Global Business Today 10e

Global Business Today 10e
by Charles W.L. Hill and G. Tomas M. Hult

The Global Trade and Investment Environment
Source: © Si wei/AP Images Listening to changing customer demands and monitoring your environment allow you and the firm to identify potential growth opportunities. Chapter 7: Government Policy and International Trade

Learning Objectives LO 7-1 Identify the policy instruments used by governments to influence international trade flows. LO 7-2 Understand why governments sometimes intervene in international trade. LO 7-3 Summarize and explain the arguments against strategic trade policy. LO 7-4 Describe the development of the world trading system and the current trade issue. LO 7-5 Explain the implications for managers of developments in the world trading system.

Opening Case: Is China Dumping Its Excess Steel Production?
Produced half the world’s output of steel by 2015 Bottom fell out of Chinese domestic market for steel Need to export unwanted product – even at a loss Low-priced exports impacting global steelmakers negatively U.S. producers claim China is dumping product U.S. Commerce Department implemented duties European Union considering similar measures In November 2015, the Commerce Department ruled that all of these countries except Taiwan were dumping steel and placed duties as high as 236 percent on some imports of foreign steel. In late December, the Commerce Department ruled that China was also selling corrosion-resistant steel at unfairly low prices and placed an additional 256 percent tariff on such imports. This erected a huge barrier to certain Chinese steel imports into the United States.

Introduction 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 While many nations are nominally committed to free trade, they tend to intervene in international trade to protect the interests of politically important groups

Instruments of Trade Policy 1 of 10
Seven main instruments of trade policy Tariffs Subsidies Import quotas Voluntary export restraints Local content requirements Administrative policies Antidumping duties LO 7-1 Identify the policy instruments used by governments to influence international trade flows.

Nontariff barriers include Subsidies Quotas Voluntary export restraints Antidumping duties LO 7-1 Identify the policy instruments used by governments to influence international trade flows.

Tariffs A tariff is a tax levied on imports that effectively raises the cost of imported products relative to domestic products Specific tariffs: levied as a fixed charge for each unit of a good imported Ad valorem tariffs: levied as a proportion of the value of the imported good

Tariffs continued Increase government revenues Provide protection to domestic producers against foreign competitors by increasing the cost of imported foreign goods Force consumers to pay more for certain imports Tariffs are generally pro-producer and anticonsumer Import tariffs reduce the overall efficiency of the world economy

Did You Know? Did you know that the high price of SUVs in the US is the result of the "chicken tariff"? Click to play video

Subsidies Subsidy: a government payment to a domestic producer Subsidies help domestic producers Compete against low-cost foreign imports Gain export markets Consumers typically absorb the costs of subsidies Country Focus: Are the Chinese Illegally Subsidizing Auto Exports? Summary This feature explores the subsidies paid by China’s government to Chinese producers of autos and auto parts. U.S. lawmakers have raised concerns that the subsidies are unfair and have filed a complaint with the World Trade Organization (WTO) arguing that the subsidies have effectively hurt U.S. auto and auto parts producers. While some in the U.S. auto industry support the complaint, others are concerned that it could jeopardize their investments in the Chinese market. Discussion of the feature can begin with the following questions: Suggested Discussion Questions 1. In your opinion, could U.S. complaints about China’s policies toward its auto exports actually harm U.S. producers more than they help? Should the U.S. dismiss its complaint with the WTO? Discussion Points: The vast market potential in China is attractive to most companies including U.S. auto producers. Consequently, when the United States registered its complaint with the WTO against the subsidies paid by China to its auto makers, U.S. manufacturers responded cautiously. Most are concerned that the move could jeopardize their opportunity to capitalize on the Chinese market if China responds to the complaint with retaliatory measures. Moreover, some U.S. companies actually benefit from the lower cost parts that China is exporting and so support the subsidies. 2. As a U.S. consumer, do you support China’s subsidies on autos and auto parts? Does your response change if you work for a U.S. auto maker? Why or why not? Discussion Points: U.S. consumers are probably generally supportive of the subsidies paid by China to its auto producers because cheaper exports from China help drive down prices in the United States by introducing additional competition in the market. The response by workers may be more mixed. The additional competition in the industry that is created as a result of the subsidies could threaten jobs, but at the same time, the cheaper parts that are available could help create jobs. Lecture Note: To extend this discussion, consider { and { to learn more.

