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Government Intervention in International Trade

By Edited Apr 19, 2014 0 0

The main reason for government intervention in the international trading system is to protect producers in domestic markets. Many countries today practice free trade, but when it comes to protecting their own markets, free trade takes a bit of a back seat. There are arrays of instruments governments can use to create barriers for foreign companies to enter their markets. Beyond this, governments generally intervene either for political or economic reasons. The world trading system has a long history, and it is important to understand the organizations policing the system, from GATT to the World Trade Organization and what these organizations promote. A new round of talks, called the Doha talks are a new round of talks in which WTO member states will discuss issues pertaining to anti-dumping actions, lowering agricultural subsidies, protecting intellectual property rights and further lowering trade and federal direct investment barriers of non-agricultural goods and services. The implications of the policies and talks have profound effects on international business, through trade barriers and firm strategy to policy implications.

There are seven instruments governments use to protect and shut foreign products out of their nations. The first is in the form of tariffs, which is any tax levied on an import or sometimes in export. Tariffs come in two forms, specific tariffs, which is a tax levied as a fixed charge for each unit of a good imported; and in ad valorem tariffs which is a tax levied as a proportion of the value of imported goods. The implication of high tariffs is producer’s gain, while consumers lose because imports are priced higher than products produced in the domestic market. Tariffs also hurt the world’s economic efficiency because it encourages production of products that could be produced elsewhere at a lower cost.

Another instrument used is subsidies, in which a government pays a domestic producer to produce a specific product in the form of cash grants, low interest loans, tax breaks and government equity participation in domestic firms. Subsidies help firms gain export markets and compete against foreign imports. The most subsidized industry has been agriculture, which reflects the fact that countries want to protect their local farmers, and it also reflects that farmers have strong political power. Essentially a subsidy is a negative tax, which the government gives money (I know when does the government ever give instead of take?) to encourage the production of certain goods and services.  When farmers go to lobby their local government, the government takes them seriously, especially when election periods are around the corner. This is not a good thing for the consumer; it gives money to inefficient producers and encourages excess production. And who ends up paying for the subsidized producer. You, the taxpayer. I think subsidies are good for economies of scale, where it is difficult to enter a market and the market can only afford to have a few companies; but for other industries where excess can be produced it is absolutely pointless and damaging to the average consumer. While US farmers face fierce competition from developing nations where production costs and wages are much lower in the short term, in the long term if subsidies are lowered or non-existent the consumer’s would probably have half the bill they receive today at the supermarket, while increasing their selections of agricultural products. As a consumer, what policy would you implement if you knew that if subsidies were completely eliminated that trade in agricultural products would be 50% higher (& greater variety would be offered) and the world as a whole would be better off by $160 billion dollars? Overall, subsidies can be a good way to support industries with economies of scale, but not for industries that are over occupied.

A third instrument governments use to protect domestic firms are import quotas, which is a direct restriction in the quantity of some good that may be imported into a country. There are two variations of government quotas; the first is tariff rate quotes in which a lower tariff rate is applied to imports within the quota than those over the quota. Essentially this means that a country will apply a lower tariff for a specific number of units, once that quota number is met, the tariff can jump a significant amount. Another hybrid version is voluntary export restraints, which is a quota imposed by the exporting country, at the importing countries request. Companies comply with this to avoid retaliation in the form of higher tariff rates, which can significantly affect the cost of production (not in a good way). One hurdle that is caused by this, however, is that the world trade organization (policing system of international trade) can do nothing about it, since it isn’t a formal agreement.

Local content requirements is a requirement that some specific fraction of a good be produced domestically either in physical or value terms. This is used by developing countries to further spur growth in their manufacturing production from a basic level to a more advanced level. Content requirements have an implicit effect on international business because it forces firms to source a higher production in one country, raising the cost of business, than if they could have sourced their production to a number of countries which specialize in that type of production.

