fms trade theories ppt 1
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International Business Theories
Chapter Six
International Trade and FactorMobility Theory
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Laissez-Faire versus Interventionist Approaches
to Exports & Imports
• Interventionist:
– Mercantilism
– Neo-mercantilism
• Free-trade theories:
– Absolute advantage
– Comparative advantage
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Theories of Trade Patterns
• Explaining trade patterns:
– Country size
– Factor proportions
– Country similarity
• Trade competitiveness:
– Product life cycle theory
– Porter diamond
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What the major trade theories Do and Don’t
discuss
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Theory of Absolute Advantage
• Suggests specialization through free trade
because consumers will be better off if they
can buy foreign-made products that are priced
more cheaply than domestic ones
• A country may produce goods more efficiently
because of a natural advantage or because of
an acquired advantage
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Theory of Comparative Advantage
• Also proposes specialization through free
trade because it says that total global output
can increase even if one country has an
absolute advantage in the production of allproducts
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Theories of Specialization
• Both absolute and comparative advantage theoriesare based on specialization
• Assumptions policymakers question: – full employment
– economic efficiency – division of gains
– transport costs
– statics and dynamics
– services – production networks
– mobility
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Trade Pattern Theories
• How much a country will depend on trade if it
follows a free trade policy
• What types of products countries will export
and import
• With which partners countries will primarily
trade
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Theory Of Country Size
• Countries with large land areas are apt to havevaried climates and natural resources
• They are generally more self-sufficient than
smaller countries are• Large countries’ production and market
centers are more likely to be located at a
greater distance from other countries, raisingthe transport costs of foreign trade
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Country-similarity Theory
• Most trade today occurs among high-income
countries because they share similar market
segments and because they produce and consume so
much more than emerging economies• Much of the pattern of two-way trading partners
may be explained by cultural similarity between the
countries, political and economic agreements, and by
the distance between them
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Product Life Cycle (PLC) Theory
• Companies will manufacture products first in
the countries in which they were researched
and developed, almost always developed
countries
• Over the product’s life cycle, production will
shift to foreign locations, especially to
developing economies as the product reachesthe stages of maturity and decline
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Life Cycle of the International Product
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The Porter Diamond
• Four conditions as important for competitive
superiority:
– demand conditions
– factor conditions
– related and supporting industries
– firm strategy, structure, and rivalry
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Limitations of the Porter Diamond Theory
• Production factors and finished goods are
only partially mobile internationally
• The cost and feasibility of transferring
production factors rather than exporting
finished goods internationally will determine
which alternative is better
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The Relationship between Trade and Factor
Mobility
• Capital and labor move internationally to gain
more income and flee adverse political
situations
• Although international mobility of production
factors may be a substitute for trade, the
mobility may stimulate trade through sales of
components, equipment, and complementaryproducts
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Theories & Current Practices of International
Trade:
The Ricardian Model: Labour Productivity &Comparative Advantage
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• Theories of why trade occurs:
– Differences across countries in labor, labor skills,
physical capital, natural resources, and
technology
– Economies of scale (larger scale of production is
more efficient)
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• Sources of differences across countries that
lead to gains from trade:
– The Ricardian model examines differences in the productivity of labor (due to differences in
technology) between countries.
– The Heckscher-Ohlin model examines differences
in labor, labor skills, physical capital, land, or
other factors of production between countries.
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Comparative Advantage and
Opportunity Cost• The Ricardian model uses the concepts of
opportunity cost and comparative advantage.
• The opportunity cost of producing somethingmeasures the cost of not being able to
produce something else with the resources
used.
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• For example, a limited number of workers
could produce either roses or computers.
– The opportunity cost of producing computers is
the amount of roses not produced.
– The opportunity cost of producing roses is the
amount of computers not produced.
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• Suppose that in the U.S. 10 million roses could
be produced with the same resources that
could produce 100,000 computers.
• Suppose that in Colombia 10 million rosescould be produced with the same resources
that could produce 30,000 computers.
• Workers in Columbia would be less productivethan those in the U.S. in manufacturing
computers.
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• Colombia has a lower opportunity cost of
producing roses.
– Colombia can produce 10 million roses, comparedto 30,000 computers that it could otherwise
produce.
– The U.S. can produce 10 million roses, comparedto 100,000 computers that it could otherwise
produce.
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• The U.S. has a lower opportunity cost of producing computers.
– Colombia can produce 30,000 computers, compared to 10 million rosesthat it could otherwise produce.
– The U.S. can produce 100,000 computers, compared to 10 million rosesthat it could otherwise produce.
– The U.S. can produce 30,000 computers, compared to 3.3 million rosesthat it could otherwise produce.
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• A country has a comparative advantage inproducing a good if the opportunity cost of
producing that good is lower in the country
than in other countries.
– The U.S. has a comparative advantage in
computer production.
– Colombia has a comparative advantage in roseproduction.
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• Suppose initially that Colombia produces
computers and the U.S. produces roses, andthat both countries want to consume
computers and roses.
• Can both countries be made better off?
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Comparative Advantage and Trade
• When countries specialize in production in which they have a
comparative advantage, more goods and services can be
produced and consumed.
– Have U.S. stop growing roses and use those resources to make
100,000 computers instead. Have Colombia stop making 30,000computers and grow roses instead.
– If produce goods in which have a comparative advantage (U.S.
produces computers and Colombia roses), they could still consume the
same 10 million roses, but could consume 100,000 – 30,000 = 70,000
more computers.
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One-Factor Ricardian Model
• The simple example with roses and computers
explains the intuition behind the Ricardianmodel.
• Constructing a one-factor Ricardian model
using the following assumptions:
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The assumptions are:
1 Labor is the only factor of production.2. Labor productivity varies across countries
due to differences in technology, but laborproductivity in each country is constant.
3. The supply of labor in each country isconstant.
4. There is no transport cost
5. There is full employment
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6. Two are only two countries & two goods.7. International trade is free from all barriers.
8. Goods are exchanged against one another
according to the relative amounts of laborembodied in them
9. Production is subject to the law of constantreturns
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Therefore, What is the Gains From
Trade?
• Gains from trade come from specializing in
the type of production which uses resources
most efficiently, and using the incomegenerated from that production to buy the
goods and services that countries desire.