Import Quotas and Voluntary Export Restraints Import quota A direct restriction on the quantity of some good that may be imported into a country Tariff rate quota A hybrid of a quota and a tariff where a lower tariff is applied to imports within the quota than to those over the quota Voluntary export restraint (VER) Quota on trade imposed by the exporting country, typically at the request of the importing country’s government Quota rent The extra profit that producers make when supply is artificially limited by an import quota Import quotas and voluntary export restraints benefit domestic producers by limiting import competition, but they raise the prices of imported goods for consumers

Figure 7.1 Hypothetical Tariff Rate Quota
Jump to Appendix 1 long image description

Export Tariffs and Bans Export tariff is a tax placed on the export of a good Goal is to discriminate against exporting Export ban is a policy that partially or entirely restricts the export of a good Ban of exports of U.S. crude oil in 1975 to ensure sufficient supply of domestic oil at home

Local Content Requirements (LCR) A local content requirement demands that some specific fraction of a good be produced domestically Can be in physical terms or in value terms Local content requirements benefit domestic producers and jobs, but consumers face higher prices

Is Having a Local Content Requirement a Good Idea?
Local content requirements refer to a specific fraction of a product that needs to be manufactured domestically. Basically, LCRs establish a minimum level of local content required under trade law when giving foreign companies the right to manufacture in a particular place. In the wake of the economic downturn in 2008, many economists feared that some governments would institute protectionist policies similar to the tariff escalations during the Great Depression of the 1930s. However, most public policy officials avoided traditional forms of protection (e.g., tariffs, quotas). This led some observers to underestimate the degree of protectionism. Instead, what had happened was that so-called nontariff barriers in the form of local content requirements had become increasingly popular. As a (1) citizen of a specific country and (2) as a global customer, do you think local content requirements help you as a citizen of a country, as a global customer, as both, or as neither? Source: G. C. Hufbauer and J. J. Scott, “Local Content Requirements: A Global Problem Washington, D.C.,” Peterson Institute for Global Economics, 2013.

Administrative Policies Administrative trade polices: bureaucratic rules that are designed to make it difficult for imports to enter a country These polices hurt consumers by denying access to possibly superior foreign products

Antidumping Policies Dumping: selling goods in a foreign market below their cost of production, or selling goods in a foreign market at below their “fair” market value Objective is to protect domestic producers from unfair foreign competition May be predatory behavior, with producers using substantial profits from their home markets to subsidize prices in a foreign market with a goal of driving indigenous competitors out, and later raising prices and earning substantial profits U.S. firms that believe a foreign firm is dumping can file a complaint with the government If the complaint has merit, antidumping duties, also known as countervailing duties may be imposed

The Case for Government Intervention 1 of 4
Political arguments Concerned with protecting the interests of certain groups within a nation (normally producers), often at the expense of other groups (normally consumers) Economic arguments Concerned with boosting the overall wealth of a nation (to the benefit of all, both producers and consumers) LO 7-2 Understand why governments sometimes intervene in international trade.

Political Arguments for Intervention Protecting jobs and industries Protecting national security Retaliating Use intervention as a bargaining tool and force trading partners to “play by the rules of the game” Protecting consumers Ban unsafe products Furthering foreign policy objectives Grant preferential trade terms to a country it wants to build relations with Pressure or punish “rogue” states Protecting human rights Protecting jobs and industries is the most common political reason for trade restrictions. The national security argument is less common today than in the past.

Economic Arguments for Intervention The infant industry argument An industry should be protected until it can develop and be viable and competitive internationally This argument has been criticized because It is useless unless it makes the industry more efficient If a country has the potential to develop a viable competitive position, its firms should be capable of raising necessary funds

Economic Arguments for Intervention continued Strategic trade policy By appropriate actions, government can help raise national income if it can ensure first-mover advantages in an industry are domestic Might be beneficial for a government to intervene in an industry by helping domestic firms overcome barriers to entry created by foreign firms with first-mover advantages

Trading with Cuba Even though the United States holds trade sanctions with Cuba, other Western countries continue to trade with the island nation. Source: © Adalberto Roque/AFP/Getty Images

The Revised Case for Free Trade 1 of 3
New trade theorists believe government intervention in international trade is justified Classical trade theorists disagree Some new trade theorists believe that while strategic trade theory is appealing in theory, it may not be workable in practice – they suggest a revised case for free trade LO 7-3 Summarize and explain the arguments against strategic trade policy.

