Cause and Effect of the US Steel Tariffs - Case Study Example

INTERNATIONAL BUSINESS ASSIGNMENT International Business Assignment Customer Inserts His/Her Name Customer Inserts Grade Course Customer Inserts Tutor’s Name 23, 10, 2010 International Business Assignment Introduction Comparative advantage is a theory used to justify the necessity for trade, as opposed to self sufficiency. By stating that different countries have different absolute and comparative advantages in their products, the theory explains how it is possible for countries with varying characteristics to trade for mutual benefit. However, governments often intervene in international trade to protect what they consider to be national interests, such as the tariffs against steel imports imposed by the US in 2002. This study discusses the impact of this intervention, and whether it has helped or hindered the industry it was supposed to protect. Definition and Characteristics of Comparative Advantage The comparative advantage theory was developed by David Ricardo in 1817 (O’Sullivan & Sheffrin 2003). Using the example of wine and cloth, he explained that trade in both goods between England and Portugal would increase their overall production, even though Portugal could produce more of both goods than England could. However, all costs are opportunity costs (Lee 1999). This means that although Portugal could be self sufficient in both commodities, the opportunity cost of producing cloth in Portugal, in terms of the amount of wine which Portugal would have to sacrifice, was greater than the opportunity cost of making cloth in England. Similarly, the opportunity cost of producing wine in England was greater than the opportunity cost of producing cloth in Portugal. Therefore Portugal had a comparative advantage in producing wine while England had a comparative advantage in producing cloth (O’Sullivan & Sheffrin 2003). The production of wine and cloth could be boosted by both countries specializing in producing the goods in which each country had a comparative advantage, and then trading the surplus with each other, which would lead to increased overall production of wine and cloth among both countries (Linder 1961). According to Deardorff (1997), comparative advantage is the low cost of a good compared to the cost of the same good in other countries. Therefore, it makes sense for a country to export a commodity if it has a comparative advantage over other counties in the production of that commodity (Deardorff 1980). Ideally, such a system would operate smoothly without the need for government intervention. However, governments do intervene in international trade, (Fletcher 2010), believing that a nation requires an absolute advantage in the production of all kinds of goods. However, this is impossible, since absolute advantage (or absolute disadvantage) in everything would eliminate the need for trade (Deardorff 1997). Nevertheless, governments are not always aware of the differences between absolute advantage and comparative advantage, and thus they try to influence world trade. This is referred to as protectionism (Keesing 1966). Most protectionist policies are implemented with the aim of boosting a country’s trade situation, but they often complicate the processes of world trade. Some protectionism can be attributed to revenue collection by governments (Deardorff 1997). One of the characteristics of comparative advantage is that some parties will benefit, and others will lose out, but that the benefits of trade are greater than the costs of trade (Lett & Bannister 2009). This is referred to as the Normative Law of Comparative Advantage. However, when the government of a nation feels that it is at the losing end of international trade, it adopts protectionist policies. Government Intervention in International Trade Whenever the government interferes with international trade for the purpose of protecting its own production and trade, this is referred to as protectionism (Buchanan 1998). The main causes of protectionism include a strong preference for self-sufficiency, caused by ignorance of the benefits of comparative advantage, as discussed above. Another reason is to help producers in local economies to survive in the international marketplace. Governments also intervene in trade to prevent dumping, which is the selling of export goods in their destination markets at lower prices than those in the market of origin. Protectionism is also used to protect key industries which are crucial to a country’s survival, such as agriculture, and to maintain employment levels. Another reason commonly given for protectionism is to give new domestic industries time and space to establish themselves and to develop a competitive advantage, as was done to protect the US semiconductor industry (Sarooshi 2004). Governments also impose tariffs, which are taxes on the import or export of goods and services (Krugman & Obstfeld 2003). The Bush administration used import tariffs to limit the quantities of steel being imported into the US, which was hurting the American steel industry. Indeed, import tariffs are the most common form of tariff for protectionist policies (Ohlin 1952; Courant & Deardorff 1992). In addition, quotas have been used to regulate the importation of steel into the US (Porter 1985), especially against countries that produce it in large quantities. Last but not least, non-tariff barriers are used to block imports. They mainly exist in the form of administrative regulations which govern packaging, health and safety, and so on (Helpman & Krugman 1985). Although quotas have been used to regulate steel imports to the US in the past, tariffs were the main form of protectionism preferred by the Bush administration. All of the aforementioned reasons for government interference in trade are driven by economic and political self interest. However, governments may not realize that it is in their national interest to promote international trade. For instance, the emphasis on opportunity costs rather than actual costs in the comparative advantage theory means that governments always have cheaper alternatives to interfering with trade, but that they hardly ever choose these alternatives (Neary 2003). As the comparative advantage theory provides for winners and losers, it means that for every loss (such as loss of jobs in the steel industry) there will be gains in other sectors (cheaper imported steel may boost construction and car making). The example of US steel tariffs shows what happens when a government decides to take “the easy way out,” so to speak, by imposing tariffs. Cause and Effect of US Steel Tariffs According to Sarooshi (2004), the US employed quotas (known as Voluntary Export Restrictions or VERs) against steel producers in Europe and Japan from the 1970s, in order to save domestic jobs. This state of affairs continued until 1997, when the Asian financial crisis led to a huge drop in demand for steel in Asia. As a result, steel producers in Asia and elsewhere began to look for new markets for their products, and they turned to the United States. Steel imports to the US increased 33% over 1997 (World