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Business-
Government
Trade Relations

Welcome to Chapter 6, Business—Government Trade Relations

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

List and explain the methods governments use to promote international trade

List and explain the methods governments use to restrict international trade

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

Chapter Objectives

In this chapter, you will explore business-government trade relations.

You will also:

Examine the political, economic, and cultural reasons why governments intervene in trade.
Learn about the instruments that countries use to restrict and promote trade.
And understand how the global trading system promotes trade.

Time Warner

Global leader in media and entertainment
Nations protect their traditional values
Time Warner must tread carefully worldwide

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Time Warner is a global leader in media and entertainment. People in almost every nation on the planet view its media creations.
But some governments fear that big-budget Hollywood productions will drown out their own nations’ entertainment industry.
Some nations also fear the replacement of their traditional values with those depicted in imported entertainment.
For these and other reasons, Time Warner must tread carefully as it expands its reach across the world.

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Political Motives

Protect

jobs

Preserve

national

security

Respond to

“unfair”

trade

Gain

influence

Sometimes, governments intervene in trade to achieve political motives.

Lawmakers often try to protect jobs in the domestic economy to protect their own job in office.
Trade in industries vital to national security are protected by governments to guarantee a domestic supply in emergencies.
Another motive for intervention is to respond to the perceived unfair trade practices of another country.
Governments also get involved in trade to gain influence over other nations.

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Economic Motives I

Potential results

National income increases

Wrong industries protected

Firms grow complacent

Consumer prices rise

Public funds poorly spent

Protect infant industries

Protect emerging industries during development from global competition

Governments sometimes protect infant industries from international competition during their development.

But there can be drawbacks to this policy.

First, governments may make errors in identifying the industries that are worth protecting.
Second, protection can make domestic firms less innovative, less competitive, and more likely to increase prices.
Third, this may not be the best use of public funds because small, promising ventures should be able to find private financing.

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Economic Motives II

Potential results

Global industry created

Firms’ efficiency reduced

Domestic costs increase

Special interests benefit

Pursue strategic trade policy

Help companies to achieve economies of scale and gain a first-mover advantage

Governments may also intervene in trade to pursue a strategic trade policy.

This involves governments helping firms gain economies of scale and first-mover advantages.
A potential benefit of a strategic trade policy is higher corporate profits resulting from solidified global market positions.
A potential drawback is that government assistance can cause corporate inefficiency and higher costs.
Assistance can also be subject to political lobbying whereby special-interest groups benefit most and consumers benefit little.

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Cultural Motives

Result of increased

globalization

Nations block imports

deemed harmful

Usual suspects

are U.S. media and

consumer goods

Protect national identity

Governments also intervene in trade for cultural reasons.

Naturally, a culture slowly changes when it is exposed to the people and products of other countries.
Unwanted cultural influence can cause distress for a people and can force governments to block imports.
The expanded influence of the United States due to globalization causes some nations to view U.S. products and media as threats to their culture.
As we saw earlier, Time Warner is sometimes opposed in countries that fear the loss of their own national media.

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Discussion Question

What are some of the political, economic, and cultural reasons why countries intervene in trade?

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Answer to Discussion Question

Political motives include to protect domestic jobs, preserve national security, respond to “unfair” trade, and gain influence over other nations. Economic motives include to protect infant industries from competition and to pursue strategic trade policy. Cultural motives include to protect national identity, block imports thought culturally harmful, and protect budding artists.

Answer:

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Trade Promotion and Restriction

Trade promotion

methods

Trade restriction

methods

Subsidies

Export financing

Foreign trade zones

Special government agencies

Tariffs

Quotas

Embargoes

Local content requirements

Administrative delays

Currency controls

Now that we understand why governments decide to promote or restrict trade with other nations, let’s take a look at each of the methods that nations use to accomplish these goals.

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Financial assistance in the form of cash, tax breaks, price supports, etc.

Subsidies

Potential results

Increased competitiveness

Encourage inefficient firms
Increased consumer prices

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

Although it is intended to increase the competitiveness of domestic companies, a subsidy can have drawbacks.
Subsidies may cause firms to grow inefficient and complacent because they receive help covering costs that efficient firms should be able to absorb.
Subsidies can benefit companies in the short term and harm consumers in the long term if governments use tax revenue to pay for subsidies.

