International
Business
Fourth Edition
CHAPTER 5
The Political Economy of
International Trade
5-3
Chapter Focus
The political reality of free trade is that while nations
are nominally committed to it, they intervene and take
actions to protect the interests of politically important
groups.
This chapter explores the political and economic
reasons for intervention; to restrict imports and
expand exports, but, more recently, for ‘social’
reasons.
The chapter describes the range of intervention
instruments used by governments and considers the
case for free trade in light of government actions.
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
5-4
The 7 Instruments of Trade Policy
Tariffs
Subsidies
Voluntary
Exports
Restraints
Import
Quotas
McGraw-Hill/Irwin
Local
Content
Requirements
Antidumping
Duties
Administrative
Policies
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
5-5
Tariffs
Specific
Fixed charge
per unit
Tariffs
 Oldest form of protection.
 Good for the Government.
 Good for producers.
 Leads to inefficiency.
 Bad for consumers.
McGraw-Hill/Irwin
Ad Valorem
Charge is
a proportion of the
goods value
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
5-6
Subsidies
Tax Breaks
Cash Grants
Government
payment to a
domestic producer
Low Interest
Loans
Government
Equity
Participation
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
5-7
Subsidies
Paid by taxing
individuals
Agriculture
1.Keeps inefficient
farmers in business.
2.Encourages production
of subsidized products.
3.Produce products grown
more cheaply elsewhere.
4.Reduces agriculture
trade.
McGraw-Hill/Irwin
Helps domestic
producers to
compete internationally.
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
5-8
Import Quotas and Voluntary Export
Restraints
Import Quotas
Quota
rent
McGraw-Hill/Irwin
Helps
producers
Direct restriction
on the quantity of a
good that can
be imported into
a country.
VERs
Quota on trade imposed
by the exporting
country at the request
of the importing
country’s government.
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
5-9
Local Content Requirements
A specific
A specific
fraction of a
fraction of a
good must be
good must be
domestically
domestically
produced.
produced.
Physical
amount
McGraw-Hill/Irwin
Value
Widely used
by developing
countries to
develop their
manufacturing
base.
Used by developed
countries to
protect local jobs
and industry from
foreign competition.
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
5-10
Administrative Policies
Bureaucratic rules designed to make it difficult for imports
to enter a country.
Japanese ‘masters’ in imposing rules.
Tulip bulbs.
Federal Express.
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
5-11
Antidumping Policies
Selling goods into a foreign market below production
costs, or
Selling below “fair market value”.
Used to unload excess production.
Or, predatory pricing.
Antidumping policies are used to punish foreign firms.
Protect local industry from “unfair” practices.
Impose “countervailing” duties.
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
5-12
Political Arguments for Intervention
Protect
Industry
and Jobs.
National
Security
McGraw-Hill/Irwin
Protect
Human
Rights
Retaliation
Further
Foreign Policy
Objectives
Protect
Consumers
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
5-13
Protect
Industry
and Jobs.
McGraw-Hill/Irwin
Most common political argument.
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
5-14
Retaliation
McGraw-Hill/Irwin
Risky strategy. If government
fails to heed warnings and
imposes its own higher tariffs,
the result is higher tariffs all
around and a corresponding
economic loss.
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
5-15
Retaliation
US Trade Sanctions
Partial List
25
20
15
New
Sanctions
10
5
0
1993 95
McGraw-Hill/Irwin
97
Afghanistan Italy
Burma
Libya
Canada
Nigeria
China
N. Korea
Cuba
Pakistan
India
Saudi Arabia
Iran
Sudan
Iraq
Syria
Yugoslavia
99
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
5-16
Protect
Consumers
McGraw-Hill/Irwin
Battleground for biotechnology
such as hormone-treated
beef and genetically altered crops.
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
5-17
Further
Foreign Policy
Objectives
McGraw-Hill/Irwin
Used to build relations with
another country or punish it
(so-called rogue states). Policy
is unilateral and easily defeated
by other countries ignoring it.
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
5-18
Protect
Human
Rights
McGraw-Hill/Irwin
Basis for the use of “Most
Favored Nation” status to
persuade China to change its
positions on human rights.
