1. Political Economy of International Trade

4. In the 1970’s US scientist discovered a synthesize certain hormones and use them to promote growth of livestock of animals, reduce fat content of meat, and increase milk production. Bovine Somatotropin (BST), a growth hormone produced by beef cattle which is to be injected to supplement an animal’s own hormone production and increase its growth rate.

5. Introduction Examine the political reality of international trade The political, economic reasons for government intervention The range of policy instruments The emergence of the modern international trading system.

6. The political, economic reason for government intervention When governments intervene, they often do so by restricting imports of goods and services into their nation while adopting policies that promote exports. Normally, their motives for intervention are to protect domestic producers and jobs from foreign competition while increase the foreign market of domestic products.

7. Example The decision of the EU to ban import of hormone treated beef was a political response to social concern about the health consequences.

9. The GATT and WTO are the creations of a series of treaties of multinational treaties.

11. Does Current Account Deficit matter ? A current account deficit Money flows to other countries These countries can use the money to purchase assets in the deficit country. The US runs a trade deficit with China The Chinese use the money To purchase US assets Stocks, bonds, real estate, whole corporations A deficit on the current account Financed by selling assets to other countries

12. Does Current Account Deficit matter ? The persistent US current account deficit Financed by a steady sale of US assets to other countries Net debtor The US must deliver a stream of interest payments to foreign bondholders Rents to foreign landowners Dividends to foreign stockholders Drain resources from a country and limit the funds available for investments within the country ?

13. Implications of trade deficits ? Investment within a country Necessary to stimulate economic growth A persistent current account deficit can Choke off a country’s future economic growth ? Opposite argument Current account deficit is not that bad after all ?

14. Is Current Account Deficit that bad ? In global capital markets Money is efficiently directed toward its highest value uses Over the last quarter of a century Many of the highest value uses of capital Have been in the US. Capital is flowing out of the US In the form of payments to foreigners Much of that capital comes back to the US To fund productive investments in the US NOT clear whether the current account deficit chokes off US economic growth.

15. The US economic growth and FDI in the US For the last 25 years The US had grown at impressive rate Because Foreigners reinvest much of the income earned from the US assets From exports to the US, right back into the US What if foreign investors lose appetite for US assets ? Instead of reinvesting earning from the US Sell dollars for another currency Invest in euro-, yen- denominated assets. A fall in the value of the dollar on foreign exchange markets Increase in the price of imports, Lower the price of US exports Making them more competitive Reduce the overall level of the current account deficit.

16. Instruments of Trade Policy Question: How do governments intervene in international trade? There are seven main instruments of trade policy Tariffs Subsidies Import quotas Voluntary export restraints Local content requirements Antidumping policies Administrative policies

17. Tariffs A tariff is a tax levied on imports raises the cost of imported products relative to domestic products Specific tariffs a fixed charge for each unit of a good imported Ad valorem tariffs a proportion of the value of the imported good

18. Tariffs Question: Why do governments impose tariffs? Tariffs 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 So, tariffs are unambiguously pro-producer and anti-consumer, reduce the overall efficiency of the world economy

19. Who gain and who lose from Tariff policy ? Winners Domestic producers : protection Increased cost for foreign producers Losers Consumers Pay more for import goods US – ad valorem tariff of 8%-30% on foreign steel. To protect domestic steel producers Raised the price of steel products in the US by 30-35% Carmakers, appliance makers lost Their costs of production increased Less competitive Led to job loss in these industries

20. Effective tariff policy ? March 2002 In the steel case, The losses to steel consumers outweighed The gains to steel producers The gain vs. the loss depends on the amount of the tariff The importance of the imported good to domestic consumers The number of jobs saved in the protected industry The number of jobs lost in other industries. The WTO declared the US tariff policy for steel industry A violation of the WTO treaty The US removed them in December.

21. Japanese economist calculated Tariffs on import of food stuffs, cosmetics, chemicals Cost the average Japanese consumer about $890 per year in the form of higher prices. Impose significant costs on domestic consumers Higher prices Tariffs reduce overall efficiency of the world economy encourage domestic firms To produce products at home Could be produced more efficiently elsewhere. Inefficient utilization of resources

22. Korea’s rice policy Tariffs on the importation of rice an increase in rice production Rice farming is an unproductive use of land Make more sense to purchase rice from lower cost foreign producers To utilize the land in other ways Produce foodstuffs that can not be produced more efficiently elsewhere Or use for residential and industrial purposes.

