1. International Business An Asian PerspectiveBy
Charles W.L. Hill
Chow-Hou Wee
Krishna Udayasankar
Welcome to International Business, An Asian Perspective, by Charles W.L. Hill, Chow-Hou Wee and Krishna Udayasankar

2. The Political Economy of International Trade
Chapter 6
The Political Economy of International Trade
Chapter 6: The Political Economy of International Trade
McGraw-Hill/Irwin
Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

3. What Is The Political Reality Of International Trade?
Free trade occurs when governments do not attempt to restrict what 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
You’ve probably heard of free trade before, but do you know what it means?
Free trade refers to a situation where a government doesn’t attempt to restrict what its citizens can buy from another country or what they can sell to another country.
Many nations today claim to support free trade.
But in reality, most countries are only nominally committed to free trade.
They tend to intervene in international trade to protect the interests of politically important groups.

4. How Do Governments Intervene In Markets?
Governments use various methods to intervene in markets including
Tariffs - taxes levied on imports that effectively raise the cost of imported products relative to domestic products
Specific tariffs - levied as a fixed charge for each unit of a good imported
Ad valorem tariffs - levied as a proportion of the value of the imported good
Tariffs
increase government revenues
force consumers to pay more for certain imports
are pro-producer and anti-consumer
reduce the overall efficiency of the world economy
Countries can intervene in markets in several ways.
Governments can implement tariffs or subsidies, set imports quotas or voluntary export restraints, establish local content requirements or antidumping policies, or use administrative policies to make it more difficult for companies to engage in trade.
Let’s talk about each one.
The oldest and simplest way for governments to intervene in the market is to impose tariffs—and tariffs are the easiest type of trade barrier for the WTO to limit.
In fact, we’ve seen the number of tariffs fall in recent years, while other types of trade barriers have become more common.
A tariff is just a tax levied on imports that effectively raises the cost of imported products relative to domestic products. There are two kinds of tariffs. Specific tariffs are levied as a fixed charge for each unit of a good that’s imported, and ad valorem tariffs are levied as a proportion of the value of the imported good.
Why do governments implement tariffs?
Well, tariffs are beneficial to governments because they increase revenues.
They’re also beneficial to domestic producers because tariffs provide protection against foreign competitors by increasing the cost of imported foreign goods. Of course, this means higher prices for consumers, though.
In 2002 for example, the U.S. steel industry successfully lobbied Congress for protection from foreign imports.
The U.S. put ad valorem tariffs of between 8 and 30 percent on all steel imports.
As a result, the price of steel products in the U.S. rose 30 to 50 percent, hurting not only consumers, but also manufacturers of appliances, cars, and other steel products.
These producers claimed that the tariffs made it difficult to compete in the global market.
Questions were raised as to whether the benefits the tariffs brought to the steel producers were worth the costs to steel consumers.
The tariffs were revoked in 2003 when the WTO ruled that they violated free trade agreements.
In any case, there is general agreement that tariffs are unambiguously pro-producer, and anti-consumer. Tariffs also reduce the overall efficiency of the world economy because they encourage domestic producers to manufacture goods that could be produced more efficiently elsewhere.

5. How Do Governments Intervene In Markets?
Subsidies - government payments to domestic producers
Subsidies help domestic producers
compete against low-cost foreign imports
gain export markets
Consumers typically absorb the costs of subsidies
Import Quotas - restrict the quantity of some good that may be imported into a country
Tariff rate quotas - 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
A quota rent - the extra profit that producers make when supply is artificially limited by an import quota
Subsidies are simply government payments to domestic producers. Governments can give subsidies in various ways including cash grants, low interest loans, and tax breaks.
Subsidies can help domestic producers in two ways. They can help them compete against low cost foreign imports, and they can help them gain export markets.
One of the biggest recipients of subsidies in most countries is agriculture. In the U.S for example, a 2002 bill designated that farmers were to receive $180 billion over 10 years.
Do subsidies help producers be more competitive?
Not really! Instead, they tend to protect inefficient producers and promote excess production.
In fact, one study showed that if developed countries eliminated their agricultural subsidies, we would see an increase in global trade in agricultural products, and a savings of $160 billion! Keep in mind that consumers typically absorb the costs of subsidies.
You can learn more about the effects of subsidies in agriculture in the Country Focus on wheat subsidies in Japan.
Another way to intervene in markets is the import quota which is a direct restriction on the quantity of some good that may be imported into a country. In the U.S. for example, there is a quota on cheese imports.
A tariff rate quota, which is common in agriculture, is 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.
A quota rent is the extra profit that producers make when supply is artificially limited by an import quota.

