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Strategic Trade Theory

Strategic trade theory emerged in the 1980s and proposes that imposing tariffs can allow domestic firms in industries with economies of scale to lower costs and gain market share internationally. This challenges assumptions of perfect competition and constant returns to scale in classical trade theory. A key paper showed export subsidies could help one country's firm expand globally at another's expense. While tariffs and subsidies aim to aid domestic producers over foreign competitors, strategic trade policies are difficult to implement and other countries may retaliate, worsening outcomes for all.

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Lalitkumar Bhole
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154 views2 pages

Strategic Trade Theory

Strategic trade theory emerged in the 1980s and proposes that imposing tariffs can allow domestic firms in industries with economies of scale to lower costs and gain market share internationally. This challenges assumptions of perfect competition and constant returns to scale in classical trade theory. A key paper showed export subsidies could help one country's firm expand globally at another's expense. While tariffs and subsidies aim to aid domestic producers over foreign competitors, strategic trade policies are difficult to implement and other countries may retaliate, worsening outcomes for all.

Uploaded by

Lalitkumar Bhole
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOC, PDF, TXT or read online on Scribd
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Strategic Trade Theory

1980s - “strategic trade policy” - In an industry with economies of scale, the


imposition of a tariff, by reserving the home market for a domestic firm, allows the
firm to cut its costs and undercut foreign rivals in overseas markets. Economists and
politicians reckon that this might work in civil aircraft, semiconductors and cars.
However, it is rare for governments to be powerful enough to set optimal tariffs—and
even rarer for them to have enough information to do so with pinpoint accuracy. Even
then, rival countries could follow suit, leaving them all worse off.

The genesis of this line of thinking arises from a relaxation of two fundamental
assumptions of classical trade theory viz. perfect competition and constant returns to
scale. If the international market is dominated by a few large global players, then the
classical conclusions about free trade need not apply.
The fundamental paper in this area is Brander & Spencer (1985) who showed that if
two big firms in 2 countries (say France and UK) were competing for the market in a
third country(say the US), then French export subsidies could enable the French firm
to expand its global market share and earn greater profits. Krugman (1987) is credited
with the modern strategic trade theory.

All forms of protection are aimed at improving the position of a domestic producer
relative to his foreign competitor. This can be done in a variety of ways:
(i) By increasing the home price of the foreign product
(ii) By decreasing the costs of domestic producers
(iii) Restricting the access of foreign producers to the home market

TARIFFS: These are taxes imposed on goods ( and sometimes also services)
entering a country from abroad and are the most common form of protection to
domestic producers (as they result in higher prices of the imported good). Tariffs also
generate significant revenues for the government.

SUBSIDIES: An alternative form of protection is to subsidize domestic producers.


2 types of subsidies may be distinguished (i) those which focus upon the industry in
general (e.g. cheap credit, tax incentives and direct subsidies as in the US
shipbuilding industry, Korean automobiles, IT industry in India) (ii) those which
focus upon the export activity of the industry (export credit, shipment credit, loan
guarantees etc.) Unlike tariffs which generate revenues for the government, subsidies
involve expenditure for the Exchequer.
QUOTAS: These typically specify the maximum quantity of a product that can be
imported from a particular country over a specific period. The most famous example
of a quota system is the multi-fibre agreement (MFA) under which the EC (prior to
1993 each country in Europe had a separate MFA system) allots to each of the major
textile producers (India, China, Malaysia, Korea etc.) a specific limit for each textile
product. Thus for knitwear say, EC may specify that it will import not more than Q1
from China, Q2 from India etc. Note that with a quota, prices in the home market are
higher than they otherwise would be—so that the effect is similar to a tariff but less
transparent and does not generate any revenue for the home government.
Because of their lack of transparency they are likely to create more distortions than
tariffs; hence the WTO has emphasized their phased but rapid dismantling.

Regulatory Barriers: In recent years several new forms of protectionism have


emerged. These can generally take 3 forms (i) specifying standards for certain
products, so that the products do not harm the health of domestic consumers.
Standard examples pertain to leather products and pharmaceuticals. (ii) specifying
standards for certain products, so that the domestic environment is not damaged (e.g.
pollution standards for imported cars) (iii) specifying conditions under which certain
products are produced (child labor in the carpets and clothing industry)

ARGUMENTS IN FAVOUR OF PROTECTION


As we have seen tariffs impose substantial welfare costs. Why is it then that tariffs
continue to be imposed? There are several explanations, which may be broadly
grouped into 2 classes:
(i) Classical
(ii) Strategic trade policy
The major classical arguments are the following:
1. National defense
2. Income redistribution
3. Optimum tariffs
4. Trade balancing
5. Protection of jobs
6. Infant industries
7. Spillover effects
The strategic trade policy is discussed above.

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