23. To raise revenue for government To reduce export from a sector for political reasons. In 2004, China imposed tariff on textile exports to moderate the growth in exports of textiles from China. Alleviate tensions with other trading nations. Export Tariff

24. A subsidyis a government payment to a domestic producer Cash grants, low interest loans, tax breaks Government equity participation in domestic firms Subsidies help domestic producers Lower production costs compete against low-cost foreign imports gain export markets Increase international competitiveness Consumers typically absorb the costs of subsidies Subsidies

25. WTO estimates In the mid-2000s Countries spent $300 billion on subsidies $250 billion of which spent by 21 developed nations. Agriculture One of the largest beneficiaries of subsidies The EU was paying around euro 44 billion annually to farm subsidies. May 2002, the president Bush signed a bill $180 billion payment for US farmers over 10 years. In 2007, a farm bill contained $286 billion payment for next 10 years Japan paid to farmers substantial subsidies for many years

26. Agricultural subsidies Allow inefficient farmers to stay in business Encourage countries to overproduce heavily subsidized products Encourage countries to produce products that could be grown more efficiently elsewhere and imported. Reduce international trade in agricultural products If abandoned subsidies to farmers Global trade in agriculture 50% higher The world as a whole would be better off by $160 billion.

27. Other sectors Subsidies given to Boeing and Airbus To lower the cost of developing new commercial jet aircraft. Boeing In the form of tax credits for R&D spending Or Pentagon money was used to develop military technology Then transferred to civil aviation projects. Airbus Subsidies in the form of Government loans at below-market interest rates.

29. Tariff rate quota (TRQ) Rice import in South Korea 10% ad valorem tariff on rice import of 1 million tons Beyond this import 80% of out of quota rate is applied. If import 2 million rice to Korea 1 million tons of rice at a 10 % tariff rate Another 1 million tons of rice at an 80% tariff. TRQ is common in agriculture To limit imports over quota. Japan applied TRQ to wheat imports To protect inefficient Japanese wheat farmers from foreign competition.

30. Voluntary Export Restraints Voluntary export restraints are quotas on trade imposed by the exporting country, typically at the request of the importing country’s government Foreign producers agree to VERs because They fear more damaging punitive tariffs or import quotas A quota rentis the extra profit that producers make when supply is artificially limited by an import quota The US Sugar industry A TRQ limited the amount foreign suppliers can sell to the US market. Raised the price of sugar in the US up to 40% greater than the world price. Higher price transferred to US sugar producers as greater profits.

31. VER example The limitation on auto exports to the US by Japan in 1981 A response to direct pressure from the US government Limited Japanese imports to no more than 1.68 million car per year. VER costs US consumers about $1 billion per year for 1981-1985 In the form of higher price Agreement revised in 1984 To allow 1.85 million Japanese car per year Import quota and VER Benefit domestic producers by limiting import competition. Don’t benefit consumers Raise the domestic price due to limited foreign supply.

32. Local Content Requirements A local content requirement demands that some specific fraction of a good be produced domestically The requirement can be in physical terms or in value terms Local content requirements benefit domestic producers and jobs, but consumers face higher prices

33. LC example The Buy America Act Government must give preference to American products When putting contracts for equipment out to bid Unless foreign producers have significant price advantages. A product as “American” If 51% of the materials by value are produced domestically. This needs to be ensured to have preference from the US government.

34. Administrative Policies Administrative trade policies are bureaucratic rules designed to make it difficult for imports to enter a country These polices hurt consumers by denying access to possibly superior foreign products.

35. Administrative Policies example Japan regulations on tulip bulbs Customs inspectors check on every tulip bulb By cutting it vertically down the middle So could not put them back together. Netherland, the world largest tulip bulb exporter, sold it to everywhere else except Japan at one point of time. Federal Express had tough time in Japan initially Japanese customs inspectors insist on Opening a large proportion of express parcels to check for pornography Delayed an ‘express’ package for days.

