Business Economics & International

Business

Md. Jahidul Islam MBA, FCMA, CAMS, CGIA

General Manager
Pubali Bank PLC
Introduction
• Free trade refers to a situation where a government does not attempt to restrict
what its citizens can buy from another country or what they can sell to another
country

• While many nations are nominally committed to free trade, they tend to
intervene in international trade to protect the interests of politically important
groups
Instruments of Trade Policy
Question: How do governments intervene in international trade?

• There are seven main instruments of trade policy

1. Tariffs
2. Subsidies
3. Import quotas
4. Voluntary export restraints
5. Local content requirements
6. Antidumping policies
7. Administrative policies
Tariffs
• A tariff is a tax levied on imports that effectively raises the cost of imported
products relative to domestic products
• Specific tariffs are levied as a fixed charge for each unit of a good imported
• Ad valorem tariffs are levied as a proportion of the value of the imported
good
Tariffs
Question: Why do governments impose tariffs?

• Tariffs
• increase government revenues
• provide protection to domestic producers against foreign competitors by
increasing the cost of imported foreign goods
• force consumers to pay more for certain imports

• Tariffs are pro-producer and anti-consumer, and tariffs reduce the overall
efficiency of the world economy
Subsidies
• A subsidy is a government payment to a domestic producer

• Subsidies help domestic producers

• compete against low-cost foreign imports
• gain export markets

• Consumers typically absorb the costs of subsidies

Import Quotas and Voluntary Export Restraints

• An import quota is a direct restriction on the quantity of some good that may be
imported into a country

• Tariff rate quotas are a hybrid of a quota and a tariff where a lower tariff is
applied to imports within the quota than to those over the quota

• Voluntary export restraints are quotas on trade imposed by the exporting

country, typically at the request of the importing country’s government

• A quota rent is the extra profit that producers make when supply is artificially
limited by an import quota
Import Quotas and Voluntary Export Restraints

Question: Who benefits from import quotas and voluntary export restraints?

• Import quotas and voluntary export restraints benefit domestic producers by

limiting import competition, but they raise the prices of imported goods for
consumers
Local Content Requirements
• A local content requirement demands that some specific fraction of a good be
produced domestically
• The requirement can be in physical terms or in value terms

• Local content requirements benefit domestic producers and jobs, but consumers
face higher prices
Administrative Policies
• Administrative trade polices are bureaucratic rules that are designed to make it
difficult for imports to enter a country

• These polices hurt consumers by denying access to possibly superior foreign

products
Administrative Policies
• Dumping is selling goods in a foreign market below their cost of production, or
selling goods in a foreign market at below their “fair” market value
• It can be a way for firms to unload excess production in foreign markets
• Some dumping may be predatory behavior to drive indigenous competitors
out of that market, and later raising prices and earning substantial profits
Administrative Policies
• Antidumping polices are designed to punish foreign firms that engage in dumping

• The goal is to protect domestic producers from “unfair” foreign competition

• U.S. firms that believe a foreign firm is dumping can file a complaint with the
government

• If the complaint has merit, antidumping duties, also known as countervailing

duties may be imposed
The Case for Government Intervention

Question: Why do governments intervene in trade?

• There are two types of arguments

1. Political arguments - protecting the interests of certain groups within a
nation (normally producers), often at the expense of other groups (normally
consumers)
2. Economic arguments - boosting the overall wealth of a nation (to the
benefit of all, both producers and consumers)
Political Arguments for Intervention
• Political arguments for government intervention include
1. protecting jobs
2. protecting industries deemed important for national security
3. retaliating to unfair foreign competition
4. protecting consumers from “dangerous” products
5. furthering the goals of foreign policy
6. protecting the human rights of individuals in exporting countries
Economic Arguments for Intervention

• Economic arguments for government intervention in international trade

include

1. Infant industry argument

2. Strategic trade policy
Economic Arguments for Intervention

1. Infant Industry Argument

• Infant industry argument - an industry should be protected

until it can develop and be viable and competitive
internationally
• This has been accepted as a justification for temporary
trade restrictions under the WTO

• Critics argue
• it is useless unless it makes the industry more efficient
• if a country has the potential to develop a viable
competitive position, its firms should be capable of
raising necessary funds
Economic Arguments for Intervention

2. Strategic Trade Policy

• Strategic trade policy - there may be important first mover advantages,

governments can help firms from their countries attain these advantages

• Strategic trade policy - governments can help firms overcome barriers to entry
into industries where foreign firms have an initial advantage
The Revised Case for Free Trade
• New trade theorists believe government intervention in international trade is
justified

• Classic trade theorists disagree

• Some new trade theorists believe that strategic trade theory is appealing in
theory, but it may not be workable in practice

• Two situations where restrictions on trade may be inappropriate

• Retaliation
• Domestic Policies
Retaliation and War
• Strategic trade policies aimed at establishing domestic firms in a dominant
position in a global industry are beggar-thy-neighbor policies that boost national
income at the expense of other countries

• A country that attempts to use such policies will probably provoke retaliation
• A trade war could leave both countries worse off
Domestic Policies
• Governments can be influenced by special interest

• A government’s decision to intervene in a market may appease a certain group,

but not necessarily the support the interests of the country as a whole
Development of the World Trading System

• Since World War II, an international trading framework has evolved to govern
world trade

• In its first fifty years, the framework was known as the General Agreement on
Tariffs and Trade (GATT)

