IB - 3 the Political Economy of Trade and Investment

The Political Economy of Trade and Investment

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Overview• Instruments of trade policy

• Arguments for political intervention

• Government intervention in FDI

• Trade liberalisation, GATT and the WTO

• Implications for international business

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Instruments of Trade Policy

• Tariffs• Subsidies• Import quotas• Voluntary export restraints• Local content requirements• Administrative policies• Anti-dumping policies

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• Taxes on imports - is a tax levied on imports that effectively raises the cost of imported products relative to domestic products

• Specific tariff - are levied as a fixed charge for each unit of a good imported

• Ad valorem tariff - are levied as a proportion of the value of the imported good

Tariffs

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•Who gains:

–Government

–Domestic producers (short run)

–Employees of protected industries

•Who loses:

–Consumers who pay higher prices

–The economy which remains inefficient

–Employees of protected industries who don’t develop new skills

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Q

P

D

S

Domestic Market Without International Trade

P*

Q*

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Q

P

D

S

qs qd

imports

Pw

Domestic Market With International Trade

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Q

P

D

S

Effects of Protection

qs2 qd

Pw + Ttariff

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qs qd2

Pw

Subsidies

Government support to domestic producers

– Cash grants, low-interest loans, tax breaks, equity participation, government purchases

– Aim to achieve lower costs to

• Compete against cheaper imports

• Gain export markets

• Increase domestic employment

• Help local producers achieve first-mover advantage in emerging industries

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Quotas

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

• A tariff rate quota is 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.

• A voluntary export restraint is a quota on trade imposed by the exporting country, typically at the request of the importing country’s government.

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Price Floor in Domestic MarketPrice

Qd Qe Qs QuantityD

Pe

SPf Price Floor

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(a)European Common Agricultural Policy

(b) United States - Export Enhancement Program

(c) Japan

Price Floors in Agricultural Markets

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1. A surplus

2. Storage costs

3. Disposal policy

4. Misallocation of resources

5. Higher Domestic prices

6. Lower World prices

Results of a Price Floor

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Other Protection Measures• Anti-dumping laws - Dumping is variously

defined as selling goods in a foreign market below their costs of production

• Voluntary restraint• Local content rules - demands that some

specific fraction of a good be produced domestically

• Health & quarantine• Other administrative measures - are bureaucratic

rules and red tape that by default or design make it difficult for imports to enter a country.

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Political Arguments for Intervention

• National security

• Individual industries and jobs protected

• Retaliation

• Consumer protection (health, safety)

• Foreign policy objectives

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Economic Arguments for Intervention

• Infant industry protection - suggests that an industry should be protected until it can develop and be viable and competitive internationally

• Strategic trade policy - suggests that in cases where there may be important first mover advantages, governments can help firms from their countries attain these advantages

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The Politics of Trade in Steel

• March 2002 President George Bush imposes sweeping tariffs ranging from 8% to 30% on a range of steel imports from foreign producers

• November 2003, the Institute for International Economics estimated the costs to steel users due to the steel tariffs amounted to $600 million in lost profits and 26,000 jobs. The benefit to the steel industry due to the tariffs was $240 million and saved 5,000 jobs

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An example: one of the conditions (for supporting an Australian government out of the hung parliament in 2010) that independent Bob Katter had was protection for agriculture and a ban on Filipino banana imports. •Katter believes that this will benefit the constituents of his North Queensland district and, notionally, ‘regional’ Australia more broadly.

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“The president of the South Australian Farmers' Federation hopes Queensland independent Bob Katter considers the big picture of Australia's agricultural industries when making a decision on which government he'll support. •Peter White thinks the independent's views to change the competition laws could be devastating for grain growers and livestock producers who rely on selling their produce overseas. •He says while tariff changes may benefit rural industries in Bob Katter's seat of Kennedy, the independent needs to consider all farmers across the country. •"If you're going down that very strong protectionist avenue, while there might be a few benefit from it overall that could very well work against them.“ •Source: “Farm lobby group challenges Katter's views on tariffs” Thursday, 26/08/2010, ABC Australia

Government Intervention in FDI

• Home and Host Country

• Resource transfer effects,

• The employment effects,

• The balance of payments effects,

• Effects on competition and economic growth,

• And national sovereignty

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Inward and Outward FDI

• “Inward” Foreign direct investment occurs when foreign capital occurs in introduced into a domestic economy (typically referred to as the ‘host country’).

