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formulation of national trade policies

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1 formulation of national trade policies
chapter 9 formulation of national trade policies

2 Chapter Objectives 1 Present the major arguments in favor of and against governmental intervention in international trade Identify the advantages and disadvantages of adopting an industrial policy Analyze the role of domestic politics in formulating a country’s international trade policies 9-2

3 Chapter Objectives 2 Describe the major tools countries use to restrict trade Specify the techniques countries use to promote international trade Explain how countries protect themselves against unfair trade practices 9-3

4 Issues on Trade Intervention
Should a national government intervene to protect the country’s domestic firms by taxing foreign goods entering the domestic market or constructing other barriers against imports? Should a national government directly help the country’s domestic firms increase their foreign sales through export subsidies, government-to-government negotiations, and guaranteed loan programs? In today’s global economy, many firms benefit from international trade, finding foreign markets a rich source of additional customers. Exports generate domestic jobs, so many national governments promote the success of their countries’ domestic firms in international markets. But at times firms believe that their foreign competitors have gained an unfair advantage as a result of policies adopted by their governments. As a result, as is the case in the commercial aircraft market, a firm may ask its national government for protection against the foreigners. Two principal issues have shaped the debate on appropriate trade policies as indicated by the questions posed in the slide. 9-4

5 Free Trade or Fair Trade?
In North America, the trade policy debate has recently focused on the issue of whether the government should promote “free” trade or “fair” trade. Free trade implies that the national government exerts minimal influence on the exporting and importing decisions of private firms and individuals. Fair trade, sometimes called managed trade, suggests that the national government should actively intervene to ensure that domestic firms’ exports receive an equitable share of foreign markets and that imports are controlled to minimize losses of domestic jobs and market share in specific industries. Some fair traders also argue that the government should ensure a “level playing field” on which foreign and domestic firms can compete on equal terms. Although sounding reasonable, the “level playing field” argument is often used to justify policies that restrict foreign competition. 9-5

6 Industry-Level Arguments
National Defense Infant Industry Maintenance of Existing Jobs Voluntary exchange makes both parties to the transaction better off and allocates resources to their highest valued use. In Adam Smith’s view the welfare of a country and its citizens is best promoted by allowing self-interested individuals, regardless of where they reside, to exchange goods, services, and assets as they see fit. However, many businesspeople, politicians, and policy makers believe that, under certain circumstances, deviations from free trade are appropriate. The next slides review the four industry-level arguments related to free trade policy. Strategic Trade 9-6

7 National Defense Argument
Country must be self-sufficient in critical raw materials, machinery, and technology or else be vulnerable to foreign threats. Appeals to general public Protects steel, electronics, and machine tools industries, and merchant marines National defense has often been used as a reason to support governmental protection of specific industries. Because world events can suddenly turn hostile to a country’s interests, the national defense argument holds that a country must be self-sufficient in critical raw materials, machinery, and technology or else be vulnerable to foreign threats. For instance, the vulnerability of Japan’s supply lines was demonstrated by the extensive damage done to its merchant marine fleet by Allied submarines during World War II. After the war, Japan banned the importation of rice as a means of promoting domestic self-sufficiency in the country’s dietary staple. The national defense argument appeals to the general public, which is concerned that its country will be pushed around by other countries that control critical resources. Many special interest groups have used this politically appealing argument to protect their industries from foreign competition. U.S. industries receiving favorable treatment for national defense reasons include steel, electronics, machine tools, and the merchant marine 9-7

8 Infant Industry Argument
Imposition of tariffs to give U.S. firms temporary protection from foreign competition until firms are fully established Powerful economic development strategy Which industries should be protected? For how long? Alexander Hamilton, the first U.S. secretary of the treasury, articulated the infant industry argument in Hamilton believed that the newly independent country’s infant manufacturing sector possessed a comparative advantage that would ultimately allow it to thrive in international markets. He feared, however, that the young nation’s manufacturers would not survive their infancy and adolescence because of fierce competition from more mature European firms. Hamilton thus fought for the imposition of tariffs on numerous imported manufactured goods to give U.S. firms temporary protection from foreign competition until they could fully establish themselves. Governmental nurturing of domestic industries that will ultimately have a comparative advantage can be a powerful economic development strategy. However, determination of which industries deserve infant industry protection is often done on a political rather than an economic basis. Firms, workers, and shareholders are not shy about using the infant industry argument to bolster support for import protection or export subsidies for their industries. Moreover, once an industry is granted protection, it may be reluctant to give it up. Many infant industries end up being protected well into their old age. 9-8

