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Business–Government Trade Relations

Business–Government Trade Relations

Business–Government Trade Relations

Learning Objectives

After studying this chapter, you should be able to

1 Describe the political, economic, and cultural motives behind governmental intervention in trade.

2 List and explain the methods governments use to promote international trade.

3 List and explain the methods governments use to restrict international trade.

4 Discuss the importance of the World Trade Organization in promoting free trade.

A LOOK BACK

Chapter 5 explored theories that have been developed to explain the pattern that international trade should take. We examined the important concept of comparative advantage and the conceptual basis for how international trade benefits nations.

A LOOK AT THIS CHAPTER

This chapter discusses the active role of national governments in international trade. We examine the motives for government intervention and the tools that nations use to accomplish their goals. We then explore the global trading system and show how it promotes free trade.

A LOOK AHEAD

Chapter 7 continues our discussion of the international business environment. We explore recent patterns of foreign direct investment, theories that try to explain why it occurs, and the role of governments in influencing investment flows.

Lord of the Media

Hollywood, California — Time Warner (www.timewarner.com) is the world’s leading media and entertainment company and earns around $46 billion annually. Its businesses include television networks (HBO, Turner Broadcasting), publishing (Time, Sports Illustrated), and film entertainment (New Line Cinema, Warner Bros.). As Time Warner marches across the globe, people in almost every nation on the planet view its media creations.

New Line Cinema’s The Lord of the Rings trilogy (based on the tale by J.R.R. Tolkien) is the most successful film franchise in history. The final installment in the trilogy, The Lord of the Rings: The Return of the King, earned more than $1 billion at the worldwide box office. The entire trilogy earned nearly $3 billion worldwide and won 17 Academy Awards. New Line is now producing the prequel to The Lord of the Rings series, The Hobbit.

Source: David James/Warner Bros/Courtesy of Warner Bros./Bureau L.A. Co./CORBIS-NY.

Warner Bros.’s ongoing Harry Potter films, based on the novels of former British schoolteacher J.K. Rowling, have been magically successful. Kids worldwide snatched up Harry Potter books in every major language and now pour into cinemas to watch young Harry on the silver screen. Warner Bros. also hit it big in 2008 with the Batman film, The Dark Knight—one of the highest-grossing films ever. The company also produces mini-movies and games exclusively for its Web site.

Yet Time Warner must tread carefully as it expands its reach. Some governments fear that their own nations’ writers, actors, directors, and producers will be drowned out by big-budget Hollywood productions such as The Lord of the Rings and Harry Potter. Others fear the replacement of their traditional values with those depicted in imported entertainment. As you read this chapter, consider all the cultural, political, and economic reasons why governments regulate international trade.1

Chapter 5 presented theories that describe what the patterns of international trade should look like. The theory of comparative advantage says that the country that has a comparative advantage in the production of a certain good will produce that good when barriers to trade do not exist. But this ideal does not accurately characterize trade in today’s global marketplace. Despite efforts by organizations such as the World Trade Organization (www.wto.org) and smaller groups of countries, nations still retain many barriers to trade.

In this chapter, we investigate business–government trade relations. We first explain why nations erect barriers to trade, exploring the cultural, political, and economic motives for such barriers. We then examine the instruments countries use to restrict imports and exports. Efforts to promote trade by reducing barriers within the context of the global trading system are then presented. In Chapter 8 we discuss how smaller groups of countries are eliminating barriers to both trade and investment.

Why Do Governments Intervene in Trade?

The pattern of imports and exports that occurs in the absence of trade barriers is called free trade. Despite the advantages of open and free trade among nations, governments have long intervened in the trade of goods and services. Why do governments impose restrictions on free trade? In general, they do so for reasons that are political, economic, or cultural—or some combination of the three. Countries often intervene in trade by strongly supporting their domestic companies’ exporting activities. But the more emotionally charged intervention occurs when a nation’s economy is underperforming. In tough economic times, businesses and workers often lobby their governments for protection from imports that are eliminating jobs in the domestic market. Let’s take a closer look at the political, economic, and cultural motives for intervention.

free trade

Pattern of imports and exports that occurs in the absence of trade barriers.

Political Motives

Government officials often make trade-related decisions based on political motives because a politician’s career can depend on pleasing voters and getting reelected. Yet a trade policy based purely on political motives is seldom wise in the long run. The main political motives behind government intervention in trade include protecting jobs, preserving national security, responding to other nations’ unfair trade practices, and gaining influence over other nations.2

Protect Jobs

Short of an unpopular war, nothing will oust a government faster than high rates of unemployment. Thus practically all governments become involved when free trade creates job losses at home. Ohio lost around 215,000 manufacturing jobs in the 14 years between 1994 and 2008. Most of those jobs went to China and the nations of Central and Eastern Europe. The despair of unemployed workers and the pivotal role of Ohio in the presidential election of 2008 lured politicians to the state who promised Ohio lower income taxes, expanded worker retraining, and greater investment in the state’s infrastructure.

But politicians’ efforts to protect jobs can draw attention away from free trade’s real benefits. General Electric (GE) sent many jobs from the United States to Mexico over the years. GE now employs 30,000 Mexicans at 35 factories that are manufacturing all sorts of its appliances and other goods. But GE also sold Mexican companies $350 million worth of its turbines made in Texas, 100 of its locomotives made in Pennsylvania, and dozens of its aircraft engines. Mexico specializes in making products that require less expensive labor and the United States specializes in producing goods that require advanced technology and a large investment of capital.3

Preserve National Security

Industries considered essential to national security often receive government-sponsored protection. This is true for both imports and exports.

NATIONAL SECURITY AND IMPORTS

Certain imports are often restricted in the name of preserving national security. In the event that a war would restrict their availability, governments must have access to a domestic supply of certain items such as weapons, fuel, and air, land, and sea transportation. Many nations continue to search for oil within their borders in case war disrupts its flow from outside sources. Legitimate national security reasons for intervention can be difficult to argue against, particularly when they have the support of most of a country’s people.

Some countries claim national security is the reason for fierce protection of their agricultural sector, for food security is essential at a time of war. France has been criticized by many nations for ardently protecting its agricultural sector. French agricultural subsidies are intended to provide a fair financial return for French farmers, who traditionally operate on a small scale and therefore have high production costs and low profit margins. But many developed nations are exposing agribusiness to market forces and prompting their farmers to discover new ways to manage risk and increase efficiency. Innovative farmers are experimenting with more intensive land management, high-tech precision farming, and greater use of biotechnology.

Yet protection from import competition does have its drawbacks. Perhaps the main one is the added cost of continuing to produce a good or provide a service domestically that could be supplied more efficiently from abroad. Also, a policy of protection may remain in place much longer than necessary once it is adopted. Thus policy makers should consider whether an issue truly is a matter of national security before intervening in trade.

NATIONAL SECURITY AND EXPORTS

Governments also have national security motives for banning certain defense-related goods from export to other nations. Most industrialized nations have agencies that review requests to export technologies or products that are said to have dual uses—meaning they have both industrial and military applications. Products designated as dual use are classified as such and require special governmental approval before export can take place.

Products on the dual-use lists of most nations include nuclear materials; technological equipment; certain chemicals and toxins; some sensors and lasers; and specific devices related to weapons, navigation, aerospace, and propulsion. Bans on the export of dual-use products were strictly enforced during the Cold War years between the West and the former Soviet Union. Whereas many countries relaxed enforcement of these controls in recent years, the continued threat of terrorism and fears of weapons of mass destruction are renewing support for such bans.

Protesters from the civic initiative called “compact.de” protest against genetically modified foods in front of the Bundestag in Berlin, Germany. All types of crops today, including corn, soybeans, and wheat, are grown with genetically enhanced seed technology to resist insects and disease. Many people in Europe fiercely resist U.S. efforts to export GM crops to their markets. Do you believe Europeans are right to be wary of the importation of genetically modified crops?

Source: Getty Images.

