The Effects of Tariffs and Transaction Costs on International Trade - Literature review Example

The Effects of Tariffs and Transaction Costs on International Trade The Effects of Tariffs and Transaction Costs on International Trade International trade, also known as world trade, involves business transitions between two or more countries. International trade has been in existence for a long time history, but its social, economic and political significance has been increasing in recent years. Different factors and global events ranging from, political, social and economic issues affect market forces of supply and demand in international trade (Khatoon, 2013). International trade is also important because it enables international organizations such as the World trade Organization to analyze and examine trends in global economy. Other factors such as outsourcing, industrialization, growth of multinational companies, globalization and developments in science and technology contribute a lot to development of international trade. International trade is in contrast to domestic trade, which involves exchange of goods and services within one country. International trade is also more costly in comparison to domestic trade because of the various costs that are associated with exporting and importing products (Hauk, 2012). International trade can occur in two different forms namely, protectionism and free trade. Protectionism entails regulating trade between two or more countries in order to maintain efficiency. Protectionism is founded on the belief that there exist market inefficiencies in international trade that may make it difficult for countries involved to experience the desired benefits. Free trade, on the other hand, involves a laissez-fare approach, where there are no trade restrictions between countries. Proponents for free trade believe that market forces of demand and supply are enough rectify any inefficiencies in international trade (Milner, 2005). While most economists are of the view that free international trade is the better option, there are many challenges that make it very difficult to implement free trade on the international level. This is because countries feel the need to protect their domestic businesses, protect jobs, salvage failing industries, and protect consumers from harmful products (Milner, 2005). The US approach to international trade embodies protectionism. This approach has survived both criticism and support in almost equal measures over the years because of the short term and long-term effects that protectionist measures have on the economy. Among the most common protectionist measures that the US government uses to regulate international trade, include tariffs and other barriers such as quotas, licenses, export restraints, and local content requirements. A trade tariff refers to a form of tax imposed on imports. There are two main types of tariffs namely, specific and ad valorem tariffs. Specific tariff refers to a tax imposed on a particular imported product and varies from one product to the other. Ad valorem tariffs, on the other hand, are levied on products depending on a percentage of the value of the product. Ad valorem is a Latin phrase meaning ‘according to value’ (Hauk, 2012). Tariffs restrict international trade in the sense that they make imports more expensive in relation to domestic goods and services (Khatoon, 2013). The increase in prices of imports discourages consumers from purchasing foreign goods and services and lean more towards domestic products. International trade also has other components that increase the costs of trade between two or more countries. These other costs of international trade include transaction costs, time costs, and transport costs. Transaction costs include costs of negotiating and enforcing trade contracts and exchange rates. Time costs include delays between the duration of placing an order and the time of delivery of products in a foreign territory. Transport costs, on the other hand, include the costs of shipping goods and services to foreign countries. Success of international trade depends on how these costs, including trade tariffs, will be minimized. Tariffs and transactional costs can have both positive and negative effects on both the domestic and global economy. In the US, different presidential regimes implemented different approaches to international trade. These approaches have brought forth differences in political ideologies between republicans and democrats over the years. As a result, the US has endured some difficult periods in international business relations with its trading partners while also experiencing good periods with improved trade relations (Hauk, 2012). A major impact on American approach to international trade came in 1930 with the enactment of Smooth-Hawley Tariff Act under the Republican President Herbert Hoover. Proponents for the Act viewed it as a good way of protecting local jobs and industries during the Great Depression (Milner, 2005). There was need to protect American products and businesses from declining because of international products entering the local market. The Smooth-Hawley Tariff Act, therefore, aimed at restricting international trade by imposing tariffs on most of the imported products. The Act received a lot of criticism and opposition from Democrats, economists and some business executives, but the president yielded to pressure from his party and signed it into law. One effect that such a move can have on international trade between the US and its trade allies is to reduce the rate of international trade. Tariffs discourage investors and foreign businesses from selling their products in the US. Trade in products with high tariffs will certainly decrease as producers of the products will seek to enter other markets that will present a relatively cheaper option. This is because tariffs increase the costs of foreign products, ultimately affecting profitability of foreign producers (Khatoon, 2013). Trade tariffs can also