A non-formal way of creating trade barriers is through administrative trade policies, in which, bureaucratic rules are designed to make it difficult for imports to enter a country. A country can come up with numerous ways to infringe on an imported product’s success within their own borders. Often these ways, are unethical, however if green is involved, it doesn’t matter. An example of this is when the Japanese decided to go through every and any “express” sent packages by FedEx to check for pornography (really?), delaying the whole point in sending something “express.”

The last measure governments use to protect domestic producers from unfair foreign competition is through filing actions when a country “dumps” its excess products into a foreign market. Dumping is selling goods in a foreign market at below their costs of production or as selling goods in foreign markets at below their “fair market” price. If a firm has excess production it may try to sell it at an inexorably low price in a foreign market, in which, domestic firms just can’t compete with. It is generally predatory behavior in which producers use profits from their home markets to subsidize prices in a foreign market, generally trying to drive domestic producers of that market out of business. To stop this the WTO has adopted anti-dumping policies designed to punish foreign firms that engage in dumping. When a country has found that another country has dumped it’s excess into the market, driving down domestic prices to unfair rates, the victim country can file a lawsuit with the WTO. If the complaint is valid then the offending country will have to pay countervailing duties which is a special tariff that is generally high and can be effective for five years. The country must show that dumping took place in what quantity, and that the prices of the product in the importing country are dramatically higher than the prices of the imports; which ultimately threatens the livelihood of the industry in that country.

                The reasons governments decide to use these measures are either for political or economic reasons. Political arguments constitute themselves in the form of protecting domestic jobs, protecting national security, retaliation to try and force trading partners to practice in a fair manner, to protect domestic consumers, to further foreign policy objectives, to discourage the violation of human rights and to protect them environment from man-made pollution. While developed nations generally have an easier time justifying their practices, it is interesting to look at how developing countries view these practices when they are enacted by a developed country. Many developing countries lack the needed authority to implement stringent laws on unfair labor practices, and even if they do, authorities often abuse their power. The poor in these nations view the enforcement of labor laws as a trade barrier. While to a westerner this may seem peculiar, as we see fair treatment of the person next to us an inherent right; this is not always the case the world over. By shutting down a plant in China due to unfair labor practices, hundreds of poverty stricken Chinese workers may be unemployed. Is this fair to the workers? It’s a catch-22, while on one hand it forces governments to rethink their stance on labor issues; it also hurts the economy and puts people out of work. While I think certain people view not doing something right now as negligent, from history we see that as a country’s economic levels increase so does the standard of living per person. Personally, if I was a manager or CEO of a company I would have a hard time locating in an area where inhumanities go on, but I haven’t been able to decide to what extent it is acceptable; and I probably won’t know until I am put in that situation. However, to attempt to push offending nations of labor rights to adopt new practices, it needs to be exposed. The more international pressure that is put on these issues, particularly through Western News Outlets, the more likely offending nations will adopt stricter policies to protect workers. For example, to this day Nike has to be careful about where and who they are employing due to their history of child labor abuses.

                Another interesting issue that sometimes calls for government intervention is that of the environment. Twenty years ago, it would have been relatively unheard of that a government would intervene in the interest of the environment, however with the so called “green movement” taking hold, people are concerned more than ever with the health of the environment. Businesses and factories emit greenhouse gases such as CO2 into the air, causing man-made pollution and further depleting the already vulnerable ozone layer. Nations that take this threat seriously might impose tariffs on import product’s that exceed   the accepted level of pollution in regards to treaty commitments. This would create tensions among nations. Another less accredited argument is that firms will move production to places where pollution laws are more lax. Unless the tariffs imposed on environmental pollution exceed cost structures in other areas, there is no reason to believe that this argument would hold.