6. How Do Governments Intervene In Markets?
Voluntary Export Restraints - quotas on trade imposed by the exporting country, typically at the request of the importing country’s government
Import quotas and voluntary export restraints
benefit domestic producers
raise the prices of imported goods
Local Content Requirements - demand that some specific fraction of a good be produced domestically
consumers face higher prices
Voluntary export restraints are quotas on trade imposed by the exporting country, usually at the request of the importing country’s government.
In 1981, Japan established voluntary export restraints for the auto industry.
Why would a country would agree to limit its exports? The answer is because the country believes that if it doesn’t, more damaging restrictions might be implemented!
Japan believed that by setting its own limits it could avoid potentially higher limits that could be set by the U.S.
As a result of the 1981 voluntary export restraints for example, Japanese producers earned an extra $1 billion from the higher prices charged to consumers because of the trade barriers.
Remember that import quotas and voluntary export restraints benefit domestic producers by limiting import competition, but they raise prices of imported goods!
Local content requirements are another form of trade barrier where the government demands that some specific fraction of a good be produced domestically.
Like other types of trade restrictions, local content requirements benefit producers, but not consumers. For example, the Buy America Act requires government agencies to buy American products unless imports are significantly cheaper! Remember in this case that American tax payers are footing the bill!

7. How Do Governments Intervene In Markets?
Administrative Polices - bureaucratic rules designed to make it difficult for imports to enter a country
polices hurt consumers by limiting choice
Antidumping Policies – aka countervailing duties - designed to punish foreign firms that engage in dumping and protect domestic producers from “unfair” foreign competition
dumping - selling goods in a foreign market below their costs of production, or selling goods in a foreign market below their “fair” market value
enables firms to unload excess production in foreign markets
may be predatory behavior - producers use profits from their home markets to subsidize prices in a foreign market to drive competitors out of that market, and later raise prices
Administrative trade policies are bureaucratic rules that are designed to make it difficult for imports to enter a country.
The Japanese are known for this type of trade barrier which can be very frustrating for companies trying to break into the market. FedEx for example, had difficulty expanding into Japan because the Japanese government required that every express package be opened to check for pornographic materials. Since the process can take several days, express packages are always delayed!
As with other trade barriers, these policies hurt consumers by denying access to foreign products that may be superior to what’s available at home.
Finally, let’s talk about antidumping policies. Dumping is defined as selling goods in a foreign market below their cost of production, or as selling goods in a foreign market at below their fair market value.
Dumping is viewed as a method by which firms unload excess production in foreign markets, and some dumping is considered to be predatory behavior where producers use profits from their home markets to subsidize prices in foreign markets with a goal of driving indigenous competitors out of the market, and then later raising prices and earning substantial profits.
To stop this type of behavior, countries implement antidumping policies or countervailing duties which are designed to punish foreign firms that are dumping and protect domestic producers from this type of unfair competition.
You can learn more about how these policies work in the Management Focus on U.S. Magnesium in your text.

8. Why Do Governments Intervene In Markets?
There are two main arguments for government intervention in the market
Political arguments - concerned with protecting the interests of certain groups within a nation (normally producers), often at the expense of other groups (normally consumers)
Economic arguments - concerned with boosting the overall wealth of a nation – benefits both producers and consumers
Why then, if we know from trade theory that free trade is beneficial, do governments intervene in the market?
Governments intervene for political reasons and for economic reasons.
Political arguments are concerned with protecting the interests of certain groups within a nation, normally producers, usually at the expense of other groups like consumers, while economic arguments are typically concerned with boosting the overall wealth of a nation.
Let’s look at each of these more closely beginning with political arguments.

9. What Are The Political Arguments For Government Intervention?
Protecting jobs - the most common political reason for trade restrictions
results from political pressures by unions or industries that are "threatened" by more efficient foreign producers, and have more political clout than consumers
Protecting industries deemed important for national security - industries like aerospace or electronics are often protected because they are deemed important for national security
Retaliating to unfair foreign competition - when governments take, or threaten to take, specific actions, other countries may remove trade barriers
if threatened governments do not back down, tensions can escalate and new trade barriers may be enacted
The main political arguments for government intervention are protecting jobs, protecting industries deemed important for national security, retaliating to unfair foreign competition, protecting consumers from dangerous products, furthering foreign policy goals, and protecting the human rights of individuals in exporting countries.
Let’s look at each one.
The most common political reason for trade restrictions is protecting jobs and industries.
Usually, this is a result of political pressures by unions or industries that are threatened by more efficient foreign producers, and that have more political clout than the consumers who will eventually pay for the intervention.
Recall for example, the tariffs that were placed on steel imports in 2002.
Not only did these tariffs protect U.S. steel workers against more efficient foreign producers, they also helped to curry favor with politically important states President Bush needed to win for his bid for reelection in 2004!
Protecting national security is another common argument for government intervention in the market. Governments claim that it’s sometimes necessary to protect certain industries in case of war.
So, aerospace, or defense-related industries may receive some protection based on this need. In 1986 for example, the U.S. government subsidized Sematech, a major producer of semiconductors, using this argument.
Sometimes governments intervene in markets to retaliate against moves made by other governments.
China has been under fire in recent years for failing to take proper steps against product piracy, and many nations have threatened to implement trade barriers against Chinese products if the practice isn’t stopped. China initially responded to the threats with threats of increasing its own barriers to trade, although it has since backed off.

