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PART 2
THE ENVIRONMENT OF INTERNATIONAL BUSINESS
CHAPTER 7
GOVERNMENT INTERVENTION AND REGIONAL ECONOMIC INTEGRATION

Instructor’s Manual by Marta Szabo White, Ph.D.
I. LECTURE STARTER/LAUNCHER
■ Governments have long intervened in international business, hindering the free flow of
trade and investment.
■ Intervention can take many forms- tariffs and quotas, restrictions on international
investment, bureaucratic procedures and red tape, regulations that restrict value-chain
activities. Governments can also provide subsidies and financial incentives intended to
sustain or develop domestic firms and industries.
■ Although studies have found a strong association between market openness
(unimpeded free trade) and economic growth, as well as the fact that market liberalization
and free trade are robust contexts for fostering economic growth and national living
standards, in reality:
There is no such thing as unimpeded free trade.
■ Ask your students to think about government intervention- what are the pros and cons?
Make two lists, pros on one side and cons on the other. Why is there no such thing as
unimpeded free trade? That is, what is the justification for government intervention? By
Copyright © 2017 Pearson Education, Inc. 1 | Page

contrast, why is free trade good? (The answer can be found in Chapter 5: Theories of
International Trade and Investment.)
■ To better understand regional integration, think of international business as existing

along a continuum where, at one extreme, the world operates as one large free-trade
area in which there are no tariffs or quotas, all countries use the same currency, and
products, services, capital, and workers can move freely among nations without
restriction.
■ At the other extreme of this continuum is a world of prohibitive barriers to trade and
investment where countries have separate currencies and have very little commercial
interaction with each other.
■ It is useful to draw this continuum on the board or screen, featuring the two extremes.
Then ask the students where their country falls on this continuum and why. Then ask the
students for examples of countries or regions that might fall at the opposite extremes of
this continuum. Ask them to justify their answers.
■ Ask your students if they know one of the major motives in creating the European
Community (the precursor to the EU).
● Members sought to strengthen their mutual defense against the expanding
influence of the former Soviet Union.
■ The European Union is the most advanced economic bloc. Describe the characteristics
of the EU.
■ The CIA World Factbook provides additional details of the EU:
https://www.cia.gov/library/publications/the-world-factbook/geos/ee.html
■ Ask students whether their favorite country is a member of an economic bloc- which
one. Ask them what advantages/disadvantages being in this bloc brings to their country.
[1] YOUTUBE
William Spaniel
International Relations 101 (#9): Tariffs and the Barriers to Free Trade
Published on Jul 11, 2012
Modeling free trade as a prisoner's dilemma provides an explanation. Although
everyone is collectively better off with free trade, individual incentives tell states to place
tariffs on imported goods. Thus, although the result is collectively crazy, it is individually
rational.
https://www.youtube.com/watch?v=Kc-bgKyPDz4
8.33 Minutes
[2] TED TALK

George Papandreou: Imagine a European democracy without borders
Published on Jun 12, 2013
Greece has been the poster child for European economic crisis, but former Prime Minister
George Papandreou wonders if it's just a preview of what's to come. "Our democracies,"
he says, "are trapped by systems that are too big to fail, or more accurately, too big to

control" -- while "politicians like me have lost the trust of their peoples." How to solve it?
Have citizens re-engage more directly in a new democratic bargain.
https://www.youtube.com/watch?v=y9ALB39wRKo
20.06 Minutes
[3] PBS NewsHour

Is NAFTA a success story or damaging policy?
Published on Feb 20, 2014
A one-day summit in Mexico between President Obama and his North American
counterparts marked the 20th anniversary of NAFTA, a trade agreement designed to
eliminate cross-border duties and other barriers. What's the legacy, effect and the future
of NAFTA? Jeffrey Brown gets debate from former U.S. Trade Representative Carla Hills
and Lori Wallach of the Public Citizen's Global Trade Watch.
https://www.youtube.com/watch?v=DGeTZ4u2jbg
11.55 Minutes
[4] YOUTUBE
The Big Picture with Thom Hartmann
Why TPP Will Be A Disaster for Americans
Published on Mar 13, 2015
Neil Sroka, Democracy for America joins Thom Hartmann. Just like every other so-called
free trade deal - the Trans Pacific Partnership is a raw deal for the American people. So
why is Congress doing everything in its power to make this bad deal a reality as soon as
possible?
https://www.youtube.com/watch?v=bTrPsFTGmYI
11.46 Minutes
II. LEARNING OBJECTIVES AND THE OPENING VIGNETTE
LEARNING OBJECTIVES
After studying this chapter, students should be able to:
7.1 Understand the nature of government intervention

7.2 Know the instruments of government intervention
7.3 Explain the evolution and consequences of government trade intervention
7.4 Describe how firms can respond to government trade intervention
7.5 Understand regional integration and economic blocs
7.6 Identify the leading economic blocs
7.7 Understand the advantages and implications of regional integration
Key Themes

■ In this chapter, there are eight themes:
[1] The nature of government intervention
[2] Instruments of government intervention
[3] Evolution and consequences of government intervention
[4] How firms can respond to government intervention
[5] Regional integration and economic blocs
[6] The leading economic blocs
[7] Advantages and implications of regional integration
■ The focus of this chapter is government intervention and regional economic integration
in international business.
■ Despite the value of free trade, governments often intervene in international business.
■ Key concepts to familiarize yourself with:
◘ Protectionism refers to national economic policies designed to restrict free trade
and protect domestic industries from foreign competition.
◘ Government intervention arises typically in the form of tariffs (e.g. duty),
nontariff trade barriers (e.g. quota), and investment barriers (target FDI).
■ Rationale for government intervention

■ Governments impose trade and investment barriers to achieve political, social, or
economic objectives. Such barriers are either defensive or offensive:
◘ Defensive barriers safeguard industries, workers, special interest groups,
protect infant industries and to promote national security (export controls).
◘ Offensive barriers pursue a strategic or public policy objective, such as
increasing employment or generating taxes.
■ Instruments of government intervention

■ Governments also impose regulations and technical standards, as well as
administrative and bureaucratic procedures.
■ Countries may also impose currency controls to minimize international withdrawal of
national currency.
■ FDI and ownership restrictions ensure that the nation maintains partial or full ownership
of firms within its national borders.
■ Governments also provide subsidies, a form of payment or other material support.
■ Foreign governments may offset foreign subsidies by imposing countervailing duties.
■ With dumping, a firm charges abnormally low prices abroad.
■ A government may respond to dumping by imposing an antidumping duty.
■ Governments support domestic firms by providing investment incentives and biased
government procurement policies.
■ Consequences of government intervention:

◘ Economic freedom - the extent of government intervention in the national
economy, assessed using the Heritage Foundation’s Index of Economic Freedom.
◘ Government intervention and trade barriers may disproportionately impact
developing economies and low-income consumers because countries in for example
Africa, Bangladesh, Pakistan, and India are taxed at relatively unjustly higher levels.

◘ Government intervention can also offset such harmful effects (e.g. subsidies).
■ Evolution of government intervention: Intervention has a long history.

◘ 1800s- (late) many countries imposed substantial protectionism.
◘ 1930s- countries reduced trade barriers worldwide.
◘ Import substitution -Latin America- delayed countries’ eventual transition to
free trade.
◘ Industrialization- Following World War II, Japan embarked on export-led
development.
◘ Protectionist policies- India
◘ 1980s - China had limited foreign involvement until then.
◘ General Agreement on Tariffs and Trade (GATT) - the most important
development for reducing trade barriers of the last several decades
◘ 1995- replaced by the World Trade Organization (WTO)
◘ The 150 members of the WTO account for nearly all world trade.
■ Intervention and the global financial crisis

◘ Crisis impetus- inadequate regulation in the banking/ finance sectors
◘ Response- new government regulations and increasing protectionism to
safeguard jobs, wages, and protect domestic industries via subsidies
◘ Ripple Effect- Government reforms transcend beyond the banking and financial
areas.
■ How should firms respond to government intervention?

◘ Firms should first undertake research to understand the extent and nature of
trade and investment barriers abroad.
◘ When trade barriers are substantial, FDI or joint ventures to produce products in
target countries are often the most appropriate entry strategies.
◘ Where importing is essential, the firm can take advantage of foreign trade zones,
areas where imports receive preferential tariff treatment.
◘ Management should try to obtain a favorable export classification for the firm’s
exported products- being familiar with the harmonized code schedules, which provide
a standardized directory for applicable tariffs.
◘ Government assistance in the form of subsidies and incentives helps reduce the
impact of protectionism.
◘ Firms sometimes lobby the home and foreign governments for freer trade and
investment.
■ Regional integration involves groups of countries forming alliances to promote free

trade, cross-national investment, and other mutual goals.
■ This integration results from economic blocs, in which member countries agree to
eliminate tariffs and other restrictions on the cross-national flow of products, services,
capital, and, in more advanced stages, labor, within the bloc.
■ Stages of regional integration:
◘ Free trade area, in which tariffs and other trade barriers are eliminated

◘ Customs union, a free trade area in which common trade barriers are imposed
on nonmember countries
◘ Common market, a customs union in which factors of production move freely
among the members
◘ Economic union, a common market in which some economic policies are
harmonized among the member states
◘ Political union does not yet exist
■ There are roughly 200 economic integration agreements in the world.
■ The European Union (EU) is the most advanced of these, comprising 28 countries in
Europe.
■ The most notable bloc (free-trade-area) in the Americas is the North American Free
Trade Agreement (NAFTA) - consisting of Canada, Mexico, and the U.S.
■ Countries pursue regional integration because:

◘ It contributes to corporate and industrial growth, economic growth, better living
standards, and higher tax revenues for the member countries.
◘ It increases market size by integrating the economies within a region.
◘ It increases economies of scale and factor productivity among firms in the
member countries and attracts foreign investors to the bloc.
◘ It also increases competition and economic dynamism within the bloc, and
increases the bloc’s political power.
■ Success factors for regional integration:
◘ Countries that are relatively similar in terms of culture, language, and economic
and political structures.
◘ Countries that are geographically close to each other.
■ Ethical dilemmas of regional integration:

◘ Regional integration simultaneously leads to trade creation, whereby new trade
is generated among the countries inside the bloc, and trade diversion, in which member
countries discontinue some trade with countries outside the bloc.
◘ It can reduce global free trade, particularly when member countries form a
customs union that results in substantial trade barriers to countries outside the bloc.
◘ When economic blocs involve many countries of various sizes, regional
integration can concentrate power into large firms and large nations inside the bloc.
◘ Regional integration results in economic restructuring, which may harm particular
industries and firms.
◘ When a country joins an economic bloc, it must relinquish some of its autonomy
and national power to the bloc’s central authority. Individual countries risk losing some of
their national identity
■ Consequences of regional integration:

●Regional integration can concentrate power into large firms and large nations inside
the bloc.
●Regional integration results in economic restructuring, which may harm particular

●When a country joins an economic bloc, it must relinquish some of its autonomy to
the bloc’s central authority.
●Regional integration leads to increased internationalization by firms inside their
economic bloc.
●Firms reconfigure value-chain activities and rationalize their operations.
●The formation of economic blocs also leads to mergers and acquisitions.
●Managers revise marketing strategies by standardizing products and developing
regional brands.
●Regional integration also leads firms from outside the bloc to invest into the bloc.
Teaching Tips
■ The challenge for this chapter is how to get students excited about something that is a
macro-environmental force, over which businesses have little or no control. Corporate-
level strategic decisions that firms can control concern whether to compete or not to
compete in a particular business/market. Before such a decision can be crafted,
management should conduct a country-specific analysis of barriers to entry in the form of
intervention, regulations, and restrictions, vs. market openness and degree of economic
freedom. This would be part of Due Diligence.
■ One strategy to induce interest in this chapter and the topic of government intervention
might be to assign students to analyze the Index of Economic Freedom, published by the
Heritage Foundation (www.heritage.org) that measures economic freedom in 186
countries. Hong Kong, Singapore and New Zealand are the top three countries in terms
of Economic Freedom as measured by the ten freedoms comprising this index.
■ Note: Economic freedom flourishes when government supports those institutions that
foster freedom and provide an appropriate level of intervention and regulation. In 2010
for the first time, the U.S. slipped into the second highest category, due to increased U.S.
federal government intervention following the global financial crisis.
■ An assignment (for credit) might be to select two countries at opposite ends of the
spectrum and create an argument why entry into country A makes more sense than
country B- then reverse the case by now arguing the opposite. Entry modes (which one
is optimal and why) should be included as required components for both sides of the
argument. The entire class may be involved if students present their positions to the rest
of the class, and reactions from other students are encouraged with participation points.
■ Regional integration is an attempt to achieve freer economic relations.

■ Two of the most well-known examples of this trend are the European Union (EU) and
the North American Free Trade Agreement area (NAFTA). The EU is composed of 28
member countries in Europe. NAFTA is composed of Canada, Mexico, and the United
States.
■ Free trade agreement (less advanced economic blocs- NAFTA) - formal arrangement
between two or more countries to reduce or eliminate tariffs, quotas, and other barriers
to trade in products and services
■ More advanced economic blocs (EU) permit the free flow of capital, labor, technology
and the harmonization of monetary and fiscal policies.

Commentary on the Opening Vignette:
INDIA’S EVOLUTION TO A LIBERAL ECONOMY
• Key message
■ India is a paradox- it is the world’s leading emerging economy in information technology
and e-business, and simultaneously, a bureaucratic nightmare- trade barriers, business
regulations, import taxes, and controls on foreign investment are substantial- with tariffs
averaging over 15% on many products, compared to less than 4% in Europe, Japan, and
the United States.
■ Hundreds of commodities, from cement to household appliances, can be imported only
after receiving government approval. Licensing fees, testing procedures, and other
hurdles can be very costly to importers.
■ India is plagued with poor infrastructure- inadequate roads, bridges, airports, &
telecommunications
■1980s (early) – India has been liberalizing regulations:
◘ Abolished/minimized import licenses
◘ Reduced tariffs substantially
◘ Privatization incentives- numerous state enterprises have been “privatized” –
sold to the private sector and to foreign investors.
■ 10 million ‘mom-and-pop’ shops scattered across 500,000 cities/villages.

■ 2012- Indian government yielded to political pressure and denied Walmart, Carrefour,
and other foreign retailers the opportunity to participate in India’s huge retailing sector. In
a joint venture with the Indian firm Bharti Enterprises, Walmart had planned to open
numerous stores nationwide.
■ India’s entrepreneurial potential is significant

■ Special Economic Zones (SEZs) introduced- territories that offer foreign firms the
benefits of India's low-cost, high-skilled labor, are exempt from trade barriers, sales and
income taxes, licensing requirements, FDI restrictions, and customs clearance
procedures.
■ Example-
◘ The Mahindra City SEZ, an 840-acre development, is focusing on a $277 million
software development complex constructed by Infosys Technologies, India’s leading IT
firm.
◘ However, Europe and North America aim to minimize outsourcing of jobs to
India; therefore demand protectionism—trade barriers and defensive measures
intended to minimize the export of jobs abroad.
• Uniqueness of the situation described

■ India is a study in contrasts.
■ The world’s leading emerging economy in IT and e-business vs. its saturation in trade
barriers and business regulations- at the federal and 28 state levels.

■ Trade barriers and government bureaucracy in India vs. protectionism demands in
Europe and the U.S. exemplify the complex world of government intervention.
• Classroom discussion
■ Define outsourcing and offshoring
Outsourcing is the purchase of a value-creating activity from an external supplier.
Offshoring is the relocation of manufacturing and other value-chain activities to cost-
effective destinations abroad.
■ Should firms balance competitive advantages of value chain global sourcing
(offshoring) with the impact of domestic job displacement? Do firms have a greater
obligation to their stakeholders or shareholders?
QUESTIONS
7-1. Describe the nature of government intervention in India? What is the likely
effect on business activities?
(LO 7.1; LO 7.3; AACSB: Application of knowledge)
■ Government intervention creates a bureaucratic nightmare for businesses- trade

barriers, business regulations, import taxes, and controls on foreign investment are
substantial- with tariffs averaging over 15% on many products, compared to less than 4%
in Europe, Japan, and the United States.
■ Hundreds of commodities, from cement to household appliances, can be imported only
after receiving government approval. Licensing fees, testing procedures, and other
hurdles can be very costly to importers.
■ India is plagued with poor infrastructure- inadequate roads, bridges, airports, &
telecommunications
■ This can only have a negative impact on business.
7-2. Why has the Indian government hindered the entry of Walmart, Carrefour, and
other large retailers into the country?
(LO 7.2; AACSB: Application of knowledge)
■ There are 10 million ‘mom-and-pop’ shops scattered across 500,000 cities/villages.

■ In order to protect these ‘mom-and-pop’ shops, the Indian government yielded to
political pressure and denied Walmart, Carrefour, and other foreign retailers the
opportunity to participate in India’s huge retailing sector.
7-3. Describe how India’s government is attempting to liberalize the nation’s

regulatory environment.
■ Only recently, has the Indian government employed pro-business incentives such as:

◘ Abolished/minimized import licenses
◘ Reduced tariffs substantially
◘ Privatization incentives- numerous state enterprises have been “privatized” –
sold to the private sector and to foreign investors.
■ To enhance India’s significant entrepreneurial potential:

■ Special Economic Zones (SEZs) were introduced- territories that offer foreign firms the
benefits of India's low-cost, high-skilled labor, are exempt from trade barriers, sales and
income taxes, licensing requirements, FDI restrictions, and customs clearance
procedures.
■ Example-
◘ The Mahindra City SEZ, an 840-acre development, is focusing on a $277 million
software development complex constructed by Infosys Technologies, India’s leading IT
firm.
III. DETAILED CHAPTER OUTLINE
GOVERNMENT INTERVENTION IN INTERNATIONAL BUSINESS
■ Governments intervene in trade and investment to achieve political, social, or economic

objectives.
■ Barriers benefit specific interest groups, such as domestic firms, industries, and labor
unions.
■ Government Intervention Rationale: Job creation by protecting industries from
foreign competition; support homegrown industries/firms.
GOVERNMENT FREE
INTERVENTION TRADE
■ Government intervention is at odds with free trade, the unrestricted flow of products,
services, and capital across national borders.
■ Market liberalization and free trade foster economic growth and improved living
standards.
■ Economists have long argued that free trade is good for the world: resources are
efficiently employed; living standards increased and value chain activities exploited.
■ Research suggests a strong positive relationship between market openness
(unimpeded free trade) and economic growth.
Study of more than 100 countries 1945-1995

Open Economies Less-free trade Economies
( Market liberalization & free trade) (Restrict trade & investment)
Per-capita GDP growth greater than 4% Per-capita GDP growth close to 0.
■ Example- Poland- Role Model: Free trade provides enormous benefits for economic
growth and individual welfare.
◘ Comparative advantage- With time, Poland lowered trade barriers and
participated more freely in international trade, leveraging their comparative advantage.
◘ Poland focused on producing and exporting goods it was best suited to produce,
and importing those goods that other nations produce more efficiently.
◘ Poland began to use its resources more efficiently, generating more overall
profits for firms and workers, and, acquiring more resources with which to import the
goods that Polish consumers demanded.
◘ Poland’s average annual income rose:

1990 2015
$1,625 $14,000
■ Unintended consequences:
◘ Employment shift- unemployment increased in certain industries as jobs
producing those goods shifted to other, more efficient countries.
■ Positive effects of free trade substantially outweighed the negative ones
■ Unimpeded free trade is a myth.

