Government influence on trade

Reading List

• John D. Daniels, Lee H. Radebaugh, Daniel P. Sullivan, Reid W. Click (2022). INTERNATIONAL
BUSINESS Environments & Operations, 17th EDITION, Pearson, Chapter 7
• Aaron X. Fellmeth (2020). Introduction to International Business Transactions, Edward Elgar.
Chapter 6
Learning Objectives (1 of 2)
Recognize the conflicting outcomes of trade
protectionism
Assess governments’ economic rationales and
outcome uncertainties with international trade
intervention
Assess governments’ noneconomic rationales
and outcome uncertainties with international
trade intervention
Learning Objectives (2 of 2)
Describe the major instruments of trade control
Understand how companies deal with import competition
 Why Government Intervenes in Trade

Table 1 Why Governments Intervene in Trade

Economic Rationales Noneconomic Rationales

Fighting unemployment Maintaining essential industries

Protecting infant industries Promoting acceptable practices abroad

Promoting industrialization Maintaining or extending spheres of influence

Improving comparative positions Preserving national culture

Economic Rationales for Governmental
Intervention and Outcome Uncertainties (1 of 2)

• Fighting unemployment
• Retaliation
• Protecting infant industries
• Developing an industrial base
Probably no pressure group is more effective than the unemployed; no other group
has more time and incentive to protest publicly and contact government
representatives. Import restrictions to create domestic employment may lead to
retaliation by other countries, affect large and small economies differently, reduce
import handling jobs, may decrease jobs in another industry, or may decrease
export jobs because of lower incomes abroad.

The infant-industry argument says that production becomes more competitive over
time because of increased economies of scale, and greater worker efficiency.
Governments must first identify those industries that have a high probability of
success, and this is hard.

Second, the security of government important protection may deter managers from
adopting the cost and quality measure needed to compete. Third, if a protected
industry fails to become globally competitive, its affected stakeholders may
successfully prevent the imports that benefit consumers.
Since the industrial revolution, countries increasing their industrial bases grew their employment
and economies more rapidly. This observation led to protectionist arguments to spur local
industrialization. These arguments have been based on the following assumptions:
• Surplus workers can increase manufacturing output more easily than agricultural output.
• Import restrictions lead to foreign investment inflows, which provide jobs in manufacturing.
• Prices and sales of agricultural products and raw materials fluctuate widely, which is a
detriment to economies that depend heavily on them, especially if the dependence is on just
one or a few commodities.
• Markets for industrial products grow faster than markets for both agricultural and raw material
commodities.

• Economic Relationships with other countries: Nations monitor their absolute economic situations
and compare their performance to other countries. Among their many practices to improve their
relative positions, four stand out: making balance-of-trade adjustments, gaining comparable
access to foreign markets, using restrictions as a bargaining tool, and controlling prices.
Economic Rationales for Governmental
Intervention and Outcome Uncertainties (2 of 2)

• Improving comparative economic positions

• Balance-of-trade adjustments
• Comparable access
• Import/export restrictions
• Optimum tariff
• Nations monitor their absolute economic situations and compare their
performance to other countries. Among their many practices to improve their
relative positions, four stand out: making balance-of-trade adjustments,
gaining comparable access to foreign markets, using restrictions as a
bargaining tool, and influencing prices.

• A trade deficit influences reductions in a nation’s exchange reserves—the funds

that help purchase priority foreign goods and maintain the trustworthiness of its
currency. So balance-of-trade deficits may cause a government to act to reduce
imports or encourage exports.

