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WEEK 6 – 7

TOPIC 7: GOVERNMENT POLICY AND INTERNATIONAL

TRADE POLICY
UNIT LEARNING OUTCOME: At the end of the unit, you are expected to:
1. Explain the purpose of establishing the WTO and its functions
2. Understand the different rounds of GATT based on global trade negotiations
3. To understand why countries, need to have barriers to TRADE and what purpose
they serve to the nation's economic growth
4. Be able to identify different types of tariff and non-tariff trade barriers.

METALANGUAGE

In the last two decades, the most drastic changes have occurred on the economic front,
which has changed the entire mathematics of the international business climates.
Political development, like the disintegration of the USSR, has turned the world into a
multipolar body. Simultaneously, technological advances, especially those in the field of
I.T., have made the world a smaller place. The strengthening of the global economic
institutions, especially the WTO, has led to significant nations' integration. However, the
economic environment remains the principal driving force behind these developments.
Every business company is left excluded from the global changes, irrespective of the
type and scale of the corporation. The rivalry is right at the firm's gate, just like
anybody else. Therefore, anyone who aspires to succeed in business must grasp these
economic, environmental techniques with the flexibility to achieve the highest profit.
Key Concepts and Terms
1. The General Agreement on Tariffs and Trade (GATT); is neither an
organization nor a court of justice. It is merely a multinational treaty that now
covers eighty percent of the world trade.
2. The WTO; was established on January 1, 1995. It is the embodiment of the
Uruguay Round results and the successor to GATT.

Course: CBM 321 – International Business and Trade

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3. Specific Tariff: Specific tariff is the fixed amount of money per physical unit or
according to the weight or measurement of the commodity imported or
exported.
4. Ad Valorem Tariff: 'Ad Valorem' is the Latin word that means 'on the value.'
When the duty is levied as a fixed percentage of the traded commodity's value, it
is called a Valorem tariff.
5. Sliding Scale Tariff: The import duties that vary with the prices of the
commodities are termed sliding scale duties.
6. Revenue Tariff: The tariff, which is imposed primarily for generating more
revenues for the government, is called the revenue tariff.
7. Protective Tariff: The government's tariff may be imposed to protect the home
industries from the cut-throat competition from the foreign-produced goods.
8. Nondiscriminatory Tariffs: If the uniform tariff rates are applicable to all the
commodities irrespective of the country of origin, they are known as
nondiscriminatory tariffs.
9. Discriminatory Tariff: In the case of the discriminatory tariff, the varying tariff
rates exist for different commodities.
10. General and Conventional Tariff: The state legislature determines the general
tariff schedule. It also makes provision for the adjustment in tariff rates as and
when required to fulfill the obligations of international commercial agreements.
11. Maximum and Minimum Tariff: Under this system, a country has maximum and
minimum tariff rates for every commodity.
12. Multiple Column Tariff: The multiple column tariff consists of three different
tariff rates – a general rate, an international rate, and a preferential rate.
13. Retaliatory Tariffs: If a foreign country has imposed tariffs upon the exports
from the home country and the latter imposes tariffs against the products of the
former, the tariffs resorted to by the home country will be regarded as the
retaliatory tariffs.
14. Countervailing Tariffs: If the foreign country has been exporting large
quantities of its products in the market of the home country on the strength of
export subsidies, the home country can neutralize the 'unfair advantage' enjoyed

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by foreign products through imposing duties upon them as they enter the
territory of the home country.
15. Import Duties: If the home country imposes tariff upon the products of the
foreign countries as they enter its territory, the tariff is known as import tariff or
import duty.
16. Export Duties: If the home country's products become subject to tax as they
leave its territory to be sold in the foreign market, the tax or duty is called export
tariff or export duty
17. Import quotas; are legal restrictions on the quantities of imports that are
imposed by the domestic government. Import quotas can be established as a
simple aggregate, presumably satisfied on a first-come-first-serve basis.
18. An export subsidy; is payments made directly to domestic producers to
encourage exports of production to the foreign sector.
19. An embargo; is a more severe form of trade restriction in which a nation
completely bans the importing of products from another country of forbids
exporting its own products to that country.
20. Local Content Requirement; Instead of placing a quota on the number of goods
that can be imported, the government can require that a certain percentage of
goods be made domestically.
21. Product Standards; Here, the importing country imposes a standard for goods.
If the standards are not met, the goods are rejected.
22. Domestic Content Requirement; Governments impose DCR to boost domestic
production
23. Product Labelling - Certain countries insist on specific labeling of the products
24. Packaging requirements - Certain nations insist on a particular type of
packaging of goods. Eg. E.U. insists on the packaging with recyclable materials.
25. Foreign Exchange Regulation - The importer has to ensure that adequate
foreign exchange is available for import of goods by obtaining clearance from
exchange control authorities before concluding the contract with the supplier.
26. State trading - Is some countries like India, certain items are imported or
exported only through canalizing agencies like MMTT (Minerals and metal
trading corporation of India)

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ESSENTIAL KNOWLEDGE

Topic 7.1: WTO

World War II, which lasted from 1939 to 1945, left many countries in Europe and Asia
ravaged. Their economies were shattered; there was a tremendous strain on political
and social systems resulting in widespread annihilation and migration of people.
Intentional peace was ruffled. Something had to be done to put these war-ravaged
economies back in shape. Simultaneously, the various colonies in Asia and Africa were
acquiring political freedom. And there was urgent pressure on them for rapid economic
development and political stabilization. In this background, the United Nations
Organization (UNO) was born on the collective wisdom of the world. Progressively, the
UNO came to encompass the concerns for development in the economic, commercial,
scientific, social, and cultural sphere of the member nations. It formed various forums
and agencies. One such discussion under the UNO was the General Agreement on Tariffs
and Trade (GATT), which was established in 1947.

