What Is Strategic Trade, Anti-Competitive Protectionism - Assignment Example

Strategic Trade Name Course Instructor Date What is strategic trade? Strategic trade is defined as a trade policy which is adopted by governments so as to influence strategic trade interactions between its firms and other international firms in an oligopolistic market or an industry with a few firms as the main players. Essentially, strategic trade aims at shifting excess profits towards the firms of the home country. It involves adoption of policies such as subsidies, import tariffs, outright grants, promises of buying large volumes of production as well as the issuing of loans at interest rates that are below the standard market rates. Through strategic trade policies, governments assist the local firms to get an upper hand over foreign firms in the market. Since this is intervention, trade agreements are emphasized in order to limit any harmful effect of strategic trade policies by different governments (Durlauf, Steven & Lawrence, 2008, p.1-2). The idea of strategic trade aims at helping raise domestic welfare in a given country. Governments therefore pursue policies that can help their local industries that face global competition from foreign firms. These policies can only be enacted in a market where there is strategic interaction between the main firms in the industry. In such a market, the action of a given firm significantly affects the action of the other firms. This is mainly present in duopolistic and oligopolistic markets where there are few players and actions of one firm influences the decisions of the others. For instance, if one firm increases its production the other firm may be forced to reduce its own because the increase in supply would lower prices and profits (Gandolfo, p.231, 1998). The theory of strategic trade is centered on the assumption of an international duopoly in the market. The theory has been studied extensively since its advancement is 1983 by Brander and Spencer. The picture in mind is that of two firms. One is a domestic firm and the other is a foreign firm but both are competing in a third country market and the state of that market is an oligopoly. According to the theory, when a domestic firm which competes in an international oligopoly market receives support from the government of its home country, it is able to compete successfully with the other firms (Siebert, 2002, p.245).The firm is able to cut its operating costs and increases its profits as a result. This contributes to a significant improvement in national welfare. In the first model of strategic trade policy by Spencer and Brander, implementation of the policy takes three stages. In the first stage, the firm is given an export subsidy or a research and development (R&D) subsidy, or both. This helps initiate the process of shifting profits from foreign firms to the domestic firm thereby increasing the overall welfare of the country. After this stage, the policy enters the second stage. The research and development subsidy enables the domestic firm to commit and initiate higher levels of research and development. Research and development is crucial for the survival of a company especially where the market is competitive and where firms are continually revising the design and range of their products. Nowadays, R&D is necessary due to the evolving technology and firms can no longer rely on acquisitions and strategic alliances in order to be able to benefit from the innovations of other firms. Lastly, in the final stage, the domestic firm has developed an upper hand over the foreign firm thus forcing it to reduce its exports. As a result, the domestic firm is able to compete effectively with the foreign firm in the third country (Grossman, 1995). In the standard model, a two-stage game is envisaged. In the first stage, the government gives an export subsidy to the home firm to help it in the production of the homogenous product. In essence, the government lowers the operating costs for the domestic firm in order to enable it produce its products at low costs and be able to sell them at competitive prices in the third country. In the second stage, both the domestic and the foreign firm choose the quantities they will produce and export to the third country. When maximizing profits, each firm assumes the other will produce the quantity it says. Due to the subsidy, the local firm is given the impetus to sell more of its homogenous product to the third country regardless of the export level of the foreign firm. Since they are selling homogenous products, the firms are strategic substitutes. As such, the foreign firm is forced to reduce its production level. With an increase in the export subsidy, the local firm is able to produce and export more at lower prices thereby lowering the prices and increasing its profits at the expense of the foreign firm. In other words, the profits are shifted from the foreign firm to the domestic firm. The effect is a rise in national welfare which is given by the profits made less the government subsidy (Stiglitz & Muet, 2001). Does strategic trade foster competition or, alternatively, facilitate anti-competitive protectionism? Strategic trade has attracted varied views since its advancement in the early 1980s. It has varied influences on how markets operates. Some of these policies have advantages which nurture completion while others facilitate anti-competitive protectionism through strategic interaction between governments and firms of different countries. This is illustrated below. 