Chapter 4 part 1(The Political Economy of International Trade)


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  • 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.
    But, while they protect domestic producers but they reduce efficiency, and create higher prices for consumers.
  • Subsidies are government payments to domestic producers. They can be in the form of:
    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.
  • Management Focus: U.S. Magnesium Seeks Protection
    This feature explores the dumping charged levied by U.S. Magnesium against Chinese and Russian producers. According to U.S. Magnesium, the sole American producer of magnesium, Russian and Chinese producers were selling magnesium significantly below market value in an effort to drive U.S. Magnesium out of business. The company failed a complaint with the International Trade Commission (ITC) which ultimately ruled in favor of U.S. Magnesium.
    Suggested Discussion Questions
    1. What is dumping? Were Chinese and Russian producers guilty of dumping? How did U.S. Magnesium justify its claims against Russian and Chinese producers?
    Discussion Points: Dumping is defined as selling goods in a foreign market below their costs of production, or below their fair market value. In 2004, U.S. Magnesium claimed that China and Russia had been dumping magnesium in the United States. The company noted that in 2002 and 2003, magnesium imports rose, and prices fell. While the ITC ruled in favor of the American company, some students might question whether the fact that the Chinese could sell their product at low prices might simply reflect the country’s significantly lower wage rates.
    2. What does the ITC’s ruling mean for American consumers of magnesium? In your opinion, was the ruling fair?
    Discussion Points: The ITC ruled in favor of U.S. Magnesium finding that indeed China and Russia had been dumping their product in the United States. Fines ranging from 50 to 140 percent on imports were imposed against China, and 19 to 22 percent on Russian companies. Most students will note that while the ITC’s decision is a good one for U.S. Magnesium and its employees. For consumers, the ruling means magnesium prices that are significantly higher than those in world markets. Students will probably argue that this result is unfair, and should be revisited.
    Teaching Tip: U.S. Magnesium’s web site is available at {}.
  • The U.S. has use trade policy against countries like Libya, Iran, Iraq, North Korea, and Cuba.
  • Country Focus: Trade in Hormone-Treated Beef
    This feature describes the trade battle between the United States and the European Union over beef from cattle that have been given growth hormones. It outlines the basic issues that led to the dispute, and shows how the World Trade Organization has treated the case.
    Suggested Discussion Questions
    1. Why is the European Union so concerned about beef from cattle that have been given growth hormones?
    Discussion Points: Some students may argue that the European Union’s ban on growth hormones in cattle was little more than a thinly veiled form of protectionism. Australia, New Zealand, and Canada, which also use the hormones in their cattle industry, were also affected by the ban. The European Union claimed that it was merely protecting the health of its citizens, however studies showed that the hormones posed no health issues for people.
    2. Why did the WTO rule against the EU?
    Discussion Points: The World Trade Organization ruled against the European Union stating that the European Union’s ban on imported hormone treated beef had no scientific justification. Even so, the European Union refused to lift the ban, which had strong public support, and in the end, the European Union was assessed punitive tariffs. The European Union held on to its principles though, and as of 2006, continued to maintain its restrictions on hormone treated beef despite the resulting punitive tariffs.
    Teaching Tip: Students can go to the WTO website {} and click on the students icon to see a range of options available to students including the ability to search the site, research countries, and even see a list of internships that are available at the WTO.
  • Oldest argument - Alexander Hamilton, 1792.
    Protected under the WTO.
    Only good if it makes the industry efficient.
    Brazil auto-makers - 10th largest - wilted when protection was eliminated.
    Requires government financial assistance.
    Today if the industry is a good investment, global capital markets would invest.
  • Strategic trade policy suggests that:
    Government should use subsidies to protect promising firms in newly emerging industries with substantial scale economies
    Governments benefit if they support domestic firms to overcome barriers to entry created by existing foreign firms
  • GATT - multilateral agreement established in 1948 under US leadership.
    Objective is to liberalize trade by eliminating tariffs, subsidies, and import quotas.
    Nineteen original members grew to 120.
    Used ‘rounds of talks’ to gradually reduce trade barriers.
    Uruguay Round GATT 1986-93
    Mutual tariff reductions negotiated.
    Dispute resolution only if complaints were received.
  • GATT regulations could be circumvented using voluntary export restraints.
  • The WTO:
    Had 145 members in 2003
    Represents 90% of world trade
    Settles 9 of 10 disputes satisfactorily
    Reduced tariff from 40% to 5%
    Saw trade volume of manufactured goods has increased 20 times
  • Because members believe that the protection of intellectual property rights is an essential element of the international trading system, TRIPS obliges WTO members to grant and enforce patents lasting at least 20 years, and copyrights lasting 50 years.
  • Country Focus: Estimating the Gains from Trade for America
    This feature explores the results of a study by the Institute for International Economics. The study, which estimated the gains to the American economy from free trade, found that America’s 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, America’s 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 {}.
  • Chapter 4 part 1(The Political Economy of International Trade)

    1. 1. International Business 7e by Charles W.L. Hill McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
    2. 2. Chapter 6 The Political Economy of International Trade
    3. 3. 6-3 Agricultural Subsidies & Development  Rich Countries provides $300 billion as SUBSIDIES to farmers in their own countries.  EU has set the price of per ton butter at euros 3,282. If price falls below that then the EU would compensate the farmers in the form of SUBSIDY.  The US provides $0.70 to her farmers for every pound of cotton they harvest.
    4. 4. 6-4 Agricultural Subsidies & Development  This results in surplus production  This surplus is then dumped in the world market.  EU provides $4000 per acre subsidies to sugar beet producers.  EU farmers produce more than the EU market can absorb  The 6 million tons per year is dumped in the world market.  If EU stopped dumping then sugar price would increase by 20%.  This would benefit the South American economy by $ 40 million from sugar exports.
    5. 5. 6-5 Agricultural Subsidies & Development  US cotton subsidies reduced world cotton price by 50% since the mid 90s  This cost Brazil $640 million in lost revenues.  In 2001 , Mali lost $43 in export revenues more than the $37million it received from the US as foreign aid.  An UN official said, “Its no good building up roads, clinics, and infrastructure in poor areas if you do not give them access to markets and engines for growth.”
    6. 6. 6-6 Introduction Free trade occurs when governments do 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
    7. 7. 6-7 Instruments Of Trade Policy The main instruments of trade policy are: Tariffs Subsidies Import Quotas Voluntary Export Restraints Local Content Requirements Administrative Policies Antidumping Policies
    8. 8. 6-8 Tariffs Tariffs are taxes levied on imports that effectively raise the cost of imported products relative to domestic products Specific tariffs are levied as a fixed charge for each unit of a good imported ($3 per barrels of oil) Ad valorem tariffs are levied as a proportion of the value of the imported good (EU tariff on Banana import from Latin America, 15 to 20 % for the first 2.5 million tons) Tariffs increase government revenues, provide protection to domestic producers against foreign competitors by increasing the cost of imported foreign goods, and force consumers to pay more for certain imports So, tariffs are unambiguously pro-producer and anti-consumer, and tariffs reduce the overall efficiency of the world economy
    9. 9. 6-9 Subsidies Subsidies are government payments to domestic producers Consumers typically absorb the costs of subsidies Subsidies help domestic producers in two ways: they help them compete against low-cost foreign imports they help them gain export markets
    10. 10. 6-10 Import Quotas And Voluntary Export Restraints Import quotas directly restrict the quantity of some good that may be imported into a country (US allows only certain firms to import cheese) Tariff rate quotas are 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 restraints are quotas on trade imposed by the exporting country, typically at the request of the importing country’s government (Japanese exports of automobiles to the US in 1981 to 1.68 million.).Countries agree due to avoid more damaging actions. A quota rent is the extra profit that producers make when supply is artificially limited by an import quota (the Japanese gained $1 billion per year from 1981 to 1985) Import quotas and voluntary export restraints benefit domestic producers by limiting import competition, but they raise the prices of imported goods
    11. 11. 6-11 Local Content Requirements A local content requirement demands that some specific fraction of a good be produced domestically Local content requirements benefit domestic producers, but consumers face higher prices.(India enforces this on cement import from Bangladesh)
    12. 12. 6-12 Administrative Policies Administrative trade polices are 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 Netherlands’ export of tulip bulbs to Japan suffered as they were all checked. France required all imported video tape recorders enter though a single small entry point which was poorly staffed.
    13. 13. 6-13 Antidumping Policies Dumping refers to selling goods in a foreign market below their costs of production, or selling goods in a foreign market below their “fair” market value (the US accused EU of dumping Steel) Dumping enables firms to unload excess production in foreign markets Some dumping may be predatory behavior, with producers using substantial profits from their home markets to subsidize prices in a foreign market with a view to driving indigenous competitors out of that market, and later raising prices and earning substantial profits Antidumping polices (or countervailing duties) are designed to punish foreign firms that engage in dumping and protect domestic producers from “unfair” foreign competition. The US imposed 9% and 4% tariffs on two Korean semi conductor exporters.
    14. 14. 6-14 The Case For Government Intervention Arguments for government intervention: Political arguments are concerned with protecting the interests of certain groups within a nation (normally producers), often at the expense of other groups (normally consumers) Economic arguments are typically concerned with boosting the overall wealth of a nation (to the benefit of all, both producers and consumers)
    15. 15. 6-15 Political Arguments For Free Trade Political arguments for government intervention include: protecting jobs protecting industries deemed important for national security retaliating to unfair foreign competition protecting consumers from “dangerous” products furthering the goals of foreign policy protecting the human rights of individuals in exporting countries
    16. 16. 6-16 Protecting Jobs And Industries Protecting jobs and industries is the most common political reason for trade restrictions : Japan imposed Import quotas on Rice to protect jobs in the agricultural sector.) Usually this results from political pressures by unions or industries that are "threatened" by more efficient foreign producers, and have more political clout than the consumers that will eventually pay the costs . (The EU applied CAP or Common Agricultural Policy to protect the politically powerful farmers.)
    17. 17. 6-17 National Security Industries such as aerospace or electronics are often protected because they are deemed important for national security. In 1986 , the US semiconductor manufacturing consortium of 14 companies , SEMATECH, convinced the government that their product was vital to defense industries and so the US could not rely on foreign supplies for these. As a result the government provided $100 million per year as subsidies. It was withdrawn in 1996 only after the rise in demand for personal computers and Intel processors.
    18. 18. 6-18 Retaliation When governments take, or threaten to take, specific actions, other countries may remove trade barriers. The US threatens China to face trade sanctions unless they impose Intellectual Property Laws. This caused the US millions of dollars due to piracy. After threats to impose 100% tariff on certain Chinese imports , China agreed to tighten its implementation of Intellectual property laws. If threatened governments don’t back down, tensions can escalate and new trade barriers may be enacted.
    19. 19. 6-19 Protecting Consumers Governments may intervene in markets to protect consumers. The US banned import of 58 types of assault weapons to avoid incidents of shooting in 1998 after such an incident took place in Arkansas, home state of the then president Bill Clinton, that killed four children and a school teacher. Austria and Luxembourg banned import of Genetically modified cotton seeds by Monsanto as they can cause genetic pollution.
    20. 20. 6-20 Furthering Policy Objectives Foreign policy objectives can be supported through trade policy Preferential trade terms can be granted to countries that a government wants to build strong relations with.(US relations with Israel) Trade policy can also be used to punish rogue states that do not abide by international laws or norms.(US sanctions against Iran) However, it might cause other countries to undermine unilateral trade sanctions The Helms-Burton Act and the D’Amato Act, have been passed to protect American companies from such actions
    21. 21. 6-21 Economic Arguments For Intervention Economic arguments for intervention include: the infant industry argument strategic trade policy
    22. 22. 6-22 The Infant Industry Argument The infant industry argument suggests that an industry should be protected until it can develop and be viable and competitive internationally The infant industry argument has been accepted as a justification for temporary trade restrictions under the WTO However, it can be difficult to gauge when an industry has “grown up” Critics argue that if a country has the potential to develop a viable competitive position its firms should be capable of raising necessary funds without additional support from the government
    23. 23. 6-23 The Infant Industry Argument  Brazil had the 10th largest auto industry in the world with protection for 30 years. But after the protection was removed in the 1980s it turned out to be one of the most inefficient in the world.  But TATA is an example of government protection being fruitful.
    24. 24. 6-24 Strategic Trade Policy Strategic trade policy suggests that in cases where there may be important first mover advantages, governments can help firms from their countries attain these advantages. (US govt. gave substantial R & D grants to Boeing which built the 707 passenger jet following a military plane) Strategic trade policy also suggests that governments can help firms overcome barriers to entry into industries where foreign firms have an initial advantage. (The Japanese government provided research support in the 70s an early 80s to LCD manufacturers who ultimately beat the Americans who entered the market first.)
    25. 25. 6-25 Development Of The World Trading System How has the current world trade system emerged?
    26. 26. 6-26 From Smith To The Great Depression Until the Great Depression of the 1930s, most countries had some degree of protectionism The Smoot-Hawley tariff was enacted in 1930 in the U.S creating significant import tariffs on foreign goods Other nations took similar steps and as the depression deepened, world trade fell further
    27. 27. 6-27 1947-79: GATT, Trade Liberalization, And Economic Growth After WWII, the U.S. and other nations realized the value of freer trade, and established the General Agreement on Tariffs and Trade (GATT) The approach of GATT (a multilateral agreement to liberalize trade) was to gradually eliminate barriers to trade
    28. 28. 6-28 1980-1993: Protectionist Trends In the 1980s and early 1990s, the world trading system was strained Japan’s economic strength and huge trade surplus stressed what had been more equal trading patterns, and Japan’s perceived protectionist (neo-mercantilist) policies created intense political pressures in other countries Persistent trade deficits by the U.S., the world’s largest economy, caused significant economic problems for some industries and political problems for the government Many countries found that although limited by GATT from utilizing tariffs, there were many other more subtle forms of intervention that had the same effects and did not technically violate GATT
    29. 29. 6-29 The Uruguay Round And The World Trade Organization The Uruguay Round of GATT negotiations began in 1986 The talks focused on several areas: Services and Intellectual Property -going beyond manufactured goods to address trade issues related to services and intellectual property, and agriculture The World Trade Organization -it was hoped that enforcement mechanisms would make the WTO a more effective policeman of the global trade rules The WTO encompassed GATT along with two sisters organizations, the General Agreement on Trade in Services (GATS) and the Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPS)
    30. 30. 6-30 WTO: Experience To Date Since its establishment, the WTO has emerged as an effective advocate and facilitator of future trade deals, particularly in such areas as services So far, the WTO’s policing and enforcement mechanisms are having a positive effect Most countries have adopted WTO recommendations for trade disputes
    31. 31. 6-31 WTO: Experience To Date In 1997, 68 countries that account for more than 90% of world telecommunications revenues pledged to open their markets to foreign competition and to abide by common rules for fair competition in telecommunications 102 countries pledged to open to varying degrees their banking, securities, and insurance sectors to foreign competition The agreement covers not just cross-border trade, but also foreign direct investment In 2005 , all the quotas on textile and apparel exports vanished.
    32. 32. 6-32 WTO: Experience To Date The 1999 meeting of the WTO in Seattle was important not only for what happened between the member countries, but also for what occurred outside the building Inside, members failed to agree on how to work toward the reduction of barriers to cross-border trade in agricultural products and cross-border trade and investment in services Outside, the WTO became a magnet for various groups protesting free trade
    33. 33. 6-33 The Future Of The WTO: Unresolved Issues And The Doha Round The WTO is encouraging members to strengthen the regulations governing the imposition of antidumping duties(India , EU and the US benefit from such laws as they account for half of the antidumping cases between 2000-2002) The WTO is concerned with the high level of tariffs and subsidies in the agricultural sector of many economies (Agricultural subsidies cover agricultural costs: 64% in Japan, 49% in EU, 24% in the US, 23% in Canada.)
    34. 34. 6-34 The Future Of The WTO: Unresolved Issues And The Doha Round TRIPS(Trade Related Aspects of Intellectual Property Rights) obliges WTO members to grant and enforce patents lasting at least 20 years and copyrights lasting 50 years The WTO would like to bring down tariff rates on nonagricultural goods and services, and reduce the scope for the selective use of high tariff rates
    35. 35. 6-35 The Future Of The WTO: Unresolved Issues And The Doha Round The WTO launched a new round of talks at Doha, Qatar in 2001 The agenda includes: cutting tariffs on industrial goods and services phasing out subsidies to agricultural producers reducing barriers to cross-border investment limiting the use of anti-dumping laws
    36. 36. 6-36 Implications For Managers Managers need to consider how trade barriers affect the strategy of the firm and the implications of government policy on the firm
    37. 37. 6-37 Trade Barriers And Firm Strategy Trade barriers raise the cost of exporting products to a country Voluntary export restraints (VERs) may limit a firm’s ability to serve a country from locations outside that country To conform to local content requirements, a firm may have to locate more production activities in a given market than it would otherwise.(The Japanese automobile industry setup manufacturing facilities in the 70s and 80s to overcome such barriers) All of these can raise the firm’s costs above the level that could be achieved in a world without trade barriers
    38. 38. 6-38 Policy Implications International firms have an incentive to lobby for free trade, and keep protectionist pressures from causing them to have to change strategies  While there may be short run benefits to having governmental protection in some situations, in the long run these can backfire and other governments can retaliate