3-1 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Global Business Today 1e by Hill. Slides prepared by Fuming Jiang. Chapter 3 T he P olitical

3-1 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Global Business Today 1e by Hill. Slides prepared by Fuming Jiang.

Chapter 3

The Political Economy of Trade and Investment 3


Lecture/Chapter Topics

• Introduction• Instruments of Trade Policy• Why Governments Intervene• Benefits and Costs of FDI• Government Policy Instruments and FDI• Trade and Investment Liberalisation• Regional Economic Integration• Managerial Implications


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• There are seven main instruments of trade policy:

1. Tariffs 2. Subsidies3. Import quotas4. Voluntary export restraints5. Local content requirements 6. Antidumping policies 7. Administrative policies


Instruments of Trade Policy1. 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.


Instruments of Trade Policy• Tariffs (Cont’d)

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

– So, tariffs are unambiguously pro-producer and anti-consumer, and tariffs reduce the overall efficiency of the world economy.


Instruments of Trade Policy2. Subsidies

– A subsidy is a government payment to a domestic producer.

– Subsidies help domestic producers in two ways: i. They help them compete against low-cost foreign imports.ii. They help them gain export markets.

– Consumers typically absorb the costs of subsidies.


Instruments of Trade Policy3/4. 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.


Instruments of Trade Policy• Import Quotas and Voluntary Export Restraints

(Cont’d)– 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.


Instruments of Trade Policy• Import Quotas and Voluntary Export Restraints

(Cont’d)– Import quotas and voluntary export restraints benefit

domestic producers by limiting import competition, but they raise the prices of imported goods.


Instruments of Trade Policy5. Local Content Requirements

– A local content requirement demands that some specific fraction of a good be produced domestically.

– Local content requirements benefit domestic producers, but consumers face higher prices.


Instruments of Trade Policy6. 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 them access to possibly superior foreign products.


Instruments of Trade Policy7. Antidumping Policies

– Dumping is defined as selling goods in a foreign market below their costs of production, or as selling goods in a foreign market at below their ‘fair’ market value.

– Dumping is viewed as a method by which firms unload excess production in foreign markets.


Instruments of Trade Policy• Antidumping Policies (Cont’d)

– Some dumping may be predatory behaviour, with producers using substantial profits from their home markets to subsidise prices in a foreign market with a view to driving indigenous competitors out of that market, and later raising prices and earning substantial profits.

– Antidumping polices (or countervailing duties) are designed to punish foreign firms that engage in dumping and protect domestic producers from ‘unfair’ foreign competition.


Why Governments Intervene

• The Case for Government Intervention– There are two types of arguments for government intervention:

political and economic. – Political arguments are concerned with protecting the interests

of certain groups within a nation (normally producers), often at the expense of other groups (normally consumers).

– Economic arguments are typically concerned with boosting the overall wealth of a nation (for the benefit of all, both producers and consumers).


Why Governments Intervene• Political Arguments for Intervention

– Protecting jobs– Protecting industries deemed important for national security– Retaliating against unfair foreign competition– Protecting consumers from ‘dangerous’ products– Furthering the goals of foreign policy– Protecting the human rights of individuals in exporting

countries


Why Governments Intervene• Protecting Jobs and Industries

– The most common political reason for trade restrictions is protecting jobs and industries.

– Usually this results from political pressures by unions or industries that are ‘threatened’ by more efficient foreign producers, and have more political clout than the consumers who will eventually pay the costs.


Why Governments Intervene• National Security

– Protecting industries such as aerospace or electronics because they are important for national security is another argument for trade restrictions.

• Retaliation– When governments take, or threaten to take, specific

actions, other countries may remove trade barriers; however, if threatened governments don’t back down, tensions can escalate and new trade barriers may be enacted.


Why Governments Intervene• Protecting Consumers

– Consumer protection can also be an argument for restricting imports.

• Furthering Foreign Policy Objectives– Trade policy can be used to support foreign policy

objectives.– Preferential trade terms can be granted to countries with

which a government wants to build strong relations.


Why Governments Intervene• Furthering Foreign Policy Objectives (Cont’d)

– Trade policy can also be used to punish ‘rogue states’ that do not abide by international laws or norms (the US has done this with Libya, Iran, Iraq, North Korea and Cuba).

– However, it might cause other countries to undermine unilateral trade sanctions.

– Two Acts, the Helms-Burton Act and the D’Amato Act, have been passed to protect American companies from such actions.


Why Governments Intervene• Protecting Human Rights

– Governments sometimes use trade policy to improve the human rights policies of trading partners.

– Unless a large number of countries choose to take such action, however, it is unlikely to prove successful.