Economic Forum 2000). This coincided with strong demand for steel in the US, which led to a price war, with the prices of imported steel falling ever lower, to the detriment of US steel producers. This led to massive losses for American steelmakers, bankruptcies and layoffs. The situation persisted until 2002, when President George W. Bush made a Presidential Proclamation, on March 5, 2002, to impose an up to 30% tariff on imported steel, which would be phased out over a 3 year period, in accordance with World Trade Organization (WTO) rules (World Economic Forum 2000). However, the causes for the decline of the US steel industry were more complex than the glut in supply caused by the Asian financial crisis (Lattimer 2003). The Voluntary Export Restrictions (VERs) of the 1970s against foreign produced steel meant that American steelmakers could stay in business, but this affected their ability to innovate. As argued by Sarooshi (2004), steel producing firms in the US became less competitive, finding it easier to lobby for protection than to invest in research and development. Consequently, American steel producers were caught completely unawares by the sudden influx of cheap steel from the late nineties onwards. The tariff imposed by President Bush was intended to seal this loophole. Thus it is fair to say that to some extent, the US set itself up for the steel crisis, and that the Asian financial crisis was just the trigger (Leipziger 2001). The consequences of the US steel tariff were more far reaching than President Bush could have imagined, as other steel producing nations reacted sharply to the measure (Gomme 2002). They argued that the tariffs were based on political considerations, rather than economic ones. In retaliation, the EU slapped a 26% tariff on US steel, China asked for up to $350 million in compensation from the US, and other steel producers stepped up diplomatic pressure to persuade the USA to reconsider its decision (Gomme 2002). A series of complaints were filed at the WTO against the US measure. The EU was particularly concerned, as it feared the global oversupply of steel would be redirected to its own borders (Krugman & Obstfeld 2003). Under the WTO rules, countries are allowed to impose tariffs against dumping (selling in foreign markets at a lower price than the producer price) and to impose countervailing tariffs (tariffs by one country in response to the tariffs of another country) (Hill, Cronk &Wickramasekera 2008). However, the US steel tariffs did not comply with either of these forms; therefore the complaints against the US in the WTO were successful (Sarooshi 2004). As a consequence of the bitter international opposition to the US steel tariff, and the WTO decision against the US, on 8 December 2003 President Bush made another Presidential Proclamation which rescinded the tariffs of the previous year. Thus the Bush tariffs potentially sparked a trade war. This raises the question whether the steel tariffs were justified. In the opinion of the US government, the tariffs were justified, because they gave the US steel industry time to restructure itself (Chang 2008). However, from a comparative advantage point of view, I would say that the US steel tariffs were not justified, for a number of reasons. To begin with, one of the main concerns of the US government was job losses in its steel industry. The government overlooked one of the main characteristics of comparative advantage, namely that the benefits of trade exceed the costs. According to (Samuelson 2004), the steel industry in the US employs less than 200,000 people, while the industries which consume steel in the US employ at least 12 million people. Thus the loss of jobs in the US steel sector would have been offset by employment growth in steel consuming industries, which were the main beneficiaries of cheap imported steel. Thus, by imposing tariffs, the US missed a chance to boost employment in a wide sector of the economy, by focusing on maintaining a few jobs in an uncompetitive industry (Day & Wensley 1988). The steel tariffs were also not justified because they were seriously detrimental to world trade. Import tariffs can be used to regulate prices in industries which experience wide fluctuations in supply and demand, such as agricultural produce. Due to the seasonal nature of such products, the tariffs are usually imposed for short periods of time. However, with durable goods such as steel, the shifts in supply and demand occur over longer cycles (Vernon 1961). Thus, the decision to impose tariffs on steel products would have perpetuated the oversupply situation, and forced down the prices of world steel. Furthermore, the tariffs were imposed at a time when the US demand for steel was still high. Thus the argument that the decision was not based on economic considerations had the ring of truth about it. Finally, the International Institute of Management Development (2000) argues that the major problem with the US steel industry is the lack of innovation fostered by protectionism. While the US was imposing quotas on foreign steelmakers in the 1970s and 1980s, steelmakers in other countries were finding cheaper and more efficient ways to boost their production. Thus, if the US steel industry is to survive, it must open up to market forces and either sink or swim, as the US government often recommends other economies should do. Competition will weed out the inefficient producers of US steel, and allow the best firms to compete with the best in the world. This will safeguard a few jobs, particularly those of skilled workers. Those workers who lose their steel making jobs will be able to move to other sectors of the economy which have benefited from free trade, in accordance with comparative advantage. Conclusion After discussing the meaning and applications of comparative advantage, it is reasonable to conclude that international trade could not possibly exist if all nations strove to be self sufficient in everything, and to have absolute advantage in the production of all types of goods. Therefore, the imposition of tariffs should take into consideration all of the factors involved in international trade, without letting political factors or misinterpretations of economic theory. The US steel tariffs can be explained by the close connections between business and politics in the United States, which lead politicians to make decisions on economic policy that will safeguard their own position domestically, without thinking about the worldwide ramifications of their decisions. For these reasons, I feel that the steel tariffs imposed by the United States are not justified. References Buchanan, PJ 1998, The Great betrayal: How American sovereignty and social justice are being sacrificed to the gods of the global economy, Little, Brown and Co., New York. Courant, PN & Deardorff, AV 1992, ‘International trade with lumpy countries’, Journal of Political Economy, vol. 100, no. 1, pp. 198-210. Day, GS & Wensley, R 1988, ‘Assessing advantage: a framework for diagnosing competitive superiority’, Journal of Marketing, vol. 52. 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