1. The Political Economy of International Trade
Chapter 6
The Political Economy of International Trade

2. Learning Objectives
If Free Trade is an ideal, then why do countries resort to protective measures?
What kinds of trade barriers do countries create?
What are the implications of trade barriers for business strategy?

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.

4. Chapter 5 Instruments of Trade Policy 1. Tariffs 2. Subsidies
A tax on imports
Government gains tariff revenues
Domestic producers are the winners
(Infant Industry Argument)
Consumers pay higher prices
Inefficient utilization of resources
2. Subsidies
A government payment to a domestic producer, cash grants, tax incentives, low interest loans, etc.
Increases international competitiveness
Government imposes taxes to finance subsidies
Raises concerns about trade practices (ex. Boeing-Airbus)

5. Instruments of Trade Policy (cont)
3. Quotas &Voluntary Export Restraints (VER)
Quotas-direct restrictions on the quantity imported from a
country
VER-Quota on trade imposed by the exporting country, typically at the request of importing country
Ex imports of vehicles per year by Japan (1981)
4. Local Content Requirements
Some specific fraction of a good to be produced domestically
Ex. U.S. insists 75% of the car component parts that go into cars built in the U.S.
Domestic producers benefit
Employment

6. Instruments of Trade Policy (cont)
5. Anti-dumping Policies
selling goods in foreign markets at below their cost of production or below their “fair” market value
subsidize prices in foreign markets with high profits in home markets
unload excess production
gain market share
gain profits when firm can raise prices
6. Administrative Policies
Bureaucratic Practices
Inspection
Delays
Poor Staffing
Custom Requirements

7. Effect of Tariffs Price Quantity World S D P1 P2 Pt Q2 Q4 Q5 Q3 c d e

8. Why Protection? 1. Protecting Jobs
Labor unions against export of jobs due to globalization and free trade.
2. Protecting Consumers
Consumer safety, health dangers of imported goods. Ban on hormone-treated beef by the E.U.
3. Environmental Protection
Ban on shrimp imports by the U.S. due to the loss of sea turtles (endangered species)
#2 and #3 are limits of domestic laws extended to international trade

9. Why Protection? (cont) 4. Retaliation
Fear of retaliation in terms of embargo or trade barriers
5. Protection of Human Rights
Granting of MFN status to China could be tied to a better record of protection of human rights
6. National Security
Industries of strategic national importance-defense, broadcasting, semiconductors are protected by the government
7. Nationalism
Japan-Isolation Era, India

10. Economic Arguments 1. Infant Industry Argument
Head start for the industries to develop competitiveness against foreign firms
2. To deal with unequal distribution of income.
Liberalization, Free trade generates economic growth and efficiency (survival of the fittest) but in many cases, results in unequal distribution of income within a country or between the countries.
Protective measures may be required to provide more benefits to poor, developing nations.
GATT, WTO monitor the world trading system, advance free trade and fair trading practices.

11. Implications for Business
1. Trade barriers constraint a firm’s ability to disperse its productive activities abroad.
Tariffs raise the cost of exporting and reduce competitiveness. A firm may decide to set up a facility abroad rather than exporting even though it may be inefficient.
2. Bypassing quota requirements by exporting from other locations.
3. Local content requirements may affect a firm’s strategy and may result in a sub-optimal decision.