1. The importance of strategic trade and how it fosters competition. The main importance of strategic trade is that it can be used by governments to raise the level of domestic welfare. By helping domestic firms become more competitive in foreign markets, profits shift from other countries to the home country. However, this may not always be the case in practice because some governments may engage in this form of trade interventionism due to a narrow interest of certain political players who have stakes in specific industries rather than for the interest of the national economy (Brander & Spencer, 1985, p.98). The other importance is that strategic trade helps nurture competition. Without this intervention, the first firm to enter into new markets would always win and thereafter deter entry by new potential rivals since they would gain a first mover advantage. This advantage would always fall into the hands of the well-established and large scale economies thereby resulting to unfair completion. Once a firm has entered a new market as the first mover and established itself in large scale, it enjoys low production costs that give it an upper hand over new rivals which are in the process of establishing themselves in the market. The high production costs incurred by new firms render them unable to produce in large scale and sell at low prices, which is necessary if they are to establish themselves and be able to compete with the already established first movers. Strategic trade helps such firms establish themselves and be able to compete with the already established firms in foreign markets (Yadav & Sanjay, 2009, p.98). Another critical argument for strategic trade policies is that of externalities and industrial policy. To increase national welfare and competitiveness of a nation, the government has to foster national key industries which exhibit positive externalities. Governments promote these industries by acting strategically with the aim of preserving social benefits provided by the industries (DeCarlo, 2007, p.6). Government intervention through strategic trade policies also motivates late comers to enter into industries where there are well established players making it difficult for new entrants. Strategic intervention enables these late entrants to challenge the first movers successfully. An example of an industry where this form of intervention is necessary is the aircraft industry. There are few firms and entering into the industry is difficult due to competition, capital requirements and other barriers. In such an industry, a government can help a local firm establish itself in the international market by giving it export subsidies to enable it compete with the established firms. In so doing, it can eventually shift the excess returns available in the given market from foreign players to the home economy (Carbaugh, 2011, p.221). The other argument in favor of strategic trade policies and how they foster competitiveness is that this form of government intervention can help new players into already established high technology industries with the aim of challenging and competing with the already established players. Through measures such as financial assistance, subsidies and guarantee of a market for its products, governments enable firms to enter into competitive markets and compete effectively with the established firms. Governments may also impose import tariffs and quotas to keep foreign goods out of the home country with the aim of promoting local goods. The combination of these interventionist measures by governments help new firms enter and compete effectively in international market. This fosters competitiveness as each firm tries to get an upper hand over its rivals (Macdonald, 1999, p.362). 2. How strategic trade facilitates anti-competitive protectionism Strategic trade theory is criticized with arguments that instead of fostering competition, it facilitates anti-competitive protectionism. When a government enacts policies that favor its domestic firms at the expense of foreign firms, foreign firms enact similar policies in retaliation. This further hinders the prospects of free trade and eventually harms consumers instead of protecting them. The success of strategic trade policies depend on the inherent reaction of the foreign governments and firms. The government implementing such a policy therefore has limited influence on whether the policy will yield the desired results. For instance, if the foreign government retaliates by subsidizes its firms, both countries will be left in a worse off situation than they were in before intervention was adopted in the first place (Batiz & Oliva, 2003). Through research and development subsidies, the resultant benefits accrue to both domestic firms as well as the foreign firms they are competing against. This may thus hinder some countries from funding R&Ds in the fear that it will benefit foreigners instead of the local firms it is intended to help. In the modern global economy, there are multiple multinational firms and the level of telecommunication advancement mea economic boundaries are virtually nonexistent and any knowledge generated through such programs becomes available internationally. As such, to safeguard such new knowledge, some countries may engage in protective interventionism with the aim of holding onto such “innovations” in