Description
6.1 Learning Outcomes:
Understand why nations trade with each other.
Summarize the different theories explaining trade flows between nations.
6.2 Action Required:
The purpose of this interactive activity is to demonstrate your understanding of the concepts learned lessons by responding to discussion questions.
6.3 Test your Knowledge (Question):
Discuss David Ricardo’s theory of comparative advantage.
——————————————————————————————————————————————————–
7.1 Learning Outcomes:
Identify the policy instruments used by governments to influence international trade flows.
Understand why governments sometimes intervene in international trade.
7.2 Action Required:
The purpose of this interactive activity is to demonstrate your understanding of the concepts learned lessons by responding to discussion questions.
7.3 Test your Knowledge (Question):
Critically discuss Infant Industry Argument.
Unformatted Attachment Preview
Because learning changes everything.®
Government
Policy and
International
Trade
Chapter 7
© 2021 McGraw Hill. All rights reserved. Authorized only for instructor use in the classroom.
No reproduction or further distribution permitted without the prior written consent of McGraw Hill.
Learning Objectives
7-1
Identify the policy instruments used by governments to
influence international trade flows.
7-2
Understand why governments sometimes intervene in
international trade.
7-3
Summarize and explain the arguments against
strategic trade policy.
7-4
Describe the development of the world trading system
and the current trade issue.
7-5
Explain the implications for managers of
developments in the world trading system.
© McGraw Hill
Introduction
Free trade occurs when governments do not
attempt to restrict what citizens can buy from
another country or what they can sell to another
country.
• Nations nominally committed to free trade but intervene to
protect interests of politically important groups.
• Modern international trading system is based on General
Agreement on Tariffs and Trade (GATT) and the World
Trade Organization (WTO).
© McGraw Hill
Instruments of Trade Policy
1
Tariffs
• Taxes levied on imports.
• Specific tariffs levied as a fixed charge for each unit of imported
good.
• Ad valorem tariffs levied as a proportion of the value of an imported
good.
• Impact:
•
Increase government revenues.
•
Force consumers to pay more for certain imports.
•
Are pro-producer and anti-consumer.
•
Reduce the overall efficiency of the world economy.
© McGraw Hill
Instruments of Trade Policy
2
Subsidies
• Government payment to a domestic producer.
1. Cash grants.
2. Low-interest loans.
3. Tax breaks.
4. Government equity participation.
• Help domestic producers compete against foreign imports
and gain export markets.
• Domestic producers gain while consumers typically absorb
the costs.
© McGraw Hill
Instruments of Trade Policy
3
Import Quotas and Voluntary Export Restraints
• Import quotas are direct restrictions on quantity of some
good that may be imported.
• Tariff rate quotas provide a lower tariff rate to imports
within the quota than those over the quota.
• Voluntary export restraint (VER) is a quota on trade
imposed by the exporting country.
• Quota rent refers to the extra profit producers make when
supply is artificially limited by an import quota.
© McGraw Hill
Instruments of Trade Policy
4
Export Tariffs and Bans
• Export tariff is a tax placed on the export of a good.
• Goal is to discriminate against exporting in order to ensure that there
is sufficient supply of a good within a country.
• Export ban is a policy that partially or entirely restricts the
export of a good.
• Example: 1975 ban on U.S. crude oil exports.
© McGraw Hill
Instruments of Trade Policy
5
Local Content Requirements
• Some fraction of a good must be produced locally.
• Expressed in either physical or value terms.
• Protects domestic producers.
• Consumers face higher prices.
Administrative Policies
• Bureaucratic rules designed to make it difficult for imports
to enter a country.
• Hurt consumers by limiting choice.
© McGraw Hill
Instruments of Trade Policy
6
Antidumping Policies
• Dumping occurs when companies sell goods in a foreign
market at below their costs of production or below their
“fair” market value.
• A way to unload excess production.
• Antidumping policies punish foreign firms that engage in
dumping and thereby protect domestic producers from
unfair foreign competition.
• Also known as countervailing duties.
© McGraw Hill
The Case for Government Intervention
1
Political Arguments for Intervention
• Protecting Jobs and Industries.
