The Ways in Which International Trade Can Be Affected by Governments Interventions - Literature review Example

The ways in which international trade can be affected by government’s interventions Introduction Adam Smith outlined that the price mechanism in international trade is like an ‘invisible hand’ that coordinates the consumption and production decisions in a well-functioning market economy (Kerr and Gaisford 2007). However, there is need for the government to intervene in free market economies in order to implement trade regulations and avoid market failure that is associated with negative externalities. International trade is affected by government’s interventions that include direct participation in supply and purchase of essential goods and services, through regulation, taxation and other indirect participation influences. The free markets enhance market efficiency through ensuring that prices are determined by the forces of demand and supply. According to Kerr and Gaisford (2007) International trade creates an incentive for the firms to ensure efficient allocation of resources and invest in innovative processes that ultimately lead to better quality goods and services. The governments intervene in international trade through use of tariffs, quotas, subsidies, reciprocal requirements, specific permission requirements, and quality standards, buy local trade policies, voluntary export restraints, embargoes, anti-dumping levies, and administrative delays (Misra and Yadav 2009). The interventions in markets have pervasive impacts on the consumption and production decisions of the firms and households. The rational consumer chooses the quantities they consume in a way that the marginal benefit is equivalent to the price and thus government interventions reduce consumer welfare (Misra and Yadav 2009). The trade flows (both exports and imports) decline thus leading to higher prices and reduction of customer marginal benefit. The profit-seeking firms choose to produce where the price is equivalent to the marginal cost of the last produced unit and when government measures affect their decision to produce. The interventions that lower the marginal costs of production such as subsidies will lead to increase in production (Kerr and Gaisford 2007). Governments intervene in international trade through use of tariffs that are levied on both imports and exports. The government may either impose fixed tariffs that are calculated per unit of the import commodity or the ad valorem tariff that is calculated as a fixed percentage of the monetary value of the imported commodity. The government imposes high import tariffs in order to control the rate of imports by making the imports more expensive in comparison to the domestically produced substitutes. The tariffs increase the prices of goods and services thus reducing the quantity demanded (Misra and Yadav 2009). The use of tariffs is detrimental to international trade since it lowers competition and results in high prices of commodities in the markets. The tariffs discourage imports and domestic producers benefit from the higher prices and reduction in competition. The EU uses variable levies to restrict importation of agricultural products such as sugar and beef while the US uses variable tariffs on products such as sweet corn, melons and barley. The EU Common Agricultural Policy (CAP) aims at protecting the domestic prices since the domestic producers are insulated from decline of world prices for wheat crops with an equivalent increase in EU variable levy thus protecting the local producers from foreign competition (Macdonald 1999). The governments may impose non-tariff international trade barriers such as policies and procedures that regulate the quantity of packaging and lengthy customs documentation clearance that aim at hindering international trade (Macdonald 1999). The government intervenes in international trade through provision of subsidies and other state aid to the local companies in order to foster growth of local industry (Misra and Yadav 2009). The economic rationale behind the subsidies is that national governments should protect infant industry from external competition and foster the competitiveness of the local companies. The governments shield emerging and strategic industries in order to ensure the country acquire comparative advantage and ultimately compete effectively in the world markets. The intervention will ensure that companies attain economies of scale in their production activities or acquire innovative technologies that are essential in ensuring competitive edge in international markets (Macdonald 1999). Government intervention measures can change the flow of foreign direct investments since multinational companies look for markets with low interest rates and low taxation (Misra and Yadav 2009). The government can provide tax holidays and other incentives such as low interest loans in order to create incentives for multinational companies to establish production activities in their country. In this case, the foreign direct investments will ultimately lead to higher tax revenues after the end of the tax holidays and create more employment opportunities for the domestic citizens (Macdonald 1999). Another government intervention is the economic protectionist policies that aim at creating employment by limiting imports since the local consumers are required to purchase domestically manufactured goods and services thus facilitating the growth in domestic investments and increasing the rate of economic growth. This is a protectionist measure that is geared at lowering down the unemployment rate, but the government must carefully assess the impact of this intervention on the prices and trade benefits that would result from international trade (Grimwade 2006). Grimwade (2006) asserts that government intervention affects international trade is the use of quotas that provides a specified limit of quantity of a product that can be imported in to the country within a specified time period. The government will grant quota licenses and monitor the quota system in order to ensure that no more imports of the commodity can enter the country after exhaustion of the allocated quota (Misra and Yadav 2009). The aim of quotas is to protect the market share and demand for the local products thus protecting the local companies from losing profitability to foreign firms. The quotas are implemented in industries where the domestic firms lack innovative capabilities or where the foreign countries have comparative advantage in the manufacture of a certain product due to access to cheap labor and raw materials. The use of voluntary export restrain (VER) is unique version of quota that is used by the domestic government on the exports or at the request of the destination countries (Grimwade 2006). The voluntary export restrain usually affects the consumers in the destination countries due to higher prices of their local substitutes, lack of adequate variety and higher prices of their domestically produced substitutes. For instance, the oil manufacturing companies usually use voluntary export restrains in order to build domestic reserves. Government policies such as ‘buy local’ legislations favour the consumption of domestically produced goods than imported goods especially in matters concerning government contracting and procurements. A related way of intervention is the local content requirement that requires the finished product to contain locally sourced raw materials thus limiting