Chapter 6
The Political Economy of International Trade
International Business
Free Trade…
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
Govt. Intervention in International Trade
There are seven main instruments of trade policy
1. Tariffs
2. Subsidies
3. Import quotas
4. Voluntary export restraints
5. Local content requirements
6. Antidumping policies
7. Administrative policies
Tariff
A tariff is a tax levied on imports that effectively raises the
cost of imported products relative to domestic products
Specific tariffs are levied as a fixed charge for each unit of a good
imported
Ad valorem tariffs are levied as a proportion of the value of the
imported good
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
Subsidies
A subsidy is 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
Import Quotas & Voluntary Export Restraints
An import quota is a direct restriction on the
quantity of some good that may be imported into a
country
Tariff rate quotas are 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 restraints are quotas on trade
imposed by the exporting country, typically at the
request of the importing country’s government
A quota rent is the extra profit that producers make
when supply is artificially limited by an import
quota
Local Content Requirements
A local content requirement demands that some
specific fraction of a good be produced
domestically
The requirement can be in physical terms or in value
terms
Local content requirements benefit domestic
producers and jobs, but consumers face higher
prices
Administrative Policies
Administrative trade polices are 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
Dumping is selling goods in a foreign market below their cost of
production, or selling goods in a foreign market at below their
“fair” market value
It can be a way for firms to unload excess production in
foreign markets
Some dumping may be predatory behavior, with producers
using substantial profits from their home markets to subsidize
prices in a foreign market with a view to driving indigenous
competitors out of that market, and later raising prices and
earning substantial profits
Administrative Policies
Antidumping polices are designed to punish
foreign firms that engage in dumping
The goal is to 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
Why do government intervene in trade?
There are two types of arguments
Political arguments are concerned with protecting the
interests of certain groups within a nation (normally
producers), often at the expense of other groups
(normally consumers)
Economic arguments are typically concerned with
boosting the overall wealth of a nation (to the benefit
of all, both producers and consumers)
Political Arguments to intervene
Political arguments for government intervention include
1. protecting jobs
2. protecting industries deemed important for national security
3. retaliating to unfair foreign competition
4. protecting consumers from “dangerous” products
5. furthering the goals of foreign policy
6. protecting the human rights of individuals in exporting
countries
Economic Arguments to intervene
Economic arguments for government
intervention in international trade include
1. The infant industry argument
2. Strategic trade policy
Different views on free trade
New trade theorists believe government intervention in
international trade is justified
Classic 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
Two situations where restrictions on trade may be
inappropriate
Retaliation
Domestic Policies
Retaliation & War
Krugman argues that strategic trade policies aimed
at establishing 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
Consequently, a government’s decision to
intervene in a market may appease a certain group,
but not necessarily the support the interests of the
country as a whole
Developing World trade 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)
From Smith to great Depression
Up until the Great Depression of the 1930s, most
countries had some degree of protectionism
In 1930, the U.S. enacted the Smoot-Hawley Act,
which created significant import tariffs on foreign
goods
Other nations took similar steps and as the
depression deepened, world trade fell further
1947-1979: GATT, Trade Liberalization, and
Economic Growth
After WWII, the U.S. and other nations realized the value
of freer trade, and established the General Agreement on
Tariffs and Trade 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 enforce by a mutual monitoring
system
1980-1993: Protectionist Trends
he 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 and
the World Trade Organization
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
Since its establishment, the WTO has emerged as an
effective advocate and facilitator of future trade deals,
particularly in such areas as services
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
The Future of the WTO:
Unresolved Issues and the Doha Round
The WTO is currently focusing on
1. Anti-dumping policies
The WTO is encouraging members to strengthen the
regulations governing the imposition of antidumping
duties
2. Protectionism in agriculture
The WTO is concerned with the high level of tariffs and
subsidies in the agricultural sector of many economies
3. Protecting intellectual property
Members believe that the protection of intellectual
property rights is essential to the international trading
system
TRIPS obliges WTO members to grant and enforce patents
lasting at least 20 years and copyrights lasting 50 years
The Future of the WTO:
Unresolved Issues and the Doha Round
4.Market access for nonagricultural goods and services
The WTO would like to 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
The WTO launched a new round of talks in 2001 to focus
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
Trade Barrier & firm strategy
Trade theory suggests why dispersing production activities
globally can be beneficial
However, trade barriers may limit a firm’s ability to do so
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
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
Questions…