• Most common political reason for government intervention.
• Critics say claims of unfair competition are overstated for political
reasons.
• Protecting National Security.
• Certain industries, like defense-related ones, must be protected.
© McGraw Hill
The Case for Government Intervention
Political Arguments for Intervention
2
continued
• Retaliating.
• Government should use threat of intervention as bargaining tool to
open foreign markets.
• May liberalize trade and result in economic gains.
• Risky strategy.
• Protecting Consumers.
• Protect consumers from unsafe products.
• Indirect effect is limit or ban of imports.
© McGraw Hill
The Case for Government Intervention
Political Arguments for Intervention
3
continued
• Furthering Foreign Policy Objectives.
• Government may grant preferential trade terms to a country where it
wants to build strong relations.
• Trade policy can be used to punish “rogue states.”
• Protecting Human Rights.
• Government trade policy used to improve human rights policies of
trading partners.
•
© McGraw Hill
Example: apartheid.
The Case for Government Intervention
4
Economic Arguments for Intervention
• The Infant Industry Argument.
• Governments should temporarily support new industries until they
have grown strong enough to meet international competition.
• Support comes through tariffs, import quotas, subsidies.
• Two criticisms:
1.
Protection of manufacturing from foreign competition does no good unless the
protection helps make the industry efficient.
2.
Assumes firms are unable to make efficient long-term investments by borrowing
money from the domestic or international capital market.
© McGraw Hill
The Case for Government Intervention
Economic Arguments for Intervention
5
continued
• Strategic Trade Policy.
• Government can help raise national income when a domestic firm
gains first-mover advantages.
• Might pay for a government to intervene in an industry by helping
domestic firms overcome the barriers to entry created by foreign
firms that have already reaped first-mover advantages.
• Both arguments support government intervention in international
trade.
© McGraw Hill
The Revised Case for Free Trade
1
Retaliation and Trade War
• Krugman – strategic trade policies aimed at establishing
domestic firms in a dominant position in a global industry
boost national income at the expense of other countries.
• These policies will probably provoke retaliation.
• Help establish antidumping policies and rules that minimize tradedistorting subsidies.
© McGraw Hill
The Revised Case for Free Trade
2
Domestic Policies
• Governments don’t always act in the national interest.
• Interest groups may influence policy.
• Krugman concludes that strategic trade policy is almost
certain to be captured by special-interest groups which will
distort it to their own ends.
© McGraw Hill
Development of the World Trading System
Strong economic arguments for unrestricted free
trade.
• Governments unwilling to unilaterally lower trade barriers
for fear others might not follow suit.
• General Agreement on Tariffs and Trade (GATT).
• World Trade Organization (WTO).
© McGraw Hill
1
Development of the World Trading System
From Smith to the Great Depression
• Case for free trade dates to late 18th century work of Adam
Smith and David Ricardo.
• First embraced by Great Britain in 1846.
• Corn Laws.
• Major trading partners did not reciprocate in free trade.
• Smoot-Hawley Act created a wall of tariff barriers against
imports into the United States.
© McGraw Hill
2
Development of the World Trading System
1947 to 1979: GATT, Trade Liberalization, and
Economic Growth
• Following the Great Depression, U.S. embraced free
trade.
• GATT was designed to liberalize trade by eliminating
tariffs, subsidies, import quotas, etc.
• Tariff reduction was spread over eight rounds with great success.
© McGraw Hill
3
Development of the World Trading System
1980 to 1993: Protectionist Trends
• Three reasons for increased protectionism:
• Japan’s perceived protectionist (neo-mercantilist) policies created
intense political pressures in other countries.
• Persistent trade deficits in the U.S.
• Use of non-tariff barriers increased (VERs).
© McGraw Hill
4
Development of the World Trading System
The Uruguay Round and the World Trade
Organization
• Uruguay Round sought to:
• Extend GATT rules to cover trade in services.
• Develop rules on intellectual property.
• Reduce agricultural subsidies.
• Strengthen GATT’s monitoring and enforcement.