• Since 1995, the framework has been known as the World Trade Organization
(WTO)
WTO Genesis -Why WTO came into existence?
GENERAL AGREEMENT ON TARIFFS & TRADE (GATT) – Predecessor to WTO:
❑ GATT was an accident
❖ Signed in 1946 as preparation for International Trade Organisation
(which never came into being), came into existence in 1947
❖ India was also signatory along with 22 other countries
❑ GATT – created set of global rules that governed trade in goods & sought:
❖ Substantial reduction in tariff and other barriers to trade &
❖ Eliminate discriminatory treatment in international commerce.
❑ 8 rounds of negotiations had taken place during 5 decades of its existence.
❑ GATT’s weaknesses:
❖ It’s successful tariff reduction caused rise in use of non-tariff barriers (e.g. standards)
❖ Dispute resolution was non-binding
❑ 8TH Uruguay Round (1986-1993) long series of GATT negotiations
❖ Created the WTO – a permanent institution
WTO Genesis -Why WTO came into existence?
❑ WTO came into existence on 1.1.1995, precisely as a response to need for;
❖ more effective regulatory, supervisory and enforcement environment for world
trade & investment than the GATT could provide.
❑ WTO’s aim- is to promote free trade and stimulate economic growth.
❑ It is made up of a series of agreements and incorporates old GATT.
❑ GATT only focused on trade in goods, WTO's rules extended to include;
❑ Intellectual Property, Investment, Services, Telecommunications and Financial
services (banking).

GATT WTO
▪Ad hoc and provisional •Permanent and legal
▪Contracting parties •Members
▪Trade in goods •Trade in goods, services, Trade & IPRS
▪Dispute based on consensus •Faster, binding & Permanent mechanism
 Overview
❑ World Trade Organization (WTO) is one of the most powerful
institutions in the world. It is an international, multilateral organization,
which sets the rules for the global trading system & resolves disputes
between its member states;

❑ It oversees global trade in goods & services and has 30 agreements.

❑ WTO headquarters are located in Geneva, Switzerland.

❑ Pascal Lamy is the current Director-General from Sept 1, 2005.

❑ Currently - 150 members; Vietnam latest to join.

❑ Mission -WTO aims to increase international trade by promoting lower

trade barriers and providing a platform for negotiation of trade & to
their business.
 BASIC PRINCIPLES
❑ Non discrimination between countries:
❖ No Most Favoured Nation (MFN) Treatment - no special deals to trading
partners, all members of WTO must be treated the same
❖ No National Special Treatment - locals and foreigners are treated equally
❑ Freer trade: gradually through negotiations
❑ Predictability: Promising not to raise tariffs is called binding a tariff and
binding leads to greater certainty for businesses
❑ Promoting competition
❑ Encouraging Development and Economic Reform
 WTO Functions
❑ Transparent, free and rule-based trading system.
❑ Provide forum for negotiations and common institutional framework for
conduct of trade relations among members
❑ Facilitate implementation, administration & operation of Multilateral Trade
Agreements
❑ Rules and Procedure Governing Dispute settlement – providing security and
predictability to system and preserving rights & obligations of Members
❑ Trade Policy Review Mechanism – designed to contribute to greater
transparency and understanding of trade policies and practices to members.
❑ Concern for LDCs (Least-developed countries) and NFIDCs(Net Food-
Importing Developing Countries)
❑ Concern on Non-trade issues like Food Security, Environment, Health etc.
❑ Coherence in global economic policy-making – cooperating with IMF and
world bank.
❑ Technical assistance and training for developing countries
 Agreements
WTO oversees about 30 different agreements which have the status of
international legal texts. Member countries must sign and ratify all WTO
agreements on accession.

MULTILATERAL
❑ General Agreement on Tariffs and Trade (GATT 1994)
❑ Agreement on Agriculture AoA
❑ Agreement on the Application of Sanitary and Phytosanitary Measures(SPS)
❑ Agreement on Textiles and Clothing (Terminated on 1st Jan, 2005)
❑ Agreement on Technical Barriers to Trade (TBT)
❑ Agreement on Trade-Related Investment Measures (TRIMs)
❑ Agreement on Pre-shipment Inspection (PSI)
❑ Agreement on Rules of Origin
❑ Agreement on Import Licensing Procedures
❑ Agreement on Subsidies and Countervailing Measures
❑ Agreement on Safeguards
❑ Agreement on Anti-Dumping (Agreement on Article VI)
❑ Agreement on Customs Valuation (Agreement on Article VII)
 Agreements
❑ General Agreement on Trade in Services (GATS)
❑ Agreement on Trade-Related Aspects of Intellectual Property Rights
(TRIPS)

PLURILATERAL
❑ Agreement on Trade in Civil Aircraft
❑ Agreement on Government Procurement
❑ International Dairy Agreement
❑ International Bovine Meat-Agreement
Implications for Managers
Question: Why should international managers care about the political economy of
free trade or about the relative merits of arguments for free trade and
protectionism?

• Trade barriers impact firm strategy

• Firms can play a role in promoting free trade or trade barriers
Trade Barriers and Firm Strategy
• Trade theory suggests why dispersing production activities globally can be
beneficial

• However, trade barriers may limit a firm’s ability to do so

• Raise the cost of exporting
• Quotas limit exports
• Firms may have to locate production activities within a country to meet local
content regulations
• The threat of future trade barriers can influence firm strategy

• All of these can raise costs above what they may have been in a world of free
trade
Policy Implications
• International firms have an incentive to lobby for free trade, and keep
protectionist pressures from causing them to have to change strategies

• While there may be short run benefits to having government protection in some
situations, in the long run these can backfire and other governments can retaliate
making it more difficult to construct a globally dispersed production system