– where “using resources most efficiently” means
producing a good in which a country has a
comparative advantage.
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• Without trade, a country has to allocate
resources to produce all of the goods that it
wants to consume.
• With trade, a country can specialize its
production and exchange for the mix of
goods that it wants to consume.
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• Consumption possibilities expand beyond theproduction possibility frontier when trade isallowed.
• With trade, consumption in each country isexpanded because world production isexpanded when each country specializes in
producing the good in which it has acomparative advantage.
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What are Relative Wages?
• Relative wages are the wages of the home country relative tothe wages in the foreign country.
• Productivity (technological) differences determine relativewage differences across countries.
• The home wage relative to the foreign wage will settle inbetween the ratio of how much better Home is at makingcheese and how much better it is at making wine compared toForeign.
• Relative wages cause Home to have a cost advantage in onlycheese and Foreign to have a cost advantage in only wine.
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Do Wages Reflect Productivity?
• Do relative wages reflect relative
productivities of the two countries?
• Evidence shows that low wages are associatedwith low productivity.
– Wage of most countries relative to the U.S. is
similar to their productivity relative to the U.S.
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• Other evidence shows that wages rise asproductivity rises.
– For example in 1975, wages in South Korea wereonly 5% of those of the United States.
– However, as South Korea’s labor productivity rose(to about half of the U.S. level by 2007), so did itswages (which were more than half of U.S. levels
by 2007).
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However, there are certain Miscon-
ceptions about Comparative
Advantage?1. Free trade is beneficial only if a country is more productive
than foreign countries.
– But even an unproductive country benefits from free trade by avoiding
the high costs for goods that it would otherwise have to producedomestically.
– High costs derive from inefficient use of resources.
– The benefits of free trade do not depend on absolute advantage,rather they depend on comparative advantage: specializing inindustries that use resources most efficiently.
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2. Free trade with countries that pay low wages hurts highwage countries.
– While trade may reduce wages for some workers, thereby affectingthe distribution of income within a country, trade benefits
consumers and other workers.
– Consumers benefit because they can purchase goods more cheaply.
– Producers/workers benefit by earning a higher income in theindustries that use resources more efficiently, allowing them to earnhigher prices and wages.
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3. Free trade exploits less productive countries.
– While labor standards in some countries are less than exemplary
compared to Western standards, they are so with or without trade.
– Are high wages and safe labor practices alternatives to trade?
Deeper poverty and exploitation may result without export
production.
– Consumers benefit from free trade by having access to cheaply
(efficiently) produced goods.
– Producers/workers benefit from having higher profits/wages—
higher compared to the alternative.
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Comparative Advantages with many
goods• If each country specializes in goods that use resources
productively and trades the products for those that it wantsto consume, then each benefits. – If a country tries to produce all goods for itself, resources
are “wasted”.
• The home country has high productivity in apples, bananas,and caviar that give it a cost advantage, despite its high wage.
• The foreign country has low wages that give it a costadvantage, despite its low productivity in date production.
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How is the relative wage determined?
• By the relative supply of and relative (derived) demand forlabor services.
• The relative (derived) demand for home labor services fallswhen w/w * rises. As domestic labor services become more
expensive relative to foreign labor services, – goods produced in the home country become more expensive, and
demand for these goods and the labor services to produce them falls.
– fewer goods will be produced in the home country, which will reducefurther the demand for domestic labor services.
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Transportation Costs and Non-traded
Goods
• The Ricardian model predicts that countriesshould completely specialize in production.
• But this rarely happens for three mainreasons:1. More than one factor of production reduces the
tendency of specialization
2. Protectionism.
3. Transportation costs reduce or prevent trade,which may cause each country to produce thesame good or service.
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• Nontraded goods and services (for ex., haircuts
and auto repairs) exist due to high transport
costs.
– Countries tend to spend a large fraction of national
income on nontraded goods and services.
– This fact has implications for the gravity model and
for models that consider how income transfers
across countries affect trade.
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Empirical Evidence
• Do countries export those goods in which their productivity isrelatively high?
• Compare Chinese output and productivity with that of
Germany for various industries using 1995 data.
• Chinese productivity (output per worker) was only 5 percentof Germany’s on average.
– In apparel, Chinese productivity was about 20
percent of Germany’s, creating a strong
comparative advantage in apparel for China.
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• The main implications of the Ricardian model
are well supported by empirical evidence:
– productivity differences play an important role in
international trade
– comparative advantage (not absolute advantage)
matters for trade
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To Sum up
1. Differences in the productivity of labor across
countries generate comparative advantage.
2. A country has a comparative advantage in
producing a good when its opportunity cost
of producing that good is lower than in other
countries.
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3. Countries export goods in which they have a
comparative advantage - high productivity
or low wages give countries a cost
advantage.
4. With trade, the relative price settles in
between what the relative prices were ineach country before trade.
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5. Trade benefits all countries due to the
relative price of the exported good rising:income for workers who produce exportsrises, and imported goods become less
expensive.6. Empirical evidence supports trade based on
comparative advantage, althoughtransportation costs and other factors
prevent complete specialization inproduction.
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Theories of Trade…cond.
Heckscher-Ohlin Model:
(Resources and Trade)
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• The Heckscher-Ohlin theory argues that trade occurs due todifferences in labor skills & its productivity, capital availability& its efficiency, or other factors of production acrosscountries.
– Countries have different relative abundance of factors of production.
– Production processes use factors of production with different relative
intensity.
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Two Factor Heckscher-Ohlin Model
1. Two countries: home and foreign.
2. Two goods: cloth and food.
3. Two factors of production: labor and capital.
4. The mix of labor and capital used varies across goods.
5. The supply of labor and capital in each country is constant andvaries across countries.
6. In the long run, both labor and capital can move acrosssectors, equalizing their returns (wage and rental rate) acrosssectors.
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• Economy must produce subject to bothconstraints – i.e., it must have enough capital
and labor.
• Without factor substitution, the productionpossibilities frontier is the interior of the two
factor constraints.
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Trade in the Heckscher-Ohlin Model
• Like the Ricardian model, the Heckscher-Ohlin
model predicts a convergence of relative prices
with trade.