© McGraw Hill
5
Development of the World Trading System
The Uruguay Round and the World Trade
Organization
continued
• The World Trade Organization:
• Encompasses GATT and two other groups:
•
General Agreement on Trade in Services (GATS).
•
Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS).
© McGraw Hill
6
Development of the World Trading System
WTO: Experience to Date
• By 2019, 164 members that account for 98 percent of
world trade.
• Strong early start, but since late 1990s unable to get
agreements to further reduce barriers.
• Limited protectionism returned following global financial
crisis of 2008 to 2009.
• The Brexit vote and election of Donald Trump also suggest
a move toward greater protectionism.
© McGraw Hill
7
Development of the World Trading System
WTO: Experience to Date
continued
• WTO as Global Police:
• Enforcement mechanisms appear to be having a positive effect.
• Countries involved have mostly adopted WTO’s recommendations.
• Expanded Trade Agreements:
• Global telecommunication and financial services industries.
• Foreign direct investment.
© McGraw Hill
8
Development of the World Trading System
The Future of the WTO: Unresolved Issues and the
Doha Round
• The current agenda of the WTO focuses on:
1. The rise of anti-dumping policies.
2. The high level of protectionism in agriculture.
3. The lack of strong protection for intellectual property rights in many
nations.
4. Continued high tariffs on nonagricultural goods and services in
many nations.
© McGraw Hill
9
Development of the World Trading System
10
The Future of the WTO: Unresolved Issues and the
Doha Round
continued
• Antidumping Actions:
• Vague definition of what constitutes “dumping” is a loophole many
countries are exploiting.
• Concentrated in certain sectors: metal industries, chemicals, plastics,
and machinery and electrical equipment.
© McGraw Hill
Development of the World Trading System
The Future of the WTO: Unresolved Issues and the
Doha Round
continued
• Protectionism in Agriculture:
• Tariff rates generally much higher on agricultural products.
• Reflects desire to protect domestic agriculture and traditional farming
communities.
• Net effect is to raise consumer prices.
© McGraw Hill
11
Development of the World Trading System
The Future of the WTO: Unresolved Issues and the
Doha Round
continued
• Protection of Intellectual Property:
• TRIPS agreement obliges WTO members to grant and enforce
patents lasting at least 20 years and copyrights lasting 50 years.
• Inadequate protections would reduce the incentive for innovation.
© McGraw Hill
12
Development of the World Trading System
The Future of the WTO: Unresolved Issues and the
Doha Round
continued
• Market Access for Nonagricultural Goods and Services:
• Most developed nations have average tariff rates of under 4 percent
of value.
• Certain imports still have high tariffs, which limits market access and
economic growth.
• Tariffs higher on services than industrial goods.
• WTO goal is to reduce tariff rates to zero.
© McGraw Hill
13
Development of the World Trading System
The Future of the WTO: Unresolved Issues and the
Doha Round
continued
• A New Round of Talks: Doha.
• Have been ongoing since 2001, currently stalled.
• Agenda includes:
•
Cut tariffs on industrial goods and services.
•
Phase out subsidies to agricultural producers.
•
Reduce barriers to cross-border investment.
•
Limit use of antidumping laws.
© McGraw Hill
14
Development of the World Trading System
Multilateral and Bilateral Trade Agreements
• Reciprocal trade agreements between two or more
partners.
• Created in response to failed Doha Round progress.
• Designed to capture gain from trade beyond WTO treaties.
© McGraw Hill
15
Development of the World Trading System
The World Trading System Under Threat
• Two events challenged belief or global consensus to
embrace free trade and lower barriers to cross-border flow
of goods and services.
1. British withdrawal from the European Union.
2. Election of Donald J. Trump.
© McGraw Hill
16
Focus on Managerial Implications
1
Trade Barriers, Firm Strategy, and Policy Implications
•
Why should an international manager care about political economy of
free trade?
•
Trade Barriers and Firm Strategy:
• Trade barriers raise the cost of exports which can create a competitive
disadvantage.
• Quotas may limit a firm’s ability to serve a country from locations outside the
country.
• Local content requirements might raise costs.
• Firm might want to locate production activities in another country to reduce
threat of future trade barriers.
