International Business
by
Daniels and Radebaugh
Chapter 6
Governmental Influence
on Trade
© 2001 Prentice Hall
6-1
Objectives
To evaluate the rationale for governmental policies that enhance and
restrict trade
To examine the effects of pressure groups on trade policies
To compare the protectionist arguments used in developed countries
with those used in developing ones
To study the potential and actual effects of governmental intervention
on the free flow of trade
To give an overview of the major means by which trade is restricted,
regulated, and liberalized
To examine the World Trade Organization
To show that governmental trade policies create business uncertainties
© 2001 Prentice Hall
6-2
Introduction
No country permits unregulated flow of goods and services
across its borders
• Governments place restrictions on imports and
occasionally on exports
• Governments may provide direct and indirect subsidies to
improve the competitive position of some industries
Protectionism
• Government action intended to limit foreign producer’s
ability to compete with domestic industry
© 2001 Prentice Hall
6-3
Physical and Societal Influences on Protectionism and
Companies’ Competitive Environment
TRADE
COUNTRY A
• Political policies and legal
practices
•Cultural values, attitudes,
and beliefs
• Economic forces
• Geographic influences
COUNTRY B
ENHANCEMENTS
TRADE
RESTRICTIONS
• Political policies and legal
practices
•Cultural values, attitudes,
and beliefs
• Economic forces
• Geographic influences
COMPANIES’
COMPETITIVE
ENVIRONMENT
© 2001 Prentice Hall
6-4
Conflicting Results of Trade Policies
Objectives may conflict
• Economic, social, and political goals of a country often conflict
May be impossible to help some industries without hurting others
• Proposed reforms of trade regulations results in heated debates
among pressure groups
Rationales for Governmental Intervention
Economic Rationales
Prevent unemployment
Protect infant industries
Promote industrialization
Improve position compared to
other countries
Noneconomic Rationales
Maintain essential industries
Deal with unfriendly countries
Maintain spheres of influence
Preserve national identity
© 2001 Prentice Hall
6-5
Unemployment
Unemployed can form effective pressure group for import restrictions
Problems stemming from restricting imports to create jobs in the
domestic economy
• Retaliation by other countries
– less tendency to retaliate against small countries
– restricting country will gain jobs in one place and lose them
somewhere else
• Pressure against protectionism among workers in industries
dependent on imports
• Import restrictions indirectly cause loss of export income
• Potential costs of import restrictions include both higher prices
and higher taxes
– such costs should be compared with those of unemployment
© 2001 Prentice Hall
6-6
Infant-Industry Argument
Government should guarantee an emerging industry a large share of the
domestic market until it becomes efficient enough to compete against
imports
Initial output costs may make products noncompetitive in world markets
• Over time costs will decrease due to:
– greater economies of scale
– greater worker efficiency
Problems with argument
• Hard to identify industries with high probability of success
– even when industries can be identified, not clear that
government should provide protection
• Protection may serve as disincentive for managers to adopt
innovations needed to become competitive
© 2001 Prentice Hall
6-7
Industrialization Argument
Use of surplus workers—many workers can leave the agricultural sector
without affecting output
• Influx of workers into industrial sector may result in several
problems
– heavy demands on social and political services
– agriculture may be a better means of effecting additional
output than industry
– government must decide which industry to protect to
minimize consumer price and tax increases
– development possibilities in the agricultural sector may be
overlooked
Promoting investment flows—import restrictions may increase foreign
direct investment
• Influx of foreign companies may hasten industrialization
• Investment inflows may add to employment
© 2001 Prentice Hall
6-8
Industrialization Argument (cont.)
Diversification—price variations due to uncontrollable factors can wreak
havoc on economies dependent on exports
• Change from agriculture to industry in emerging economies may
simply shift the dependence from a few agricultural products to a
few industrial products
• Greater growth for manufactured products
• Terms of trade—quantity of imports that a given quantity of a
country’s exports can buy
– prices of raw material and agricultural commodities do not
rise as fast as prices of finished goods
– deterioration in emerging economies
» demand for primary products grows more slowly
» cost savings passed on to consumers
© 2001 Prentice Hall
6-9
Industrialization Argument (cont.)