■ Government intervention obstructs the free flow of trade and investment.
■ Intervention alters the competitive position of companies and industries and takes the
form of: tariffs, quotas, subsidies, FDI restrictions, bureaucratic procedures, regulations
that restrict business types/value-chain activities, and financial incentives to sustain
domestic firms.
■ Exhibit 7.1- underscores that government intervention is an important dimension
of COUNTRY RISK.
THE NATURE OF GOVERNMENT INTERVENTION

■ Motivation Government Intervention: Protectionism
■ Protectionism – (hinders imports) national economic policies designed to restrict free
trade and protect domestic industries from foreign competition, and is manifested through:
◘ Tariff (duty) - tax imposed by a government on imported products, thus
increasing the acquisition cost for the customer.
Example-
● Customs- ports of entry checkpoints in each country where government
officials inspect imported products and levy tariffs.
◘ Nontariff trade barrier- government policy, regulation, or procedure that
impedes trade through means other than explicit tariffs
Example-

● Quota - a quantitative restriction placed on imports of a specific product
over a specified period of time.
◘ Investment barriers target FDI thus restricting foreign firm operations.
■Government intervention alters the competitive landscape- by hindering or helping the

ability of its indigenous firms to compete internationally
■ Firms, labor unions, and other special interest groups convince governments to adopt
policies that benefit them-
■ Examples of Protectionism Hindering Competitiveness-

◘ U.S. tariffs on imported steel:
● 2000s- The Bush administration imposed tariffs on the import of foreign
steel into the U.S. because tough competition from foreign steel manufacturers
had bankrupted several U.S. steel firms, and this measure was to allow the U.S.
steel industry time to restructure and revive itself.
● U.S. jobs were saved at the expense of higher material costs, making
these firms less competitive domestically and globally, and increasing the
production costs for downstream firms that use steel, such as Ford, Whirlpool, and
General Electric.
● The steel tariffs were removed within two years, but only after causing
significant harm.
◘ Japanese voluntary export restraints:

● 1980s- The number of Japanese vehicle imports were voluntarily
controlled by Japan to help insulate the U.S. auto industry.
● In this protected environment, Detroit automakers had less of an incentive
to improve quality, design, and overall product appeal.
● Thus, government intervention motivated by protectionism weakened
Detroit’s ability to compete in the global auto industry.
■ Protectionist policies may also lead to price inflation- when supply is restricted, domestic
prices increase.
■ By restricting variety, tariffs may also reduce the choices available to buyers.
■ In a complex world, there are adverse unintended consequences- thus due diligence-
careful planning and implementation- is paramount when considering government
intervention.
RATIONALE FOR GOVERNMENT INTERVENTION: FOUR REASONS

■ There are four main motives for government intervention:
(1) Generate revenue

■ Example- the “Hamilton Tariff,” enacted July 4, 1789, was the second statute passed
by the newly founded United States, providing revenue for the federal government.
■ Today, Ghana and Sierra Leone generate more than 25% of their total government
revenue from tariffs.

(2) Ensure citizen safety, security, and welfare
■ Example- governments pass laws to prevent importation of harmful products such
as contaminated food.
(3) Pursue economic, political, or social objectives
■ In most cases, tariffs and similar forms of intervention are intended to promote job
growth and economic development.
(4) Serve company and industrial interests
■ Governments may devise regulations to stimulate development of home-grown
industries.
■ Special interest groups often serve as strong advocates for trade and investment
barriers that protect their interests.
■ Example- U.S. vs. Mexico
◘ Trade dispute - the U.S. government imposed a $50 per ton duty on the import
of Mexican cement after U.S. cement makers lobbied the U.S. Congress.
◘ Mexican imports can comprise 10% of U.S. domestic cement consumption.
◘ Mexico proposed substituting import quotas instead of the tariffs.
◘ The two governments have negotiated for years to resolve this dispute.
■ Rationale for trade and investment barriers fall into two major categories: defensive and
offensive.
■ Defensive barriers are imposed to safeguard industries, workers, special interest
groups, and to promote national security.
■ Offensive barriers are imposed to pursue a strategic or public policy objectives, such
as increasing employment or generating tax revenues.
DEFENSIVE RATIONALE
■ Four major defensive motives:
[1] PROTECTION OF THE NATIONAL ECONOMY

Proponents Argue:
●Firms in advanced economies cannot compete with those in developing
countries that employ low-cost labor, thus governments should impose trade barriers to
block low-priced imports.
● Fear is that advanced-economy manufacturers will be undersold, wages
will fall, and home country jobs will be lost.
Critics Argue:
●Protectionism is at odds with the theory of comparative advantage, which
argues for more international trade, not less- b/c trade barriers interfere with country-
specific specialization of labor, thus blocking the opportunity for superior living standards.
● Blocking imports reduces the availability and increases the cost of
products sold in the home market.

● Protectionism may trigger retaliation, where foreign governments impose
their own trade barriers, reducing sales prospects for exporters
[2] PROTECTION OF AN INFANT INDUSTRY

● Emerging industry firms may lack experience, technological expertise and
economies of scale.
● Therefore, an infant industry may need protection from foreign
competitors, e.g. temporary trade barriers on foreign competitors
● Infant industry protection has allowed some countries to develop modern
industrial sectors
Examples-
● Japan became extremely competitive in global automobiles
● South Korea achieved great success in consumer electronics.
● U.S. government imposed tariffs on the import of inexpensive Chinese-
made solar cells to protect the emerging U.S. solar power industry.
Challenges-
■ Difficult to remove- industry owners and workers tend to lobby to preserve government
incentives indefinitely.
■ Infant industries (especially in Latin America, South Asia, and Eastern Europe) have
remained dependent on government protection for prolonged periods.
■ Industry inefficiencies result in higher taxes and higher prices for the products produced
by the protected industry.
[3] NATIONAL SECURITY

■ Countries impose trade restrictions on products viewed as critical to national defense
and security, such as military technology and computers.
■ Trade barriers can help retain domestic production in security-related products-
computers, weaponry, and certain transportation equipment.
Example-
◘ Russia blocked a bid by Siemens (German engineering giant) to purchase the
Russian turbine manufacturer OAO Power Machines, due to national security.
■ Export controls- governments manage/prevent the export of certain products or trade

with specific countries.
Examples-
◘ Many countries do not allow the export of plutonium to North Korea because it
can be used to make nuclear weapons.
◘ The U.S. generally blocks exports of nuclear and military technology to countries
it deems state sponsors of terrorism, such as Iran, and Syria.
[4] NATIONAL CULTURE AND IDENTITY

■ Governments seek to protect certain occupations, industries, and public assets that are
considered central to national culture and identity- restrict/prohibit certain imports-
Examples-

◘ U.S. opposed Japanese investors’ purchase of the Seattle Mariners baseball
team, Pebble Beach golf course in California, and New York’s Rockefeller Center-
because these are viewed as part of the national heritage.
◘ France does not allow significant foreign ownership of its TV stations because
of concerns about foreign influences on French culture.
◘ Switzerland imposed trade barriers to preserve its long-established tradition in
watch making.
◘ Japanese restrict the import of rice because this product is central to the nation’s
diet and food culture.
OFFENSIVE RATIONALE
■ Two offensive categories:
[1] NATIONAL STRATEGIC PRIORITIES

■ Intervention encourages the development of industries that bolster the nation’s
economy.
■ This is a proactive variation of the infant industry rationale, related to national industrial
policy.
■ Countries with many high-tech or high-value-adding industries—such as information
technology, pharmaceuticals, car manufacturing, or financial services—create better jobs
and higher tax revenues than economies based on low-value-adding industries—such as
agriculture, textile manufacturing, or discount retailing.
■ Examples- Germany, South Korea, Japan, Norway—devise policies that promote the
development of more desirable industries.
■ Implementation:
◘ Financing for investment in high-tech or high-value-adding industries
◘ Encourage citizens to save money to ensure a steady supply of loanable funds
for industrial investment
◘ Fund public education to provide citizens the skills and flexibility needed to
perform in key industries
■ Deciding which industries to support is challenging because it is difficult to predict which
industries will produce comparative advantages. Poor choices may result in continuous
subsidization of underperforming industries.
[2] INCREASING EMPLOYMENT

■ Import barriers may be imposed to protect employment in designated industries.
■ By insulating domestic firms from foreign competition, national output is stimulated,
leading to more jobs in the protected industries.
■ Most effective- import-intensive industries that employ much labor to produce normally
imported products. Example- A joint venture between Shanghai Automotive Industry
Corporation (SAIC) and Volkswagen created jobs in China.

INSTRUMENTS OF GOVERNMENT INTERVENTION
■ Exhibit 7.2 highlights most common forms of government intervention and their effects.
(Great table)
■ Traditional forms of protectionism are tariffs and nontariff trade barriers.
■ Barriers can be imposed by individual countries or groups of countries, such as the
European Union (http://europa.eu)
■ United Nations estimates that trade barriers alone cost developing countries over $500
billion in lost trading opportunities with developed countries every year.
Tariffs
■ Export tariffs- taxes on products exported by domestic firms

Example- Russia charges a duty on oil exports, intended to generate government
revenue and maintain higher oil stocks within Russia.
■ Import tariff (most common) - tax levied on imported products.

■ Ad valorem tariffs are assessed as a percentage of the value of the imported product.
■ Specific tariff—a flat fee or fixed amount per unit of the imported product—based on
weight, volume, or surface area (such as barrels of oil or square meters of fabric).
■ Revenue tariff - intended to raise revenue for the government, e.g. taxing cigarette
imports.
■ Protective tariff - protects domestic industries from foreign competition.
■ Prohibitive tariff - is so high that no one can import any of the items.
■ Harmonized code (harmonized tariff) – tariffs determined according to this

synchronized worldwide system that classifies products according to 8,000 unique codes
and assigns standardized tariffs accordingly
■ Developing economies- tariffs are common.

■ Advanced economies- tariffs still provide a significant source of revenue.
 Shoes and Tariffs

■ Interestingly, The U.S. collects high tariffs (often 48%) on imports of low-end shoes,
and low tariffs (just 9%) on luxury shoes. Low-income shoe buyers end up paying the
highest tariffs.
■ Ask your students why this is the case… why would the U.S. discourage low-end
shoes? Sweatshop; child labor issues?
■ The European Union applies tariffs of up to 191% on meat, 118% on cereals, and 106%
on sugar and confectionary products.
■ Exhibit 7.3 provides a sample of import tariffs in selected countries.

■ Under the North American Free Trade Agreement (NAFTA), Canada, Mexico, and
the U.S. have eliminated nearly all tariffs on product imports from each other. However,

Mexico maintains significant tariffs with the rest of the world—19.7% for agricultural
products and 5.9% for nonagricultural goods.
■ India’s tariff system lacks transparency. Tariffs are high, especially in agriculture-
33.5%.
■ China- reduced tariffs significantly since joining the WTO in 2001, (World Trade
Organization, www.wto.org) but trade barriers remain high in some areas.
■ Africa- over half of all workers are employed in agriculture. Significant tariffs and other
trade barriers in the advanced economies hinder imports of agricultural goods from Africa,
which worsens already severe poverty in African countries.
■ Governments realize that high tariffs inhibit free trade and economic growth, thus have
tended to reduce tariffs over time- in fact this was the primary goal of the General
Agreement on Tariffs and Trade (GATT; now the WTO).
■ Countries as diverse as Chile, Hungary, Turkey, and South Korea have liberalized their
previously protected markets, lowering trade barriers and subjecting themselves to
greater competition from abroad.
■ Exhibit 7.4 illustrates trends in average world tariff rates over time. Notice that
developing economies have been lowering their tariff rates since the 1980s.
 Major driver of market globalization- continued tariff reductions.
Nontariff Trade Barriers

■ Government policies that restrict trade without imposing a direct tax or duty - quotas,
import licenses, local content requirements, government regulations, and administrative
or bureaucratic procedures
■ The use of nontariff barriers has grown substantially in recent decades- they are easier
to conceal from the WTO and other monitoring organizations.
■ Quotas restrict the physical volume or value of products that firms can import into a
country.
■ The upside is that domestic producers are protected from cheaper imports, giving them
a competitive edge over foreign producers.
■ The downside is that domestic consumers and producers of certain types of products
pay more for the product.
■ It also means that firms that manufacture products containing the higher-priced product
can save money by moving production to countries that do not impose quotas or tariffs
on this product.
■ Voluntary export/import restraints (VERs/VIRs) are voluntary quotas imposed by

governments whereby firms agree to limit exports/imports of certain products.
■ Example- EU impounded the Chinese-made clothing when China exceeded the
voluntary import quotas it had negotiated with the EU; millions of Chinese-made garments
piled up at European ports/borders; European retailers were challenged having ordered
their clothing inventory several months in advance.

■ Import license - government permission to import, which restricts imports similarly to
quotas- a costly, complicated, bureaucratic process in some countries
■ Note: Different from licensing a strategy for entering foreign markets in which one firm
allows another the right to use its intellectual property in return for a fee.
■ Governments sell import licenses to firms on a competitive basis or on a first-come,
first-served basis - a process that discriminates against smaller firms, which typically lack
the resources to purchase the licenses.
■ Examples-
◘ Russia- a complex web of licensing requirements limits imports of alcoholic
beverages.
◘ India- until the 1990s, the government imposed the “license raj,” an especially
elaborate system of licenses that regulated establishing/running businesses in the
country.
■ Local content requirements stipulate that production must include a certain

percentage of local value added production, i.e. locally produced.
■ These are usually imposed in economic bloc countries, such as the European Union
and NAFTA. The so called “rules of origin requirement” specifies that a certain
proportion of products and supplies, or of intermediate goods used in local manufacturing,
must be produced within the bloc.
◘ Example- about 60% of the value of a car manufactured within NAFTA must
originate within the NAFTA member countries, if not, then the product becomes subject
to the tariffs charged to non-NAFTA countries.
■ Government regulations and technical standards include safety regulations for

motor vehicles and electrical equipment, health regulations for hygienic food preparation,
labeling requirements that indicate a product’s country of origin, technical standards for
computers, and bureaucratic procedures for customs clearance.
■ Examples of protecting domestic firms by imposing red tape for foreign firms:
◘ European Union strictly regulates genetically modified (GM); a policy that blocks
some food imports into Europe from the U.S. b/c GM food regulations are relatively lax in
the U.S.
◘ China requires foreign firms to obtain special permits to import GM foods.
◘ Chinese government clashed with Google when it refused to censor its Web
search and news services in mainland China. The government has historically censored
material it considers subversive, which has hindered Google’s attempts to enter China’s
huge Internet market.
ADDITIONAL EXAMPLES:
◘ China, Japan, and Taiwan require that imported agricultural products undergo
strict testing, a process that may require considerable time and expense
◘ Japan prohibited the import of snow skis on the unlikely grounds that Japanese
snow is different from snow in other countries.
◘ Canada is officially bilingual (English and French), the provincial government of
Quebec requires that all product labeling be in French.

◘ A requirement that products indicate their country of origin may constitute a
barrier because people may prefer to buy domestic products.
■ Administrative or bureaucratic procedures that hinder the activities of importers or

foreign firms
■ Examples-
◘ India- business sector is burdened by countless regulations, standards, and
administrative hurdles at the state and federal levels.
◘ Mexico- government imposed bureaucratic procedures led United Parcel
Service to temporarily suspend its ground delivery service across the U.S.- Mexican
border.
◘ U.S. barred Mexican trucks from entering the U.S. on the grounds that they were
unsafe.
◘ Saudi Arabia- every foreign business traveler to the Arab kingdom must hold an
entry visa that can be obtained only by securing the support of a Saudi sponsor - a citizen
who vouches for the visitor’s actions- very difficult to get.
ADDITIONAL EXAMPLES:
◘ France- government restricted the import of Japanese video recording
equipment by requiring that it be cleared through a single customs office in Poitiers, a
town in the middle of France.
◘ Africa/Latin America - commercial activities and business start-ups hindered
by countless bureaucratic procedures
■ By Contrast:
◘ Australia, Canada, Ireland, New Zealand, Singapore, and the United Kingdom
impose relatively few such procedures.
■ The revenue generated by tariffs depends on how customs authorities classify imported
products - thousands of categories exist for customs classification, a product can be
easily misclassified, either by accident or intent.
■ Example- a sport utility vehicle could be classified as a truck, a car, or a van. Each of
these categories can entail a different tariff.
Investment Barriers
■ In order to bypass tariffs, firms may enter countries via FDI, yet be subject to ownership
restrictions.
■ Globally, FDI and ownership restrictions are common in industries such as
broadcasting, utilities, air transportation, military technology, and financial services, as
well as industries that involve major government holdings, such as oil and key minerals.
■ Examples-
◘ Mexico- government restricts FDI by foreign investors to protect its oil industry,
which is deemed critical to the nation’s security.
◘ Canada- government restricts foreign ownership of local movie studios and TV
networks to protect its indigenous film and TV industries from excessive foreign influence.

◘Services sector - FDI and ownership restrictions are particularly burdensome
because services usually cannot be exported and providers must establish a physical
presence in target markets.
■ Smuggling may be an unintended consequence.
Currency controls
■ Restrictions on the outflow of hard currency (such as the U.S. dollar, the euro, and the
yen), or the inflow of foreign currencies
■ These controls are used to conserve valuable hard currency, reduce the risk of capital
flight, and are particularly common in developing countries.
■ Dual official exchange rates- Some countries employ a system of offering exporters
a relatively favorable rate to encourage exports, while importers receive a relatively
unfavorable rate to discourage imports.
■ Help and Hinder- Currency controls favor companies when they export their products
from the host country but harm those that rely heavily on imported parts and components.
■ Repatriation of profits– restrictions on revenue transfer from profitable operations back
to the home country.
■ Example-
◘ Venezuela- currency controls have led to a shortage of dollars and other hard
currencies. Multinational firms avoid doing business in Venezuela because strict currency
rules limit the amount of profits they can take out of the country or limit their ability to
receive payment for imports at reasonable prices. Venezuela imposed the controls to
keep imports inexpensive and retain a base of hard currencies in the country.
ADDITIONAL EXAMPLE:
◘ Colombia- international investors who wish to buy stocks and bonds must make
a refundable deposit of 40% of their total investment with the Banco de la Republica
(www.banrep.gov.co), the central bank of Colombia, for a minimum of six months, which
allows monetary authorities monitor the inflow and outflow of foreign investments and
helps ensure foreign funds will not be used for speculative activities.
Subsidies and Other Government Support Programs

■ Subsidies - Monetary or other resources that a government grants to a firm or group
of firms, intended to encourage exports or to facilitate the production and marketing of
products at reduced prices, to ensure the involved firms prosper.
■ Examples-
Cash disbursements, material inputs, services, tax breaks, infrastructure construction,
and inflated government contracts.
■ Examples-
◘ France- government provided large subsidies to Air France, the national airline.
◘European government support of Airbus, the leading European manufacturer of
commercial aircraft

◘ China- Several leading corporations, such as China Minmetals ($39 billion
annual sales) and Shanghai Automotive ($34 billion annual sales), are state enterprises
wholly or partly owned by the Chinese government, which provides these firms with huge
financial resources.
■ Critics – unfair advantages- subsidies artificially reduce the cost of business for the
recipient. The WTO prohibits subsidies when it can be proven that they hinder free trade.
■ Example-
◘ India- government provides massive subsidies to state-owned oil companies,
which allows them to offer gasoline at very low prices. Foreign MNEs such as Royal Dutch
Shell cannot operate profitably at such prices and consequently avoid doing business in
that market.
■ Subsidies encourage overproduction, which lower domestic food prices, making
agricultural imports from developing countries less competitive.
■ Difficult to Define- when a government provides land, infrastructure,
telecommunications systems, or utilities to corporate park firms, this is technically a
subsidy- yet many would argue that this is just an appropriate public function
■ European and U.S. governments provide agricultural subsidies to supplement the

income of farmers and help manage the supply of agricultural commodities.
●The U.S. government grants subsidies for over two dozen commodities,
including corn, soybeans, wheat, cotton, and rice.
●In Europe, the Common Agricultural Policy (CAP) is a system of subsidies
that represents about 40% of the EU's budget, amounting to tens of billions of
euros annually.
■ Countervailing duties - government retaliation against foreign subsidies by imposing

a duty on imported products to offset subsidies in the exporting country.
◘ The duty cancels out the effect of the subsidy.
■ Dumping - subsidies may allow a manufacturer to engage in dumping, which is

charging an unusually low price for exported products, typically lower than that for
domestic or third-country customers, or even lower than manufacturing cost.
■ Example - The EU subsidy to sugar producers allows EU farmers to dump massive
amounts of sugar at artificially low prices onto world markets, making them the largest
exporters of sugar- without the subsidies Europe would be one of the world’s biggest
sugar importers.
■ Dumping is against WTO rules because it amounts to unfair competition, but it is hard
to prove.
■ A large MNE that charges very low prices could conceivably drive competitors out of a
foreign market, thereby achieving a monopoly, and later raise its prices.
■ Antidumping duty - a tax imposed on products deemed to be dumped and causing
injury to producers of competing products in the importing country.
■ The WTO allows this practice.