10. What Are The Political Arguments For Government Intervention?
Protecting consumers from “dangerous” products – limit “unsafe” products
Furthering the goals of foreign policy - preferential trade terms can be granted to countries that a government wants to build strong relations with
trade policy can also be used to punish rogue states
the Helms-Burton Act and the D’Amato Act, have been passed to protect American companies from such actions
Protecting the human rights of individuals in exporting countries – through trade policy actions
the decision to grant China MFN status in 1999 was based on this philosophy
Governments also claim that trade barriers are sometimes necessary to protect consumers.
In the U.S. for example, a ban on imports of certain assault weapons was put in place in 1998.
The European Union has limited imports of hormone treated beef for many years, and as the Country Focus in your text points out, this is a source of a huge conflict between the European Union, and the U.S.
Governments also argue that intervention in the market is necessary to support their foreign policy objectives.
A country might, for example, extend favorable trade terms to a country that it’s trying to build a relationship with, or implement policies designed to punish countries.
You’re probably already familiar with some of the trade embargoes the U.S. maintains against countries like Cuba and North Korea.
Keep in mind however, that just because one country has implemented these embargoes, it doesn’t mean that other countries have. In the case of Cuba for example, other countries like Germany and Canada have stepped in where the U.S. left.
The U.S. passed the Helms-Burton Act in 1996 to try to prevent foreign companies from using assets that were confiscated from American companies during the 1959 revolution, and a similar act, the D’Amato Act, to try to prevent the same thing from happening in Libya and Iran.
So far, these Acts have had little effect because the U.S. really doesn’t have much say in what companies from other countries are doing outside the U.S.
Protecting human rights is another argument used by governments that intervene in the market. The basic idea is that the best way to change human rights practices in a country is to encourage it to trade. This will raise income levels, which generally means that human rights practices improve.
For many years, the U.S. debated annually whether to extend most favored nation status to China which would give China preferential trade terms with the U.S. China gained automatic most favored nation status in 2001 when it joined that World Trade Organization.

11. What Are The Economic Arguments For Government Intervention?
The infant industry argument - an industry should be protected until it can develop and be viable and competitive internationally
accepted as a justification for temporary trade restrictions under the WTO
Question: When is an industry “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
Now, let’s look at the two main economic reasons for government intervention: the infant industry argument, and strategic trade policy.
The infant industry argument which suggests that an industry should be protected until it can develop and be a viable and competitive industry internationally.
One of the problems with this argument though is determining when an industry has grown up enough to stop the government support.
In fact, many people believe that protecting these industries is really no different than sponsoring the development of inefficient industries.

12. What Are The Economic Arguments For Government Intervention?
Strategic trade policy - in cases where there may be important first mover advantages, governments can help firms from their countries attain these advantages
governments can help firms overcome barriers to entry into industries where foreign firms have an initial advantage
Strategic trade policy suggests that in cases where there may be important first mover advantages, governments can help firms achieve these advantages.
So, U.S. support of Boeing in the 1950s and 60s probably helped the company become one of the firms to survive in the industry.
Governments can also intervene in the markets to help domestic firms overcome barriers to entry in industries where foreign firms have an advantage.
This is how Boeing’s chief competitor managed to gain its position in the commercial jet industry.
In 1966, the company had less than 5 percent of the global market, but by 2007, thanks to government subsidies, Airbus had increased its market share to 45 percent!