Nations also place certain companies and organizations in other countries on a list of entities that are restricted from receiving their exports. In 2008, the owner of an electronics firm pleaded guilty to charges of conspiracy to illegally export dual-use items from the United States to India for possible use in ballistic missiles, space launch vehicles, and fighter jets. Parthasarathy Sudarshan admitted that he provided the components to government entities in India including two companies on the U.S. Department of Commerce’s “Entity List.” Sudarsham was sentenced to 35 months in a U.S. federal prison and was fined $60,000.4

Respond to “Unfair” Trade

Many observers argue that it makes no sense for one nation to allow free trade if other nations actively protect their own industries. Governments often threaten to close their ports to another nation’s ships or to impose extremely high tariffs on its goods if the other nation does not concede on some trade issue that is seen as being unfair. In other words, if one government thinks another nation is not “playing fair,” it will often threaten to retaliate unless certain concessions are made.

Gain Influence

Governments of the world’s largest nations may become involved in trade to gain influence over smaller nations. The United States goes to great lengths to gain and maintain control over events in all of Central, North, and South America, and the Caribbean basin.

The United States has banned all trade and investment with Cuba since 1961 in the hope of exerting political influence against its communist leaders. Designed to pressure Cuba’s government to change, the policy caused ordinary Cubans to suffer and many perished trying to reach the United States on homemade rafts. But change is occurring in Cuba and since 2008 ordinary Cubans can buy DVD players, stay in tourist hotels, and use mobile phones. Even the concept of performance-related pay was introduced. These seemingly trivial freedoms represent monumental change to ordinary Cubans, who now hope for the right to buy cars, travel, and buy and sell property.5

Economic Motives

Although governments intervene in trade for highly charged cultural and political reasons, they also have economic motives for their intervention. The most common economic reasons for nations’ attempts to influence international trade are the protection of young industries from competition and the promotion of a strategic trade policy.

Protect Infant Industries

According to the infant industry argument, a country’s emerging industries need protection from international competition during their development phase until they become sufficiently competitive internationally. This argument is based on the idea that infant industries need protection because of a steep learning curve. In other words, only as an industry grows and matures does it gain the knowledge it needs to become more innovative, efficient, and competitive.

Although this argument is conceptually appealing, it does have several problems. First, the argument requires governments to distinguish between industries that are worth protecting and those that are not. This is difficult, if not impossible, to do. For years, Japan has targeted infant industries for protection, low interest loans, and other benefits. Its performance on assisting these industries was very good through the early 1980s but has been less successful since then. Until the government achieves future success in identifying and targeting industries, supporting this type of policy remains questionable.

Second, protection from international competition can cause domestic companies to become complacent toward innovation. This can limit a company’s incentives to obtain the knowledge it needs to become more competitive. The most extreme examples of complacency are industries within formerly communist nations. When their communist protections collapsed, nearly all companies that were run by the state were decades behind their competitors from capitalist nations. To survive, many government-owned businesses required financial assistance in the form of infusions of capital or outright purchase.

Third, protection can do more economic harm than good. Consumers often end up paying more for products because a lack of competition typically creates fewer incentives to cut production costs or improve quality. Meanwhile, companies become less competitive and more reliant on protection. Protection in Japan created a two-tier economy where in one tier highly competitive multinationals faced rivals in overseas markets and learned to become strong competitors. In the other tier, domestic industries were made noncompetitive through protected markets, high wages, and barriers to imports.

Fourth, the infant industry argument also says that it is not always possible for small, promising companies to obtain funding in capital markets, and thus they need financial support from their government. However, international capital markets today are far more sophisticated than in the past, and promising business ventures can normally obtain funding from private sources.

Pursue Strategic Trade Policy

Recall from our discussion in Chapter 5 that new trade theorists believe government intervention can help companies take advantage of economies of scale and be the first movers in their industries. First-mover advantages result because economies of scale in production limit the number of companies that an industry can sustain.

BENEFITS OF STRATEGIC TRADE POLICY

Supporters of strategic trade policy argue that it results in increased national income. Companies should earn a good profit if they obtain first-mover advantages and solidify positions in their markets around the world. Advocates claim that strategic trade policies helped South Korea build global conglomerates (called chaebol) that dwarf competitors. For years, South Korean shipbuilders received a variety of government subsidies, including low-cost financing. The chaebol made it possible for companies to survive poor economic times because of the wide range of industries in which they competed. Such policies had spin-off effects on related industries. Yet some argue that South Korea’s chaebol must shift their focus from manufacturing to services and become more open organizations to help improve their nation’s competitiveness.6

Hyundai Heavy Industries is one of South Korea’s giant chaebol and the world’s largest shipbuilder. The ship shown here, named Al Gattara, was built by Hyundai and sold to a client in the United States. Al Gattara’s capacity is 216,000 square meters of liquid natural gas, which makes it the largest carrier of the gas in the world. Can you think of other products that are made by the Hyundai group?

Source: CORBIS-NY.

DRAWBACKS OF STRATEGIC TRADE POLICY

Although it sounds as if strategic trade policy has only benefits, there can be drawbacks as well. Lavish government assistance to domestic companies caused inefficiency and high costs for both South Korean and Japanese companies. Large government concessions to local labor unions hiked wages and forced Korea’s chaebol to accept low profit margins.

In addition, when governments decide to support specific industries, their choice is often subject to political lobbying by the groups seeking government assistance. It is possible that special interest groups could capture all the gains from assistance with no benefit for consumers. If this were to occur, consumers could end up paying more for lower-quality goods than they could otherwise obtain.

Cultural Motives

Nations often restrict trade in goods and services to achieve cultural objectives, the most common being protection of national identity. Culture and trade are intertwined and greatly affect one another. The cultures of countries are slowly altered by exposure to the people and products of other cultures. Unwanted cultural influence in a nation can cause great distress and cause governments to block imports that it believes are harmful (recall our discussion of cultural imperialism in Chapter 2).

French law bans foreign-language words from virtually all business and government communications, radio and TV broadcasts, public announcements, and advertising messages—at least whenever a suitable French alternative is available. You can’t advertise a best-seller; it has to be a succès de librairie. You can’t sell popcorn at le cinéma; French moviegoers must snack on mais soufflé. The Higher Council on French Language works against the inclusion of so-called “Franglais” phrases such as le marketing, le cash flow, and le brainstorming into commerce and other areas of French culture.

Canada also tries to mitigate the cultural influence of entertainment products imported from the United States. Canada requires at least 35 percent of music played over Canadian radio to be by Canadian artists. In fact, many countries are considering laws to protect their media programming for cultural reasons. The downside of such restrictions is they reduce the selection of products available to consumers.

Cultural Influence of the United States

The United States, more than any other nation, is seen by many around the world as a threat to local culture. The reason is the global strength of the United States in entertainment and media (such as movies, magazines, and music) and consumer goods. These products are highly visible to all consumers and cause groups of various kinds to lobby government officials for protection from their cultural influence. Domestic producers find it easy to join in the calls for protection because the rhetoric of protectionism often receives widespread public support.

International trade is the vehicle by which the English language swiftly infiltrates the cultures of other nations. International trade in all sorts of goods and services is exposing people around the world to new words, ideas, products, and ways of life. But as international trade continues to expand, many governments try to limit potential adverse effects on their cultures and economies. This is where the theory of international trade meets the reality of international business.7

Quick Study

1. What are some political reasons why governments intervene in trade? Explain the role of national security concerns.

2. Identify the main economic motives for government trade intervention. What are the drawbacks of each method of intervention?

3. What cultural motives do nations have for intervening in free trade?

Methods of Promoting Trade

In the previous discussion, we alluded to the types of instruments governments use to promote or restrict trade with other nations. The most common instruments that governments use are shown in Table 6.1. In this section we examine methods of trade promotion. We cover methods of trade restriction in the next section.

Subsidies

Financial assistance to domestic producers in the form of cash payments, low interest loans, tax breaks, product price supports, or other form is called a subsidy. Regardless of the form a subsidy takes, it is intended to assist domestic companies in fending off international competitors. This can mean becoming more competitive in the home market or increasing competitiveness in international markets through exports. It is nearly impossible to calculate the amount of subsidies a country offers its producers because of their many forms. This makes the work of the World Trade Organization difficult when it is called upon to settle arguments over subsidies (the World Trade Organization is presented later in this chapter).

subsidy

Financial assistance to domestic producers in the form of cash payments, low interest loans, tax breaks, product price supports, or other form.

Drawbacks of Subsidies

Critics say that subsidies encourage inefficiency and complacency by covering costs that truly competitive industries should be able to absorb on their own. Many believe subsidies benefit companies and industries that receive them but harm consumers because they tend to be paid for with income and sales taxes. Thus, although subsidies provide short-term relief to companies and industries, whether they help a nation’s citizens in the long term is questionable.