                One last issue that is interesting to evaluate is that governments should intervene to protect jobs and industries. First it is important to understand who is being protected. When a government decides that a certain industry or sector of the economy is being threatened by a foreign competitor they step in with some kind of tariff. This was the case for the tire industry in 2008, when the Obama administration imposed a high tariff on tire imports to limit the amount of tires that were entering the US at substantially cheaper market prices. This did three things. The tire producers in the United States were affected positively because they were competing with artificial competition. Whether it encouraged inefficient production, is up for debate. Second, it hurt US consumers and taxpayers because demand exceeded the government’s cap on supply. Taxpayers had to pay the bill in order to finance this. So in essence, consumers lose the most. Third, Chinese tire producers enjoyed higher profits per tire, the limited supply drives up demand, which in turn, drives up prices. So should Obama have let the tire industry go through the formal bankruptcy process, where private investors come in and change the game; or should he have done what he did, and give the industry time in the midst of a financial crisis to recover? By not allowing the industry to go through a formal bankruptcy, it really only hurt consumers. If the Chinese are more efficient at tire production, then the Chinese should be making our tires, and we should extend our resources to an area that the Chinese isn’t productive in.

                Now we will look at the two economic arguments for government intervention. The first argument is called the infant industry argument, which contends that developing nations have a potential comparative advantage in manufacturing, but new manufacturing industries can’t initially compete with established industries from developed nations. Many critics say that this only promotes inefficient industries and today, if a developing nation has a comparative advantage and wishes to borrow money in the form of federal direct investment, most times they can. The second economic argument for government intervention is strategic trade policy. It contends that a government should intervene if it can help a firm gain a first mover advantage. Second, governments should intervene if it can help domestic firms overcome the barriers to entry where foreign firms already have first mover advantages.

                Who monitors all of this activity? A brief history. The General Agreement on Tariffs and Trade originated by the US after WW2 to open markets to free trade. The goal was to reduce tariffs and other forms of government restrictions on trade. In 1986 GATT embarked on their eighth round of talks, known as the Uruguay Round where most notably the world trade organization was created as an extension of GATT to monitor and police the world trading system. GATS was created to include services as a product. And TRIPS was formed to enforce intellectual property regulations as many countries such as China were making imitation products and essentially stealing ideas from the inventor.

                So far the WTO has been taken seriously as a policing system because they were able to resolve over four hundred trade disputes most informally and some formally. The fact that countries are even filing suits is a good sign. The WTO has also been successful in opening markets in sectors of telecommunication technology and financial services. Future discussions of the WTO will be negotiated in the DOHA rounds where they will attempt to close loopholes in anti-dumping actions. They will also attempt to lower tariff rates and subsidies to agriculture (a sector that costs consumers on average 300 billion dollars a year in OECD countries). On average, we pay 21% more on agricultural products than we should, meaning your grocery bill could be 21% more cheaper if subsidies and tariffs were eliminated. Another issue on the table is protecting intellectual property rights. When TRIPS was created members had oblige to enforcing patents for 20 years and copyrights for fifty; the richest countries had 1 year to comply, poor countries in 5 years and the poorest in 10 years. This was a good start, but violations are still way too prevalent reducing the incentive for innovators to embark on costly research and development. If intellectual property is respected by all, the world would see more innovative products and product variety. Firms can run into problems though, when a counterfeiter has ties and is protected by local law enforcement it can be hard to prove your case. Another reason, which might seem dumb, some people aren’t educated in intellectual property rights, nor do they understand it is illegal. That is why it is important to train your workers in a foreign country so that they understand the repercussions of such actions. Nevertheless, some countries such as China actually encourage infringements through search engines like Baidu, where one can find imitated products for up to 70% cheaper. In the future the WTO will have to look at online sales as well, because it is the biggest loophole in PR regulations out there (not surprising because the industry is so new).

                Trade barriers directly affect managers for firms. First affects their strategy, while certain production factors may make economic sense, for instance dispersing productive activities to an optimal location, it may not be feasible because of trade barriers. For instance, what if the country has a local content requirement for a product? You will have to shift more production in that country in order to maintain a competitive advantage. Or you might have to move your location to another country where local content requirements are lower or non-existent. Nevertheless, these types of laws increase costs for firms. Another implication is in the form of policies toward trade. Major firms weigh heavily on government policy toward trade, and by lobbying for free trade. If we wish to live in a world where products are globally dispersed and where production facilities can operate in several countries at the same time, then we will have to promote policies that open markets, rather than promoting policies that protect our markets.




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