• With trade, the relative price of cloth rises in
the relatively labor abundant (home) country
and falls in the relatively labor scarce (foreign)
country.
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• Relative prices and the pattern of trade: In
Home, the rise in the relative price of clothleads to a rise in the relative production of
cloth and a fall in relative consumption of cloth.
– Home becomes an exporter of cloth and animporter of food.
• The decline in the relative price of cloth in
Foreign leads it to become an importer of cloth
and an exporter of food.
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• Heckscher-Ohlin Model: An economy has acomparative advantage in producing, and thus
will export, goods that are relatively intensive
in using its relatively abundant factors ofproduction,
– and will import goods that are relatively intensive
in using its relatively scarce factors of production.
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Factor Price Equalization
• Unlike the Ricardian model, the Heckscher-Ohlin modelpredicts that factor prices will be equalized among countries
that trade.
• Free trade equalizes relative output prices.
• Due to the connection between output prices and factorprices, factor prices are also equalized.
• Trade increases the demand of goods produced by relatively
abundant factors, indirectly increasing the demand of these
factors, raising the prices of the relatively abundant factors.
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• In the real world, factor prices are not equal across countries.
• The model assumes that trading countries produce the samegoods, but countries may produce different goods if their
factor ratios radically differ.
• The model also assumes that trading countries have the same
technology, but different technologies could affect the
productivities of factors and therefore the wages/rates paid to
these factors.
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• The model also ignores trade barriers and transportation
costs, which may prevent output prices and thus factor prices
from equalizing.
• The model predicts outcomes for the long run, but after an
economy liberalizes trade, factors of production may not
quickly move to the industries that intensively use abundant
factors.
– In the short run, the productivity of factors will be determined by their
use in their current industry, so that their wage/rental rate may vary
across countries.
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Therefore, the question is:
Does Trade Increase Income Inequality?
• Over the last 40 years, countries like South Korea, Mexico,
and China have exported to the U.S. goods intensive in
unskilled labor (ex., clothing, shoes, toys, assembled goods).
• At the same time, income inequality has increased in the U.S.,as wages of unskilled workers have grown slowly compared
to those of skilled workers.
• Did the former trend cause the latter trend?
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• The Heckscher-Ohlin model predicts that owners of relativelyabundant factors will gain from trade and owners of
relatively scarce factors will lose from trade.
– Little evidence supporting this prediction exists.
1. According to the model, a change in the distribution of
income occurs through changes in output prices, but there is
no evidence of a change in the prices of skill-intensive goods
relative to prices of unskilled-intensive goods.
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2. According to the model, wages of unskilled workers should
increase in unskilled labor abundant countries relative to
wages of skilled labor, but in some cases the reverse has
occurred:
– Wages of skilled labor have increased more rapidly in Mexico than
wages of unskilled labor.
• But compared to the U.S. and Canada, Mexico is supposed to beabundant in unskilled workers.
3. Even if the model were exactly correct, trade is a small
fraction of the U.S. economy, so its effects on U.S. prices and
wages prices should be small.
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Trade and Income Distribution
• Changes in income distribution occur with every economicchange, not only international trade. – Changes in technology, changes in consumer preferences, exhaustion
of resources and discovery of new ones all affect income distribution.
– Economists put most of the blame on technological change and the
resulting premium paid on education as the major cause of increasingincome inequality in the US.
• It would be better to compensate the losers from trade (or anyeconomic change) than prohibit trade. – The economy as a whole does benefit from trade.
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• There is a political bias in trade politics:
potential losers from trade are betterpolitically organized than the winners fromtrade. – Losses are usually concentrated among a few, but
gains are usually dispersed among many. – Each of you pays about $8/year to restrict importsof sugar, and the total cost of this policy is about$2 billion/year.
– The benefits of this program total about $1 billion,but this amount goes to relatively few sugarproducers.
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Empirical Evidence on the
Heckscher-Ohlin Model
• Tests on US data – Leontief found that U.S. exports were less capital-
intensive than U.S. imports, even though the U.S.is the most capital-abundant country in the world:
Leontief paradox.
• Tests on global data
– Bowen, Leamer, and Sveikauskas tested the
Heckscher-Ohlin model on data from 27 countriesand confirmed the Leontief paradox on aninternational level.
Empirical Evidence on the
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Empirical Evidence on the
Heckscher-Ohlin Model …cond.
• Because the Heckscher-Ohlin model predicts that factor prices
will be equalized across trading countries, it also predicts that
factors of production will produce and export a certain
quantity goods until factor prices are equalized.
– In other words, a predicted value of services from factors of
production will be embodied in a predicted volume of trade between
countries.
E i i l E id f th
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Empirical Evidence of the
Heckscher-Ohlin Model (cont.)
• But because factor prices are not equalized across countries,the predicted volume of trade is much larger than actuallyoccurs. – A result of “missing trade” discovered by Daniel Trefler.
• The reason for this “missing trade” appears to be theassumption of identical technology among countries. – Technology affects the productivity of workers and therefore the value
of labor services.
– A country with high technology and a high value of labor serviceswould not necessarily import a lot from a country with low technology
and a low value of labor services.
E i i l E id f th
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Empirical Evidence of the
Heckscher-Ohlin Model (cont.)
• Looking at changes in patterns of exportsbetween developed (high income) and
developing (low/middle income) countries
supports the theory.
• US imports from Bangladesh are highest in
low-skill-intensity industries, while US imports
from Germany are highest in high- skill-intensity industries.
Empirical Evidence of the
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Empirical Evidence of the
Heckscher-Ohlin Model (cont.)
• As Japan and the four Asian “miracle”
countries became more skill-abundant, U.S.
imports from these countries shifted from less
skill-intensive industries toward more skill-intensive industries.
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3. An increase in the relative price of a good causes the real
wage or real rental rate of the factor used intensively in the
production of that good to increase, – while the real wage and real rental rates of other factors of
production decrease.
4. If output prices remain constant as the amount of a factor ofproduction increases, then the supply of the good that uses
this factor intensively increases, and the supply of the other
good decreases.
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5. An economy exports goods that are relatively intensive in its
relatively abundant factors of production and imports goods
that are relatively intensive in its relatively scarce factors of
production.
6. Owners of abundant factors gain, while owners of scarce
factors lose with trade.7. A country as a whole is predicted to be better off with trade,
so winners could in theory compensate the losers within
each country.