• If domestic producers have less access to foreign markets than foreign producers
have to their market, they may be disadvantaged, but restricting foreign entry may
disadvantage domestic consumers and negotiating equal market access for each
product is impractical.
• The threat or imposition of import restrictions may persuade other countries to
lower their import barriers or not raise them. The danger is that each country then
escalates its restrictions instead, creating, in effect, a trade war that negatively
impacts all their economies. Successful countries’ threats to levy trade
restrictions to coerce other countries to change their policies must be believable
and involve products important to the other countries.
• Export restrictions may raise world prices, require more controls to prevent
smuggling, be ineffective for digital products, lead to product substitution or new
ways to produce the product, keep domestic prices down by increasing domestic
supply, and give producers less incentive to increase output. There is fear that
foreign producers will price their exports so artificially low that they will drive
producers out of business in the importing country. Exporting below cost or below
home-country price is called dumping. This may be used to introduce a new
product. It may cause higher prices or subsidies in the exporting country. But it is
hard to prove.
• An optimum tariff’s success shifts revenue to an importing country, is difficult to
predict, and may cause lower worker income in developing countries.
 Conflicting Outcomes of Trade Protectionism

Figure 1 Institutional Factors Affecting the Flow of Goods and Services

Noneconomic Rationale for Governmental Trade
Intervention and Outcome Uncertainties

• Maintaining essential industries

• Promoting acceptable practices abroad
• Maintaining or extending spheres of influence
• Preserving national culture
• Although noneconomic arguments are used to influence trade, many of these
also have economic undertones and consequences.

• Under the essential-industry argument nations apply trade restrictions to protect

crucial domestic industries so that they are not dependent on foreign supplies
during hostile political periods. In addition, governments buy and stockpile
supplies or essential raw materials that might be in future short supply.

Governments limit exports, even to friendly countries, of strategic goods that might
fall into the hands of potential enemies. They also limit exports and imports to
compel a foreign country to change some objectionable policy or capability. The
rationale is to weaken the foreign country’s economy by decreasing its foreign sales
and by limiting its access to needed products, thus coercing it to amend its
practices on some issue such as human rights, environmental protection, military
activities, and production of harmful products.
Governments use trade to support their spheres of influence—giving aid and
credits to, and encouraging imports from, countries that join a political alliance or
vote a preferred way within international bodies.

To help sustain a collective identity that sets their citizens apart from other
nationalities, governments prohibit exports of art and historical items deemed to
be part of their national heritage. In addition, they limit imports that may either
conflict with or replace their dominant values.
Major Instruments of Trade Control: Tariffs

• Tariff (Duty)
• Why are Tariffs levied?
• Types of Tariffs
In seeking to influence exports or imports, governments’ choice of trade-control
instrument is crucial because each may incite different responses from domestic
and foreign groups. One way to understand these instruments is by distinguishing
between those that directly influence export or import prices and those that
directly limit the amount of a good that can be traded.

Tariff barriers directly affect prices, and nontariff barriers may directly affect either
price or quantity. A tariff (also called a duty) is a tax levied on a good shipped
internationally. That is, governments charge a tariff on a good when it crosses an
official boundary— whether it be that of a nation or a group of nations that have
agreed to impose a common tariff on goods crossing the boundary of their bloc. A
tariff assessed on a per-unit basis is a specific duty, on a percentage of the item’s
value an ad valorem duty, and on both a compound duty
Tariffs collected by the exporting country are called export tariffs; if
they’re collected by a country through which the goods pass, they’re
transit tariffs; if they’re collected by importing countries, they’re import
tariffs.

Developing countries have argued that the effective tariff on the

manufactured portion turns out to be higher than the published tariff
rate. This anomaly further challenges developing countries to find
export markets for products that use their raw materials.
Non-Tariff Barriers: Direct Price Influences
• Subsidies
• Agriculture Subsidies
• Overcoming market imperfections
Subsidies offer direct assistance to companies to boost their competitiveness.
Although this definition is straightforward, disagreement on what constitutes a
subsidy causes trade frictions. In essence governmental subsidies may help
companies be competitive. But there is little agreement on what a subsidy is and
agricultural subsidies are difficult to dismantle.

The one area in which everyone agrees that subsidies exist is agriculture especially
in developed countries. The official reason is that food supplies are too critical to
be left to chance. Although subsidies lead to surplus production, they are argued
to be preferable to the risk of food shortages.