GATT emerged from the ashes of the Havana Charter. In the International Conference on
Trade and Employment in Havana in the winter of 1947-48, fifty-three nations drew up
and signed a charter for establishing an International Trade Organization (ITO). But the
U.S. Congress did not ratify the Havana Charter with the result that the ITO never came
into existence.

Simultaneously, twenty-three nations agreed to continue extensive tariff negotiations

for trade concessions at Geneva, which were incorporated in a General Agreement on
Tariffs and Trade. This was signed on October 30, 1947, and came into force from
January 1, 1948, when other nations had signed it. The critical juncture was reached
during the Uruguay Round of multilateral trade negotiations, which may be called the
final act. It was signed by 12 countries in which India was a signatory. Popularly known
as Dunkel agreement, It finally emerged as the World Trade Organization (WTO) on
January 1, 1995.

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Topic 7.1.1: What is GATT

The General Agreement on Tariffs and Trade (GATT) is neither an organization nor a
court of justice. It is merely a multinational treaty that now covers eighty percent of the
world trade. It is a decision-making body with a code of rules for international Trade
and a mechanism for trade liberalization. It is a forum where the contracting parties
meet from time to time to discuss and solve their trade problems and also negotiate to
enlarge their Trade. The GATT rules provide for the settlement of trade disputes, call for
consultations, waive trade obligations, and even authorize retaliatory measures.

The GATT has been a permanent international organization having a permanent Council
of Representative with headquarters at Geneva. Twenty-five governments have signed
it. Its function is to call International conferences to decide on trade liberalizations on a
multilateral basis.

Topic 7.1.2: GATT ‘Rounds’ of Global Trade Negotiations

The brief particulars of the various GATT ‘Rounds‘(conferences) for global trade
negotiations are discussed below:

First Round - The earlier rounds of GATT have achieved a limited measure of success. In
the first round of talks held in Havana in 1947, 23 countries formed GATT and
exchanged tariff concessions on 45,000 products worth 10 billion U.S. dollars of Trade
per annum.

Second Round - Ten more countries had joined GATT when its second round was held
in Annecy (France) in 1949. In this round, customs and tariffs on 5000 additional items
of international Trade were reduced.

Third Round - The Third round was organized in Torquay (England) in 1950-51.
Thirty-eight member countries of GATT participated in it, and they adopted tariff
reduction on 8700 items.

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Fourth Round - The fourth round of world trade negotiations was held in Geneva in
1955-56. In this round, the country decided to further cut duties on goods entering
international Trade. The value of merchandise trade subjected to tariff cut was
estimated at $ 2.5b.

Fifth Round - The fifth round took place during 1960-62 at Geneva. In this round, the
negotiations covered the approval of standard external tariff (CET) of the European
countries and cut in customs duties amounting to the U.S. $ 5 billion on 4400 items.
Twenty-six states participated in this round.

Sixth Round or the Kennedy Round - With the formation of EEC, the U.S. had been put
at a disadvantage. As a reaction to this, the U.S. Congress passed the Trade Expansion
Act in October 1962, which authorized the Kennedy administration to make a 50
percent tariff reduction in all commodities. This paved the way for the opening of the
Kennedy round of trade negotiations at Geneva in May 1964, which were to be
completed by June 30, 1967.

This round had the participation of 62 countries and negotiated tariff reductions of
approximately $ 40 billion, covering about four-fifths of the world trade. The major
industrial countries in this group applied substantial cuts on their dutiable imports, e.g.,
as much as 64 percent cuts in the case of the United States, 3 percent in case of Britain,
30 percent in case of Japan, 24 percent in case of Canada. They left the U.S. and
European tariffs on the manufactured goods in the range of 5 to 15 percent.

However, concerning agricultural products, the negotiations had lesser success. They
agreed on an average duty reduction of 25 percent on agricultural items. Non-tariff
obstacles too remained untouched and scant attention was paid to the problems of
developing countries.

An IMF study revealed that the weighted average tariff for all industrial products had
been reduced to 7.7 percent, 9.8 percent on finished manufactured products, 8 percent
on semi-finished products, and 2 percent on raw materials. Thus, Trade-in industrial

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products after the completion of the Kennedy Round was substantially free of
restrictions.

Seventh Round or Tokyo Round - The Seventh Round of Multilateral Trade

Negotiations (MTN) was launched in September 1973 under GATT's auspices. Its
objectives were laid down in the Tokyo Declaration. The Declaration set out a far-
reaching program for the negotiations in six areas. These are (i) tariff reduction; (ii)
reduction or elimination of non-tariff barriers; (iii) coordinated reduction of all trade
barriers in selected sectors; (iv) discussion on the multilateral safeguard system; (v)
trade liberalization in the agricultural sector taking into account the unique
characteristics and (vi) special treatment of tropical products. It also emphasized that
MTN must take into account the special interests and problems of developing countries.

Eight Round or the Uruguay Round - The Eighth Round of GATT negotiations, which
began at Punta Del Esta in Uruguay in September 1986, ought to have been concluded
by the end of 1990. But at the ministerial meeting in Brussels in December 1990, an
impasse was reached over the area of agriculture, and the talks broke down.