Some observers say that far more devastating is the effect of subsidies on farmers in developing and emerging markets. We’ve already seen that many wealthy nations award subsidies to their farmers to ensure an adequate food supply for their people. These subsidies worth billions of dollars make it difficult, if not impossible, for farmers from poor countries to sell their unsubsidized (i.e., more expensive) food on world markets, it is said. Compounding the plight of these farmers is that their nations are being forced to eliminate trade barriers by international organizations. The economic consequences for poor farmers in Africa, Asia, and Latin America are higher unemployment and poverty.8

Subsidies can lead to an overuse of resources, negative environmental effects, and higher costs for commodities. As fuel prices soared in 2008, governments fearing inflation and street protests increased their heavy subsidies of energy. Fuel subsidies in China alone for 2008 were estimated to be a whopping $40 billion. These subsidies eliminate incentives to conserve fuel and drive fuel prices higher. Whereas countries without fuel subsidies saw steady or falling demand, subsidizing countries saw rising demand that threatened to outstrip growth in global fuel supplies.9

Export Financing

Governments often promote exports by helping companies finance their export activities. They can offer loans that a company could otherwise not obtain or charge them an interest rate that is lower than the market rate. Another option is for a government to guarantee that it will repay the loan of a company if the company should default on repayment; this is called a loan guarantee.

TABLE 6.1 Methods of Promoting and Restricting Trade

Trade Promotion

Trade Restriction

Subsidies

Tariffs

Export financing

Quotas

Foreign trade zones

Embargoes

Special government agencies

Local content requirements

Administrative delays

Currency controls

Many nations have special agencies dedicated to helping their domestic companies obtain export financing. For example, a very well-known institution is called the Export-Import Bank of the United States—or Ex-Im Bank for short. The Ex-Im Bank (www.exim.gov) finances the export activities of companies in the United States and offers insurance on foreign accounts receivable. Another U.S. government agency, the Overseas Private Investment Corporation (OPIC), also provides insurance services, but for investors. Through OPIC (www.opic.gov), companies that invest abroad can insure against losses due to: (1) expropriation; (2) currency inconvertibility; and (3) war, revolution, and insurrection.

Receiving financing from government agencies is often crucial to the success of small businesses that are just beginning to export. Taken together, small businesses account for over 80 percent of all transactions handled by the Ex-Im Bank. For instance, the Ex-Im Bank guaranteed to cover a loan of $3.88 million to help fund development of the GI Leisure Amusement Park project in Efua Sutherland Park in Accra, Ghana. The company’s investment in Africa is in response to rising demand for world class amusement parks across West Africa. The park will employ at least 175 local Ghanaians under the supervision of U.S. expatriate managers. For more on how the Ex-Im Bank helps businesses gain export financing, see the Entrepreneur’s Toolkit titled, “Experts in Export Financing.”10

ENTREPRENEUR’S TOOLKIT: Experts in Export Financing

Here are several Ex-Im Bank (www.exim.gov) programs to help businesses obtain financing:

■ City/State Program. This program brings the Ex-Im Bank’s financing services to small and medium-sized U.S. companies that are ready to export. These partnership programs currently exist with 38 state and local government offices and private sector organizations.

■ Working Capital Guarantee Program. This program helps small and medium-sized businesses that have exporting potential but lack the needed funds by encouraging commercial lenders to loan them money. The bank guarantee covers 90 percent of the loan’s principal and accrued interest. The exporter may use the guaranteed financing to purchase finished products for export or pay for raw materials, for example.

■ Credit Information Services. The bank’s repayment records provide credit information to U.S. exporters and commercial lenders. The bank can provide information on a country or specific company abroad. But the bank does not divulge confidential financial data on non-U.S. buyers to whom it has extended credit or confidential information regarding particular conditions in other countries.

■ Credit Insurance. This program helps U.S. exporters develop and expand their overseas sales by protecting them against loss should a non-U.S. buyer or other non-U.S. debtor default for political or commercial reasons. The insurance policy can make obtaining export financing easier because, with approval by the bank, the proceeds of the policy can be used as collateral.

■ Guarantee Program. This program provides repayment protection for private sector loans made to creditworthy buyers of U.S. capital equipment, projects, and services. The bank guarantees that, in the event of default, it will repay the principal and interest on the loan. The non-U.S. buyer must make a cash payment of at least 15 percent. Most guarantees provide comprehensive coverage against political and commercial risks.

■ Loan Program. The bank makes loans directly to non-U.S. buyers of U.S. exports and intermediary loans to creditworthy parties that provide loans to non-U.S. buyers. The program provides fixed-interest-rate financing for export sales of U.S. capital equipment and related services.

Source: Export-Import Bank of the United States Web site (www.exim.gov).

Foreign Trade Zones

Most countries promote trade with other nations by creating what is called a foreign trade zone (FTZ)—a designated geographic region in which merchandise is allowed to pass through with lower customs duties (taxes) and/or fewer customs procedures. Increased employment is often the intended purpose of foreign trade zones, with a by-product being increased trade. A good example of a foreign trade zone is Turkey’s Aegean Free Zone, in which the Turkish government allows companies to conduct manufacturing operations free from taxes.

foreign trade zone (FTZ)

Designated geographic region in which merchandise is allowed to pass through with lower customs duties (taxes) and/or fewer customs procedures.

Customs duties increase the total amount of a good’s production cost and increase the time needed to get it to market. Companies can reduce such costs and time by establishing a facility inside a foreign trade zone. A common purpose of many companies’ facilities in such zones is final product assembly. The U.S. Department of Commerce (www.commerce.gov) administers dozens of foreign trade zones within the United States. Many of these zones allow components to be imported at a discount from the normal duty. Once assembled, the finished product can be sold within the U.S. market with no further duties charged. State governments welcome such zones to obtain the jobs that the assembly operations create.

China has established a number of large foreign trade zones to reap the employment advantages they offer. Goods imported into these zones do not require import licenses or other documents nor are they subject to import duties. International companies can also store goods in these zones before shipping them to other countries without incurring taxes in China. Moreover, five of these zones are located within specially designated economic zones in which local governments can offer additional opportunities and tax breaks to international investors.

Another country that has enjoyed the beneficial effects of foreign trade zones is Mexico. Decades ago, Mexico established such a zone along its northern border with the United States. Creation of the zone caused development of companies called maquiladoras along the border inside Mexico. The maquiladoras import materials or parts from the United States duty free, process them to some extent, and export them back to the United States, which charges duties only on the value added to the product in Mexico. The program has expanded rapidly over the five decades since its inception, employing hundreds of thousands of people from all across Mexico who move north looking for work.

Special Government Agencies

The governments of most nations have special agencies responsible for promoting exports. Such agencies can be particularly helpful to small and medium-sized businesses that have limited financial resources. Government trade promotion agencies often organize trips for trade officials and businesspeople to visit other countries to meet potential business partners and generate contacts for new business. They also typically open trade offices in other countries. These offices are designed to promote the home country’s exports and introduce businesses to potential partners in the host nation. Government trade promotion agencies typically do a great deal of advertising in other countries to promote the nation’s exports. For example, Chile’s Trade Commission, ProChile, has commercial offices in 40 countries and a Web site (www.chileinfo.com).

Governments not only promote trade by encouraging exports but also can encourage imports that the nation does not or cannot produce. For example, the Japan External Trade Organization (JETRO) (www.jetro.go.jp) is a trade promotion agency of the Japanese government. The agency coaches small and medium-sized overseas businesses on the protocols of Japanese deal making, arranges meetings with suitable Japanese distributors and partners, and even assists in finding temporary office space.

For all companies, and particularly small ones with fewer resources, learning the government regulations in other countries is a daunting task. A company must know whether its product is subject to a tariff or quota, for instance. Fortunately, it is now possible to get answers to many such questions through the Internet. For some informative Web sites, see the Global Manager’s Briefcase titled, “Surfing the Regulatory Seas.”

GLOBAL MANAGER’S BRIEFCASE Surfing the Regulatory Seas

U.S. Department of Commerce

■ The International Trade Administration (ITA) Web site (www.trade.gov) offers trade data by country, region, and industry sector. It also has information on export assistance centers around the United States, a national export directory, and detailed background information on each trading partner of the United States.