• •“Outward” FDI refers to the other side of this transaction, i.e. local capital is introduced into a foreign economy (typically referred to as the ‘home country’).

• •Of course there is by definition an ‘inward’ and ‘outward’ perspective on any FDI.

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Benefits of Inward FDI

• Host Country Benefits: The main potential benefits of inward FDI for a host country are: The resource transfer effect, i.e. the country’s pool of capital is increased by capital injections from the investing country.

• The employment effect, which simply refers to an increase in local jobs resulting from the foreign investment.

• The balance of payments effect, i.e. FDI helps finance imports of goods (and perhaps other non-investment capital) from abroad.

• Effects on competition and economic growth, i.e. FDI increases a country’s domestic and international competitiveness and, through that, increases national GDP growth. Often this effect is through new and improved (from a local perspective) technology and ‘know-how.’

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Costs of Inward FDI

– Host Country Costs: There are three main costs of inward FDI: The possible adverse effects of FDI on competition within the host nation which can include a ‘crowding out’ of domestic investment by more sophisticated and powerful foreign investors.

– Adverse effects on the balance of payments, which is dependent mainly on how many of the benefits from FDI (especially profits) are ‘repatriated’ (i.e. leave the host country and returned to the investing country)

– But also include if the new enterprise buys inputs from the home country as oppose to the host’s domestic market

– The perceived or actual loss of national sovereignty and autonomy and control.

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Benefits and Costs of Outward FDI • Home-Country Costs and benefits include: • Reverse Resource Transfer Effect – home countries

MNE learns valuable new skills from exposure to foreign markets

• Balance-of-Payments Effects, i.e. the direct cost of the initial capital outflow required to finance the FDI also if production is moved offshore to low cost location. Alternatively the benefit of profits being repatriated and if the new investment creates demand for home country product.

• Employment Effects, which occurs when FDI is a substitute for domestic production (i.e. ‘offshoring’). If the home country is suffering from unemployment, concern about the export of jobs intensifies

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Trading Blocs and Trading Agreements

• When certain countries integrate economically, or form an agreement, to:

– trade freely with each other, or– reduce trade barriers between each

other• Members of blocs or agreements impose

trade restrictions against non-member countries, reducing free trade

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Promoting Free Trade

• World resource use would be more efficient, and consumer prices would be lower

• The World Trade Organization (formerly the General Agreement of Tariffs and Trade - GATT) promotes free trade and works toward gaining agreements to reduce tariff protection world-wide

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International Trade Institutions

• WTO• World Bank• IMF• United Nations

-ILO, UNESCO etc• NGOs

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Trade Blocks

• European Union (EU)

• North American Free Trade Association (NAFTA)

• Asia Pacific Economic Cooperation (APEC)

• Closer Economic Relations (CER)

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GATT/WTO

•MFN

-any preferential treatment offered to one member country must be extended to all other members

•Exceptions

-regional arrangements such as NAFTA

-GSP (Generalized System of Preferences) for LDCs

-countries still use NTBs, other loopholes

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Uruguay Round• Tariffs cut further

• Agricultural Policy Modified:

– cut price supports 20%, export subsidies 36%

• Services given prominence: developed set of principles

• IP rights protected further

• WTO created to implement Uruguay round

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• Main focus has been on the reduction of domestic support, and increasing export competition and market access • Negotiations with respect to agriculture stalled in mid 2005• Reduction of domestic support• Increasing export competition and market access • Reduction of protection to agriculture

Doha Round

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Implications For Business

• Trade barriers affect firm strategy

• Government policy has direct impact on a firm’s business

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