order to prevent spillover to rival firms and this leads to anti-competitiveness (Afuah, 2009, p.158). Another argument against strategic trade argues that there is scarce knowledge that can help determine the industry to target strategically. A strategic trade policy supporting one industry for instance with a subsidy is, on the other hand, a strategic trade policy against the other industries because they do not receive any help. This is complicated by the highly likelihood of inability by the government to determine the right strategic policies thus leading to massive policy failure. In such a case, it is likely to foster anti-competitive retaliation and be detrimental to the economy (Kamath, 1994). A good example to illustrate this and how lack of precise knowledge can lead to losses is the case of Airbus A300 versus Boeing 767. Airbus was given subsidies in the form of low-interest loan of about $1.5billion worth of 1975 dollars by European governments but it ended up losing the money after the launch of the A300 carrier. This shows that strategic policies can be disastrous either by failing to discourage foreign firms from producing in large quantities or by encouraging domestic firms to overproduce (DeCarlo, 2007, p.4) Strategic trade policy also has another weakness of vulnerability of such policies to interest groups pressure. This comes from the fact that the theory is founded on the implications of an imperfect market on government policies and assumes the government is all-knowing and that there is no pressure on those policies from interest groups. In normal markets, however, government intervention can never be a totally reliable basis for policy if it does not take into consideration the implications of opportunistic behaviors and imperfect knowledge on policy formulation and implementation (Brander & Spencer, 1985, p.98). Conclusion Strategic trade helps us understand how a country can increase its international trade competitiveness by devising and adopting strategic policies. The policies eventually shift profits from foreign countries to the home country. This can help engineer its economy and expand it (Brawley, 2005, p.155). These policies include subsidizing local firms and imposing import tariffs to help the local industries. It can also attract high-tech firms by relaxing environmental standards and operating requirements and which can in turn confer technological spillovers to the local firms in the industry. However, strategic trade policies also lead to implementation of protectionist barriers. In other words, these barriers are direct anticompetitive measures. These policies interfere with the flow of free trade and the macro-competitiveness that drives economies. In its attempt to foster competition, some of its pitfalls defeat this goal. It can therefore be concluded that even though some strategic trade policies are beneficial and end up yielding the intended goals, many of foster anti-competitive protectionism which undermines the effectiveness and benefits of free trade (Harrison, 1999, p.22). References Afuah, A. (2009). First Mover Advantages/Disadvantages And Competitor's Handicaps. Strategic innovation: new game strategies for competitive advantage (pp. 158-159). New York: Routledge. Batiz, L., & Oliva, M. (2003). Competition And Rivalry . International trade: theory, strategies, and evidence (pp. 217-220). Oxford: Oxford University Press. Brawley, M. R. (2005). The Politics of Trade. Power, money, and trade: decisions that shape global economic relations (p. 155). Peterborough, Ont.: Broadview Press. Carbaugh, R. J. (2011). Trade Regulations and Industrial Policies. International economics (13th ed., pp. 221-223). Mason, OH: South-Western Cengage Learning. DeCarlo, D. (2007). Industrial Policy as Strategic Trade Policy in a Global Economy. Undergraduate Economic Review, 3(1), 2-15. Durlauf, S. N., & Blume, L. (2008). Strategic Trade Policies. The new Palgrave dictionary of economics (2nd ed., pp. 1-2). Basingstoke, Hampshire: Palgrave Macmillan. Gandolfo, G. (1998). The New Trade Theories: An Overview. International trade theory and policy (p. 231). Berlin: Springer. Grossman, G. M. (1995). Handbook of international economics. Amsterdam: North-Holland. Harrison, F. (1999). International Trade. Theory and policy of international competitiveness (pp. 20-23). Westport, Conn.: Praeger. Kamath, S. J. (1994, August 1). The Case Against Managed Fair Trade and Strategic Trade : The Freeman : Foundation for Economic Education. Foundation for Economic Education. Retrieved May 4, 2013, from http://www.fee.org/the_freeman/detail/the-case-against-managed-fair-trade-and-strategic-trade#axzz2SLT4Ns1z Macdonald, N. (1999). The International Scenario. Macroeconomics and business: an interactive approach (p. 362). London: International Thomson Business Press. Siebert, H. (2002). National protectionism Versus World free Trade. The world economy (2nd ed., pp. 245-248). London: Routledge. Spencer, B. J., & Brander, B. (1985). Export Subsidies and International Market Share Rivalry. Cambridge, Mass.: National Bureau of Economic Research. Stiglitz, J. E., & Muet, P. (2001). Governance, equity, and global markets: the Annual Bank Conference on Development Economics, Europe. New York, N.Y.: Oxford University Press. Yadav, P. K., & Sanjay, M. (2009). The Political Economy of International Trade. International Business: Text And Cases (p. 98). New Delhi: Phi Learning. Read More