■ The FedWorld Web site (www.fedworld.gov) is a comprehensive central access point for locating and acquiring information on U.S. government activities and trade regulations.

■ The Stat-USA Web site (www.stat-usa.gov) lists databases on trade regulations and documentation requirements on a country-by-country basis.

U.S. Chamber of Commerce

Dun & Bradstreet’s (www.dnb.com) 2,000-page Exporter’s Encyclopedia has been called the “bible of exporting,” and it’s now available online on the U.S. Chamber of Commerce’s International Business Exchange Web site (www.uschamber.org/international). Access to the encyclopedia is offered as part of a chamber membership package, which also includes information on a variety of international trade topics.

U.S. Trade Representative

The Office of the United States Trade Representative Web site (www.ustr.gov) has a wealth of free information on trade policy issues. Up-to-date reports on the site list important barriers that affect U.S. exports to other countries. It is also a source for information on trade negotiations, including a wide range of documents on all subjects relating to trade talk agendas, as well as a helpful section on acronyms to help you get through the entries.

U.S. Export Portal

This is the U.S. government’s online point of entry (www.export.gov) for U.S. exporters. The site organizes exportrelated programs, services, and market research information across 19 federal agencies. The site can be used to search for official trade shows, seminars, missions, and other related activities around the world.

Quick Study

1. How do governments use subsidies to promote trade? Identify the drawbacks of subsidies.

2. How does export financing promote trade? Explain its importance to small and medium-sized firms.

3. Define the term foreign trade zone. How can it be used to promote trade?

4. How can special government agencies help promote trade?

Methods of Restricting Trade

Earlier in this chapter we read about the political, economic, and cultural reasons for governmental intervention in trade. In this section we discuss the methods governments can use to restrict unwanted trade. There are two general categories of trade barrier available to governments. A tariff is a government tax levied on a product as it enters or leaves a country. A tariff increases the price of an imported product directly and, therefore, reduces its appeal to buyers. A nontariff barrier limits the availability of an imported product, which increases its price indirectly and, therefore, reduces its appeal to buyers. Let’s take a closer look at tariffs and the various types of nontariff barriers.

tariff

Government tax levied on a product as it enters or leaves a country.

Tariffs

We can classify a tariff into one of three categories. An export tariff is levied by the government of a country that is exporting a product. Countries can use export tariffs when they believe an export’s price is lower than it should be. Developing nations whose exports consist mostly of low-priced natural resources often levy export tariffs. A transit tariff is levied by the government of a country that a product is passing through on its way to its final destination. Transit tariffs have been almost entirely eliminated worldwide through international trade agreements. An import tariff is levied by the government of a country that is importing a product. The import tariff is by far the most common tariff used by governments today.

We can further break down the import tariff into three subcategories based on the manner in which it is calculated. An ad valorem tariff is levied as a percentage of the stated price of an imported product. A specific tariff is levied as a specific fee for each unit (measured by number, weight, etc.) of an imported product. A compound tariff is levied on an imported product and calculated partly as a percentage of its stated price and partly as a specific fee for each unit. Let’s now discuss the two main reasons why countries levy tariffs.

ad valorem tariff

Tariff levied as a percentage of the stated price of an imported product.

specific tariff

Tariff levied as a specific fee for each unit (measured by number, weight, etc.) of an imported product.

compound tariff

Tariff levied on an imported product and calculated partly as a percentage of its stated price and partly as a specific fee for each unit.

Protect Domestic Producers

Nations can use tariffs to protect domestic producers. For example, an import tariff raises the cost of an imported good and increases the appeal of domestically produced goods. In this way, domestic producers gain a protective barrier against imports. Although producers that receive tariff protection can gain a price advantage, in the long run protection can keep them from increasing efficiency. A protected industry can be devastated if protection encourages complacency and inefficiency and it is later thrown into the lion’s den of international competition. Mexico began reducing tariff protection in the mid-1980s as a prelude to NAFTA negotiations, and many Mexican producers went bankrupt despite attempts to grow more efficient.

Generate Revenue

Tariffs are also a source of government revenue, but mostly among developing nations. The main reason is that less-developed nations tend to have less formal domestic economies that lack the capability to record domestic transactions accurately. The lack of accurate record keeping makes collection of sales taxes within the country extremely difficult. Nations solve the problem by simply raising their needed revenue through import and export tariffs. As countries develop, however, they tend to generate a greater portion of their revenues from taxes on income, capital gains, and other economic activity.

The discussion so far leads us to question: “Who benefits from tariffs?” We’ve already learned the two principal reasons for tariff barriers—protecting domestic producers and raising government revenue. On the surface it appears that governments and domestic producers benefit. We also saw that tariffs raise the price of a product because importers typically charge a higher price to recover the cost of this additional tax. Thus it appears on the surface that consumers do not benefit. As we also mentioned earlier, there is the danger that tariffs will create inefficient domestic producers that may go out of business once protective import tariffs are removed. Analysis of the total cost to a country is far more complicated and goes beyond the scope of our discussion. Suffice it to say that tariffs tend to exact a cost on countries as a whole because they lessen the gains that a nation’s people obtain from trade.

Quotas

A restriction on the amount (measured in units or weight) of a good that can enter or leave a country during a certain period of time is called a quota. After tariffs, quotas are the second most common type of trade barrier. Governments typically administer their quota systems by granting quota licenses to the companies or governments of other nations (in the case of import quotas) and domestic producers (in the case of export quotas). Governments normally grant such licenses on a year-by-year basis.

quota

Restriction on the amount (measured in units or weight) of a good that can enter or leave a country during a certain period of time.

Reason for Import Quotas

A government may impose an import quota to protect its domestic producers by placing a limit on the amount of goods allowed to enter the country. This helps domestic producers maintain their market shares and prices because competitive forces are restrained. In this case, domestic producers win because their market is protected. Consumers lose because of higher prices and limited selection attributable to lower competition. Other losers include domestic producers whose own production requires the import subjected to a quota. Companies relying on the importation of so-called intermediate goods will find the final cost of their own products increase.

Workers sew at a garment factory in Gazipur near the Bangladeshi capital Dhaka. Across Bangladesh, hundreds of small clothing factories have thrived following removal of worldwide import quotas allowed under the Multi-Fibre Agreement. Under the MFA, wealthy nations guaranteed imports of textiles and garments from poor countries under a quota system. Under what conditions do you think nations should be allowed to impose import quotas?

Source: Rafiqur Rahman/Reuters/CORBIS-NY.

Historically, countries placed import quotas on the textile and apparel products of other countries under the Multi-Fibre Arrangement. This arrangement at one time affected countries accounting for over 80 percent of world trade in textiles and clothing. When that arrangement expired in 2005, many textile producers in poor nations feared the loss of jobs to China. But some countries, such as Bangladesh, are benefiting from cheap labor and the reluctance among purchasers to rely exclusively on China for all its inputs.11

Reasons for Export Quotas

There are at least two reasons why a country imposes export quotas on its domestic producers. First, it may wish to maintain adequate supplies of a product in the home market. This motive is most common among countries that export natural resources that are essential to domestic business or the long-term survival of a nation.

Second, a country may limit the export of a good to restrict its supply on world markets, thereby increasing the international price of the good. This is the motive behind the formation and activities of the Organization of Petroleum Exporting Countries (OPEC) (www.opec.org). This group of nations from the Middle East and Latin America attempts to restrict the world’s supply of crude oil to earn greater profits.

VOLUNTARY EXPORT RESTRAINTS

A unique version of the export quota is called a voluntary export restraint (VER)—a quota that a nation imposes on its own exports, usually at the request of another nation. Countries normally self-impose a voluntary export restraint in response to the threat of an import quota or total ban on the product by an importing nation. The classic example of the use of a voluntary export restraint is from the 1980s when Japanese carmakers were making significant market share gains in the United States. The closing of U.S. carmakers’ production facilities in the United States was creating a volatile anti-Japan sentiment among the population and the U.S. Congress. Fearing punitive legislation if Japan did not limit its automobile exports to the United States, the Japanese government and its carmakers self-imposed a voluntary export restraint on cars headed for the United States.

voluntary export restraint (VER)

Unique version of export quota that a nation imposes on its exports, usually at the request of an importing nation.