Import substitution— restricting imports in order to produce for local
consumption goods that formerly were imported
• Not the best way to develop new industries
• An initial response to industrialization
Export-led development—creation of industries for which export markets
should logically exist
• A later stage in the industrialization process
© 2001 Prentice Hall
6-10
Economic Relationships with Other Countries
Balance-of-payments adjustments—governments attempt to modify
import or export movement in a free market
Comparable access or “fairness”
• In industries in which increased production will greatly decrease
cost, producers that lack equal access to a competitor’s market
will have a disadvantage in becoming cost competitive
• Equal access discussed in terms of fairness
– arguments against fairness doctrine
» there are advantages of freer trade, even if imposed
unilaterally
» may escalate economic tensions among trading partners
» cumbersome and expensive to negotiate separate
agreements for all products that could be traded
internationally
© 2001 Prentice Hall
6-11
Economic Relationships with Other Countries (cont.)
Price-control objectives
• Export restrictions may:
– raise costs of smuggling prevention
– lead to substitution
– keep domestic prices down by increasing domestic supply
– give producers less incentive to increase output
– shift foreign production and sales
• Import restrictions may:
– prevent dumping—exports priced below cost or homecountry price
– get other countries to bargain away restrictions
– get foreign producers to lower their prices
© 2001 Prentice Hall
6-12
Maintaining Essential Industries
Protecting domestic industries during peacetime so that country is not
dependent on foreign sources of supply during war
• Popular argument to support import restrictions
• Countries must
– determine which industries are essential
– consider costs and alternatives
– consider political consequences
Dealing with “Unfriendly” countries
Prevention of exports that might be acquired by potential enemies
• May lead to retaliation that prevents securing other essential
goods
• Trade controls on nondefense goods also may be used as a
weapon of foreign policy
© 2001 Prentice Hall
6-13
Maintaining Spheres of Influence
Governments may:
• Provide aid and credits to, and encourage imports from, countries
that are political allies
• Impose trade restrictions to coerce foreign countries to follow
certain political actions
Preserving Cultures and National Identity
Countries have a common sense of identity that separates them from
other nationalities
• May limit foreign products and services to protect their separate
identity
© 2001 Prentice Hall
6-14
Instruments of Trade Control
Tariffs—a tax governments levy on goods shipped internationally
• Most common type of trade control
– export tariff—collected by exporting country
– transport tariff—collected by country through which the goods
have passed
– import tariff—collected by importing country
» most common type of tariff
• Used to protect domestically produced goods
• Used as a source of governmental revenue
– specific duty—tariff assessed on per unit basis
– ad valorem duty—assessment is a percentage of the value of
the item
– compound duty—combination of specific duty and ad
valorem duty on the same product
© 2001 Prentice Hall
6-15
Trade Restrictions Based on Tariffs
Pric
e
S
Higher Price
D
As tax raises
price, quantity
sold decreases
P2
P1
Tax
0
Q2
Q1
Quantity
Higher Sales
© 2001 Prentice Hall
6-16
Instruments of Trade Control (cont.)
Nontariff Barriers: Direct Price Influences
• Subsidies—direct government payments to domestic companies
to compensate them for losses incurred from selling abroad
– other types of government assistance makes it cheaper or
more profitable to sell abroad
» potential exporters provided with an array of services
– subsidies to overcome market imperfections are least
controversial
– there is little agreement on what a subsidy is
– there has been a recent increase in export-credit assistance
• Aid and loans—given to other countries with the proviso that the
funds be spent in the donor country
– repayment insurance for exporters
© 2001 Prentice Hall
6-17
Instruments of Trade Control (cont.)
Nontariff Barriers: Direct Price Influences (cont.)