■ Examples of indirect government subsidies- support home country businesses by
funding R&D initiatives, granting tax exemptions, and offering business development
services, such as market information, trade missions, and privileged access to key foreign
contacts.
■ Agency Examples-
◘ Canada- the Department of Foreign Affairs and International Trade (www.dfait-
maeci.gc.ca)
◘ United Kingdom- U.K. Trade & Investment (www.uktradeinvest.gov.uk)
◘ U.S. - the International Trade Administration of the U.S. Department of
Commerce (www.doc.gov)
■ Investment incentives- related to subsidies- transfer payments or tax concessions

made directly to individual foreign firms to entice them to invest in the country.
■ Examples-
◘ Hong Kong government put up most of the cash to build the Hong Kong Disney
Park (park.hongkongdisneyland.com). While the theme park and facilities cost about
$1.81 billion, the government provided an investment of $1.74 billion to Walt Disney to
develop the site.
◘ Austin, Texas and Albany, New York competed to have the Korean manufacturer
Samsung Electronics (www.samsung.com) build a semiconductor plant in their regions.
Austin offered $225 million worth of tax relief and other concessions in its successful bid
to attract Samsung's $300 million plant, estimated to create nearly 1,000 new jobs locally.
◘ Macedonia entices MNEs with incentives such as low corporate taxes,
immediate access to utilities and transportation, and financial support for training workers
(www.investinmacedonia.com).
◘ 1990s- Germany encouraged foreign firms to invest in the economically
disadvantaged East German states by providing tax and investment incentives.
◘ 1990s- Ireland achieved an economic renaissance through proactive promotion
of Ireland as a place to do business. Targeting foreign firms in the high-tech sector—
including medical instruments, pharmaceuticals, and computer software- foreign firms
were offered preferential corporate tax rates of 12%.
■ Government procurement policies support domestic industries and constitute an

indirect form of nontariff trade barrier.
■ Government procurement policies restrict government-funded purchases to home-
country suppliers.
■Example- Several governments require that air travel purchased with government funds
be with home-country carriers.
■ Government procurement policies are common in countries with large public sectors,
such as China, Russia, and various Middle Eastern countries.
■ U.S. - government agencies favor domestic suppliers unless their prices are higher than
foreign suppliers.

■ Japan- government agencies often do not even consider foreign bids, regardless of
pricing.
EVOLUTION AND CONSEQUENCES OF GOVERNMENT INTERVENTION
■ Trade barriers, two World Wars and the Great Depression shaped the trading
environment of the twentieth century.
■ 1930 - Smoot-Hawley Tariff Act - raised U.S. tariffs to more than 50% (compared to
only about 4% today).
■ 1940s - Prudent international trade policies reduced worldwide tariffs
Protectionist Policies
■ Import substitution - substituting local production for imports - Government-supported

local enterprises producing previously imported products
◘ Example- 1950s- Latin America adopted protectionist policies aimed at
industrialization and economic development. With protected industries requiring ongoing
subsidies, most countries experimenting with import substitution eventually rejected it.
■ Protectionist Policies- did not succeed. Domestic firms that enjoyed government
subsidies and the protection of high tariffs never became competitive in world
markets. Living standards remained relatively low.
■ Export- led development -1970s - Singapore, Hong Kong, Taiwan, and South Korea,
Malaysia, Thailand, and Indonesia achieved rapid economic growth by encouraging the
development of export-intensive industries. Their model proved much more successful
than import substitution. Living standards improved and a rising middle class helped
transform these countries into competitive economies.
■ Japanese miracle - Following World War II, Japan launched an ambitious program of
export-led development and national strategic policies- tariffs that protected Japan’s
infant industries- automobiles, shipbuilding, and consumer electronics, resulting in
Japan’s rise from poverty in the 1940s to become one of the world’s wealthiest countries
by the 1980s.
■ Both China and India have long sheltered themselves through protectionism and
government intervention, relying on centralized economic planning, in which
agriculture and manufacturing were controlled by state-run industries.
■ China –
◘ 1949- Mao Tse Tung established a communist regime.
◘ China - centralized economic planning- agriculture and manufacturing were
controlled by inefficient state-run industries- focus on national self-sufficiency- China
closed to international trade.

◘ 1990s- China began to liberalize its economy.
◘ 1992 - China joined the Asia-Pacific Economic Cooperation (APEC) group, a
free-trade organization.
◘ 2001 -China joined the WTO and committed to reducing trade barriers and
increasing intellectual property protections.
◘ 2008- China’s GDP was more than ten times the 1978 level, and the value of
exports had reached $1.5 trillion.
◘ 2012- GDP was more than ten times the 1995 level, and the value of exports
had reached nearly $1.9 trillion.
◘ 2015- GDP was more than ten times the 1998 level, and the value of exports
had reached $2.2 trillion.
◘ China has become a leading exporter of manufactured products and home to
large MNEs that compete with western firms.
■ India -
◘ Independence from Britain in 1947
◘ Adopted a quasi-socialist model of isolationism and strict government control.
◘ Poor economic performance due to high trade and investment barriers, state
intervention in labor and financial markets, a large public sector, heavy regulation of
business, and central planning.
◘ Early 1990s - markets opened to foreign trade and investment, free-trade
reforms, privatization of state enterprises.
◘ Trade liberalization and privatization of state enterprises fueled economic
progress.
◘ Between 2000 and 2015, India’s average annual income rose from about $470
in real terms to more than $1,800 in 2015, an impressive achievement.
General Agreement on Tariffs and Trade (GATT)

■ 1947- 23 nations signed the General Agreements on Tariffs and Trade (GATT), the first
major effort to systematically reduce trade barriers worldwide.
■ GATT created:
(1) A process to reduce tariffs among member nations- through continuous
negotiations;
(2) An agency to serve as a watchdog over world trade; and
(3) A forum for resolving trade disputes.
■ GATT introduced the concept of most favored nation (renamed normal trade
relations in 1998), according to which each signatory nation agreed to extend the tariff
reductions covered in a trade agreement with a trading partner to all other countries- A
concession to one country became a concession to all.
■ 1995, the GATT was superseded by the WTO, and grew to include 150 member
nations- historically- resulted in the greatest global decline in trade barriers.

■ 2008- The global financial crisis arose largely from inadequate regulation and
enforcement of current regulations in the banking and finance sectors- and raised new
questions about government’s role in business and the world economy
■ Governments around the world are increasing regulation and examining ways to
improve enforcement.
■ Increasing Protectionism to safeguard jobs and wages
■ Examples-
◘ Argentina and Brazil increased import tariffs on numerous products.
◘ Russia raised tariffs on dozens of goods, including cars and combine harvesters.
◘ United Kingdom- Government provided substantial subsidies to U.K. banks and
financial institutions.
◘ China pumped hundreds of billions of dollars into its own economy
◘ U.S. government has increased the power of its Treasury Department, Federal
Reserve System, and Federal Deposit Insurance Corporation (FDIC).
◘ The European Central Bank is creating a new agency that aims to take
aggressive action in needed areas.
◘ The European Union is increasing oversight of multinational banks and
supervision of financial institutions.
◘ The United Nations has called for greater transparency in financial activities
and closure of loopholes that allow excessive speculation in global finance.
◘ The EU granted over $50 billion in aid to Daimler (Germany), Skoda (Czech
Republic), and other struggling carmakers in Europe.
◘ U.S. government provided billions to banks and carmakers in the U.S.
■ Rising protectionism has impacted international commerce

■ Ripple effects of government reforms extend well beyond the banking and financial
areas.
■ Exhibit 7.5 illustrates the relationship among Tariffs, World GDP, and the Volume of
World Trade, demonstrating that while average tariffs have declined (Exhibit 7.4), world
trade and GDP have flourished.
■ Growth of Global Commerce/International Trade:
◘ Driver- Decreasing Trade Barriers
◘ Consequence- Rising Global Incomes/Poverty Reduction
◘ Consequence- Improved Firm Performance
■ Effects- Government Intervention may be measured by a nation’s Ease of Doing

Business, an index developed by the World Bank that ranks 189 countries.
■ A high ease of doing business ranking means the country’s regulatory environment is
business-friendly; very conducive to starting and operating a company there.

■ Ease of Doing Business Index
10 variables are rated per country for a total ranking index:
●Starting a business
●Dealing with construction permits
●Getting electricity
●Registering property
●Getting credit
●Protecting minority investors
●Paying taxes
●Trading across borders
●Enforcing contracts
●Resolving insolvency
■ Exhibit 7.6 illustrates the ease of doing business for each country.
■ Business-Friendly Countries
●The “easiest” countries are advanced economies that enjoy high living standards.
●The “easiest” group also includes emerging markets that have simplified their
regulatory environment in an effort to encourage entrepreneurship and investment.
■ Business- Less-Friendly Countries

●The “moderately hard” and “hardest” countries are relatively difficult places to do
business, and characterized by severe poverty and other hardships.
Ethical Concerns
■ Government intervention and trade barriers disproportionately impact developing
economies and low-income consumers because countries such as Bangladesh,
Pakistan, India, Cambodia and Africa- where clothing and shoe exporters are
concentrated- are taxed at relatively higher levels than UK imports- U.S. import tariffs on
clothing and shoes exceed 20%.
■The tariffs that confront less-developed economies are often several times those faced
by the richest countries.
■ Government intervention can also offset harmful effects- create or protect jobs:
◘ Example- Globalization has affected thousands of European workers whose
jobs have been shifted to other countries with lower labor costs. The European
governments have provided subsidies for the unemployed, aimed at retraining workers to
upgrade their job skills or find work in other fields.
HOW FIRMS CAN RESPOND TO GOVERNMENT INTERVENTION

■ Firms must cope with protectionism and other forms of intervention- impractical to avoid
markets with high trade and investment barriers or excessive government intervention.
■ Industries particularly susceptible to government intervention:
●Aluminum
●Petroleum
●Food-processing

●Biotechnology
●Pharmaceutical
Strategies for Managers

■ Emerging markets, e.g. China, India, and countries in Africa, Asia, Latin America, are
characterized by extensive trade barriers and never-ending government intervention.
■ Despite the challenges, firms target emerging markets and developing economies
because they promise significant long-term potential.
(1) RESEARCH TO GATHER KNOWLEDGE AND INTELLIGENCE

■ Firms should first undertake research to understand the extent and nature of trade and
investment barriers abroad.
■ Scan the business environment to identify the nature of government intervention, plan
market-entry strategies and host-country operations, and capitalize upon government
support opportunities.
■ Review return-on-investment criteria to account for the increased risk/cost of trade and
investment barriers
■ Example- EU is devising new guidelines that affect firms in areas ranging from product
liability laws to standards for investment in European industries.
(2) CHOOSE THE MOST APPROPRIATE ENTRY STRATEGIES

■ Exporting- Tariffs and most nontariff trade barriers
■ FDI - Investment barriers
■ Most firms choose exporting as their initial entry strategy. However, if high tariffs are
present, managers should consider other strategies, such as FDI, licensing, and joint
ventures that allow the firm to operate directly in the target market, avoiding import
barriers.
◘ Example-Taiwan’s Foxconn, a contract manufacturer for Apple and other
electronics firms, built a factory in Brazil to avoid the high import tariffs.
■ Even FDI can be impacted by tariffs- if it requires importing raw materials and parts to
manufacture finished products in the host country.
■ Tariffs often vary with the form of an imported product.

◘ Companies often ship manufactured products “knocked-down” and assemble
them in the target market.
◘ In countries with relatively high tariffs on imported personal computers, importers
often bring in the parts and assemble the computers locally.
◘ Example- Eastman Kodak (www.kodak.com) imports parts into the U.S. to
manufacture photographic equipment, thereby avoiding higher import tariffs applicable
to finished goods.
(3) TAKE ADVANTAGE OF FOREIGN TRADE ZONES

■ Governments establish foreign trade zones (FTZs; free trade zones or free ports) in an
effort to create jobs and stimulate local economic development.

■ Products brought into an FTZ are not subject to duties, taxes, or quotas until they, or
the products made from them, enter into the non-FTZ commercial territory of the country
where the FTZ is located.
■ Firms use FTZs to assemble foreign dutiable materials and components into finished
products, which are then re-exported.
■ Firms may use FTZs to manage inventory of parts, components, or finished products
that the firm will eventually need at some other location.
■ Example- Japanese carmakers store vehicles at the port of Jacksonville, Florida,
without having to pay duties until the cars are shipped to U.S. dealerships.
■ FTZs exist in more than 75 countries, usually near seaports or airports.

■ The U.S. is home to several hundred FTZs used by thousands of firms.
■ Located on the Atlantic side of the Panama Canal, the Colon Free Zone
(www.colonfreezone.com) is an enormous FTZ where products are imported, stored,
modified, repacked, and re-exported without being subject to tariffs or customs
regulations.
■ Example- A successful experiment with FTZs has been the maquiladoras—export-

assembly plants in northern Mexico along the U.S. border that produce components and
finished products destined for the U.S. - e.g. clothing, furniture, car parts, electronics, etc.
■ Now under NAFTA (North American Free Trade Agreement), the collaboration enables
firms from the U.S., Asia, and Europe to tap low-cost labor, favorable duties, and
government incentives, while serving the U.S. market.
■ Maquilas account for about half of Mexico’s exports
(4) SEEK FAVORABLE CUSTOMS CLASSIFICATIONS FOR EXPORTED PRODUCTS

■ Reduce exposure to trade barriers by classifying products according to the appropriate
harmonized product code.
■ Since many products can be classified in several categories, ensure that the exported
products are classified under the lowest tariff code.
■ Example- Some telecommunications equipment can be classified as electric
machinery, electronics, or measuring devices.
■ Manufacturers may also modify the exported product in a way that classifies it according
to the lowest tariff code, thereby minimizing trade barriers.
■ Example- South Korea faced a quota on the export of non-rubber footwear to the U.S.
- by shifting manufacturing to rubber-soled shoes, Korean firms greatly increased their
footwear exports
(5) TAKE ADVANTAGE OF INVESTMENT INCENTIVES AND OTHER GOVERNMENT

SUPPORT PROGRAMS
■ Government assistance in the form of subsidies and incentives is another strategy for
reducing the cost of trade and investment barriers.
■ Examples-
◘ Mercedes- built a factory in Alabama, it benefitted from reduced taxes and direct
subsidies provided by the Alabama state government.

◘ Siemens- built a semiconductor plant in Portugal; it received subsidies from the
Portuguese government and the EU. These incentives covered nearly 40% of Siemen’s
investment and training costs.
◘ Governments in Europe, Japan, and the U.S. increasingly provide incentives to
companies that set up shop within their borders
■ Incentives also include reduced utility rates, employee training programs, tax holidays,
and construction of new roads and communications infrastructure.
(6) LOBBY FOR FREER TRADE AND INVESTMENT

Increasingly, nations are liberalizing markets in order to create jobs and increase tax
revenues.
■ Firms can lobby foreign governments to lower trade and investment barriers.
■ Foreign firms often hire former government officials to help lobby their former colleagues
■ Examples-
●Japanese- have achieved much success in reducing trade barriers by lobbying
U.S. and European governments.
●China- domestic and foreign firms lobby the government to relax protectionist
policies and regulations that make China a difficult place to do business. Foreign firms
often hire former Chinese government officials to help lobby their former colleagues.
■ The private sector lobbies federal authorities to undertake government-to-government

trade negotiations, aimed at lowering barriers.
■ Private firms bring complaints to world bodies, e.g. the WTO, to address unfair trading
practices of key international markets.
 MyManagementLab: Watch It!

Government Intervention: Spotlight on China and Germany
Apply what you have learned in this chapter by watching a video on government
intervention in two nations with distinctive political and legal systems.
Go to MyManagementLab; click on your course; click on Multimedia Library
REGIONAL INTEGRATION AND ECONOMIC BLOCS

■ Governments play an important role in facilitating:
■ Regional economic integration (regional integration), refers to the growing economic
interdependence that results when two or more countries within a geographic region form
an alliance aimed at reducing barriers to trade and investment.
■ Example- European Union (EU) formation- regional integration increases economic
activity and makes doing business easier among nations within the alliance.
■ Economic bloc members are at a minimum parties to free trade agreement.

■ Free trade agreement- formal arrangement between two or more countries to reduce
or eliminate tariffs, quotas, and barriers to trade in products and services

■ 50% (more than) of world trade today is under some form of (bloc) preferential trade
agreement.
■ Premise- mutual advantages for cooperating nations within a common geography,
history, culture, language, economics, and/or politics
■The free trade that results from economic integration helps nations attain higher living
standards by encouraging specialization, lower prices, greater choices, increased
productivity, and more efficient use of resources.
■ Regional Economic Integration Bloc or Economic Bloc- a geographic area that
consists of two or more countries that agree to pursue economic integration by reducing
tariffs and other restrictions to cross-border flow of products, services, capital, and, in
more advanced stages, labor.
■ Examples of Regional Integration-
●European Union (EU)
●North American Free Trade Agreement (NAFTA)- Canada, Mexico, and the U.S.
■ Example- EU
◘ More advanced economic bloc
◘ Permits the free flow of capital, labor, and technology among their member
countries
◘ Harmonizing monetary policy (to manage the money supply and currency
values) and fiscal policy (to manage government finances, especially tax revenues)
■ Still, recent crises in Greece, Italy, Spain, and Portugal, and general discord among
EU members, are challenging the progress of regional integration in Europe.
INTERNATIONAL BUSINESS CONTINUUM- TWO EXTREMES:
WORLD-WIDE FREE TRADE

World operates as one large free-
trade area in which there are no
tariffs or quotas, all countries use
the same currency, and products,
services, capital, and workers
can move freely among nations
without restriction.
WORLD-WIDE RESTRICTED
TRADE
World of prohibitive barriers to
trade and investment where
countries have separate
currencies and very little
commercial interaction with
each other.

Regional integration is a compromise, a middle-ground along this continuum.
Levels of Regional Integration
■ Synergies of Regional Integration- the total output of the integrated area becomes
greater than that achievable by individual states.
■ Exhibit 7.7 identifies five possible levels of regional integration.
■ Regional integration is a continuum, with economic interconnectedness progressing
from a low level of integration—the free trade area— through higher levels to the most
advanced form of integration—the political union— ultimate degree of integration- no
countries have achieved this yet.
Free Trade Area

■ The simplest and most common arrangement, in which member countries agree to
gradually eliminate formal barriers to trade in products and services within the bloc, while
each member country maintains an independent international trade policy with countries
outside the bloc.
◘ Example- NAFTA
●The free trade area emphasizes the pursuit of comparative advantage for
a group of countries rather than for individual states.
● Local content requirements- if unmet, products subject to tariffs imposed
on non-member countries.
Customs Union
■ Second level of regional integration- similar to a free trade area except that the member
states harmonize their external trade policies and adopt common tariff and nontariff
barriers on imports from nonmember countries
◘ Example- MERCOSUR (Argentina, Brazil, Paraguay, and Uruguay)
●. The adoption of a common tariff system means that an exporter outside
MERCOSUR faces the same tariffs and nontariff barriers when trading with any
MERCOSUR member country.
Common Market – (Single Market)

■ Third stage of regional integration- trade barriers are reduced or removed, common
external barriers are established and products, services, and factors of production such
as capital, labor, and technology are allowed to move freely among the member countries.
■ Like a customs union - common trade policy with nonmember countries is also
established.
◘ Example- EU
● Reduced/eliminated restrictions on immigration and the cross border flow
of capital
● A worker from an EU country has the right to work in other EU countries,
and EU firms can freely transfer funds among their subsidiaries within the bloc.
Challenges:
◘ Require substantial cooperation from the member countries on labor and
economic policies.

◘ As labor and capital can flow freely inside the bloc, benefits to individual
members vary, because skilled labor may move to countries where wages are higher and
investment capital may flow to countries where returns are greater.
● Example- Germany: influx of workers from Poland and the Czech
Republic, because these workers can earn substantially higher wages in Germany than
they can at home.
Economic Union- (Monetary Union- sometimes)

■Fourth stage of regional integration- member countries enjoy all the advantages of early
stages, but also strive to have common fiscal and monetary policies.
■ At the extreme-
◘ Identical tax rates
◘ Fixed exchange rates
◘ Free currency convertibility among member states
◘ Free movement of capital
■ Standardization-
◘ Helps eliminate discriminatory practices that might favor one member state over
another.
◘ Through greater mobility of products, services, and production factors, an
economic union enables firms within the bloc to locate productive activities in member
states with the most favorable economic policies.
◘ Example- the EU
■ Monetary unions:
◘ EU has made great strides toward this. Nineteen EU countries have established
a monetary union with a single currency, the euro.
◘ European financial institutions can establish EU branches and offer banking &
insurance services far easier with a monetary union and the euro.
◘ The single currency enables easier trading and investment for European firms
doing business within the union.
■ Economic unions:
◘ Member countries strive to eliminate border controls, harmonize product and
labeling standards, and establish region-wide policies for energy, agriculture, and social
services.
◘ Also members standardize laws and regulations regarding competition, mergers,
and other corporate behaviors, and harmonize professional licensing procedures.
■ Fictitious Example-
U.S. provides a good analogy for an economic union. Imagine each state is like an
individual country, but all are joined together in a union. The members have a common
currency, a single central bank with a uniform monetary policy, trade among the members
takes place unobstructed, and both labor and capital move freely among them, the federal
government applies a uniform tax and fiscal policy. Just as would occur in an economic

union, the individual U.S. states also govern themselves in such areas as education,
police protection, and local taxes. This analogy can only go so far- unlike members of a
real economic union, the states cannot withdraw.
■ Political Union: (ultimate)

◘ Perfect unification of all policies by a common organization- submersion of all
separate national institutions
◘ Example- Remains an ideal, yet to be achieved.
LEADING ECONOMIC BLOCS

■ Exhibit 7.8 illustrates the most active economic blocs.
■ Europe has the longest experience with regional integration and is home to several
economic blocs, most paramount are the EU and the European Free Trade Association.