© McGraw Hill
Focus on Managerial Implications
2
Trade Barriers, Firm Strategy, and Policy
Implications
continued
• Why should an international manager care about political
economy of free trade? continued
• Policy Implications:
• Three drawbacks to government intervention:
•
Tends to protect the inefficient rather than help firms become efficient global
competitors.
•
Might invite retaliation and trigger a trade war.
•
Unlikely to be well executed with the opportunity for it to be captured by specialinterest groups.
© McGraw Hill
Because learning changes everything.
www.mheducation.com
© 2021 McGraw Hill. All rights reserved. Authorized only for instructor use in the classroom.
No reproduction or further distribution permitted without the prior written consent of McGraw Hill.
®
Because learning changes everything.®
International
Trade
Theory
Chapter 6
© 2021 McGraw Hill. All rights reserved. Authorized only for instructor use in the classroom.
No reproduction or further distribution permitted without the prior written consent of McGraw Hill.
Learning Objectives
6-1
Understand why nations trade with each other.
6-2
Summarize the different theories explaining trade flows between
nations.
6-3
Recognize why many economists believe that unrestricted free
trade between nations will raise the economic welfare of countries
that participate in a free trade system.
6-4
Explain the arguments of those who maintain that government can
play a proactive role in promoting national competitive advantage
in certain industries.
6-5
Understand the important implications that international trade
theory holds for management practice.
© McGraw Hill
An Overview of Trade Theory
1
Free Trade
• Government does not attempt to influence through quotas
or duties what its citizens can buy from another country or
what they can produce and sell to another country.
• Adam Smith’s theory of absolute advantage.
• David Ricardo’s theory of comparative advantage.
• Heckscher-Ohlin theory.
© McGraw Hill
An Overview of Trade Theory
2
The Benefits of Trade
• Trade theories show why some international trade is
beneficial even for products a country can produce itself.
• Allows specialization.
• Limits on imports are often in the interests of domestic
producers but not domestic consumers.
© McGraw Hill
An Overview of Trade Theory
3
The Pattern of International Trade
• Much of the observed pattern of international trade is
difficult to explain.
• Ricardo’s theory of comparative advantage focuses on differences in
labor productivity.
• Heckscher-Ohlin theory focuses on factors of production.
• Vernon’s product life-cycle theory focuses on production location
changes as products become more widely accepted.
• Krugman’s new trade theory focuses on first-mover advantages.
© McGraw Hill
Competitive Advantage
A Rolex Group logo sits on display above a luxury
wristwatch store in Vienna, Austria.
© McGraw Hill
Source: ©Bloomberg/Bloomberg/Getty Images
An Overview of Trade Theory
4
Trade Theory and Government Policy
• Mercantilism advocates government involvement in
promoting exports and limiting imports.
• Smith, Ricardo, and Heckscher-Ohlin:
• Argument for unrestricted free trade.
• New trade theory and Porter:
• Justify limited government intervention for certain export-oriented
industries.
© McGraw Hill
Mercantilism
Mercantilism
• Emerged in 16th century England.
• Gold and silver are mainstays of national wealth.
• It is in a country’s best interest to maintain a trade
surplus—to export more than it imports.
• Advocates government intervention to achieve a surplus in
the balance of trade.
• Mercantilism views trade as a zero-sum game—one in
which a gain by one country results in a loss by another.
© McGraw Hill
Absolute Advantage
Adam Smith (1776) The Wealth of Nations
• Attacked the mercantilist assumption of zero-sum game.
• Promoted absolute advantage:
• Country has an absolute advantage in producing a product when it is
more efficient than any other country at producing it.
• Countries should specialize in the production of goods for which they
have an absolute advantage and then trade these goods for goods
produced by other countries.
• Both countries benefit from specialization and trade.
© McGraw Hill
Figure 6.1 The theory of absolute advantage
Access the text alternative for slide images
© McGraw Hill
Comparative Advantage
1
David Ricardo (1817) Principles of Political
Economy
• Promoted comparative advantage.
• A country should specialize in the production of those goods that it
produces most efficiently and buy the goods that it produces less
efficiently from other countries, even if it can produce those goods
more efficiently itself.