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8. The Heckscher-Ohlin model predicts that relative output
prices and factor prices will equalize, neither of whichoccurs in the real world.
9. Empirical support of the Heckscher-Ohlin model is weak
except for cases involving trade between high-income
countries and low/middle- income countries or whentechnology differences are included.
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Tariff & Non-tariff Trade Barriers
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Tariff is a custom duty or a tax on the products that move
across borders. The custom duty is normally imposed upon by
the importing country on the products that enter into their
country
1. Ad valorem Duty: These duties are imposed “according to
value.” When a fixed percent of value of a commodity is
added as a tariff it is known as ad valorem duty. It ignores the
consideration of weight, size or volume of commodity.
The imposition of ad valorem duty is more justified in case of
those goods whose values cannot be determined on the basis
of their physical and chemical characteristics, such as costly
works of art, rare manuscripts, etc. In practice, this type of duty is mostly levied on majority of items.
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2. Countervailing Duty: It is imposed on certain importswhere products are subsidized by exporting governments. As
a result of government subsidy, imports become morecheaper than domestic goods. To nullify the effect of subsidy,
this duty is imposed in addition to normal duties.
3. Revenue Tariff : A tariff which is designed to provide
revenue to the home government is called revenue tariff.Generally, a tariff is imposed with a view of earning revenue
by imposing duty on consumer goods, particularly, on luxury
goods whose demand from the rich is inelastic.
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4. Anti-dumping Duty: At times, exporters attempt to
capture foreign markets by selling goods at rock-bottom
prices, such practice is called dumping. As a result of dumping, domestic industries find it difficult to compete
with imported goods. To offset anti-dumping effects, duties
are levied in addition to normal duties.
5.Protective Tariff: In order to protect domestic industriesfrom stiff competition of imported goods, protective tariff
is levied on imports. Normally, a very high duty is imposed,
so as to either discourage imports or to make the imports
more expensive as that of domestic products.
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NON-TARIFF BARRIERS
A non tariff barrier is any barrier other than a tariff,that raises an obstacle to free flow of goods in
overseas markets. Non-tariff barriers, do not affect
the price of the imported goods, but only the
quantity of imports. Some of the important non-tariff barriers are as follows:
Types of non-tariff barriers
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1. Import quotas:
Quotas are a restriction on the quantity of a good that may beimported in any one period (usually below free-trade levels)
Global quotas restrict the total quantity of an import,
regardless of origin
Selective quotas restrict the quantity of a good coming from aparticular country
ypes o o ta ba e s
Types of non-tariff barriers
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2. Orderly marketing agreements
Market sharing pact signed by trading partners
Intended to protect less efficient domestic producers
Usually involve voluntary export restraints, or export quotas
Recent trade negotiations have restricted the use of these
agreements
Carbaugh, Chap. 6 80
Types of non-tariff barriers
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3. Domestic content requirements
Rules that require a certain percentage of a product’s totalvalue to be produced domestically
Often has the effect of forcing lower-priced imports to include
higher-cost domestic components or be assembled in a
higher-cost domestic market Governments impose domestic content requirements to
boost domestic production. For instance, in the US bailout
package (to bailout General Motors and other organizations),
the US Govt. introduced ‘Buy American Clause’ which meansthe US firms that receive bailout package must purchase
domestic content rather than import from elsewhere.
Carbaugh, Chap. 6 81
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4.Product Standards: Most developed countries imposeproduct standards for imported items. If the imported items
do not conform to established standards, the imports are notallowed. For instance, the pharmaceutical products must
conform to pharmacopoeia standards.
5.Product Labeling: Certain nations insist on specific
labeling of the products. For instance, the European Unioninsists on product labeling in major languages spoken in EU.
Such formalities create problems for exporters.
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6.Packaging Requirements: Certain nations insist onparticular type of packaging materials. For instance, EU
insists on recyclable packing materials, otherwise, the
imported goods may be rejected.
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7. Subsidies
Domestic subsidy
Payments made to import-competing producers
to raise the price they receive above the market
price Export subsidy
Payments and incentives offered to export
producers intended to raise the volume of exports
Carbaugh, Chap. 6 84
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8. Dumping
The practice of selling a product at a lowerprice in export markets than at home (or
exporting at prices below production cost)
Sporadic dumping - to clear unwantedinventories or cope with excess capacity
Predatory dumping - to undermine foreign
competitors
Persistent dumping - reaping greater profits by
engaging in price discrimination
Carbaugh, Chap. 6 85
9 P f i l A
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9. Preferential Arrangements: Some nations formtrading groups for preferential arrangements in respect of
trade amongst themselves. Imports from member
countries are given preferences, whereas, those from other
countries are subject to various tariffs and other
regulations.
10. Foreign Exchange Regulations: The importer hasto ensure that adequate foreign exchange is available for
import of goods by obtaining a clearance from exchange
control authorities prior to the concluding of contract with
the supplier.
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11.Other Non-Tariff Barriers: There are number of
other non – tariff barriers such as:• health and safety regulations,
•technical formalities,
• environmental regulations,
• embargoes, etc.
•Sea transport and freight restrictions
• Government procurement policies
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International Strategic Alliances
St t i Alli
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Strategic Alliances
A strategic alliance is a business arrangementwhereby two or more firms choose to cooperate
for their mutual benefit.
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Joint Venture
A joint venture (JV) is a special type of strategicalliance in which two or more firms join
together to create a new business entity that is
legally separate and distinct from its parents.
