BS Chapter 08

International Business© Oxford Fajar Sdn. Bhd. (008974-T) 2010 Ch. 8: 1

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PART III

Countries and TradePolicies

8


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LEARNING OBJECTIVES

To understand the motives for government intervention in trade

To explain the instruments of trade policies and how governments can implement them

To understand how the instruments of trade policies will affect countries and international firms

To discuss the case for government intervention in trade policies


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8.1 INTRODUCTION

In today’s global economy, firms must deal with both domestic and foreign competitors

Due to competition, local firms may request protection or special privileges from the government

Exports generate domestic jobs, so unsurprisingly many national governments encourage the success of their countries’ domestic firms in international markets


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8.1 INTRODUCTION (cont.)

A national government may develop trade policies that begin considering the needs of the economy and society as a whole

After assessing these needs, the government then adopts industry-by-industry policies to promote the country’s overall economic agenda


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8.2 GOVERNMENT INTERVENTIONIN TRADE

Governments normally intervene in a nation’s international trade for reasons such as political, economic, and socio-cultural factors

Figure 8.1 Reasons for Government Intervention in Trade


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8.2.1 Political Factors – Protecting Consumers

Tariffs have long been used as a political tool to establish a nation’s independence

The 1789 United States Tariff Act is an early act designed to achieve political and economic goals in international trade

Recently, tariffs have resulted in many political impacts, both positive and negative

Tariffs are usually politicized during elections, particularly in the US and Australia


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8.2.1 Political Factors – Protecting Consumers (cont.)

While developing nations want more government intervention in international trade to protect their infant industries, developed nations may intervene to protect their consumers

Government intervention in agricultural products, for example, may be necessary as a protective measure to ensure a stable supply of food for local consumers

The main purpose of health, safety, and sanitation regulations is to protect domestic agriculture and consumers from foreign pests, diseases, or chemical residues


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8.2.1 Political Factors – Protecting Consumers (cont.)

Government intervention in international trade lead to the establishment of international organizations regulating international trade, such as the World Trade Organization

The United Nations has also set up councils to monitor activities related to international trade, such as UNCTAD to regulate trade and its development

The World Bank and International Monetary Fund are also international organizations developed due to government intervention in international trade

Government intervention has also contributed to the existence of trading blocs based on locations


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8.2.2 Economic Factors

Economic factors prompting government intervention in international trade include protecting jobs and infant industries, implementing strategic trade policies, or securing national economic security

i) Protecting Jobs Well-established firms (in high-wage countries), are

often threatened by imports from low-wage countries To maintain existing employment levels, firms and

workers often try to lobby their governments for assistance from foreign competition


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8.2.2 Economic Factors (cont.)

Assistance may come in many forms, such as tariffs, quotas, or other trade barriers

Perhaps the most recent development of lobbying for government intervention to protect jobs is the Confederation of All-India Traders (CAIT) request to the Indian government for a National Trade Policy to be drafted especially for their retail and small enterprises


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ii) Protecting Infant Industries In the economic view, government intervention in

international trade protects local infant industries By implementing protectionism measures, newly

founded industries will have the support to grow and develop to stay competitive in the international economy

The measures also enable the industries to become self-sufficient

In a free market economic system, measures such as tariffs must be completely eradicated


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As proposed by economist Ludwig Von Mises, a free market is defined by four requirements: private property, a persuasive government, the dearth of institutional meddling within the system, and the division of labour

Although there is some truth in the infant-industry argument, it must be qualified in several respects: Once a protective tariff is put in place, it is very difficult to

remove, even after the infant industry has reached its maturity level

It is very hard to find out which industries will have the required capabilities of accomplishing comparative advantage potential, and thus merit protection


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This argument is not applicable for developed or industrialized nations like the US, Canada, Japan, and Germany

Apart from using trade barriers like tariffs, a developing industry can be protected from intense competition via other means

In providing protection to infant industries, government intervention allows for young industries to be competitive in international trade


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8.2.2 Economic Factors

iii) Strategic Trade Policies Gained importance in international trade since the

1980s This policy proposes that the government may

provide required aid to local firms to confine economic profits from foreign competitors

