CHAPTER 3 - THE POLITICAL ECONOMY OF INTERNATIONAL TRADE

This chapter delves into the political reality of international trade, highlighting that despite
nominal commitments to free trade, many nations intervene to protect political interests, domestic
producers, or national security. This chapter then explores various policy instruments governments use
to intervene in trade and discusses their motives. It also evaluates how government intervention aligns
with the case for free trade.

INSTRUMENTS OF TRADE POLICY

❖ Import Tariffs

- An import tariff is a tax imposed on imports or exports.

- There are two types of tariffs: specific tariffs, which are a fixed charge per unit of the imported good,
and ad valorem tariffs, which are a percentage of the imported good's value.
- Import tariffs are typically used to protect domestic producers from foreign competition by
increasing the price of imported goods.
- Import tariffs also generate revenue for the government, and historically, they were a significant
source of government income.
- Import tariffs are paid by importers, not foreign producers or exporters, making them essentially a
tax on domestic consumers.
- The impact of import tariffs can result in winners and losers: government gains revenue, domestic
producers gain protection, but consumers face higher prices.
- Import tariffs also reduce overall economic efficiency by encouraging domestic production of goods
that could be produced more efficiently abroad, leading to an inefficient allocation of resources in the
global economy.

❖ Export Tariffs and Bans

- An export tariff is a tax applied to goods being exported, aiming to discourage exports and ensure
an adequate domestic supply of the product.
- Export tariffs are relatively uncommon since most countries want to promote exports, but they can
be used to maintain domestic supply, as seen in China's past export tariffs on grain and steel.
- Argentina has used export tariffs on agricultural products like wheat, corn, and soybeans to prioritize
domestic consumption, which can benefit local consumers but negatively impact farmers and the
overall economy.
- An export ban restricts or completely prohibits the export of a particular product.
- An example of an export ban was the U.S. crude oil export ban imposed in 1975 during OPEC's oil
supply restrictions to stabilize domestic prices and enhance national security.
- The U.S. lifted the crude oil export ban in 2015 to allow American oil producers to sell on global
markets.
- Another example is the Trump Administration's 2019 export ban on microprocessors to Huawei, a
Chinese telecommunications company, which had implications for U.S. firm Qualcomm.
 ❖ Subsidies

- A subsidy is a payment made by the government to domestic producers, which can come in various
forms such as cash grants, low-interest loans, tax breaks, or government equity participation.
- Subsidies benefit domestic producers by lowering their production costs, making them more
competitive against foreign imports and helping them gain export markets.
- Advocates of strategic trade policy support subsidies, particularly for industries with economies of
scale where a first-mover advantage can be achieved. Large commercial jet aircraft and advanced
semiconductors are examples.
- Subsidies can lead to benefits for the domestic economy, including increased employment and tax
revenues generated by dominant global companies. However, subsidies are typically funded through
taxation.
- The overall benefits of subsidies relative to their costs are debatable. In practice, many subsidies may
not significantly enhance international competitiveness but rather protect inefficient producers and
promote overproduction.
- Studies suggest that eliminating subsidies to farmers in advanced countries could lead to a 50
percent increase in global trade in agricultural products and result in a $160 billion benefit to the
world. Removing all trade barriers in agriculture could increase world income by $182 billion due to
more efficient land use.

