Formulation of National Trade Policies

1
Chapter 9

• Formulation of National Trade Policies

2
Free Trade vs. Fair Trade

• U.S. Steel Tariffs imposed in 2002
• Some steel tariffs are still in place
• While such tariffs may temporarily save steel
  jobs, they cause higher prices for consumers and
  cost jobs in steel using industries
• Free trade vs. Fair Trade
• Free trade minimal govt. influence on exporting
  and importing decisions of private firms and
  individuals
• Fair trade national govt. should actively
  intervene to support export industries and
  protect domestic industries from competition

3
What arguments are used to justify govt.
intervention in trade in certain industries?

• 1. National Defense Argument
• Country must be self sufficient in critical raw
  materials, machinery, and technology or be
  vulnerable to foreign threats
• Appealing to the general public, but used to
  protect special interests
• e.g. National Wool Act subsidized the Mohair
  Industry until 1994

4
Arguments used to justify trade intervention in
spec. inds. (cont.)

• 2. Infant Industry Argument
• Young industries where a country is likely to
  ultimately have a competitive advantage need to
  be supported in their infancy to survive against
  mature foreign firms
• Problems
• Determination of industries deserving infant
  protection often done on a political basis
• Once an industry is granted protection, it is
  difficult to remove it
• 3. Maintain Existing Jobs
• Established firms facing competition from low
  wage countries
• Often costs jobs in other industries also,
  results in high costs to consumers

5
Arguments used to justify trade intervention in
spec. inds. (cont.)

• 4. Strategic Trade Theory
• Because of cost conditions, some industries may
  only support a few firms world wide
• If a country can provide a subsidy to a firm in
  such an industry, it may benefit the country
  overall
• To illustrate strategic trade theory, we can use
  the concepts of game theory

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Using Game Theory to Illustrate Strategic Trade
Theory

• Every Game Has
• Players, strategies, payoffs
• Games are solved by choosing the best action for
  each player given the actions of other players
• Example Suppose a French firm (Framatome) and a
  Japanese firm (Mitsubishi) are the only 2 firms
  in the world with the expertise and resources to
  develop a nuclear power plant design that can
  safely and cheaply produce energy
• if only one firm develops the design, it will be
  extremely profitable
• if both develop the design, they will each lose
  money

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Hypothetical Payoffs to Framatome and Mitsubishi
with No Subsidy

• Each firm is taking the best action given the
  action of its rival if one firm develops the
  design and the other does not

Mitsubishi
Dont Develop
Develop
Develop
(-1, -1)
(10, 0)
Framatome
(0, 0)
Dont Develop
(0, 10)
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Hypothetical Payoffs to Framatome and Mitsubishi
with 2Billion French Subsidy to Framatome if
they Develop
Mitsubishi

• French Govt. provides a subsidy of 2 Bill to
  enable Framatome to generate profits of 12 Bill.

Dont Develop
Develop
Develop
(1, -1)
(12, 0)
Framatome
(0, 0)
Dont Develop
(0, 10)
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Hypothetical Payoffs to Framatome and Mitsubishi
with 2Billion Subsidy From Each Government
Mitsubishi

• If both govts. subsidize, each firm will develop
  the design and both countries are worse off
  they pay a 2 Bill. subsidy for 1 Bill. in
  profits

Dont Develop
Develop
Develop
(1, 1)
(12, 0)
Framatome
(0, 0)
Dont Develop
(0, 12)
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Strategic Trade Theory and Subsidy Wars

• Strategic trade theory suggests that a subsidy by
  one country may be beneficial in less competitive
  industries
• But, countries considering subsidizing less
  competitive industries have incentives to engage
  in subsidy wars in this case, the subsidy makes
  both countries worse off

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Strategic Trade Theory and Subsidy Wars

• Example Suppose the U.S. and Japanese govts.
  are considering subsidizing their automobile
  industries
• Current corporate tax receipts in each country
  are 100 Bill.
• The amount of subsidy being considered in each
  country is 2 Bill.
• Subsidy in one country and not the other will
  result in an increase in that countrys worldwide
  automobile share so that tax receipts go up by 5
  Bill. this occurs at the expense of the
  non-subsidizing country (their tax receipts go
  down by 5 Bill.)
• If both countries subsidize, there is no change
  in tax receipts

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Hypothetical Payoffs to U.S. and Japanese Govts.
From a Potential 2 Bill. Subsidy to their Auto
Industries
Japan

• Both countries subsidize, even though both are
  worse off than if neither subsidized. ---- These
  types of incentives are one reason why formal
  institutions and agreements have been developed
  to prevent such actions and facilitate trade

Dont Subsidize
Subsidize
Subsidize
(98, 98)
(103, 95)
U.S.
Dont Subsidize
(100, 100)
(95, 103)
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Broader National Rationales for Trade Intervention

• 1. Economic Development
• Govt. intervenes in trade to promote economic
  development in its country
• Often to diversify its economy
• Export promotion strategy
• Import substitution strategy
• 2. Industrial Policy
• Govt. identifies industries that are critical to
  the countrys future growth and promotes them
• Problems
• Govt. bureaucrats cannot perfectly identify the
  right industries to promote
• Choice of industries receiving support often
  depends on political clout, rather than potential
  international competitiveness

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Public Choice Analysis

• Most govt. trade intervention hurts the general
  public and other domestic interests, while
  helping some special interest group --- why does
  it happen?
• Special interest groups have an incentive to be
  informed, to exert political pressure, and to use
  resources to educate/disinform the general public
  because the benefits of govt. intervention to
  each individual in the group are large
• The costs to the general public are high, but
  because the costs are spread out among so many
  people, the costs to each individual are low
  relative to the benefits received by each
  individual in the beneficiary group
• General public has less incentive to become
  informed, or to exert political pressure to
  prevent govt. intervention
• Politicians know that they can intervene and that
  the political benefits of doing so will be much
  greater than the political costs

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Public Choice Analysis (cont.)

