Government Intervention in Trade - Assignment Example

Running Head: INTERNATIONAL BUSINESS Government Intervention in Trade (Name) (Course) (University) Date of presentation: Lecturer: Government Intervention in Trade Introduction Governments in both developed and developing countries intervene in trade in order to attain certain objectives. These objectives can be motivated by political, economic or cultural circumstances and their impact can be short-term or long-term (Escaith & Gonguet, 2009). Governments often intervene in trade by offering subsidies or by imposing tariffs and other trade barriers. Subsidies can be offered in the form of affordable and long term interest loans, cash payments, tax breaks and product price support and are primarily used to enable domestic producers compete effectively with established foreign producers in the international markets. Governments can also intervene in trade by imposing restrictions on the amount of goods and services that can be produced and sold in the international market during a particular period of time. Such restrictions are called quotas and play a crucial role in stabilizing supplies in the domestic and international market (Hamilton & Stiegert, 2002). Some governments offer export financing to domestic companies that are engaged in export business. Export financing makes domestic firms products cheap hence more competitive in the international markets. Other governments have established foreign trade zones with their trading partners. These zones allow certain goods and services to pass through specified geographic zones under minimum or low custom procedures. Because of the high competitiveness of international markets, other countries have established trading agencies to promote domestic products and services. Such agencies help organize trips for domestic producers and local trade officials to foreign countries for the purpose of promoting export products (Kreinin, 1995). A government can also intervene in trade by directly discouraging the importation or exportation of certain goods. This intervention can be in the form of strict bureaucratic rules and administrative delays. In some cases, a government can impose restrictions on importation of currency to restrict importation of certain commodities (Hamilton & Stiegert, 2002). a) Political Motives for Government Intervention in Trade Political motives for government intervention in trade often relate to the need to protect the interests of some groups within a nation such as producers. The main political motives for government intervention in trade are: i. Protection of jobs (unemployment) Protection of jobs is the most common argument used by politicians to support government intervention in trade. High unemployment rate can have political impacts on the government and it, therefore, becomes necessary for the government to protect jobs and industries from unfair foreign competition. As an example, the United States government placed a tariff on steel imports in 2002. The import tariff was designed to protect imminent dismissal of steel workers due to cheap steel imports and hence was a good initiative by the government to protect employment in the steel industry (Hamilton & Stiegert, 2002). ii. National Security Certain industries are of central importance to a nation’s security that they require regular government supervision. Defense related industries such as aerospace, advanced electronics and nuclear industries often get preferential attention from the government. As an example, semiconductors have become an essential component of defense products such that it could be extremely dangerous to rely fully on foreign production (Kreinin, 1995). This argument was used in 1986 to persuade the United States government to offer subsidies to Sematech, a semiconductor manufacturing company. The subsidies have helped the company to grow tremendously, and it is now a global leader in the industry. Some countries have invested in exploration of oil within their territories for fear that in case of a war or some other conflicts they are not cut off from the supply of the commodities (Hamilton & Stiegert, 2002). iii. Retaliation against unfair practices by another country or trading partners Governments often intervene in trade to retaliate against unfair practices of other nations. Retaliation is mostly used as a bargaining tool to compel other countries to open their market for foreign trade and to force trading partners to stick by the rules of the game (Stolper & Samuelson, 2001). In the past, the United States government has threatened to use punitive trade sanctions to force the Chinese government to enforce America’s intellectual property laws. Before the enactment of these laws, the Chinese had been costing American companies millions of dollars in lost revenue. Although this was a risky strategy used by the United States government, it compelled China to tighten its enforcement of intellectual property laws (Hamilton & Stiegert, 2002). iv. Protection of Consumers Governments often interfere with free trade to protect consumers from exploitation or from consuming harmful products. Such interventions have the effect of limiting the importation of the harmful products. In 2003, the European Union and several other countries banned the importation of certain meat products from the United States (Hamilton & Stiegert, 2002). This was in response to a reported case of a deadly disease that affected cows in the United States. The ban was motivated by the need to protect beef consumers in importing countries against unhealthy products. The ban had deleterious impacts on the American meat exporters and forced the American government to reconsider its food safety policies (Stolper & Samuelson, 2001). v. Further foreign Policy Objectives Some countries intervene in trade or use trade policies to support their foreign policies or to force other countries to accept certain policies. Governments in powerful countries have always offered preferential trade terms to countries with which they want to build strong political and economic relationships (Reimer & Stiegert, 2006). Other countries have used trade policies on a number of occasions to put pressure on states that do not abide by international or regional standards. As an example, the world’s most developed nations including Britain, the United States, France and Germany have in the past imposed trade sanctions against Libya for its alleged involvement in financing terrorism and for pursuing nuclear ambitions. These sanctions were so severe and economically crippling that the Libyan government in 2003 formally halted its nuclear ambitions. Similar trade and investment sanctions have also been imposed against the governments of North Korea, Iraq, Syria and Iran, all of which have been accused by the international community of