The European Union (EU)
■1957- Treaty of Rome- European Economic Community (EEC) alliance formation-

origins of the EU -Belgium, France, West Germany, Italy, Luxembourg, and the
Netherlands- sought to promote peace and prosperity through economic and political
cooperation (www.europa.eu).
■ 1992- the formal creation of the EU
■ 28 countries from Eastern and Western Europe.
■ EU - world’s most advanced and largest regional economic bloc.
■ Home to a half-billion people.
■ $18 trillion- total annual GDP.
The European Union has taken specific steps to become an economic union:
Market access
■ Tariffs and most nontariff barriers were eliminated for trade in products and
services.
■ Rules of origin favor manufacturing using inputs produced in the EU.
Common market
■ Barriers to the cross-national movement of production factors—labor, capital, and
technology—have been removed.
■ Example-
◘ Italian worker now has the right to get a job in Ireland, and a French
company can invest freely in Spain.
Trade rules
■ Customs procedures and regulations have been eliminated, streamlining
transportation and logistics within Europe.

Standards harmonization
■Technical standards, regulations, and enforcement procedures related to
products, services, and commercial activities are being harmonized.
■ Examples-
◘ British firms once used imperial measures (pounds, ounces, and inches);
they have converted to the metric system used by all EU countries.
◘ German food merchants that once had their own standard for handling
meat and produce now follow procedures prescribed by the EU.
Common fiscal, monetary, taxation, and social welfare policies -in the long run
■ The euro (common currency since 2002):
●Simplified the process of cross-border trade and enhanced Europe’s

international competitiveness.
●Eliminated exchange rate risk in much of the bloc and forced member
countries to improve their fiscal and monetary policies.
●Unified consumers and businesses to think of Europe as a single market
●Forced national governments to relinquish monetary power to the European
Central Bank, in Luxembourg, which oversees EU monetary functions.
● The EU has four additional institutions that perform its executive, administrative,
legislative, and judicial functions.
◘ The Council of the European Union, based in Brussels, is the EU's main
decision-making body. Composed of representatives from each member country, it
makes decisions regarding economic policy, budgets, foreign policy, as well as admission
of new member countries.
◘ The European Commission, also based in Brussels, is similarly composed of
delegates from each member state and represents the interests of the EU as a whole. It
proposes legislation and policies and is responsible for implementing the decisions of the
European Parliament and the Council of the EU.
◘ The European Parliament consists of elected representatives that hold joint
sessions each month. By common agreement, the Parliament meets in three different
cities (Brussels, Luxembourg, and Strasbourg, France) and can have up 785 total
representatives. The Parliament has three main functions:
(1) Develops EU legislation
(2) Supervises EU institutions
(3) Makes decisions about the EU budget
◘ The European Court of Justice, based in Luxembourg, interprets and enforces
EU laws and settles legal disputes between member states.
Challenges of integrating new member states into the EU

■ New member countries- especially in Eastern Europe- are important, low-cost
manufacturing platforms for EU firms.
◘ Examples-
● Peugeot and Citroën- production plant in the Czech Republic.
● Hyundai (South Korea) - produces the Kia at a plant in Slovakia.
● Suzuki (Japan) makes cars in Hungary.
■ Most of the newest EU entrants are one-time satellites of the former Soviet Union, and
have economic growth rates higher than their Western European counterparts.
■ Less-developed economies such as Romania, Bulgaria, and Lithuania may require
years of developmental aid to catch up.
■ Recently, long-standing EU members - Greece and Spain have been afflicted by
economic crises. In many ways.
■ EU is still a work in progress.
■ Common Agricultural Policy (CAP) is a long-standing fixture of the EU.

◘ CAP- system of agricultural subsidies and programs that guarantees a minimum
price to EU farmers and ranchers
◘ Original goals were to provide a fair living standard for agricultural producers and
food at reasonable prices for consumers.
◘ Reality- CAP has increased food prices in Europe, consumes almost 50% of the
EU's annual budget, and complicates negotiations with the World Trade Organization for
reducing global trade barriers.
◘ CAP imposes high import tariffs that unfairly affect exporters in developing
economies, e.g. Africa that rely heavily on agricultural production.
◘ The EU is working to reform the CAP, but progress has been slow.
 MyManagementLab: Watch It! 2

Regional Economic Integration: Outlook for the European Union
Apply what you have learned in this chapter by watching a video on the world’s leading
economic bloc.
Go to MyManagementLab to view the video.
North American Free Trade Agreement (NAFTA)

■ 1994- NAFTA (http://www.nafta-sec-alena.org)- Canada, the U.S. and Mexico
■ Most significant economic bloc in the Americas
■ Maquiladora program facilitated NAFTA passage - since the 1960s U.S. firms have
located manufacturing facilities just south of the U.S. border, and access low-cost labor
without having to pay significant tariffs.
■ NAFTA:
◘ Increased market access between Canada, Mexico and the U.S.
◘ Eliminated tariffs and most nontariff barriers for products/services traded in the
bloc.

◘ Launched government contract bidding in all three countries by any member-
country firm
◘ Established trade rules and uniform customs procedures and regulations
◘ Prohibited standards/technical regulations to be used as trade barriers.
◘ Instituted rules for investment and intellectual property rights.
◘Provided a forum for dispute settlement for issues: investment, unfair pricing,
labor issues, and the environment.
■ NAFTA RESULTS:
◘ Canada and Mexico are the most important export markets of the U.S. -
accounting for about 1/3 of U.S. exports
◘ Trade among the members has more than tripled and now exceeds one trillion
dollars per year.
◘ Early 1980s- Mexico’s tariffs averaged 100% and gradually disappeared under
NAFTA.
◘ FDI in Mexico rose dramatically - from U.S. and Canadian firms
◘ Mexico’s per-capita income has risen substantially, making Mexico into Latin
America’s wealthiest country in per-capita income terms
■ NAFTA resulted in North American labor market restructuring:

◘ Falling trade barriers triggered job losses in the North as factories were
“exported” to Mexico to profit from its low-cost labor.
◘ Increased purchasing power of Mexican consumers meant that they could afford
to buy U.S. and Canadian imports.
◘ The accord helped to improve working conditions and compliance with labor
laws.
◘ NAFTA also includes provisions promoting sustainable development and
environmental protection.
◘ Quebec is easing commerce and labor barriers with France, and Canada is in
negotiations to join the EU
◘ Canada and the U.S. are streamlining regulations/bureaucratic hassles between
their two countries
■ Compared to the EU or NAFTA, other economic blocs are less stable and have been
less successful- e.g. in Latin America, Asia, the Middle East, and Africa.
El Mercado Comun del Sur (MERCOSUR)

■ 1991- MERCOSUR or (the Southern Common Market) is the strongest economic bloc
in South America (www.mercosur.int).
■ Includes Argentina, Brazil, Paraguay, and Uruguay.
■ MERCOSUR established the free movement of products and services, a common
external tariff and trade policy, and coordinated monetary and fiscal policies.
■ Priority- construction of reliable infrastructure—roads, electricity grids, and gas
pipelines.

■ Goal- to expand market size, achieve scale economies, attract FDI, and build defensive
and political posture.
■ MERCOSUR eventually aims to become an economic union.
■ Trade tripled among member countries during its first six years.
■ Five associate members (besides its regular members) have access to preferential
trade but not to the tariff benefits of full members
■ MERCOSUR may be integrated with NAFTA and the Dominican Republic-Central
American Free Trade Agreement (DR-CAFTA) as part of the proposed Free Trade Area
of the Americas (FTAA). If implemented, this integration would bring free trade to the
entire western hemisphere.
Association of Southeast Asian Nations (ASEAN)

■ 1967- One of the few examples of economic integration in Asia, ASEAN was created
with the goal of maintaining political stability and promoting regional economic and social
development (www.aseansec.org).
■ ASEAN created a free trade area in which many tariffs were reduced to less than 5%.
■ Economic diversity has slowed further regional integration.
■Example- oil-rich Brunei has a per capita income of over $50,000, while Vietnam's is
only about $3,000.
■ The mass movement of workers from poor to prosperous countries that would likely
result with further ASEAN integration reduces the likelihood that this bloc will become a
common market or an economic union.
■ ASEAN aims to incorporate powerhouses like Japan and China, whose membership
would accelerate the development of extensive trade relationships.
■ Note that Singapore’s exports as a percent of its GDP exceed 100%. The reason is that
Singapore is an entrepôt nation, an import-export platform for Asia, trading far more
goods than it manufactures.
Asia Pacific Economic Cooperation (APEC)

■ APEC aims for greater free trade and economic integration of the Pacific Rim countries.
■ It incorporates 21 nations on both sides of the Pacific, including Australia, Canada,
Chile, China, Japan, Mexico, Russia, and the U.S. (www.apec.org).
■ Its members account for 85% of total regional trade, as well as 1/3 of the world’s
population and over 1/2 its GDP.
■ APEC aspires to remove trade and investment barriers by 2020.
■ Members have varying national economic/political priorities, and the inclusion of less
affluent Asian countries alongside strong international traders like Australia, Japan, and
the U.S. complicates agreement on a range of issues.
Australia and New Zealand Closer Economic Relations Agreement (CER)

■ 1966- Australia and New Zealand reached a free trade agreement that removed 80%
of tariffs and quotas between the two nations, but was relatively complex and
bureaucratic.
■ 1983 - the CER sought to accelerate free trade, leading to further economic integration
of the two nations.
■ The CER gained importance when Australia and New Zealand lost their privileged
status in the British market as Britain joined the EU.
■ 2009- members concluded important negotiations on creating a free trade agreement
with the ASEAN countries.
■ Many believe the CER has been one of the world's most successful economic blocs.
Economic Integration in the Middle East and Africa

■ 1981- Gulf Cooperation Council (GCC) (www.gcc-sg.org.htm)- The Middle East’s
primary regional organization
■ Established to coordinate economic (oil), social, and cultural affairs, the GCC consists
of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates.
■ GCC initiatives include coordination of the petroleum industry, abolition of certain tariffs,
and liberalization of investment, and the harmonization of banking, financial, and
monetary policies.
■ 2008- the GCC established a common market among all its member countries.
OTHERS
Caribbean Community and Common Market (CARICOM)
■ 1973- Composed of roughly 25 member and associate member states around the
Caribbean Sea.
■ CARICOM was established to lower trade barriers and institute a common external tariff
(www.caricom.org).
■ Economic difficulties of individual members has hindered its success
■ Still, the bloc is progressing toward establishing the Caribbean Single Market, a
common market that allows for a greater degree of free movement for products, services,
capital, and labor, and gives citizens of all CARICOM countries the right to establish
businesses throughout the region.
Comunidad Andina de Naciones (CAN)

■ 1969- Called the Andean Pact, the CAN includes Bolivia, Colombia, Ecuador, Peru, and
Venezuela (www.comunidadandina.org).
■ CAN is expected to merge with MERCOSUR to form a new economic bloc that
encompasses all of South America.
■ Geography (Andes mountain range) has hindered intrabloc trading - reaching only 5 %
of bloc members’ total trade.
■ Other regional economic integration examples in the Middle East:

◘ Arab Maghreb Union (composed of Algeria, Libya, Mauritania, Morocco, and
Tunisia) - still struggling to become a viable economic bloc.
ADDITIONAL INFORMATION:
◘ Regional Cooperation for Development (RCD; composed of Pakistan, Iran,
and Turkey) - the RCD was dissolved in 1979 and replaced by the Economic
Cooperation Organization (ECO).
◘ The ECO includes ten Middle Eastern and Asian countries, seeking to promote
trade and investment opportunities in the region.
◘ The Arab League is a longstanding political organization with 22 member states-

promotes unity and nationalism in the Middle East. It has been relatively unsuccessful in
fostering regional economic development.
■ Africa would like better access to European and North American markets for sales of
farm and textile products- to enhance their negotiation power with the developed world-
they have formed economic blocs through regional integration.
■ There are at least:
● Nine economic blocs in Africa:
● Southern African Development Community
● Economic Community of West African States
● Economic Community of Central African States
◘ These groups have not had much impact on regional trade.
◘ Economic development in many African countries has been hindered by political
instability, civil unrest and war, military dictatorships, corruption, and infectious diseases.
ADVANTAGES AND SUCCESS FACTORS OF REGIONAL INTEGRATION

■ Economic integration contributes to corporate and industrial growth, to economic
progress, better living standards, and higher tax revenues for the member countries.
■ Nations seek at least four objectives in pursuing regional integration:
EXPAND MARKET SIZE

■ Regional integration greatly increases the scale of the marketplace for firms inside the
economic bloc.
■ Consumers also gain access to a wider selection of products and services.
■ Examples-
◘ Belgium has a population of just 10 million; the EU gives Belgian firms free
access to a total market of roughly 500 million buyers.
◘ The German insurance firm Allianz considers Europe as one large marketplace.
◘ Under NAFTA, Canadian firms gained access to the much larger markets of
Mexico and the U.S.
ACHIEVE SCALE ECONOMIES AND ENHANCED PRODUCTIVITY

■ Expansion of market size within an economic bloc gives member country firms the
opportunity to increase the scale of operations and gain economies of scale in production
and marketing.
■ Internationalization inside the bloc helps firms learn to compete more effectively outside
the bloc as well.
■ Labor and other inputs are allocated more efficiently among the member countries-
leading to lower prices for consumers.
ATTRACT DIRECT INVESTMENT FROM OUTSIDE THE BLOC

■ Foreign firms prefer to invest in countries that are part of an economic bloc because
factories that they build within the bloc receive preferential treatment for exports to other
member countries.
■ Examples- General Mills, Samsung, and Tata- invested heavily in the EU to take
advantage of Europe's economic integration.
■ By establishing operations in a single EU country, these firms gain free trade access to
the entire EU market.
ACQUIRE STRONGER DEFENSIVE AND POLITICAL POSTURE

■ Strengthen member countries relative to other nations and world regions- this was one
of the motives for initially creating of the European Community (precursor to the EU),
whose members sought to fortify their mutual defense against the expanding influence of
the former Soviet Union.
■ For some, the EU is one way Europe counterbalances the power and international
influence of the U.S.
■ Countries are more powerful when than cooperate than individually.
Characteristics of Successful Economic Blocs

■ Successful economic blocs tend to possess the following characteristics.
CROSS-NATIONAL ECONOMIC DYNAMISM

■ Economic bloc precursor- there must be strong potential for trade and development
among the member countries.
■ Economic dynamism refers to the extent of entrepreneurial activity and the existence
of supporting business systems in a given environment.
■ Developing economies- deficient economic dynamism and less successful economic
integration.
ECONOMIC SIMILARITY
■ The more similar the economies of the member countries, the more likely the economic
bloc will succeed.
■ Significant wage rate differences means that workers in lower-wage countries will
migrate to higher wage countries.
■ Significant economic instability in one member can quickly spread and harm the
economies of the other members.

■ Compatibility of economic characteristics is so important that the EU requires its current
and prospective members to meet strict membership conditions, ideally low inflation, low
unemployment, reasonable wages, and stable economic conditions.
POLITICAL SIMILARITY
■ Similarity in political systems enhances prospects for a successful bloc.
■ Countries that seek to integrate regionally should share similar aspirations and a
willingness to surrender national autonomy for the broader goals of the proposed union.
■ Examples-
◘ Many Europeans have been reluctant to allow Ukraine to enter the EU, partly
due to the country’s history of socialism and political turmoil, as most of the existing EU
members are characterized by a long history of stable, socially democratic forms of
government.
◘ Sweden –aligning its fiscal policy to be more commensurate with other EU
countries- it has attempted to lower its corporate income tax rate and other taxes to
improve the country’s attractiveness as a place to do business in the larger EU
marketplace.
SIMILARITY OF CULTURE AND LANGUAGE

■ Cultural and linguistic similarity among the countries in an economic bloc provides the
basis for mutual understanding and cooperation.
■ This partially explains the success of the MERCOSUR bloc in Latin America, whose
members share many cultural and linguistic similarities.
■ Under NAFTA, it was easier for Canadian firms to establish trade and investment
relationships in the U.S. than in Mexico because of the similarities between the two
northern countries.
GEOGRAPHIC CLOSENESS
■ Most economic blocs are formed by countries within the same geographic region, i.e.
regional integration.
■ Close geographic proximity facilitates transportation of products, labor, and other
factors of production.
■ Neighboring countries tend to share culture and language.
■ ADDITIONAL NOTE- while the four types of similarities enhance the potential for
successful regional integration, economic interests are often the most important
factor.
■ This was demonstrated in the EU, whose member countries, despite strong cultural and
linguistic differences, achieved common goals based on pure economic interests.
CHALLENGES AND MANAGERIAL IMPLICATIONS OF REGIONAL INTEGRATION

■ Broader challenges of regional integration are trade creation, trade diversion, sacrifice
of autonomy, the failure of small or weak firms, and job loss.

■ Trade creation –
Member countries will trade more with member countries because as trade barriers fall
within the bloc, each member country favors trade with members over trade with
nonmembers.
■ Trade diversion –
Member countries will trade less with nonmember countries.
■ Aggregate effect - national patterns of trade are altered - more trade takes place inside
the bloc and less trade takes place with countries outside the bloc.
■ Policymakers worry that the EU, NAFTA, and other economic blocs could turn into
economic fortresses resulting in a decline in between bloc trading that exceeds the gains
from within bloc trading.
■ Thus far, the record indicates that trade diversion has not ensued within the world’s
leading economic integration blocs
■ Paradox: Two opposing forces-

◘ A country that reduces trade barriers is moving toward free trade.
◘ On the other hand, an economic bloc that imposes external trade barriers is
moving away from worldwide free trade.
■ Sacrifice of Autonomy
■ Establishment of a central authority to manage the bloc’s affairs is required at later
stages of regional integration.
■ Members must sacrifice some autonomy to the central authority, such as control over
its own economy, i.e. loss of national sovereignty.
■ In Britain, critics see the passage of many new laws and regulations by centralized EU
authorities as a direct threat to British self-governance. The British have resisted joining
the European Monetary Union because such a move would reduce the power that they
currently hold over their own currency, economy, and monetary regime.
■ Import Tariffs-
◘ Such trade barriers artificially shield suppliers inside the economic bloc from
competitors based outside the bloc.
◘ However, consumers inside the bloc are worse off because they must pay higher
prices for the products that they consume.
◘ Tariffs counteract comparative advantages and interfere with trade flows that
should be dictated by national endowments.
◘ Overall- external trade barriers imposed by economic blocs result in a net loss
to all bloc members
◘ Foreign firms sell less into a bloc that imposes restrictions, so they are harmed
as well.
External Suppliers Based in Developing Economies: Significant Consequences

◘ By limiting imports from such countries, trade barriers imposed by economic
blocs threaten the ability of producers in these countries to improve their poor living
conditions- significantly.

