In this chapter, you will explore business-government trade relations. You will also: Examine the political, economic, and cultural reasons why

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1 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. 1

2 In this topic, 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. 2

3 Sometimes, governments intervene in trade to achieve political motives. Lawmakers often try to protect jobs in the domestic economy because they fear being voted out of office for high rates of unemployment. Imports and exports in industries vital to national security receive government protection so that a country can guarantee a domestic supply in emergencies. Another motive for intervention is to respond to the perceived unfair trade practices of another country. And governments get involved in trade to gain influence over other nations. 3

4 Governments also have economic motives to intervene in trade. The infant industry argument says that emerging industries need protection 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,p 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 can typically get private funding today. 4

5 Another economic motive for trade intervention is to pursue a strategic trade policy. This involves government intervention to help 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. 5

6 Governments also intervene in trade for cultural reasons. Naturally, a culture will slowly change when it is exposed to the people and products of other countries. Unwanted cultural influence causes great distress for a people and can force governments to block imports. The laws of many countries protect national media programming for cultural reasons. The United States is often seen as a threat to national cultures because of its global strength in consumer goods, entertainment, and media. 6

7 Recap Political motives include to protect domestic jobs, to preserve national security, to respond to unfair trade by another nation, and to gain influence over other nations. Economic motives include to protect infant industries from competition and to pursue strategic trade policy. And Cultural motives include to protect national identity, to block imports thought culturally harmful, and to protect budding artists. 7

8 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. 8

9 Financial assistance to domestic producers in the form of cash payments, lowinterest-rate loans, tax breaks, product price supports, or some other form is called a subsidy. Although it is intended to help domestic companies fend off international competitors, a subsidy can have drawbacks. For example, a subsidy may cover costs that a competitive industry should be able to absorb, which may encourage firms to grow inefficient and complacent. Subsidies may benefit companies in the short term and harm consumers in the long term if governments pay for subsidies with tax revenues. 9

10 Governments promote exports by helping companies finance their export activities through 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. 10

11 The main goals of a foreign trade zone are to create jobs and increase trade. 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. Examples include the very large zones established in China s manufacturing regions and Mexico s maquiladora zone along its border with the United States. 11

12 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. 12

13 A geographic region within a nation and in which merchandise passes through with lower customs duties or fewer customs procedures is called a Foreign trade zones 13

14 Tariffs can take the form of an export tariff, a transit tariff, or an import tariff. Tariffs can protect domestic producers because an import tariff raises the cost of imports relative to domestically produced goods. Tariffs can also generate government revenue. A less-developed nation may impose an import or export tariff because it has difficulty recording and taxing domestic transactions. As a country develops, however, it tends to reduce tariffs and generate more revenue from taxes on income, capital gains, and other economic activities. But tariffs can have drawbacks they can make domestic producers less competitive and less efficient, and can increase consumer prices. 14

15 Import quotas limit the quantity of an import and thereby protect domestic producers and help them to maintain market shares and prices. Import quotas can also force non-domestic firms to compete for market access by lowering prices or by giving other concessions. Although domestic producers obtain protection from import quotas, consumers often suffer higher prices and fewer product choices. Companies that rely on imported goods in the manufacture of their products can also suffer from import quotas. Export quotas boost 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 domestic producers do not curtail production and prices fall. On the other hand, export quotas can harm consumers in importing markets through reduced selection and higher prices. 15

16 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. 16

17 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. 17

18 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. 18

19 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. 19

20 Answer: To restrict trade, governments can use methods such as tariffs, quotas, embargoes, local content requirements, administrative delays, and currency controls. 20

21 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. 21

22 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. Reforms further exposed 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. 22

23 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, which 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. When a member files a complaint, the Dispute Settlement Body of the WTO renders a decision in less than one year. Offenders must realign policies according to WTO guidelines or suffer financial penalties and, perhaps, trade sanctions. The Doha Round of Negotiations began in Doha, Qatar, in late Negotiations were expected to bring particular benefits for developing nations, but their eventual success is now in doubt. 23

24 The World Trade Organization principle that calls for nondiscrimination among trading partners is called Normal trade relations. 24

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2. Specific tariffs are levied as a proportion of the value of the imported good.

Chapter 07 The Political Economy of International Trade True / False Questions 1. Tariffs are unambiguously pro-consumer and anti-producer. True False 2. Specific tariffs are levied as a proportion of