threatening world peace by seeking to acquire nuclear weapons. From1960, the United States and her major economic partners have imposed trade sanctions against Cuba. The principal objective of these sanctions was to impoverish the country with the hope that the communist government would collapse and be replaced by a democratically elected government (Helpman & Krugman, 2001). vi. Protection of human rights. Some countries intervene in trade with their partners in order to protect and promote human rights in other countries or to bring about speedy enactment of democratic reforms. As an example, the United States government has for along time been skeptic in its trade relations with China because of the latter’s poor human rights record and lack of democracy. America’s selective trade with China compelled the Chinese government to make rapid improvements in its human rights record and to abandon communist policies in favor of active capitalism (Reimer & Stiegert, 2006). This has made China’s to make swift economic progress within a very short time and today, China is a leading global economic player. The United States also took similar measures against the Soviet Union before its breakup in early 1990s. b) Economic motives for government intervention in trade From the economic perspective, the reasons for government intervention in trade are related with the need to boost a country’s wealth to the benefit of both consumers and producers. The main reasons for government intervention in trade are: i. Infant industry protection and industrial promotion argument Infant industry argument is the most favored argument for government intervention in trade. According to this argument, less developed countries have the potential for comparative advantages in production but newly established industries in these countries can not compete effectively with established industries in more developed countries (Sally, 2008). In order for manufacturing to take roots in the less developed countries, the infant industry argument holds that it is imperative for governments to support new industries, at least temporarily until they are mature enough to face international competition (Escaith & Gonguet, 2009). The support can be through subsidies, tariffs or import quotas and has been used by several countries to fend off foreign competition in order to stimulate raid growth of domestic industries. A key shortcoming of the infant industry argument is that protection against foreign competition does no good unless the protection streamlines and makes the industry efficient. As an example, Brazil built one of the top ten largest automobile industries in the world. This was made possible through quotas and tariff barriers but when the barriers were removed in 1980s, cheap imports from the United States flooded the Brazilian market making it one of the most inefficient by international standards (Reimer & Stiegert, 2006). Policy makers in developing countries have often considered subsidies and tariff a useful tool to develop sensitive industries in the agricultural, service and manufacturing sectors. This objective is strongly linked to the infant industry argument in the view that in the presence of competition from more developed countries, less developed countries cannot develop new industries without government intervention. In his book, (Krugman, 2000) has explained that many of today’s industrialized countries successfully used infant industry protection strategy during the earlier stages of their development. The same applies to newly industrialized and emerging global economic leaders such as Turkey, South Korea, Singapore and Taiwan. The important role of government intervention is responsible for rapid industrial success of many countries in South East Asia (Brander & Spencer, 2001). Helpman and Krugman, (2001) have argued that the need for government intervention in trade rests with the existence of market failures in some industries. Government support often cause resources to be utilized in an industry in the most optimal manner. This is especially the case if subsidized products are exported and cause deteriorations in terms of trade. When there are market imperfections or distortions, optimal policy interventions are required to address the distortions directly, a role which is played by the government. Thus, whenever there are market imperfections, government interventions, whether in terms of tariffs or subsidies help improve industrial efficiency and promote industrial production (Escaith & Gonguet, 2009). Another important argument that has been cited to explain government intervention in trade involves coordination and information problems. Learning spillovers among producers and informational barriers to entry are variants to the infant industry argument. This happens to be case where firms gain productivity advantages through learning-by-doing to other firms rather than the ones that do the actual production (Dong, Marsh & Stiegert, 2006). Information problems faced by domestic industries have provided reasonable justification for government intervention in trade. To bridge the information gaps, governments often support research and development programs besides offering other benefits which are critical to bypassing informational challenges. As an example, the government of Japan offered millions dollars in assistance to its automotive industries to conduct R&D programs in order to bridge information gaps between Japanese and American industries. This assistance helped Japan’s automotive industry to experience rapid growth and today, Japan is a leading automotive producer in the world (Dhar, 2006). Imperfections in capital markets have been used to justify subsidized credit insurance for export products. The process of entering into new industrial activities can only be efficient if producers are allowed to borrow funds at rates which take into account social costs and the risks associated with the new activities. However, capital markets are part of those that are affected severely by information problems. In developing countries, equity markets are often weak or missing while credit is rarely allocated to the highest bidder. As a result, capital is allocated by evaluation procedures that are different from what could be found in perfect markets. But if the private cost of capital is higher than its social cost, it becomes imperative for the government to subsidize credits hence the need for government intervention (Borchert & Mattoo, 2009). ii. Strategic Trade Policy Through appropriate actions, a government can boost industrial growth by ensuring that firms make first time moves to invest in certain key industries and markets. It is for this reason that governments offer subsidies to promising firms that are active in newly emerging and promising industries (Bown, 2009). For example, the