• Customs valuation—procedures for assessing value when
customs agents levy tariffs
– may be based on
» invoice price
» value of identical goods
» similar goods coming in at the same time
» final sales value or on reasonable cost
– valuation problems created by the large number of products
that are traded
• Other direct price influences
– special fees
– customs deposits
– minimum price levels
© 2001 Prentice Hall
6-18
Instruments of Trade Control (cont.)
Nontariff Barriers: Quantity Controls
• Quotas—limits the quantity of a product allowed to be imported in
a given year
– Most-common restriction based on quantity
– amount frequently reflects guarantee that domestic
producers will have access to a certain percentage of the
domestic market
– problems with quotas
» transshipping goods among countries
» transforming product into one for which there is no quota
– export quotas
» assure domestic consumers a supply of goods at low
price
» prevent depletion of natural resources
» raise export prices
– Embargo—quota that prohibits all trade
© 2001 Prentice Hall
6-19
Trade Restrictions Based on Available Supply
Pric
e
D
S1
S
Higher Price
Import restriction
causes quantity
sold to fall
P2
P1
0
Q2
Q1
Quantity
Higher Sales
© 2001 Prentice Hall
6-20
Instruments of Trade Control (cont.)
Nontariff Barriers: Quantity Controls
• “Buy local” legislation—governments favor purchasing goods
produced domestically
– legislation that prescribes a minimum percentage of domestic
value
• Standards—classification, labeling, and testing standards limit
sales of foreign products
• Specific permission requirements
– import license—potential importers or exporters require
governmental permission before conducting trade
transactions
– foreign-exchange control—importer required to apply to a
governmental agency to secure foreign currency to pay for a
product
• Administrative delays—intentional delays that create uncertainty
and raise the cost of carrying inventory
© 2001 Prentice Hall
6-21
Instruments of Trade Control (cont.)
Nontariff Barriers: Quantity Controls (cont.)
• Reciprocal requirements—governmental requirements that
– exporters take merchandise in lieu of money
– exporters promise to buy merchandise or services in the
country to which they export
– countertrade or offset—barter transaction
• Restriction on services—exist for three reasons
– Essentiality—countries do not want to depend on foreign
companies for strategic services
– Standards—ensure qualifications of providers
» little reciprocal recognition in licensing from one country
to another
– Immigration—protect employment of country’s own citizens
» require local search for qualified personnel before hiring
a foreigner
© 2001 Prentice Hall
6-22
General Agreement on Tariffs and Trade (GATT)
Created in 1947 by 23 countries
• Intended to negotiate reductions in trade restrictions and develop
common procedures for handling imports and exports
• Efforts led to a number of multilateral reductions in tariffs and
nontariff barriers for member countries
– across-the-board reductions
– each country negotiated exceptions to its reductions
• Codes of conduct developed in each of five areas
Inherent weakness of GATT
• Cumbersome negotiations
• Most-favored nation— trade concessions applied to all trading
partners
• No mechanism to assure compliance with negotiated agreements
© 2001 Prentice Hall
6-23
World Trade Organization (WTO)
Created in 1995 to replace GATT
Negotiating process
• Ongoing negotiations about
– restrictions on trade in services
– nontariff barriers to trade
– protection of intellectual-property rights
– investment policies that affect trade
Granting of normal trade relations
• Apply to WTO members
• Eliminates the free-rider complaint raised during GATT
negotiations
• Certain exceptions recognized
Settlement of disputes
• Clearly defined settlement mechanism
• Sanctions may be applied to countries that do not comply with
rulings
© 2001 Prentice Hall
6-24
Dealing with Governmental Trade Influences
When faced with import competition, companies may
• Move production to a lower-cost country
• Concentrate on market niches in which there is less international
competition
• Effect internal adjustments
Companies may require assistance of government to limit imports or
open foreign markets
• Governments deny some requests for assistance
companies attitudes differ toward protectionism
• Companies likely to lose from protectionism
– those that depend heavily on trade
– those that have integrated production in different global
locations
• Companies likely to gain from protectionism have single or
multidomestic production facilities
© 2001 Prentice Hall
6-25