International Business Homework : Country Analysis Report

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Global Business Today 9e

by Charles W.L. Hill

7-1

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Chapter 7

Government Policy and International Trade

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Learning Objectives

The learning objectives for this chapter are to:

Identify the policy instruments used by governments to influence international trade flows.

Understand why governments sometimes intervene in international trade.

Summarize and explain the arguments against strategic trade policy.

Describe the development of the world trading system and the current trade issues.

Explain the implications for managers of developments in the world trading system.

Introduction

Free trade refers to a situation where a government does not attempt to restrict what its citizens can buy from another country or what they can sell to another country

While many nations are nominally committed to free trade, they tend to intervene in international trade to protect the interests of politically important groups

Instruments of Trade Policy

Question: How do governments intervene in international trade?

Answer:

There are seven main instruments of trade policy:

Tariffs

Subsidies

Import quotas

Voluntary export restraints

Local content requirements

Antidumping policies

Administrative policies

Tariffs

A tariff: a tax levied on imports that effectively raises the cost of imported products relative to domestic products

Specific tariffs: levied as a fixed charge for each unit of a good imported

Ad valorem tariffs: levied as a proportion of the value of the imported good

Tariffs (continued from Slide 7-6)

Question: Why do governments impose tariffs?

Answer:

Tariffs:

Increase government revenues

Provide protection to domestic producers against foreign competitors by increasing the cost of imported foreign goods

Force consumers to pay more for certain imports

So, tariffs are unambiguously pro-producer and anti-consumer, and tariffs reduce the overall efficiency of the world economy .

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Subsidies

Subsidy: a government payment to a domestic producer

Subsidies help domestic producers:

Compete against low-cost foreign imports

Gain export markets

Consumers typically absorb the costs of subsidies

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Country Focus: Are the Chinese Illegally Subsidizing Auto Exports?

Summary

This feature explores the subsidies paid by China’s government to Chinese producers of autos and auto parts. U.S. lawmakers have raised concerns that the subsidies are unfair and have filed a complaint with the World Trade Organization (WTO) arguing that the subsidies have effectively hurt U.S. auto and auto parts producers. While some in the U.S. auto industry support the complaint, others are concerned that it could jeopardize their investments in the Chinese market. Discussion of the feature can begin with the following questions:

Suggested Discussion Questions

1. In your opinion, could U.S. complaints about China’s policies toward its auto exports actually harm U.S. producers more than they help? Should the U.S. dismiss its complaint with the WTO?

Discussion Points: The vast market potential in China is attractive to most companies including U.S. auto producers. Consequently, when the United States registered its complaint with the WTO against the subsidies paid by China to its auto makers, U.S. manufacturers responded cautiously. Most are concerned that the move could jeopardize their opportunity to capitalize on the Chinese market if China responds to the complaint with retaliatory measures. Moreover, some U.S. companies actually benefit from the lower cost parts that China is exporting and so support the subsidies.

2. As a U.S. consumer, do you support China’s subsidies on autos and auto parts? Does your response change if you work for a U.S. auto maker? Why or why not?

Discussion Points: U.S. consumers are probably generally supportive of the subsidies paid by China to its auto producers because cheaper exports from China help drive down prices in the United States by introducing additional competition in the market. The response by workers may be more mixed. The additional competition in the industry that is created as a result of the subsidies could threaten jobs, but at the same time, the cheaper parts that are available could help create jobs.

Lecture Note: To extend this discussion, consider {http://www.bbc.co.uk/news/business-16827138} and {http://www.bbc.co.uk/news/world-asia-china-16713608} to learn more.

Import Quotas and VERs

Import quota

A direct restriction on the quantity of some good that may be imported into a country

Tariff rate quota

A hybrid of a quota and a tariff where a lower tariff is applied to imports within the quota than to those over the quota

Voluntary export restraint (VER)

Quota on trade imposed by the exporting country, typically at the request of the importing country’s government

Quota rent

The extra profit that producers make when supply is artificially limited by an import quota

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Import Quotas and VERs (continued from Slide 7-9)

Question: Who benefits from import quotas and voluntary export restraints?