Such assistance entails government support for certain ‘strategic’ industries (such as high-technology industries) that are important to future domestic economic growth and that provide widespread benefits (externalities) to society (Carbaugh, 2004)


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iv) National Economic Security A country’s security may be jeopardized in the

event of an international crisis or war if it is heavily dependant on foreign suppliers To ensure the subsistence of local producers,

tariff protections and other protectionism measures must be implemented even though domestic producers are not as efficient

However, critical industries are always specified by the conditions and the existing problems often indicate the critical industry


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If the term is defined broadly, many industries may be able to win import protection, and the argument loses its meaning


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8.2.3 Cultural Factors

International trade may have a significant impact on national culture

For example, in Canada, many nationalists maintain that Canadian culture is too fragile to survive without government protection The big threat is US cultural imperialism Thus, Canada has long maintained some

restrictions on sales of US publications and textbooks

By the 1990s, the envelope of Canada’s cultural protectionism had greatly expanded


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8.2.3 Cultural Factors (cont.)

The most blatant example was a 1994 law that levied an 80% tax on American advertisements in Canadian editions of US magazines, in an effort to discourage the intrusion of US culture

Without protection for Canadian media, cultural nationalists feared that US magazines such as Sports Illustrated, Times and Business Week would deprive Canadians of the ability to read about themselves in Maclean’s and Canadian Business

Although the tax was eventually abolished due to US protests, the Canadian government continues to examine other methods of preserving its culture


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8.3 INSTRUMENTS OF TRADE POLICY

Nations can impose restrictions that are considered essential for the benefit of the nation

This freedom is known as national sovereignty National sovereignty enables the government of

a country to establish certain policies regarding its international trade

Trade policies refer to the planning or procedures set up by a government that determine what and how international trading can be conducted


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8.3 INSTRUMENTS OF TRADE POLICY (cont.)

Trade policies imposed by countries can be considered as trade barriers, as this is against the WTO liberalization of trade policy

These trade policies create obstacles and make it hard for other countries to trade with that particular country. Hence, trade policies can impede the growth of international trade among nations


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8.3 INSTRUMENTS OF TRADE POLICY (cont.)

Trade policies are also sometimes referred to as trade barriers, which can generally be classified into tariff and non-tariff barriers

Figure 8.2 Trade Policy Instruments


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8.4 TARIFF BARRIERS

Tariff A tax (duty) enforced on a product when it crosses

national boundaries Import tariff

Tax levied on an imported product The most widespread tariff

Export tariff Tax imposed on an exported product Less common tariff Often used by developing nations


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8.4 TARIFF BARRIERS (cont.)

A tariff is a tax on goods upon importation. When a ship reaches a port, a customs officer inspects the contents and charges tax according to a tariff formula

Since the goods cannot be landed until the tax is paid, it is the easiest tax to collect, and the cost of collection is considered small

Traders seeking to evade tariffs are known as smugglers


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8.4.1 Purpose of Tariffs

i) Protective Tariffs Designed to shield import-competing producers

from foreign competition Generally not intended to totally prohibit imports

from entering a country Place foreign producers at a competitive

disadvantage when selling in the domestic market


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8.4.1 Purpose of Tariffs (cont.)

ii) Revenue Tariffs Imposed for the purpose of generating tax revenues

and may be placed on either exports or imports Over time, tariff revenues have decreased as a

source of government revenue for industrial nations, including the US In 1990, tariff revenues constituted more than 41% of US

government receipts Records at the millennium show the figure to be 1%

However, many developing nations currently rely on tariffs as a major source of government revenue


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8.4.2 Types of Tariffs

Three types of tariffs: specific, ad valorem, and compound tariffs

i) Specific Tariffs Expressed in terms of a fixed amount of money per

physical unit of imported product As a fixed monetary duty per unit of the imported

product, a specific tariff is relatively easy to apply and administer, particularly to standardized commodities and staple products where the value of the dutiable goods cannot be easily observed

A specific tariff has the advantage of providing domestic producers with more protection during a business recession, when cheaper products are purchased


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8.4.2 Types of Tariffs (cont.)