13. When Should Governments Avoid Using Trade Barriers?
Paul Krugman argues that strategic trade policies aimed at establishing domestic firms in a dominant position in a global industry are beggar-thy-neighbor policies that boost national income at the expense of other countries
countries that attempt to use such policies will probably provoke retaliation
Krugman argues that since special interest groups can influence governments, strategic trade policy is almost certain to be captured by such groups who will distort it to their own ends
When are restrictions on trade inappropriate?
When they involve retaliation and trade wars, or efforts to further domestic policies.
Let’s look at each situation.
First, let’s go back to the question of whether free trade is beneficial for countries.
While many people have argued unequivocally for free trade, recall that new trade theorists argue that there may be justification for intervention.
Paul Krugman, who helped develop new trade theory, argues that strategic trade policies that are designed to establish domestic firms in dominant positions in the global market will probably result in retaliation.
So, in other words, when the European Union provided $15 billion in subsidies to Airbus, the U.S. naturally had to take steps to protect Boeing.
In the end, the subsidies probably canceled each other out, and consumers and taxpayers footed the bill!
Krugman also argues that since special interest groups in a country tend to influence governments that want their support on critical issues, government policies on trade don’t always support national interests.
So, the policies adopted by the European Union to protect consumers from imported agricultural products, probably did nothing more than protect inefficient farmers and politicians who relied on the farm vote, and cause consumers to pay more for food.

14. How Has The Current World Trading System Emerged?
Until the Great Depression of the 1930s, most countries had some degree of protectionism
Smoot-Hawley tariff (1930)
After WWII, the U.S. and other nations realized the value of freer trade
established the General Agreement on Tariffs and Trade (GATT) - a multilateral agreement to liberalize trade
In the 1980s and early 1990s protectionist trends emerged
Japan’s perceived protectionist (neo-mercantilist) policies created intense political pressures in other countries
persistent trade deficits by the U.S
use of non-tariff barriers increased
You may be wondering how has the current world trade system emerged.
Well, Great Britain embraced free trade in the mid 1800s, and for 80 years or so, pushed for free trade around the world, but most countries resisted, preferring instead to maintain some protectionist policies.
When the Great Depression hit, countries responded to the economic chaos by erecting significant trade barriers to keep imported products out, and create jobs at home.
In the U.S., the Smoot-Hawley Act established significant barriers to imports.
At the conclusion of World War II, the U.S. and other developed nations realized that free trade could be beneficial, and set about liberalizing trade by establishing the General Agreement in Trade and Tariffs, or GATT as it was commonly known. GATT was a multilateral agreement designed to gradually eliminate barriers to trade.
During the 1980s and early 1990s, the world trading system became strained, and many countries increased trade barriers.
There were three main reasons for this.
First, Japan became a major factor in the global trading system. The country’s economic strength, and huge trade surplus prompted many countries to implement trade barriers.
Many countries were convinced that Japan was following a neo-mercantilist policy to limit imports and encourage exports!
Second, the world’s largest economy, the U.S. was struggling with persistent trade deficits which resulted in significant problems in some industries like textiles and automobiles.
Foreign producers, especially Japan, were increasing their market share, and the resulting unemployment in the U.S. caused significant pressure on the government to “do something,” and so trade barriers were erected.
Finally, many countries found ways to get around GATT regulations.
So, while tariffs were a clear violation of GATT, other, more subtle forms of intervention were not.
The U.S. for example, forced Japan to voluntarily limit its exports of cars to the U.S., or suffer the consequences of more damaging tariffs.

15. How Has The Current World Trading System Emerged?
The Uruguay Round of GATT negotiations began in 1986 focusing on
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
With protectionism on the rise, a new round of GATT negotiations to reduce trade barriers began in 1986.
This round, called the Uruguay Round, was significant for several reasons.
It went beyond what had been accomplished to that point to include discussion of how to address trade issues related to services and intellectual property, and to trade in agriculture.
It also created the WTO to act as an umbrella organization that encompassed GATT, along with two new organizations, the General Agreement on Trade in Services or GATS, and the Agreement on Trade Related Aspects of Intellectual Property Rights or TRIPS.
The WTO was given enforcement power that was lacking in GATT, and so was expected to be a more powerful organization.

16. How Has The Current World Trading System Emerged?
The WTO encompassed GATT along with two sisters organizations
the General Agreement on Trade in Services (GATS)
the Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPS)
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
How is the WTO doing?
So far, the WTO appears to be successful at its goals. In 2009, it had 153 members.
The additional enforcement powers that were given to the WTO seem to be working.
Most countries that have been involved in disputes have accepted WTO recommendations, demonstrating confidence in the organization’s dispute resolution process.