37. with a view to driving indigenous competitors out of that market,

39. Antidumping case 1997, Korean semiconductor manufacturers LG Semicon Hyundai Electronics Accused of DRAMs in the US at below production costs. The world market – oversupplied at that time. Alleged the firms were trying to unload excess production in the US. US manufacturer-Micron Technology filed the petition to The Commerce Department The International Trade Commission Impose an antidumping duty (countervailing duty) of 9% on the offending foreign imports (LG and Hyundai) Special tariff.

40. Are you sure you’re ok?

41. The Case for Government Intervention Question: Why do governments intervene in trade? There are two types of arguments Political arguments are concerned with protecting the interests of certain groups within a nation (normally producers), often at the expense of other groups (normally consumers) Economic arguments are typically concerned with boosting the overall wealth of a nation (to the benefit of all, both producers and consumers)

42. Political Arguments for Intervention Political arguments for government intervention include protecting jobs protecting industries deemed important for national security retaliating to unfair foreign competition protecting consumers from “dangerous” products furthering the goals of foreign policy protecting the human rights of individuals in exporting countries

43. Political Arguments for Intervention 1. Protecting jobs and industries the most common political reason for trade restrictions the result of political pressures by unions or industries that are "threatened" by more efficient foreign producers, have more political clout than the consumers who will eventually pay the costs

44. Political Arguments for Intervention 2. National Security Governments sometimes protect certain industries such as aerospace or advanced electronics because they are important for national security This argument is less common today than in the past

45. National Security example Federal funding for supporting Sematech A consortium of 14 US semiconductor companies Account for 90 % of the US industry’s revenues To conduct joint research into manufacturing techniques US government considered it critical Sematech was protected from antirust laws. Provided $100 million in subsidies Lasted until 1994.

46. Political Arguments for Intervention 3. Retaliation When governments take, or threaten to take, specific actions, other countries may remove trade barriers This can be a risky strategy If threatened governments don’t back down, tensions can escalate and new trade barriers may be enacted

47. Retaliation example The US government used the threat of punitive trade sanctions To get Chinese government to enforce its intellectual property laws In china, massive copyright infringements Costing US companies, MS hundreds of millions of $ per year The threat : to impose 100% tariffs on a range of Chinese imports. Chinese government agreed to tighter enforcement of IP regulations.

48. Political Arguments for Intervention 4. Protecting Consumers Protecting consumers from unsafe products This often involves limiting or banning the import of certain products

49. Consumer protection example The US government in 1998 Permanently banned imports of 58 types of military style assault weapons. To increase public safety The EU in 1989 Banned the sale and importation of hormone-treated beef To protect European consumers from food safety risk. Banned imports of GM foods and grains. Monsanto- global food supplier wants to expand the global market for GM foods Germany, Switzerland strongly against consumption of such products. WTO drawn into the conflict between these two parities.

51. Political Arguments for Intervention 6. Protecting Human Rights Governments can use trade policy to improve the human rights policies of trading partners Unless a large number of countries choose to take such action, however, it is unlikely to prove successful Some critics have argued that the best way to change the internal human rights of a country is to engage it in international trade The decision to grant China MFN status in 1999 was based on this philosophy

52. Human right issue The US grant Most Favored Nation (MFN) status to China MFN are allowed to export goods to the US under favorable terms. The average tariff on Chinese goods was 8% Without the MFN status, tariffs would have been 40%. WTO members mostly receive MFN status. China joined WTO in 2001 China had a poor human rights record. The 1989 Tiananmen square massacre Subjugation of Tibet Critics argue it is wrong for the US to grant MFN status to China.

53. Economic Arguments for Intervention Economic arguments for government intervention in international trade include The infant industry argument Strategic trade policy

56. Economic Arguments for Intervention 2. Strategic Trade Policy where there may be important first mover advantages, governments can help firms from their countries attain these advantages governments can help firms overcome barriers to entry into industries where foreign firms have an initial advantage

57. The Revised Case for Free Trade New trade theorists believe government intervention in international trade is justified Classic trade theorists disagree Some new trade theorists believe while strategic trade theory is appealing in theory, it may not be workable in practice they suggest a revised case for free trade Two situations where restrictions on trade may be inappropriate Retaliation Domestic Policies

