The political economy of international trade

Dr. Adam NovotnyInternational Business

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Why and how do governments intervene in international trade?

WHY?• To restrict imports and promote imports• To protect domestic producers and jobs from foreign competition• To increase the foreign market for home products• To raise revenue for the governmentHOW?• Instruments of trade policy:

– Tariffs– Subsidies– Import quotas– Voluntary export restraints– Local content requirements– Administrative policies– Antidumping duties

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TARIFFS• Tax levied on imports. Types:

– Specific: fixed charge for each unit imported ($3/barrel of oil)

– Ad valorem: levied as a proportion of the value of the imported good (15% on the first 2 million tons of bananas)

• Who wins? Who loses?– Domestic producers & government gains,

but consumers (higher prices) and the „world” loses (inefficient utilization of resources)

– Balance depends on• Amount of tariff, importance of good, number

of jobs saved

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SUBSIDIES• Government payment to

a domestic producer. Types:– Cash grants– Low-interest loans– Tax breaks– Government equity participation in domestic firms

• Helps domestic producers to compete against foreign import and to gain export markets

• Helps firms to achieve dominant position: first-mover advantage!• Amount:

– in agriculture: ~ 50% (Japan: 62%, EU: 43%, USA: 22% of farm revenues)– In industry: ~ 0-2%

• Consequences:– Inefficient farmers can stay in business– Overproduction of heavily subsidized agricultural products (that could be produced more

cheaply elsewhere)– Reduces international trade (by 50%; world would be better of by $160 billion)

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IMPORT QUOTAS &VOLUNTARY EXPORT RESTRAINTS (VER)

• Direct restriction on the quantity of some good that may be imported into the country– by issuing import licenses to a group of firms

• VER: quota on trade imposed by the exporting country (at the request of the importing country)– E.g. Japan car producers limited their exports to the

US to 1.85 million cars/year (1981-85)– Quota rent (artificially limited supply): $ 1 billion

/year Japanese producers– Because of quotas,

US sugar prices were 40%,textile prices were 70 % greaterthan world prices

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LOCAL CONTENT REQUIREMENTS

• Requirement that some specific fraction of a good be produced domestically– Physical terms (e.g. 75% of component

parts)– Value terms (75% of the value)

• e.g. the Buy American Act (1933): requires US government to prefer US-made products in its purchases (51% of materials by value are produced domestically)

• Raises the price of imported components• It benefits producers not consumers

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ADMINISTRATIVE POLICIES

• Bureaucratic rules that make it difficult for imports to enter a country

• E.g. Japan has low formal tariff and nontariff barriers, but! cutting tulip bulbs vertically, opening express packages to check for pornography

• Consumers are denied access to possibly superior foreign products

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ANTIDUMPING POLICIES

• Selling goods at foreign markets at below their cost of production, or below their „fair” market value

• Firms try to unload excess production in foreign markets

• Predatory behavior drive indigenous competitors out of the market (then they raise price and earn profit)

• Domestic firms can file a petition at the government– The government can impose antidumping duties

(countervailing duties) on offending foreign imports

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Political arguments for intervention• Protecting jobs and industries (from foreign competition)

– E.g. CAP in the EU (restrict imports, guarantee prices)– VER in the US against Japanese and Taiwanese machine tools

• National security– Defense-related industries (e.g. aerospace, semiconductors)– Sematech in the US (nonprofit, performs R&D to advance chip

manufacturing)• Retaliation

– To force foreign partners to play by the rules of the game– Punitive tariff is a risky business (e.g. US against China because of copyright

infringements)• Protecting consumers (from unsafe products)

– Hormone-treated animals and GM food, weapon– EU’s ban on most GM food genetic pollution

• Furthering foreign policy objectives– Persuade „rogue states” to mend their ways, hasten a change of

government– E.g. US trade sanctions against Iraq, Iran, Libya, Cuba (to impoverish them)– Helms-Burton Act (USA Canada, Mexico)

• Protecting human rights– Trade policy used as a political weapon– (e.g. embargo on Syria, MFN status to China)

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Economic arguments for intervention• Infant industry argument

– Alexander Hamilton (1972)– potential comparative advantage of developing countries

well-established industries in developed countries– Government should temporary support new industries– Critics:

• It can help the development of inefficient industries (e.g. Brazilian automobile industry)

• Given efficient global capital markets, only inefficient firms would require government protection

• Strategic trade policy (New trade policy)– First-mover advantage (e.g. Boeing)– Government should support promising firms that are active in

newly emerging industries (e.g. R&D grants to Boeing in 1950-60s; Japan: to LCD monitors in 1970-80s)

– To help domestic industries overcome the barriers created by foreign firms that have already reaped first-mover advantage (e.g. Airbus)

– By home market protection and export promotion

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Literature• Charles W.L. Hill: International Business: Competing in the Global Marketplace,

Irwin/McGraw-Hill; 2007• Marios I. Katsioloudes & Spyros Hadjidakis: International Business - A Global

Perspective, Elsevier - BH, 2007• Paul R. Krugman & Maurice Obstfeld: International Economic: Theory and Policy,

Pearson,2003• Janet Morrison: The International Business Environment - Diversity and the global

economy, PALGRAVE 2002• Robert M. Dunn, Jr., John H. Mutti: International Eonomics, 5th Ed., Routledge, 2000