Business-Government Trade Relationships 6-1

No country permits unregulated flow of goods and services across its borders Governments place restrictions on imports and occasionally on exports Governments may provide direct and indirect subsidies to improve the competitive position of some industriesProtectionism Government action intended to limit foreign producer’s ability to compete with domestic industry

Rationale for Government Intervention Preserve national identity Improve position compared to other countries Maintain spheres of influence Promote industrialization Deal with unfriendly countries Protect infant industries Maintain essential industries Prevent unemployment Non-economic Rationale Economic Rationales 6-4

Infant-Industry Argument Government should guarantee an emerging industry a large share of the domestic market until it becomes efficient enough to compete against imports Initial output costs may make products noncompetitive in world markets Over time costs will decrease due to: – –greater economies of scale – –greater worker efficiency

Problems with argument Hard to identify industries with high probability of success – –even when industries can be identified, not clear that government should provide protection Protection may serve as disincentive for managers to adopt innovations needed to become competitive Public funds poorly spent Consumer prices rise

Industrialization Argument Industrialization represents high per capita income Industrialization represents high per capita income Most developing countries try to emulate strategy of developed countries Most developing countries try to emulate strategy of developed countries Surplus workers can more easily increase manufacturing output than agricultural outputSurplus workers can more easily increase manufacturing output than agricultural output Inflows of foreign investment can promote sustainable growthInflows of foreign investment can promote sustainable growth Prices and sales of agricultural products and raw materials fluctuatePrices and sales of agricultural products and raw materials fluctuate 6-5

Industrialization Argument, con’t Markets for industrial products grow faster than markets for agricultural productsMarkets for industrial products grow faster than markets for agricultural products Local industry reduces imports and promotes exportsLocal industry reduces imports and promotes exports Industrial activity helps the nation building processIndustrial activity helps the nation building process 6-6

Economic Motives Potential results Potential results + Global industry created – Firms’ efficiency reduced – Domestic costs increase – Special interests benefit Pursue strategic trade policy Help companies achieve economies of scale and gain a first- mover advantage

Non-economic Rationales for Government Intervention Maintenance of essential industries Maintenance of essential industries Prevention of shipments to unfriendly countries Prevention of shipments to unfriendly countries Maintenance or extension of spheres of influence Maintenance or extension of spheres of influence Protecting activities that preserve national identity Protecting activities that preserve national identity 6-8

Maintaining Essential Industries Protecting domestic industries during peacetime so that country is not dependent on foreign sources of supply during war Popular argument to support import restrictions Countries must –determine which industries are essential –consider costs and alternatives –consider political consequences Dealing with “Unfriendly” countries Prevention of exports that might be acquired by potential enemies May lead to retaliation that prevents securing other essential goods Trade controls on nondefense goods also may be used as a weapon of foreign policy

Maintaining Spheres of Influence Governments may: Provide aid and credits to, and encourage imports from, countries that are political allies Impose trade restrictions to coerce foreign countries to follow certain political actions Preserving Cultures and National Identity Countries have a common sense of identity that separates them from other nationalities May limit foreign products and services to protect their separate identity

Trade Promotion and Restriction Trade promotion methods Trade restriction methods  Subsidies  Export financing  Foreign trade zones  Special government agencies  Tariffs  Quotas  Embargoes  Local content requirements  Administrative delays  Currency controls  Antidumping policy

Instruments of Trade Policy: Subsidies Government payment to a domestic producer Government payment to a domestic producer Cash grantsCash grants Low-interest loansLow-interest loans Tax breaksTax breaks Government equity participation in the companyGovernment equity participation in the company Subsidy revenues are generated from taxes Subsidy revenues are generated from taxes Subsidies encourage over-production, inefficiency and reduced trade Subsidies encourage over-production, inefficiency and reduced trade

Potential results + Increased competitiveness – Encourage inefficient firms – Increased consumer prices – Overuse of resources Subsidies

Subsidies —direct government payments to domestic companies to compensate them for losses incurred from selling abroad –other types of government assistance makes it cheaper or more profitable to sell abroad »potential exporters provided with an array of services –subsidies to overcome market imperfections are least controversial –there is little agreement on what a subsidy is –there has been a recent increase in export-credit assistance Aid and loans —given to other countries with the proviso that the funds be spent in the donor country –repayment insurance for exporters

