International Business by Daniels and Radebaugh

1. International Business by Daniels and Radebaugh Chapter6 Governmental Influence on Trade ©2001 Prentice Hall

2. Objectives • To evaluate the rationale for governmental policies that enhance and restrict trade • To examine the effects of pressure groups on trade policies • To compare the protectionist arguments used in developed countries with those used in developing ones • To study the potential and actual effects of governmental intervention on the free flow of trade • To give an overview of the major means by which trade is restricted, regulated, and liberalized • To examine the World Trade Organization • To show that governmental trade policies create business uncertainties ©2001 Prentice Hall

3. Introduction • No country permits unregulated flow of goods and services across its borders • Governments place restrictions on imports and occasionally on exports • Governments may provide direct and indirect subsidies to improve the competitive position of some industries • Protectionism • Government action intended to limit foreign producer’s ability to compete with domestic industry ©2001 Prentice Hall

4. COUNTRY A COUNTRY B • Political policies and legal • practices • Cultural values, attitudes, • and beliefs • Economic forces • Geographic influences • Political policies and legal • practices • Cultural values, attitudes, • and beliefs • Economic forces • Geographic influences Physical and Societal Influences on Protectionism and Companies’ Competitive Environment TRADE ENHANCEMENTS TRADE RESTRICTIONS COMPANIES’ COMPETITIVE ENVIRONMENT ©2001 Prentice Hall

5. Conflicting Results of Trade Policies • Objectives may conflict • Economic, social, and political goals of a country often conflict • May be impossible to help some industries without hurting others • Proposed reforms of trade regulations results in heated debates among pressure groups • Rationales for Governmental Intervention Economic RationalesNoneconomic Rationales Prevent unemployment Maintain essential industries Protect infant industries Deal with unfriendly countries Promote industrialization Maintain spheres of influence Improve position compared to Preserve national identity other countries ©2001 Prentice Hall

6. Unemployment • Unemployed can form effective pressure group for import restrictions • Problems stemming from restricting imports to create jobs in the domestic economy • Retaliation by other countries • less tendency to retaliate against small countries • restricting country will gain jobs in one place and lose them somewhere else • Pressure against protectionism among workers in industries dependent on imports • Import restrictions indirectly cause loss of export income • Potential costs of import restrictions include both higher prices and higher taxes • such costs should be compared with those of unemployment ©2001 Prentice Hall

7. Infant-Industry Argument • Government should guarantee an emerging industry a large share of the domestic market until it becomes efficient enough to compete against imports • Initial output costs may make products noncompetitive in world markets • Over time costs will decrease due to: • greater economies of scale • greater worker efficiency • Problems with argument • Hard to identify industries with high probability of success • even when industries can be identified, not clear that government should provide protection • Protection may serve as disincentive for managers to adopt innovations needed to become competitive ©2001 Prentice Hall

8. Industrialization Argument • Use of surplus workers—many workers can leave the agricultural sector without affecting output • Influx of workers into industrial sector may result in several problems • heavy demands on social and political services • agriculture may be a better means of effecting additional output than industry • government must decide which industry to protect to minimize consumer price and tax increases • development possibilities in the agricultural sector may be overlooked • Promoting investment flows—import restrictions may increase foreign direct investment • Influx of foreign companies may hasten industrialization • Investment inflows may add to employment ©2001 Prentice Hall

9. Industrialization Argument (cont.) • Diversification—price variations due to uncontrollable factors can wreak havoc on economies dependent on exports • Change from agriculture to industry in emerging economies may simply shift the dependence from a few agricultural products to a few industrial products • Greater growth for manufactured products • Terms of trade—quantity of imports that a given quantity of a country’s exports can buy • prices of raw material and agricultural commodities do not rise as fast as prices of finished goods • deterioration in emerging economies • demand for primary products grows more slowly • cost savings passed on to consumers ©2001 Prentice Hall

10. Industrialization Argument (cont.) • Import substitution— restricting imports in order to produce for local consumption goods that formerly were imported • Not the best way to develop new industries • An initial response to industrialization • Export-led development—creation of industries for which export markets should logically exist • A later stage in the industrialization process ©2001 Prentice Hall

11. Economic Relationships with Other Countries • Balance-of-payments adjustments—governments attempt to modify import or export movement in a free market • Comparable access or “fairness” • In industries in which increased production will greatly decrease cost, producers that lack equal access to a competitor’s market will have a disadvantage in becoming cost competitive • Equal access discussed in terms of fairness • arguments against fairness doctrine • there are advantages of freer trade, even if imposed unilaterally • may escalate economic tensions among trading partners • cumbersome and expensive to negotiate separate agreements for all products that could be traded internationally ©2001 Prentice Hall

12. Economic Relationships with Other Countries (cont.) • Price-control objectives • Export restrictions may: • raise costs of smuggling prevention • lead to substitution • keep domestic prices down by increasing domestic supply • give producers less incentive to increase output • shift foreign production and sales • Import restrictions may: • prevent dumping—exports priced below cost or home-country price • get other countries to bargain away restrictions • get foreign producers to lower their prices ©2001 Prentice Hall

13. Maintaining Essential Industries • Protecting domestic industries during peacetime so that country is not dependent on foreign sources of supply during war • Popular argument to support import restrictions • Countries must • determine which industries are essential • consider costs and alternatives • consider political consequences • Dealing with “Unfriendly” countries • Prevention of exports that might be acquired by potential enemies • May lead to retaliation that prevents securing other essential goods • Trade controls on nondefense goods also may be used as a weapon of foreign policy ©2001 Prentice Hall