The talks were restarted in February 1991 and continued till August 1991. On
December 20, 1991. Author Dunkel, the then Director-General of GATT tabled a Final
Draft Act of the Uruguay Round, known as the Dunkel Draft Text. This was a take-it-or-
leave-it document which was hotly discussed at various fora in the member countries
through 1992 till July 1993 when the then Director-General, Sutherland relaunched the
negotiations in Geneva. On August 31, 1993, the Trade Negotiations Committee (TNC)
passed a resolution to conclude the Uruguay Round by December 15. On December 15,
1993, at the final session, Chairman Sutherland declared that seven years of Uruguay
Round negotiations had come to an end. Finally, on April 15, 1994, 123 Ministers of
member countries ratified the results of the Uruguay Round at Marrakesh (Morocco),
and the GATT disappeared and passed into history. It was absorbed by the World Trade
Organization (WTO) on January 1, 1995.

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The Uruguay Round of trade negotiations undertaken by the GATT since its
establishment in 1947 had a comprehensive list. The GATT originally covered
international trade rules in the goods sector only. Domestic policies were outside the
GATT purview, and it operated only at the international border. In the Uruguay Round,
the GATT extended to three new areas, viz. Intellectual property rights services and
investment. It also covered agriculture and textiles, which were outside the GATT
jurisdiction.

The final year embodying the results of the Uruguay Round of Multilateral Trade
Negotiations comprises 28 Agreements. It had two components: the WTO Agreement
and the Ministerial decisions and declarations. The WTO Agreement covers the
formation of the organization and the rules governing it's working. Its Annexures
contain the Agreements covering Trade in goods, services, intellectual property rights,
plurilateral Trade, GATT Rules 1994, dispute settlement rules, and trade policy review.

The Uruguay Round was concerned with two aspects of Trade in goods and services.
The first related to increasing market access by reducing or eliminating trade barriers.
Reductions in tariffs, reductions in non-tariff support in agriculture, the elimination of
bilateral quantitative restrictions, and reductions in barriers to Trade in services met
this. The second was related to increasing the legal security of the new market access
levels by strengthening and expanding rules and procedures and institutions.

Topic 7.1.3: World Trade Organization (WTO)

The WTO was established on January 1, 1995. It is the embodiment of the Uruguay
Round results and the successor to GATT. 76 Governments became members of WTO on
its first day. It now has 146 members, India is one of the founder members. It has a legal
status and enjoys privileges and immunities on the same footing as the IMF and the
World Bank. It is composed of the Ministerial Conference and the General Council. The
Ministerial Conference (MC) is the highest body. It is composed of the representatives of
all the Members. The Ministerial Conference is the WTO executive and is responsible for
carrying out the WTO functions. The MC meets at least once every two years.

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The General Council (G.C.) is an executive forum composed of representatives of all the
Members. The G.C. discharges the functions of MC during the intervals between
meetings of MC. The G.C. has three functional councils working under its guidance and
supervision, namely:
a) Council for Trade in Goods.
b) Council for Trade in Services.
c) Council for Trade-Related Aspects of Intellectual Property Rights (TRIPs).

Director-General heads the secretariat of WTO. He is responsible for preparing budgets

and financial statements of the WTO. The WTO has become the third pillar of the United
Nations Organization (UNO) after the World Bank and International Monetary Fund.

Objectives Of WTO
In its preamble, the Agreement establishing the WTO lays down the following objectives
of the WTO.
1. Its relation in the field of Trade and economic endeavor shall be conducted to
raise living standards, ensure full employment and a large and steadily growing
volume of real income and sufficient demand, and expanding the production and
Trade in goods and services.
2. To allow for the optimal use of the world's resources following the objective of
sustainable development, seeking both (a) to protect and preserve the
environment, and (b) to enhance the means for doing so in a manner consistent
with individual needs and concerns at different levels of economic development.
3. To make positive efforts designed to ensure that developing countries, especially
the least developed among them, secure a share in the growth in international
Trade commensurate with their economic development needs.
4. To achieve these objectives by entering into reciprocal and mutually
advantageous arrangements directed towards substantial reduction of tariffs and
other barriers to Trade and the elimination of discriminatory treatment in
international trade relations.
5. To develop an integrated, more viable, and durable multilateral trading system
encompassing the GATT, the results of past trade liberalization efforts, and all

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the results of the Uruguay Round of multilateral trade negotiations.

6. To ensure linkages between trade policies, environmental policies, and
sustainable development.

Functions of WTO
The following are the functions of the WTO:
1. It facilitates the implementation, administration, and operation of the
objectives of the Agreement and the Multilateral Trade Agreements.
2. It provides the framework for the implementation, administration, and
operation of the Plurilateral Trade Agreements relating to Trade in civil
aircraft, government procurement, Trade in dairy products, and bovine meat.
3. It provides the forum for negotiations among its members concerning their
multilateral trade relations in matters relating to the agreements and a
framework for the implementation of the result of such talks, as decided by
the Ministerial Conference.
4. It administers the Understanding on Rules and Procedures governing the
Settlement of Disputes of the Agreement.
5. It cooperates with the IMF and the World Bank and its affiliated agencies to
achieve greater coherence in global economic policymaking.