Consumers in the country that imposes an export quota benefit from lower-priced products (due to their greater supply) as long as domestic producers do not curtail production. Producers in an importing country benefit because the goods of producers from the exporting country are restrained, which may allow them to increase prices. Export quotas hurt consumers in the importing nation because of reduced selection and perhaps higher prices. Yet export quotas might allow these same consumers to retain their jobs if imports were threatening to put domestic producers out of business. Again, detailed economic studies are needed to determine the winners and losers in any particular export quota case.

Tariff-Quotas

A hybrid form of trade restriction is called a tariff-quota—a lower tariff rate for a certain quantity of imports and a higher rate for quantities that exceed the quota. Figure 6.1 shows how a tariff-quota actually works. Imports entering a nation under a quota limit of, say, 1,000 tons are charged a 10 percent tariff. But subsequent imports that do not make it under the quota limit of 1,000 tons are charged a tariff of 80 percent. Tariff-quotas are used extensively in the trade of agricultural products. Many countries implemented tariff-quotas in 1995 after their use was permitted by the World Trade Organization, the agency that regulates trade among nations.

tariff-quota

Lower tariff rate for a certain quantity of imports and a higher rate for quantities that exceed the quota.

Embargoes

A complete ban on trade (imports and exports) in one or more products with a particular country is called an embargo. An embargo may be placed on one or a few goods, or it may completely ban trade in all goods. It is the most restrictive nontariff trade barrier available, and it is typically applied to accomplish political goals. Embargoes can be decreed by individual nations or by supranational organizations such as the United Nations. Because they can be very difficult to enforce, embargoes are used less today than they have been in the past. One example of a total ban on trade with another country is the U.S. embargo on trade with Cuba. In fact, U.S. tourists are not legally able to vacation in Cuba.

embargo

Complete ban on trade (imports and exports) in one or more products with a particular country.

After a military coup ousted elected President Aristide of Haiti in the early 1990s, restraints were applied to force the military junta either to reinstate Aristide or to hold new elections. One restraint was an embargo by the Organization of American States. Because of difficulties in actually enforcing the embargo and after two years of fruitless United Nations diplomacy, the embargo failed. The United Nations then stepped in with a ban on trade in oil and weapons. Despite some smuggling through the Dominican Republic, which shares the island of Hispaniola with Haiti, the embargo was generally effective, and Aristide was eventually reinstated.

Local Content Requirements

Recall from Chapter 3 that local content requirements are laws stipulating that producers in the domestic market must supply a specified amount of a good or service. These requirements can state that a certain portion of the end product consists of domestically produced goods or that a certain portion of the final cost of a product has domestic sources.

The purpose of local content requirements is to force companies from other nations to use local resources in their production processes—particularly labor. Similar to other restraints on imports, such requirements help protect domestic producers from the price advantage of companies based in other, low-wage countries. Today, many developing countries use local content requirements as a strategy to boost industrialization. Companies often respond to local content requirements by locating production facilities inside the nation that stipulates such restrictions.

FIGURE 6.1 How a Tariff-Quota Works

Source: Based on World Trade Organization Web site (www.wto.org).

Although many people consider music the universal language, not all cultures are equally open to the world’s diverse musical influences. To prevent Anglo-Saxon music from invading French culture, French law requires radio programs to include at least 40 percent French content. Such local content requirements are intended to protect both the French cultural identity and the jobs of French artists against other nations’ pop culture that may wash up on French shores.

Administrative Delays

Regulatory controls or bureaucratic rules designed to impair the flow of imports into a country are called administrative delays. This nontariff barrier includes a wide range of government actions, such as requiring international air carriers to land at inconvenient airports, requiring product inspections that damage the product itself, purposely understaffing customs offices to cause unusual time delays, and requiring special licenses that take a long time to obtain. The objective of all such administrative delays for a country is to discriminate against imported products—it is, in a word, protectionism.

administrative delays

Regulatory controls or bureaucratic rules designed to impair the flow of imports into a country.

Currency Controls

Restrictions on the convertibility of a currency into other currencies are called currency controls. A company that wishes to import goods generally must pay for those goods in a common, internationally acceptable currency such as the U.S. dollar, European Union euro, or Japanese yen. Generally, it must also obtain the currency from its nation’s domestic banking system. Governments can require companies that desire such a currency to apply for a license to obtain it. Thus a country’s government can discourage imports by restricting who is allowed to convert the nation’s currency into the internationally acceptable currency.

currency controls

Restrictions on the convertibility of a currency into other currencies.

Another way governments apply currency controls to reduce imports is by stipulating an exchange rate that is unfavorable to potential importers. Because the unfavorable exchange rate can force the cost of imported goods to an impractical level, many potential importers simply give up on the idea. Meanwhile, the country will often allow exporters to exchange the home currency for an international currency at favorable rates to encourage exports.

Quick Study

1. How do tariffs and quotas differ from one another? Identify the different forms each can take.

2. Describe how a voluntary export restraint works and how it differs from a quota.

3. What is an embargo? Explain why it is seldom used today.

4. Explain how local content requirements, administrative delays, and currency controls restrict trade.

Global Trading System

The global trading system certainly has seen its ups and downs. World trade volume reached a peak in the late 1800s, only to be devastated when the United States passed the Smoot–Hawley Act in 1930. The act represented a major shift in U.S. trade policy from one of free trade to one of protectionism. The act set off round after round of competitive tariff increases among the major trading nations. Other nations felt that if the United States was going to restrict its imports, they were not going to give exports from the United States free access to their domestic markets. The Smoot–Hawley Act, and the global trade wars that it helped to usher in, crippled the economies of the industrialized nations and helped spark the Great Depression. Living standards around the world were devastated throughout most of the 1930s.

We begin this section by looking at early attempts to develop a global trading system, the General Agreement on Tariffs and Trade, and then examine its successor, the World Trade Organization.

General Agreement on Tariffs and Trade (GATT)

Attitudes toward free trade changed markedly in the late 1940s. For the previous 50 years, extreme economic competition among nations and national quests to increase their resources for production helped create two world wars and the worst global economic recession ever. As a result, economists and policy makers proposed that the world band together and agree on a trading system that would help to avoid similar calamities in the future. A system of multilateral agreements was developed that became known as the General Agreement on Tariffs and Trade (GATT)—a treaty designed to promote free trade by reducing both tariff and nontariff barriers to international trade. The GATT was formed in 1947 by 23 nations—12 developed and 11 developing economies—and came into force in January 1948.12

The GATT was highly successful throughout its early years. Between 1947 and 1988, it helped to reduce average tariffs from 40 percent to 5 percent and multiply the volume of international trade by 20 times. But by the middle to late 1980s, rising nationalism worldwide and trade conflicts led to a nearly 50 percent increase in nontariff barriers to trade. Also, services (not covered by the original GATT) had become increasingly important and had grown to account for a much greater share of total world trade. It was clear that a revision of the treaty was necessary and in 1986 a new round of trade talks began.

Uruguay Round of Negotiations

The ground rules of the GATT resulted from periodic “rounds” of negotiations among its members. Though relatively short and straightforward in the early years, negotiations later became protracted as issues grew more complex. Table 6.2 shows the eight completed negotiating rounds that occurred under the auspices of the GATT. Note that whereas tariffs were the only topic of the first five rounds of negotiations, other topics were added in subsequent rounds.

TABLE 6.2 The Rounds of GATT

Year

Site

Number of Countries Involved

Topics Covered

1947

Geneva, Switzerland

23

Tariffs

1949

Annecy, France

13

Tariffs

1951

Torquay, England

38

Tariffs

1956

Geneva

26

Tariffs

1960–1961

Geneva (Dillon Round)

26

Tariffs

1964–1967

Geneva (Kennedy Round)

62

Tariffs, antidumping measures

1973–1979

Geneva (Tokyo Round)

102

Tariffs, nontariff measures, “framework agreements”

1986–1994

Geneva (Uruguay Round)

123

Tariffs, nontariff measures, rules, services, intellectual property, dispute settlement, investment measures, agriculture, textiles and clothing, natural resources, creation of the WTO

Source: Based on “About the WTO,” World Trade Organization Web site (www.wto.org).