❖ Import Quotas and Voluntary Export Restraints

- An import quota is a direct restriction on the quantity of a specific good that can be imported into a
country, often enforced through the issuance of import licenses to specific individuals or firms.
- An example is the U.S. quota on cheese imports, where only designated trading companies are
allowed to import a set amount of cheese annually.
- Tariff rate quotas combine elements of quotas and tariffs; they involve lower tariff rates for imports
within the quota and higher rates for imports exceeding the quota, typically used in agriculture to
limit imports.
- Voluntary export restraints (VERs) are similar to quotas but imposed by the exporting country at
the request of the importing country's government to limit exports. For instance, Brazil imposed
VERs on vehicle shipments from Mexico to Brazil in 2012.
- Foreign producers often agree to VERs to avoid potentially harsher measures like punitive tariffs or
import quotas.
- Import quotas and VERs benefit domestic producers by reducing import competition but lead to
higher prices for imported goods, ultimately harming consumers.
- When imports are restricted by a quota or VER, the limited supply causes prices to rise, resulting in
extra profits for producers, known as quota rent.
- Import quotas can even raise prices for domestically produced goods if the domestic industry cannot
meet demand, as seen in the U.S. sugar industry, where quotas have led to sugar prices up to 40
percent higher than the world price, benefiting domestic sugar producers.
 ❖ Local Content Requirements

- A local content requirement (LCR) mandates that a specific portion of a product must be produced
domestically, either in terms of physical components or the value of the product.
- Developing countries often use LCRs to transition from simple product assembly to local component
manufacturing.
- Developed countries may employ LCRs to protect domestic jobs and industries from foreign
competition.
- For example, the Buy America Act in the United States specifies that government agencies must
favor American products in equipment contracts unless foreign products offer a significant price
advantage. To qualify as "American," at least 51 percent of the product's value must be domestically
produced, representing a local content requirement.
- LCRs protect domestic producers by limiting foreign competition, similar to import quotas, and the
economic effects are comparable: domestic producers’ benefit, but higher prices for imported
components result in increased prices for consumers of the final product.
- In summary, like other trade policies, LCRs tend to favor producers while raising prices for consumers.

❖ Administrative Policies

- Administrative trade policies are informal rules established by governments to create obstacles for
imports and promote exports.
- Japan has been known for its skill in employing administrative barriers to trade. Despite having low
formal tariff and nontariff barriers, Japan has been criticized for using informal administrative barriers
that impede foreign access to its markets.
- An example is the Japanese car market, where foreign car makers, particularly American companies,
have faced challenges in gaining a significant share. In 2016, only 6 percent of the 4.9 million cars sold
in Japan were foreign, with just 1 percent being U.S. cars.
- Critics argue that Japan uses regulatory hurdles, such as unique vehicle parts standards, to make it
difficult for foreign car makers to compete in the Japanese market.
- The Trans-Pacific Partnership (TPP), negotiated by the Obama administration, aimed to address this
issue by having the U.S. reduce tariffs on Japanese light trucks in exchange for Japan adopting U.S.
standards on auto parts. This would have facilitated the import and sale of American cars in Japan.
- However, President Donald Trump withdrew the United States from the TPP in January 2017,
affecting the potential resolution of these trade issues.

❖ Antidumping Policies

- Dumping in international trade refers to the practice of selling goods in a foreign market at prices
below their production costs or below their perceived "fair" market value, which includes a
reasonable profit margin.
- Dumping is often a way for firms to dispose of excess production in foreign markets.
- Some instances of dumping may be predatory, where companies intentionally sell products at low
prices in foreign markets, subsidized by profits from their domestic markets, with the aim of driving
 local competitors out of business. Once competitors are eliminated, the predatory firm can raise
prices and increase profits.
- Antidumping policies are put in place to combat such practices and protect domestic producers from
unfair foreign competition.
- Antidumping policies vary between countries, but the general approach in the United States involves
domestic producers filing a petition with two government agencies, the Commerce Department and
the International Trade Commission (ITC), if they believe a foreign firm is engaging in dumping in the
U.S. market.
- If the complaint is deemed valid, the Commerce Department may impose antidumping duties, also
known as countervailing duties, on the foreign imports responsible for dumping. These duties are
essentially special tariffs and can be substantial, remaining in place for up to five years.

THE CASE FOR GOVERNMENT INTERVENTION

Government intervention in international trade can be justified through two main paths: political
and economic arguments.
Political arguments: revolve around safeguarding the interests of specific groups, usually producers,
even if it means sacrificing the interests of other groups like consumers. They may also relate to achieving
non-economic objectives, such as environmental protection or human rights.
Economic arguments: focus on enhancing a nation's overall prosperity, benefiting both producers and
consumers. This intervention aims to boost the country's wealth for the greater good of its citizens.