© McGraw Hill
Comparative Advantage
2
The Gains from Trade
• Potential world production is greater with unrestricted free
trade than it is with restricted trade.
• The theory of comparative advantage suggests that trade
is a positive-sum game in which all countries that
participate realize economic gains.
© McGraw Hill
Comparative Advantage
3
Qualifications and Assumptions
• Simple world with two countries and two goods.
• No transportation costs.
• No differences in price of resources.
• Resources can move freely.
• Constant returns to scale.
• Each country has a fixed stock of resources and free
trade does not change the efficiency with which a country
uses its resources.
• No effects of trade on income distribution within a country.
© McGraw Hill
Comparative Advantage
4
Extensions of the Ricardian Model
• Immobile Resources:
• Resources do not always move easily from one economic activity to
another.
• Political opposition to the adoption of a free trade regime typically
comes from those whose jobs are most at risk.
© McGraw Hill
Comparative Advantage
5
Extensions of the Ricardian Model
continued
• Diminishing Returns:
• Comparative advantage model assumes constant returns to
specialization.
• More realistic to assume diminishing returns to specialization.
•
Not all resources are the same quality.
•
Different goods use resources in different proportions.
© McGraw Hill
Comparative Advantage
6
Extensions of the Ricardian Model
continued
• Dynamic Effects and Economic Growth:
• Trade can result in two types of dynamic gains:
1. Free trade might increase a country’s stock of resources as increased supplies of
labor and capital from abroad become available for use within the country.
2. Free trade might also increase the efficiency with which a country uses its
resources.
• Dynamic gains in both the stock of a country’s resources and the
efficiency with which resources are utilized will cause a country’s
PPF to shift outward.
© McGraw Hill
Figure 6.4 The influence of free trade on the PPF
© McGraw Hill
Comparative Advantage
7
Extensions of the Ricardian Model
continued
• Trade, Jobs, and Wages: The Samuelson Critique.
• What happens when a rich country (U.S.) enters into a free trade
agreement with a poor country (China) that rapidly improves its
productivity after the introduction of a free trade regime?
• Lower prices may not make up for lower wages in the U.S.
• Concerned with offshoring of service jobs.
• Historically, free trade has benefited wealthy countries.
• Introducing protectionist measures may be harmful to U.S.
© McGraw Hill
Comparative Advantage
8
Extensions of the Ricardian Model
continued
• Evidence for the Link between Trade and Growth.
• Countries that adopt a more open stance toward international trade
enjoy higher growth rates than those that close their economies to
trade.
• Sachs and Warner created a measure of how “open” to international
trade an economy was.
© McGraw Hill
Heckscher-Ohlin Theory
1
Factor Endowments
• Comparative advantage arises from differences in national
factor endowments.
• The extent to which a country is endowed with resources such as
land, labor, and capital.
• Countries will export those goods that make intensive use
of factors that are locally abundant.
• Countries will also import goods that make intensive use
of factors that are locally scarce.
© McGraw Hill
Heckscher-Ohlin Theory
2
The Leontief Paradox
• Raised questions about the validity of the HeckscherOhlin theory.
• Found that U.S. exports were less capital intensive than
U.S. imports.
© McGraw Hill
The Product Life-Cycle Theory
1
Raymond Vernon proposed life-cycle theory in the
mid-1960s.
• Most new products were developed and first sold in the
U.S.
• The wealth and size of the U.S. market gave U.S. firms a
strong incentive to develop new consumer products.
• The high cost of U.S. labor gave U.S. firms an incentive to
develop cost-saving process innovations.
• Over time, demand grows in other countries, and price
becomes the main competitive weapon.
© McGraw Hill
The Product Life-Cycle Theory
2
Product Life-Cycle Theory in the Twenty-First
Century
• Historically, an accurate theory.
• Now seems ethnocentric and increasingly dated.
© McGraw Hill
New Trade Theory
1
Economies of Scale
• Cost reductions associated with large-scale production.
• The ability of firms to gain economies of scale can have
important implications for international trade.
• Trade can increase the variety of goods available to consumers and
decrease the average cost of those goods.
