Copyright © 2008 Pearson Addison-Wesley. All rights reserved. Chapter 7 Commercial Policy

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-2 Introduction Since the end of WWII, average tariff rates around the world have fallen substantially By 2002, average nominal rates were 3.9% in US, 3.3% in Japan, 4.4% in EU However, all nations have higher levels of protection in particular industries they deem sensitive In addition to tariffs and quotas, many countries provide generous subsidies to some of their agricultural producers, particularly among developed nations

Applied Tariffs for Major World Traders

7-4 Why Protect? The Logic of Collective Action Given that the costs of tariffs and quotas are high to consumers, why do consumers tolerate them? Others might say given that the gains from liberalization are relatively small at this point and the costs of de-regulation so real then why do consumers tolerate them? Either way: Mancur Olson´s Logic of Collective Action –The costs of tariffs and quotas are borne by a great many people: everyone pays a little for protection –The benefits of protection are concentrated in a few industries: few benefit a lot from protection –Thus, there is an asymmetry in the incentives to oppose the policy: those benefiting from protection have much greater incentives than those hurt by it to lobby for it

US Steel AFLCIO CEOs of steel factories Consumers Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-5

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-6 Main Arguments behind Trade Barriers 1: JOBS Labor: Protection must be used against imports from countries where wages are much lower –Problem: Does not consider differences in productivity between different workforces: as productivity rises, so will wages

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-7 Direct Costs and Jobs Saved Since the phase in of the Uruguay Round tariff cuts, average tariffs have fallen 40%but few sectors are average For example, agriculture, clothing and textiles experience much smaller reductions in tariffs and quotas (12%, 14%, 14% respectively) In addition, all of these sectors in the EU, Japan, and US have significant non-tariff barriers applied to them including large government subsidies in the case of agriculture

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-8 Jobs Saved through Tariffs and Quotas Sums: a+b+c+d

Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-9 The Costs of Protection: Lessons Trade policy is a grossly inefficient mechanism to create jobs –It is a non-transparent job-creation program –It relies on too many intervening variables, and does not go directly to the heart of the problem –If job creation is the goal, tariffs and quotas are very expensive

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Main Arguments behind Trade Barriers 2: INFANT INDUSTRY Infant industry: Developing countries have nascent industries that must be protected against competition from industrial countries Strategic trade: import protection allows national oligopolies to get economies of scale in national market and prepare it tocrack into global markets –Assumes: (1) market forces do not allow for the development of a certain industry and (2) the industry has positive externalitiesspillover benefits (valuable linkages to other industries or technologies) –Problems: (1) may increase inefficiency and result in negative linkage effects and (2) technological externalities are difficult to measurewhich industries should be protected?

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Main Arguments behind Trade Barriers 3: SECURITY National security: Certain industries must be protected in order to guard national security (military security, cultural values) –Problems: (1) Vital mineral resources, for example, can be purchased cheaply abroad during peacetime; and (2) how to assess the effects of, say, U.S. television programs on Canadian culture? Economics of sanctions:

US Sanctions Currently in Place Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-12

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Economic Sanctions since World War I

7-14 When Sanctions Work When the target country is small, economically weak, and relatively unstable When the target country is an ally When sanctions are imposed quickly and decisively When target country has few options to obtain goods otherwise When the costs to the sending country are small When the goal is a relatively small change Source: Economic Sanctions Reconsidered, Peterson Institute for International Economics, 2007

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Main Arguments behind Trade Barriers 4: RETALIATE Retaliation: Another country´s trade barriers must be countered with trade barriers –Problems: Although retaliation can provide an incentive for trade negotiations, it can also lead to escalating trade wars

Main Arguments for Tariffs 5: Revenue Poorer regions (Africa, South Asia, parts of the Middle East) rely more on tariffs as a source of government revenue. Tariffs may still be used for other purposes, but for some countries, the primary goal is to generate income for the operation of government services. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 7-16