The Uruguay Round of GATT negotiations, begun in 1986 in Punta del Este, Uruguay (hence its name), was the largest trade negotiation in history. It was the eighth round of GATT talks within a span of 40 years and took more than seven years to complete. The Uruguay Round made significant progress in reducing trade barriers by revising and updating the 1947 GATT. In addition to developing plans to further reduce barriers to merchandise trade, the negotiations modified the original GATT treaty in several important ways.

AGREEMENT ON SERVICES

Because of the ever-increasing importance of services to the total volume of world trade, nations wanted to include GATT provisions for trade in services. The General Agreement on Trade in Services (GATS) extended the principle of nondiscrimination to cover international trade in all services, although talks regarding some sectors were more successful than were others. The problem is that, although trade in goods is a straightforward concept—goods are exported from one country and imported to another—it can be difficult to define exactly what a service is. Nevertheless, the GATS created during the Uruguay Round identifies four different forms that international trade in services can take:

1. Cross-border supply Services supplied from one country to another (for example, international telephone calls).

2. Consumption abroad Consumers or companies using a service while in another country (for example, tourism).

3. Commercial presence A company establishing a subsidiary in another country to provide a service (for example, banking operations).

4. Presence of natural persons Individuals traveling to another country to supply a service (for example, business consultants).

AGREEMENT ON INTELLECTUAL PROPERTY

Like services, products consisting entirely or largely of intellectual property account for an increasing portion of international trade. Recall from Chapter 3 that intellectual property refers to property resulting from people’s intellectual talent and abilities. Products classified as intellectual property are supposed to be legally protected by copyrights, patents, and trademarks.

Although international piracy continues, the Uruguay Round took an important step toward getting it under control. It created the Agreement on Trade-Related Aspects of Intellectual Property (TRIPS) to help standardize intellectual property rules around the world. The TRIPS Agreement agrees that protection of intellectual property rights benefits society because it encourages the development of new technologies and other creations. It supports the articles of both the Paris Convention and the Berne Convention (see Chapter 3) and in certain instances takes a stronger stand on intellectual property protection.

AGREEMENT ON AGRICULTURAL SUBSIDIES

Trade in agricultural products has long been a bone of contention for most of the world’s trading partners at one time or another. Some of the more popular barriers that countries use to protect their agricultural sectors include import quotas and subsidies paid directly to farmers. The Uruguay Round addressed the main issues of agricultural tariffs and nontariff barriers in its Agreement on Agriculture. The result is increased exposure of national agricultural sectors to market forces and increased predictability in international agricultural trade. The agreement forces countries to convert all nontariff barriers to tariffs—a process called “tariffication.” It then calls on developed and developing nations to cut agricultural tariffs significantly, but places no requirements on the least-developed economies.

World Trade Organization (WTO)

Perhaps the greatest achievement of the Uruguay Round was the creation of the World Trade Organization (WTO)—the international organization that regulates trade between nations. The three main goals of the WTO (www.wto.org) are to help the free flow of trade, to help negotiate further opening of markets, and to settle trade disputes between its members. One key component of the WTO that was carried over from GATT is the principle of nondiscrimination called normal trade relations (formerly called “most favored nation status”)—a requirement that WTO members extend the same favorable terms of trade to all members that they extend to any single member. For example, if Japan were to reduce its import tariff on German automobiles to 5 percent, it must reduce the tariff it levies against auto imports from all other WTO nations to 5 percent.

normal trade relations (formerly “most favored nation status”)

Requirement that WTO members extend the same favorable terms of trade to all members that they extend to any single member.

The WTO replaced the institution of GATT but absorbed the GATT agreements (such as on services, intellectual property, and agriculture) into its own agreements. Thus the GATT institution no longer officially exists. The WTO recognizes 153 members and 30 observers.

Dispute Settlement in the WTO

The power of the WTO to settle trade disputes is what really sets it apart from the GATT. Under the GATT, nations could file a complaint against another member and a committee would investigate the matter. If appropriate, the GATT would identify the unfair trade practices, and member countries would pressure the offender to change its ways. But in reality, GATT rulings (usually given only after very long investigative phases that sometimes lasted years) were likely to be ignored.

By contrast, the various WTO agreements are essentially contracts between member nations that commit them to maintaining fair and open trade policies. When one WTO member files a complaint against another, the Dispute Settlement Body of the WTO moves into action swiftly. Decisions are to be rendered in less than one year—although within nine months if the case is urgent and 15 months if the case is appealed. The WTO dispute settlement system is not only faster and automatic, but its rulings cannot be ignored or blocked by members. Offenders must realign their trade policies according to WTO guidelines or suffer financial penalties and perhaps trade sanctions. Because of its ability to penalize offending member nations, the WTO’s dispute settlement system is the spine of the global trading system.

Dumping and the WTO

The WTO also gets involved in settling disputes that involve “dumping” and the granting of subsidies. When a company exports a product at a price that is either lower than the price normally charged in its domestic market or lower than the cost of production, it is said to be dumping. Charges of dumping are made (fairly or otherwise) against companies from almost every nation at one time or another and can occur in any type of industry. For example, western European plastic producers considered retaliating against Asian competitors whose prices were substantially lower in European markets than at home. More recently, U.S. steel producers and their powerful union charged that steelmakers in Brazil, Japan, and Russia were dumping steel on the U.S. market at low prices. The problem arose as those nations tried to improve their economies through increased exporting of all products, including steel.

dumping

Exporting a product at a price either lower than the price that the product normally commands in its domestic market or lower than the cost of production.

The WTO cannot punish the country in which the company accused of dumping is based because dumping is an act by a company, not a country. The WTO can respond only to the actions of a country that retaliates against a company that is dumping. The WTO allows a nation to retaliate against dumping if it can show that dumping is actually occurring, can calculate the damage to its own companies, and can show that the damage is significant. The normal way a country retaliates is to charge an antidumping duty—an additional tariff placed on an imported product that a nation believes is being dumped on its market. But such measures must expire within five years of the time they are initiated unless a country can show that circumstances warrant their continuation. A large number of antidumping cases have been brought before the WTO in recent years.

antidumping duty

Additional tariff placed on an imported product that a nation believes is being dumped on its market.

Subsidies and the WTO

Governments often retaliate when the competitiveness of their companies is threatened by a subsidy that another country pays its own domestic producers. Like antidumping measures, nations can retaliate against product(s) that receive an unfair subsidy by charging a countervailing duty—an additional tariff placed on an imported product that a nation believes is receiving an unfair subsidy. Unlike dumping, because payment of a subsidy is an action by a country, the WTO regulates the actions of the government that reacts to the subsidy as well as those of the government that originally paid the subsidy.

countervailing duty

Additional tariff placed on an imported product that a nation believes is receiving an unfair subsidy.

Doha Round of Negotiations

The WTO launched a new round of negotiations in Doha, Qatar, in late 2001. The renewed negotiations were designed to lower trade barriers further and help poor nations in particular. Agricultural subsidies that rich countries pay to their own farmers are worth $1 billion per day—more than six times the value of their combined aid budgets to poor nations. Because 70 percent of the exports of poor nations are agricultural products and textiles, wealthy nations had intended to open these and other labor-intensive industries further. Poor nations were encouraged to reduce tariffs among themselves and were to receive help from rich nations in integrating themselves into the global trading system. Although the Doha round was to conclude by the end of 2004, negotiations are ongoing.13

WTO and the Environment

Steady gains in global trade and rapid industrialization in many developing and emerging economies have generated environmental concerns among both governments and special interest groups. Of concern to many people are levels of carbon dioxide emissions—the principal greenhouse gas believed to contribute to global warming. Most carbon dioxide emissions are created from the burning of fossil fuels and the manufacture of cement.

The World Trade Organization has no separate agreement that deals with environmental issues. The WTO explicitly states that it is not to become a global environmental agency responsible for setting environmental standards. It leaves such tasks to national governments and the many intergovernmental organizations that already exist for such purposes. The WTO works alongside existing international agreements on the environment, including the Montreal Protocol for protection of the ozone layer, the Basel Convention on international trade or transport of hazardous waste, and the Convention on International Trade in Endangered Species.

Nevertheless, the preamble to the agreement that established the WTO does mention the objectives of environmental protection and sustainable development. The WTO also has an internal committee called the Committee on Trade and Environment. The committee’s responsibility is to study the relationship between trade and the environment and to recommend possible changes in the WTO trade agreements.