14. Maintaining Spheres of Influence • Governments may: • Provide aid and credits to, and encourage imports from, countries that are political allies • Impose trade restrictions to coerce foreign countries to follow certain political actions • Preserving Cultures and National Identity • Countries have a common sense of identity that separates them from other nationalities • May limit foreign products and services to protect their separate identity ©2001 Prentice Hall

15. Instruments of Trade Control • Tariffs—a tax governments levy on goods shipped internationally • Most common type of trade control • export tariff—collected by exporting country • transport tariff—collected by country through which the goods have passed • import tariff—collected by importing country • most common type of tariff • Used to protect domestically produced goods • Used as a source of governmental revenue • specific duty—tariff assessed on per unit basis • ad valorem duty—assessment is a percentage of the value of the item • compound duty—combination of specific duty and ad valorem duty on the same product ©2001 Prentice Hall

16. Price D S As tax raises price, quantity solddecreases Higher Price P2 Tax P1 Q2 Q1 0 Quantity Higher Sales Trade Restrictions Based on Tariffs ©2001 Prentice Hall

17. Instruments of Trade Control (cont.) • Nontariff Barriers: Direct Price Influences • Subsidies—direct government payments to domestic companies to compensate them for losses incurred from selling abroad • other types of government assistance makes it cheaper or more profitable to sell abroad • potential exporters provided with an array of services • subsidies to overcome market imperfections are least controversial • there is little agreement on what a subsidy is • there has been a recent increase in export-credit assistance • Aid and loans—given to other countries with the proviso that the funds be spent in the donor country • repayment insurance for exporters ©2001 Prentice Hall

18. Instruments of Trade Control (cont.) • Nontariff Barriers: Direct Price Influences (cont.) • Customs valuation—procedures for assessing value when customs agents levy tariffs • may be based on • invoice price • value of identical goods • similar goods coming in at the same time • final sales value or on reasonable cost • valuation problems created by the large number of products that are traded • Other direct price influences • special fees • customs deposits • minimum price levels ©2001 Prentice Hall

19. Instruments of Trade Control (cont.) • Nontariff Barriers: Quantity Controls • Quotas—limits the quantity of a product allowed to be imported in a given year • Most-common restriction based on quantity • amount frequently reflects guarantee that domestic producers will have access to a certain percentage of the domestic market • problems with quotas • transshipping goods among countries • transforming product into one for which there is no quota • export quotas • assure domestic consumers a supply of goods at low price • prevent depletion of natural resources • raise export prices • Embargo—quota that prohibits all trade ©2001 Prentice Hall

20. Price D S1 S Import restriction causes quantity sold to fall Higher Price P2 P1 Q2 Q1 0 Quantity Higher Sales Trade Restrictions Based on Available Supply ©2001 Prentice Hall

21. Instruments of Trade Control (cont.) • Nontariff Barriers: Quantity Controls • “Buy local” legislation—governments favor purchasing goods produced domestically • legislation that prescribes a minimum percentage of domestic value • Standards—classification, labeling, and testing standards limit sales of foreign products • Specific permission requirements • import license—potential importers or exporters require governmental permission before conducting trade transactions • foreign-exchange control—importer required to apply to a governmental agency to secure foreign currency to pay for a product • Administrative delays—intentional delays that create uncertainty and raise the cost of carrying inventory ©2001 Prentice Hall

22. Instruments of Trade Control (cont.) • Nontariff Barriers: Quantity Controls (cont.) • Reciprocal requirements—governmental requirements that • exporters take merchandise in lieu of money • exporters promise to buy merchandise or services in the country to which they export • countertrade or offset—barter transaction • Restriction on services—exist for three reasons • Essentiality—countries do not want to depend on foreign companies for strategic services • Standards—ensure qualifications of providers • little reciprocal recognition in licensing from one country to another • Immigration—protect employment of country’s own citizens • require local search for qualified personnel before hiring a foreigner ©2001 Prentice Hall

23. General Agreement on Tariffs and Trade (GATT) • Created in 1947 by 23 countries • Intended to negotiate reductions in trade restrictions and develop common procedures for handling imports and exports • Efforts led to a number of multilateral reductions in tariffs and nontariff barriers for member countries • across-the-board reductions • each country negotiated exceptions to its reductions • Codes of conduct developed in each of five areas • Inherent weakness of GATT • Cumbersome negotiations • Most-favored nation— trade concessions applied to all trading partners • No mechanism to assure compliance with negotiated agreements ©2001 Prentice Hall

24. World Trade Organization (WTO) • Created in 1995 to replace GATT • Negotiating process • Ongoing negotiations about • restrictions on trade in services • nontariff barriers to trade • protection of intellectual-property rights • investment policies that affect trade • Granting of normal trade relations • Apply to WTO members • Eliminates the free-rider complaint raised during GATT negotiations • Certain exceptions recognized • Settlement of disputes • Clearly defined settlement mechanism • Sanctions may be applied to countries that do not comply with rulings ©2001 Prentice Hall

25. Dealing with Governmental Trade Influences • When faced with import competition, companies may • Move production to a lower-cost country • Concentrate on market niches in which there is less international competition • Effect internal adjustments • Companies may require assistance of government to limit imports or open foreign markets • Governments deny some requests for assistance • companies attitudes differ toward protectionism • Companies likely to lose from protectionism • those that depend heavily on trade • those that have integrated production in different global locations • Companies likely to gain from protectionism have single or multidomestic production facilities ©2001 Prentice Hall