international trade. An example is ‘buy Ontario’s policy that aims at excluding the purchase of cheap Japanese green energy bulbs (Grimwade 2006). The government may intervene in international trade in order to prevent dumping of goods. Dumping occurs when the goods are exported at lower prices than their normal value in their originating country or at a lower price than the incurred production costs. The anti-trust practice makes the domestically manufactured goods more expensive thus undermining the growth of local industries (Misra and Yadav 2009). Dumping is illegal under WTO regulations and governments usually impose an anti-dumping levy that is equivalent to the difference between normal price and export price. For instance, the EU retailers were lobbying the EU to drop the anti-dumping tariffs imposed on Chinese energy saving lightbulbs from China. The World Trade Organisation rules grant member countries an opportunity to retaliate to aggressive trade policies from their trading partners that violate the provisions of WTO on free and fair competition (Pelaez 2008). The government intervention may also be in the form of embargoes on one or more goods from a certain country. An embargo completely bans the importation of the good or service thus acting as a restrictive international trade barrier. Embargoes are mainly used for geopolitical goals or retaliation by the trading partners for unfair restrictive trade barriers. For instance, the US government imposed embargoes on Cuban imports and other countries that are perceived to threaten the US interests by supporting terrorism organizations (Pelaez 2008). Some governments usually restrict trade international trade in services due to essentiality and need to maintain acceptable standards. The foreign private companies in those service industries may be prohibited in trading in the domestic market due to the essential nature of the service (Misra and Yadav 2009). For instance, many governments usually provide subsidised services in public transportation and other public utilities due to the essential nature of the service. The government may also limit entry of foreign professionals in certain professions in order to maintain standards. For instance, some countries require the foreigners to undertake lengthy examinations and skills certifications before engaging in provision of services such as civil engineering or accounting services (Pelaez 2008). The government may require specific permission requirements such as export and import licenses for the firms before engaging in any international trade activities. The requirement will restrict international trade if the license is not issued and also create barriers for the smaller firms due to the cost, uncertainty and delays that are experienced in processing the license (Pelaez 2008). The government may impose trade policies that require reciprocity in access of markets. The exporting firms are required to at the same time use specified percentage of the proceeds from their exports to import specified product from the export destination country (Pelaez 2008). The arrangement constitutes a countertrade and both countries benefit from the mutual offsetting relationship that aims at ensuring positive balance of trade. Snyder (2002) points out that the infant industry argument is one of the economic arguments that many nations use in implementing protectionist measures such as high tariffs on imports and quotas in reducing the quantity of imports in the economy in sectors where the local companies have not gained economies of scale and competitive capabilities. Other economic reasons for government intervention that has been raised include the industrialisation argument that aims at spurring local industrialisation through promoting foreign direct inflows, diversification of the economy, import substitution and export promotion incentives (Grimwade 2006). The government may intervene in order to make a balance of payments adjustment through restricting imports or attain price-control objectives through withholding the products until the world prices rise thus improving the export earnings (Snyder 2002). The political arguments for government’s intervention in international trade include the need to protect local jobs, the need to protect the emerging domestic industries and furthering a certain foreign policy goal. Other political reasons that force government to intervene include retaliation measures for unfair competition by the foreign trading partners, protection of the health of the citizens from harmful and substandard foreign products and compliance with sanction directives issued by the United Nations in order to protect human rights in certain exporting nations (Snyder 2002). The government has a role of setting up the regulatory framework that facilitates international trade such as trade policies, quality standards, and trade contracts. The government intervention aims at protecting the consumers in the market against unhealthy products and fraudulent activities (Snyder 2002). The government sets up the law that promotes competitive markets by prohibiting cartels and anti-trust business practices that aim at determining prices in the market. Poorly regulated international trade is detrimental to consumer welfare since consumers’ desire protection from frauds and abusive practices. In this case, the government provides public goods such as national defence and requires government’s approved labeling in order to safeguard the quality of goods consumed in the market. An international externality that has resulted from increased international trade is global warming and some governments have started limiting their own production through imposition of taxes on certain industries in order to curb greenhouse emissions (Snyder 2002). Conclusion Government intervention in international trade may lead to market efficiency distortions and decline in standards of living across the world due to higher prices and low quality products. The national governments should deregulate their markets in order to reduce monopoly power, privatise the public firms and implement tough laws that will prohibit anti-competition behaviour. The governments should reduce import controls since free trade encourages competition that ultimately leads to higher quality goods and lower prices for the consumers. There should be laws that prohibit cartels and unhealthy products in order to promote interests of consumers. References: Grimwade, N. 2006. International Trade Policy: A contemporary Analysis. New York: Routledge. Kerr, W.A and Gaisford, J.D. 2007. Handbook of international trade policy. London: Edward Elgar Publishing. Macdonald, N.T. 1999. Macroeconomic and Business: an Interactive Approach. New York: Cengage Learning Publishing. Misra, S and Yadav, P.K. 2009. International Business: Text and Cases. London: PHI Learning. Accessed from https://books.google.co.ke/books?id=7kPVjUnpw5gC&pg=PA95&dq=Ways+in+which+ international+trade+is+affected+by+government%27s+interventions&hl=en&sa=X&ei=- bI4VfX_A8zFPfXhgLAG&redir_esc=y#v=onepage&q=Ways%20in%20which%20inter national%20trade%20is%20affected%20by%20government%27s%20interventions&f=false. Pelaez,C.M. 2008. Government intervention in globalization: Regulation, Trade and Devaluation Wars. Accessed from http://www.palgrave.com/page/detail/Government- Intervention-in-Globalization/?K=9780230222212. Snyder, F.G. 2002. Regional and Global Regulation of International trade. London: Hart Publishing. Read More