Topic 7.1.4: Differences Between GATT and WTO

The WTO is not an extension of the GATT but succession to the GATT. It completely
replaces GATT and has a very different character. The significant differences between
the two are:
1. The GATT had no status, whereas the WTO has a legal status. It has been created
by an international treaty ratified by governments and legislatures of member
states.
2. The GATT was a set of rules and procedures relating to multilateral agreements
of selective nature. There were separate agreements on separate issues, which
were not binding on members. Any member could stay out of the Agreement.
The arrangements, which form part of the WTO, are permanent and binding on
all members.

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3. The GATT dispute settlement system was lazy and not binding on the parties to
the dispute. The WTO dispute settlement mechanism is faster and binding on all
parties.
4. GATT was a forum where the member countries met once in a decade to discuss
and solve world trade problems. On the other hand, the WTO is an adequately
established rule-based World Trade Organization where decisions on Agreement
are time-bound.
5. The GATT rules applied to trade in goods. Trade-in services were included in the
Uruguay Round, but no agreement was arrived at. The WTO covers both Trade in
Goods and Trade in services.
6. The GATT had a small secretariat managed by a Director-General. But the WTO
has a large secretariat and a huge organizational setup

(Source: http://www.pondiuni.edu.in/storage/dde/downloads/ibiii_ibe.pdf)

Topic 7.2: Trade Barriers

Free Trade vs. Protectionism
Free Trade is a laissez-faire approach with no restrictions on Trade. The main idea is
that supply and demand factors, operating on a global scale, will ensure that production
happens efficiently. Therefore, nothing needs to be done to protect or promote Trade
and growth because market forces will do so automatically.

Free Trade is the absence of trade barriers or restrictions on foreign Trade. Based on
the notion of comparative advantage, unrestricted Trade is generally beneficial to a
trading country. However, while consumers benefit through a greater selection of
products and lower prices, producers in a country are on the receiving end of lower
prices and stiffer competition. In that producers tend to have more political clout than
consumers, ultimately, unhindered free Trade is seldom seen in the real world.

According to the theory first espoused by economist David Ricardo two centuries ago,
free Trade enables nations to concentrate their efforts on manufacturing products or
providing services where they have a distinct comparative advantage. Free trade policy

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should allow a country to generate enough foreign currency to purchase the products or
services that it does not produce indigenously. The process works best when there are
few if any barriers to entry for such imports. The imposition of artificial constraints
such as tariffs on imports or the provision of subsidies to export will introduce
distortions and impede Free Trade.

In contrast, protectionism or trade restrictions hold that international trade regulation

is vital to ensure that markets function properly. Advocates of this theory believe that
market inefficiencies may hamper the benefits of foreign Trade, and they aim to guide
the market accordingly. Protectionism exists in many different forms, but the most
common are tariffs, subsidies, and quotas. These strategies attempt to correct any
inefficiency in the international market. (Montaño, et., al 2015 p158-159)

Topic 7.2.1: Trade Restrictions

Despite the growth in free trade agreements such as the North American Free Trade
Agreement (NAFTA) and organizations such as the World Trade Organization, the
majority of nations in the world continue to impose trade restrictions, usually tariffs.
Governments typically impose trade restrictions to protect domestic industries. Most
economists, however, argue that trade restrictions are detrimental and that the benefits
of free Trade far outweigh the adverse effects it may have on some industries.
(Montaño, et., al 2015 p159)

Topic 7.2.2: Trade Barriers: Tariff

A tariff is a duty or tax imposed by the government of a country upon the traded
commodity as it crosses the national boundaries. Tariffs can be levied both upon
exports and imports. The tariffs or duties imposed upon the goods originating in the
home country and scheduled for abroad are called export duties. States interested in
maximizing their exports generally avoid the use of export duties. Tariffs have,
therefore, become synonymous with import duties.

The import duties or import tariffs are levied upon the goods originating from abroad
and scheduled for the home country. Sometimes a country may also resort to what is

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called a transit duty. It is imposed upon the goods originating in a foreign country and
scheduled for a third country crossing the borders of the home country. For instance, if
India imposes tariffs on goods that Bangladesh exports to Nepal through the Indian
territory, these will be called as transit duties. Such duties are usually a matter of much
concern for the land-locked countries—the imposition of import tariff results in the
relative changes in prices of products and factors.

That brings about a significant change in the structure of international Trade. High
tariffs certainly have the effect of restricting the volume of international Trade. A
negative tariff or subsidy is often supposed to expand foreign Trade over and above its
capacity in the absence of the subsidy. (Montaño, et., al 2015 p159)

Types of Tariffs:
Specific Tariff: Specific tariff is the fixed amount of money per physical unit or
according to the weight or measurement of the commodity imported or exported. Such
duties can be levied on goods like wheat, rice, fertilizers, cement, sugar, cloth, etc.
Specific duties are quite easy to administer, as they do not involve the evaluation of the
goods.

The determination of the value of the traded goods may be difficult as there are several
variants of price such as demand price, supply price, market price, contract price,
invoice price, f.o.b, (free on board) price, c.i.f (cost, insurance, freight) price, etc. The
resort to specific duties enables the government to keep out of the complexities of
prices.

However, the specific duties cannot be levied on high valued goods such as diamonds,
jewelers, watches, T.V. sets, motor cars, works of arts like paintings, etc. These articles
can be taxed either on the basis of weight, the surface area covered, or the number of
articles.

Ad Valorem Tariff: 'Ad Valorem' is the Latin word that means 'on the value.' When the
duty is levied as a fixed percentage of the traded commodity's value, it is called a

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Valorem tariff. Such taxes are levied on the products' value disproportionately higher
than their physical characteristics such as weight or measurement.