58. Retaliation and War Krugman argues that strategic trade policies aimed at establishing domestic firms in a dominant position in a global industry beggar-thy-neighbor policies boost national income at the expense of other countries A country that attempts to use such policies probably provoke retaliation A trade war could leave both countries worse off

59. Beggar thy neighbor policy example The US government response to EU policy EU provide Airbus subsidy US provide subsidies to Boeing The result : cancel each other out Both European & American taxpayers support an expensive trade war EU and the US worse off The danger of a strategic trade policy Leading to a trade war. How to respond when one’s competitors are already being supported by government subsidies ? How should Boeing and the US respond to the subsidization of Airbus ? Not to engage in retaliatory action to help establish rules of the game – minimize the use of trade distorting subsidies ( WTO objectives)

60. Domestic Policies Governments can be influenced by special interest Consequently, a government’s decision to intervene in a market may appease a certain group, but not necessarily the support the interests of the country as a whole

61. Domestic Policy example The EU support for the Common Agriculture Policy (CAP) Due to the political power of French and German farmers The CAP benefits Inefficient farmers The politicians who relies on farmers’ vote NOT consumers in the EU – pay more for their foodstuffs. Not a good strategic trade policy

62. Development of the World Trading System 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)

63. 1947-1979: GATT, Trade Liberalization, and Economic Growth After WWII, the U.S. and other nations realized the value of freer trade, and established the GATT in 1947 The approach of GATT (a multilateral agreement to liberalize trade) was to gradually eliminate barriers to trade GATT’s membership grew from 19 to more than 120 nations Tariff reduction was spread over eight rounds of negotiation GATT regulations were enforce by a mutual monitoring system

64. 1980-1993: Protectionist Trends The world trading system came under strain during the 1980s and early 1990s because 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 had the same effect that did not technically violate GATT

65. The Uruguay Round and the World Trade Organization The Uruguay Round (1986) focused on 1. Services and Intellectual Property Trade issues related to services and intellectual property and agriculture were emphasized 2. The World Trade Organization The WTO was established as a more effective policeman of the global trade rules The WTO encompassed GATT and the General Agreement on Trade in Services (GATS) the Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPS)

66. WTO Experience to Date Since its establishment, the WTO has emerged as an effective advocate and facilitator of future trade deals, particularly in such areas as services So far, most countries have adopted WTO recommendations for trade disputes The WTO has brokered negotiations to reform the global telecommunications and financial services industries The 1999 meeting of the WTO in Seattle demonstrated that issues surrounding free trade have become mainstream, and dependent on popular opinion

67. The Future of the WTO: Unresolved Issues and the Doha Round The WTO is currently focusing on 1. Anti-dumping policies The WTO is encouraging members to strengthen the regulations governing the imposition of antidumping duties 2. Protectionism in agriculture The WTO is concerned with the high level of tariffs and subsidies in the agricultural sector of many economies 3. Protecting intellectual property Members believe that the protection of intellectual property rights is essential to the international trading system TRIPS obliges WTO members to grant and enforce patents lasting at least 20 years copyrights lasting 50 years

68. The Future of the WTO: Unresolved Issues and the Doha Round 4. Market access for nonagricultural goods and services The WTO would like to bring down tariff rates on nonagricultural goods and services, reduce the scope for the selective use of high tariff rates 5. A new round of talks: Doha The WTO launched a new round of talks in 2001 to focus on cutting tariffs on industrial goods and services phasing out subsidies to agricultural producers reducing barriers to cross-border investment limiting the use of anti-dumping laws

69. Implications for Managers Question: Why should international managers care about the political economy of free trade or about the relative merits of arguments for free trade and protectionism? Trade barriers impact firm strategy Firms can play a role in promoting free trade or trade barriers

70. Trade Barriers and Firm Strategy Trade theory suggests why dispersing production activities globally can be beneficial However, trade barriers may limit a firm’s ability to do so Trade barriers raise the cost of exporting Quotas limit exports Firms may have to locate production activities within a country to meet local content regulations The threat of future trade barriers can influence firm strategy All of these can raise costs above what they may have been in a world of free trade

71. Policy Implications International firms have an incentive to lobby for free trade, and keep protectionist pressures from causing them to have to change strategies While there may be short run benefits to having government protection in some situations, in the long run these can backfire other governments can retaliate making it more difficult to construct a globally dispersed production system

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