Retaliation and Trade War Krugman: strategic trade policies to establish 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 A country that attempts to use such policies will probably provoke retaliation A trade war could leave both countries worse off Don’t engage in retaliation but help establish rules to minimize the use of trade-distorting subsidies

Domestic Policies Governments can be influenced by special interest groups A government’s decision to intervene in a market may appease a certain group, but not necessarily support the interests of the country as a whole Krugman sees this as a further reason for not embracing strategic trade policy

Development of The World Trading System 1 of 8
Since World War II, an international trading framework has evolved to govern world trade In its first fifty years, the framework was known as the General Agreement on Tariffs and Trade (GATT) Since 1995, the framework has been known as the World Trade Organization (WTO) LO 7-4 Describe the development of the world trading system and the current trade issue. Country Focus: Estimating the Gains from Trade for America Summary This feature explores the results of a study by the Institute for International Economics. The study, which estimated the gains to the U.S. economy from free trade, found that the United States’ GDP was more than 7 percent higher as a result of reductions in trade barriers than it would have been if the barriers remained. The study also estimated that if tariffs were reduced to zero, significant gains would still result. Suggested Discussion Questions 1. What does the Institute for International Economics suggest about the benefits of free trade? Discussion Points: The Institute for International Economics found that thanks to reductions in trade restrictions, the United States’ GDP was up. The Institute also estimated that even greater gains in the country’s GDP would occur if protectionism was eliminated all together. Students should recognize that these findings follow the principles of Adam Smith and David Ricardo and suggest that free trade is beneficial. 2. According to the Institute for International Economics study, a move toward free trade would cause disruption in employment. Is it still worth pursuing free trade if it means that some people lose their jobs? Discussion Points: This question should prompt a strong debate among students. Some students will probably suggest that the costs in terms of lost wages and benefits associated with free trade outweigh the benefits that would be gained. Other students however, will probably argue that since protectionism typically benefits only a few at the expense of others, while free trade generates greater economic growth and higher wages, a free trade policy should be followed. Teaching Tip: The Web site for Institute for International Economics is available at {

Do You Believe in Free Trade Agreements?
The benefits of free trade agreements are often hard to see. At the same time, the benefits of protecting certain industries and/ or companies from foreign competition are often very visible. Given these scenarios, many people often argue that free trade agreements are bad for their country. Perhaps as a result, many governments impose many tariffs, quotas, and other nontariff barriers to trade. For example, the common perception is that by establishing trade barriers, a country keeps the jobs at home instead of jobs being shipped overseas. But is this really true? Source: D. J. Boudreaux, The Benefits of Free Trade: Addressing the Myths (Washington, DC: Mercatus Center, George Mason University, 2013).

From Smith to the Great Depression Up until the Great Depression of the 1930s, most countries had some degree of protectionism The U.S. enacted the Smoot-Hawley Act (1930): created significant import tariffs on foreign goods Other nations took similar steps and as the depression deepened, world trade fell further

: GATT, Trade Liberalization, and Economic Growth The General Agreement on Tariffs and Trade (GATT) was established in 1947 Multilateral agreement to liberalize trade and gradually eliminate barriers to trade Tariff reduction was spread over eight rounds Very successful in early rounds

: Protectionist Trends Japan’s economic success strained what had been more equal trading patterns Persistent trade deficits by the U.S caused significant problems in some industries and political problems for the government Many countries found that although GATT limited the use of tariffs, there were many other forms of intervention that had the same effect that did not technically violate GATT