United States government gave research and development assistance to the Boeing in 1950s and 1960s. This assistance help tilt the file of competition in the newly emerging market of passenger planes in Boeing’s favor. In another example, Japan has dominated the production of liquid crystal display screens. Although the United States pioneered the production of these screens, the Japanese government in collaboration with major electronics companies invested in the industry and supported research programs in 1970s. This has seen Japan dominate the market instead of the United States (Dhar, 2006). It also pays for a government to intervene in trade by helping domestic industries overcome discouraging barriers to entry created by foreign firms which have already taken advantage of first time moves (Helpman & Krugman, 2001). This argument underlies Europe’s support of Airbus Company, which is Boeing’s main competitor. Airbus is a consortium of companies from Britain, France, Germany and Spain and had only 5% of the global aircraft manufacturing market when it started production in mid 1970s. By 2006, Airbus had increased its market share to more than 45%. This was made possible through massive subsidies offered by the government without which the company could not have broken into the world market (Brander & Spencer, 2001). Governments offer assistance to domestic exporters by supporting any activities dealing with the export facilitation, participation in fairs and image building. Export assistance to local producers has been available in developed countries for a very long time and has helped stabilize industrial production (Brander, 2005). Institutions responsible for export promotion programs vary from one country to another and include governments and private sector organizations. Export assistance programs by the government can be divided into two categories: activities providing information on a country’s production potentials and activities providing information about a country’s export opportunities. The two categories have proven justifiable grounds for government intervention in export activities (Newman, Fulton & Glaser, 2003). iii. Revenue Collection There are numerous opportunities for a government to gain revenue from foreign trade transactions. For this reason, governments often intervene in trade to regulate and restrict production and movement of goods to and from the country. Majority of countries have rules that goods must be brought into a country or leave the country at particular locations. This makes it easy for the government to impose and collect import and export revenues on the goods (Borchert & Mattoo, 2009). c) Cultural Motives Governments intervene in trade with the objective of protecting their countries’ cultural identities. Certain imports can be culturally offensive to the people and hence governments intervene to prevent the importation of such products. For instance, pork products are culturally offensive in Saudi Arabia and some other Muslim countries. Accordingly, the government of Saudi Arabia has a strict policy on food retailers not to import pig products into the country. This restriction forced McDonalds, the world’s largest food retailer to offer a vegetarian menu instead of pork in Saudi Arabia (Bown, 2009). In order to preserve and promote the unique culture of its people, the government of Canada implemented a legislation requiring that a third of all the music played in local radio and TV stations be composed by Canadian musicians. In addition to preserving the country’s unique and highly diversified culture, the legislation helped protect Canada’s music industry which was under constant attack from the United States music industry (Brander & Spencer, 2001). Some countries have strong economic and political influence over other countries. Uncontrolled influx of cheap products from developed countries can be a threat to other countries’ cultures. For instance, the United States has a strong influence in the global entertainment and media industries. Importation of media and entertainment products from the United States can be a cause of concern for some countries. Iran has for instance enacted laws which make it offensive for women to dress in Western styles and outfits because such dressing styles are considered anti-Islam. For fear of French language being overrun by English, France has enacted laws banning use of English words in public announcements and government communications whenever appropriate words are available (Brander, 2005). References Brander J.A. and B.J. Spencer, (2001). “Tariffs and the extraction of foreign monopoly rent under potential entry” Canadian Journal of Economics, 14(1), pp. 371-89. Brander J.A., (2005). “Strategic trade policy”, National Bureau of Economic Research Working Paper No. 5020. Bown, C. P. (2009). “Protectionism continues its climb: A Monitoring Update to the Global Antidumping Database”. Brandeis University and The Brookings Institution. Mimeo. Borchert, I. and A. Mattoo (2009), “The Crisis-Resilience of Services Trade”, Policy Research Working Paper 4917, The World Bank, April. Dhar, B., (2006). “Modelling the Doha Round outcome: A critical view. ARTNeT Working Paper Series, No. 6. Dong, F., T. Marsh, and K. Stiegert, (2006). “State trading enterprises in a differentiated environment: The case of global malting barley markets”, American Journal of Agricultural Economics, 88(1), pp. 90-103. Escaith, H. and F. Gonguet (2009). “International Trade and Real Transmission Channels of Financial Shocks in Globalized Production Networks”, WTO Working Papers ERSD- 2009- 06, May. Hamilton, S.F. and K. Stiegert, (2002). “An empirical test of the rent-shifting hypothesis: The case of state trading enterprises”, in Journal of International Economics, vol. 58, issue 1, pp. 135-157. Helpman and Krugman, (2001). Trade Policy and Market Structure. Cambridge, MA: The MIT Press. Kreinin, M. E. (1995). International Economics: A Policy Approach. New York, N.Y: Harcourt Brace Jovanovich, Inc. Krugman, P.R., (2000). Rethinking International Trade. Cambridge, MA: The MIT Press. Newman, M., T. Fulton, and L. Glaser. (2003). A Comparison of Agriculture in the United States and the European Community. Economic Research Service, United States Department of Agriculture, Washington, D.C. Reimer, J.J. and K. Stiegert, (2006). “Imperfect competition and strategic trade theory: Evidence for international food and agricultural markets”, in Journal of Agricultural and Food Industrial Organization, 4(6), pp. 56-78. Stolper, W. and P.A. Samuelson, (2001). “Protection and real wages”, in Readings in the Theory of International Trade, American Economic Association. Sally, R. (2008). Trade Policy, New Century: The WTO, FTAs and Asia Rising. London: Institute of Economic Affairs. 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