Government Intervention in Trade - Essay Example

Running Head: Government Intervention in Trade (Name) (Course) (University) Date of presentation: Lecturer: Reasons for Government Intervention in Trade Governments often intervene in international trade for three reasons: economic, political and cultural or for a combination of the three. On various occasions, governments intervene in trade when they provide support to their domestic industries’ export businesses (Stolper & Samuelson, 2001). A government can also intervene in trade during tougher economic times, when local producers lobby the government to reduce imports or when workers in industries feel that they might be laid off. In all these cases, the government plays a critical role in streamlining economic activities and boosting industrial development and production. 1. Political motives for government intervention in trade The main political motives for government intervention in international trade are: a) Protection of jobs and unnecessary laying off of workers Governments often intervene in trade so as to protect laying off of workers in case domestic industries close down due to stiff competition (Helpman & Krugman, 2001). To protect jobs, a government can offer subsidies and cash bailouts to domestic firms that are faced with stiff competition from foreign companies. A government can also offer domestic industries access to low interest loans so that they can face market competition (Stolper & Samuelson, 2001). b) Preservation of National Security Issues of national security are of strategic importance to a nation and the lives of its people. Governments often impose restrictions on the production and exportation of certain industrial products such as those related to defense. In most cases, industries related to national defense and production of war materials will often get government funding and this is true for both import and export trade (Helpman & Krugman, 2001). In order to survive, all countries need to arrange their defense for possible military attacks. This important task cannot be left to the private sector because national security is an issue of public importance (Helpman & Krugman, 2001). It is, therefore, possible that a government must subsidize it defense industries, notwithstanding the fact that defense establishments are usually operated by the government itself. In other cases, a government intervenes in trade to ensure that certain defense products are not sold to enemy countries or terrorist groups. The United States for instance has a policy which restricts exportation of classified military appliances and technologies to other countries for fear that these technologies and appliances can be used against the country and its people in case of a war. Newman, Fulton and Glaser (2003) have noted that certain resources are vital to the lives of the people and are critical to realization of national security objectives. These resources include energy products such as oil and coal. Countries that are dependent of importation of those products might be disadvantaged in case international conflicts disrupt their capability to access those products. This consideration has been used as a basis for government support of domestic exploration of such valuable resources (Sally, 2008). c) Retaliation against other countries’ unfair trade practices It is strongly argued that free trade cannot be fair if some countries actively seek to protect their domestic industries by implementing tariffs and other forms of trade barriers. For this reason, governments intervene in trade to get their trading partners to align their foreign trade policies with the desired terms and regulations. Retaliation has been used in a number of occasions to get trading partners comply with the rules of the game (Newman, Fulton & Glaser, 2003). d) Furtherance of foreign policy objectives and gaining influence over other nations Governments of more dominant and larger nations intervene in trade relations with their partners especially weaker nations to gain political and economic influence. As an example, the United Kingdom has over the years gained strong influence over her former colonies in Africa and other continents (Krugman, 2000). This influence has made the United Kingdom a major trading partner for these countries. Similarly, the United States of America has for a long time developed close trade relations with countries in South America and the Caribbean. This has made these countries to develop strong economic dependence on the United States. 2. Economic motives for government intervention in trade The main economic motives for government intervention in trade include protection of infant industries and pursuance of strategic economic objectives. a. Protection of infant industries Economists have argued that infant industries need some amount of government support and protection so that they can grow and compete with well established industries from foreign countries. According to Krugman (2000) majority of industrially stable countries attained such status because they at one time protected their infant industries from foreign competition. Accordingly, protection of infant industries has become the most important reason for government intervention in trade. The reason for protection of infant industries is that businesses need firms need time to attain growth, maturity and knowledge necessary to become innovative and efficient. According to Reimer and Stiegert (2006) poorly supported infant industries are not likely to grow into competitive forces in the market because of lack of resources. b. Pursuance of strategic investment