◘ Example- agricultural tariffs imposed by the EU and NAFTA blocs - do the most
harm to farmers and ranchers in Africa, South America, and other areas characterized by
substantial poverty.
◘ Governments need to consider the ethical consequences of such trade barriers
when drafting regional integration agreements.
■ Loss of National Identity

■ Homogenizing effect- increased cross-border contact - the members become more
similar to each other and national cultural identity is diluted.
■ To counter this- Member countries typically retain the right to protect certain industries
vital to national heritage or security.
■ Example- Canada has restricted the ability of U.S. movie and TV producers to invest
in the Canadian film market - Canada sees its film industry as a critical part of its national
heritage and fears the dilution of its indigenous culture from an invasion of U.S. movie
and TV entertainment programming.
■ Failure of Small or Weak Firms

■ With the decline of trade and investment barriers, protections are eliminated that
previously shielded smaller or weaker firms from foreign competition
■ The risk can be substantial for companies in smaller bloc countries, or in industries that
lack comparative advantages.
■ Example- Under NAFTA, many U.S. companies relocated their production to Mexico,
which has low wage rates, resulting in the U.S. tomato-growing industry going out of
business as that industry shifted to Mexico.
■ Corporate Restructuring and Job Loss

■ Increased competitive pressures and corporate restructuring may lead to worker layoffs
or reassignments to distant locations- disrupting worker lives and entire communities.
■ Example- MERCOSUR was a factor in the layoff of thousands of workers in Argentina’s
auto parts manufacturing sector. Low-priced auto parts from Brazil flowed into the
MERCOSUR countries forcing parts manufacturers in Argentina to cut costs, leading to
worker layoffs.
■ Regional integration agreements should include provisions that minimize harmful
effects such as job losses and the failure of small or weak firms.
■ Example- NAFTA included provisions for firms to incorporate long phase-in periods
(often 10 years or more) to adjust to falling protectionist barriers. Funds were allocated to
support the retraining of workers who lost their jobs due to NAFTA.
■ Controversies:
◘ Critics suggest NAFTA has disproportionately helped some and harmed others.
◘ Increased industrialization has led to substantial pollution in Mexico.
◘ Thousands of Canadian firms faced bankruptcy or were taken over by foreigners.
◘ EU-imposed standards have forced firms to substantially revise manufacturing
practices, packaging, and other value-chain activities.
◘ Mass migration of workers into high-income countries has triggered increased
social problems.

■ Despite such controversies, most governments regard regional integration as
advantageous. Nations worldwide continue to pursue free trade and economic
interdependence within their regions.
Managerial Implications of Regional Integration

■ Appropriate strategies depend on the characteristics of the firm’s industry, the firm’s
current position in the regional market, and the market’s particular rules and regulations.
■ Five Strategic Implications of Regional Economic Integration:
INTERNATIONALIZATION BY FIRMS INSIDE THE ECONOMIC BLOC

■ Regional integration pressures firms to internationalize into neighboring countries within
the bloc.
■ The elimination of trade and investment barriers presents new opportunities to source
input goods from foreign suppliers within the bloc.
■ Competitive advantages gained from internationalizing within the bloc may be
leveraged to internationalizing outside the bloc.
■ Example- following NAFTA, many U.S. companies entered Canada and gained
valuable international experience that inspired them to launch ventures into Asia and
Europe.
RATIONALIZATION OF OPERATIONS
■ Managers develop strategies and value-chain activities suited to the region as a whole,
rather than to individual countries.
■ Rationalization is the process of restructuring and consolidating company operations
that managers often undertake following regional integration- goal: reducing redundancy
and increasing efficiencies.
■ Goal - reduce redundancy & costs and increase the efficiencies through economies of
scale.
■ Rationalization becomes an attractive option because, as trade and investment barriers
decline, the firm that formerly operated factories in each of several countries reaps
advantages by consolidating the factories into one or two central locations inside the
economic bloc.
■ Example- Caterpillar, the U.S. manufacturer of earth-moving equipment, undertook a
massive program of modernization and rationalization at its EU plants to streamline
production, reduce inventories, increase economies of scale, and lower operating costs.
■ Rationalization may be applied to value chain-functions such as manufacturing,
distribution, logistics, purchasing, and R&D.
■ Example- creation of an economic bloc eliminates the need to devise separate
distribution strategies for individual countries. Instead, firms are able to employ a more
global approach for a larger marketplace, generating economies of scale in distribution.
MERGERS AND ACQUISITIONS

■ Economic blocs leads to mergers and acquisitions (M&A)- that is, the tendency of one
firm to buy another, or of two or more firms to merge and form a larger company.

■ Mergers and Acquisitions are related to rationalization- the merger of two or more
firms creates a new company that produces a product on a much larger scale.
■ Examples-
◘ Engineering industry- Two giants, Asea AB of Sweden and Brown, Boveri &
Co. of Switzerland, merged to form Asea Brown Boveri (ABB), facilitated by development
of the EU. The merger allowed the new firm to increase its R&D activities and pool greater
capital funding for major projects, such as construction of power plants and large-scale
industrial equipment.
◘ Pharmaceutical industry- Britain’s Zeneca purchased Sweden's Astra to form
AstraZeneca. The acquisition led to the development of blockbusters such as the ulcer
drug Nexium and helped transform the new company into a leader in the gastrointestinal,
cardiovascular, and respiratory areas.
REGIONAL PRODUCTS AND MARKETING STRATEGY

■ Standardization of products and services- firms prefer standardized merchandise in
their various markets- easier and much less costly.
■ In more advanced stages of regional integration, member countries tend to harmonize
product standards and commercial regulations, and eliminate trade barriers and
transportation bottlenecks.
■ As conditions in the member countries become similar to each other, companies can
increasingly standardize their products and marketing.
■ Example- J. I. Case Company, a manufacturer of agricultural machinery once produced
17 versions of the Magnum model of farm tractors to comply with varying national
regulations. The harmonization of EU product standards allowed the firm to standardize
its tractor, and produce only a handful of models appropriate for serving the whole EU
market.
INTERNATIONALIZATION BY FIRMS FROM OUTSIDE THE BLOC

■ Regional integration and large multi-country markets are attractive to firms from outside
the bloc.
■ The most effective way for a foreign firm to enter an economic bloc is to establish a
physical presence via FDI.
■ Foreign firms tend to avoid exporting as an entry strategy because economic blocs
erect trade barriers against imports from outside the bloc.
■ A production facility, marketing subsidiary, or regional headquarters anywhere inside a
bloc affords the outsider access to the entire bloc and to advantages enjoyed by local
firms based inside the bloc.
■ Examples- with the EU formation, Britain has become the largest recipient of FDI from
the United States. U.S. firms choose Britain as the beachhead to gain access to the
massive EU market. In a similar way, European firms have established factories in Mexico
to access countries in the NAFTA bloc.
◘ Collaborative ventures
■ Regional integration creates opportunities for cooperation.
■ Example-

◘ Firms from France, Germany, Spain, and the United Kingdom collaborated to
establish Airbus Industries, the giant commercial aircraft manufacturer- under the
European Community (precursor to the EU).
◘ The elimination of trade and investment barriers in the EU allowed Airbus to
move aircraft parts, capital, and labor among the member countries from one factory to
another.
◘ Outsiders ease their entry into the bloc by entering joint ventures and other
collaborative arrangements with companies based inside the bloc.
■ 1990- there were approximately 50 regional economic integration agreements

worldwide. Today there are some 400, in various stages of development.
■ 2008- Since the Doha round of global trade negotiations collapsed, countries have been
putting more emphasis on developing regional trade agreements- continuing to liberalize
trade policies, encourage imports, and restructure regulatory regimes, largely via regional
cooperation.
■ Many nations belong to several free trade agreements.
■ More countries – including Canada and India – are negotiating free trade agreements
with the EU, which has signed trade agreements with other economic blocs worldwide.
■ The evidence suggests that regional economic integration is gradually giving way to a
system of worldwide free trade- global free trade will emerge as economic blocs connect
with each other over time.
IV. CLOSING CASE

GOVERNMENT INTERVENTION AT AIRBUS AND BOEING
● Summary [Identifying key issues]

■ Most Europeans are accustomed to intervention and expect government to play a
significant role in guiding the national economy.
■ European governments typically implement public policies based on democratic
socialism, where the government plays a key role in health care, utilities, mass transit and
sometimes banking and housing.
■ Corporate tax rates in France and Germany are high relative to other industrial
countries.
BOEING VERSUS AIRBUS: THE COMPLEX GLOBAL COMMERCIAL AIRCRAFT

INDUSTRY
■ In the 1960s, United States firms such as Boeing (www.boeing.com) and McDonnell
Douglas were the dominant players in global aircraft manufacturing.
■ Founded in 1916, Boeing was the recipient of many lucrative Department of Defense
contracts during World War II and the subsequent Cold War years.
■ In Europe, no single country possessed the means to launch a capital-intensive,
workforce-skilled, aerospace company capable of challenging Boeing.
■ 1970- France and Germany formed an alliance (later joined by Spain and Britain),
supported with massive government subsidies, to create Airbus S.A.S.
(www.airbus.com).

■ 1981- the four-country alliance succeeded in becoming the number-two civil aircraft
maker in the world.
■ 1992- Airbus had one-third of the global commercial aircraft market.
■ 2000- 2015 - Airbus surpassed Boeing in orders for new aircraft.
Government Support for Airbus

■ Since the 1940s- European governments have pursued public policies based on
democratic socialism, where governments play a key role in guiding economic affairs.
■ Airbus received billions of dollars of subsidies and loans- which need to be repaid only
if profitability is achieved.
■ Government aid had financed- in whole or part- every major Airbus aircraft model;
European governments have forgiven Airbus’ debt, provided huge equity infusions,
dedicated infrastructure support, and financed R&D for civil aircraft projects.
■ Capital structure- stock-held firm jointly owned by the British, Germans, French, and
Spanish, and based in Toulouse, France.
■ Financial aid justification:

◘ First- Airbus R&D activities result in new technologies of considerable value to
the EU.
◘ Second- Airbus provides jobs to some 55,000 skilled and semiskilled
Europeans.
◘ Third- Airbus’ value-chain activities attract massive amounts of capital into
Europe.
◘ Finally- Airbus generates enormous tax revenues.
Complaints about Unfair Government Intervention

■ 2000s- When Airbus surpassed Boeing in annual sales to become the world’s leading
commercial aircraft manufacturer, the outcries from Boeing and the U.S. government
became even louder- that Airbus never would have gotten this far without government
support.
■ 2005- the U.S. Trade Representative brought its case to the World Trade Organization
(WTO) because EU member states approved $3.7 billion in new subsidies and soft loans
to Airbus.
■ The case alleged that financial aid for the A350, A380, and earlier Airbus aircraft
qualified as subsidies under the WTO’s Agreement on Subsidies and Countervailing
Measures (ASCM) and that the subsidies constituted unfair international trade.
■ Under the ASCM, subsidies to specific firms or industries from a government or other
public bodies are prohibited.
■ EU officials had argued that government subsidies to Airbus were permissible and that
it was up to individual EU countries to decide whether to provide them.
■ 2012- WTO ruled that EU aid to Airbus had caused Boeing to lose market share in Asia
and other markets
■ WTO also ruled that Boeing received more than $5 billion in U.S. government subsidies
in the development of the 787 Dreamliner.

Government Support for Boeing
■ The EU argued that the U.S. had indirectly subsidized Boeing through massive defense
contracts that were paid with tax dollars- U.S. has given Boeing $23 billion dollars in
indirect government subsidies by means of R&D funding and other indirect support from
the Pentagon and from NASA.
■ Boeing may transfer the knowledge acquired from government projects to produce
civilian aircraft.
■ Washington state, Boeing’s primary manufacturing and assembly location, has provided
tax breaks, infrastructure support, and other incentives totaling billions of dollars.
■ The EU also has a case at the WTO regarding Boeing’s relations with its Japanese
business partners.
■ The new Boeing 787 Dreamliner is built in an alliance with the heavy-industry divisions
of Japanese MNEs like Mitsubishi, Kawasaki, and Fuji.
■ They have provided more than $1.5 billion in soft loans, repayable only if the aircraft is
commercially successful- the EU argues- just like the soft loans given to Airbus.
Recent Aircraft from Airbus and Boeing

■ 2007- Airbus A380- innovative airplane with an upper deck extending the entire length
of the fuselage and a cabin that provides 50% more floor space than Boeing’s largest
aircraft
■ The total cost of developing and launching the A380 has reached 15 billion euros, of
which some 2 billion euros were subsidies and soft loans that Airbus received from
various European governments.
■ 2007- Boeing successfully launched the Boeing 787 Dreamliner and is several years
ahead of Airbus in launching innovative and fuel-efficient aircraft.
■ 2008- China (government) established a company to make passenger jumbo jets, part
of its quest to challenge Boeing and Airbus- China Commercial Aircraft Co. was
established in Shanghai amid forecasts that China's domestic market for commercial
aircraft will increase fivefold by 2026.
■ 2011- Boeing successfully launched the 787 Dreamliner and is ahead of Airbus in
launching innovative and fuel-efficient aircraft. At the same time, Airbus launched the
A380, an innovative airplane with an upper deck extending the entire length of the
fuselage and a cabin that provides 50% more floor space than Boeing’s largest aircraft.
◘ The A380 can seat between 555 and 853 passengers, depending on the seating
configuration.
◘ It has a maximum range of 15,000 kilometers (8,000 nautical miles). The total
cost to develop and launch the A380 reached 15 billion euros (U.S. $21 billion), partly
supported by funding from European governments.
■ 2014- Airbus is developing a mid-sized A350 model to compete against Boeing’s 787.
China
■ China is developing its capacity to produce jumbo jets, part of its quest to challenge
Boeing and Airbus in the global aircraft industry.
■ China Commercial Aircraft Co. was established in Shanghai amid forecasts that China’s

domestic market for commercial aircraft will increase fivefold by 2026.
● SUGGESTED SOLUTIONS TO CASE QUESTIONS
7-4. Where do you stand? Do you think EU subsidies and soft loans to Airbus are
fair? Why or why not? What advantages are gained by Airbus from free financial
support from the EU governments? Are complaints about the EU subsidies fair in
light of Europe’s history of democratic socialism?
(LO 7.2; LO 7.3; AACSB: Reflective thinking)
■ This case underscores the complexities and interdependencies of political and

economic systems. In Europe, where democratic, socialist regimes prevail, mixed
economies result with some government interference. By contrast, the U.S. is
characterized by a market economy with minimal government interference. The following
table is replicated from Chapter 6:
● Most government interference

Totalitarianism Command economies ● Least innovation
● Adverse commercial environment
● Some government interference
Socialism Mixed economies ● Mixed innovation
● Diverse commercial environment
● Least government interference
Capitalism Market economies ● Most innovation
● Ideal commercial environment
■ The political/economic context defines the expectation and extent of government

subsidies. These are very much a part of the supply chain in Europe. If, however, socialist
governments track too far to the totalitarian/command economy side, then history has
demonstrated the demise of those systems that fully subsidize inefficient enterprises, just
to keep firms in existence. Excessive subsidization of business activity is detrimental to
economic growth
■ For capitalist, market economies such as the U.S., military contracts sustain a firm,
although are not equivalent to subsidies. The U.S. government does not see contracts
with the military as equivalent to direct government grants. One could argue that the
economic policies based on democratic socialism are aimed at investing in key public
services such as health, education, communication and utilities to increase social capital.
Commercial aviation activities are not public services. The government should take
regulatory position rather than a shareholder position. Taken to its extreme, government
intervention may negatively impact the market dynamics.
■ What about the fact that Boeing has turned the tables on Airbus’ subsidies by getting
its own subsidies- from the Japanese - the new Boeing 787 is built in an alliance with
Mitsubishi, Kawasaki, and Fuji- the Japanese government provided at least $1.5 billion in

soft loans, repayable only if the aircraft is a commercial success, just like the soft loans
given to Airbus.
7-5. Do you believe U.S. military contracts with Boeing amount to subsidies? Have
these types of payments provided Boeing with unfair advantages? Justify your
answer.
(LO 7.2; LO 7.3; AACSB: Reflective thinking)
■ 2005- the U.S. Trade Representative brought its case to the World Trade Organization
(WTO).
■ It arose because EU member states approved $3.7 billion in new subsidies and soft
loans to Airbus.
■ The case alleged that financial aid for the A350, A380, and earlier aircraft qualified as
subsidies under the WTO’s Agreement on Subsidies and Countervailing Measures
(ASCM) and that the subsidies were actionable because they caused adverse effects to
international trade.
■ Under the ASCM, subsidies to specific firms or industries from a government or other
public bodies are prohibited. If a WTO member provides such support, it is subject to
official sanction.
■ Airbus confirmed that it had applied to the governments of Britain, France, Germany,
and Spain for launch aid for its model A350. Officials of the European Commission
countered that government subsidies are permissible and that it is up to individual EU
countries to decide whether to provide them.
■ U.S. officials, concluding that EU subsidies and soft loans to Airbus constitute unfair
trade practices, were going ahead with their action at the WTO.
■ The WTO’s subsidy definition contains three basic elements:

◘ A financial contribution
◘ By a government or any public body within the territory of a member
◘ Which confers a benefit
■ All three of these elements must be satisfied in order for a subsidy to exist.
■ Military contracts are not subsidies. Performance is a condition of payment. Although
the recipient of lucrative military contracts, Boeing must generate products/services as a
condition of the contract. This is vastly different from the soft loans given to Airbus and
repayable only if the aircraft is a commercial success.
7-6. Assuming that Airbus cannot compete without subsidies and loans, is it likely
that the EU will discontinue its financial support of Airbus? Is it in the EU’s interests
to continue supporting Airbus? Justify your answer.
(LO 7.3; AACSB: Analytical Thinking)
■ Most likely, the European Union would continue providing subsidies to Airbus unless
the WTO prohibits such activity.
■ Commercial aircraft manufacturing is highly labor and capital intensified industry, thus
the support would most likely continue even if Airbus performs well.

■ Airbus generates the following benefits to European community:
◘ First, Airbus R&D activities result in new technologies of considerable value to
the EU, which can be applied to different fields other than aerospace and lead to new
knowledge creation.
◘ Second, Airbus provides jobs to some 55,000 skilled and semiskilled Europeans.
◘ Third, Airbus’ value-chain activities attract massive amounts of capital into
Europe.
◘ Fourth, Airbus generates enormous tax revenues.
◘ Finally, EU branding- Airbus is the vehicle for European best practices and pride
in commercial aviation. Airbus strengthens the EU’s position as a global player.
7-7. If the WTO rules against Airbus and tells it to stop accepting subsidies and soft
loans, how should Airbus management respond? What new approaches can
management pursue to maintain Airbus’s lead in the global commercial aircraft
industry?
■ If the WTO blocks subsidies and soft loans provided to Airbus by the consortium,
alternative means to support Airbus may be sought.
■ Financial resources through government contracts, similar to what has helped Boeing,
may also serve Airbus well.
■ Strategic alliances with partners in the military or aerospace industry for the purposes
of knowledge transfer and R&D cost/risk sharing.
■ Global sourcing of R&D or manufacturing to lower cost countries could result in
significant efficiencies.
■ Diversifying into new industries that are related to their current business line, e.g. the
customized private jet market. The sharing of resources and economies of scope would
easily translate with this related diversification. Barriers to entry would be lower since
Airbus is already in the commercial aircraft industry. Profit margins would be higher for
this niche market..
 MyManagementLab: Watch It! 3

Airbus vs. Boeing
Apply what you have learned by watching a video on the rivalry between the world’s two
leading aircraft manufacturers.
Go to MyManagementLab to view the video.
V. END OF CHAPTER QUESTIONS

● TEST YOUR COMPREHENSION

7-8. Explain tariffs, nontariff trade barriers, investment barriers, and government
subsidies. What are their main characteristics? How do they differ?
■ Protectionism refers to national economic policies designed to restrict free trade and
protect domestic industries from foreign competition.
■ Government intervention arises typically in the form of tariffs, nontariff trade barriers,
and investment barriers.
■ Tariffs are taxes on imported products, imposed mainly to collect government revenue
and protect domestic industries from foreign competition.
■ Nontariff barriers consist of policies that restrict trade without directly imposing a tax,
e.g. a quota - a quantitative restriction on imports.
■ Investment barriers- Governments impose trade and investment barriers to achieve
political, social, or economic objectives – these barriers are either defensive or offensive.
A key rationale is the protection of the nation's economy, its industries, and workers.
■ Subsidies- Governments also provide subsidies, a form of payment or other material
support. Foreign governments may offset foreign subsidies by imposing countervailing
duties.
■ Critics – unfair advantages- subsidies artificially reduce the cost of business for the
recipient. The WTO prohibits subsidies when it can be proven that they hinder free trade.
■ Example-
◘ India- government provides massive subsidies to state-owned oil companies,
which allows them to offer gasoline at very low prices. Foreign MNEs such as Royal Dutch
Shell cannot operate profitably at such prices and consequently avoid doing business in
that market.
■ Subsidies encourage overproduction, which lower domestic food prices, making
agricultural imports from developing countries less competitive.
■ Difficult to Define- when a government provides land, infrastructure,
telecommunications systems, or utilities to corporate park firms, this is technically a
subsidy- yet many would argue that this is just an appropriate public function
■ Governments impose trade and investment barriers to achieve political, social, or

economic objectives.
■ Such barriers are either defensive or offensive. A key rationale is the protection of the
nation’s economy, its industries, and its workers.
7-9. In what ways do government subsidies amount to protectionism?