Answer:

Import quotas and voluntary export restraints benefit domestic producers by limiting import competition, but they raise the prices of imported goods for consumers

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Local Content Requirements

A local content requirement demands that some specific fraction of a good be produced domestically

Can be in physical terms or in value terms

Local content requirements benefit domestic producers and jobs, but consumers face higher prices

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Administrative Policies

Administrative trade polices: bureaucratic rules that are designed to make it difficult for imports to enter a country

These polices hurt consumers by denying access to possibly superior foreign products

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Antidumping Policies

Dumping: selling goods in a foreign market below their cost of production, or selling goods in a foreign market at below their “fair” market value

May be predatory behavior, with producers using substantial profits from their home markets to subsidize prices in a foreign market with a goal of driving indigenous competitors out, and later raising prices and earning substantial profits

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Antidumping Policies (continued from Slide 7-13)

Antidumping polices: designed to punish foreign firms that engage in dumping

Goal: protect domestic producers from “unfair” foreign competition

U.S. firms that believe a foreign firm is dumping can file a complaint with the government

If the complaint has merit, antidumping duties, also known as countervailing duties may be imposed

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Management Focus: U.S. Magnesium Seeks Protection

Summary

This feature explores the dumping charged levied by U.S. Magnesium against Chinese and Russian producers. According to U.S. Magnesium, the sole American producer of magnesium, Russian and Chinese producers were selling magnesium significantly below market value in an effort to drive U.S. Magnesium out of business. The company failed a complaint with the International Trade Commission (ITC) which ultimately ruled in favor of U.S. Magnesium.

Suggested Discussion Questions

1. What is dumping? Were Chinese and Russian producers guilty of dumping? How did U.S. Magnesium justify its claims against Russian and Chinese producers?

Discussion Points: Dumping is defined as selling goods in a foreign market below the cost of production, or below fair market value. In 2004, U.S. Magnesium claimed that China and Russia had been dumping magnesium in the United States. The company noted that in 2002 and 2003, magnesium imports rose, and prices fell. While the ITC ruled in favor of the American company, some students might question whether the fact that the Chinese could sell their product at low prices might simply reflect the country’s significantly lower wage rates.

2. What does the ITC’s ruling mean for American consumers of magnesium? In your opinion, was the ruling fair?

Discussion Points: The ITC ruled in favor of U.S. Magnesium finding that indeed China and Russia had been dumping their product in the United States. Fines ranging from 50 to 140 percent on imports were imposed against China, and 19 to 22 percent on Russian companies. Most students will note that while the ITC’s decision is a good one for U.S. Magnesium and its employees. for consumers, the ruling means magnesium prices that are significantly higher than those in world markets. Students will probably argue that this result is unfair, and should be revisited.

Lecture Note: Complaints about alleged dumping have hit a number of industries recently. To extend this discussion, consider exploring some of the other cases. Go to {http://www.businessweek.com/news/2014-08-04/vikram-solar-opposes-dumping-duties-as-manufacturer-split}, {http://www.businessweek.com/news/2014-03-25/u-dot-s-dot-steel-says-south-korean-companies-are-dumping-pipes-in-u-dot-s} and {http://www.businessweek.com/news/2014-04-21/argentina-to-cut-taxes-on-biodiesel-amid-eu-anti-dumping-dispute} to learn more.

Teaching Tip: U.S. Magnesium’s web site is available at {http://www.usmagnesium.com/}.

Case for Intervention

Question: Why do governments intervene in trade?

Answer:

Political arguments: concerned with protecting the interests of certain groups within a nation (normally producers), often at the expense of other groups (normally consumers)

Economic arguments: concerned with boosting the overall wealth of a nation (to the benefit of all, both producers and consumers)

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Political Arguments

Protecting jobs and industries

Typically the result of political pressures by unions or industries that are "threatened" by more efficient foreign producers, and have more political clout than the consumers who will eventually pay the costs

2. National security: governments protect industries important for national security

Protecting jobs and industries is the most common political reason for trade restrictions. The national security argument is less common today than in the past.

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Political Arguments (continued from Slide 7-16)

3. Retaliation: when governments take, or threaten to take, specific actions, other countries may remove trade barriers

If threatened governments don’t back down, tensions can escalate and new trade barriers may be enacted

4. Protecting consumers: protecting consumers from unsafe products

Often involves limiting or banning the import of certain products

Country Focus: Trade in Hormone-Treated Beef

Summary

This feature describes the trade battle between the United States and the European Union over beef from cattle that have been given growth hormones. It outlines the basic issues that led to the dispute, and shows how the World Trade Organization has treated the case.