Political Arguments for Intervention

1. Protecting Jobs and Industries: One of the most common political arguments for government
intervention in international trade is the need to protect domestic jobs and industries from what
is perceived as unfair competition, often driven by foreign subsidies. However, there is a debate
about whether claims of unfair competition are sometimes exaggerated for political reasons, and
government interventions aimed at protecting jobs and industries can have unintended
consequences, such as higher prices for consumers and reduced competitiveness in the global
market.
2. Protecting National Security: Countries sometimes invoke the need to protect certain
industries, particularly those related to national security like aerospace and electronics, as a
justification for government intervention in international trade. This argument was notably used
by the Trump administration when imposing tariffs on foreign steel and aluminum in 2018, citing
national security concerns. However, critics argued that these tariffs could actually harm the U.S.
defense industry by raising input prices for defense contractors, potentially having a negative
impact on national security instead.
3. Retaliating: Some argue for using the threat of government intervention in trade policy as a
bargaining tool to pressure foreign governments into adhering to international rules and
regulations. This approach has been used by the U.S. government, particularly in the case of
China, where threats of punitive trade sanctions were employed to compel better enforcement
of intellectual property laws. While this politically motivated strategy can potentially lead to
trade liberalization and economic gains, it carries risks. The targeted country may retaliate by
 imposing its own trade barriers, as seen with China's response to Trump's tariffs, resulting in
adverse consequences such as reduced exports and financial support for affected industries. In
the end, negotiated deals like the "phase I" agreement with China may not fully deliver on their
commitments.
4. Protecting Consumers: Many governments have regulations in place to protect consumers from
unsafe products, and these regulations can indirectly affect international trade by limiting or
banning the importation of such products. An example is the ban on American beef imports by
countries like Japan and South Korea in 2003 due to concerns about mad cow disease. This ban
had a significant impact on U.S. beef producers. Eventually, the ban was lifted, but with strict
requirements to reduce the risk of importing contaminated beef, such as age restrictions on
cattle. These regulations aim to safeguard consumer health and safety but can have substantial
trade implications.
5. Furthering Foreign Policy Objectives: Governments sometimes use trade policy as a tool to
support their foreign policy objectives. They may grant preferential trade terms to strengthen
relations with certain countries or impose trade sanctions on rogue states that do not comply
with international laws or norms. Trade sanctions, such as those imposed on Iraq, Cuba, Libya,
and Iran, are intended to pressure these nations to change their behavior or government. In some
cases, these sanctions have had limited success, as seen with Libya's decision to terminate its
nuclear weapons program and the subsequent relaxation of sanctions. However, other countries
can undermine unilateral trade sanctions, as seen with Cuba, where other Western nations
continued to trade with the country despite U.S. sanctions. Trade policy is thus used strategically
to advance foreign policy objectives, but its effectiveness can vary.
6. Protecting Human Rights: Governments, particularly democracies, often use trade policy as a
means to promote and protect human rights in other countries. This approach involves applying
trade sanctions or restrictions to pressure trading partners into improving their human rights
practices. An example is the use of trade sanctions against South Africa in the 1980s and 1990s
to push for the abandonment of apartheid policies, which were considered a violation of basic
human rights. Similarly, the United States maintained trade sanctions against Myanmar due to
its poor human rights record until late 2012, when sanctions were lifted in response to democratic
reforms. However, recent political developments, including a military coup in 2021, may lead to
the re-imposition of sanctions to address human rights concerns.

