International Business

Competing in the Global Marketplace

by Charles W.L. Hill
and G. Tomas M. Hult

©McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom.  No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.
 Learning Objectives
LO 7-1Identify the policy instruments used by governments to
influence international trade flows.
LO 7-2Understand why governments sometimes intervene in
international trade.
LO 7-3Summarize and explain the arguments against strategic
trade policy.
LO 7-4Describe the development of the world trading system
and the current trade issue.
LO 7-5Explain the implications for managers of developments in
the world trading system.

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 The Global Trade and Investment Environment

Chapter 7: Government Policy and International Trade

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 Introduction
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

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 Instruments of Trade Policy 1 of 10
Seven main instruments of trade policy
1. Tariffs
2. Subsidies
3. Import quotas
4. Voluntary export restraints
5. Local content requirements
6. Administrative policies
7. Antidumping duties

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 Instruments of Trade Policy 1 of 9
Nontariff barriers include
1. Subsidies
2. Quotas
3. Voluntary export restraints
4. Antidumping duties

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 Instruments of Trade Policy 2 of 9
Tariffs
 A tariff is a tax levied on imports that effectively raises
the cost of imported products relative to domestic
products
 Specific tariffs: levied as a fixed charge for each unit of a good
imported
 Ad valorem tariffs: levied as a proportion of the value of the
imported good

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 Instruments of Trade Policy 3 of 9
Tariffs continued
• 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
• Tariffs are generally pro-producer and anticonsumer
• Import tariffs reduce the overall efficiency of the world
economy

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 Instruments of Trade Policy 4 of 9
Subsidies
 Subsidy: 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

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 Instruments of Trade Policy 5 of 9
Import Quotas and Voluntary Export Restraints
Import quota
 A direct restriction on the quantity of some good that may be
imported into a country
Tariff rate quota
 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 restraint (VER)
 Quota on trade imposed by the exporting country, typically at the
request of the importing country’s government
Quota rent
 The extra profit that producers make when supply is artificially
limited by an import quota

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 Figure 7.1 Hypothetical Tariff Rate Quota

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escription
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 Instruments of Trade Policy 6 of 9
Export Tariffs and Bans
 Export tariff is a tax placed on the export of a good
 Goal is to discriminate against exporting

 Export ban is a policy that partially or entirely restricts

the export of a good
 Ban of exports of U.S. crude oil in 1975 to ensure sufficient
supply of domestic oil at home

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 Instruments of Trade Policy 7 of 9
Local Content Requirements (LCR)
 A local content requirement demands that some specific
fraction of a good be produced domestically
 Can be in physical terms or in value terms

 Local content requirements benefit domestic producers

and jobs, but consumers face higher prices

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 Is Having a Local Content Requirement a Good Idea?
Local content requirements refer to a specific fraction of a product that needs
to be manufactured domestically. Basically, LCRs establish a minimum level of
local content required under trade law when giving foreign companies the
right to manufacture in a particular place. In the wake of the economic
downturn in 2008, many economists feared that some governments would
institute protectionist policies similar to the tariff escalations during the Great
Depression of the 1930s. However, most public policy officials avoided
traditional forms of protection (e.g., tariffs, quotas). This led some observers
to underestimate the degree of protectionism. Instead, what had happened
was that so-called nontariff barriers in the form of local content requirements
had become increasingly popular. As a (1) citizen of a specific country and (2)
as a global customer, do you think local content requirements help you as a
citizen of a country, as a global customer, as both, or as neither?
Source: G. C. Hufbauer and J. J. Scott, “Local Content Requirements: A Global Problem Washington, D.C.,”
Peterson Institute for Global Economics, 2013.

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 Instruments of Trade Policy 8 of 9
Administrative Policies
 Administrative trade polices: 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

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 Instruments of Trade Policy 9 of 9
Antidumping Policies
 Dumping: selling goods in a foreign market below their
cost of production, or selling goods in a foreign market at
below their “fair” market value
 Objective is to protect domestic producers from unfair foreign
competition
 May be predatory behavior, with producers using substantial
profits from their home markets to subsidize prices in a foreign
market with a goal of driving indigenous competitors out, and later
raising prices and earning substantial profits
 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

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 The Case for Government Intervention 1 of 4
Political arguments
 Concerned with protecting the interests of certain
groups within a nation (normally producers), often at
the expense of other groups (normally consumers)
Economic arguments
 Concerned with boosting the overall wealth of a nation
(to the benefit of all, both producers and consumers)

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 The Case for Government Intervention 2 of 4
Political Arguments for Intervention
 Protecting jobs and industries
 Protecting national security
 Retaliating
 Use intervention as a bargaining tool and force trading partners
to “play by the rules of the game”
 Protecting consumers
 Ban unsafe products
 Furthering foreign policy objectives
 Grant preferential trade terms to a country it wants to build
relations with
 Pressure or punish “rogue” states
 Protecting human rights

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 The Case for Government Intervention 3 of 4
Economic Arguments for Intervention
 The infant industry argument
 An industry should be protected until it can develop and be
viable and competitive internationally
 This argument has been criticized because
 It is useless unless it makes the industry more efficient
 If a country has the potential to develop a viable
competitive position, its firms should be capable of raising
necessary funds

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 The Case for Government Intervention 4 of 4
Economic Arguments for Intervention continued
 Strategic trade policy
 By appropriate actions, government can help raise national
income if it can ensure first-mover advantages in an industry
are domestic
 Might be beneficial for a government to intervene in an
industry by helping domestic firms overcome barriers to entry
created by foreign firms with first-mover advantages

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 Trading with Cuba

Even though the

United States holds
trade sanctions
with Cuba, other
Western countries
continue to trade
with the island
nation.