Because it is difficult for customs officials to determine the honesty of import

invoices, valuation procedures have been developed. They may restate the value
and they may question the origin of and product-classification of imports.
Non-Tariff Barriers: Quantity Controls
(1 of 2)

• Quantity controls
• Quotas
• Voluntary Export Restraints (VER)
• Embargoes
• Governments’ regulations and practices affect the quantity of imports and
exports directly.

A quota limits the quantity of a product that can be imported or exported in a given
time frame, typically per year. Import quotas normally raise prices because they (1)
limit supplies and (2) provide little incentive to use price competition to increase
sales.

A voluntary export restraint (VER) is a quota variation whereby, essentially, Country

A asks Country B to voluntarily reduce its companies’ exports to Country A. The
term voluntarily is misleading; typically, either Country B agrees to reduce its
exports or else Country A may impose tougher trade restrictions.
A specific type of quota that prohibits all trade is an embargo. As with quotas, a
country or group of countries may place embargoes on either imports or exports,
on particular products regardless of origin or destination, on specific products
with certain countries, or on all products with given countries. Buy local
legislation sets rules whereby governments give preference to domestic
production in their purchases.
Countries can devise classification, labeling, and testing standards to allow the
sale of domestic products while obstructing foreign-made ones. Countries may
require that importers or exporters secure governmental permission (an import or
export license) before transacting trade. Closely akin to specific permission
requirements are administrative customs delays that may be caused by intention
or inefficiency.
Non-Tariff Barriers: Quantity Controls
(2 of 2)

• Restrictions on Services
• Essentiality
• Not-for-Profit Services
• Standards
• Immigration
• Service is the fastest-growing sector in international trade. In deciding whether to
restrict service trade, countries typically consider four factors: essentiality, not-
for-profit preference, standards, and immigration.

Governments sometimes prohibit private companies, foreign or domestic, from

operating in some sectors because they feel the services are essential and provide
social stability. In other cases, they set price controls or subsidize government-
owned service organizations that create disincentives for foreign private
participation. Some essential services in which foreign firms might be excluded
are media, communications, banking, utilities, and domestic transport.

Mail, education, and hospital health services are often not-for profit sectors in
which few foreign firms compete. When a government privatizes these industries,
it customarily prefers local ownership and control.
Some services require face-to-face interaction between professionals and clients,
and governments limit entry into many of them to ensure practice by qualified
personnel. The licensing requirements include such professionals as accountants,
actuaries, architects, electricians, engineers, gemologists, hairstylists, lawyers,
medical personnel, real estate brokers, and teachers.

Satisfying the standards of a particular country is no guarantee that a foreigner can

then work there. In addition, governmental regulations often require an
organization— domestic or foreign—to search extensively for qualified personnel
locally before it can even apply for work permits for personnel it would like to bring
in from abroad.
Anti-Dumping and Countervailing Measures
• Anti-dumping: a product has been sold at less than
“normal” value
• Tariff can be applied against “dumped” goods if the
dumping causes “material injury” to the domestic
competing sector producing a “like product.”
• Anti-dumping is consistent with obligations under the WTO
• Determination of dumping:
• Price-based dumping: determined with evidence that an exporter is selling
a good in the importing country at a price below what it charges in its own
country.
• Cost-based dumping: determined with evidence that an exporter is selling
a good in the importing country below its costs of production
• Dumping
• The export of a commodity at below cost, or the sale of a commodity at a
lower price abroad than domestically.
• Three types of dumping:
1. Persistent dumping is the continuous tendency of a domestic monopolist to
maximize total profits by selling the commodity at a higher price in the domestic
market.
Other Nontariff Barriers and the New Protectionism

• Dumping
• The export of a commodity at below cost, or the sale of a commodity at a
lower price abroad than domestically.
• Three types of dumping:
1. Persistent dumping
2. Predatory dumping is the temporary sale of a commodity at below cost or a lower
price abroad to drive foreign producers out of business.
Other Nontariff Barriers and the New Protectionism