■ Protectionism refers to national economic policies designed to restrict free trade and
protect domestic industries from foreign competition.

■ Indirect government subsidies- support home country businesses by funding R&D
initiatives, giving tax exemptions, and offering business development services, such as
market information, trade missions, and privileged access to key foreign contacts.
■ Government procurement policies - Governments support domestic firms by
providing investment incentives and biased government procurement policies.
■ Government purchases account for a substantial portion of GDP, and support local
industries by adopting procurement policies that restrict purchases to home-country
suppliers.
■ Example- several governments require that air travel purchased with government funds
be with home-country carriers.
such as China, Russia, and various Middle Eastern countries.
 7-10. What is the rationale for intervention? Why do governments engage in

protectionism?
Visit MyManagementLab for suggested answers.
7-11. Describe various company strategies to manage government intervention.

Strategies for Managers

■ Emerging markets, e.g. China, India, and countries in Africa, Asia, Latin America,
Eastern and Central Europe are characterized by extensive trade barriers and never-
ending government intervention.
■ Despite the challenges, firms target emerging markets and developing economies
because they promise long-term potential.
(1) Research to gather knowledge and intelligence Firms should first undertake
research to understand the extent and nature of trade and investment barriers abroad.
Scan the business environment to identify the nature of government intervention, plan
market-entry strategies and host-country operations, and capitalize upon government
support opportunities.
(2) Choose the most appropriate entry strategies. Most firms choose exporting as their
initial entry strategy, however, if high tariffs are present, managers should consider other
strategies, such as FDI, licensing, and joint ventures that allow the firm to produce directly
in the target market, avoiding import barriers.
(3) Take advantage of foreign trade zones Governments establish foreign trade zones
(FTZs; free trade zones or free ports) in an effort to create jobs and stimulate local
economic development. Products brought into an FTZ are not subject to duties, taxes, or
quotas until they, or the products made from them, enter into the non-FTZ commercial

territory of the country where the FTZ is located. Where importing is essential, the firm
can take advantage of FTZs, areas where imports receive preferential tariff treatment.
■ Example- A successful experiment with FTZs has been the maquiladoras—export-

assembly plants in northern Mexico along the U.S. border that produce components and
finished products destined for the U.S.
■ Now under NAFTA (North American Free Trade Agreement), the collaboration enables
firms from the U.S., Asia, and Europe to tap low-cost labor, favorable taxes and duties,
and government incentives, while serving the U.S. market.
(4) Seek favorable customs classifications for exported products. Reduce exposure
to trade barriers by classifying products according to the appropriate harmonized product
code.
■ Alternatively, manufacturers might modify the exported product in a way that helps
minimize trade barriers.
(5) Take advantage of investment incentives and other government support

programs. Government assistance in the form of subsidies and incentives is another
strategy for reducing the cost of trade and investment barriers.
(6) Lobby for freer trade and investment. Increasingly, nations are liberalizing markets
in order to create jobs and increase tax revenues.
■ Mid-2000s -the Doha round of WTO negotiations sought to make trade more equitable
for developing countries.
■ Firms can lobby foreign governments to lower trade and investment barriers.
■ Foreign firms often hire former government officials to help lobby their former colleagues
■ Private firms bring complaints to world bodies, e.g. the WTO, to address unfair trading
practices of key international markets.
7-12. What is the role of FDI, licensing, and joint ventures in reducing the impact of
import tariffs?
■ Most firms choose exporting as their initial entry strategy, however, if high tariffs are
present, managers should consider other strategies, such as FDI, licensing, and joint
ventures that allow the firm to produce directly in the target market.
7-13. What is a regional economic integration bloc (also called an economic bloc)?
■ Regional economic integration bloc (economic bloc)- member countries agree to

eliminate tariffs and other restrictions on the cross-national flow of products, services,
capital, and, in more advanced stages, labor, within the bloc. At minimum, the countries

in an economic bloc become parties to a free trade agreement, which eliminates tariffs,
quotas, and other trade barriers.
7-14. What is the difference between a free trade area and a customs union?
Between a customs union and a common market?
■ There exist five potential levels of regional integration.

■ Regional integration is a continuum, with economic interconnectedness progressing
from a low level of integration—the free trade area— through higher levels to the most
advanced form of integration—the political union.
Free Trade Area

■ The simplest and most common arrangement, in which member countries agree to
gradually eliminate formal barriers to trade in products and services within the bloc, while
each member country maintains an independent international trade policy with countries
outside the bloc.
◘ Example- NAFTA
●The free trade area emphasizes the pursuit of comparative advantage for
a group of countries rather than for individual states.
● Local content requirements- if unmet, products subject to tariffs imposed
on non-member countries.
Customs Union
■ Second level of regional integration- similar to a free trade area except that the member
states harmonize their external trade policies and adopt common tariff and nontariff
barriers on imports from nonmember countries

●. The adoption of a common tariff system means that an exporter outside
MERCOSUR faces the same tariffs and nontariff barriers when trading with any
MERCOSUR member country.
Common Market – (Single Market)

■ Third stage of regional integration- trade barriers are reduced or removed, common
external barriers are established and products, services, and factors of production such
as capital, labor, and technology are allowed to move freely among the member countries.
■ Like a customs union - common trade policy with nonmember countries is also
established.
◘ Example- EU
● Reduced/eliminated restrictions on immigration and the cross border flow
of capital
● A worker from an EU country has the right to work in other EU countries,
and EU firms can freely transfer funds among their subsidiaries within the bloc.

Challenges:
economic policies.
● Example- Germany: influx of workers from Poland and the Czech
Republic, because these workers can earn substantially higher wages in Germany than
they can at home.
Economic Union- (Monetary Union- sometimes)

■Fourth stage of regional integration- member countries enjoy all the advantages of early
stages, but also strive to have common fiscal and monetary policies.
■ At the extreme-
◘ Identical tax rates
◘ Fixed exchange rates
◘ Free currency convertibility among member states
◘ Free movement of capital
■ Standardization-
◘ Helps eliminate discriminatory practices that might favor one member state over
another.
◘ Through greater mobility of products, services, and production factors, an
economic union enables firms within the bloc to locate productive activities in member
states with the most favorable economic policies.
◘ Example- the EU
■ Monetary unions:
◘ EU has made great strides toward this. Nineteen EU countries have established
a monetary union with a single currency, the euro.
◘ European financial institutions can establish EU branches and offer banking &
insurance services far easier with a monetary union and the euro.
◘ The single currency enables easier trading and investment for European firms
doing business within the union.
services.
■ Fictitious Example-

U.S. provides a good analogy for an economic union. Imagine each state is like an
individual country, but all are joined together in a union. The members have a common
currency, a single central bank with a uniform monetary policy, trade among the members
takes place unobstructed, and both labor and capital move freely among them, the federal
government applies a uniform tax and fiscal policy. Just as would occur in an economic
union, the individual U.S. states also govern themselves in such areas as education,
police protection, and local taxes. This analogy can only go so far- unlike members of a
real economic union, the states cannot withdraw.
■ Political Union: (ultimate)

7-15. What are the worlds’s leading economic blocs? Explain their key features.
■ Exhibit 7.8 illustrates the most active economic blocs.

■ Europe has the longest experience with regional integration and is home to several
economic blocs, most paramount are the EU and the European Free Trade Association.

The European Union (EU)
■1957- Treaty of Rome- European Economic Community (EEC) alliance formation-

origins of the EU -Belgium, France, West Germany, Italy, Luxembourg, and the
Netherlands- sought to promote peace and prosperity through economic and political
cooperation (www.europa.eu).
■ 1992- the formal creation of the EU
■ 28 countries from Eastern and Western Europe.
■ EU - world’s most advanced and largest regional economic bloc.
■ Home to a half-billion people.
■ $18 trillion- total annual GDP.
The European Union has taken specific steps to become an economic union:
Market access
■ Tariffs and most nontariff barriers were eliminated for trade in products and
services.
■ Rules of origin favor manufacturing using inputs produced in the EU.
Common market

■ Barriers to the cross-national movement of production factors—labor, capital, and
technology—have been removed.
■ Example-
◘ Italian worker now has the right to get a job in Ireland, and a French
company can invest freely in Spain.
Trade rules
■ Customs procedures and regulations have been eliminated, streamlining
transportation and logistics within Europe.
Standards harmonization
■Technical standards, regulations, and enforcement procedures related to
products, services, and commercial activities are being harmonized.
■ Examples-
◘ British firms once used imperial measures (pounds, ounces, and inches);
they have converted to the metric system used by all EU countries.
◘ German food merchants that once had their own standard for handling
meat and produce now follow procedures prescribed by the EU.
Common fiscal, monetary, taxation, and social welfare policies -in the long run
■ The euro (common currency since 2002):
●Simplified the process of cross-border trade and enhanced Europe’s

international competitiveness.
●Eliminated exchange rate risk in much of the bloc and forced member
countries to improve their fiscal and monetary policies.
●Unified consumers and businesses to think of Europe as a single market
●Forced national governments to relinquish monetary power to the European
Central Bank, in Luxembourg, which oversees EU monetary functions.
■ Most of the newest EU entrants are one-time satellites of the former Soviet Union, and
have economic growth rates higher than their Western European counterparts.
■ Less-developed economies such as Romania, Bulgaria, and Lithuania may require
years of developmental aid to catch up.
■ Recently, long-standing EU members - Greece and Spain have been afflicted by
economic crises. In many ways.
■ EU is still a work in progress.
■ Common Agricultural Policy (CAP) is a long-standing fixture of the EU.

◘ CAP- system of agricultural subsidies and programs that guarantees a minimum
price to EU farmers and ranchers
◘ Original goals were to provide a fair living standard for agricultural producers and
food at reasonable prices for consumers.
◘ Reality- CAP has increased food prices in Europe, consumes almost 50% of the
EU's annual budget, and complicates negotiations with the World Trade Organization for
reducing global trade barriers.

◘ CAP imposes high import tariffs that unfairly affect exporters in developing
economies, e.g. Africa that rely heavily on agricultural production.
◘ The EU is working to reform the CAP, but progress has been slow.
North American Free Trade Agreement (NAFTA)

■ 1994- NAFTA (http://www.nafta-sec-alena.org)- Canada, the U.S. and Mexico
■ Most significant economic bloc in the Americas
■ Maquiladora program facilitated NAFTA passage - since the 1960s U.S. firms have
located manufacturing facilities just south of the U.S. border, and access low-cost labor
without having to pay significant tariffs.
■ NAFTA:
◘ Increased market access between Canada, Mexico and the U.S.
◘ Eliminated tariffs and most nontariff barriers for products/services traded in the
bloc.
◘ Launched government contract bidding in all three countries by any member-
country firm
◘ Established trade rules and uniform customs procedures and regulations
◘ Prohibited standards/technical regulations to be used as trade barriers.
◘ Instituted rules for investment and intellectual property rights.
◘Provided a forum for dispute settlement for issues: investment, unfair pricing,
labor issues, and the environment.
■ NAFTA RESULTS:
◘ Canada and Mexico are the most important export markets of the U.S. -
accounting for about 1/3 of U.S. exports
◘ Trade among the members has more than tripled and now exceeds one trillion
dollars per year.
◘ Early 1980s- Mexico’s tariffs averaged 100% and gradually disappeared under
NAFTA.
◘ FDI in Mexico rose dramatically - from U.S. and Canadian firms
◘ Mexico’s per-capita income has risen substantially, making Mexico into Latin
America’s wealthiest country in per-capita income terms
El Mercado Comun del Sur (MERCOSUR)

■ 1991- MERCOSUR or (the Southern Common Market) is the strongest economic bloc
in South America (www.mercosur.int).
■ Includes Argentina, Brazil, Paraguay, and Uruguay.
■ MERCOSUR established the free movement of products and services, a common
external tariff and trade policy, and coordinated monetary and fiscal policies.
■ Priority- construction of reliable infrastructure—roads, electricity grids, and gas
pipelines.
■ Goal- to expand market size, achieve scale economies, attract FDI, and build defensive
and political posture.
■ MERCOSUR eventually aims to become an economic union.

■ Trade tripled among member countries during its first six years.
■ Five associate members (besides its regular members) have access to preferential
trade but not to the tariff benefits of full members
■ MERCOSUR may be integrated with NAFTA and the Dominican Republic-Central
American Free Trade Agreement (DR-CAFTA) as part of the proposed Free Trade Area
of the Americas (FTAA). If implemented, this integration would bring free trade to the
entire western hemisphere.
Association of Southeast Asian Nations (ASEAN)

■ 1967- One of the few examples of economic integration in Asia, ASEAN was created
with the goal of maintaining political stability and promoting regional economic and social
development (www.aseansec.org).
■ ASEAN created a free trade area in which many tariffs were reduced to less than 5%.
■ Economic diversity has slowed further regional integration.
■Example- oil-rich Brunei has a per capita income of over $50,000, while Vietnam's is
only about $3,000.
■ The mass movement of workers from poor to prosperous countries that would likely
result with further ASEAN integration reduces the likelihood that this bloc will become a
common market or an economic union.
■ ASEAN aims to incorporate powerhouses like Japan and China, whose membership
would accelerate the development of extensive trade relationships.
■ Note that Singapore’s exports as a percent of its GDP exceed 100%. The reason is that
Singapore is an entrepôt nation, an import-export platform for Asia, trading far more
goods than it manufactures.
Asia Pacific Economic Cooperation (APEC)

■ APEC aims for greater free trade and economic integration of the Pacific Rim countries.
■ It incorporates 21 nations on both sides of the Pacific, including Australia, Canada,
Chile, China, Japan, Mexico, Russia, and the U.S. (www.apec.org).
■ Its members account for 85% of total regional trade, as well as 1/3 of the world’s
population and over 1/2 its GDP.
■ APEC aspires to remove trade and investment barriers by 2020.
■ Members have varying national economic/political priorities, and the inclusion of less
affluent Asian countries alongside strong international traders like Australia, Japan, and
the U.S. complicates agreement on a range of issues.
Australia and New Zealand Closer Economic Relations Agreement (CER)

■ 1966- Australia and New Zealand reached a free trade agreement that removed 80%
of tariffs and quotas between the two nations, but was relatively complex and
bureaucratic.
■ 1983 - the CER sought to accelerate free trade, leading to further economic integration
of the two nations.

■ The CER gained importance when Australia and New Zealand lost their privileged
status in the British market as Britain joined the EU.
■ 2009- members concluded important negotiations on creating a free trade agreement
with the ASEAN countries.
■ Many believe the CER has been one of the world's most successful economic blocs.
Economic Integration in the Middle East and Africa

■ 1981- Gulf Cooperation Council (GCC) (www.gcc-sg.org.htm)- The Middle East’s
primary regional organization
■ Established to coordinate economic (oil), social, and cultural affairs, the GCC consists
of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates.
■ GCC initiatives include coordination of the petroleum industry, abolition of certain tariffs,
and liberalization of investment, and the harmonization of banking, financial, and
monetary policies.
■ 2008- the GCC established a common market among all its member countries.
OTHERS
Caribbean Community and Common Market (CARICOM)
■ 1973- Composed of roughly 25 member and associate member states around the
Caribbean Sea.
■ CARICOM was established to lower trade barriers and institute a common external tariff
(www.caricom.org).
■ Economic difficulties of individual members has hindered its success
■ Still, the bloc is progressing toward establishing the Caribbean Single Market, a
common market that allows for a greater degree of free movement for products, services,
capital, and labor, and gives citizens of all CARICOM countries the right to establish
businesses throughout the region.
Comunidad Andina de Naciones (CAN)

■ 1969- Called the Andean Pact, the CAN includes Bolivia, Colombia, Ecuador, Peru, and
Venezuela (www.comunidadandina.org).
■ CAN is expected to merge with MERCOSUR to form a new economic bloc that
encompasses all of South America.
■ Geography (Andes mountain range) has hindered intrabloc trading - reaching only 5 %
of bloc members’ total trade.
■ Other regional economic integration examples in the Middle East:

◘ Arab Maghreb Union (composed of Algeria, Libya, Mauritania, Morocco, and
Tunisia) - still struggling to become a viable economic bloc.
◘ Regional Cooperation for Development (RCD; composed of Pakistan, Iran,
and Turkey) - the RCD was dissolved in 1979 and replaced by the Economic
Cooperation Organization (ECO).

◘ The ECO includes ten Middle Eastern and Asian countries, seeking to promote
trade and investment opportunities in the region.
◘ The Arab League is a longstanding political organization with 22 member states-

promotes unity and nationalism in the Middle East. It has been relatively unsuccessful in
fostering regional economic development.
■ Africa would like better access to European and North American markets for sales of
farm and textile products- to enhance their negotiation power with the developed world-
they have formed economic blocs through regional integration.
■ There are at least:
● Nine economic blocs in Africa:
● Southern African Development Community
● Economic Community of West African States
● Economic Community of Central African States
◘ These groups have not had much impact on regional trade.
◘ Economic development in many African countries has been hindered by political
instability, civil unrest and war, military dictatorships, corruption, and infectious diseases.
7-16. Why do nations seek to join or form economic blocs? What are the
advantages of such arrangements?
■ Economic integration contributes to corporate and industrial growth, to economic

progress, better living standards, and higher tax revenues for the member countries.
■ Nations seek at least four objectives in pursuing regional integration:
EXPAND MARKET SIZE

■ Regional integration greatly increases the scale of the marketplace for firms inside the
economic bloc.
■ Example- Belgium has a population of just 10 million; the EU gives Belgian firms easier
access to a total market of roughly 500 million buyers.
■ Consumers also gain access to a greater selection of products and services.
ACHIEVE SCALE ECONOMIES AND ENHANCED PRODUCTIVITY

■ Expansion of market size within an economic bloc gives member country firms the
opportunity to increase the scale of operations and gain economies of scale in production
and marketing.
■ Internationalization inside the bloc helps firms learn to compete more effectively outside
the bloc as well.
■ Labor and other inputs are allocated more efficiently among the member countries-
leading to lower prices for consumers.

ATTRACT DIRECT INVESTMENT FROM OUTSIDE THE BLOC
■ Compared to investing in stand-alone countries, foreign firms prefer to invest in
countries that are part of an economic bloc because factories that they build within the
bloc receive preferential treatment for exports to other member countries.
■ Examples- General Mills, Samsung, and Tata- have invested heavily in the EU to take
advantage of Europe's economic integration.
■ By establishing operations in a single EU country, these firms gain free trade access to
the entire EU market.
ACQUIRE STRONGER DEFENSIVE AND POLITICAL POSTURE

■ Strengthen member countries relative to other nations and world regions- this was one
of the motives for initially creating of the European Community (precursor to the EU),
whose members sought to strengthen their mutual defense against the expanding
influence of the former Soviet Union.
■ Some view the EU as a means for Europe to counterbalance the power and
international influence of the U.S.
■ Forming an economic bloc allows countries to obtain greater bargaining power in world
affairs (WTO) and political power.
■ Countries are more powerful when than cooperate than when they operate as individual
entities.
 7-17. What strategies should companies use to maximize the benefits of regional
integration?
● APPLY YOUR UNDERSTANDING
7-18. TelComm Corporation is a manufacturer of components for the cell phone

industry. TelComm founder Alex Bell heard that China has the world’s largest
number of cell phone users and wants to begin exporting the firm’s products there,
but TelComm has little international experience. Mr. Bell is unaware of the various
types of nontariff trade barriers that TelComm might face in China and other foreign
markets. Please summarize major nontariff trade barriers to Mr. Bell. What types of
investment barriers might TelComm face in the event management decides to
establish a factory in China to manufacture cell phone components? What can
TelComm management do to minimize the threat of these nontariff trade and
investment barriers?
TO: Mr. Alex Bell

FROM: Tommy Edison
DATE:

RE: Nontariff Trade and Investment Barriers
Nontariff Trade Barriers

■ Government policies that restrict trade without imposing a direct tax or duty - quotas,
import licenses, local content requirements, government regulations, and administrative
or bureaucratic procedures
■ The use of nontariff barriers has grown substantially in recent decades- they are easier
to conceal from the WTO and other monitoring organizations.
■ Quotas restrict the physical volume or value of products that firms can import into a
country.
■ The upside is that domestic producers are protected from cheaper imports, giving them
a competitive edge over foreign sugar producers.
■ The downside is that domestic consumers and producers of certain types of products
pay more for the product.
■ It also means that firms that manufacture products containing the higher-priced product
can save money by moving production to countries that do not impose quotas or tariffs
on this product.
■ Voluntary export/import restraints (VERs/VIRs) are voluntary quotas imposed by
governments whereby firms agree to limit exports or imports of certain products.
■ Import license - a formal permission to import, which restricts imports in a way that is
similar to quotas- a complicated, bureaucratic process in some countries
■ Governments sell import licenses to firms on a competitive basis- a process that
discriminates against smaller firms, which typically lack the resources to purchase the
licenses.
■ Local content requirements stipulate that production must include a certain
percentage of local value added.
■ These are usually imposed in economic bloc countries, such as the European Union
and NAFTA. The so called “rules of origin” requirement specifies that a certain
proportion of products and supplies, or of intermediate goods used in local manufacturing,
must be produced within the bloc.
■ Government regulations and technical standards include safety regulations for
motor vehicles and electrical equipment, health regulations for hygienic food preparation,
labeling requirements that indicate a product’s country of origin, technical standards for
computers, and bureaucratic procedures for customs clearance.
■ Administrative or bureaucratic procedures that hinder the activities of importers or
foreign firms
■ The revenue generated by tariffs depends on how customs authorities classify imported
products - thousands of categories exist for customs classification, a product can be
easily misclassified, either by accident or intention- use the harmonized code schedules.
■ Government procurement policies constitute an indirect form of nontariff trade barrier.