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Benefits of Strategic Alliances
Potential Benefitsof Strategic Alliances
Ease of Market
Entry
SharedRisk
SharedKnowledge
andExpertise
Synergyand
Competitive Advantage
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Scope of Strategic Alliances
• Significant variation – Comprehensive alliance
– Narrowly defined alliance
• Degree of collaboration depends upon basicgoals of each partner
Th S f S i Alli
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The Scope of Strategic Alliances
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Types of Functional Alliances
Production alliances
Marketing alliances
Financial alliances
R&D alliances
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Issues in the Implementation of Strategic
Alliances
13-95
Partnerselection
Jointmanagement
Form of ownership
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Factors Affecting Partner Selection
CompatibilityNature of
partner services
Relative safeness Learning potential
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Approaches to
Joint Management
Sharedmanagementagreements
Delegatedarrangements
Assignedarrangements
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Shared Management Agreement
Partner
1
Partner
2
Alliance
Both parties are activeparticipants
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Assigned Arrangement
Partner
1
Partner
2
Alliance
One partner takes primaryresponsibility
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Delegated Arrangement
Partner
1
Partner
2
Joint venture
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Pitfalls of Strategic Alliances
Pitfalls
Access toinformation
Distributionof earnings
Loss of autonomy
Incompatibilityof partners
Changingcircumstances
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Significance of PTAs
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Economic integrations among countries significantly influence
international business. The preferential treatment granted to
member countries affects the competitiveness of goods in
international markets. Elimination of import tariffs by the member
countries of a trade group encourages sourcing of goods from cost-
efficient production locations. However, discriminatory tariff
against non-members do result in trade diversion to member
countries, even at the cost of production efficiency.
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Trade-Diversion Impact
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Trade Diversion Impact
Formation of an FTA results in trade diversion to its members
from non-members since the elimination of import tariffs
among member countries makes sourcing of goods from
member countries more attractive compared to non-
members, even at the cost of production efficiency.
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Forms of International Economic Integration
Preferential Trade Agreement (PTA)
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Preferential Trade Agreement (PTA)
Member countries in a PTA lower tariff barriers to
imports of identified products from one another e. g.
ECOWAS, GSTP, COMESA, etc.
Free Trade Agreement (FTA)
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g ( )
Form of economic integration in which member
countries seek to remove all tariffs and non-tariff
barriers for cross-border trade of goods and services
among themselves e.g. NAFTA, LAFTA., etc.
Customs Union (CU)
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Customs Union (CU)
Countries not only eliminate tariff barriers among
themselves but also apply common external import tariffs for
non-members e. g. CARICOM, CACM, etc.
Common Market (CM)
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Common Market (CM)
In addition to free trade among members anduniform tariff policy for non-members in a common
market, it involves elimination of all restrictions on
cross-border investments, movement of labour,
technology transfer, management, sharing of capital
resources, e.g. COMESA, MERCOSUR, etc.
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Political Union (PU)
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Political Union (PU)
As a culmination of economic integration, the member
countries strive to harmonize their security and foreign
policies. A common parliament is created with
representatives of member countries who work in
synchronization with an individual country’s legislature.
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Major Regional Trade Agreements
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North American Free Trade Area (NAFTA)
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North American Free Trade Area (NAFTA)
Formed on 1 January, 1994, the economic integration
between the US, Canada and Mexico aims at elimination of
trade barriers related to industrial goods and services,
besides separate agreement on agriculture, intellectual
property rights(IPRs), labour adjustment, and environmental
protection.
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Economic Cooperation (APEC) Asia-Pacific
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Established in 1989, APEC aims to enhance economic growth
and prosperity for the region and to strengthen the Asia-
Pacific Community. APEC has no treaty obligations required
of its participants. Decisions are reached by consensus and
commitments and undertaken on a voluntary basis.
Association of South East Asian Nations (ASEAN)
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The ASEAN was established on 8 August 1967 with majorobjectives:
To accelerate economic growth, social progress, and
cultural development in the region through joint
endeavors
To promote regional peace and stability through abiding
respect for justice and the rule of law in the relationship
among countries
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Regional Comprehensive Economic
Partnership(RCEP)RCEP is a FTA negotiation that has been deve-loped
among 16 countries: 10 members of ASEAN and six
countries with which ASEAN has existing FTAs-Australia, China, India, Japan, Korea & New Zealand
covers total population of 3 billion, trade estimated
around 27 % of global trade covering GDP of US$ 21
trillion (2012).
L h d i N b 2012 RCEP ld b
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Launched in November,2012, RCEP would be a
modern, comprehensive, high quality and mutually
beneficial economic partnership
Agreement establishing an open trade and
investment environment in the region to facilitate
the expansion of regional trade and investmentand contribute to global economic growth and
development.
T P ifi P t hi (TPP)
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Trans- Pacific Partnership(TPP)TPP is a proposed regional regulatory and investment
treaty. Though agreement began in 2005, however as of
2014, 12 countries throughout of Asia Pacific region
participated in negotiations on the TPP: Australia,
Brunei, Canada, Chile, Japan, Malaysia, Mexico, New
Zealand, Peru, Singapore, United States and Vietnam.Basic aims is to counter the rising diplomatic and
economic influence of China in Asia.
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India’s Participation in PTAs
SAARC Preferential Trading Agreement (SAPTA)
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SAARC Preferential Trading Agreement (SAPTA)
The SAPTA was signed on 11 April 1993 at the Seventh SAARC
Summit held in Dhaka to provide a framework for the
exchange of tariff concessions with a view to promoting
trade and economic cooperation among the SAARC member
countries.
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Framework Agreement on Comprehensive Economic
Cooperation between the Association of South East Asian
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p f
Nations (ASEAN) and India
The framework agreement between ASEAN and India wassigned on 8 October 2003. It covers several aspects such as:
– gradual tariff reductions leading to formation of FTA
– trade facilitation measures, – Trade and investment promotion measures
– early harvest programmes
– tariff concessions.
Bay of Bengal Initiative for Multi-sectoral Technical
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and Economic Co-operation (BIMSTEC)
BIMSTEC provides a unique link between South Asia and
Southeast Asia aimed to develop into an FTA and focus on
activities that facilitate trade, increase investment, and promote
technical cooperation among member countries.Six areas were identified for cooperation include trade and
investment, technology, transportation and communication,
energy, tourism, and fisheries.
Indo Sri Lanka Free Trade Agreement (ISLFTA)
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Indo-Sri Lanka Free Trade Agreement (ISLFTA)
An FTA between India and Sri Lanka was signed on 28
December 1998. The agreement envisages phasing out of
tariffs on all products except for a limited number of items in
the Negative List and tariff rate quota items over a period of
time.
Asia-Pacific Trade Agreement (APTA)
(Bangkok Agreement)
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(Bangkok Agreement)
The Bangkok agreement was approved by the GATT council
in March 1978 aimed to liberalize and expand trade
progressively in the ESCAP region through mutually agreed
concessions by member countries. From 2 November 2005,
this agreement is renamed the Asia Pacific Trade Agreement
(APTA).