– Some critics have argued that the best way to improve the internal human rights of a country is to engage it in international trade.


Why Governments Intervene• Economic Arguments for Intervention

– The Infant Industry Argument The infant industry argument holds that an industry should be

protected until it can develop and be viable and competitive internationally.

The infant industry argument has been accepted as a justification for temporary trade restrictions under the WTO.


Why Governments Intervene• Economic Arguments for Intervention

– The Infant Industry Argument (Cont’d) However, it can be difficult to gauge when an industry has

grown up. Critics argue that if a country has the potential to develop a

viable competitive position its firms should be capable of raising necessary funds without additional support from the government.


Why Governments Intervene• Strategic Trade Policy

– 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.

– Strategic trade policy also suggests that governments can help firms overcome barriers to entry into industries where foreign firms have an initial advantage.


Why Governments Intervene• The Revised Case for Free Trade

– Two situations where restrictions on trade may be inappropriate: retaliation and politics.

• Retaliation and Trade War– Krugman argues that 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.


Why Governments Intervene• Domestic Politics

– Since special interest groups can influence governments, Krugman argues that strategic trade policy is almost certain to be captured by special interest groups within an economy, who will distort it to serve their own ends.


Managerial Implications • Trade Barriers and Firm Strategy

– Trade barriers raise the cost of exporting products to a country.

– Voluntary export restraints (VERs) may limit a firm’s ability to serve a country from locations outside that country.


Managerial Implications• Trade Barriers and Firm Strategy (Cont’d)

– To conform to local content requirements, a firm may have to locate more production activities in a given market than it otherwise would.

– All of these implications can raise the firm’s costs above the level that could be achieved in a world without trade barriers.


Implication for Managers• 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 governmental protection in some situations, in the long run these measures can backfire and cause other governments to retaliate.


Benefits and Costs of FDI

• Host Country Benefits: The main benefits of inward

FDI for a host country are: – The resource transfer effect

– The employment effect

– The balance of payments effect

– Effects on competition and economic growth


Benefits and Costs of FDI• Resource-Transfer Effects

– FDI can make a positive contribution to a host economy by supplying capital, technology and management resources that would otherwise not be available.

• Employment Effects – FDI can bring jobs to a host country that would otherwise

not be created there.


Benefits and Costs of FDI•Balance-of-Payments Effects

– A country’s balance-of-payments account is a record of its payments to and receipts from other countries.

– The current account is a record of a country’s exports and imports of goods and services.

– Governments typically prefer to see a current account surplus than a deficit.


Benefits and Costs of FDI•Balance-of-Payments Effects (Cont’d)

– FDI can help a country to achieve a current account surplus:

If the FDI is a substitute for imports of goods and services If the MNE uses a foreign subsidiary to export goods and

services to other countries


Benefits and Costs of FDI• Effect on Competition and Economic Growth

– FDI in the form of greenfield investment increases the level of competition in a market, driving down prices and improving the welfare of consumers.

– Increased competition can lead to increased productivity growth, product and process innovation, and greater economic growth.


Benefits and Costs of FDI• Host Country Costs: There are three main costs of

inward FDI:1. The possible adverse effects of FDI on competition

within the host nation.

2. Adverse effects on the balance of payments.

3. The perceived loss of national sovereignty and autonomy.


Benefits and Costs of FDI• Adverse Effects on Competition

– Host governments worry that the subsidiaries of foreign MNEs operating in their country may have greater economic power than indigenous competitors because they may be part of a larger international organisation.


Benefits and Costs of FDI• Adverse Effects on the Balance of Payments

– FDI has two possible adverse effects on a host country’s balance-of-payments:

i. With the initial capital inflows of FDI must come the subsequent outflow of capital as the foreign subsidiary repatriates earnings to its parent country.

ii. When a foreign subsidiary imports a substantial number of its inputs from abroad, there is a debit on the current account of the host country’s balance of payments.


Benefits and Costs of FDI• National Sovereignty and Autonomy

– Many host governments worry that FDI is accompanied by some loss of economic independence.

– The concern is that key decisions that can affect the host country’s economy will be made by a foreign parent that has no real commitment to the host country, and over which the host country’s government has no real control.



• Home Country Benefits – The benefits of FDI to the home country include:

Balance of payments The employment effects Reverse resource-transfer effect


Benefits and Costs of FDI• Balance of Payments

– The home country’s balance of payments benefits from the inward flow of repatriated foreign earnings.

– FDI can also benefit the home country’s balance of payments if the foreign subsidiary creates demands for home-country exports such as capital equipment, intermediate goods and complementary products.



• The Employment Effects – Positive employment effects arise when the foreign subsidiary

creates demand for home-country exports.

