Governmental Influence on Trade

Chapter Seven
 Introduction

Protectionism refers to those government restrictions and

incentives specifically designed to help a county’s
domestic firms compete with foreign competitors at
home and abroad.
• Governments intervene in the trade process to attain
economic, social, and/or political objectives.
• Whenever governments impede the flow of imports and/or
encourage the flow of exports, they simul-taneously provide
direct and/or indirect subsidies for their domestic firms.
Protectionist measures are likely to lead to retaliation
by affected stakeholders.

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 I. Rationales for Government
Intervention in Trade
ECONOMIC RATIONALES NONECONOMIC RATIONALES

Prevent unemployment Maintain essential

industries
Protect infant industries Deal with unfriendly
countries
Promote industrialization Maintain or extend
spheres of influence
Improve position com- Preserve national
pared to other countries identity
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 Economic Rationales for Government Intervention:
Prevent Unemployment

By limiting imports, local jobs are retained as firms and

consumers are forced to purchase domestically
produced goods and services.
• Unless the protectionist country is relatively small, such measures
are usually ineffective.
• Such measures are likely to lead to retaliation unless either the
protectionist or the affected country is relatively small.
• Such measures may decrease export-related jobs because of (i)
price increases for components or (ii) lower incomes abroad.
Governments must carefully balance the costs of higher prices with the
costs of unemployment and the displaced production that would result
from freer trade.

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 Economic Rationales for Government Intervention:
Protect Infant Industries
Infant Industry Argument [Alexander Hamilton, 1792]:
A government should temporarily shield emerging
industries in which the country may ultimately possess a
comparative advantage from international competition
until its firms are able to compete in world markets.
Hamilton reasoned that eventual competitiveness would result
from: • movement along the learning curve
• the efficiency gains from achieving the
economies of large-scale production
Ultimately, the validity of the argument rests on the expectation that the future
benefits of an internationally competitive industry will exceed the costs of the
associated protectionist measures.

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 Economic Rationales for Government Intervention:
Promote Industrialization

Industrialization Argument:
The development of national industrial output should be
supported, even though domestic prices may not be
competitive on the world market.
• Terms of trade describes the quantity of imports that a given
quantity of a country’s exports can buy.
• Export-led development encourages national economic development
by harnessing a country-specific advantage and building a vibrant
manufacturing sector through the stimulation of exports.
Many of today’s emerging economies emulate historical practices and use
protectionism to spur local industrialization.
[continued]

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Supporters of the industrialization argument claim
that:
• surplus workers can more easily increase manufacturing
output than agricultural output
• foreign investment inflows promote sustainable growth
• fluctuating prices are a major detriment to those economies
that depend on just a few commodities
• demand for and prices of raw materials and agricultural
commodities do not rise as fast as the demand for and prices
of finished goods
• export promotion, and possibly import substitution, lead to
sustainable economic development
• industrialization helps the nation-building process

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 Economic Rationales for Government Intervention:
Improve Relative Economic Position

Countries may impose trade restrictions to

improve their relative competitive positions.
Their primary motivations are:
• balance-of-payments adjustments
• comparable access, i.e., “fairness”
• leverage as a bargaining tool
• price-control objectives
[continued]

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• The comparable access argument, i.e., “fairness,”
promotes the idea that a country’s firms are entitled
to the same access to foreign markets as foreign
firms have to its market.
• Dumping refers to the practice of pricing exports
below cost, or below their home-country prices, i.e.,
below their “fair market value.”
• The optimum-tariff theory claims that a foreign
producer will lower its prices if the destination
country places a tariff on its products. So long as the
price is reduced by any amount, some shift in
revenue goes to the importing country, and the tariff
is deemed an optimum one.
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 Noneconomic Rationales for Government
Intervention

• Maintenance of essential industries

Essential industry argument: a government applies
restrictions to protect essential domestic industries
(particularly defense) so that the country is not
dependent on foreign sources of supply
• Prevention of shipments to “unfriendly” countries
• Maintenance or extension of spheres of influence
• Preservation of national identity

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 II. Instruments of Trade Control
Instruments of trade control can:
-directly limit the amount that can be traded
-indirectly affect the amount traded by directly influencing
prices
• Tariffs (also called duties) are taxes levied on (internationally)
traded products.
• Nontariff barriers (NTBs) represent administrative regulations,
policies, and procedures, i.e., quantitative and qualitative
barriers, that directly or indirectly impede international
trade.
While tariff barriers directly affect prices and subsequently the quantity
demanded, nontariff barriers may directly affect price and/or quantity.

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Fig. 7.4: Comparison
of Trade Restrictions

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 Instruments of Trade Control: Tariffs

Tariffs, i.e., taxes levied on (internationally) traded

products, include:
• exports tariffs, levied by the country of origin on
exported products
• transit tariffs, levied by a country through
which goods pass en route to their final destination
• import tariffs , levied by the country of destination
on imported products
A tariff increases the delivered price of a product, and, at the higher price,
the quantity demanded will be less.
[continued]

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• A specific duty is a tariff that is assessed on a per unit
basis.
• An ad valorem tariff is assessed as a percentage of the
value of an item.
If both a specific duty and an ad valorem tariff are
assessed on the same product, it is known as a compound
duty.
While raw materials frequently enter industrial countries tariff free, an
ad valorem tariff is often applied to the total value of manufactured
goods. Critics argue that the effective tariff on the manufactured
portion, i.e., the value-added portion, is higher than the published
tariff.

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 Instruments of Trade Control: Nontariff
Barriers—Direct Price Influences

• Subsidies: direct or indirect financial assistance from

governments to their domestic firms to help them
overcome market imperfections and thus make them
more competitive in the marketplace.
• Aid and loans: tied aid and loans require that the
recipient spend the funds in the donor country
• Customs valuation: determining the true value and/or
origin of traded products
• Other direct price influences: special fees, deposits,
minimum price levels

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 Instruments of Trade Control: Nontariff
Barriers—Quantity Controls

• Quota: a numerical limit on the quantity of a product

that may be imported or exported in a given period
of time
– Voluntary export restraints (VERs): negotiated limitations
of exports from one country to another
– Embargo: an outright ban on imports from or exports to a
particular country
Because of the increase in the equilibrium price, a quota may increase
per unit revenues for participants within the protected market.
[continued]

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• “Buy local” legislation
• Specific permission requirements
– Import and export licenses
– Foreign exchange controls
• Administrative delays
• Reciprocal requirements
– Barter
– Offset
• Restrictions on services
– Essentiality
– Professional standards
– Immigration

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 Implications/Conclusions

• When governments choose to impede the flow of

imports and encourage the flow of exports, they
simultaneously provide direct and/or indirect
subsidies for their domestic industries.
• It is difficult to determine the real effects of trade
barriers due to the likelihood of retaliation and
the fact the imports and exports can both have
positive effects.

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• Much government interference in the
international trade process is motivated by
political rather than economic factors.
• A company’s particular international strategy will
determine the extent to which it might benefit
from protectionist measures.
• Firms can deal with trade restrictions by:
1. moving operations to lower-cost countries
2. concentrating on market niches that attract less
international competition
3. adopting internal innovations that lead to greater
efficiency and/or superior products
4. trying to secure government protection
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