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Export Financing

Export-Import Bank of the United States

Working capital loan guarantees
Credit information on nation or firm abroad
Export credit insurance against loss
Loan guarantees to buyers of U.S. goods

and much more…

Financing such as low-interest loans and loan guarantees

Governments can finance domestic companies’ export activities with low-interest-rate loans or loan guarantees.

Two agencies that help U.S. companies obtain export financing are the Export-Import Bank of the United States and the Overseas Private Insurance Corporation (OPIC).
The practice of financing small businesses just starting to export is widely supported.
But financing large multinational companies at taxpayer expense is criticized as corporate welfare.

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

Purpose is to increase

employment and trade

within the nation

Foreign Trade Zones

The main goals of a foreign trade zone are to create jobs and increase trade flows.

Foreign trade zones reduce customs duties that typically increase production costs and lengthen the time needed to get a product to market.
Companies often use such zones for final product assembly.
China established large manufacturing regions and Mexico has the maquiladora zone along its border with the United States.

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Special Government Agencies

Organize trade missions for officials and businesses

Operate export-promotion offices at locations abroad

Help import products the home nation does not produce

Governments also have special agencies that promote exports through trips abroad for trade officials and businesspeople and through trade offices in other countries.

Such agencies not only promote a nation’s exports but can also encourage needed imports.

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Discussion Question

A geographic region within a nation and in which merchandise passes through with lower customs duties or fewer customs procedures is called a __________.

a. No subsidy zone

b. Special quota zone

c. Foreign trade zone

A geographic region within a nation and in which merchandise passes through with lower customs duties or fewer customs procedures is called a __________.

a. No subsidy zone

b. Special quota zone

c. Foreign trade zone

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Answer to Discussion Question

A geographic region within a nation and in which merchandise passes through with lower customs duties or fewer customs procedures is called a __________.

a. No subsidy zone

b. Special quota zone

c. Foreign trade zone

The correct answer is c. Foreign Trade Zone

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Tariffs

Potential results

Protect domestic firms

from competitors

Generate income for the

government

Reduce competitiveness

of home-based firms

Raise consumer prices

Government tax levied as a product enters or leaves a nation

Export tariff

Transit tariff

Import tariff

Tariffs can take the form of an export tariff, a transit tariff, or an import tariff.

Tariffs protect domestic producers because they raise the cost of imports relative to domestically produced goods.
Tariffs also generate government revenue. Less-developed nations impose import and export tariffs but tend to reduce them as it generates more revenue from taxes on income, capital gains, and other economic activities.
Drawbacks of tariffs include making domestic producers less competitive and less efficient and increasing consumer prices.

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Import and Export Quotas

Restriction on the amount of a good that can enter or leave a country during a certain period of time

Import Quotas

Protect domestic producers of a good
Force outside firms to compete for market access

Export Quotas

Retain adequate domestic supply of a product
Restrict world supply of a product to raise its price

Import quotas limit the quantity of an import and thereby protect domestic producers. Import quotas can force foreign firms to compete for market access by lowering prices or by offering other concessions.

Consumers often suffer higher prices and fewer product choices because of import tariffs. Companies that rely on imported goods to manufacture their products can also suffer from import quotas.

Export quotas increase supplies of a product in a home market, such as when a country blocks the export of a natural resource. Export quotas can also be used to restrict a product’s supply on world markets and thereby increase its global price.

Consumers can benefit from export quotas if increased supply of a product causes prices to fall. But an export quota can cause buyers in other markets that rely on the product to experience reduced supply and higher prices.

How a Tariff-Quota Works

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A tariff-quota charges a lower tariff rate for a certain quantity of imports and a higher rate for quantities that exceed the quota.
Imports under a quota limit of, say, 1,000 tons are charged a 10-percent tariff. Subsequent imports over the quota limit of 1,000 tons would be charged a tariff of 80 percent.
Tariff-quotas are used extensively in the trade of agricultural products and their use is permitted by the World Trade Organization.

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Embargoes

Can be difficult for a nation to enforce

Often used to achieve political goals

Most restrictive nontariff trade barrier

Complete ban on trade (imports and exports)

in one or more products with a particular country

An embargo is a complete ban on trade in one or more products with a particular country.

It is the most restrictive nontariff trade barrier available and it is often used to achieve political goals.
An embargo can be imposed by individual nations or by organizations such as the United Nations.