Specific tariffs thus progressively cushion domestic producers against foreign competitors who cut their prices

The main disadvantage of a specific tariff is that the degree of protection it affords domestic producers varies inversely with changes in import prices

During times of rising import prices, a given specific tariff loses some of its protective effect

The higher the price of imported product, the less effective the specific tariff protective function

Thus, domestic firms are encouraged to produce less expensive goods, for which the degree of protection against imports is higher


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ii) Ad Valorem Tariffs Expressed as a fixed percentage of the value of

the imported product Ad valorem tariffs usually lend themselves more

satisfactorily to manufactured goods, because they can be applied to products with a wide range of grade variations

As a percentage applied to the value of a product, an ad valorem tariff can be distinguished in small differentials in product quality to the extent that they are reflected in product price


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Under a system of specific tariffs, the duty would be the same

An advantage of an ad valorem tariff is that it tends to maintain a constant degree of protection for domestic producers during periods of changing prices


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This tariff is similar to a proportional tax in that the real proportional tax burden or protection does not change as the tax base changes

Determination of duties under the ad valorem principle at first appears to be simple, but in practice has suffered from administrative complexities

The main problem is to determine the value of an imported product, a process referred to as customs valuation

Another customs-valuation problem stems from variations among nations in the methods used to determine a commodity’s value


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iii) Compound Tariffs Compound duties combine both characteristics of

specific and ad valorem tariffs Often applied to manufactured products

embodying raw materials that are subject to tariffs Thus, the specific portion of the duty neutralizes

the cost disadvantage of domestic manufacturers due to tariff protection granted to domestic suppliers of raw materials, and the ad valorem portion of the duty grants protection to the finished-goods industry


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8.4.3 Tariffs and Exports

A tariff causes additional burdens to exporters and importers In protecting import-competing producers, a tariff

leads indirectly to a reduction in domestic exports The net outcome of protectionism is to move the

economy toward greater self-sufficiency, with lower imports and exports

For domestic workers, the protection of jobs in import-competing industries comes at the expense of jobs in other sectors of the economy, including exports

Although a tariff is intended to help domestic producers, the economy-wide implications of a tariff are undesirable toward the export sector


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8.4.3 Tariffs and Exports (cont.)

Welfare losses due to restrictions in output and employment in the economy’s export industry may offset the welfare gains enjoyed by import-competing producers

Importers are required to pay duties to the domestic government upon entering the domestic market, which is translated as an increase in the cost of import

– They will try to pass the increased costs to buyers or end users through price increases


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8.4.3 Tariffs and Exports (cont.)

There are at least three ways in which the resulting higher prices of imports injure domestic exporters: Exporters often purchase imported inputs, which are

subject to tariffs Tariffs also raise the cost of living by increasing the

price of imports Import tariffs have international consequences that

lead to reductions in domestic exports


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8.4.4 Effect of Tariffs on International Trade

According to some economic theories, tariffs have a harmful effect on individual freedom and free market concepts

These theories believe that tariffs are unfair toward consumers and that it is generally disadvantageous for a country to maintain an inefficient industry

The principle underlying free trade opposes all types of tariffs

The World Trade Organization, WTO, as a regulatory body of international trade and the main platform for free trade, intends to abolish or reduce tariffs among contracting nations involved in international trade


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8.4.4 Effect of Tariffs on International Trade (cont.)

Figure 8.3 The effects of international trade on the economy


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8.4.4 Effect of Tariffs on International Trade (cont.)

Apparently, with or without tariffs, there is no incentive to buy the imported goods over the domestic goods, as the price of each is the same

Only by adjusting available purchasing power through debt, selling off assets, or new wages from new forms of domestic production, will the imported goods be purchased

In the real world, as more imports replace domestic goods, they consume a larger fraction of available domestic wages, moving the graph towards this view of the model


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8.4.5 Tariffs and Quotas

Tariffs and quantitative restrictions, commonly known as import quotas, both serve the purpose of controlling the number of foreign products that can enter the domestic market

There are a few reasons why tariffs are a more attractive option compared to import quotasi. Tariffs generate revenue for the governmentii. Import quotas can lead to administrative

corruptioniii. Import quotas are more likely to cause smuggling


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8.4.6 Countervailing Duties

Countervailing duties (CVDs) are used as a means to restrict international trade

They are executed to protect local industries from unfair competition due to subsidization of imports by the exporting side, be it the exporting firms’ government or other agencies