These duties are more equitable as the costly goods, generally consumed by the rich,
bear a greater burden of tax, while the cheaper products bought by the poor bear a
lesser burden. For instance, if the import of watches is subject to a 70 percent ad
valorem tariff, a watch valued at Rs. 1000 will be subject to Rs' duty. 700 and a watch
valued at Rs. 1200 will be subject to a tariff amounting to Rs. 840. The ad valorem duties
have an added advantage that the international comparison of tariffs, in their case, can
be easily made.

Sliding Scale Tariff: The import duties that vary with the prices of the commodities are
termed sliding scale duties. These may either be on a specific or ad valorem basis. In
practice, these are generally on a particular basis.

Revenue Tariff: The tariff, which is imposed primarily for generating more revenues for
the government, is called the revenue tariff. In advanced countries, the introduction and
diversification of direct taxes have reduced the importance of tariffs as a source of
government revenues. But in the less developed countries, there is still much reliance of
the governments on this source of revenue.

Generally, a pure revenue tariff is not possible. The imposition of taxes, even for the
purpose of securing revenues, does have a protective effect when it leads to a switch of
demand by the domestic consumers from the imported to home-produced goods.

Protective Tariff: The government's tariff may be imposed to protect the home
industries from the cut-throat competition from the foreign-produced goods. The higher
the tariff, the greater, maybe the protective effect of tariff. A perfect protective tariff is
likely to prohibit completely the import from abroad.

In practice, the perfect protective tariff may not exist. If the domestic demand for
imports remains strong, there can be the possibility of smuggling imported goods. Also,

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such a tariff will not yield any revenue to the government. A high rate of protective
tariffs can make domestic producers more lethargic and inefficient and unable to face
foreign competition in the long run.

Nondiscriminatory Tariffs: If the uniform tariff rates are applicable to all the
commodities irrespective of the country of origin, they are known as nondiscriminatory
tariffs. Low rates of tariffs on certain commodities may exist because of commercial
agreements with some countries, but the tariff-imposing home country extends the
same low tariff rates to the commodities of all the countries.
Such a system of nondiscriminatory tariff is called a single column tariff. This system of
tariff is easy and simple to administer. However, one deficiency is that it is not elastic
enough to adjust according to the changing needs of the home country's industries.
From the viewpoint of revenues, too, it may not be satisfactory for the tariff-imposing
country.

Discriminatory Tariff: In the case of the discriminatory tariff, the varying tariff rates
exist for different commodities. The products originating from favored countries are
subject to a lower tariff rate than those of other countries. The discriminatory tariffs can
be double or multiple column tariffs.

In the double-column tariff, two different rates of duty exist for all or some
commodities. Both rates are either announced by the government right from the
beginning. The two rates come into existence after the country enters into a favored-
nation commercial Agreement with some foreign countries. The favored rates of the
tariff may either be on a unilateral basis or on a reciprocal basis.

General and Conventional Tariff: The state legislature determines the general tariff
schedule. It also makes provision for the adjustment in tariff rates as and when required
to fulfill the obligations of international commercial agreements. The conventional tariff
schedule is evolved through the commercial contracts of the home country with other
countries. It does not permit changes in tariff rates according to the changes in domestic
conditions or requirements.

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The changes can be possible only after negotiations and agreements are reached
between the concerned countries or after the expiry of the existing Agreement. It is
clear that there is some rigidity in the conventional tariff schedule. In contrast, the
general tariff schedule is more flexible.

Maximum and Minimum Tariff: Under this system, a country has maximum and
minimum tariff rates for every commodity. The legislature fixes these tariff rates, and
the government is authorized to apply specific tariffs to the goods imported from
different countries. The minimum tariff rates are applied to the products originating
from the countries treated as 'The Most Favored Nations.' The maximum tariff rates are
used to improve the bargaining position of the home country vis-a-vis foreign countries.

Multiple Column Tariff: The multiple column tariff consists of three different tariff
rates – a general rate, an international rate, and a preferential rate. The general and
international tariff rates can be considered equivalent to the maximum and minimum
tariff rates discussed above. A subject country generally applies the preferential tariff to
the products originating from the colonial countries.

The preferential tariff rate is kept lower than the general rate of tariff. For instance, the
goods imported by India from Britain before independence were subjected to a lower
tariff or duty-free on account of Imperial Preferences. On the other hand, the goods
imported from other countries such as Japan, Germany, and others were subject to
higher tariff rates.

Retaliatory Tariffs: If a foreign country has imposed tariffs upon the exports from the
home country and the latter imposes tariffs against the products of the former, the
tariffs resorted to by the home country will be regarded as the retaliatory tariffs. While
adopting this measure, the home country does not either have the object of raising
revenues or protecting home industries but of acting in retaliation.

Countervailing Tariffs: If the foreign country has been exporting large quantities of its
products in the market of the home country on the strength of export subsidies, the

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home country can neutralize the 'unfair advantage' enjoyed by foreign products through
imposing duties upon them as they enter the territory of the home country. The latter
has full justification for resorting to these countervailing duties so that the unfair
advantage given by export subsidies to the foreign products is offset, and the
competition takes place on an equal footing between the foreign and home-produced
goods.

Import Duties: If the home country imposes tariff upon the products of the foreign
countries as they enter its territory, the tariff is known as import tariff or import duty.

Export Duties: If the home country's products become subject to tax as they leave its
territory to be sold in the foreign market, the tax or duty is called export tariff or export
duty.