and trade policies Governments pursue certain strategic trade policies in order to increase revenue collection. For instance, governments can gain immense benefits by capitalizing on first-mover advantages (Willett, 2005). As such, a government can intervene in trade by supporting domestic industries that invest in emerging markets by offering subsidies, low interest loans or by offering tax reliefs. Strategic trade policies are those that affect the strategic outcomes of interactions in a potential or actual international oligopoly (Kreinin, 1995). The main idea of pursuing strategic trade policies is to raise the raise welfare by shifting profits from foreign firms to domestic producers. A common application in development of strategic trade policy is the use of export subsidies, import tariffs and R&D to firms facing global competition. These programs enable domestic companies to become sufficient in production and hence competitive in the international markets (Dhar, 2006). c. Correction of Market Failures A government can intervene in international trade practices to rectify market failures. According to Hamilton and Stiegert (2002) a country’s economic development follows the principles of optimization in which the marginal benefits should exceed the marginal cost for any meaningful policy changes. With properly defined costs and benefits, the principle of optimization has been used to explain economic behavior in countries. Governments apply these principles in deciding how to produce optimally in order to attain economic growth objectives. Domestic consumers apply the principles of optimization in order to decide how much to consume. Most governments rely on optimization principles in order to decide on how and when to intervene in international trade practices. Borchert and Mattoo (2009) have noted that governments intervene in international trade so that government policies can redirect the economy towards a certain preferred outcome. This is why it is common for countries to levy taxes or introduce subsidies, which in turn alter marginal costs and marginal benefits for the businesses involved in international trade (Reimer & Stiegert, 2006; McArthur & Marks, 1998). d. Distribution of Income In highly competitive economies, income accrues to whoever owns an economy’s productive assets in direct proportion to the level of their productivity. As such, the government has a legitimate reason to intervene in international trade practices to enhance fair distribution of income and wealth (Dhar, 2006). Depending on who is in control of the production process and the government, trade practices can end up benefiting very few individuals rather than the people who deserve it. It is for this reason that international trade policies enacted by governments are usually designed to shift wealth from some people to others without necessarily changing the country’s available resources. Changes in government policies in respect of income distribution occur in real time and are usually anticipated by the people whom they affect. This results in individuals and firms changing behavior to avoid adverse consequences of policy change (Escaith & Gonguet, 2009). e. Tax and revenue collection An important economic reason for government intervention in international trade affairs relates to the need to raise revenue form duties and taxes. Almost every government in the world has set up a body that is responsible for collecting revenue from import and export activities. These bodies are usually based at the points of entry and exit such as airport, sea port and border check points (Hamilton & Stiegert, 2002). Governments have also enacted rules that products for import or export trade should be cleared at specific locations. This makes it easier for the country to monitor international trade practices and to levy appropriate taxes on such trade practices. These arrangements offer good opportunities for the government to gain additional revenue (Escaith & Gonguet, 2009). d. Conflict resolution in tax collection and free shares to all In corporation and income taxes, countries would like to collect the right amount of taxes due under laws and may not like to see other countries taking all the tax revenue. In issues of international trade, there are possibilities that some transactions are taxed more than once. Therefore, governments intervene in such trade to ensure that appropriate tax relief is given if the right amount of tax has been paid (Brander, 2005). Incidents of two or more countries fighting over the same tax were so severe in the past that bilateral tax treaties and international trade agreements were formed to develop policies for allocating tax rights between countries. Further, these treaties and agreements were formed to provide a mechanism for resolving disputes in case of tax disagreements. The Organization for Economic Cooperation and Development (OECD) has made efforts to develop a framework for governments and their trading partners to reach bilateral and multilateral trade agreements to eliminate incidences of double taxation (Dong, Marsh & Stiegert, 2006). e. Attraction of foreign investments Governments intervene in trade to make the domestic market more attractive to foreign investment. Foreign direct investments are welcome to especially less developed countries to stimulate economic development and create jobs for the people. As such, foreign investors can be given preferential treatment and can be regarded with priority for investing in certain sectors. Priority can be given for investing in certain industries such as strategic industries such as defense. According to Brander (2005) particular attention has been directed at the sovereign wealth gained under the auspices of foreign investment. While foreign investments re welcome in various countries, there are always fears that they pave way for shadowy involvement of foreign countries in the domestic affairs of host countries. The need to regulate international trade practices has led to the formation of a number of trading blocks such as the North Atlantic Free Trade Agreement (NAFTA), European Union (EU) and the Association of South East Asian Nations (ASEAN). These blocks have helped eliminate several tariffs and other barriers in international trade (Dhar, 2006). 