• Reverse Resource-Transfer Effect– Benefits arise when the home-country MNE learns valuable skills

from its exposure to foreign markets that can subsequently be transferred back to the home country.


Benefits and Costs of FDI• Home-Country Costs

– The most important concerns centre on the balance-of-payments and employment effects of outward FDI.

• Balance-of-Payments Effects– Suffers from the initial capital outflow required to finance

the FDI.


Benefits and Costs of FDI• Balance-of-Payments Effects (Cont’d)

– The current account of the balance of payments suffers if the purpose of the foreign investment is to serve the home market from a low-cost production location.

– The current account of the balance of payments suffers if the FDI is a substitute for direct exports.


Cost and benefit of FDI• Employment Effects

– The most serious concerns arise when FDI is a substitute for domestic production.

– This concern gets expressed in terms such as ‘exporting jobs’ and ‘offshoring’.

– If the home country is suffering from unemployment, concern about the export of jobs intensifies.


Government Policy Instruments and FDIHome Country Policies

• Encouraging Outward FDI – Many investor nations now have government-backed

insurance programs to cover major types of foreign investment risk.

• Restricting Outward FDI – Virtually all investor countries, including the United States,

have exercised some control over outward FDI from time to time.


Government Policy Instruments and FDI• Host Country Policies

– Policies to restrict and encourage inward FDI

• Encouraging Inward FDI – Governments offer incentives to foreign firms to invest in

their countries.– Incentives are motivated by a desire to gain from the

resource-transfer and employment effects of FDI, and to capture FDI away from other potential host countries.


Government Policy Instruments and FDI• Restricting Inward FDI

– Ownership restraints and performance requirements– The rationale underlying ownership restraints is twofold:

i. First, foreign firms are often excluded from certain sectors on the grounds of national security or competition.

ii. Second, ownership restraints seem to be based on a belief that local owners can help to maximise the resource-transfer and employment benefits of FDI for the host country.


Trade and Investment Liberalisation•Trade Liberalisation and the WTO

– After WWII, the US and other nations realised the value of freer trade, and established the General Agreement on Tariffs and Trade (GATT) in 1947.

– The approach of GATT was to gradually eliminate barriers to trade.

– GATT provided a set of rules and a means for their enforcement.


Trade and Investment Liberalisation• Trade Liberalisation and the WTO (Cont’d)

– The clarification, strengthening and extension of GATT rules and the creation of the WTO in 1995 held out the promise of more effective policing and enforcement of the global trading system.

– The Uruguay Round of GATT negotiations gave the WTO a mandate to extend global trading rules to cover new areas of international business.


Trade and Investment Liberalisation• Trade Liberalisation and the WTO (Cont’d)

– Four issues on the current agenda of the WTO i. The increase in anti-dumping policiesii. The high level of protectionism in agricultureiii. The lack of strong protection for intellectual property rights in

many nationsiv. The continued high tariff rates on non-agricultural goods and

services in many nations


Trade and Investment Liberalisation• Anti-Dumping Actions

– The WTO is encouraging members to strengthen the regulations governing the imposition of antidumping duties.

• Protectionism in Agriculture– The WTO is concerned with the high level of tariffs and

subsidies in the agricultural sector of many economies.


Trade and Investment Liberalisation• Protecting Intellectual Property

– Because members believe that the protection of intellectual property rights is an essential element of the international trading system, TRIPS obliges WTO members to grant and enforce patents lasting at least 20 years and copyrights lasting 50 years.


Trade and Investment Liberalisation• The Continued High Tariff Rates on Non-agricultural

Goods and Services in Many Nations– The WTO would like to bring down tariff rates on non-

agricultural goods and services, and reduce the scope for the selective use of high tariff rates.


Trade and Investment Liberalisation• A New Round of Talks: Doha

– In late 2001, the WTO launched a new round of talks at Doha, Qatar.

– The agenda includes cutting tariffs on industrial goods and services, phasing out subsidies to agricultural producers, reducing barriers to cross-border investment, and limiting the use of anti-dumping laws.


Trade and Investment Liberalisation• A New Round of Talks: Doha (Cont’d)

– Little progress, however, has been made on the Doha agenda.

– In July 2006, after five years, the Doha Round eventually stalled.

– In January 2007, the 149 members of the WTO agreed to fully resume the Doha Round of global trade talks.

– It remains to be seen if and when the Doha Round of talks will be completed.


Trade and Investment Liberalisation• Liberalisation of FDI

– Multilateral institutions have had little success in the pursuit of a universal and binding investment agreement, similar to the one governing trade.

– With the formation of the WTO in 1995, some agreements in relation to investment were achieved under TRIMS, but they did not represent a universal set of rules designed to promote the liberalisation of FDI.


