Business-Government Trade Relationships 6-1

No country permits unregulated flow of goods and services across its borders Governments place restrictions on imports and occasionally on exports Governments may provide direct and indirect subsidies to improve the competitive position of some industries Protectionism Government action intended to limit foreign producer’s ability to compete with domestic industry

Rationale for Government Intervention Preserve national identity Improve position compared to other countries Maintain spheres of influence Promote industrialization Deal with unfriendly countries Protect infant industries Maintain essential industries Prevent unemployment Non-economic/Political Rationale Economic Rationales 6-4

Infant-Industry Argument Government should guarantee an emerging industry a large share of the domestic market until it becomes efficient enough to compete against imports Initial output costs may make products noncompetitive in world markets Over time costs will decrease due to: greater economies of scale greater worker efficiency

Problems with argument Hard to identify industries with high probability of success even when industries can be identified, not clear that government should provide protection Protection may serve as disincentive for managers to adopt innovations needed to become competitive Public funds poorly spent Consumer prices rise

Industrialization Argument Industrialization represents high per capita income Most developing countries try to emulate strategy of developed countries Surplus workers can more easily increase manufacturing output than agricultural output Inflows of foreign investment can promote sustainable growth Prices and sales of agricultural products and raw materials fluctuate 6-5

Industrialization Argument, con’t Markets for industrial products grow faster than markets for agricultural products Local industry reduces imports and promotes exports Industrial activity helps the nation building process 6-6

Pursue strategic trade policy Economic Motives Potential results Global industry created Firms’ efficiency reduced Domestic costs increase Special interests benefit Pursue strategic trade policy Help companies achieve economies of scale and gain a first-mover advantage

Non-economic Rationales for Government Intervention Maintenance of essential industries Prevention of shipments to unfriendly countries Maintenance or extension of spheres of influence Protecting activities that preserve national identity 6-8

Maintaining Essential Industries Protecting domestic industries during peacetime so that country is not dependent on foreign sources of supply during war Popular argument to support import restrictions Countries must determine which industries are essential consider costs and alternatives consider political consequences Dealing with “Unfriendly” countries Prevention of exports that might be acquired by potential enemies May lead to retaliation that prevents securing other essential goods Trade controls on nondefense goods also may be used as a weapon of foreign policy

Maintaining Spheres of Influence Governments may: Provide aid and credits to, and encourage imports from, countries that are political allies Impose trade restrictions to coerce foreign countries to follow certain political actions Preserving Cultures and National Identity Countries have a common sense of identity that separates them from other nationalities May limit foreign products and services to protect their separate identity

Trade Promotion and Restriction methods Trade restriction Subsidies Export financing Foreign trade zones Special government agencies Tariffs Quotas Embargoes Local content requirements Administrative delays Currency controls Antidumping policy

Instruments of Trade Policy: Subsidies Government payment to a domestic producer Cash grants Low-interest loans Tax breaks Government equity participation in the company Subsidy revenues are generated from taxes Subsidies encourage over-production, inefficiency and reduced trade

Subsidies Potential results Increased competitiveness Encourage inefficient firms Increased consumer prices Overuse of resources

Export Financing Export-Import Bank Financing such as low-interest loans and loan guarantees Export-Import Bank Working capital loan guarantees Credit information on nation or firm abroad Export credit insurance against loss Loan guarantees to buyers of domestic co…

Foreign Trade Zones Designated geographic region in which merchandise is allowed to pass through with lower or no customs duties (taxes) and/or fewer customs procedures Purpose is to increase employment and trade within the nation

Special Government Agencies Organize trade missions for officials and businesses Operate export-promotion offices at locations abroad Help import products the home nation does not produce

Instruments of Trade Policy: Tariffs Tariffs are the oldest form of trade policy; they fall into two categories Specific tariffs are levied as a fixed charge for each unit Ad valorem tariffs are levied as a proportion of the value of the imported good Tariffs are good for government because they generate revenue Tariffs protect domestic producers but they reduce efficiency Tariffs are bad for consumers because they increase the cost of goods

Tariffs Potential results Export tariff Transit tariff Import tariff Protect domestic firms from competitors Generate income for the government Reduce competitiveness of home-based firms Raise consumer prices Export tariff Transit tariff Import tariff

Import and Export Quotas Restriction on the amount of a good that can enter or leave a country during a certain period of time Import Quotas Protect domestic producers of a good Force outside firms to compete for market access Export Quotas Retain an adequate domestic supply of a product Restrict world supply of a product to raise its price

Embargoes Complete ban on trade (imports and exports) in one or more products with a particular country Can be difficult for a nation to enforce Often used to achieve political goals Most restrictive nontariff trade barrier

Local Content Requirements Laws that domestic producers must supply a specific amount of a good or service Forces international companies to employ local resources (usually labor) in production process

Administrative Delays Regulatory controls or bureaucratic rules to slow imports into a country Inconvenient ports for imports Product-damaging inspections Understaffed customs offices Lengthy licensing procedures

convertibility of a nation’s currency Currency Controls Restrictions on the convertibility of a nation’s currency Limit the amount of globally accepted currency available to pay for imports 1$=100 from 50 exporter gains 1$= 100 rs from 50 importer loses 1$=100 rs repatriater from india loses 1$= 100 rs repatriater from forg gains… As curr weakens exp and people residing in india gain and As curr strenthens importer and forg rep or residents outside india gain.. Set an unfavorable exchange rate when paying for imports

Instruments of Trade Policy: Antidumping Policies Defined as Selling goods in a foreign market below production costs Selling goods in a foreign market below fair market value Result of Unloading excess production Predatory behavior Remedy: seek imposition of tariffs