• Example The Jones Act prevents foreign ships
  from providing U.S. to U.S. service
• Estimated increase in profits for owners of U.S.
  oceangoing vessels of 630 Million ann.
• Estimated costs to general public of 10.5
  Billion annually
• Increased profits per ship - 4.8 Million
• Increased costs per person - 40

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What Methods do Countries Use to Protect Domestic
Industries?

• 1. Tariffs
• Tax placed on a good traded internationally
• Export tariff
• Import tariff
• Transit tariff
• 3 forms of import tariffs
• Ad Valorem Tariff - of market value
• Specific Tariff - amount per unit
• Compound Tariff combination of ad valorem and
  specific

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What Methods do Countries Use to Protect Domestic
Industries?

• More on Tariffs Why do govts. Impose?
• Tax Revenues for National Govt.
• Important for developing countries
• Restrict Imports
• Domestic special interests
• 2. Non-Tariff Barriers
• Any govt. action, policy, regulation that impedes
  international trade that is not a tariff.

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Types of Non-Tariff Barriers

• A. Quotas
• Numerical limit on the amount that may be
  imported into a country during a specific time
  period (e.g. a year)
• Tariff Rate Quotas have replaced quotas in most
  cases
• Place a low tariff rate on a limited amount of
  the imported good and then a very high rate after
  that
• Often used for foreign policy purposes
• Hurt domestic consumers and other industries
  using the products

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Types of Non-Tariff Barriers

• B. Numerical Export Controls
• Restrict exports to another country as negotiated
  (voluntary export restraint)
• Purpose avoid trade conflicts with a friendly
  country
• C. Product Testing Standards
• Foreign goods are often tested more stringently
  than domestic goods
• D. Restricted access to distribution networks
• Imported goods can only be handled by specific
  firms

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Types of Non-Tariff Barriers

• E. Public Sector Procurement Policies
• Govt. gives preferential treatment to domestic
  firms in govt. contracts or only allows domestic
  firms to get govt. contracts
• Very important in countries where a lot of
  industry is state owned
• F. Local Purchase Requirements
• Govt. requires some industries to only buy
  locally
• G. Regulatory Controls
• Health and safety inspections, enforcing
  environmental regs., requiring firms to obtain
  licenses, etc. to make it more difficult for
  foreign firms to compete in the home market

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Types of Non-Tariff Barriers

• H. Currency Controls
• Favorable exchange rates given to exporters
• Unfavorable exchange rates given to importers
• I. Investment controls
• Limit foreign investment in various industries
• Non-Tariff Barriers are more important
  impediments to international trade than tariffs,
  but it is often difficult to tell whether they
  are in place for legitimate reasons or to limit
  trade

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How Does Govt. Promote International Trade?

• 1. Subsidies
• Subsidies on exports
• Tax breaks for export firms
• Exempt imported imports from tariffs when used to
  produce a product for export
• Economic Development Incentives
• Tax breaks, free land, workforce training, hwy
  construction, low utility rates entice firms to
  locate in the community
• Subsidies can cause distortions in internatl.
  trade efficient producers may be displaced

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How Does Govt. Promote International Trade?

• 2. Foreign Trade Zones
• Geographic area where imported or exported goods
  receive preferential tariff treatment
• Used to spur regional economic development
• Firm can import a component into the FTZ, process
  it further, and export it without paying customs
  duties
• Maquiladora system in Mexico
• 3. Export Financing Programs
• Success in exporting often depends on offering an
  attractive financing package to buyers esp. for
  big ticket items aircraft, supercomputers
• Govt. owned agencies assist their countrys firms
  in arranging financing of export sales

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How do Countries Protect Firms from Unfair Trade
Practices?

• In the U.S., firms complain to the Internatl.
  Trade Administration (ITA)
• If ITA deems that unfair trade practices have
  occurred, it forwards to the Intl. Trade
  Commission (ITC)
• ITC can then impose duties (tariffs) on the
  offending imports to counteract the practice
• ITC and other similar agencies world wide are
  concerned with
• Govt. subsidies that distort trade
• Unfair pricing practices

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How do Countries Protect Firms from Unfair Trade
Practices?

• World wide tools
• Countervailing Duties
• A tariff on an imported good designed to counter
  the impact of foreign subsidies
• Antidumping Regulations
• 2 types of dumping
• Price discrimination sell in a foreign market
  at a lower price than at home
• Predatory pricing price below costs in a
  foreign market
• Concern that firm will eventually raise prices
  after eliminating competitors

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How do Countries Protect Firms from Unfair Trade
Practices?

• U.S. specific Super 301
• Section 301 of the 1974 Trade Act requires the
  U.S. Trade Representative to publicly list
  countries engaging in the most unfair trade
  practices
• Representative must then negotiate with these
  countries if unsuccessful, then U.S. imposes
  tariffs and quotas