• Dumping
• The export of a commodity at below cost, or the sale of a commodity at a
lower price abroad than domestically.
• Three types of dumping:
1. Persistent dumping
2. Predatory dumping
3. Sporadic dumping is the occasional sale of a commodity at below cost or lower
price abroad to unload surplus of the commodity without reducing domestic prices.
Anti-Dumping and Countervailing Measures
• Calculating the dumping margins can be complicated,
particularly when market systems in exporting countries are
not completely operational.
• The importing country can choose from three policy
responses.
• (1) Impose anti-dumping duties equal to the found dumping
margin.
• (2) Impose anti-dumping duties sufficient to remove “material
injury” (“lesser-duty rule”).
• (3) Have foreign exporting firms increase their prices (“price
undertakings”)
• Criticisms on anti-dumping
Anti-Dumping and Countervailing Measures

• Countervailing duties can be imposed on foreign exporters as offsets when

they benefit from subsidies offered to them by their national governments
• Also allowed by the WTO: CVD actions are allowed if it can be shown both
that the subsidies benefited the foreign exporter and that the resulting
exports caused “material injury” to the domestic competing industry in the
importing country.
• Criticisms: also protectionism?
How Companies Deal with Import Competition

• Threats from import competition

• Convincing decision-makers
• Preparing for changes in the competitive environment
When companies are threatened by import competition, they have several options,
four of which stand out.

• Move operations to another country.

• Concentrate on market niches that attract less international competition.
• Adopt internal innovations, such as greater efficiency or superior products.
• Try to get governmental protection.

• Governments cannot try to help every company that faces tough international
competition. Likewise, helping one industry may hurt another. Thus, as a manager,
you may propose or oppose a particular protectionist measure. Inevitably, the
burden falls on you and your company to convince officials that your situation
warrants particular policies. You must identify the key decision-makers and
convince them by using the economic and noneconomic arguments.
• A company improves the odds of success if it can ally most, if not all, domestic
companies in its industry. Involving stakeholders can help. Finally, it can lobby
decision-makers and endorse the political candidates who are sympathetic to its
situation.

• Companies take different approaches to deal with changes in the international

competitive environment. Frequently, their attitudes toward protectionism are a
function of the investments they have made to implement their international
strategy.

• Companies also differ in their confidence to compete against imports.

Fiscal and Monetary Policy-Interest Rates and Inflation
 Causes of Inflation
1. DEMAND-PULL INFLATION
“Too many dollars (Euros TL) chasing too few goods”
DEMAND PULLS UP PRICES!!!
• Demand increases but supply stays the
same. What is the result?
• A Shortage driving prices up
• An overheated economy with excessive
spending but same amount of goods.
 Causes of Inflation
2. COST-PUSH INFLATION
Higher production costs increase prices
A negative supply shock increases the costs of
production and forces producers to increase
prices.
Examples:
• Hurricane Katrina destroyed oil refineries and
causes gas prices to go up. Companies that use
gas increase their prices.
• Russian Invasion of Ukraine raised prices on
energy, fertilizers.
 The Wage-Price Spiral
A Perpetual Process:
1.Workers demand raises
2.Owners increase prices to
pay for raises
3. High prices cause workers
to demand higher raises
4. Owners increase prices to
pay for higher raises
5. High prices cause workers
to demand higher raises
6. Owners increase prices to
pay for higher raises
Transmission of Money
interest
S1 S2 Money
Balances
Monetary Policy rate

• When the Fed shifts to a more expansionary i1

monetary policy, it usually buys additional
bonds, expanding the money supply.
i2
• This increase in the money supply (shift
from S1 to S2 in the market for money) D1
provides banks with additional reserves. Qs Qb
Quantity
of money
• The Fed’s bond purchases and the bank’s
use of new reserves to extend new loans Real S1 Loanable
increases the supply of loanable funds interest Funds
rate
(shifting S1 to S2 in the loanable funds
market) and puts downward pressure S2
on real interest rates (a reduction to r2). r1

r2
D Qty of
loanable
Q1 Q2 funds
Transmission of Real
interest
S1 Loanable
Funds
Monetary Policy rate