3. Cultural objectives Governments intervene is trade by restricting trade on certain goods and product so as to pursue certain cultural objectives. One of the most commonly cited cultural objective for government intervention in trade is the preservation of national identity. Harmful cultural influences in a country can cause concern for the people and the leadership alike (Borchert & Mattoo, 2009). This is why some countries in the Muslim world have banned the importation of Western songs and movies, since such entertainments are considered anti-Islamic (Kreinin, 1995). Policies for Government Intervention in Trade Governments use different policies to intervene in international trade practices and hence achieve protectionist goals. Tariffs: tariffs are a special kind of taxes imposed on imported goods to restrict their flow into the country. Tariffs rates vary according to the type of products imported and are meant to increase the cost of importing the products. The high cost of importing increase the price of the imported products in the local market thus making them less competitive. In some cases, tariffs can be imposed on exports. In economies with floating exchange rates, exports tariffs serve similar purpose as import tariffs. However, since most export tariffs have adverse impacts on the development of local industries, they are rarely used (Bown, 2009). Import quotas: import quotas are restrictions imposed on importation of certain commodities to increase the local market price of those commodities. Import quotas serve similar effects as tariffs. The only different between the two is that tax revenue gained from tariffs is distributed to the individuals who receive import licenses. Some economists have argued that import licenses should be auctioned to the highest bidders so that import quotas can be replaced by more equivalent tariffs (Dong, Marsh & Stiegert, 2006). Administrative barriers: some countries use administrative rules as a way of restricting international trade. These administrative rules may relate to food safety, electrical safety and environmental safety. As an example, the United Kingdom passed a legislation limiting importation of energy saving bulbs from China, citing difficulties in dumping the products. Although this legislation was enacted to protect environmental interests, it served protectionism measures. Some countries have enacted antidumping legislations to prevent dumping of cheaper foreign products in their local markets (Brander & Spencer, 2001). Subsidies: a government can offer subsidies to local producers in the form of cheap loans or lump-sum payments to enable them compete effectively in international trade. Subsidies are supposed to protect local jobs and to help local producers adjust to changes in international markets. Governments also offer export subsidies to increase exports. These subsidies increase the amount of trade in countries with floating exchange rates (Bown, 2009). Foreign exchange rate manipulation: some governments intervene in foreign exchange rates by lowering the values of their currencies. This raises the cost of imports and lowers the cost of exports and hence leads to improvements in the balance of trade. However such policies are only effective in the short run and can easily result into on inflation, which in turn raises the cost of exports (Brander, 2005). Restriction of imports: Governments restrict imports in order to encourage exports by companies based in their territories. The underlying objective is to boost their economies and bring in foreign currencies. Governments also restrict imports so as to protect their local markets from cheap foreign imports. When another country is suspected of keeping products from its domestic market unfairly or dumping low-priced products onto another country, trade wars can break out (Harris, 1984). Protectionist measures implemented in the form of quotas and high tariffs help restrict importation of certain types of products and effectively raise the cost of importing such products. This causes the prices of the imported goods to be increased so that disadvantaged domestic producers can be able to compete in the international markets. However, empirical researches show that protectionist measures can be counter-productive in the long run if domestic industries become inefficient and remain uncompetitive (Brander & Spencer, 2001). Certain measures are taken as legitimate steps to protect the security and safety of a nation’s people. For instance, a government can implement regulations stipulating that certain types of imported goods such as food meet approved safety standards, although some countries can use such measures as a form of disguised protectionism. Reference Brander J.A. and B.J. Spencer, (2001). “Tariffs and the extraction of foreign monopoly rent under potential entry” Canadian Journal of Economics 14, 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. 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