The import tariffs have remained a matter of deep interest both for analytical and policy
reasons. These are far more widespread, and almost every country takes resort to them.
In contrast, the export duties are applied to a minimal extent. Some countries, like the
USA, have prohibited export duties by law. Even in those countries, where these are in
vogue, the basic purpose is to secure more substantial revenues.

Topic 7.2.3: Trade Barriers: Non-Tariff

Non-Tariff Barriers (NTBs) refer to restrictions that result from prohibitions,
conditions, or specific market requirements that make importation or exportation
difficult and costly. NTBs also include the unjustified and improper application of Non-
Tariff Measures (NTMs) such as sanitary and phytosanitary (SPS) measures and other
technical barriers to Trade (TBT).

NTBs arise from different measures taken by governments and authorities in the form
of government laws, regulations, policies, conditions, restrictions or specific
requirements, and private sector business practices, or prohibitions that protect the
domestic industries from foreign competition.

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Import Quotas
Import quotas are legal restrictions on the quantities of imports that are imposed by the
domestic government. Import quotas can be established as a simple aggregate,
presumably satisfied on a first-come-first-serve basis. Once the total is reached, then no
more imports of the particular goods are allowed. Alternatively, the total quotas can be
divided among foreigner producers, perhaps pro-rated based on past imports. While
import quotas benefit domestic producers, they are harmful to domestic consumers.
With fewer imports available in the domestic economy, consumers have fewer choices,
and those choices more often than not come at higher prices.

A quota places a limit on the amount of specific goods or products that can be imported.
Quotas create a shortage of the goods in question, which also causes prices to increase.
Both measures benefits domestic producers, but harm consumers because of the higher
prices and reduced supplies.

Export Subsidies
An export subsidy is payments made directly to domestic producers to encourage
exports of production to the foreign sector. This export subsidization effectively
increases the overall revenue received by the domestic firms when exporting
production, which is bound to encourage exports. Export subsidies are usually justified
as a means of helping domestic producers compete with lower-cost imports. While
imports might have lower costs due to comparative advantages, they also might be
subsidized by a foreign government. Unlike tariffs and import quotas, domestic
consumers, like local producers, tend to benefit from lower prices of both imports and
domestic production. However, domestic taxpayers end up paying for this subsidization.

This involves direct government aid to a particular industry, often an industry in its
infancy that the government wishes to support and develop. Subsidies are often
defended as only temporary, but they often become permanent as the supported
industry becomes dependent on government aid. Subsidies have the effect of giving a
domestic industry an advantage over foreign competitors that are not subsidized.

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Embargo
An embargo is a more severe form of trade restriction in which a nation completely
bans the importing of products from another country of forbids exporting its own
products to that country. The United States has had an embargo against Cuba since
1960 because of the island nations' Communist government. In the early 1970s,' some
oil-producing Arab nations halted oil export to the United States because of its support
of Israel during the 1973 Yom Kippur War. The embargo caused a huge jump in world
oil prices and resulted in gasoline shortages.

Other non-tariff trade barriers

Ø Local Content Requirement - Instead of placing a quota on the number of goods
that can be imported, the government can require that a certain percentage of
goods be made domestically. The restriction can be a percentage of the good
itself or a percentage of the value of the good. For example, a restriction on the
import of computers might say that 25% of the pieces used to make the
computer are made domestically or can say that 15% of the value of the good
must come from domestically produced components.
Ø Product Standards - Here, the importing country imposes a standard for goods.
If the standards are not met, the goods are rejected.
Ø Domestic Content Requirement - Governments impose DCR to boost domestic
production
Ø Product Labelling - Certain countries insist on specific labeling of the products
Ø Packaging requirements - Certain nations insist on a particular type of
packaging of goods.
Eg. E.U. insists on the packaging with recyclable materials.
Ø Foreign Exchange Regulation - The importer has to ensure that adequate
foreign exchange is available for import of goods by obtaining clearance from
exchange control authorities before concluding the contract with the supplier.
Ø State trading - Is some countries like India, certain items are imported or
exported only through canalizing agencies like MMTT (Minerals and metal
trading corporation of India)

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Topic 7.2.4: Five Reasons for Placing Tariffs

Domestic Employment: Because imports are produced in other countries by foreign
workers, decreasing imports and increasing domestic production also increases local
employment.

Low Foreign Wages: Placing tariffs on imports produced by foreign workers who
receive lower wages "level the competitive playing field" compared to domestic goods
produced by higher-paid domestic workers.

Infant Industry: if imports compete with a relatively young domestic industry that is
not mature enough nor large enough to benefit from economies of scale, then tariffs on
imports protect the "infant industry" while it matures and develops.

Unfair Trade: the import might be sold at lower prices in the domestic economy
because foreign producers engage in unfair trade practices, such as "dumping" imports
at prices below production cost. Tariffs then balance the competitive playing field.