In addition, the WTO does take explicit positions on some environmental issues related to trade. Although the WTO supports national efforts at labeling “environmentally friendly” products as such, it states that labeling requirements or policies cannot discriminate against the products of other WTO members. Also, the WTO supports policies of the least developed countries that require full disclosure of potentially hazardous products entering their markets for reasons of public health and environmental damage.

Quick Study

1. What was the General Agreement on Tariffs and Trade (GATT)? List its main accomplishments.

2. What is the World Trade Organization (WTO)? Describe how the WTO settles trade disputes.

3. Explain the difference between an antidumping duty and a countervailing duty.

4. What efforts have been made to protect the environment from trade and rapid industrialization?

Bottom Line FOR BUSINESS

Despite the theoretical benefits of free trade, nations do not simply throw open their doors to trade and force their domestic businesses to sink or swim. This chapter presented why governments protect their industries and how they go about it. The World Trade Organization tries to strike a balance between national desires for protection and international desires for free trade.

Implications of Trade Protection

Protection of free trade allows firms to move production to locations that maximize efficiency. Yet government interference in the free flow of trade has implications for production efficiency and firm strategy. Subsidies often encourage complacency on the part of companies receiving them because they discourage competition. Subsidies can be thought of as a redistribution of wealth in society whereby international firms not receiving subsidies are at a disadvantage. Unsubsidized firms must either cut production and distribution costs, or differentiate in some way to justify a higher selling price.

Import tariffs raise the cost of an imported good and make domestically produced goods more attractive to consumers. But because a tariff can create inefficient domestic producers, deteriorating competitiveness may offset the benefits of import tariffs. Companies trying to enter markets having high import tariffs often produce within that market. Import quotas help domestic producers maintain market share and prices by restraining competitive forces. Domestic producers protected by the quota win because the market is protected. Yet other producers that require the import subjected to a quota lose. These companies will need to pay more for their intermediate products or locate production outside the market imposing the quota.

Local content requirements protect domestic producers from producers based in low-cost countries. A firm trying to sell to a market imposing local content requirements may have no alternative but to produce locally. The objective of administrative delays is to discriminate against imported products, but it can discourage efficiency. Currency controls can require firms to apply for a license to obtain an internationally accepted currency. The nation thus discourages imports by restricting who is allowed to obtain such a currency to pay for imports. A government may also block imports by stipulating an exchange rate that is unfavorable to potential importers. The unfavorable exchange rate forces the cost of imported goods to an impractical level. The same country then often stipulates an exchange rate that is favorable for exporters.

Government subsidies are typically paid for by levying taxes across the economy. Whether subsidies help a nation’s people long term is questionable, and they may actually harm a nation. Import tariffs also hurt consumers because they raise the price of imports and protect domestic firms that may raise prices. Import quotas hurt consumers because they lessen competition, boost prices, and decrease selection. Protection tends to lessen the long-term gains a people can obtain from free trade.

Implications of the Global Trading System

Development of the global trading system benefits international companies by promoting free trade through the reduction of both tariffs and nontariff barriers to international trade. The GATT treaty was successful in its early years, and its revision significantly improved the climate for trade. Average tariffs on merchandise trade were reduced and subsidies for agricultural products were lowered. Firms also benefited from an agreement that extended the principle of nondiscrimination to cover trade in services. The revision of GATT also clearly defined intellectual property rights—giving protection to copyrights, trademarks and service marks, and patents. This encourages firms to develop new products and processes because they know their rights to the property will be protected.

Creation of the WTO is also good for international firms because the various WTO agreements commit member nations to maintaining fair and open trade policies. Both domestic and international firms based in relatively poor nations should benefit most from future rounds of trade negotiations. Because poor nations tend to export agricultural products and textiles, their firms in these industries will benefit from wealthy nations reducing barriers to imports in these sectors. Companies based in poor countries should also benefit from better cooperation among poor countries and their further integration into the global trading system.

Chapter Summary

1. Describe the political, economic, and cultural motives behind governmental intervention in trade.

■ Political motives behind government intervention in trade include: (a) protecting jobs, (b) preserving national security, (c) responding to other nations’ unfair trade practices, and (d) gaining influence over other nations.

■ Economic reasons for government intervention in trade are: (a) protection of infant industries and (b) promotion of a strategic trade policy.

■ The infant industry argument says that a country’s emerging industries need protection from international competition during their development until they become sufficiently competitive, but this may reduce competitiveness and inflate prices.

■ Strategic trade policy argues for government intervention to help companies take advantage of economies of scale and be first movers in their industries; but this may cause inefficiency, higher costs, and trade wars.

■ The most common cultural motive for trade intervention is protection of national identity.

2. List and explain the methods governments use to promote international trade.

■ A subsidy is financial assistance to domestic producers in the form of cash payments, low interest loans, tax breaks, product price supports, or other form.

■ Although subsidies are intended to help domestic companies fend off international competitors, critics say that they amount to corporate welfare and are detrimental in the long term.

■ Export financing includes loans at below-market interest rates, loans that would otherwise be unavailable, and loan guarantees that a government will repay a loan if the company defaults.

■ A foreign trade zone (FTZ) is a designated geographic region in which merchandise is allowed to pass through with lower customs duties (taxes) and/or fewer customs procedures.

■ Special government agencies organize trips abroad for trade officials and businesspeople and open offices abroad to promote home country exports.

3. List and explain the methods governments use to restrict international trade.

■ A tariff is a government tax levied on a product as it enters or leaves a country; its three types are the export tariff, transit tariff, and import tariff.

■ An import tariff can be an ad valorem tariff, specific tariff, or compound tariff.

■ A restriction on the amount of a good that can enter or leave a country during a certain period of time is called a quota.

■ Import quotas protect domestic producers, whereas export quotas maintain adequate supplies domestically or increase the world price of a product.

■ A complete ban on trade with a particular country is an embargo.

■ Local content requirements are laws stipulating that a specified amount of a good or service be supplied by producers in the domestic market.

■ Imports can also be discouraged using administrative delays (regulatory controls or bureaucratic rules) or currency controls (restrictions on currency convertibility).

4. Discuss the importance of the World Trade Organization in promoting free trade.

■ The General Agreement on Tariffs and Trade (GATT) was a treaty designed to promote free trade by reducing tariff and nontariff barriers to trade.

■ The Uruguay Round of GATT negotiations: (a) for the first time included trade in services, (b) defined intellectual property rights, (c) reduced trade barriers in agriculture, and (d) created the World Trade Organization (WTO).

■ The three goals of the WTO are to help the free flow of trade, to help negotiate further opening of markets, and to settle trade disputes between its members.

■ A key component of the WTO is the principle of nondiscrimination called normal trade relations, which requires WTO members to treat all members equally.

■ Dumping is said to occur when a company exports a product at a price either lower than the price it normally charges in its domestic market or lower than the cost of production.

Talk It Over

1. Imagine that people in your country believe international trade is harmful to their wages and jobs and your task is to change their minds. What kinds of programs would you implement to educate your people about the benefits of trade? Describe how each would help change people’s attitudes.

2. Most countries create a list of “hostile” countries that require special permission before an exporter will be allowed to proceed. Which countries and products would you place on such a list for your nation, and why?

3. Two students are discussing efforts within the global trading system to reduce trade’s negative effects on the environment. One student says, “Sure, there may be pollution effects, but they’re a small price to pay for a higher standard of living.” The other student agrees, saying, “Yeah, those ‘tree-huggers’ are always exaggerating those effects anyway. Who cares if some little toad in the Amazon goes extinct? I sure don’t.” What counterarguments can you offer to these students?

Teaming Up

1. Research Project. As a group, select a company in your city or town that is involved in importing and/or exporting, and interview the owner or a top manager. Your goal is to understand how government involvement in international trade has helped or harmed the company’s business activities. Prepare for your appointment by researching the topic of government trade intervention in a business periodical (in print or online), and follow-up the interview with additional research. Ask for past examples and specific potential impacts of government intervention on the business.

2. Market Entry Strategy Project. This exercise corresponds to the MESP online simulation. For the country your team is researching, to what extent does its government intervene in trade? What are its political, economic, or cultural motives for intervention? What methods, if any, does the government use to: (a) promote exports and (b) restrict imports? Does the nation maintain a free trade zone within its borders? Has the country filed a complaint with the WTO against another member nation? Has it been reported by another nation for unfair trade practices? Integrate your findings into your completed MESP report.