9 Maintenance of Existing Jobs
Jobs in high-wage countries threatened by imports from low-wage countries Forms of assistance Tariffs Quotas Well-established firms and their workers, particularly in high-wage countries, are often threatened by imports from low-wage countries, as in the case of the U.S. steel industry. To maintain existing employment levels, firms and workers often petition their governments for relief from foreign competition. Government officials, eager to avoid the human and economic misery inflicted on workers and communities when factories are shut down, tend to lend a sympathetic ear to such pleas. Assistance may come in the form of tariffs, quotas, or other barriers. The assistance may be temporary, as was the case when Harley-Davidson received tariff protection from Japanese imports for five years in the mid-1980s to allow the firm to revamp its operations and restore its image in the marketplace. Conversely, the assistance may be long lived, as in the case of governmental protection of the U.S. commercial shipbuilding industry, which has extended that industry’s life by over 30 years. 9-9

10 Strategic Trade Theory
Strategic trade theory suggests that a national government can make its country better off if it adopts trade policies that improve the competitiveness of its domestic firms in such oligopolistic industries. When firms and labor union officials plead for government intervention to help them compete internationally, their efforts are usually criticized by economists, who claim that such intervention ultimately harms the economy. The economists base this claim on the theoretical predictions of the classical trade theories—absolute advantage and comparative advantage. These trade theories, however, assume that firms operate in perfectly competitive markets and that each country’s consumers are able to buy goods and services at the lowest possible prices from the world’s most efficient producers. According to the classical theories, any governmental intervention that denies consumers these buying opportunities will make the country as a whole worse off, although it could make certain groups within the society better off. In the early 1980s, however, new models of international trade—known collectively as strategic trade theory—were developed. These models provide a new theoretical justification for government trade intervention, thereby supporting firms’ requests for protection. Strategic trade theory applies to those industries capable of supporting only a few firms worldwide. A firm can earn monopoly profits if it can succeed in becoming one of the few firms in such a highly concentrated industry. Strategic trade theory suggests that a national government can make its country better off if it adopts trade policies that improve the competitiveness of its domestic firms in such oligopolistic industries. 9-10

11 National Trade Policies
Economic Development Programs Industrial Policy A national government may also develop trade policies that begin by taking an economy-wide perspective. After assessing the needs of the national economy, the government then adopts industry-by-industry policies to promote the country’s overall economic agenda. These three policy approaches will be discussed on the following slides. Public Choice Analysis 9-11

12 Economic Development Programs
Export Promotion Strategy Import Substitution Strategy An important policy goal of many governments, particularly those of developing countries, is economic development. Countries that depend on a single export often choose to diversify their economies to reduce the impact of, say, a bad harvest or falling prices for the dominant export . some countries, such as Japan, Korea, and Taiwan, based their post-World War II economic development on heavy reliance on exports. According to this export promotion strategy, a country encourages firms to compete in foreign markets by harnessing some advantage the country possesses, such as low labor costs. Other countries, such as Australia, Argentina, India, and Brazil, adopted an import substitution strategy after World War II; such a strategy encourages the growth of domestic manufacturing industries by erecting high barriers to imported goods. Many multinational corporations (MNCs) responded by locating production facilities within these countries to avoid the costs resulting from the high barriers. In general, the export promotion strategy has been more successful than the import substitution strategy. 9-12

13 Industrial Policy When industrial policy is pursued, the national government identifies key domestic industries critical to the country’s future economic growth and then formulates programs that promote their competitiveness. Ideally, industrial policy assists a country’s firms in capturing large shares of important, growing global markets, as MITI has done for Japanese multinational corporations (MNCs). Many experts, however, do not view industrial policy as a panacea for improving the global competitiveness of a country’s firms. They argue that government bureaucrats cannot perfectly identify the right industries to favor under such a policy. Opponents of industrial policy also fear that the choice of industries to receive governmental largesse will depend on the domestic political clout of those industries, rather than on their potential international competitiveness. Instead of selecting future winners in the international marketplace, opponents say, industrial policy will become a more sophisticated-sounding version of pork barrel politics. At the heart of the industrial policy debate is the question of what is the proper role of government in a market economy. 9-13

14 Public Choice Analysis
Special interest groups are willing to work harder for the passage of laws favorable to their interests than the general public is willing to work for the defeat of laws unfavorable to its interests. Why do national governments adopt public policies that hinder international business and hurt their own citizenry overall, even though the policies may benefit small groups within their societies? According to public choice analysis, a branch of economics that analyzes public decision making, the special interest will often dominate the general interest on any given issue for a simple reason: Special interest groups are willing to work harder for the passage of laws favorable to their interests than the general public is willing to work for the defeat of laws unfavorable to its interests. According to public choice analysis, domestic trade policies that affect international business stem not from some grandiose vision of a country’s international responsibilities but rather from the mundane interaction of politicians trying to get elected. 9-14