■ Government purchases account for a substantial portion of GDP, and support local
industries by adopting procurement policies that restrict purchases to home-country
suppliers.
such as China.

Investment Barriers
■ In order to bypass tariffs, firms may enter countries via FDI, and be subject to
investment barriers.
■ Globally, FDI and ownership restrictions are common in industries such as
broadcasting, utilities, air transportation, military technology, and financial services, as
well as industries that involve major national holdings, such as oil, fisheries, and key
minerals.
■ Example-
◘ Canada- government restricts foreign ownership of local movie studios and TV
shows to protect its indigenous film and TV industry from excessive foreign influence.
■ China –
◘ 1949- Mao Tse Tung established a communist regime.
◘ China - centralized economic planning- agriculture and manufacturing were
controlled by inefficient state-run industries- focus on national self-sufficiency- China
closed to international trade.
◘ 1980s- China began to open itself to the global economy.
◘ 1992 - China joined the Asia-Pacific Economic Cooperation (APEC) group, a
free-trade organization.
◘ 2001 - China joined the World Trade Organization (WTO) and has committed to
reducing trade barriers and increasing intellectual property protections.
◘ 2004 - China’s GDP was four times the level it was in 1978, and foreign trade
exceeded $1 trillion.
◘ 2014 - China’s GDP reached a record high of 10360.10 USD Billion, representing
16.71% of the world economy. Record low was set in 1962 at 46.68 USD Billion. Foreign
trade exceeded $3 trillion.
http://www.tradingeconomics.com/china/gdp
Accessed September 26, 2015
◘ 2015 - China’s GDP grew by 7% in the first half of 2015.
In 2011, GDP grew by 9.3%; then slowed to 7.7% in 2012 and 2013. In 2014, it grew by
an average of 7.4%.
http://china-trade-research.hktdc.com/business-news/article/Fast-Facts/Economic-and-
Trade-Information-on-China/ff/en/1/1X000000/1X09PHBA.htm
◘ Balance of Trade –
● Since 1995- China has recorded consistent trade surpluses.
● 2004 - 2009 surplus has increased 10 times
● 2014 - China’s trade growth reached only 3.4%, below the 7.5% target,
since exports rose at a slower pace and imports remained basically unchanged.
● 2014- largest trade surpluses were recorded with Hong Kong, the U.S.,
Netherlands, Vietnam and the UK.
● 2014- trade deficits were recoded with Taiwan, South Korea, Australia
and Germany.
http://www.tradingeconomics.com/china/balance-of-trade

■ China is characterized by low per capita income and high import tariffs- which tend to
exacerbate national poverty.
■ China and most emerging markets are characterized by endless government
intervention.
7-19. Ethical Dilemma:

You are Vice President for International Sales at FoodTrade, a large trading
company that exports processed foods to Africa. You are often frustrated that
African countries impose high tariffs (typically 75 percent) on processed food
imports. These barriers raise FoodTrade’s cost of doing business and make your
prices less competitive in African markets. But Africa suffers from widespread
poverty and African governments use tariffs to raise needed revenues and achieve
policy objectives. Using the concepts in this chapter and the Ethical Framework in
Chapter 4, analyze the arguments for and against high agricultural tariffs in Africa.
How do the tariffs harm or benefit Africa? Do you perceive any ethical concerns in
Africa’s use of high tariffs on agricultural goods? What ethical concerns do you
perceive in FoodTrade’s efforts to avoid the tariffs? How should FoodTrade
respond to the tariffs?
(LO 7.3; AACSB: Reflective thinking)
The tariffs that African countries impose can be justified for various reasons. First, tariffs
and other forms of intervention can generate substantial amounts of revenue for national
governments. Intervention might also help a government pursue broad-based economic,
political, or social objectives. This is important where such objectives are well intended.
Intervention can help better serve the interests of the nation’s firms and industries. For
example, if Africa nations are attempting to develop local food processing industries, the
trade barriers might be justified. However, if the food processing industries need imported
components from abroad, then the trade barriers may disproportionately affect developing
economies and low-income consumers because indigenous industries may face higher
costs of doing business. Achieving a reasonable level of employment is an important goal
in Africa. By insulating domestic firms from foreign competition, national output is
stimulated, leading to more jobs in the protected industries. In this way, protectionism in
Africa may be justified.
■ Framework for making ethical decisions consists of five steps:
1. Identify the problem

2. Examine the facts
3. Create alternatives
Evaluate each proposed action to assess its consistency with accepted ethical
standards, using the approaches described earlier:

■ Utilitarian—which action results in the most good and least harm?
■ Rights—which action respects the rights of everyone involved?
■ Fairness—which action treats people most fairly?
■ Common good—which action contributes most to the overall quality
of life of the people affected?
■ Virtue—which action embodies the character strengths you value?
4. Implement course of action

5. Evaluate results
As a general rule, in addressing this ethical dilemma, the manager should apply the
following steps.

Recognize the existence of a potential ethical problem. Who does this problem harm?
Foreign firms, individuals in Africa, customers, communities, or entire nations? The
exercise suggests there is indeed a problem.

Get the facts. Determine the nature and dimensions of the situation. What individuals or
groups have a stake in the outcome? How much weight should be given to the interests
of each? Do some parties have a greater stake because they are disadvantaged or have
a special need? It appears that, in aggregate, the poverty and other challenges that
confront African nations are substantial. Indeed, Africa’s problems are so large that its
priorities are likely to outweigh the interests of many foreign entities, such as large trading
companies like FoodTrade.
Evaluate alternative courses of action. Identify potential courses of action and evaluate
each. Initially, consistent with the pyramid of ethical behavior, review any proposed action
to ensure it is legal. If it violates host or home country laws or international treaties, it
should be rejected. Next, review any proposed action to ensure it is acceptable according
to company policy, the firm’s code of conduct, and/or its code of ethics. If discrepancies
are found, the action should be rejected. Finally, evaluate each proposed action to assess
its consistency with accepted ethical standards, using the approaches described earlier:

■ Common good—which action contributes most to the overall quality of life of the people
affected?
The goal is to arrive at the best decision or most appropriate course of action. Assess the
consequences of each action from the perspective of all parties who will be affected by it.

In terms of the utilitarian approach, it would appear that the priorities of Africa outweigh
those of FoodTrade, and thus most actions favoring Africa will likely result in the most
good and least harm. In terms of the rights approach, it is impossible to satisfy the rights
of everyone involved. Again, it is probably best to err on the side of favoring the rights of
Africa. In terms of fairness, Africa has a long history of suffering and has been victimized
for centuries by foreign powers that sought to colonize the continent and take advantage
of Africa in other ways. Accordingly, the fair path would tend to be the one that favors
Africa. Africa’s needs tend to be more important than those of FoodTrade. Accordingly,
actions take should be aimed at contributing most to the overall quality of life of the
people affected in Africa. The virtue approach emphasizes the values of the affected
parties. Here again, Africa should be favored in future actions.

Implement your decision.
5. Evaluate results
Then evaluate it to see how effective it was.
7-20. Levi Strauss & Co. (LS) makes and sells blue jeans, Dockers, and Slates brand
name apparel in over 60 countries. With the onset of regional integration in Europe
and Latin America, LS management decided to revise the firm’s production and
marketing strategies to make them more appropriate for regional, as opposed to
national, operations. Based on the regional integration changes underway in these
areas, and on your understanding of the business implications of regional
integration, what should LS do? In answering, think in terms of LS’s major value
chain activities, especially production and marketing. What are the pros and cons
to LS of producing and marketing its apparel on a regional basis, as opposed to a
national or global basis? Justify your answer.
■ Levi Strauss should reform its production and marketing activities to better facilitate its
focus on regional operations instead of its national ones. They can do this by following
five steps that reduce their costs and capitalize on some advantages economic blocs
have to offer. This will help increase Levi’s brand popularity and profits for the coming
future.
■ The first step is for Levi to take advantage of the economic bloc’s market size. They
can do this by internationalizing the company’s value chain activities in other countries.
This is because there is an absence of trade and investment barriers that will help create
an opportunity.
◘ Example- of this opportunity is taking advantage of another country’s natural
resources or infrastructure by buying cheaper input goods or increasing production
capabilities. This also allows them to be able to get close to their suppliers so they can
better communicate.

■ The second step is to reduce redundancy within the company. This is accomplished
through rationalization, which looks for ways a company can reduce its costs and increase
operations.
◘ For instance, Levi could combine some of its value chain operations together to
increase productivity and efficiency. They could combine factories or stores in a close
area to gain economies of scale and scope, reduce unwanted costs, and better serve its
customers.
■ The third step is to look for a potential partnership or joint ventures. These coalitions
can help Levi develop new products and ideas that can move the company forward. It
can also provide more capital towards projects or research and development initiatives
that could be beneficial for both partners.
■ The fourth step is for Levi to standardize their products and marketing activities. This
is possible because the member countries in economic blocs tend to be more
homogeneous than heterogeneous, adopting uniform standards and regulations to
become one market.
◘ Therefore, Levi does not need to vary its products or marketing strategy, and still
appeal to a wide range of customers.
■ The last step is for Levi to gain a physical presence within a member country through
foreign direct investment. This entry strategy will ensure Levi’s operations are in their
control by having one or more of their value chain activities in the target country. This will
also enable Levi direct access to the economic bloc countries so that it can take
advantage of trade agreements with member and nonmember countries.
■ Levi should switch their operational focus from national to regional because it will launch
a wider range of opportunities and benefits for their firm. In order to accomplish this they
should globally source their value chain, reduce redundancy, seek out partnerships,
standardize their activities, and pursue foreign direct investment. These steps will help
ensure Levi transitions smoothly into a regional operations focus.
7-21. Ethical Dilemma:

Suppose you are a member of a government task force evaluating the future of
NAFTA between Canada, Mexico, and the United States. Proponents want to
transform NAFTA into a common market by removing barriers to the movement of
labor. The goal is to reduce poverty in Mexico by allowing Mexican citizens to work
freely and legally in Canada and the United States. Critics oppose the common
market because of the big income difference between the two countries. They
argue that an open border would encourage millions of Mexicans to migrate
northward seeking work, and threaten jobs in the United States and Canada.
Proponents argue that, as economic integration progressed under a common
market, average wages in the three countries would equalize and eliminate

pressures on northern job markets. Analyze this situation using the Ethical
Framework in Chapter 4. Should the task force recommend the common market?
What could U.S. and Canadian firms do to maintain their competitiveness relative
to Mexican firms, given Mexico’s low-wage advantage?
A FRAMEWORK FOR MAKING ETHICAL DECISIONS [Chapter 4]

Evaluate each proposed action to assess its consistency with accepted ethical
standards, using the approaches described earlier:
■ Common good—which action contributes most to the overall quality
of life of the people affected?

5. Evaluate results

Currently NAFTA is a Free Trade Area. Should NAFTA be transformed into a Common
Market, similar to the EU?
Critics- oppose the common market because of the huge income difference. They argue
an open border would induce millions of Mexicans to migrate northward seeking work,
and threaten the jobs and wages of millions of Americans and Canadians.
Proponents- argue that, as economic integration progressed under a common market,
average wages in the three countries would equalize and eliminate pressures on northern
job markets.

■ There are five possible levels of regional integration.
[1] Free trade area- is the simplest and most common arrangement, in which member
countries agree to gradually eliminate formal barriers to trade in products and services
within the bloc, while each member country maintains an independent international trade
policy with countries outside the bloc.
◘ Example- NAFTA
[2] Customs union- the next (second) level of regional integration- similar to a free trade
area except that the member states harmonize their external trade policies and adopt
common tariff and nontariff barriers on imports from nonmember countries

[3]Common market (single market) - the next stage (third) of regional integration- trade
barriers are reduced or removed, common external barriers are established and products,
services, and factors of production such as capital, labor, and technology are allowed to
move freely among the member countries. Like a customs union - common trade policy
with nonmember countries.
◘ Example- the EU
■ Common market challenges:
economic policies.
[4] Economic union- fourth stage of regional integration in which member countries
enjoy all the advantages of early stages, but also strive to have common fiscal and
monetary policies- identical tax rates, fixed exchange rates, free convertibility of
currencies among the member states and the free movement of capital.
◘ Example- the EU has made great strides toward this. Sixteen EU countries have
established a monetary union with a single currency, the euro.
services.
[5] Political union:

Each proposed action should be evaluated according to the following accepted ethical
standards:
• Utilitarian – which action results in the greatest good and least harm?
The greatest balance of good over harm would result from U.S. and Canadian companies
investing more FDI in Mexico, and governments providing tax incentives to these firms.
This would enable Mexico to cultivate their domestic growth towards stabilization without
taking jobs or lowering minimum wage rates in the U.S. and Canada.
• Rights – which action respects the rights of everyone involved?

The rights of the Mexicans to work wherever they wish to is at odds with the rights of
Canadians and Americans to secure jobs and maintain income levels commensurate with
their economies, if jobs are limited and must be shared with non-citizens.
• Fairness – which action treats people most fairly?

There may be other alternative courses of action that may achieve the same goal of
reducing poverty in Mexico other than allowing Mexican citizens to work freely in the
Canada and the U.S. While overly generous to the Mexicans, it is unfair to the Canadians
and Americans.
• Common Good – which action contributes most to the overall quality of life of the
people affected?
Here ethical actions should be based on the good of the community or the nation. This
approach asks which action contributes most to the quality of life of all affected people. It
suggests that the interlocking relations of society are the basis of ethical reasoning and
that respect and compassion for all people, especially the vulnerable, should be the basis
for decision making. One might argue that the U.S. and Canada have a standard of norms
regarding human rights, that is to be compassionate but not at the expense of their own
people. Currently, the influx of illegal aliens into the U.S. and Canada is unprecedented,
and creates severe financial hardships on these two governments in an effort to create
new programs to handle housing, healthcare and hunger. If NAFTA were elevated to a
Common Market and the borders became even more open by removing barriers to the
movement of labor, the current problems, which are quite severe, would be exacerbated
even more.
• Virtue – which action embodies the character strengths that you value?
The goal is to reduce poverty in Mexico by allowing Mexican citizens to work freely in
Canada and the U.S. By removing these barriers, per-capita income eventually achieves
a state of equilibrium. The per-capita income in Mexico is about $10,000, compared to
more than $35,000 in both Canada and the U.S. If poverty reduction is the value that
drives our actions, then permitting Mexican workers the freedom to work in Canada or the
U.S. would foster a more equal distribution of wealth throughout the NAFTA countries.

Implement your decision.
5. Evaluate results
Then evaluate it to see how effective it was. How did it turn out? If you had it to do again,
would you do anything differently?
NAFTA should remain a Free Trade Area.

NAFTA should be transformed into a Common Market.
■ As a task force member your job is to analyze the ethical dilemma in four steps:
recognize an ethical problem, get the facts, evaluate alternative courses of action and

implement and evaluate your decision.
■ Your goal is to arrive at the best decision or most appropriate course of action.
■ Leverage your knowledge and the expertise of colleagues who are familiar with the
situation and can provide insights/generate options.
■ If the integration of NAFTA to a Common Market would financially destroy the United
States and Canada, then the answer must be a resounding no.
■ If however, it is the responsibility of two economic powerhouses, such as the U.S. and
Canada to help lesser-developed economies such as Mexico burst out of poverty, then
the answer might be yes.
■ What is the diplomatic course of action that does not devastate two world leaders'
economies?
● GlobalEDGE™ INTERNET EXERCISES http://globaledge.msu.edu
7-22. Your firm is considering exporting to two countries: Kenya and Vietnam.
However, management’s knowledge about the trade policies of these countries is
limited. Conduct a search at globalEDGE™ to identify the current import policies,
tariffs, and restrictions in these countries. Prepare a brief report on your findings.
In addition to globalEDGE™, other useful sites include the World Trade
Organization (www.wto.org; enter country name in the search engine) and the U.S.
Commercial Service (www.buyusa.gov).
(LO 7.2; LO 7.3; AACSB: Analytical Thinking)
The solution for Kenya is included here. Tariffs in Kenya are as follows. Import tariffs
involve:
Ad valorem rates based on the cost, insurance and freight (c.i.f.) value. Kenya’s MFN
duty rates have 10 levels (0%, 2.5%, 5%, 10%, 15%, 20%, 25%, 30%, 35%, 45%).
- Mixed duties apply to products such as commodities (wheat, maize, rice, sugar), milk,
textiles and clothing, footwear, tobacco, spirits, and manufactured goods.
- Specific duties are imposed on petroleum products.
All importers who are granted duty exemption pay at least the import declaration fee (a
minimum of 2.75%), regardless of the destination or final imports’ use. The Kenyan
government also collects an additional fee of 1% based on the c.i.f. value of agriculture
imports to support domestic programs.
Common External Tariff (CET) (preferential duties under trade agreements). As a
member of Common Market for East and South Africa (COMESA), Kenya’s CET duties
are: 0% on capital goods; 5% on raw materials; 15% on intermediate goods; 30% on final
goods.
In terms of Normal Trade Relations (NTR) and Most Favored Nation (MFN), Kenya grants
all countries, including non-WTO countries, MFN treatment (ad valorem, mixed, specific
duties).
In terms of internal taxes, Kenya imposes a value-added tax at a standard rate of 18% on
the custom value plus border charges of imports. Certain exemptions apply. Kenya

imposes an excise tax in the range of 10%-130%, assessed on the import value (including
custom duties) of imported items. For instance, the rate is 10% on products such as
mineral water, essential oils and cosmetic products. It is 130% on products such as
tobacco.
Kenya has an importing licensing system that applies only to a list of ‘negative’ products
that entail environmental, health and security concerns. Import authorization or approval
is required for nuclear reactors and parts (via the Ministry of Energy); pyrotechnic articles,
propellant powder, explosives, fireworks, safety and detonation fuses (via the Mines and
Geology Department); firearms and parts, cartridges, munitions of war, swords and
similar firearms (via the Kenya Police); armored fighting vehicles, warships, and military
weapons importation (via the Office of the President). The following items are prohibited
and cannot be imported: toxic chemical waste, products of animal origin (e.g., bones and
horn-cores, ivory, rhinoceros horns, tortoise shell, coral, and natural sponges).
7-23. The United States Trade Representative (USTR) develops international trade
and investment policies for the U.S. government. Visit the USTR Web site from
globalEDGE™ or directly (www.ustr.gov). Search for “National Trade Estimate
Report” for the latest year. This document summarizes trade barriers around the
world. See the reports for the country of your choice. What are the country’s import
policies and practices? What are its nontariff trade barriers? What about barriers
in the services sector? Are there any sectors that seem to be particularly protected
(for example, energy, telecommunications)? What is the nature of government
restrictions on e-commerce? If you worked at a firm that exported its products to
the country, how would you use the USTR report to develop international business
strategies?
(LO 7.2; LO 7.3; LO 7.4; AACSB: Analytical Thinking)
Brazil’s average tariff rate is 10.73%. As a member of MERCOSUR, common external

tariffs (CETs) prevail. Although there are some country-specific exceptions, CETs range
from 0% to 35% ad valorem (taxes are assessed according to the value of the imported
item). Brazil has a list of 100 exceptions to CET. The tariff ceiling, for example, is 55% for
certain imported produce such as peaches and nectarines, although the government only
assesses them at a 10% tariff. Brazil imposes additional taxes and charges to effectively
increase importing costs by 100% for information technology products and components,
agricultural products, distilled spirits, and computer and telecommunication equipment.
Currently, Brazil prohibits the import of a number of products such as toys, blood products,
and all used consumer goods (e.g., machinery, automobiles, clothing, refurbished
medical equipment and other consumer goods). The Brazilian government also imposes
a 25% merchant marine tax on freight at certain seaports. In addition, it imposes a 60%
flat import tax on most manufactured retail goods by import buyers that uses the country’s
simplified custom clearance procedure referred to as a simplified tax regime (RTS).
In the telecommunications section, Former state-owned telecom companies enjoy the