S2
r1

• As the real interest rate falls, AD increases r2

(to AD2). D Qty of
• When the monetary expansion is Q1 Q2
loanable
funds
unanticipated, the expansion in AD leads
to a short-run increase in output (from Y1
to Y2) and an increase in the price level Price
Level AS1
(from P1 to P2) – inflation.
• The impact of a shift in monetary policy
is transmitted through interest rates,
exchange rates, and asset prices. P2

P1
AD2
AD1 Goods &
Services
Y1 Y2 (real GDP)
Transmission of Monetary Policy
• Here, a shift to an expansionary monetary policy is shown.
• The Fed buys bonds (expanding the money supply), which increases bank
reserves—pushing real interest rates down—leading to a direct increase in
investment and consumption. There will also be, a depreciation of the dollar,
(increased net exports), an increase in asset prices (increasing personal
wealth), and indirectly increasing investment and consumption.
• So, an unanticipated shift to a more expansionary monetary policy will
stimulate AD and, thereby, increase both output and employment.

Increases in
This investment &
increases Real consumption
Fed Net exports Increase in
buys money interest Depreciation rise
bonds supply rates aggregate
of the dollar demand
and bank fall Increases in
reserves Increase in investment &
asset prices consumption
Expansionary Monetary Policy
Price
Level
LRAS

•If expansionary monetary policy SRAS1

leads to an in increase in AD
when the economy is below
capacity, the policy will help
direct the economy toward LR
full-employment output (YF). P2 E2
P1 e1
•Here, the increase in output from
Y1 to YF will be long-term. AD2
AD1
Goods & Services
Y1 Y F (real GDP)
A Shift to More
Restrictive-Contractionary Monetary Policy
• Suppose the Fed shifts to a more restrictive monetary
policy. Typically it will do so by selling bonds which will:
• depress bond prices and
• drain reserves from the banking system,
• which places upward pressure on real interest rates.
• As a result, an unanticipated shift to a more restrictive
monetary policy reduces aggregate demand and
thereby decreases both output and employment.
 S2
Short-run Effects of More Real
interest S1
rate
Restrictive Monetary Policy
r2

r1
• A shift to a more restrictive monetary
D
policy, will increase real interest rates. Qty of
loanable
• Higher interest rates decrease aggregate Q2 Q1 funds
demand (to AD2). Price AS1
Level
• When the change in AD is unanticipated,
real output will decline (to Y2) and
downward pressure on prices will result.
P1

P2
AD1
AD2 Goods &
Services
Y2 Y1 (real GDP)
Restrictive Monetary Policy

•The stabilization effects of LRAS

Price
restrictive monetary policy Level
depend on the state of the SRAS1
economy when the policy
exerts its impact.
P1 e1
•Restrictive monetary policy will
reduce aggregate demand. P2 E2
If the demand restraint occurs
during a period of strong AD1
AD2
demand and an overheated
economy, then it may limit or Goods & Services
prevent an inflationary boom. YF Y1 (real GDP)
Fiscal Policy and the Economy
• The total level of government spending can be changed to help
increase or decrease the output of the economy

• Expansionary Policies: Policies that try to increase the output of

the economy
• Contractionary Policies: Policies that try to decrease the output of
the economy
Expansionary Policies
• During a contraction or recession, the government can do two
things:

1. Decrease Taxes
Or
2. Increase Spending
Decreasing Taxes
1. Gives people more money to spend
2. More money = more demand
3. More demand = more production
4. More production = more jobs
5. More jobs = more demand etc. etc.
Increase Spending
1. Increases demand for goods
2. More demand = more production
3. More production = more jobs
4. More jobs = more demand etc. etc.