National Security: Tariffs can also discourage imports and encourage domestic
production of goods deemed critical to the security of the national economy.
(Montaño, et., al 2015 p160-161)

SELF HELP

Please refer to the articles below to further deepen your understanding of government
and international trade policy.
Read more: https://courses.lumenlearning.com/boundless-
economics/chapter/barriers-to-trade/

https://corporatefinanceinstitute.com/resources/knowledge/other
/tariff/

https://files.stlouisfed.org/files/htdocs/publications/review/89/01/
Trade_Jan_Feb1989.pdf

http://wits.worldbank.org/WITS/docs/Multi-

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Agency_Classification_of_NTMs.pdf

LET’S CHECK

Congratulations! You just finished the most vital concept in the study of international
business and Trade. Let us check your understanding of the critical concept. Please
proceed to the multiple-choice. Select the letter that best describes your answer.
1. General Agreement on Tariffs and Trade (GATT) went into effect?
a. 1945 b. 1948 c. 1946 d. 1947
2. GATT was initially signed by how many countries, including the USA?
a. 22 b. 20 c. 23 d. 25
3. Name the Agreement which was signed by the United States. Canada and Mexico
towards removing trade barriers?
a. SEATO b. CENTO c. NAFTA d. None of them
4. When was GATT replaced with WTO?
a. 1994 b. 1992 c. 1995 d. 1993
5. Does WTO come as the third economic pillar of world-wide dimensions along
with the World Bank and ___________?
a. International Monetary Funds (IMF)
b. International Economic Association (IEA)
c. International Funding Organization (IFO)
d. International Development Bank (IDB)
6. Which of the following is the main objective behind the establishment of WTO?
a. To settle disputes between nations
b. To widen the principle of free Trade to sectors such as services and
agriculture
c. To cover more areas than GATT
d. All of them
7. Which of the following is the headquarters of the World Trade Organization
(WTO)?
a. Paris b. New York c. Geneva d. Madrid
8. How many countries are the current members of WTO?

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a. 181 b. 191 c. 161 d. 123

9. China became a member of world trade Organization in_________?
a. 1945 b. 1660 c. 1990 d. 2001
10. When did World Trade Organization come into effect?
a. February 5, 1994, c. March 8, 1996
b. January 1, 1995 d. April 8, 1994
11. Which of the following is classed as a tariff barrier?
a. Red Tape c. Taxes on Imports
b. Subsidies d. Embargo
12. The U.S. band beef imports from Canada after a Mad Cow Disease outbreak there.
This is an example of which type of barrier to trade?
a. Standards c. Quota
b. Subsidy d. Tariff
13. Government payments to a local supplier to reduce the supplier cost. This helps
local businesses survive because it is getting direct aid from the federal
government. What is this called?
a. Balance of trade c. Protectionism
b. Exchange rate d. Subsidy
14. Limit of the amount (quantity) of a good that can be imported is called a(n),
a. Subsidy c. Quota
b. Exports d. Appreciation
15. A protective tariff is intended to protect the;
a. Consumer from higher prices on foreign goods
b. Manufacturer from higher prices on materials produced within the country
c. Consumer from higher price goods produced within the country.
d. Manufacturer or farmer from lower priced goods imported into the country.
16. All of these restrict international Trade EXCEPT
a. Quotas c. Subsidies
b. Embargoes d. Trade deficits
17. What are tariffs?
a. Political boundaries between nations
b. Disputes between state government over boundaries

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c. Military blockades of specific countries

d. Taxes on the import or export of goods from a country
18. When one country refuses to trade with another country because of political or
infringements of human rights it is called:
a. Standard of Care c. Subsidy
b. Embargo d. Revenue tariff
19. In 2019, China placed a tax on imported American poultry of u to 105. 4%. This is
an example of a?
a. Tariff c. Market
b. Embargo d. Quotas
20. Japanese auto firms agree to limits set in Washington D.C., on the number of
Japanese cars that may be sold in the U.S.
a. Embargo c. Quotas
b. Tariff d. Subsidy

QUESTION AND ANSWER

Question/s: Answer/s:
1. 1.
2. 2.
3. 3.
4. 4.
5. 5.

KEYWORD INDEX

A Domestic employment, p20

Ad valorem tariff, p13 E
C Export duties, p16
Countervailing tariff, p16 Export Subsidies, p18
D Embargo, p19
Discriminatory tariff, p15

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F P
Free trade, p11 Protectionism, p11
G Protective tariff, p14
General and conventional tariff, p15 R
GATT, p4 Revenue tariff, p14
I Retaliatory tariff, p16
Import duties, p16 S
Import Quotas, p18 Specific tariffs, p13
Infant Industry, p20 Sliding scale tariff, p14
L T
Laisser-faire, p11 Trade, p11
Low Foreign wages, p20 Trade restrictions, p12
M Trade Barriers, 12
Maximum and Minimum tariff, p15 Tariff, p12
Multiple Column tariff, p16 U
N Unfair trade, p20
National Security, p20 W
Nondiscriminatory tariff, p14 WTO, p4-8

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TOPIC 8: FOREIGN DIRECT INVESTMENT

UNIT LEARNING OUTCOME: At the end of the unit, you are expected to:
1. Understand the types of international investments
2. Identify the factors that influence foreign direct investment (FDI).
3. Explain why and how governments encourage FDI in their countries

METALANGUAGE

FDI has a strong impact not only on the investor country’s economy but also on the host
country’s cultural and social welfare. The role of FDI has increased considerably in
recent years. FDI has become an important source of external finance for the developing
countries as it not only fulfills the ever-increasing requirements of various sectors of the
economy but also promotes growth, even more through spillovers of technology,
improved innovative capacity, and gives them effective marketing links in highly
competitive world markets. Thus, FDI has become an essential mechanism for global
economic integration.
Key Concepts and Terms
1. Foreign direct investment (FDI); is the type of investment in which foreign
investors own assets and control the activities that produce revenue flows in the
recipient country.

ESSENTIAL KNOWLEDGE

Topic 8.1: What is Foreign Direct Investment (FDI)?