The Uruguay Round and the World Trade Organization Uruguay Round emphasized services, intellectual property, and agricultural subsidies Trade issues related to services and intellectual property and agriculture were emphasized Dragged on for seven years The World Trade Organization The WTO encompassed GATT, the General Agreement on Trade in Services (GATS), and the Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPS) Procedures subject to strict time limits The Uruguay Round dragged on for seven years before an agreement was reached on December 15, It went into effect July 1, The Uruguay Round contained the following provisions: Tariffs on industrial goods were to be reduced by more than one-third, and tariffs were to be scrapped on more than 40 percent of manufactured goods. Average tariff rates imposed by developed nations on manufactured goods were to be reduced to less than 4 percent of value, the lowest level in modern history. Agricultural subsidies were to be substantially reduced. GATT fair trade and market access rules were to be extended to cover a wide range of services. GATT rules also were to be extended to provide enhanced protection for patents, copyrights, and trademarks (intellectual property). Barriers on trade in textiles were to be significantly reduced over 10 years. The World Trade Organization was to be created to implement the GATT agreement.

WTO: Experience to Date Members account for 98% of world trade It was hoped that it would emerge as an effective advocate and facilitator of future trade deals So far, most countries have adopted WTO recommendations for trade disputes In general, countries involved in disputes accept WTO recommendations Global telecommunication and financial service industries targeted for reform

The Future of the WTO: Unresolved issues and the Doha Round Anti-dumping actions Encourage members to strengthen the regulations governing the imposition of antidumping duties Protectionism in agriculture Concerned with the high level of tariffs and subsidies in the agricultural sector of many economies Protecting intellectual property Members believe that the protection of intellectual property rights is essential to the international trading system TRIPS obliges WTO members to grant and enforce patents lasting at least 20 years and copyrights lasting 50 years.

Protecting Agriculture
Removing barriers to trade and subsidies in agricultural products should benefit consumers. Source: © Mark Elias/Bloomberg/Getty Images

The Future of the WTO: Unresolved issues and the Doha Round continued Market access for nonagricultural goods and services Tariffs on services remain higher than on industrial goods A new round of talks Doha Have been ongoing since 2001 concerned with cutting tariffs on industrial goods and services, phasing out subsidies to agricultural producers, reducing barriers to cross-border investment, limiting the use of antidumping laws In response to the apparent failure of the Doha Round to progress, many nations have pushed forward with multilateral or bilateral trade agreements, which are reciprocal trade agreements between two or more partners. For example, in 2014 Australia and China entered into a bilateral free trade agreement. Multilateral and bilateral trade agreements are designed to capture gain from trade beyond those agreements currently attainable under WTO treaties.

The Future of the WTO: Unresolved issues and the Doha Round continued Multilateral and Bilateral Trade Agreements Designed to capture gain from trade beyond those agreements currently attainable under WTO treaties Tariff barriers raise the costs of exporting products to a country Quotas may limit a firm’s ability to serve a country from locations outside that country A firm may have to locate more production activities in a given market than it would otherwise. The threat of antidumping action limits the ability of a firm to use aggressive pricing to gain market share in a country Policy Implications In response to the apparent failure of the Doha Round to progress, many nations have pushed forward with multilateral or bilateral trade agreements, which are reciprocal trade agreements between two or more partners. For example, in 2014 Australia and China entered into a bilateral free trade agreement. Multilateral and bilateral trade agreements are designed to capture gain from trade beyond those agreements currently attainable under WTO treaties.

Focus on Managerial Implications 1 of 2
Trade Barriers, Firm Strategy, and Policy implications Trade barriers impact firm strategy Tariff barriers raise the costs of exporting Quotas may limit a firm’s ability to serve a country Firms may need to conform to local content requirements Future trade barriers can influence firm strategy Firms can play a role in promoting free trade or trade barriers

Focus on Managerial Implications 2 of 2
Policy Implications International firms have an incentive to lobby for free trade, and keep protectionist pressures from causing them to have to change strategies Three drawbacks to government intervention Self-defeating as it protects the inefficient Dangerous as it might invite retaliation Unlikely to be well-executed as can be captured by special interest groups

Summary In this chapter we have
Identified the policy instruments used by governments to influence international trade flows. Understood why governments sometimes intervene in international trade. Summarized and explained the arguments against strategic trade policy. Described the development of the world trading system and the current trade issues. Explained the implications for managers of developments in the world trading system.

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