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
5-19
Economic Arguments for Intervention
Infant
Industry
Strategic
Trade
Policy
McGraw-Hill/Irwin
 Infant industry is the oldest economic
argument for government intervention,
dating to 1792 and Alexander Hamilton.
 Protect developing country’s new industry
from developed countries better
established industries. Recognized by
GATT.
 Strategic trade policy can help a
firm gain ‘first mover’ advantages
or overcome barriers created by a
different (foreign) first mover.
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
5-20
Revised Case for Free Trade
Paul Krugman, MIT economist, argues that strategic
trade policies can lead to trade wars. The best way to
handle disputes is to work to establish rules that minimize
trade-distorting subsidies - a function of the World
Trade Organization.
He also argues that government intervention usually favors
special interest groups that distort the subsidy to their
own ends.
Therefore, “a blanket policy of free trade, with exceptions
granted only under extreme pressure … may be the best
policy that the country is likely to get.”
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
5-21
Development of the World Trading
System
Intellectual arguments for free trade:
Adam Smith and David Ricardo.
Free trade as government policy:
Britain’s (1846) repeal of the Corn Laws.
Britain continued free trade policy.
Fear of trade war.
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
5-22
World War I to World War II
1918 - 1939
Great Depression
US stock market collapse
Smoot-Hawley Act (1930)
US had positive trade balance with world
Act imposes tariffs to protect U.S. firms.
Foreign response was to impose own barriers
US exports tumbled
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
5-23
General Agreement on Tariffs and
Trade
WWII allies want international organization in trade arena
similar to UN in political arena.
GATT proposed by US in 1947 as step toward ITO.
1948: Havana Conference.
Failed charter for the International Trade Organization.
GATT
19 original members grew to 120 nations by the time it was
superceded by the WTO.
GATT members agree not to raise tariffs above negotiated
rates.
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
5-24
GATT Negotiating Rounds
%
Geneva 1947
Annecy 1949
Torquay 1950-51
Geneva 1956
Dillon
1960-62
Kennedy 1964-67
Tokyo
1973-79
Uruguay 1986-94
23
13
38
26
45
62
99
117
Annual Growth Under
GATT
9.0
8.5
8.0
7.5
7.0
6.5
6.0
5.5
5.0
4.5
4.0
1953-63
1963-73
World Trade
World Income
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
5-25
Average Reduction in US Tariff Rates
1947 - 85
120
Index
Pre-Geneva
Tariff = 100
100
80
60
40
20
McGraw-Hill/Irwin
yo
To
k
ed
y
en
n
K
ill
on
D
en
ev
a
G
ay
To
rq
u
nn
ec
y
A
en
ev
a
G
Pr
eG
en
ev
a
0
GATT Negotiating Rounds
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
5-26
1980-1993: Disturbing Trends
Pressures for greater protectionism:
Japan’s economic success.
World’s second largest economy.
World’s largest exporter.
The U.S.’s persistent trade deficit.
Many countries had found ways to avoid GATT
restrictions.
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
5-27
Uruguay Round
Most comprehensive trade agreement in history.
Created the World Trade Organization.
Impacted:
Agriculture subsidies (stumbling block:
US/EU).
Applied GATT rules to services and
intellectual property.
Strengthened GATT monitoring and
enforcement.
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
5-28
World Trade Organization
Umbrella organization for:
GATT
Services
Intellectual property
154 Rue de Lausanne, Geneva
Responsibility for trade arbitration:
Reports adopted unless specifically rejected.
After appeal, fail to comply can result in compensation to
injured country or trade sanctions.
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
5-29
WTO
141 members (China) and 28 candidates.
Between 1995 and 2000, 213 disputes brought before
the WTO.
Significant victories:
Telecommunications
68 countries (90%) of world
telecommunications revenues
Pledged to open their markets
to fair competition
Financial Services
95% of financial services market
102 countries will open, to varying
degrees, their markets.
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.
5-30
Failure of Countries to Agree on Goals
WTO
Seattle
Private Groups & Unions Oppose “faceless” Organization
McGraw-Hill/Irwin
© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.