Global System of Trade Preferences (GSTP)
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Global System of Trade Preferences (GSTP)
The GSTP establishes a framework for exchange of trade
concessions among the member developing countries. It also
lays down the rules, principles, and procedures for conduct of
negotiations and implementation of the decisions made.
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Framework Agreement for Establishing FTA between
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Framework Agreement for Establishing FTA between
India and Thailand
Signed on 9 October 2003, the framework agreement covers
FTA in goods, services and investment, and areas of
economic cooperation. It also provides an Early Harvest
Scheme (EHS) under which common items have been agreed
for elimination of tariffs on a fast-track basis.
l l f l d h
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Bilateral Preferential Trading Agreement with
Afghanistan
The Preferential Trade Agreement between India and
Afghanistan, signed on 6 March 2003, aims to provide for
grant or concessions on a range of products of export
interest to Afghanistan, as a part of India’s endeavour to
strengthen bilateral trade and economic relations.
India–MERCOSUR PTA
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India MERCOSUR PTA
Signed on 19 March, 2005, the PTA aims to expand and
strengthen existing trade relations between India and
MERCOSUR by granting reciprocal fixed trade preferences
with the ultimate objective of creating an FTA.
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Long Awaited India- EU FTA
India & EU have been negotiating a trade pact, known as
the Broad-based Trade and Investment Agreement(BTIA)
since 2007, however could not resolve on certain
contentious issues & latest is on drug ban issue on thesale of 700 pharma products. Such ban will affect India’s
exports of $15 billion & this is our flagship sectors and has
developed its reputation through strong research and
safety protocols.
Limitations of Regional Economic Integrations
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It can create an incentive for even further discrimination,
which eventually will hurt all trading partners.
PTAs cannot solve systemic issues, such as rules of origin,
anti-dumping, agricultural, and fisheries subsidies. These
issues simply cannot be handled at the bilateral or
regional level.
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Regional Trade Agreements Vis-à-vis
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Multilateral Trading System Under the WTO
RTAs are an important exception under Article XXIV of the
GATT Agreement to the MFN rule of the WTO
agreements, under which tariff and other technical
barriers to trade can be reduced on preferential basis by
countries under the regional agreement.
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Regionalism Vs Multilateralism
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A RTA i b d t h t i t d di t ti
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Any RTA is bound to have certain trade distortion
effects. This trade distortion arises due to
discriminatory treatment advanced to the non-
members of the RTA vis-à-vis its members on account
of market access granted to the members of the same
regional bloc.
Though under Article XXIV of GATT of 1994 is now anintegral part of WTO agreement effective from 1995
recognizes the conditional right of members to form
RTAs imposes three conditions stipulated for regional
agreements under WTO :
w r t the overall impact of the RTAs with non members there is
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w.r.t. the overall impact of the RTAs with non-members, there is
an obligation not to raise barriers to trade . Though this is
quantifiable in terms of tariffs, however less easy to measure interms of other trade regulations such as Rules of Origin.
For an ‘external requirement’, FTA can not lead to higher import
duties for its members while a custom union must harmonize the
external trade policies of its members and compensate affected
non-members accordingly. on the ‘internal dimension’ of regional agreements, tariffs and
other restrictive regulations of commerce must be phased out
substantially on all trade. (again the tariff component can be
quantified, but it is harder to determine in the case of their
restrictive trade regulations, as there is no agreed definition of theterm.
The WTO authorizes RTAs the operation of which
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The WTO authorizes RTAs, the operation of which
should not lead to the situations where non-party
would ‘pay the price’ for internal preferences. Toensure coherence, RTAs are to be ‘promptly’ notified tothe WTO and reviewed by peers before beingimplemented.
The MFN treatment calls for non-discrimination among
members, while national treatment ensures non-discrimination between domestic produced andimported items.
RTA implies a higher degree if liberalization within the
region as compared to the rest of the world.
RTAs are thus allowed under the multilateral
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trading system as an exception to the MFN principle
of the WTO in the belief that they would facilitatetrade liberalization at the multilateral level. The
idea is that regionalism would gradually expand,
leading to multilateral trade liberalization.
Therefore, it would facilitate the formation of a
liberalized fair global trading regime.
However, because of the discriminatory
environment created by its formation, any RTA is
bound to result in some amount of trade diversion.
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2.Proliferating regional agreements absorb scarcenegotiating resources (especially in poorer WTO
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negotiating resources (especially in poorer WTOmembers) and crowding out policy-makers
attention.3. Competing RTAs (especially different North-South
combinations) may lock in incompatibleregulatory structures and standards and mayresult in inappropriate norms for developingpartners; and
4. By creating alternative legal frameworks anddispute settlement mechanisms, RTAs mayweaken the discipline and efficiency associated
with a broadly recognized multilateral frameworkof rules
Building blocks proponents stress that:
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1. Regional/bilateral agreements can help sensitize domestic
constituencies to liberalization and keep the stakes lowerto allow for incremental progress on trade.
2. Expanding the number and coverage of RTAs can erode
vested opposition to multilateral liberalisation because
each successive RTAs reduces the value of the margin of
preference , thereby reducing the discriminatory impact.
3. RTAs are often more about building strategic and /or
political alliances or locking in domestic reforms than
about actual trade liberalization and so are not necessarily
competitive with multilateral efforts.
4 Regional arrangement can provide an incubator for
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4. Regional arrangement can provide an incubator for
developing country firms/producers to learn to trade
with RTAs partners without facing full globalcompetition;
5. For some issues, such as regulatory cooperation,
RTAs may be a viable and more manageable
alternative to the WTO where ‘lowest commondenominator’ outcome trends to prevail.
Therefore, RTAs can be complement tomultilateral reform, but they are not
substitutes.
RTAs can be stumbling blocks to multilateralarrangements by creating incentives to resist the
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arrangements by creating incentives to resist thepreference erosion that can occur through new
multilateral liberalization.However, because the gains are often substantially largerin multilateral agreements, concerns over preferenceserosion may be limited to a few small countries that couldconceivably block a multilateral agreement.