Key Terms

ad valorem tariff (p. 179)

administrative delays (p. 182)

antidumping duty (p. 185)

compound tariff (p. 179)

countervailing duty (p. 185)

currency controls (p. 182)

dumping (p. 185)

embargo (p. 181)

foreign trade zone (FTZ) (p. 177)

free trade (p. 170)

normal trade relations (p. 185)

quota (p. 179)

specific tariff (p. 179)

subsidy (p. 175)

tariff (p. 178)

tariff-quota (p. 181)

voluntary export restraint (VER) (p. 180)

Take It to the Web

1. Video Report. Visit this book’s channel on YouTube (You Tube.com/MyIBvideos). Click on “Playlists” near the top of the page and click on the set of videos labeled “Ch 06: Business–Government Trade Relations.” Watch one video from the list and summarize it in a half page report. Reflecting on the contents of this chapter, which aspects of governmental trade intervention can you identify in the video? How might a company engaged in international business act on the information contained in the video?

2. Web Site Report. The WTO recently ordered the United States to repeal $4 billion of tax breaks for U.S. exporters who operate through offshore subsidiaries or face possible sanctions. Although the case was brought by the European Union, many European companies were ambivalent about the tax breaks because they have U.S. subsidiaries that benefit from them.

Visit the Web site of the WTO (www.wto.org) and the Web sites of business periodicals on the Internet. Identify a case on which the WTO has recently ruled. What countries are involved? List as many cultural, political, or economic reasons you can think of that motivated the country to bring the case. Do you think it was a fair charge and do you think the ruling was correct? Explain your answer.

Do you think the WTO should have the power to dictate the trade policies of individual nations and punish them if they do not comply? Why or why not? Do you think countries experiencing economic difficulties should be allowed to erect temporary tariff and nontariff barriers? Why or why not? What effect do you think such an allowance would have on the future of the global trading system?

Ethical Challenges

1. You are an executive for a U.S. oil firm interested in forming a partnership with an Iranian oil producer. This will be a challenge because of the poor relations between the United States and Iran over the years. Since the early 1980s the United States has drawn fire from the business community for imposing economic sanctions (similar to an embargo) against Iran for primarily political reasons. Those sanctions disallow international trade and investment between U.S. and Iranian businesspeople. Business leaders in the United States would like the sanctions removed so they can be included in lucrative Iranian oil and gas deals in which firms from other countries are engaging. Other sanction opponents wonder if a policy of offering “all stick and no carrot” is undermining social and political change in Iran because the offending regime goes largely unpunished while ordinary citizens suffer. What arguments would you present to the U.S. government for removing sanctions on Iran? Do you think that one country, acting alone, can bring about reforms through the use of economic sanctions or embargoes?

2. You are the president of a sugar company based in southern Florida. Your firm is struggling lately to meet demand because of poor harvests in the Caribbean Islands, where your firm sources much of its raw product. Because of the Helms–Burton Act and the U.S. embargo on Cuba, your firm is not allowed to trade with Cuba. If the embargo were dropped, your firm would have an excellent source of cheap sugar, and profits would improve significantly. A U.S. senator from your state of Florida serves on an influential committee in Washington, D.C., that is reviewing the status of the embargo on Cuba. What arguments would you provide your senator that could help eliminate this trade barrier?

3. You are a consultant advising the World Trade Organization (WTO) on the U.S. Supreme Court decision regarding the state of Massachusetts and the country of Myanmar. A nonprofit trade and industry group, the National Foreign Trade Council (NFTC), based in Washington, D.C., won a court battle recently against the state of Massachusetts. In a unanimous decision, the U.S. Supreme Court sided with the NFTC and struck down a Massachusetts law that was designed to deny state contracts to any company doing business in Myanmar. The Court ruled that the Massachusetts law intruded on the federal government’s authority and was preempted by federal law regarding Myanmar. In fact, the U.S. Constitution states that “foreign policy is exclusively reserved for the federal government.” The NFTC says that it shares concern over human rights abuses occurring in Myanmar, but believes that a coordinated, multinational effort would be most effective at instilling change in the nation.

Do you think companies should be penalized in their domestic business dealings because of where they do business abroad? Should the World Trade Organization get involved in these types of political matters? Why or why not? How might domestic firms be affected if each state were allowed to punish firms based on its individual foreign policy ideals?

PRACTICING INTERNATIONAL MANAGEMENT CASE: Down with Dumping

“Canada Launches WTO Challenge to U.S. . . . Mexico Widens Anti-dumping Measure . . . China to Begin Probe of Synthetic Rubber Imports . . . Rough Road Ahead for U.S.-China Trade . . . It Must Be Stopped,” are just a sampling of headlines from around the world.

International trade theories argue that nations should open their doors to trade. Conventional free-trade wisdom says that by trading with others, a country can offer its citizens a greater quantity and selection of goods at cheaper prices than it could in the absence of trade. Nevertheless, truly free trade still does not exist because national governments intervene. Despite the efforts of the World Trade Organization (WTO) and smaller groups of nations, governments still cry foul in the trade game. On average, 234 antidumping cases are initiated each year.

In the past, the world’s richest nations would typically charge a developing nation with dumping. But today, emerging markets, too, are jumping into the fray. China recently launched an inquiry to determine whether synthetic rubber imports (used in auto tires and footwear) from Japan, South Korea, and Russia are being dumped in the country. Mexico expanded coverage of its Automatic Import Advice System. The system requires importers (from a select list of countries) to notify Mexican officials of the amount and price of a shipment 10 days prior to its expected arrival in Mexico. The 10-day notice gives domestic producers advanced warning of low-priced products so they can report dumping before the products clear customs and enter the marketplace. India set up a new government agency to handle antidumping cases. Even Argentina, Indonesia, South Africa, South Korea, and Thailand are using this recently popular tool of protectionism.

Why is dumping so popular? Oddly enough, the WTO allows it. The WTO has made major inroads on the use of tariffs, slashing them across almost every product category in recent years. But it does not have authority to punish companies, only governments. Thus the WTO cannot make judgments against individual companies that are dumping products in other markets. It can only pass rulings against the government of the country that imposes an antidumping duty. But the WTO allows countries to retaliate against nations whose producers are suspected of dumping when it can be shown that: (1) alleged offenders are significantly hurting domestic producers and (2) the export price is lower than the cost of production or lower than the home market price.

Alternatives to bringing antidumping cases before the WTO do exist. U.S. President George W. Bush relied on a Section 201 or “global safeguard” investigation under U.S. trade law to slap tariffs of up to 30 percent on steel imports. The U.S. steel industry had been suffering under an onslaught of steel imports from Brazil, the European Union, Japan, and South Korea. Yet nations still brought complaints about the action before the WTO. Similarly, in 2004 the U.S. government slapped around 100 percent tariffs on shrimp imported from China and Vietnam, charging those nations with dumping their crustaceans on U.S. shores.

Supporters of antidumping tariffs claim that they prevent dumpers from undercutting the prices charged by producers in a target market, driving them out of business. Another claim in support of antidumping is that it is an excellent way of retaining some protection against the potential dangers of totally free trade. Detractors of antidumping tariffs charge that once such tariffs are imposed they are rarely removed. They also claim that it costs companies and governments a great deal of time and money to file and argue their cases. It is also argued that the fear of being charged with dumping causes international competitors to keep their prices higher in a target market than would otherwise be the case. This would allow domestic companies to charge higher prices and not lose market share—forcing consumers to pay more for their goods.

Thinking Globally

1. “You can’t tell consumers that the low price they are paying for that fax machine or automobile is somehow unfair. They’re not concerned with the profits of some company. To them, it’s just a great bargain, and they want it to continue.” Do you agree with this statement? Do you think that people from different cultures would respond differently to this statement? Explain your answers.

2. As we have seen, currently the WTO cannot get involved in punishing individual companies—its actions can only be directed toward governments of countries. Do you think this is a wise policy? Why or why not? Why do you think the WTO was not given authority to charge individual companies with dumping? Explain.

3. Identify a recent antidumping case that was brought before the WTO. Locate as many articles in the press as you can that discuss the case. Identify the nations, product(s), and potential punitive measures involved. If you were part of the WTO dispute settlement body, would you vote in favor of the measures taken by the retaliating nation? Why or why not?

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