Foreign direct investment (FDI) is the type of investment in which foreign investors
own assets and control the activities that produce revenue flows in the recipient
country. So, it includes both capital transfer and management transfer and know-how.

Foreign Direct Investment (FDI) is an investment in a company or organization in

another country by a group in one country to create an abiding interest. Lasting value
differentiates FDI from investment in international portfolios, in which investors
passively hold foreign securities. You can make a foreign direct investment by gaining a

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permanent interest or extending your business to a foreign country.

An investment into a foreign firm is considered an FDI if it establishes a lasting

interest. Sustained interest is established when an investor obtains at least 10% of the
firm's voting power. The key to foreign direct investment is the element of control.
Control represents the intent to manage and influence an international firm's
operations actively. This is the primary differentiating factor between FDI and passive
foreign portfolio investment.

Thus, a 10% stake in the foreign company's voting stock is necessary to define FDI.
However, there are cases when this criterion is not always applied. For example, it is
possible to exert control over more widely traded firms despite owning a smaller
percentage of voting.

To read more about FDI that includes;

Ø Methods of Foreign Direct Investment (FDI)
Ø Benefits of Foreign Direct Investment (FDI)
Ø The disadvantage of Foreign Direct Investment (FDI)
Ø Types of Foreign Direct Investment (FDI)

Go to this link:
https://corporatefinanceinstitute.com/resources/knowledge/economics/foreign-
direct-investment-fdi/.

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SELF HELP

Please refer to the articles below to further deepen your understanding of Foreign
Direct Investment.
Read more: https://www.imf.org/external/pubs/ft/fdi/2004/fditda.pdf

https://www.nber.org/chapters/c6531.pdf

https://www.researchgate.net/publication/270505709_Foreign_D
irect_Investment

https://www.thebalance.com/foreign-direct-investment-fdi-pros-
cons-and-importance-3306283

LET’S CHECK

Congratulations! You just finished the most vital concept in the study of international
business and Trade. Let us check your understanding of the critical concept. Please
proceed to the multiple-choice. Select the letter that best describes your answer.
1. Which of the following would be an example of foreign direct investment from
the United States to Taiwan?
I. U.S. bank buys bonds issued by a Taiwan computer manufacturer.
II. A U.S. car manufacturer enters into a contract with a Taiwan firm for the
latter to make and sell it spark plugs.
III. The state of California rents space in Taipei for one of its employees to use
promoting tourism in California.
IV. Warren Buffet (a U.S. citizen) buys a controlling share in a Taiwanese
electronics firm.
2. What is the relationship between foreign direct investment (FDI) and
multinational enterprises (MNEs)?
a. An MNE never involves FDI. c. All MNEs involve FDI.
b. FDI is never done by an MNE. d. All FDI is done by MNEs
3. If a German manufacturer of household appliances wants to take advantage of

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the cheaper labor available in the Czech Republic, which of the following actions
will not serve that purpose?
a. Build a manufacturing subsidiary there and employ Czech workers.
b. Build a plant in the Czech Republic and send all German workers to operate
it.
c. License a Czech firm to produce its products under its own label.
d. A contract for a Czech firm to do some of the processing for it.
4. The Foreign Direct Investment includes
a. Tangible Goods c. Intellectual Property
b. Intangible Goods d. Human Resources
5. For spreading information, the foreign policy decision-makers rely on;
a. Media c. Bureaucrats
b. Politicians d. Public
6. More expansion of foreign direct investment can boost
a. Employment c. Money circulation
b. Unemployment d. Demand
7. When capital and labor are moved internationally to will develop the;
a. Gains more from trade c. Economic growth
b. Gains more from incomed. None of the Above
8. Which of the following is an example of horizontal FDI?
a. Ford Motor Company acquires the British Jaguar
b. Lenovo, a Chinese company, acquires IBM’s personal computing business
c. The Venezuelan government acquires the Venezuelan operations of B.P.
Petroleum, a British Firm
d. General Motors Corporation builds a plan in Chins to supply Buicks to the
Chinese market.
9. Which of the following statement refer to a vertical FDI?
a. Ford Motors company establishes a plant in Canada
b. GM opens a plant in India
c. BMW opens a plant in Bilbao, Spain
d. None of the Above

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Suppose that Mexico has previously had restrictions on inflows of foreign direct
investment from all sources, including the United States. Then suppose that they
remove those restrictions on flows from the United States in a particular industry, say
hammocks. As a result, several hammock producers in the U.S. move production to
Mexico via FDI. Indicate for each of the groups below whether you expect them to gain
or to lose from this flow of investment.
10. Workers previously employed in hammock production in the U.S.
a. Gain b. Lose
11. Workers previously employed in hammock production in Mexico.
a. Gain b. Lose
12. Owners of firms that move production to Mexico.
b. Gain d. Lose
13. Owners of U.S. hammock firms that do not move production to Mexico.
c. Gain d. Lose
14. Owners of firms in Mexico that previously produced hammocks.
a. Gain b. Lose
15. Consumers of hammocks (assume that there already was free Trade in
hammocks).
a. Gain b. Lose

QUESTION AND ANSWER

Question/s: Answer/s:
1. 1.
2. 2.
3. 3.
4. 4.
5. 5.

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KEYWORD INDEX

F M
Foreign direct investment, p25 Management transfer, p25
Foreign investors, 25 V
I Voting stock, p26
Investment, p25
International portfolios, p25

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