destabilize business and political relationship between the US and its international trading partners. Business and politics are closely related and a change in one is likely to affect the other in international relations. Trade tariffs make it difficult for foreign companies to access a huge market in the US. The foreign trade partners will also feel the need to respond to these trade tariffs by retaliating against the US. Retaliation will come in the form of enacting trade restrictions to products from the US in their own territories. This is likely to bring business and political relations to a standstill. The Smooth-Hawley Tariff Act, for instance, affected the relationship between the US and its main trading partner, Canada, and many other countries (Hauk, 2012). Before President Hoover assented to the bill, he had received concerns and petitions from about 23 international trade partners requesting him not to assent to the bill. After the bill became law, several countries, including Canada responded by enacting similar tariff on American products. Canada’s tariffs and trade restrictions accounted for about 30% of American Exports to Canada (Milner, 2005). This had a huge impact on American exporters and broke down relationship between Canada and the US. As a result, Canada reached out to other countries Europe such as France and the British Empire to strengthen its international business. Another effect of tariffs on international trade is to discourage investment. International trade involved expansion of foreign businesses into foreign markets thereby creating more jobs and improving economies of both the foreign and home countries. Tariffs discourage foreign countries from entering American markets because of the huge transaction costs. This in essence affects the local economy because there will be fewer jobs and fewer prospects of real economic development. A multinational Canadian timber firm, Softwood, was greatly affected by trade tariffs (Milner, 2005). The firm opted to cut down its production. This led to the company relieving most of its employees off their services. Tariffs also imply that the US will not benefit from diversity and competition that comes with international trade. International trade allows a variety of products in the country, giving consumers a wide range of options to choose from. International trade also creates a competitive environment within the country where local businesses will have to raise their standards in order to appeal to more consumers. This ultimately affects domestic trade of the US in the long-term. Tariffs are mainly intended to regulate international trade, but they can also affect domestic trade to a great extent. Tariffs also lead to misallocation of resources among countries by opting to support inefficient businesses and products in the domestic market (Sourdin, & Pomfret, 2012). One of the main objectives of enacting tariffs on imports is to protect local companies and products in declining industries. The declining industries find themselves on the lower curve of economic growth because of various factors including inefficiency, mismanagement, and the inability to compete with foreign products and companies. When the country opts to support such businesses and product at the expense of promoting international trade that will provide high quality products and services to consumers is not a good economic and business choice (Sourdin, & Pomfret, 2012). Resources used to support these local companies could be allocated to support other projects and let international trade to thrive in the US. Tariffs also affect the value of exports of the country on the international scene. Continuous protection of local industries and products can greatly affect the country’s exports in future. Tariffs make it difficult for the country to import foreign technology, ideas and labor because of the high costs involved. This makes it difficult for the US to produce certain products using the required level of technical expertise. Local production can also become costly in the long run thereby affecting their competitiveness in the international market. Without the necessary skills and technology needed to manufacture products of high quality, the US is bound to suffer with regard to global trade because its products will not meet the international standards (Sourdin, & Pomfret, 2012). While the products may do well domestically, the prospects of being successful on the international scene are very slim. In conclusion, the impact that trade tariffs and transactional costs have on international trade cannot be understated. While enactment of tariffs is unavoidable in international trade, such a move should be approached with great caution. There should be a compromise on the types of tariffs and restrictions that trading partners can impose on each other. Two or more trading partners should focus on their competitive advantage and improve cooperation in areas where there is competitive advantage while restricting other areas. This will help to avoid conflicts of a political or business nature between trading partners. The US should therefore, move with haste in a bid to reform its international trade approach and become more accommodative to foreign products and businesses. The government can achieve this by entering into international business agreements or treaties with various trading partners in order to promote a harmonious business relationship (Khatoon, 2013). References Hauk, W. R. (2012). Trade restriction indices and US trade policy. Applied Economics Letters, 19(8), 795-799. Khatoon, S. (2013). Nature of Bilateral FTAs-The Case Study of US Israel, US Jordan and US Bahrain FTAs. International Journal Of Business Insights & Transformation, 6(2), 110-121. Milner, C. (2005). Protection by tariff barriers and international transaction costs. Scottish Journal Of Political Economy, 52(1), 105-121. Sourdin, P., & Pomfret, R. (2012). Measuring International Trade Costs. World Economy, 35(6), 740-756. Read More