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Local Content Requirements

Laws that domestic market must supply a specific amount of a product

Forces international companies to

employ local resources in production process

Local content requirements are designed to force companies from other nations to employ local resources in their production processes—particularly labor.

Such requirements may help protect domestic producers in countries with low production costs, or be used to boost industrialization in developing nations.

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Administrative Delays

Regulatory controls or bureaucratic rules to slow imports into a country

Inconvenient ports for imports

Product-damaging inspections

Understaffed customs offices

Lengthy licensing procedures

Administrative delays are regulatory controls or bureaucratic rules designed to impair the rapid flow of imports into a country.

They can include forcing international air carriers to land at inconvenient airports, requiring inspections that damage the product, understaffing customs offices to cause delays, and requiring special licenses that take a long time to obtain.

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Currency Controls

Restrictions on the

convertibility of a currency

Limit the amount of globally accepted currency available to pay for imports

Set an unfavorable exchange rate when paying for imports

Currency controls are restrictions on the convertibility of a currency.

A government can discourage imports by setting an exchange rate that is unfavorable to potential importers.
On the other hand, it can encourage exports by setting an exchange rate that is favorable to potential exporters.

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Discussion Question

What are some of the methods that governments use to restrict international trade?

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Answer Discussion Question

To restrict trade, governments can use methods such as tariffs, quotas, embargoes, local content requirements, administrative delays, and currency controls.

Answer:

To restrict trade, governments can use methods such as tariffs, quotas, embargoes, local content requirements, administrative delays, and currency controls.

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General Agreement on
Tariffs and Trade (GATT)

Early Success:

Tariffs down 35%
Trade up 2,000%

Then Problems:

Nontariff barriers
Services left out

The General Agreement on Tariffs and Trade was a 1947 treaty designed to promote free trade by reducing tariffs and nontariff trade barriers.

Over nearly 40 years, the Agreement reduced tariffs globally by 35 percent and helped grow world trade by 2,000 percent.
But nontariff trade barriers grew rapidly in the 1980s and the Agreement failed to address trade in services, which comprised an ever-greater portion of world trade.

Completed Rounds of GATT

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The ground rules of the GATT resulted from periodic rounds of negotiations among its members.
Though straightforward in the early years, negotiations later became protracted as issues grew more complex.
Note that whereas tariffs were the only topic of the first five rounds of negotiations, other topics were added in subsequent rounds.

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Uruguay Negotiations

Improved intellectual property rules

Extended coverage to services

Created World Trade Organization

Reduced agriculture barriers

The Uruguay Round of negotiations revised the original General Agreement on Tariffs and Trade in four ways.

The Agreement on Trade-Related Aspects of Intellectual Property standardized the intellectual-property rules used in trade.
The General Agreement on Trade in Services extended the principle of nondiscrimination to cover trade in services.
Further opened national agricultural sectors to market forces and lowered barriers, including import quotas and subsidies paid to farmers.
Perhaps most importantly, the Uruguay Round created the World Trade Organization.

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World Trade Organization (WTO)

Dispute settlement body

Doha trade talks

Normal trade relations status

Dumping and antidumping

The World Trade Organization is the international organization that regulates trade between nations.

WTO rules force members to follow the nondiscrimination principle called normal trade relations. This principle says that WTO members must extend the same favorable terms of trade to all members that they extend to any single member.
The WTO settles disputes that involve the granting of subsidies and the practice of “dumping”—which occurs 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.
WTO rules let a nation retaliate against proven dumping by imposing an antidumping duty—which is an additional tariff placed on an imported product that is being dumped on a market.
WTO agreements are contracts between member nations that commit them to fair and open trade policies.
The Doha Round of Negotiations began in Doha, Qatar, in 2001 but progress has been disappointingly slow.

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Discussion Question

The World Trade Organization principle that calls for nondiscrimination among trading partners is called __________.

a. Least favored status

b. Normal trade relations

c. Countervailing relations

The World Trade Organization principle that calls for nondiscrimination among trading partners is called __________.

a. Least favored status

b. Normal trade relations

c. Countervailing relations

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Answer to Discussion Question

The World Trade Organization principle that calls for nondiscrimination among trading partners is called __________.

a. Least favored status

b. Normal trade relations

c. Countervailing relations

The correct answer is b. Normal trade relations

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