Suggested Discussion Questions

1. Why is the European Union so concerned about beef from cattle that have been given growth hormones?

Discussion Points: Some students may argue that the European Union’s ban on growth hormones in cattle was little more than a thinly veiled form of protectionism. Australia, New Zealand, and Canada, which also use the hormones in their cattle industry, were also affected by the ban. The European Union claimed that it was merely protecting the health of its citizens, however studies showed that the hormones posed no health issues for people.

2. Why did the WTO rule against the European Union?

Discussion Points: The World Trade Organization ruled against the European Union stating that the European Union’s ban on imported hormone treated beef had no scientific justification. Even so, the European Union refused to lift the ban, which had strong public support, and in the end, the European Union was assessed punitive tariffs. The European Union held on to its principles though, and as of 2008, continued to maintain its restrictions on hormone treated beef despite the resulting punitive tariffs.

Teaching Tip: The WTO maintains a site for students. Go to {www.wto.org} and click on the students icon to search the site, research countries, and even see a list of internships that are available at the WTO.

Lecture Note: Recent trade negotiations between the European Union and the United States have brought the issue of hormone-treated beef to the forefront once again. To learn more, consider {http://www.bbc.com/news/business-29572475}.

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Political Arguments (continued from Slide 7-17)

5. Furthering foreign policy objectives:

Preferential trade terms given to countries that a government wants to build strong relations with

Rogue states that do not abide by international laws or norms can be punished

However, it might cause other countries to undermine unilateral trade sanctions

Political Arguments (continued from Slide 7-18)

6. Protecting human rights: governments can use trade policy to improve the human rights policies of trading partners

Some critics have argued that the best way to change the internal human rights of a country is to engage it in international trade

The decision to grant China MFN status in 1999 was based on this philosophy

Economic Arguments

1. The infant industry argument: an industry should be protected until it can develop and be viable and competitive internationally

Accepted as a justification for temporary trade restrictions under the WTO

This argument has been criticized because:

It is useless unless it makes the industry more efficient

If a country has the potential to develop a viable competitive position, its firms should be capable of raising necessary funds

Economic Arguments (continued from Slide 7-20)

2. Strategic trade policy: in cases where there may be important first mover advantages, governments can help firms from their countries attain these advantages

Also suggests that governments can help firms overcome barriers to entry into industries where foreign firms have an initial advantage

Revised Case for Free Trade

New trade theorists believe government intervention in international trade is justified

Classical trade theorists disagree

Some new trade theorists believe that while strategic trade theory is appealing in theory, it may not be workable in practice – they suggest a revised case for free trade

Situations where restrictions may be inappropriate

Retaliation

Domestic policies

Retaliation and War

Krugman: strategic trade policies to establish domestic firms in a dominant position in a global industry are beggar-thy-neighbor policies that boost national income at the expense of other countries

A country that attempts to use such policies will probably provoke retaliation

A trade war could leave both countries worse off

Domestic Policies

Governments can be influenced by special interest groups

A government’s decision to intervene in a market may appease a certain group, but not necessarily support the interests of the country as a whole

The World Trading System

Since World War II, an international trading framework has evolved to govern world trade

In its first fifty years, the framework was known as the General Agreement on Tariffs and Trade (GATT)

Since 1995, the framework has been known as the World Trade Organization (WTO)

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Country Focus: Estimating the Gains from Trade for America

Summary

This feature explores the results of a study by the Institute for International Economics. The study, which estimated the gains to the U.S. economy from free trade, found that the United States’ GDP was more than 7 percent higher as a result of reductions in trade barriers than it would have been if the barriers remained. The study also estimated that if tariffs were reduced to zero, significant gains would still result.

Suggested Discussion Questions

1. What does the Institute for International Economics suggest about the benefits of free trade?

Discussion Points: The Institute for International Economics found that thanks to reductions in trade restrictions, the United States’ GDP was up. The Institute also estimated that even greater gains in the country’s GDP would occur if protectionism was eliminated all together. Students should recognize that these findings follow the principles of Adam Smith and David Ricardo and suggest that free trade is beneficial.

2. According to the Institute for International Economics study, a move toward free trade would cause disruption in employment. Is it still worth pursuing free trade if it means that some people lose their jobs?