15 Map 9.1 An Effect of the Jones Act
Under the 1920 Jones Act, the United States restricts foreign ships from providing transportation services between U.S. ports. This restriction is supported by owners of U.S. oceangoing vessels, who gain increased profits estimated at $630 million per year. However, the Jones Act is also estimated to increase the transportation costs that consumers pay by $10.5 billion annually, or $40 per person. Further, like other restrictions on free trade, the Jones Act has had unintended consequences, as Map 9.1 ­suggests. Public choice analysis suggests that few consumers will be motivated to learn how the Jones Act impacts them or to write or call their elected officials to save a trivial sum like $40. The special interests, however, such as shipowners and members of U.S. maritime unions, are motivated to know all the ins and outs of the Jones Act and to protect it from repeal because what they gain makes it worth their while to do so. As a result, members of Congress constantly hear from special interest groups about the importance of preserving the Jones Act, while the average consumer is silent on the issue. Knowing that they will be harmed by the special interest groups and will not be rewarded by the general public if they repeal the Jones Act, members of Congress will rationally vote with the special interests on this issue. 9-15

16 Reasons for Tariffs Tariffs raise revenues for national governments
Tariffs act as a barrier to trade 9-16

17 Tariff Barriers to International Trade
Export tariffs Ad valorem Import tariffs A tariff is a tax placed on a good that is traded internationally. Some tariffs are levied on goods as they leave the country (an export tariff) or as they pass through one country bound for another (a transit tariff). Most, however, are collected on imported goods (an import tariff). Three forms of import tariffs exist: An ad valorem tariff is assessed as a percentage of the market value of the imported good. A specific tariff is assessed as a specific dollar amount per unit of weight or other standard measure. A compound tariff has both an ad valorem component and a specific component. Specific Compound 9-17

18 More than 300 workers lost their jobs when this Detroit auto plant closed.

19 Figure 9.3 Impact of an Import Tariff on Demand for U.S.–Made Minivans
Suppose the U.S. government imposes a $2,000 specific tariff on imported minivans. Foreign producers of minivans will be forced to raise their U.S. prices, thereby reducing their U.S. sales. However, foreign-made minivans and U.S.-made minivans are substitute goods. Thus the higher prices of foreign minivans will increase the demand for U.S.-made minivans. This is shown in Figure 9.4 by the shift in the demand for U.S.-made minivans from D to D1, resulting in more domestic vehicles being sold at higher prices. The $2,000 specific tariff creates both gainers and losers. Gainers include GM, Ford, and Chrysler dealerships selling domestic minivans; suppliers to domestic producers; workers at domestic GM, Ford, and Chrysler minivan assembly plants; and the communities in which domestic minivan factories are located. Domestic consumers are losers because they pay higher prices for both domestic and foreign minivans. Foreign producers also lose, as do people and firms that depend on them, including Toyota and Mazda dealerships in the United States, workers and suppliers in Japan, and communities in Japan in which the minivans are manufactured. 9-19

20 Nontariff Barriers Quotas Numerical export controls
Product and testing standards Restricted access to distribution networks Public-sector procurement policies Regulatory controls Currency controls Investment controls Local-purchase requirements Nontariff barriers are the second category of governmental controls on international trade. Any government regulation, policy, or procedure other than a tariff that has the effect of impeding international trade may be labeled a nontariff ­barrier (NTB). Though there are several forms of non-tariff barriers, as indicated in the slide, quotas and numerical export controls deserve special attention. A quota is a numerical limit on the quantity of a good that may be imported into a country during some time period, such as a year. Quotas have traditionally been used to protect politically powerful industries, such as agriculture, automobiles, and textiles, from the threat of competition. A tariff rate quota (TRQ) imposes a low tariff rate on a limited amount of imports of a specific good; above that threshold, a TRQ imposes a prohibitively high tariff rate on the good. A country also may impose quantitative barriers to trade in the form of numerical limits on the amount of a good it will export. A voluntary export restraint (VER) is a promise by a country to limit its exports of a good to another country to a prespecified amount or percentage of the affected market. Often this is done to resolve or avoid trade conflicts with an otherwise friendly trade partner. 9-20

21 Figure 9.4 Tariff Rate Quota on Widgets
A tariff rate quota (TRQ) imposes a low tariff rate on a limited amount of imports of a specific good; above that threshold, a TRQ imposes a prohibitively high tariff rate on the good. This situation is depicted in Figure 9.4, where the first 100,000 widgets imported into a country are subjected to a low tariff rate, TL; all widgets after the first 100,000 are subjected to the high tariff rate, TH. A tariff rate quota imposes high tariff rates on imports above the threshold level. 9-21

22 These Indian sugar cane workers receive less for their crops because of the tariff-rate quota imposed by the U.S. 9-22