Source: © Adalberto Roque/AFP/Getty Images

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 The Revised Case for Free Trade 1 of 3
 New trade theorists believe government intervention
in international trade is justified
 Classical 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

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 The Revised Case for Free Trade 2 of 3
Retaliation and Trade War
 Krugman: strategic trade policies to establish 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
 Don’t engage in retaliation but help establish rules to minimize the
use of trade-distorting subsidies

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 The Revised Case for Free Trade 3 of 3
Domestic Policies
 Governments can be influenced by special interest groups
 A government’s decision to intervene in a market may appease a
certain group, but not necessarily support the interests of the
country as a whole
 Krugman sees this as a further reason for not embracing strategic
trade policy

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 Development of The World Trading System 1 of 8
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)

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 Do You Believe in Free Trade Agreements?
The benefits of free trade agreements are often hard to see. At
the same time, the benefits of protecting certain industries and/
or companies from foreign competition are often very visible.
Given these scenarios, many people often argue that free trade
agreements are bad for their country. Perhaps as a result, many
governments impose many tariffs, quotas, and other nontariff
barriers to trade. For example, the common perception is that
by establishing trade barriers, a country keeps the jobs at home
instead of jobs being shipped overseas. But is this really true?
Source: D. J. Boudreaux, The Benefits of Free Trade: Addressing the Myths (Washington, DC: Mercatus Center,
George Mason University, 2013).

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 Development of The World Trading System 2 of 8
From Smith to the Great Depression
 Up until the Great Depression of the 1930s, most countries
had some degree of protectionism
 The U.S. enacted the Smoot-Hawley Act (1930): created
significant import tariffs on foreign goods
 Other nations took similar steps and as the depression
deepened, world trade fell further

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 Development of The World Trading System 3 of 8
1947-1979: GATT, Trade Liberalization, and Economic
Growth
 The General Agreement on Tariffs and Trade (GATT) was
established in 1947
 Multilateral agreement to liberalize trade and gradually
eliminate barriers to trade
 Tariff reduction was spread over eight rounds
 Very successful in early rounds

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 Development of The World Trading System 4 of 8
1980-1993: Protectionist Trends
 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

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 Development of The World Trading System 5 of 8
The Uruguay Round and the World Trade Organization
 Uruguay Round emphasized services, intellectual
property, and agricultural subsidies
 Trade issues related to services and intellectual property and
agriculture were emphasized
 Dragged on for seven years
 The World Trade Organization
 The WTO encompassed GATT, the General Agreement on Trade
in Services (GATS), and the Agreement on Trade Related Aspects
of Intellectual Property Rights (TRIPS)
 Procedures subject to strict time limits

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 Development of The World Trading System 6 of 8
WTO: Experience to Date
 Members account for 98% of world trade
 It was hoped that it would emerge as an effective
advocate and facilitator of future trade deals
 So far, most countries have adopted WTO
recommendations for trade disputes
 In general, countries involved in disputes accept WTO
recommendations
 Global telecommunication and financial service
industries targeted for reform

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 Development of The World Trading System 7 of 8
The Future of the WTO: Unresolved issues and the Doha
Round
 Anti-dumping actions
 Encourage members to strengthen the regulations governing
the imposition of antidumping duties
 Protectionism in agriculture
 Concerned with the high level of tariffs and subsidies in the
agricultural sector of many economies
 Protecting intellectual property
 Members believe that the protection of intellectual property
rights is essential to the international trading system
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 Protecting Agriculture

Removing barriers
to trade and
subsidies in
agricultural
products should
benefit consumers.
Source: © Mark Elias/Bloomberg/Getty Images

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 Development of The World Trading System 8 of 8
The Future of the WTO: Unresolved issues and the
Doha Round continued
 Market access for nonagricultural goods and services
 Tariffs on services remain higher than on industrial goods
 A new round of talks Doha
 Have been ongoing since 2001 concerned with cutting tariffs on
industrial goods and services, phasing out subsidies to
agricultural producers, reducing barriers to cross-border
investment, limiting the use of antidumping laws

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 Development of The World Trading System 8 of 8
The Future of the WTO: Unresolved issues and the
Doha Round continued
 Multilateral and Bilateral Trade Agreements
 Designed to capture gain from trade beyond those agreements
currently attainable under WTO treaties
 Tariff barriers raise the costs of exporting products to a country
 Quotas may limit a firm’s ability to serve a country from locations
outside that country
 A firm may have to locate more production activities in a given
market than it would otherwise.
 The threat of antidumping action limits the ability of a firm to
use aggressive pricing to gain market share in a country
 Policy Implications

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 Focus on Managerial Implications 1 of 2
TRADE BARRIERS, FIRM STRATEGY, AND POLICY
IMPLICATIONS
• Trade barriers impact firm strategy
• Tariff barriers raise the costs of exporting
• Quotas may limit a firm’s ability to serve a country
• Firms may need to conform to local content requirements
• Future trade barriers can influence firm strategy
• Firms can play a role in promoting free trade or trade
barriers

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 Focus on Managerial Implications 2 of 2
Policy Implications
 International firms have an incentive to lobby for free
trade, and keep protectionist pressures from causing them
to have to change strategies
 Three drawbacks to government intervention
 Self-defeating as it protects the inefficient
 Dangerous as it might invite retaliation
 Unlikely to be well-executed as can be captured by special interest
groups

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 Summary
In this chapter we have
 Identified the policy instruments used by governments to
influence international trade flows.
 Understood why governments sometimes intervene in
international trade.
 Summarized and explained the arguments against strategic
trade policy.
 Described the development of the world trading system
and the current trade issues.
 Explained the implications for managers of developments
in the world trading system.

©McGraw-Hill Education.