Economic Arguments for Intervention

1. The Infant Industry Argument: The infant industry argument proposes that developing
countries should protect their new manufacturing industries with measures like tariffs and
subsidies to help them compete with established industries in developed nations. However, this
argument has faced criticism because it often leads to inefficient industries, as seen in Brazil's
auto industry. Additionally, with access to global capital markets, firms in developing countries
can secure long-term investments without government subsidies, making protectionism
unnecessary for potentially competitive industries.
2. Strategic Trade Policy: The strategic trade policy argument, proposed by some new trade
theorists, suggests that governments can strategically intervene in certain industries to boost
national income. There are two main components to this argument:
 i. First-Mover Advantages: Governments can support domestic firms that gain
first-mover advantages in industries with substantial economies of scale. For
instance, the U.S. government's R&D grants to Boeing in the 1950s and 1960s
helped it dominate the commercial aircraft industry. Japan similarly targeted the
production of liquid crystal display screens, leading Japanese firms to capture
first-mover advantages in this market, even though the technology originated in
the United States.
ii. Overcoming Foreign First-Mover Advantages: Governments may also
intervene to help domestic firms overcome barriers to entry created by foreign
firms that have already gained first-mover advantages. An example is Airbus,
which received substantial subsidies from European governments and
successfully competed with Boeing in the commercial aircraft market.

If these arguments hold, they provide a rationale for government intervention in

international trade. Governments can focus on crucial future technologies, offer subsidies for
development, and provide export support until domestic firms establish first-mover advantages
in global markets. Government support may also be justified when helping domestic firms
compete against foreign first-mover advantages, requiring a combination of domestic protection
and export-promoting subsidies.

The Revised Case for Free Trade

The strategic trade policy argument challenges the traditional case for unrestricted free trade.
Paul Krugman and others argue that while it may sound good in theory, in practice, it can lead to
retaliation and trade wars, harming all involved nations. Instead, they propose minimizing trade-
distorting subsidies through international rules, such as those promoted by the World Trade
Organization.

Additionally, domestic policies are often influenced by special interest groups, leading to
inefficient interventions. Krugman suggests that in reality, it may be best for countries to adopt a blanket
policy of free trade, with exceptions granted only in extreme cases, as it is more practical and less prone
to distortion by special interests.

Managerial Implications

The implications for business practice regarding trade barriers and government intervention in
international trade are as follows:

Trade Barriers and Firm Strategy:

1. Trade barriers, such as tariffs, quotas, and local content regulations, can impact a firm's global
strategy for production and distribution.
2. Tariffs raise the cost of exporting products to a country, potentially putting the firm at a
competitive disadvantage compared to local competitors.
 3. Quotas may limit a firm's ability to serve a country from locations outside that country, pushing
the firm to establish production facilities within that country.
4. Local content regulations may necessitate more production activities in a market than would be
optimal, increasing costs.
5. The threat of trade barriers may lead firms to locate production activities in specific countries to
mitigate potential risks.

Policy Implications:
1. Business firms play a significant role in international trade and can influence government policies.
2. Firms can encourage protectionism or advocate for government support for open markets and
free trade, affecting their own interests.
3. Government intervention can have drawbacks, including protecting inefficiencies, risking
retaliation, and potential capture by special-interest groups.
4. While a laissez-faire approach may not always be suitable, most economists argue that
promoting greater free trade, strengthening organizations like the WTO, and opening protected
markets is in the best long-term interest of the business community.
5. The increasing integration of the world economy and internationalization of production make
freer trade advantageous for firms that rely on globally dispersed production systems.
6. Firms that advocate protectionism should be aware that they may hinder their own opportunities
to build competitive advantages through globally dispersed production if other governments
retaliate in response to protectionist measures.

In summary, business firms should carefully consider the consequences of advocating for
protectionist measures and instead focus on promoting greater free trade and open markets, which can
benefit their global strategies and competitive positions in the long run.

REFERENCES:

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[3] Hill, C., & Hult, T. G. M. (2018). International Business: Competing in the Global Marketplace (12th ed.).
McGraw-Hill Education.
[4] Hill, C. (2022). International Business: Competing in the Global Marketplace (14th ed.). McGraw-Hill
Education.
[5] Hill, J. (2008). International Business: Managing Globalization. SAGE Publications, Inc.