Fourth Edition International Business

CHAPTER 5 The Political Economy of International Trade

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-3 Chapter Focus The political reality of free trade is that while nations are nominally committed to it, they intervene and take actions to protect the interests of politically important groups. This chapter explores the political and economic reasons for intervention; to restrict imports and expand exports, but, more recently, for ‘social’ reasons. The chapter describes the range of intervention instruments used by governments and considers the case for free trade in light of government actions.

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-4 The 7 Instruments of Trade Policy Antidumping Duties Local Content Requirements Tariffs Voluntary Exports Restraints Subsidies Administrative Policies Import Quotas

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-5 Tariffs Specific Fixed charge per unit Ad Valorem Charge is a proportion of the goods value  Oldest form of protection.  Good for the Government.  Good for producers.  Leads to inefficiency.  Bad for consumers.

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-6 Subsidies Government payment to a domestic producer Cash Grants Tax Breaks Low Interest Loans Government Equity Participation

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-7 Subsidies Agriculture 1.Keeps inefficient farmers in business. 2.Encourages production of subsidized products. 3.Produce products grown more cheaply elsewhere. 4.Reduces agriculture trade. Helps domestic producers to compete internationally. Paid by taxing individuals

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-8 Import Quotas and Voluntary Export Restraints Direct restriction on the quantity of a good that can be imported into a country. Import Quotas Quota on trade imposed by the exporting country at the request of the importing country’s government. VERs Hurts consumers Raises domestic prices on imported goods (and possibly imported good) Helps producers Quota rent

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 5-9 Local Content Requirements A specific fraction of a good must be domestically produced. A specific fraction of a good must be domestically produced. Physical amount Value Widely used by developing countries to develop their manufacturing base. Used by developed countries to protect local jobs and industry from foreign competition.

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Administrative Policies Bureaucratic rules designed to make it difficult for imports to enter a country. Japanese ‘masters’ in imposing rules. Tulip bulbs. Federal Express.

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Antidumping Policies Selling goods into a foreign market below production costs, or Selling below “fair market value”. Used to unload excess production. Or, predatory pricing. Antidumping policies are used to punish foreign firms. Protect local industry from “unfair” practices. Impose “countervailing” duties.

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Political Arguments for Intervention Further Foreign Policy Objectives Protect Industry and Jobs. National Security Retaliation Protect Consumers Protect Human Rights

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Protect Industry and Jobs. Most common political argument.

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Retaliation Risky strategy. If government fails to heed warnings and imposes its own higher tariffs, the result is higher tariffs all around and a corresponding economic loss.

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Retaliation US Trade Sanctions Afghanistan Italy Burma Libya Canada Nigeria China N. Korea Cuba Pakistan India Saudi Arabia Iran Sudan Iraq Syria Yugoslavia Partial List

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Protect Consumers Battleground for biotechnology such as hormone-treated beef and genetically altered crops.

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Further Foreign Policy Objectives Used to build relations with another country or punish it (so-called rogue states). Policy is unilateral and easily defeated by other countries ignoring it.

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Protect Human Rights Basis for the use of “Most Favored Nation” status to persuade China to change its positions on human rights.

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Economic Arguments for Intervention Infant Industry Strategic Trade Policy  Infant industry is the oldest economic argument for government intervention, dating to 1792 and Alexander Hamilton.  Protect developing country’s new industry from developed countries better established industries. Recognized by GATT.  Strategic trade policy can help a firm gain ‘first mover’ advantages or overcome barriers created by a different (foreign) first mover.

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Revised Case for Free Trade Paul Krugman, MIT economist, argues that strategic trade policies can lead to trade wars. The best way to handle disputes is to work to establish rules that minimize trade-distorting subsidies - a function of the World Trade Organization. He also argues that government intervention usually favors special interest groups that distort the subsidy to their own ends. Therefore, “a blanket policy of free trade, with exceptions granted only under extreme pressure … may be the best policy that the country is likely to get.”

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Development of the World Trading System Intellectual arguments for free trade: Adam Smith and David Ricardo. Free trade as government policy: Britain’s (1846) repeal of the Corn Laws. Britain continued free trade policy. Fear of trade war.

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved World War I to World War II Great Depression US stock market collapse Smoot-Hawley Act (1930) US had positive trade balance with world Act imposes tariffs to protect U.S. firms. Foreign response was to impose own barriers US exports tumbled

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved General Agreement on Tariffs and Trade WWII allies want international organization in trade arena similar to UN in political arena. GATT proposed by US in 1947 as step toward ITO. 1948: Havana Conference. Failed charter for the International Trade Organization. GATT 19 original members grew to 120 nations by the time it was superceded by the WTO. GATT members agree not to raise tariffs above negotiated rates.

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved GATT Negotiating Rounds Geneva Annecy Torquay Geneva Dillon Kennedy Tokyo Uruguay World Trade World Income Annual Growth Under GATT %

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Average Reduction in US Tariff Rates Index Pre-Geneva Tariff = 100 GATT Negotiating Rounds

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved : Disturbing Trends Pressures for greater protectionism: Japan’s economic success. World’s second largest economy. World’s largest exporter. The U.S.’s persistent trade deficit. Many countries had found ways to avoid GATT restrictions.

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Most comprehensive trade agreement in history. Created the World Trade Organization. Impacted: Agriculture subsidies (stumbling block: US/EU). Applied GATT rules to services and intellectual property. Strengthened GATT monitoring and enforcement. Uruguay Round

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Umbrella organization for: GATT Services Intellectual property Responsibility for trade arbitration: Reports adopted unless specifically rejected. After appeal, fail to comply can result in compensation to injured country or trade sanctions. World Trade Organization 154 Rue de Lausanne, Geneva

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved WTO 141 members (China) and 28 candidates. Between 1995 and 2000, 213 disputes brought before the WTO. Significant victories: Telecommunications 68 countries (90%) of world telecommunications revenues Pledged to open their markets to fair competition Financial Services 95% of financial services market 102 countries will open, to varying degrees, their markets.

McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved WTO Seattle Failure of Countries to Agree on Goals Private Groups & Unions Oppose “faceless” Organization