1. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. Chapter 7 Commercial Policy

2. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-2 Chapter Objectives Examine the dollar cost of the effects of tariffs and quotas in the European Union, U.S. and Japan in the agriculture, clothing, and textile industries Analyze the most common reasons for countries to protect certain industries Discuss the mechanisms used to provide protection

3. Introduction: Commercial Policy and Jobs This chapter examines the dollar value of the effects of tariffs and quotas in the European Union (EU), Japan, and the United States It is important to compare the costs and benefits of trade barriers and examine the most common reasons given for protecting specific industries Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-3

4. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-4 Protection in the European Union, Japan, and the United States Since the end of WWII, average tariff rates around the world have fallen substantially By 2002, average nominal rates were 3.9% in US, 3.3% in Japan, 4.4% in EU However, all nations have higher levels of protection in particular industries they deem sensitive In addition to tariffs and quotas, many countries provide generous subsidies to some of their agricultural producers, particularly among developed nations

5. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-5 Direct Costs and Jobs Saved in Agriculture, Clothing, and Textiles Since the phase in of the Uruguay Round tariff cuts, average tariffs have fallen 40%but few sectors are average For example, agriculture, clothing and textiles experience much smaller reductions in tariffs and quotas (12%, 14%, 14% respectively) In addition, all of these sectors in the EU, Japan, and US have significant non-tariff barriers applied to them including large government subsidies in the case of agriculture

6. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-6 TABLE 7.1 EU, Japanese, and U.S. Protection in Three Sectors (Mid-1990s, Millions of US$)

7. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-7 TABLE 7.1 (continued) EU, Japanese, and U.S. Protection in Three Sectors (Mid-1990s, Millions of US$)

8. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-8 TABLE 7.2 Jobs Saved through Tariffs and Quotas

9. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-9 TABLE 7.2 (continued) Jobs Saved through Tariffs and Quotas

10. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-10 Direct Costs and Jobs Saved in Agriculture, Clothing, and Textiles (cont.) Trade policy is a grossly inefficient mechanism to create jobs –It is a non-transparent job-creation program –It relies on too many intervening variables, and does not go directly to the heart of the problem –If job creation is the goal, tariffs and quotas are very expensive -Better job-creation tools: (1) sound macroeconomic polices and (2) flexible labor markets

11. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-11 The Logic of Collective Action Given that the costs of tariffs and quotas are high to consumers, why do consumers tolerate them? Mancur Olson´s Logic of Collective Action –The costs of tariffs and quotas are borne by a great many people: everyone pays a little for protection –The benefits of protection is concentrated in a few industries: few benefit a lot from protection –Thus, there is an asymmetry in the incentives to oppose the policy: those benefiting from protection have much greater incentives than those hurt by it to lobby for it

12. Table 7.3 Agricultural Subsidies, 2007 Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-12

13. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-13 Why Nations Protect Their Industries: The Labor Argument The Labor Argument: Protection must be used against imports from countries where wages are much lower -Problem: Does not consider differences in productivity between different workforces: As productivity rises, so will wages

14. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-14 Why Nations Protect Their Industries: The Infant Industry Argument Infant Industry Argument: Developing countries have nascent industries that must be protected against competition from industrial countries -Assumes: (1) market forces do not allow for the development of a certain industry and (2) the industry has positive externalitiesspillover benefits (valuable linkages to other industries or technologies) -Problems: (1) may increase inefficiency and result in negative linkage effects and (2) technological externalities are difficult to measurewhich industries should be protected?

15. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-15 Why Nations Protect Their Industries: The National Security Argument National Security Argument: Certain industries must be protected in order to guard national security (military security, cultural values) -Problems: (1) Vital mineral resources, for example, can be purchased cheaply abroad during peacetime; and (2) how to assess the effects of, say, U.S. television programs on Canadian culture?

16. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-16 Why Nations Protect Their Industries: The Retaliation Argument Retaliation Argument: Another country's trade barriers must be countered with trade barriers -Problems: Although retaliation can provide an incentive for trade negotiations, it can also lead to escalating trade wars

17. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-17 The Politics of Protection in the United States Protectionist pressures have increased in the U.S. –Political reforms: reduced Congresss past insulation from industry lobbyists –The end of the Cold War: reduced U.S. willingness to sacrifice domestic political considerations for geopolitical alliances –The rise of the newly industrialized countries (NICs): increased competitive pressures on U.S. industries –The growth of the U.S. trade deficit in the 1980s: spurred fears of the loss of competitiveness

18. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-18 The Politics of Protection in the United States: Main Mechanisms Protection is obtained through (1) direct action by the president (e.g., VERs) or (2) four types of legal procedures –Countervailing duties –Antidumping duties –Escape clause relief –Section 301 retaliation

19. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-19 The Politics of Protection in the United States: Main Mechanisms (cont.) In the case of these four legal procedures, a firm or industry petitions the federal government to initiate an investigation into foreign country or foreign firm practices Let's analyze each of the four procedures in greater detail…

20. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-20 Countervailing Duties Countervailing duty: A tariff that is granted to a U.S. industry that has been hurt by a foreign countrys subsidizing its firms –Subsidies allow foreign firms to sell their products at lower prices; countervailing duty seeks to counter the effect of the subsidy –Problem: defining subsidy is subjective –Uruguay Round defined subsidies as (1) a direct loan or transfer, (2) preferential tax treatment, (3) the supply of goods or services other than general infrastructure, or (4) income and price supports

21. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-21 Antidumping Duties Antidumping duty: a tariff levied on an import that is selling at a price below the products fair value -Problem: Defining fair value is subjective; antidumping duties are thus a source of tension between countries

22. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-22 Antidumping Duties (cont.) According to the WTO: Dumping occurs when an exporter sells a product at a price below the one it charges in its home market -Problem: Comparing domestic and foreign market prices is difficult due to differences in the price of transportation, wholesale, and other add-ons

23. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-23 Antidumping Duties (cont.) There are three methods to determine whether a good is being dumped: 1.Comparing the price in third-country markets 2.Estimating the cost of production 3.Estimating the foreign firms production costs (dumping occurs if the foreign firm is not selling at a price that provides a normal rate of return on invested capital)

24. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-24 Antidumping Duties (cont.) In order for antidumping duties to be allowed, the country claiming dumping must show that the dumping has caused material injury to its firms -If dumping occurs without material injury, antidumping duty is not allowed

25. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-25 Antidumping Duties (cont.) Problems: Economic theory and legal definitions are not in agreement –If a firm is not earning above average profits somewhere, it cannot maintain a price somewhere else that is below the cost –Firms often sell below costs May sell at below costs in order to penetrate a market May go for extended periods selling at prices that do not cover fixed costs as long as the costs of variable inputs (labor and materials) are covered

26. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-26 Antidumping Investigation U.S. firms can initiate antidumping actions by filing a petition with the International Trade Administration (ITA) in the Department of Commerce If ITA finds dumping (or subsidization in the case of countervailing duty) occurred, the U.S. International Trade Commission (USITC) conducts an additional investigation to determine whether the dumping has posed substantial harm to the domestic industry The relative success of U.S. firms in proving foreign dumping has induced a growing number of firms to file petitions with ITA

27. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-27 Escape Clause Relief Escape clause relief: Temporary tariff on imports to allow a domestic industry to escape the pressure of imports and thus obtain a period of adjustment –Refers to a clause in the U.S. and GATT trade rules –Initiated when a firm or industry petitions the USTIC directly for relief from a surge of imports –The petitioning firm or industry must show that it has been harmed by imports and not some other factor (e.g., poor management)

28. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-28 Section 301 and Special 301 Section 301: A section of the U.S. 1974 Trade Act that requires the U.S. Trade Representative (USTR) to take action against any nation that persistently engages in unfair trade practices –U.S. defines the meaning of unreasonable and unfair trade practices –Action is launched by a request for negotiations with the country in question

29. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-29 Section 301 and Special 301 (cont.) Special 301: Requires the USTR to monitor property rights enforcement around the world -In 2005, the USTR surveyed 90 countries and identified 52 as lacking adequate enforce or denying market access

30. Table 7.4 Economic Sanctions since World War I Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-30

31. Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-31