The duty is imposed when the subsidization of the imported product, in one way or another, hurts the local import competing producers

CVD is an ad valorem tariff on an imported good that is imposed by the importing country to counter the impact of foreign subsidies

The purpose of CVDs is merely to counter the advantages enjoyed by the exporters through the subsidized imports entering the market


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8.5 NON-TARIFF BARRIERS (NTBs)

Non-tariff barriers differ from tariff barriers in the sense that it is in the form of restrictions rather than taxes as in tariff barriers

Non-tariff barriers may also hinder international trading activities, as it would add costs to exporting and importing activities

Non-tariff barriers can be in various forms such quotas, subsidies, and local content requirements


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8.5.1 Subsidies

National governments sometimes grant subsidies (also known as a subvention) to local producers to help improve their trade position

By providing domestic firms with a cost advantage, a subsidy allows them to market their products at prices lower than their actual cost or profit considerations

Governmental subsidies assume a variety of forms, including outright cash disbursements, tax concessions, insurance arrangements, and loans at below-market interest rates (Carbaugh, 2004)


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8.5.1 Subsidies (cont.)

Subsidies can be regarded as a form of protectionism or trade barrier by making domestic goods and services artificially competitive against imports

Subsidies may distort markets, and can impose large economic costs

Financial assistance in the form of a subsidy may come from one’s government, but the term subsidy may also refer to backing granted by others, such as individuals or non-governmental institutions, although these would be normally described as charity


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i) Types of Subsidies There are many different ways to classify

subsidies based on purpose for the subsidy, the recipients of the subsidy, or the source of funds (government, consumer, general tax revenue, etc.)

In economics, one of the primary ways to classify subsidies is by the means of distributing the subsidy


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In economics, a subsidy may nonetheless be characterized as inefficient relative to no subsidy; inefficient relative to other means of producing the same results; ‘second-best’, implying an inefficient but feasible solution (contrasted with an efficient but not feasible ideal), among other possible terminology

In other cases, a subsidy may be an efficient means of correcting a market failure

Subsidies would generally be considered by economists to be bad, as economics is the study of efficient use of limited resources


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Ultimately , the choice to impose a subsidy is a political choice

ii) Economic Subsidies Economics has also explicitly identified a number

of areas where subsidies are entirely justified by economics, particularly in the area of provision of public goods Direct subsidy – A direct subsidy is the simplest, and

arguably the least frequently used subsidy. It involves a direct cash transfer to a recipient

Indirect subsidy – The term covers any form of subsidy that does not involve a direct transfer


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Labour subsidy – A labour subsidy is any form of subsidy where the recipients receive subsidies to pay for labour costs. Tax deductions imposed on workers in certain industries are also a part of labour subsidy

Tax subsidy – A tax subsidy is any form of subsidy where the recipients receive the benefit through the tax system. The subsidy can be distributed via tax related channels such as income tax, profit tax, consumption tax systems, etc. A tax subsidy may also be exercised through consumption tax exemption (value added tax or sales tax)

Perverse subsidies – The term ‘perverse’ is sometimes applied to a subsidy when it encourages undesirable outcomes, which largely impose social costs upon the rest of the society


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Production subsidy – In certain cases, such as to encourage the development of a particular industry, governments may provide direct production subsidies in terms of cash payments for production of a given good or service

Regulatory advantages – A policy can be directly or indirectly in favour of one industry, company, product, or class of producer over other means of regulations

Infrastructure subsidy – An infrastructure subsidy can be classified as a form of indirect production subsidy, whereby the provision of infrastructure using public expenses may effectively be useful for a limited group of potential users


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Trade protection (imports) – Measures used to limit imports from other countries may constitute another form of hidden subsidy, as consumers of a given imported product are forced to pay higher prices than they are supposed to pay without the trade barrier

Export subsidy (trade promotion) – Various taxes or other measures are often used to promote exports. Consequently, this has constituted subsidies to favoured industries

Procurement subsidy – Subsidies may occur in this process by the choice of products consumed, the producer, the nature of the product itself, and by other means, including payment of higher-than-market prices for goods purchased