Large developed countries may gain more from signingindividual bilateral agreements than they would from amultilateral accord, because they can use the carrot of preferential access to extract concessions in nontradeareas from developing country partners that would be
resisted in the WTO negotiating framework.
From development perspective WTO remains the best-il bl f t di i li th f t d di t ti
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available forum to discipline the use of trade-distortingpolicies. RTAs can complement the WTO efforts bycooperating on behind-the-border policies, especiallyon regulation-intensive issues such as services, tradefacilitation and the investment climate. Governmentspursuing this agenda through RTAs must adopt rulesthat are appropriate to their own level of development.The potential for inappropriate outcomes is higher inNorth-South RTAs because the asymmetry innegotiating power can overtake real developmentpriorities.
All countries could take step to promote openregionalism – the developing countries, high income
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eg o a s t e de e op g cou t es, g co ecountries and the international community working
together through WTO. Developing countries arelikely to have the greatest success in harnessingtrade for growth and poverty alleviation if they adopta three-pronged strategy that involves autonomousliberalization, active multilateralism and open
regionalism.High income countries could promote openregionalism by including agriculture in RTA s. Theycould adopt more common and non-restrictive ‘rulesof origin’ across agreements.
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International community working through the WTOh
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can reduce discrimination in the system. WTO
members should establish stronger multilateralsurveillance mechanisms to document , analyze andmonitor the effects of RTAs on non-members.Expanding the information on the impact of RTAs tostackholders- firms, consumers, taxpayers- would also
help to ensure that the potential benefits of liberalization are both realiz
ed and distributed more equitably. Medium-termefforts should focus on implementing WTO disciplineson regional agreements.
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Tariff & Non-tariff Trade Barriers
Tariff is a custom duty or a tax on the products that move
across borders. The custom duty is normally imposed upon by
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the importing country on the products that enter into their
country1. Ad valorem Duty: These duties are imposed “according to
value.” When a fixed percent of value of a commodity is
added as a tariff it is known as ad valorem duty. It ignores the
consideration of weight, size or volume of commodity.The imposition of ad valorem duty is more justified in case of
those goods whose values cannot be determined on the basis
of their physical and chemical characteristics, such as costly
works of art, rare manuscripts, etc. In practice, this type of duty is mostly levied on majority of items.
2. Countervailing Duty: It is imposed on certain importswhere products are subsidized by exporting governments As
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where products are subsidized by exporting governments. As
a result of government subsidy, imports become more
cheaper than domestic goods. To nullify the effect of subsidy,
this duty is imposed in addition to normal duties.
3. Revenue Tariff : A tariff which is designed to provide
revenue to the home government is called revenue tariff.
Generally, a tariff is imposed with a view of earning revenueby imposing duty on consumer goods, particularly, on luxury
goods whose demand from the rich is inelastic.
4. Anti-dumping Duty: At times, exporters attempt to
capture foreign markets by selling goods at rock bottom
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capture foreign markets by selling goods at rock-bottom
prices, such practice is called dumping. As a result of
dumping, domestic industries find it difficult to compete
with imported goods. To offset anti-dumping effects, duties
are levied in addition to normal duties.
5.Protective Tariff: In order to protect domestic industries
from stiff competition of imported goods, protective tariff
is levied on imports. Normally, a very high duty is imposed,
so as to either discourage imports or to make the imports
more expensive as that of domestic products.
NON-TARIFF BARRIERS
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A non tariff barrier is any barrier other than a tariff,
that raises an obstacle to free flow of goods inoverseas markets. Non-tariff barriers, do not affect
the price of the imported goods, but only the
quantity of imports. Some of the important non-
tariff barriers are as follows:
1. Import quotas:
Types of non-tariff barriers
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Quotas are a restriction on the quantity of a good that may beimported in any one period (usually below free-trade levels)
Global quotas restrict the total quantity of an import,
regardless of origin
Selective quotas restrict the quantity of a good coming from aparticular country
2. Orderly marketing agreements
Types of non-tariff barriers
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Market sharing pact signed by trading partners
Intended to protect less efficient domestic producers
Usually involve voluntary export restraints, or export quotas
Recent trade negotiations have restricted the use of these
agreements
Carbaugh, Chap. 6 164
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6.Packaging Requirements: Certain nations insist onf
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particular type of packaging materials. For instance, EU
insists on recyclable packing materials, otherwise, theimported goods may be rejected.
7. Subsidies
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Domestic subsidy Payments made to import-competing producers
to raise the price they receive above the market
price
Export subsidy
Payments and incentives offered to export
producers intended to raise the volume of
exports
Carbaugh, Chap. 6 168
8. Dumping
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The practice of selling a product at a lowerprice in export markets than at home (or
exporting at prices below production cost)
Sporadic dumping - to clear unwantedinventories or cope with excess capacity
Predatory dumping - to undermine foreign
competitors
Persistent dumping - reaping greater profits by
engaging in price discrimination
Carbaugh, Chap. 6 169
9. Preferential Arrangements: Some nations formtrading groups for preferential arrangements in respect of
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trade amongst themselves. Imports from member
countries are given preferences, whereas, those from othercountries are subject to various tariffs and other
regulations.
10. Foreign Exchange Regulations: The importer has
to ensure that adequate foreign exchange is available forimport of goods by obtaining a clearance from exchange
control authorities prior to the concluding of contract with
the supplier.
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INDIA’S FOREIGN TRADE POLICY (FTP) 2015 –
2020
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• INDIA’S FOREIGN TRADE POLICY (FTP) 2015 – 2020
• ALSO SOMETIMES CALLED COMMERCIAL POLICY ANDFORMULATED ; INTERPRETED AND ADMINISTERED BY DIRECTORATEGENERAL OF FOREIGN TRADE (DGFT), A SUBORDINATE OFFICE OFDEPARTMENT OF COMMERCE, MINISTRY OF COMMERCE ANDINDUSTRY, GOVERNMENT OF INDIA.
• FTP 2015 – 2020 IS THE MICRO TRADE POLICY AND THE MACROTRADE POLICY – INTERFACE WITH WORLD TRADE ORGANISATION(WTO); PTAs AND FTAs WITH VARIOUS COUNTRIES AND TRADEBLOCKS IS THE DOMAIN OF DEPARTMENT OF COMMERCE.
INDIA’S FTP 2015 - 2020
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• India’s new five year FTP 2015 – 2020 provides a stableand sustainable policy environment ; overarchingframework and architecture to catalyse exports andfacilitate nay rationalise imports; generateemployment and increase value addition in the
country.• India’s FTP – Domestic Trade Policy is anchored in theDomestic Policy framework (symbiotic relationship andsynergy) Export Promotion Mission to be created thatwould be synergised with the National Missions of
‘Make in India’; ‘Digital India’ – e Governance -Improve the ‘ease of doing business’ index; ‘Skill India’.
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INDIA’S FTP 2015 – 2020 – SUPER ORDINATE
GOAL (bHAG)
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• India’s FTP Statement explains the Vision ,Mission. Objectives andGoals ; Market and Product strategy; Structure and Architecture toachieve the goals.
• VISION - Super Ordinate Goal – big Hairy Audacious Goal (b HAG )of doubling India’s exports of merchandise and services from aboutUSD 450 Billion in FY 2013 -14 to USD 900 Billion in FY 2019 – 2020
and to raise India’s share in world exports from 2% to 3.5%.• Every thing hangs together in International Trade – so ‘Whole ofGovernment’ approach - State Governments ; Other CentralGovernment Ministries to be also involved rather than just the roleof Department of Commerce in the export value chain (both upstream and down stream activities in terms of Michael Porter’s
value chain)
INDIA’S FTP 2015 - 2020
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• State Governments and Central Government have toact in tandem to remove the inefficiencies andbottlenecks in India’s export value chains ; enhanceIndia’s export competitiveness ; address constraintsand in house challenges like infrastructural bottlenecks;
high transaction costs ; complex procedures.• Analyses India’s position on WTO (Multilateral TradingSystem) – ensures that India’s FTP is aligned with bothIndia’s national interests as well as it’s obligations andcommitments under various WTO Agreements.
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MARKET STRATEGY
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• Market Strategy – Market Penetration and MarketDevelopment (Diversification). India has signed 5limited PTAs ; 11 FTAs and is negotiating 17 FTAs. Someof the issues being addressed are Rules of Origin;Inversion in Duty Structure; Capturing preferential
export data; FTA outreach and informationdissemination and setting up a Trade Portal. UnderMEIS (Chapter – 3 – Export Reward Scrips), countrieshave been grouped into three categories – A –
Traditional Markets ; B – Emerging & Focus Markets; C – Other Markets.
MARKET STRATEGY
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• NAFTA Countries – USA , Canada and Mexico – negotiating a FTAwith Canada.
• European Union (EU) – negotiating a BTIA.
• Australia and New Zealand – negotiating a CECA/CEPA
• South Asia – Sri Lanka FTA and discussions with Pakistan.
• Focus on Iran.
• SE Asia under the Look/ Act East Policy – ASEAN – India Trade inGoods/Services/ Investment Agreement.
• Future Focus on CLMV (Cambodia; Lao PDR; Myanmar; Vietnam)and India – Myanmar – Thailand Trilateral Highway.
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PRODUCT STRATEGY
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• PRODUCT STRATEGY – Focus on moving up the value chain – Value added products (more domestic value in sync withMake in India) – Engineering Products ; Electronics andDrugs and Pharmaceuticals.
• Focus on labour intensive products (create employmentopportunities so that our demographic dividend does notbecome a demographic disaster) – handicrafts , leather,textiles, gems and jewellery; agro and plantation products;marine products.
• Focus on new , innovative and high tech products andProject Exports.
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PRODUCT STRATEGY
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• Facilitating and encouraging export of defenceitems – normal export obligation period under
Advance Authorisation is 18 months which has
been extended to 24 months. A list of military
stores requiring NOC of Department of
Defence Production has been notified by
DGFT recently. A committee has been formed
to create ITC (HS) codes for defence andsecurity items for which industrial licenses are
issued by DIPP.
PRODUCT STRATEGY
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• E – COMMERCE EXPORTS• Goods falling in the category of handloom
products, books/periodicals, leather footwear,
toys and customised fashion garments, havingFOB value up to Rs 25,000 per consignment
(finalised using e – commerce platform) shall
be eligible for benefits under FTP. Such goods
can be exported in manual mode through
Foreign Post Offices at New Delhi, Mumbai
and Chennai.
PRODUCT STRATEGY – BOOST TO MAKE IN INDIA
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• Reduced Export Obligation (EO) for domestic procurementunder EPCG scheme – specific EO under EPCG scheme incase capital goods are procured from indigenousmanufacturers which is currently 90% of the normal EO (6times the duty saved amount) has been reduced to 75% inorder to boost ‘Make in India’.
• Higher level of reward DCSs under MEIS for export itemswith high domestic content and value addition.
• In order to encourage manufacturing of indigenous capitalgoods, imports under EPCG authorisation shall not beeligible for exemption from payment of Anti Dumping Duty,Safeguard Duty and Transitional Product Specific SafeguardDuty.
STRUCTURE /ARCHITECTURE
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• Already Board of Trade (BOT) exists as a forum fordiscussion and consultation.
• Other Institutional Mechanisms to be set up – Councilfor Trade Development and Promotion (CTDP) –community of Central Government and various Statesand UT Governments; National Committee on TradeFacilitation (NCTF) for domestic coordination andimplementation of the Trade Facilitation Agreement(TFA); Export Promotion Mission (EPM) to work with
State Governments to boost India’s exports.
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SYSTEMS
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• In sync with Digitise India andrecommendations of the two Task Forces on
reducing transaction time and cost in
International Trade headed by DGFT , e –
governance initiatives and ease of doing
measures have been taken in the new FTP
and HBP. Simple, transparent , user friendly
and Electronic Data Interchange (EDI)compatible procedures have been put in place
in HBP 2015 -2020 to implement the FT(D&R)
SYSTEMS
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• Online filing of documents/applications and paperlesstrade in 24 x 7 environment -:
• 70% of applications filed in DGFT relate to Chapter 3and Chapter 4. Henceforth hard copies of applicationsand specified documents under these chapters would
not be required to be submitted to the RegionalAuthorities (RAs) under DGFT. Applications underChapter – 5 would be taken in the next phase.
•
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