Discussion Points: This question should prompt a strong debate among students. Some students will probably suggest that the costs in terms of lost wages and benefits associated with free trade outweigh the benefits that would be gained. Other students however, will probably argue that since protectionism typically benefits only a few at the expense of others, while free trade generates greater economic growth and higher wages, a free trade policy should be followed.

Teaching Tip: The Web site for Institute for International Economics is available at {http://www.iie.com/}.

Smith to the Great Depression

Up until the Great Depression of the 1930s, most countries had some degree of protectionism

The U.S. enacted the Smoot-Hawley Act (1930): created significant import tariffs on foreign goods

Other nations took similar steps and as the depression deepened, world trade fell further

1947-1979

The General Agreement on Tariffs and Trade was established in 1947

The approach of GATT (a multilateral agreement to liberalize trade) was to gradually eliminate barriers to trade

GATT’s membership grew from 19 to more than 120 nations

Tariff reduction was spread over eight rounds of negotiation

GATT regulations were enforced by a mutual monitoring system

1980-1993

The world trading system came under strain during the 1980s and early 1990s because:

Japan’s economic success strained what had been more equal trading patterns

Persistent trade deficits by the U.S caused significant problems in some industries and political problems for the government

Many countries found that although GATT limited the use of tariffs, there were many other forms of intervention that had the same effect that did not technically violate GATT

The Uruguay Round

The Uruguay Round (1986) focused on:

1. Services and Intellectual Property

Trade issues related to services and intellectual property and agriculture were emphasized

2. The World Trade Organization

The WTO was established as a more effective policeman of the global trade rules

The WTO encompassed GATT and the General Agreement on Trade in Services (GATS) and the Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPS)

WTO: Experience to Date

The WTO has emerged as an effective advocate and facilitator of future trade deals

So far, most countries have adopted WTO recommendations for trade disputes

The WTO has brokered negotiations to reform the global telecommunications and financial services industries

The 1999 meeting of the WTO in Seattle demonstrated that issues surrounding free trade have become mainstream, and dependent on popular opinion

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Internet Extra: The WTO site {http://www.wto.org} provides a wealth of information on current trade issues. Go to the site, and click on Trade Topics.

Browse down the menu to explore the current situation at the Doha Round, the status of talks on electronic commerce, or the WTO’s current efforts regarding trade and the environment.

The Future of the WTO

The WTO is currently focusing on:

Anti-dumping policies: encouraging members to strengthen the regulations governing the imposition of antidumping duties

Protectionism in agriculture: concerned with the high level of tariffs and subsidies in the agricultural sector of many economies

Protecting intellectual property: members believe that the protection of intellectual property rights is essential to the international trading system

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TRIPS obliges WTO members to grant and enforce patents lasting at least 20 years and copyrights lasting 50 years.

The Future of the WTO (continued from Slide 7-31)

4. Market access for nonagricultural goods and services: bring down tariff rates on nonagricultural goods and services, and reduce the scope for the selective use of high tariff rates

5. A new round of talks: Doha: focusing on:

Cutting tariffs on industrial goods and services

Phasing out subsidies to agricultural producers

Reducing barriers to cross-border investment

Limiting the use of anti-dumping laws

The Doha Round was launched in 2001, and despite very slow progress, was still going on as of late 2012.

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Implications for Managers

Question: Why should international managers care about the political economy of free trade or about the relative merits of arguments for free trade and protectionism?

Answer:

Trade barriers impact firm strategy

Firms can play a role in promoting free trade or trade barriers

Trade Barriers and Firm Strategy

Trade barriers can limit a firm’s ability to disperse production globally

Trade barriers raise the cost of exporting

Quotas limit exports

Firms may have to locate production activities within a country to meet local content regulations

The threat of future trade barriers can influence firm strategy

All of these can raise costs above what they may have been in a world of free trade

Trade theory suggests why dispersing production activities globally can be beneficial.

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Policy Implications

International firms have an incentive to lobby for free trade, and keep protectionist pressures from causing them to have to change strategies

While there may be short run benefits to having government protection in some situations, in the long run these can backfire and other governments can retaliate making it more difficult to construct a globally dispersed production system

Summary

In this chapter we have:

Identified the policy instruments used by governments to influence international trade flows.

Understood why governments sometimes intervene in international trade.

Summarized and explained the arguments against strategic trade policy.

Described the development of the world trading system and the current trade issues.

Explained the implications for managers of developments in the world trading system.