17. What Is The Future Of The World Trade Organization?
The WTO has become a magnet for various groups protesting free trade
The current agenda of the WTO focuses on
the rise of anti-dumping policies
the high level of protectionism in agriculture
the lack of strong protection for intellectual property rights in many nations
continued high tariffs on nonagricultural goods and services in many nations
Where is the WTO going?
Well, a defining moment for the WTO occurred at a 1999 meeting focusing on reducing trade barriers in agriculture. The talks fell apart when the U.S. and the EU failed to reach an agreement over subsidies to exporters of farm products, and the U.S. was accused of unfair tactics by developing countries.
Perhaps more important though, were the events taking place outside the meeting which had become a magnet for various groups protesting free trade.
Marches were held in the streets, property was damaged and looted when the demonstrations became violent, and the issues surrounding free trade became the focus of the global media.
Further efforts to liberalize trade will now be part of mainstream life.
In countries like the U.S. where public opinion is influential, the success of free trade efforts will depend on how well the public can be convinced of the merits of making the required changes.
So today, the WTO is focusing on a number of key issues including the rise of anti-dumping policies, the high level of protectionism in agriculture, the lack of strong protection for intellectual property rights in many nations, and the high tariffs on nonagricultural goods and services in that persist in many nations.

18. What Is The Future Of The World Trade Organization?
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
In 2001, the WTO began a new round of talks in Doha, Qatar.
Issues on the table at this round of meetings include cutting tariffs and industrial goods and services, phasing out subsidies to agricultural producers, reducing barriers to cross-border investment, and limiting the use of anti-dumping laws.

19. What Do Trade Barriers Mean For Managers?
Managers need to consider how trade barriers affect the strategy of the firm and the implications of government policy on the firm
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
Managers have an incentive to lobby for free trade, and keep protectionist pressures from causing them to have to change strategies
What are the implications of all of this for managers?
Well, you already know that trade barriers raise the cost of exporting to another country, and that voluntary export restraints also limit a company’s ability to sell its product.
Firms may also find that they have to revise their production plans if they are affected by local content requirements.
Keep in mind too, that the focus on anti-dumping limits the ability of a company to use aggressive pricing to gain market share.
It’s important for international businesses to think carefully about their strategies toward free trade.
If they lobby for protection, how will this affect the future?
Are there likely to be retaliatory moves that could ultimately make a firm less competitive rather than more competitive?
Do firms actually have an incentive to lobby for free trade?

20. Review Question When tariffs are levied as a fixed charge for
each unit of a good imported, they are called
a) Specific tariffs
b) Ad valorem tariffs
c) Tariff rate quotas
d) Transit tariffs
Now, let’s see how well you understand the material in this chapter. I’ll ask you a few questions. See if you can get them right. Ready?
When tariffs are levied as a fixed charge for each unit of a good imported, they are called
a) Specific tariffs
b) Ad valorem tariffs
c) Tariff rate quotas
d) Transit tariffs
The answer is a.

21. Review Question
A ________ demands that some specific fraction of a good be produced domestically
a) subsidy
b) quota rent
c) voluntary export requirement
d) local content requirement
A ________ demands that some specific fraction of a good be produced domestically
a) subsidy
b) quota rent
c) voluntary export requirement
d) local content requirement
The answer is d.

22. Review Question Which of the following is not a political argument for
government intervention?
a) protecting jobs
b) protecting infant industries
c) protecting industries deemed important for national security
d) protecting consumers from “dangerous” products
Which of the following is not a political argument for government intervention?
a) protecting jobs
b) protecting infant industries
c) protecting industries deemed important for national security
d) protecting consumers from “dangerous” products
The answer is b.

23. Review Question What is the most common political reason for trade
barriers?
a) To protect infant industries
b) Strategic trade policy
c) To protect jobs
d) To protect industries that are important for national security
All of the following except _____ are key issues on the table at the Doha Round.
a) Anti-dumping policies
b) Protectionism in agriculture
c) Intellectual property rights
d) Infant industry protection
The answer is d.

24. Review Question Which theory suggests that in cases where there may
be important first mover advantages, governments
can help firms from their countries attain these
advantages?
a) The infant industry argument
b) Strategic trade theory
c) Comparative advantage theory
d) The Leontief paradox
Which theory suggests that in cases where there may be important first mover advantages, governments can help firms from their countries attain these advantages?
a) The infant industry argument
b) Strategic trade theory
c) Comparative advantage theory
d) The Leontief paradox
The answer is b.

25. Review Question All of the following except _____ are key issues
on the table at the Doha Round.
a) Anti-dumping policies
b) Protectionism in agriculture
c) Intellectual property rights
d) Infant industry protection
What is the most common political reason for trade barriers?
a) To protect infant industries
b) Strategic trade policy
c) To protect jobs
d) To protect industries that are important for national security
The answer is c.