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Consumption subsidy – Governments provide consumption subsidies in a number of ways: by giving away a good or service, providing use of government assets, property, or services below the cost of provision, or by providing economic incentives (cash subsidies) to purchase or use such goods


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8.5.2 Import Quotas and Voluntary Export Restraints

An import quota is a physical restriction on the quantity of goods that may be imported during a specific period

A global quota is a method used to administer import activities in the international trade

When the specified quota of a product has been filled, further imports of the product will be frozen

In practice, a global quota is unmanageable because both domestic importers and foreign exporters will rush to get their goods shipped into an importing country before the quotas are filled


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8.5.2 Import Quotas and Voluntary Export Restraints (cont.)

It is also disadvantageous to products imported from a distant location because of the longer transportation period, or by a smaller merchant to a bigger one, due to the limited trade connections

In effort to avoid the problems of a global quota system, import quotas are normally allotted to specific countries. This type of quota is known as a selective quota

Selective quotas suffer from many of the same problems as global quotas


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8.5.2 Import Quotas and Voluntary Export Restraints (cont.)

Another feature of quotas is that their use may lead to domestic monopoly of production and higher prices because of limited availability of the goods

A voluntary export restraint (VER) is a promise made by a country in imposing certain restrictions on its exports of a good to another country to an agreed amount or percentage of the affected importing market

Often this is done to resolve or avoid trade conflicts with an otherwise friendly trade partner


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8.5.3 Local Content Requirement

Today, many products, represent worldwide production

Domestic manufacturers of these products purchase resources or perform assembly functions or production activities outside the home country

This practice is known as foreign sourcing (outsourcing) or production sharing

Firms have used foreign sourcing to take advantage of lower production costs offered abroad, including lower wage rates


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8.5.3 Local Content Requirement (cont.)

To limit the negative impact of foreign sourcing practices, certain countries have imposed a local content requirements policy

This policy specifies the minimum percentage of a product’s total production value that must be produced locally


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8.5.4 Administrative Policies

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

This is considered an informal approach used by a government in creating trade barriers

These rules have successfully delayed the process of import activities into a country exercising such rules

According to the national trade policy of Tanzania, administrative procedures prevail in developing economies as a response to hard situations at times of natural disasters

Their main impact includes the discouragement of cross-border trade in grains and other food crops, timber and livestock in border regions/ districts


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8.5.5 Antidumping Policies

Antidumping policies are policies designed to counteract dumping practices

Governments of foreign markets often use antidumping policies to protect import competing producers from unfair competition caused by dumping practices

Dumping is recognized as a form of international price discrimination

It occurs when foreign buyers are charged lower prices than domestic buyers for an identical product, after allowing for transportation costs and tariff duties

Selling in foreign markets at a price below the cost of production is also considered dumping


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8.5.5 Antidumping Policies (cont.)

Several aims of exercising dumping are to oust competitors from the particular markets, to maintain production in the home market so that the local product’s price are kept high, and also to unload excess production to foreign markets

Numerous methods can be used to measure whether a product is heavily or lightly dumped

The main method is based on the price in the exporter’s domestic market

When this cannot be used, two alternatives are available


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The two alternatives are the price charged by the exporter in another country, or a calculation based on the combination of the exporter’s production costs, other expenses, and normal profit margins

Anti-dumping measures can only be applied if the dumping is hurting the industry in the importing country

Therefore, a detailed investigation first has to be conducted according to specified rules

The investigation must evaluate all appropriate economic factors that have a position on the state of the industry in question


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If the investigation reveals that dumping is taking place and domestic industries are being hurt, the exporting company can undertake pertinent actions such as raising its price to an agreed level in order to avoid anti-dumping import duty

Anti-dumping investigations are to be concluded instantaneously in cases where the authorities determine that the margin of dumping is insignificantly small, normally when it is defined as less than 2% of the export price of the product

Firms can report to two government agencies when suspected dumping activities take place


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The two government agencies are the Commerce Department and the International Trade Commission

Countervailing duties are another form of duty closely related to antidumping duties

While antidumping duties are imposed to offset injurious dumping, countervailing duties are implemented to off set the injurious subsidization

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