Managerial Implications • The Theory of FDI

– The location-specific advantages argument associated with John Dunning helps explain the direction of FDI.

• Government Policy– A host government’s attitude to FDI is an important

variable in decisions about where to locate foreign production facilities and where to make a foreign direct investment.


Regional Economic Integration• Regional Economic Integration

– Refers to agreements between countries in a geographic region to reduce tariff and non-tariff barriers to the free flow of goods, services, and factors of production between signatories.

– While regional trade agreements are designed to promote free trade, there is some concern that the world is moving towards a situation in which a number of regional trade blocks compete against each other.


Regional Economic Integration• Levels of Economic Integration


Regional Economic Integration• Free Trade Area (FTA)

– In a free trade area all barriers to the trading of goods and services among member countries are removed, but members determine their own trade policies with regard to non-members.

– Examples of free trade areas include the European Free Trade Association (between Norway, Iceland, Liechtenstein and Switzerland) and the North American Free Trade Agreement (between the US, Canada and Mexico).


Regional Economic Integration• Customs Union

– The customs union is a further step along the road to full economic and political integration—eliminating trade barriers between member countries and adopting a common external trade policy.

– The Andean Pact (between Bolivia, Columbia, Ecuador and Peru) is an example of a customs union.


Regional Economic Integration• Common Market

– The common market has no barriers to trade between member countries, a common external trade policy and free movement of the factors of production.

– MERCOSUR (between Brazil, Argentina, Paraguay and Uruguay) is aiming for common market status.


Regional Economic Integration

• Economic Union– An economic union involves the free flow of products and

factors of production between members, the adoption of a common external trade policy and, in addition, a common currency, harmonisation of member countries’ tax rates and a common monetary and fiscal policy.

– The European Union (EU) is an economic union, although an imperfect one since not all members of the EU have adopted the euro.


Regional Economic Integration• Political Union

– In a political union, independent states are combined into a single union.

– The EU is headed towards at least partial political union, and the United States is an example of even closer political union.


Regional Economic Integration• The Case for Regional Integration

– The Economic Case for Integration Regional economic integration is an attempt to achieve

additional gains from the free flow of trade and investment between countries beyond those attainable under international agreements such as the WTO.


Regional Economic Integration• The Case for Regional Integration (Cont’d)

– The Political Case for Integration By linking countries together, making them more dependent

on each other and forming a structure where they regularly have to interact, the likelihood of violent conflict and war will decrease.

By linking countries together, they have greater clout and are politically much stronger in dealing with other nations.


Regional Economic Integration• Impediments to Integration

– While a nation as a whole may benefit from a regional free trade agreement, certain groups may lose.

– Integration raises concerns of loss of national sovereignty.


Regional Economic Integration• The Case Against Regional Integration

– Regional economic integration only makes sense when the amount of trade it creates exceeds the amount it diverts.

– Trade creation occurs when low-cost producers within the free trade area replace high-cost domestic producers.

– Trade diversion occurs when higher cost suppliers within the free trade area replace lower cost external suppliers.


Managerial Implications • Opportunities

– Markets that were formerly protected from foreign competition are opened.

– The free movement of goods across borders, the harmonisation of product standards and the simplification of tax regimes makes it possible for firms to realise potentially enormous cost economies by centralising production in those locations where the mix of factor costs and skills is optimal.


Managerial Implications• Threats

– The business environment becomes competitive.

– For non-EU and/or non-North American firms, challenges arise from the likely long-term improvements in the competitive position of many European and North American companies.


Managerial Implications• Threats (Cont’d)

– There is a risk of being shut out of the single market by the creation of a ‘trade fortress’.

– Firms may be limited in their ability to pursue the strategy of their choice in the EU as the EU continues to increase its role in competition policy and intervene in and impose conditions on companies proposing mergers and acquisitions.


Summary of Main Themes

• The goal of this chapter was to explain how the political and economic realities of international trade and FDI impact on businesses as they venture across international borders.

• We have discussed the various instruments of trade and FDI policy and reviewed the political and economic arguments for government intervention.

• We have also described attempts to liberalise international trade and investment. At the multilateral level we have examined the progress of liberalisation at the WTO.


Summary of Main Themes

• Following an account of how the various levels of economic integration differ, we reviewed the economic and political debates concerning regional economic integration.

• The chapter concluded with an assessment of how business may be affected by the various government interventions in international trade and investment and the various attempts to liberalise trade and investment at the multilateral and regional levels.

Documents

3-1 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Global Business Today 1e by Hill. Slides prepared by Fuming Jiang. Chapter 3 T he P olitical