• In those industries in which the output required to attain economies
of scale represents a significant proportion of total world demand, the
global market may be able to support only a small number of
enterprises.
© McGraw Hill
New Trade Theory
2
Increasing Product Variety and Reducing Costs
• What would happen in a world without trade?
• The variety of goods that a country can produce, and the scale of
production are limited by the size of the market.
• What happens in a world with trade?
• Individual national markets are combined into a larger world market.
• Each nation can increase the variety of goods available to its
consumers and lower the costs of those goods.
© McGraw Hill
New Trade Theory
3
Economies of Scale, First-Mover Advantages, and
the Pattern of Trade
• First-mover advantages:
• Economic and strategic advantages accruing to the first to enter a
market.
• Can gain a scale-based cost advantage that later entrants find
almost impossible to match.
© McGraw Hill
New Trade Theory
4
Implications of New Trade Theory
• Nations may benefit from trade even when they do not
differ in resource endowments or technology.
• A country may predominate in the export of a good simply
because it was lucky enough to have one or more firms
among the first to produce that good.
• Useful in explaining trade patterns.
• Luck, entrepreneurship, and innovation give a firm firstmover advantages.
© McGraw Hill
National Competitive Advantage: Porter’s
Diamond
1
Porter believed existing theories only told part of the
story.
• Wanted to explain why a nation achieves international
success in a particular industry.
• Four broad attributes of a nation shape the environment in
which local firms compete:
1. Factor endowments.
2. Demand conditions.
3. Related and supporting industries.
4. Firm strategy, structure, and rivalry.
© McGraw Hill
Figure 6.5 The determinants of national
competitive advantage: Porter’s diamond
Access the text alternative for slide images
© McGraw Hill
Source: Michael E. Porter, The Competitive Advantage of Nations (New York: Free Press, 1990; republished with a new introduction, 1998), p. 72.
National Competitive Advantage: Porter’s
Diamond
2
Porter’s four attributes constitute a diamond.
• Firms are most likely to succeed in industries or industry
segments where the diamond is most favorable.
• The diamond is a mutually reinforcing system.
• Two additional variables can influence the national diamond.
1. Chance.
2. Government.
© McGraw Hill
National Competitive Advantage: Porter’s
Diamond
3
Factor Endowments
• Basic factors:
• Natural resources, climate, location, demographic.
• Advanced factors:
• Communication infrastructure, sophisticated and skilled labor,
research facilities, and technological know-how.
• Advanced factors are a product of investment by individuals,
companies, and governments.
© McGraw Hill
National Competitive Advantage: Porter’s
Diamond
4
Demand Conditions
• Firms gain competitive advantage if their domestic
consumers are sophisticated and demanding.
Related and Supporting Industries
• The benefits of investments in advanced factors of
production by related and supporting industries can spill
over into an industry, thereby helping it achieve a strong
competitive position internationally.
© McGraw Hill
National Competitive Advantage: Porter’s
Diamond
5
Firm Strategy, Structure, and Rivalry
• Different nations are characterized by different
management ideologies, which may or may not help them
build national competitive advantage.
• There is a strong association between vigorous domestic
rivalry and the creation and persistence of competitive
advantage in an industry.
© McGraw Hill
National Competitive Advantage: Porter’s
Diamond
6
Evaluating Porter’s Theory
• Government policy can influence supporting and related
industries through regulation and influence firm rivalry
through such devices as capital market regulation, tax
policy, and antitrust laws.
• Porter’s theory has not been subjected to detailed
empirical testing.
© McGraw Hill
Focus on Managerial Implications
Location, First-Mover Advantages, and Government
Policy
• Location: from a profit perspective, firms should disperse
production to countries where they can be performed most
efficiently.
• First-mover advantages: it pays to invest substantial
financial resources in trying to build an early advantage.
• Government policy: according to Porter, government
should invest in education, infrastructure, and basic
research.
© McGraw Hill
Because learning changes everything.
www.mheducation.com
© 2021 McGraw Hill. All rights reserved. Authorized only for instructor use in the classroom.
No reproduction or further distribution permitted without the prior written consent of McGraw Hill.
®
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