Tariffs as a Share of Government Revenue, By Region

Copyright © 2008 Pearson Addison-Wesley. All rights reserved The Politics of Protection in the United States Protectionist pressures have increased in the U.S. –Political reforms: reduced Congresss past insulation from industry lobbyists –The end of the Cold War: reduced U.S. willingness to sacrifice domestic political considerations for geopolitical alliances –The rise of China hsincreased competitive pressures on U.S. industries –The growth of the U.S. trade deficit has spurred fears of the loss of competitiveness

Copyright © 2008 Pearson Addison-Wesley. All rights reserved The Politics of Protection in the U.S.: Main Mechanisms Protection is obtained through (1) direct action by the president (e.g., VERs) or (2) four types of legal procedures –Countervailing duties –Antidumping duties –Escape clause relief –Section 301 retaliation

Copyright © 2008 Pearson Addison-Wesley. All rights reserved The Politics of Protection in the U.S.: Main Mechanisms (cont.) In the case of these four legal procedures, a firm or industry petitions the federal government to initiate an investigation into foreign country or foreign firm practices Let´s analyze each of the four procedures in greater detail…

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Countervailing Duties Countervailing duty: a tariff that is granted to a U.S. industry that has been hurt by a foreign country that is subsidizing its firms –Subsidies allow foreign firms to sell their products at lower prices; countervailing duty seeks to counter the effect of the subsidy –Problem: defining subsidy is subjective –Uruguay Round defined subsidies as (1) a direct loan or transfer, (2) preferential tax treatment, (3) the supply of goods or services other than general infrastructure, or (4) income and price supports

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Antidumping Duties Antidumping duty: a tariff levied on an import that is selling at a price below the products fair value –Problem: Defining fair value is subjective; antidumping duties are thus a source of tension between countries

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Antidumping Duties (cont.) WTO: Dumping occurs when an exporter sells a product as a price below the one it charges in its home market –Problem: Comparing domestic and foreign market prices is difficult due to differences in the price of transportation, wholesale, and other add-ons

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Antidumping Duties (cont.) Three methods to determine whether a good is being dumped 1.Comparing the price in third-country markets 2.Estimating the cost of production; or 3.Estimating the foreign firms production costs (dumping occurs if the foreign firm is not selling at a price that provides a normal rate of return on invested capital)

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Antidumping Duties (cont.) In order for antidumping duties to be allowed, the country claiming dumping must show that the dumping has caused material injury to its firms –If dumping occurs without material injury, antidumping duty is not allowed

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Antidumping Duties (cont.) Problems: Economic theory and legal definitions are not in agreement –If a firm is not earning above average profits somewhere, it cannot maintain a price somewhere else that is below the cost –Firms often sell below costs May sell at below costs in order to penetrate a market May go for extended periods selling at prices that do not cover fixed costs as long as the costs of variable inputs (labor and materials) are covered

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Antidumping Investigation U.S. firms can initiate antidumping actions by filing a petition with the International Trade Administration (ITA) in the Department of Commerce If ITA finds dumping (or subsidization in the case of countervailing duty) occurred, the U.S. International Trade Commission (USITC) conducts an additional investigation to determine whether the dumping has posed substantial harm to the domestic industry The relative success of U.S. firms in proving foreign dumping has induced a growing number of firms to file petitions with ITA

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Escape Clause Relief Escape clause relief: temporary tariff on imports to allow a domestic industry to escape the pressure of imports and thus obtain a period of adjustment –Refers to a clause in the U.S. and GATT trade rules –Initiated when a firm or industry petitions the USTIC directly for relief from a surge of imports –The petitioning firm or industry must show that it has been harmed by imports and not some other factor (e.g., poor management)

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Section 301 Retaliation Section 301: section of the U.S Trade Act that requires the U.S. Trade Representative (USTR) to take action against any nation that persistently engages in unfair trade practices –U.S. defines the meaning of unreasonable and unfair trade practices –Action is launched by a request for negotiations with the country in question

Copyright © 2008 Pearson Addison-Wesley. All rights reserved Special 301 Special 301: requires the USTR to monitor property rights enforcement around the world –In 2005 the USTR surveyed 90 countries and identified 52 as lacking adequate enforce or denying market access.