Export Financing Export-Import Bank of the United States  Working capital loan guarantees  Credit information on nation or firm abroad  Export credit insurance against loss  Loan guarantees to buyers of U.S. goods and much more… Export-Import Bank of the United States  Working capital loan guarantees  Credit information on nation or firm abroad  Export credit insurance against loss  Loan guarantees to buyers of U.S. goods and much more… Financing such as low-interest loans and loan guarantees

 Designated geographic region in which merchandise is allowed to pass through with lower customs duties (taxes) and/or fewer customs procedures  Purpose is to increase employment and trade within the nation Foreign Trade Zones

Special Government Agencies Organize trade missions for officials and businesses Organize trade missions for officials and businesses Operate export-promotion offices at locations abroad Operate export-promotion offices at locations abroad Help import products the home nation does not produce Help import products the home nation does not produce

Instruments of Trade Policy: Tariffs Tariffs are the oldest form of trade policy; they fall into two categories Tariffs are the oldest form of trade policy; they fall into two categories Specific tariffs are levied as a fixed charge for each unitSpecific tariffs are levied as a fixed charge for each unit Ad valorem tariffs are levied as a proportion of the value of the imported goodAd valorem tariffs are levied as a proportion of the value of the imported good Tariffs are good for government because they generate revenue Tariffs are good for government because they generate revenue Tariffs protect domestic producers but they reduce efficiency Tariffs protect domestic producers but they reduce efficiency Tariffs are bad for consumers because they increase the cost of goods Tariffs are bad for consumers because they increase the cost of goods

Tariffs Potential results + Protect domestic firms from competitors + Generate income for the government – Reduce competitiveness of home-based firms – Raise consumer prices  Export tariff  Transit tariff  Import tariff

Import and Export Quotas Restriction on the amount of a good that can enter or leave a country during a certain period of time Import Quotas 1. Protect domestic producers of a good 2. Force outside firms to compete for market access Export Quotas 1. Retain an adequate domestic supply of a product 2. Restrict world supply of a product to raise its price

Embargoes Complete ban on trade (imports and exports) in one or more products with a particular country Can be difficult for a nation to enforce Often used to achieve political goals Most restrictive nontariff trade barrier

Local Content Requirements Laws that domestic producers must supply a specific amount of a good or service Forces international companies to employ local resources (usually labor) in production process

Administrative Delays Regulatory controls or bureaucratic rules to slow imports into a country  Inconvenient ports for imports  Product-damaging inspections  Understaffed customs offices  Lengthy licensing procedures

Currency Controls Restrictions on the convertibility of a nation’s currency Limit the amount of globally accepted currency available to pay for imports Set an unfavorable exchange rate when paying for imports

Instruments of Trade Policy: Antidumping Policies Defined as Defined as Selling goods in a foreign market below production costsSelling goods in a foreign market below production costs Selling goods in a foreign market below fair market valueSelling goods in a foreign market below fair market value Result of Result of Unloading excess productionUnloading excess production Predatory behaviorPredatory behavior Remedy: seek imposition of tariffs Remedy: seek imposition of tariffs

General Agreement on Tariffs and Trade (GATT) Formed in 1947 by 23 countries to abolish quotas and reduce tariffs Formed in 1947 by 23 countries to abolish quotas and reduce tariffs Laid the foundation to liberalize world trade Laid the foundation to liberalize world trade Required members to open markets equally to every other member Required members to open markets equally to every other member However, it could not enforce compliance However, it could not enforce compliance The World Trade Organization replaced GATT in 1995 The World Trade Organization replaced GATT in

World Trade Organization (WTO) 150 current members (>90% of trade) 150 current members (>90% of trade) Adopted the principles and trade agreements of GATT Adopted the principles and trade agreements of GATT Expanded to cover trade in Expanded to cover trade in ServicesServices InvestmentInvestment Intellectual propertyIntellectual property Governments bring charges of unfair trade practices to the WTO Governments bring charges of unfair trade practices to the WTO WTO rulings are binding WTO rulings are binding 6-13

Dealing with Governmental Trade Influences Companies can: Companies can: Move operations to a lower-cost countryMove operations to a lower-cost country Concentrate on markets that attract less international competitionConcentrate on markets that attract less international competition Adopt internal innovationsAdopt internal innovations Increase efficiency Increase efficiency Superior products Superior products Try to get government protectionTry to get government protection 6-14