23 Forms of Nonquantitative NTBs
Product and testing standards Restricted access to distribution networks Public-sector procurement policies Local-purchase requirements Regulatory controls Currency controls Investment controls International negotiations in the post-World War II era have reduced the use of tariffs and quotas. For this reason, nonquantitative NTBs have now become major impediments to the growth of international trade. These NTBs are more difficult to eliminate than tariffs and quotas because they often are embedded in bureaucratic procedures and are not quickly changeable. 9-23

24 Figure 9.5 Types of Barriers to International Trade

25 Promotion of International Trade
Subsidies Foreign Trade Zones National, state, and local governments often provide economic development incentives—another type of subsidy—to entice firms to locate or expand facilities in their communities to provide jobs and increase local tax bases. These incentives may be in the form of property tax abatements, free land, training of workforces, reduced utility rates, new highway construction, and so on. A foreign trade zone (FTZ) is a geographic area where imported or exported goods receive preferential tariff treatment. FTZs are used by governments worldwide to spur regional economic development. Through utilization of an FTZ, a firm typically can reduce, delay, or sometimes totally eliminate customs duties. Generally, a firm can import a component into an FTZ, process it further, and then export the processed good abroad and avoid paying customs duties on the value of the imported component. The maquiladora system is an example of the use of FTZs. For many big-ticket items such as aircraft, supercomputers, and large construction projects, success or failure in exporting depends on a firm’s producing a high-quality product, providing reliable repair service after the sale, and offering an attractive financing package. Because of the importance of the financing package, most major trading countries have created government-owned agencies to assist their domestic firms in arranging financing of export sales. Export Financing Programs 9-25

26 Map 9.2 Foreign Trade Zone on Mauritius

27 Controlling Unfair Trade Practices
International Trade Administration (ITA) Division of U.S. Department of Commerce Determines whether an unfair trade practice has occurred Confirmed cases transferred to U.S. International Trade Commission (ITC) Two types of unfair trade practices Government subsidies Unfair pricing practices In the United States, complaints from firms affected by alleged unfair trade practices are first investigated by the International Trade Administration (ITA), a division of the U.S. Department of Commerce, which determines whether an unfair trade practice has occurred. The Department of Commerce transfers confirmed cases of unfair trading to the U.S. International Trade Commission (ITC), an independent government agency. If a majority of the six ITC commissioners decide that U.S. producers have suffered “material injury,” the ITC will impose duties on the offending imports to counteract the unfair trade practice. The ITC, like the Canadian International Trade Tribunal and other similar government agencies worldwide, focuses on two types of unfair trade practices: government subsidies that distort trade and unfair pricing practices. 9-27

28 Controlling Unfair Trade Practices
Countervailing Duties Antidumping Regulations Most countries protect local firms from foreign competitors that benefit from subsidies granted by their home governments. A countervailing duty (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 CVD is calculated to just offset the advantage the exporter obtains from the subsidy. In this way, trade can still be driven by the competitive strengths of individual firms and the laws of comparative advantage, rather than by the level of subsidies that governments offer their firms. Many countries are also concerned about their domestic firms being victimized by discriminatory or predatory pricing practices of foreign firms, such as dumping. Dumping can occur when a firm sells its goods in a foreign market at a price below what it charges in its home market. This type of dumping is a form of international price discrimination. The second type of dumping involves the firm’s selling its goods below cost in the foreign market, in which case the dumping is a form of predatory pricing. The concern with predatory pricing is that a foreign company may lower its prices in the host country, drive host country firms out of the market, and then charge monopoly prices to host country consumers once competitors have been eliminated. 9-28

29 Objectives of Unfair Trade Practice Laws
Promote global efficiency by encouraging production in those countries that can produce a good most efficiently Ensure that trade occurs on the basis of comparative advantage, not the size of government subsidies Protect consumers from predatory behavior Many economists argue for abolishing unfair trade practice laws. Advocates of abolishing unfair trade practice laws generally agree with the objectives of these laws, which are stated in the slide. However, abolition advocates assert that in practice these laws do more harm than good. Foreign firms alleged to have dumped goods in the United States must provide comprehensive documentation of their pricing and cost-accounting procedures, in English, using U.S. Generally Accepted Accounting Principles (GAAP). Firms failing to comply with the short deadlines for supplying these documents find themselves at a disadvantage in defending themselves before the International Trade Commission. Moreover, critics of unfair trade practice laws argue that the ITC’s costing methodology is flawed and biased toward finding dumping when none exists. Most major trading countries believe that U.S. enforcement of its unfair trade practice laws is based on politics, not the law, and thus the laws serve as a protectionist trade barrier. Some economists believe the laws make no sense, either in theory or in practice, because of the harm they cause consumers. These economists are skeptical of the predatory pricing argument, contending that decades of economic research have failed to find many real-world examples of such behavior. With regard to international price discrimination or government subsidization, the economists argue that if foreigners are kind enough (or dumb enough) to sell their goods to our country below cost, why should we complain? 9-29

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