advantages of more favorable interconnection charge, among other perks, which creates

formidable entry barriers for foreign telecom companies. Foreign ownership of Brazilian
cable companies is restricted to 49% and foreign owners must have a headquarters in
the country and have had a presence in Brazil for the prior 10 years. The government
imposes an11% remittance tax on foreign cable and satellite television programmers. The
Brazilian government requires that 100% of all films and television shows be printed
locally. It imposes quotas on theatrical screen for local films. In summary, the audio visual
services sector seems to be particularly protected. The telecommunication sector is very
protected.
Brazilian government restriction on e-commerce seems to be limited. Foreign exporters

can sell directly to Brazilian consumers or distributors via Internet. However, different
customs rules apply to these transaction types. According to external government report,
Brazil leads Latin America as being the most advanced Internet and e-commerce market.
There are more than 20 million Brazilians that regularly use on-line activities, typically
with high speed access.
Managers at companies that desire to export products to Brazil should be apprised of the
tariffs and non-tariff barriers that exist. To effectively penetrate the Brazilian market via
exporting, managers should first research the country’s trade control instruments in order
to see which ones apply to its products and how severe the trade restrictions will impact
its ability to profitably serve this market. Second, they should seek favorable customs
classifications for its exported products by establishing the appropriate harmonized
product code. This may entail having their products classified in two or more categories
where alternative tariffs apply or modifying the products before exporting them to Brazil
in order to assist in reducing the impact of trade barriers. Exporters should also join others
in lobbying home and host governments to lower trade barriers. If exporting proves to be
ineffective because of Brazil’s trade barriers, then managers should consider the
feasibility of other entry strategies such as FDI, licensing, and joint ventures, which
facilitate avoiding import barriers. If local production is feasible and attractive, managers
should assess Brazil’s foreign trade zones to locate production and thereby reduce the
impact of local duties.
7-24. There has been much opposition to the Trans-Pacific Partnership (TPP). For
a sampling of arguments against this proposed pact, visit:
www.globalexchange.org, www.citizenstrade.org, and www.citizen.org. Also visit
the U.S. government site promoting the TPP at http://ustr.gov/tpp, or obtain
information on the proposed pact from globalEDGE™. Based on your reading of
this chapter, evaluate the arguments against the TPP. Do you agree with arguments
made by the critics? Why or why not? Would the proposed TPP harm special
interest groups? Would it be a boon international trade? Justify your answers.
(LO 7.5; LO 7.7; LO 7.8; AACSB: Analytical Thinking; Reflective thinking)
The Trans-Pacific Partnership (TPP) is a regional trade agreement that seeks to

eliminate tariffs among member countries.
Overview

The TPP proposes:
●To lower trade barriers such as tariffs
●Establish a common framework for intellectual property
●Enforce labor and environmental law standards
●Establish an investor-state dispute settlement mechanism
Goal
The stated goal of the agreement is to "enhance trade and investment among the TPP
partner countries, to promote innovation, economic growth and development, and to
support the creation and retention of jobs."
https://en.wikipedia.org/wiki/Trans-Pacific_Partnership
For the U.S., TPP is considered to be the companion agreement to Transatlantic Trade
and Investment Partnership (TTIP), a similar agreement between the U.S. and the EU.
History
In the late 1990s, several Asia Pacific Economic Cooperation (APEC) economies
including Singapore, New Zealand and Chile began discussing a framework for tariff
liberalization. These discussions led to the formation of the P4 (renamed TPP). The U.S.
expressed interest in 2008, and then in 2009 President Obama affirmed that the U.S.
wished to be involved in Asia through the TPP. This interest led to the possible expansion
of the TPP in 2010. This was just around the time that Lehman Brothers collapsed,
demonstrating clearly that the world’s growth sector would be Asia. For the U.S., stronger
ties with Asia would clearly be indispensable for future economic growth.” (The Japan
Journal, January, 2011)
http://www.japanjournal.jp/wp-content/uploads/2012/02/1202e_15-17_TPP.pdf
2006- The TPP is an extension of the Trans-Pacific Strategic Economic Partnership

Agreement (TPSEP or P4) which was signed in 2006 by Brunei, Chile, Singapore, and
New Zealand.
2008- Beginning in 2008, additional countries joined the agreement for a total of twelve
participating nations: Australia, Canada, Japan, Malaysia, Mexico, Peru, Vietnam, and
the U.S.
Contents
According to the website of the Office of the United States Trade Representative, TPP
chapters include:

●Competition
●Co-operation and capacity building
●Cross-border services
●Customs
●E-commerce
●Environment
●Financial services
●Government procurement
●Intellectual property
●Investment
●Labor
●Legal issues
●Market access for goods
●Rules of origin
●Sanitary and phytosanitary standards
●Technical barriers to trade
●Telecommunications
●Temporary entry
●Textiles and apparel
●Trade remedies
Also according to the USTR, the contents of the TPP seek to address issues that promote:
• Comprehensive market access by eliminating tariffs and other barriers to goods
and services trade and investment, so as to create new opportunities for our
workers and businesses and immediate benefits for our consumers.
• A fully regional agreement by facilitating the development of production and supply
chains among TPP members, which will support the goals of job creation,
improving living standards and welfare, and promoting sustainable growth among
member countries.
• Cross-cutting trade issues by building on work being done in APEC and other fora
by incorporating four new cross-cutting issues in the TPP. These issues are:
1. Regulatory coherence: Commitments will promote trade between the
countries by making trade among them more seamless and efficient.
2. Competitiveness and business facilitation: Commitments will enhance the
domestic and regional competitiveness of each member country's economy
and promote economic integration and jobs in the region, including through
the development of regional production and supply chains.
3. Small- and Medium-Sized Enterprises: Commitments will address concerns
small- and medium-sized businesses have raised about the difficulty in
understanding and using trade agreements, encouraging these sized
enterprises to trade internationally.
4. Development: Comprehensive and robust market liberalization,
improvements in trade and investment enhancing disciplines, and other
commitments will serve to strengthen institutions important for economic

development and governance and thereby contribute significantly to
advancing TPP countries' respective economic development priorities.
• New trade challenges by promoting trade and investment in innovative products
and services, including the digital economy and green technologies, and to ensure
a competitive business environment across the TPP region.
• Living agreement by enabling the updating of the agreement when needed to
address trade issues that materialize in the future as well as new issues that arise
with the expansion of the agreement to include new countries.
Issues
Although the goal was to finalize negotiations by 2012, issues such as agriculture,
intellectual property, and services and investments have delayed negotiations with the
latest round taking place in July 2015.
Implementation of the TPP is one of the primary goals of the Obama administration.
ARGUMENTS AGAINST THE TPP
CON:
[1] INTELLECTUAL PROPERTY
The Intellectual Property Rights and Environmental chapters of the TPP revealed “just
how far apart the US is from the other nations involved in the treaty, with 19 points of
disagreement in the area of intellectual property alone. One of the documents speaks of
‘great pressure’ being applied by the US.”
The Electronic Frontier Foundation has been highly critical of the chapter on intellectual
property covering copyright, trademarks, and patents. In the U.S., this is likely to further
entrench controversial aspects of U.S. copyright law, e.g. the Digital Millennium Copyright
Act, and restrict the ability of Congress to engage in domestic law reform to meet the
evolving IP needs of American citizens and the innovative technology sector.
CON:
[2] CURRENCY MANIPULATION
Since countries can devalue their currency to boost exports and gain a trade advantage,
economists claim that currency manipulation by Asian manufacturing countries has

become pervasive, “allowing them to boost their exports at the expense of manufacturing
companies in the U.S. and Europe.”
Furthermore, organizations such as the WTO or IMF cannot control such currency
manipulation. Senator Lindsey Graham and Representative Sander Levin “gathered a
group of economists, manufacturing industry officials and labor leaders who agreed that
the TPP should die unless it credibly prohibits countries from manipulating the value of
their currency.
CON:
[3] LACK IF TRANSPARENCY
While the text of the treaty has not been made public, some documents have been leaked.
The secrecy of negotiations, the agreement’s expansive scope, and controversial clauses
in leaked drafts provide the foundation for global health officials, professionals, Internet-
freedom activists, environmentalists, organized labor advocates, and elected officials to
criticize and protest against the treaty.
United States Senator Ron Wyden (D-OR) said:

“The majority of Congress is being kept in the dark as to the substance of the TPP
negotiations, while representatives of U.S. corporations—like Haliburton, Chevron,
PHRMA, Comcast, and the Motion Picture Association of America—are being consulted
and made privy to details of the agreement. …
We hear that the process by which TPP is being negotiated has been a model of
transparency. I disagree with that statement.”
In addition, in 2013, Senator Elizabeth Warren (D-Mass) and Rep. Alan Grayson (D-Fla.)
were among a group of individuals who criticized the Obama administration’s secrecy
policies on the Trans-Pacific Pact.
CON:
[4] COST OF MEDICINE
A June 2015 article in the New England Journal of Medicine summarized concerns about
TPP´s impact on healthcare in developed and less developed countries including
potentially increased prices of medical drugs due to patent extensions, which it claimed,
could threaten millions of lives.
Malaysian protesters dressed as zombies outside a shopping mall in Kuala Lumpur on
21 February 2014 to protest the impact of the TPP on the price of medicines, including
treatment drugs for HIV.

CON:
[5] INCOME INEQUALITY
Those opposed to the TPP believe the agreement will lead to a larger gap between the
rich and the poor. In 2013, Nobel prize-winning economist Joseph Stiglitz warned that
based on leaked drafts of the TPP, it presented "grave risks" and "serves the interests of
the wealthiest. Organized labor in the U.S. argued that the trade deal would largely benefit
corporations at the expense of workers in the manufacturing and service industries.
CON:
[6] ENVIRONMENT
Ilana Solomon, Sierra Club’s director of responsible trade, argued that the TPP "could
directly threaten our climate and our environment [including] new rights that would be
given to corporations, and new constraints on the fossil fuel industry all have a huge
impact on our climate, water, and land.
CON:
[7] CHINA NOT INTERESTED
The most fundamental challenge for the TPP project regarding China is that "it may not
constitute a powerful enough enticement to propel China to sign on to these new
standards on trade and investment. China so far has reacted by accelerating its own trade
initiatives in Asia.
CON:
[8] WTO DOMINANCE
In reality, the TPP will be of secondary importance, (just like many bilateral and regional
trade agreements that are) and subsumed under the broader framework established by
the World Trade Organization (WTO), which is likely to maintain its preeminent role in
trade governance.
http://www.cato.org/publications/commentary/putting-tpp-perspective
CON:
[9] GLOBAL RACE TO THE BOTTOM
In a statement denouncing the TPP, Senator (I-VT) Bernie Sanders wrote:
“Let’s be clear: the TPP is much more than a “free trade” agreement. It is part of a global
race to the bottom to boost the profits of large corporations and Wall Street by outsourcing
jobs; undercutting worker rights; dismantling labor, environmental, health, food safety and

financial laws; and allowing corporations to challenge our laws in international tribunals
rather than our own court system. If TPP was such a good deal for America, the
administration should have the courage to show the American people exactly what is in
this deal, instead of keeping the content of the TPP a secret.”
ARGUMENTS FOR THE TPP
PRO:
[1] WINNERS
According to the New York Times, "the clearest winners of the Trans-Pacific Partnership
agreement would be American agriculture, along with technology and pharmaceutical
companies, insurers and many large manufacturers" who could expand exports to the
other nations that have signed the treaty.
PRO:
[2] RESHAPE GLOBAL ARCHITECTURE
TPP is often talked about as a “high standard,” 21st century trade agreement that could
reshape the international economic architecture.
PRO:
[3] SMALL BUSINESSES
Small businesses tend to benefit disproportionately from trade liberalization, since they
are less likely than large enterprises to establish overseas subsidiaries to overcome trade
barriers.
PRO:
[4] U.S. IS A PLAYER IN THE ASIA-PACIFIC REGION
The TPP will also help counter the trend toward greater economic integration, which
excludes the U.S., in the Asia-Pacific region. For example, ASEAN already has free trade
agreements with China, Japan, South Korea, Australia, and New Zealand, while the U.S.
has been excluded from economic cooperation agreements in this region.
ADDITIONAL POINTS

With trade promotion authority (TPA) - also called fast track negotiating authority -
the President of the United States has authority to negotiate international agreements
that Congress can only vote yes or no to, and cannot amend or Filibuster. In June 2015,
the TPA passed the Senate thus granting President Obama "enhanced power to
negotiate major trade agreements with Asia and Europe”.
https://en.wikipedia.org/wiki/Fast_track_(trade)
Given TPA, The Trans Pacific Partnership (TPP) trade pact will likely be one of the first
considerations.
As the Wall Street Journal’s Greg Ip argues: TTP could "lay down rules for the rest of the
world in sectors such as services and intellectual property where nontariff barriers are
especially onerous." That will particularly impact the services sector.
http://www.heritage.org/research/commentary/2015/5/after-obama-a-7-step-economic-
recovery-plan-for-america
When evaluating the arguments surrounding TPP, six of the eight chapter themes
are relevant:
• EVOLUTION AND CONSEQUENCES OF GOVERNMENT INTERVENTION

Government intervention and trade barriers raise ethical concerns when one segment
is unfairly impacted- more/less- than another. How is it that everyone is kept in the
dark, with the exception of Haliburton, Chevron, PHRMA, Comcast, and the Motion
Picture Association of America?
• HOW FIRMS CAN RESPOND TO GOVERNMENT INTERVENTION

Given the lack of TPP transparency, firms cannot conduct the requisite research to
understand the extent and nature of trade and investment barriers abroad. Therefore,
appropriate entry strategies cannot be determined. Government subsidies and
incentives could help reduce the impact of protectionism. For example, will subsidies
be paid to Japanese agricultural producers to maintain production, as in the U.S. and
EU?
http://www.japanjournal.jp/wp-content/uploads/2012/02/1202e_15-17_TPP.pdf
• REGIONAL INTEGRATION AND ECONOMIC BLOCS

Under regional economic integration, groups of countries form alliances to promote
free trade, cross-national investment, and other mutual goals. This integration results
from regional economic integration blocs (or economic blocs), in which member
countries agree to eliminate tariffs and other restrictions on cross-national commerce.
At minimum, the countries in an economic bloc become parties to a free trade

agreement, which eliminates tariffs, quotas, and other trade barriers. TPP is a
regional trade agreement that seeks to eliminate tariffs among member countries. The
question is how mutual are the goals given all of the areas of controversy?
• THE LEADING ECONOMIC BLOCS

There are hundreds of economic integration agreements in the world. The successful
ones have more similarities than differences. The success of TPP remains in question.
• ADVANTAGES AND SUCCESS FACTORS OF REGIONAL INTEGRATION

Regional integration contributes to corporate and industrial growth and hence to
economic growth, better living standards, and higher tax revenues for the member
countries. It increases market size by integrating the economies within a region. It
increases economies of scale and factor productivity among firms in the member
countries and attracts foreign investors to the bloc. The most successful blocs consist
of countries that are relatively similar in terms of culture, language, and economic and
political structures. Members also are usually close to each other geographically.
Whether TPP has enough of these success factors remains to be seen.
• CHALLENGES AND MANAGERIAL IMPLICATIONS OF REGIONAL

INTEGRATION
Regional integration simultaneously leads to trade creation, whereby new trade is
generated among the countries inside the bloc, and trade diversion, in which member
countries reduce trade with countries outside the bloc.
Consequences of regional integration:

●Regional integration can concentrate power into large firms and large nations inside
the bloc.
●Regional integration results in economic restructuring, which may harm particular
●When a country joins an economic bloc, it must relinquish some of its autonomy to
the bloc’s central authority.
●Regional integration leads to increased internationalization by firms inside their
economic bloc.
●Firms reconfigure value-chain activities and rationalize their operations.
●The formation of economic blocs also leads to mergers and acquisitions.
●Managers revise marketing strategies by standardizing products and developing
regional brands.
●Regional integration also leads firms from outside the bloc to invest into the bloc.
Do you agree with arguments made by the critics? Why or why not?
Both sides have been presented. For an interesting in-class exercise, you might split the
class into two groups, one side arguing pro and the other con. Take a poll before and
after of where students stand on the TPP. Was there any movement based on the
discussion?

Would the proposed TPP harm special interest groups?
Yes, according to the above arguments.
Would it be a boon international trade?

Yes, according to the above arguments.
CAREER TOOLBOX EXERCISE

PERFORMING A PRELIMINARY COUNTRY RISK ANALYSIS
Visit MyManagementLab for more information.
 Simulation Tariffs, Subsidies, and Quotas

Apply what you have learned in this chapter by doing a simulation and answering
questions on how a firm selling fishing equipment attempts to ward off competition by
lobbying its government for subsidies and tariff protections.
Go to MyManagementLab to access the simulation.
MyManagementLab
Go to MyManagementLab.com for Auto-graded writing questions as well as the
following Assisted-graded writing questions.
 7-25. Discuss the relationship between government intervention and
protectionism.
 7-26. How did government intervention evolve between the first and second
halves of the twentieth century?
 7-27. MyManagementLab Only– comprehensive writing assignment for this
chapter.

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THE ENVIRONMENT OF INTERNATIONAL BUSINESS

GOVERNMENT INTERVENTION AND REGIONAL ECONOMIC INTEGRATION

Copyright © 2017 Pearson Education, Inc. 1 | Page

■ To better understand regional integration, think of international business as existing

[2] TED TALK

Copyright © 2017 Pearson Education, Inc. 2 | Page

[3] PBS NewsHour

II. LEARNING OBJECTIVES AND THE OPENING VIGNETTE

7.1 Understand the nature of government intervention

Copyright © 2017 Pearson Education, Inc. 3 | Page

■ Rationale for government intervention

■ Instruments of government intervention

■ Consequences of government intervention:

Copyright © 2017 Pearson Education, Inc. 4 | Page

■ Evolution of government intervention: Intervention has a long history.

■ Intervention and the global financial crisis

■ How should firms respond to government intervention?

■ Regional integration involves groups of countries forming alliances to promote free

Copyright © 2017 Pearson Education, Inc. 5 | Page

■ Countries pursue regional integration because:

■ Ethical dilemmas of regional integration:

■ Consequences of regional integration:

Copyright © 2017 Pearson Education, Inc. 6 | Page

■ Regional integration is an attempt to achieve freer economic relations.

Copyright © 2017 Pearson Education, Inc. 7 | Page

■ 10 million ‘mom-and-pop’ shops scattered across 500,000 cities/villages.

■ India’s entrepreneurial potential is significant

• Uniqueness of the situation described

Copyright © 2017 Pearson Education, Inc. 8 | Page

■ Government intervention creates a bureaucratic nightmare for businesses- trade

■ There are 10 million ‘mom-and-pop’ shops scattered across 500,000 cities/villages.

7-3. Describe how India’s government is attempting to liberalize the nation’s

Copyright © 2017 Pearson Education, Inc. 9 | Page

■ To enhance India’s significant entrepreneurial potential:

III. DETAILED CHAPTER OUTLINE

GOVERNMENT INTERVENTION IN INTERNATIONAL BUSINESS

■ Governments intervene in trade and investment to achieve political, social, or economic

Study of more than 100 countries 1945-1995

Copyright © 2017 Pearson Education, Inc. 10 | Page

◘ Poland’s average annual income rose:

■ Unimpeded free trade is a myth.

THE NATURE OF GOVERNMENT INTERVENTION

Copyright © 2017 Pearson Education, Inc. 11 | Page

◘ Investment barriers target FDI thus restricting foreign firm operations.

■Government intervention alters the competitive landscape- by hindering or helping the

■ Examples of Protectionism Hindering Competitiveness-

◘ Japanese voluntary export restraints:

RATIONALE FOR GOVERNMENT INTERVENTION: FOUR REASONS

(1) Generate revenue

Copyright © 2017 Pearson Education, Inc. 12 | Page

[1] PROTECTION OF THE NATIONAL ECONOMY

Copyright © 2017 Pearson Education, Inc. 13 | Page

[2] PROTECTION OF AN INFANT INDUSTRY

[3] NATIONAL SECURITY