation however, and it is hoped that this new awareness will
result in further breakthroughs that reduce the likelihood for another deadly outbreak
related to food borne bacteria as well as a new mechanism for containing one should it
happen.
Discussion Questions:
1. Discuss the global nature of today’s food industry. What has contributed to its
internationalization? What unique challenges does the internationalization of the industry
create?
2. What are the implications of policy decisions to limit food imports from countries that
are in the midst of food borne crises? Is this type of decision in fact simply thinly veiled
protectionism?
3. Reflect on the opportunities provided by a global food industry for small farmers.
Discuss the importance of these opportunities for economic growth in developing
countries.
4. Can an international organization be established to govern the safety of the global food
industry? Is such an organization needed? Why?
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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.
❖ Explore the relationship between environmental sustainability and economic
development for Morocco.
❖ Understand how strategic trade policy can help a country gain a competitive
advantage and recognize the importance of first mover advantages.
❖ Discuss the effect of exports on a country’s balance of payments.
Key Words
❖ Comparative advantage
❖ Levels of economic and social development
❖ Strategic trade policy
❖ Exports
❖ Competitive advantage
❖ First mover advantage
❖ Environmental sustainability
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.
The environmentally friendly aspects of the plant are significant. The Beni Mathar plant
should produce some 3.5 terawatt hours of energy per year, enough to power a million
homes. At the same time, because the plant integrates thermal solar technology, it avoids
allowing some 33,000 tons of CO2 emissions every year. Moreover, because the plant
uses dry cooling technology, water consumption is also minimized, allowing for a
savings of 80 percent per year.
The new solar energy plant is also expected to bring additional benefits. Morocco’s king
believes that it will bring social and economic development to the country’s eastern
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region. Already, workers in the plant have learned new skills that they can use at other
companies. In addition, as part of the plant’s social dimension, a new school has been
built in the village along with a new mosque, and roads have been constructed.
Expectations are also high that this plant will be followed by additional ones and that
eventually the kingdom will not only produce enough power for its own country, but
enough for parts of Europe as well.
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?
3. Why are first mover advantages important in the solar power industry? What
disadvantages do you see in being a first mover? What are the implications of being a
leader in the production of solar power?
4. Explain the significance of solar energy to Morocco. How can it help the country
achieve greater social and economic development?
INCORPORATING globalEDGE™ EXERCISES
Use the globalEDGE™ site {http://globalEDGE.msu.edu/} to complete the following
exercises:
Exercise 1
The European subsidiary of your company is considering exporting its products to Egypt.
Yet, management’s current knowledge of this country’s trade policies and barriers is
limited. Before your company’s management decides to export, a more detailed analysis
of the political and economic conditions in Egypt is required. In fact, you have heard that
the Market Access Database may be a good place to start. Begin your search and identify
Egypt’s current import policies with respect to fundamental issues such as tariffs and
restrictions. Prepare an executive summary of your findings.
Exercise 2
The number of member nations of the World Trade Organization (WTO) has increased
considerably in recent years. As a global international organization, some non-member
countries have observer status in the WTO. Such status requires accession negotiations to
begin within five years of attaining this preliminary position. Identify the current total
number of WTO members. Also, prepare a list of current observer countries. Do you
notice anything in particular about the countries that have observer status?
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Answers to Exercise Questions
Exercise 1
The database can be accessed by searching the term “Market Access Database” at
http://globaledge.msu.edu/ResourceDesk/. The Market Access Database is the only
source from this search. Once at the source’s webpage, click on the trade barriers
database link to search all current trade barriers for Egypt. As this is a multi-country data
Exercise 2
The World Trade Organization’s website can be accessed by searching the term “global
international organization” at http://globaledge.msu.edu/ResourceDesk/. The link to the
WTO (www.wto.org) is found under the globalEDGE category “Research: