BS Chapter 08 Countries and TradePolicies.ppt

International Business
© Oxford Fajar Sdn. Bhd. (008974-T) 2010 Ch. 8: 1
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PART III
Countries and Trade
Policies
8

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LEARNING OBJECTIVES
 To understand the motives for government
intervention in trade
 To explain the instruments of trade policies and
how governments can implement them
 To understand how the instruments of trade
policies will affect countries and international
firms
 To discuss the case for government intervention
in trade policies

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8.1 INTRODUCTION
 In today’s global economy, firms must deal with
both domestic and foreign competitors
 Due to competition, local firms may request
protection or special privileges from the
government
 Exports generate domestic jobs, so
unsurprisingly many national governments
encourage the success of their countries’
domestic firms in international markets

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8.1 INTRODUCTION (cont.)
 A national government may develop trade
policies that begin considering the needs of the
economy and society as a whole
 After assessing these needs, the government
then adopts industry-by-industry policies to
promote the country’s overall economic agenda

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8.2 GOVERNMENT INTERVENTION
IN TRADE
 Governments normally intervene in a nation’s
international trade for reasons such as political,
economic, and socio-cultural factors
Figure 8.1 Reasons for Government Intervention in Trade

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8.2.1 Political Factors – Protecting
Consumers
 Tariffs have long been used as a political tool to
establish a nation’s independence
 The 1789 United States Tariff Act is an early act
designed to achieve political and economic
goals in international trade
 Recently, tariffs have resulted in many political
impacts, both positive and negative
 Tariffs are usually politicized during elections,
particularly in the US and Australia

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Consumers (cont.)
 While developing nations want more government
intervention in international trade to protect their
infant industries, developed nations may intervene
to protect their consumers
 Government intervention in agricultural products,
for example, may be necessary as a protective
measure to ensure a stable supply of food for local
consumers
 The main purpose of health, safety, and sanitation
regulations is to protect domestic agriculture and
consumers from foreign pests, diseases, or
chemical residues

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Consumers (cont.)
 Government intervention in international trade lead
to the establishment of international organizations
regulating international trade, such as the World
Trade Organization
 The United Nations has also set up councils to
monitor activities related to international trade, such
as UNCTAD to regulate trade and its development
 The World Bank and International Monetary Fund
are also international organizations developed due to
government intervention in international trade
 Government intervention has also contributed to the
existence of trading blocs based on locations

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8.2.2 Economic Factors
 Economic factors prompting government
intervention in international trade include
protecting jobs and infant industries, implementing
strategic trade policies, or securing national
economic security
i) Protecting Jobs
 Well-established firms (in high-wage countries),
are often threatened by imports from low-wage
countries
 To maintain existing employment levels, firms and
workers often try to lobby their governments for
assistance from foreign competition

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8.2.2 Economic Factors (cont.)
 Assistance may come in many forms, such as
tariffs, quotas, or other trade barriers
 Perhaps the most recent development of
lobbying for government intervention to protect
jobs is the Confederation of All-India Traders
(CAIT) request to the Indian government for a
National Trade Policy to be drafted especially for
their retail and small enterprises

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ii) Protecting Infant Industries
 In the economic view, government intervention in
international trade protects local infant industries
 By implementing protectionism measures, newly
founded industries will have the support to grow
and develop to stay competitive in the
international economy
 The measures also enable the industries to
become self-sufficient
 In a free market economic system, measures
such as tariffs must be completely eradicated

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 As proposed by economist Ludwig Von Mises, a
free market is defined by four requirements:
private property, a persuasive government, the
dearth of institutional meddling within the system,
and the division of labour
 Although there is some truth in the infant-industry
argument, it must be qualified in several respects:
 Once a protective tariff is put in place, it is very difficult
to remove, even after the infant industry has reached
its maturity level
 It is very hard to find out which industries will have the
required capabilities of accomplishing comparative
advantage potential, and thus merit protection

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 This argument is not applicable for developed or
industrialized nations like the US, Canada, Japan, and
Germany
 Apart from using trade barriers like tariffs, a
developing industry can be protected from intense
competition via other means
 In providing protection to infant industries,
government intervention allows for young
industries to be competitive in international trade

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8.2.2 Economic Factors
iii) Strategic Trade Policies
 Gained importance in international trade since the
1980s
 This policy proposes that the government may
provide required aid to local firms to confine
economic profits from foreign competitors
 Such assistance entails government support for
certain ‘strategic’ industries (such as high-
technology industries) that are important to future
domestic economic growth and that provide
widespread benefits (externalities) to society
(Carbaugh, 2004)

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iv) National Economic Security
 A country’s security may be jeopardized in the
event of an international crisis or war if it is
heavily dependant on foreign suppliers
 To ensure the subsistence of local producers,
tariff protections and other protectionism
measures must be implemented even though
domestic producers are not as efficient
 However, critical industries are always specified
by the conditions and the existing problems
often indicate the critical industry

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 If the term is defined broadly, many industries
may be able to win import protection, and the
argument loses its meaning

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8.2.3 Cultural Factors
 International trade may have a significant impact
on national culture
 For example, in Canada, many nationalists
maintain that Canadian culture is too fragile to
survive without government protection
 The big threat is US cultural imperialism
 Thus, Canada has long maintained some
restrictions on sales of US publications and
textbooks
 By the 1990s, the envelope of Canada’s cultural
protectionism had greatly expanded

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8.2.3 Cultural Factors (cont.)
 The most blatant example was a 1994 law that
levied an 80% tax on American advertisements in
Canadian editions of US magazines, in an effort to
discourage the intrusion of US culture
 Without protection for Canadian media, cultural
nationalists feared that US magazines such as
Sports Illustrated, Times and Business Week would
deprive Canadians of the ability to read about
themselves in Maclean’s and Canadian Business
 Although the tax was eventually abolished due to
US protests, the Canadian government continues to
examine other methods of preserving its culture

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8.3 INSTRUMENTS OF TRADE POLICY
 Nations can impose restrictions that are
considered essential for the benefit of the nation
 This freedom is known as national sovereignty
 National sovereignty enables the government of
a country to establish certain policies regarding
its international trade
 Trade policies refer to the planning or
procedures set up by a government that
determine what and how international trading
can be conducted

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(cont.)
 Trade policies imposed by countries can be
considered as trade barriers, as this is against
the WTO liberalization of trade policy
 These trade policies create obstacles and make
it hard for other countries to trade with that
particular country. Hence, trade policies can
impede the growth of international trade among
nations

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(cont.)
 Trade policies are also sometimes referred to as
trade barriers, which can generally be classified
into tariff and non-tariff barriers
Figure 8.2 Trade Policy Instruments

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8.4 TARIFF BARRIERS
 Tariff
 A tax (duty) enforced on a product when it crosses
national boundaries
 Import tariff
 Tax levied on an imported product
 The most widespread tariff
 Export tariff
 Tax imposed on an exported product
 Less common tariff
 Often used by developing nations

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8.4 TARIFF BARRIERS (cont.)
 A tariff is a tax on goods upon importation. When
a ship reaches a port, a customs officer inspects
the contents and charges tax according to a tariff
formula
 Since the goods cannot be landed until the tax is
paid, it is the easiest tax to collect, and the cost
of collection is considered small
 Traders seeking to evade tariffs are known as
smugglers

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8.4.1 Purpose of Tariffs
i) Protective Tariffs
 Designed to shield import-competing producers
from foreign competition
 Generally not intended to totally prohibit imports
from entering a country
 Place foreign producers at a competitive
disadvantage when selling in the domestic
market

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8.4.1 Purpose of Tariffs (cont.)
ii) Revenue Tariffs
 Imposed for the purpose of generating tax
revenues and may be placed on either exports or
imports
 Over time, tariff revenues have decreased as a
source of government revenue for industrial
nations, including the US
 In 1990, tariff revenues constituted more than 41% of US
government receipts
 Records at the millennium show the figure to be 1%
 However, many developing nations currently rely
on tariffs as a major source of government
revenue

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8.4.2 Types of Tariffs
 Three types of tariffs: specific, ad valorem, and
compound tariffs
i) Specific Tariffs
 Expressed in terms of a fixed amount of money per
physical unit of imported product
 As a fixed monetary duty per unit of the imported
product, a specific tariff is relatively easy to apply
and administer, particularly to standardized
commodities and staple products where the value of
the dutiable goods cannot be easily observed
 A specific tariff has the advantage of providing
domestic producers with more protection during a
business recession, when cheaper products are
purchased

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8.4.2 Types of Tariffs (cont.)
 Specific tariffs thus progressively cushion domestic
producers against foreign competitors who cut their
prices
 The main disadvantage of a specific tariff is that the
degree of protection it affords domestic producers
varies inversely with changes in import prices
 During times of rising import prices, a given specific
tariff loses some of its protective effect
 The higher the price of imported product, the less
effective the specific tariff protective function
 Thus, domestic firms are encouraged to produce
less expensive goods, for which the degree of
protection against imports is higher

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ii) Ad Valorem Tariffs
 Expressed as a fixed percentage of the value of
the imported product
 Ad valorem tariffs usually lend themselves more
satisfactorily to manufactured goods, because they
can be applied to products with a wide range of
grade variations
 As a percentage applied to the value of a product,
an ad valorem tariff can be distinguished in small
differentials in product quality to the extent that
they are reflected in product price

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 Under a system of specific tariffs, the duty would
be the same
 An advantage of an ad valorem tariff is that it
tends to maintain a constant degree of
protection for domestic producers during periods
of changing prices

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 This tariff is similar to a proportional tax in that the
real proportional tax burden or protection does not
change as the tax base changes
 Determination of duties under the ad valorem
principle at first appears to be simple, but in practice
has suffered from administrative complexities
 The main problem is to determine the value of an
imported product, a process referred to as customs
valuation
 Another customs-valuation problem stems from
variations among nations in the methods used to
determine a commodity’s value

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iii) Compound Tariffs
 Compound duties combine both characteristics of
specific and ad valorem tariffs
 Often applied to manufactured products
embodying raw materials that are subject to tariffs
 Thus, the specific portion of the duty neutralizes
the cost disadvantage of domestic manufacturers
due to tariff protection granted to domestic
suppliers of raw materials, and the ad valorem
portion of the duty grants protection to the finished-
goods industry

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8.4.3 Tariffs and Exports
 A tariff causes additional burdens to exporters
and importers
 In protecting import-competing producers, a tariff
leads indirectly to a reduction in domestic exports
 The net outcome of protectionism is to move the
economy toward greater self-sufficiency, with lower
imports and exports
 For domestic workers, the protection of jobs in import-
competing industries comes at the expense of jobs in
other sectors of the economy, including exports
 Although a tariff is intended to help domestic
producers, the economy-wide implications of a tariff
are undesirable toward the export sector

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8.4.3 Tariffs and Exports (cont.)
 Welfare losses due to restrictions in output and
employment in the economy’s export industry may
offset the welfare gains enjoyed by import-
competing producers
 Importers are required to pay duties to the domestic
government upon entering the domestic market,
which is translated as an increase in the cost of
import
– They will try to pass the increased costs to buyers or
end users through price increases

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8.4.3 Tariffs and Exports (cont.)
 There are at least three ways in which the
resulting higher prices of imports injure domestic
exporters:
 Exporters often purchase imported inputs, which are
subject to tariffs
 Tariffs also raise the cost of living by increasing the
price of imports
 Import tariffs have international consequences that
lead to reductions in domestic exports

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8.4.4 Effect of Tariffs on International
Trade
 According to some economic theories, tariffs have a
harmful effect on individual freedom and free market
concepts
 These theories believe that tariffs are unfair toward
consumers and that it is generally disadvantageous
for a country to maintain an inefficient industry
 The principle underlying free trade opposes all types
of tariffs
 The World Trade Organization, WTO, as a regulatory
body of international trade and the main platform for
free trade, intends to abolish or reduce tariffs among
contracting nations involved in international trade

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Trade (cont.)
Figure 8.3 The effects of international trade on the economy

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Trade (cont.)
 Apparently, with or without tariffs, there is no
incentive to buy the imported goods over the
domestic goods, as the price of each is the same
 Only by adjusting available purchasing power
through debt, selling off assets, or new wages from
new forms of domestic production, will the imported
goods be purchased
 In the real world, as more imports replace domestic
goods, they consume a larger fraction of available
domestic wages, moving the graph towards this
view of the model

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8.4.5 Tariffs and Quotas
 Tariffs and quantitative restrictions, commonly
known as import quotas, both serve the
purpose of controlling the number of foreign
products that can enter the domestic market
 There are a few reasons why tariffs are a more
attractive option compared to import quotas
i. Tariffs generate revenue for the government
ii. Import quotas can lead to administrative
corruption
iii. Import quotas are more likely to cause smuggling

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8.4.6 Countervailing Duties
 Countervailing duties (CVDs) are used as a means to restrict
international trade
 They are executed to protect local industries from unfair
competition due to subsidization of imports by the exporting
side, be it the exporting firms’ government or other agencies
 The duty is imposed when the subsidization of the imported
product, in one way or another, hurts the local import
competing producers
 CVD is an ad valorem tariff on an imported good that is
imposed by the importing country to counter the impact of
foreign subsidies
 The purpose of CVDs is merely to counter the advantages
enjoyed by the exporters through the subsidized imports
entering the market

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8.5 NON-TARIFF BARRIERS (NTBs)
 Non-tariff barriers differ from tariff barriers in the
sense that it is in the form of restrictions rather
than taxes as in tariff barriers
 Non-tariff barriers may also hinder international
trading activities, as it would add costs to
exporting and importing activities
 Non-tariff barriers can be in various forms such
quotas, subsidies, and local content
requirements

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8.5.1 Subsidies
 National governments sometimes grant
subsidies (also known as a subvention) to local
producers to help improve their trade position
 By providing domestic firms with a cost
advantage, a subsidy allows them to market their
products at prices lower than their actual cost or
profit considerations
 Governmental subsidies assume a variety of
forms, including outright cash disbursements, tax
concessions, insurance arrangements, and
loans at below-market interest rates (Carbaugh,
2004)

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8.5.1 Subsidies (cont.)
 Subsidies can be regarded as a form of
protectionism or trade barrier by making
domestic goods and services artificially
competitive against imports
 Subsidies may distort markets, and can impose
large economic costs
 Financial assistance in the form of a subsidy
may come from one’s government, but the term
subsidy may also refer to backing granted by
others, such as individuals or non-governmental
institutions, although these would be normally
described as charity

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i) Types of Subsidies
 There are many different ways to classify
subsidies based on purpose for the subsidy, the
recipients of the subsidy, or the source of funds
(government, consumer, general tax revenue,
etc.)
 In economics, one of the primary ways to
classify subsidies is by the means of distributing
the subsidy

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 In economics, a subsidy may nonetheless be
characterized as inefficient relative to no
subsidy; inefficient relative to other means of
producing the same results; ‘second-best’,
implying an inefficient but feasible solution
(contrasted with an efficient but not feasible
ideal), among other possible terminology
 In other cases, a subsidy may be an efficient
means of correcting a market failure
 Subsidies would generally be considered by
economists to be bad, as economics is the study
of efficient use of limited resources

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 Ultimately , the choice to impose a subsidy is a
political choice
ii) Economic Subsidies
 Economics has also explicitly identified a number
of areas where subsidies are entirely justified by
economics, particularly in the area of provision of
public goods
 Direct subsidy – A direct subsidy is the simplest, and
arguably the least frequently used subsidy. It involves
a direct cash transfer to a recipient
 Indirect subsidy – The term covers any form of
subsidy that does not involve a direct transfer

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 Labour subsidy – A labour subsidy is any form of subsidy
where the recipients receive subsidies to pay for labour
costs. Tax deductions imposed on workers in certain
industries are also a part of labour subsidy
 Tax subsidy – A tax subsidy is any form of subsidy where
the recipients receive the benefit through the tax system.
The subsidy can be distributed via tax related channels
such as income tax, profit tax, consumption tax systems,
etc. A tax subsidy may also be exercised through
consumption tax exemption (value added tax or sales tax)
 Perverse subsidies – The term ‘perverse’ is sometimes
applied to a subsidy when it encourages undesirable
outcomes, which largely impose social costs upon the rest
of the society

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 Production subsidy – In certain cases, such as to
encourage the development of a particular industry,
governments may provide direct production subsidies in
terms of cash payments for production of a given good or
service
 Regulatory advantages – A policy can be directly or
indirectly in favour of one industry, company, product, or
class of producer over other means of regulations
 Infrastructure subsidy – An infrastructure subsidy can be
classified as a form of indirect production subsidy,
whereby the provision of infrastructure using public
expenses may effectively be useful for a limited group of
potential users

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 Trade protection (imports) – Measures used to limit
imports from other countries may constitute another form
of hidden subsidy, as consumers of a given imported
product are forced to pay higher prices than they are
supposed to pay without the trade barrier
 Export subsidy (trade promotion) – Various taxes or
other measures are often used to promote exports.
Consequently, this has constituted subsidies to
favoured industries
 Procurement subsidy – Subsidies may occur in this
process by the choice of products consumed, the
producer, the nature of the product itself, and by other
means, including payment of higher-than-market prices
for goods purchased

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 Consumption subsidy – Governments provide
consumption subsidies in a number of ways: by
giving away a good or service, providing use of
government assets, property, or services below the
cost of provision, or by providing economic
incentives (cash subsidies) to purchase or use such
goods

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8.5.2 Import Quotas and Voluntary
Export Restraints
 An import quota is a physical restriction on the
quantity of goods that may be imported during a
specific period
 A global quota is a method used to administer
import activities in the international trade
 When the specified quota of a product has been
filled, further imports of the product will be frozen
 In practice, a global quota is unmanageable
because both domestic importers and foreign
exporters will rush to get their goods shipped into
an importing country before the quotas are filled

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Export Restraints (cont.)
 It is also disadvantageous to products imported
from a distant location because of the longer
transportation period, or by a smaller merchant
to a bigger one, due to the limited trade
connections
 In effort to avoid the problems of a global quota
system, import quotas are normally allotted to
specific countries. This type of quota is known as
a selective quota
 Selective quotas suffer from many of the same
problems as global quotas

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Export Restraints (cont.)
 Another feature of quotas is that their use may
lead to domestic monopoly of production and
higher prices because of limited availability of
the goods
 A voluntary export restraint (VER) is a promise
made by a country in imposing certain
restrictions on its exports of a good to another
country to an agreed amount or percentage of
the affected importing market
 Often this is done to resolve or avoid trade
conflicts with an otherwise friendly trade partner

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8.5.3 Local Content Requirement
 Today, many products, represent worldwide
production
 Domestic manufacturers of these products
purchase resources or perform assembly
functions or production activities outside the
home country
 This practice is known as foreign sourcing
(outsourcing) or production sharing
 Firms have used foreign sourcing to take
advantage of lower production costs offered
abroad, including lower wage rates

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8.5.3 Local Content Requirement (cont.)
 To limit the negative impact of foreign sourcing
practices, certain countries have imposed a local
content requirements policy
 This policy specifies the minimum percentage of
a product’s total production value that must be
produced locally

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8.5.4 Administrative Policies
 Administrative trade policies are bureaucratic rules that
are designed to make it difficult for imports to enter a
country
 This is considered an informal approach used by a
government in creating trade barriers
 These rules have successfully delayed the process of
import activities into a country exercising such rules
 According to the national trade policy of Tanzania,
administrative procedures prevail in developing
economies as a response to hard situations at times of
natural disasters
 Their main impact includes the discouragement of
cross-border trade in grains and other food crops,
timber and livestock in border regions/ districts

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8.5.5 Antidumping Policies
 Antidumping policies are policies designed to
counteract dumping practices
 Governments of foreign markets often use antidumping
policies to protect import competing producers from
unfair competition caused by dumping practices
 Dumping is recognized as a form of international price
discrimination
 It occurs when foreign buyers are charged lower prices
than domestic buyers for an identical product, after
allowing for transportation costs and tariff duties
 Selling in foreign markets at a price below the cost of
production is also considered dumping

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8.5.5 Antidumping Policies (cont.)
 Several aims of exercising dumping are to oust
competitors from the particular markets, to maintain
production in the home market so that the local
product’s price are kept high, and also to unload
excess production to foreign markets
 Numerous methods can be used to measure
whether a product is heavily or lightly dumped
 The main method is based on the price in the
exporter’s domestic market
 When this cannot be used, two alternatives are
available

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 The two alternatives are the price charged by the
exporter in another country, or a calculation based
on the combination of the exporter’s production
costs, other expenses, and normal profit margins
 Anti-dumping measures can only be applied if the
dumping is hurting the industry in the importing
country
 Therefore, a detailed investigation first has to be
conducted according to specified rules
 The investigation must evaluate all appropriate
economic factors that have a position on the state of
the industry in question

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 If the investigation reveals that dumping is taking
place and domestic industries are being hurt, the
exporting company can undertake pertinent actions
such as raising its price to an agreed level in order to
avoid anti-dumping import duty
 Anti-dumping investigations are to be concluded
instantaneously in cases where the authorities
determine that the margin of dumping is
insignificantly small, normally when it is defined as
less than 2% of the export price of the product
 Firms can report to two government agencies when
suspected dumping activities take place

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 The two government agencies are the Commerce
Department and the International Trade Commission
 Countervailing duties are another form of duty
closely related to antidumping duties
 While antidumping duties are imposed to offset
injurious dumping, countervailing duties are
implemented to off set the injurious subsidization

BS Chapter 08 Countries and TradePolicies.ppt

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