This document is a chapter from a textbook about governmental influence on trade. It discusses how governments intervene in trade to achieve economic and political goals, but must consider conflicting objectives and interest groups. It describes various rationales governments use to restrict or enhance trade, such as protecting domestic industries, managing unemployment, and furthering geopolitical influence. The chapter also outlines the major tools governments use to control trade, such as tariffs, quotas, subsidies, and standards. It notes both the uncertainties and opportunities these policies can create for businesses.
The Learning Objectives for this chapter are
To explain the rationales for governmental policies that enhance and restrict trade
To show the effects of pressure groups on trade policies
To describe the potential and actual effects of governmental intervention on the free flow of trade
To illustrate the major means by which trade is restricted and regulated
To demonstrate the business uncertainties and business opportunities created by governmental trade policies
While free trade is beneficial, in reality all countries regulate the flow of goods and services across their borders. Governments want to help companies that are struggling, but it’s difficult to do so without hurting those that are doing well.
This Figure shows the physical and social factors that affect the flow of goods and services.
Government officials use trade policy to try to achieve economic, social, and political goals. However, their efforts are hampered by uncertain and conflicting policy outcomes, as well as the goals of special interest groups.
Proposed government policies often spark fierce debate among those who could be affected. Those who are most directly affected tend to be loudest in voicing their concerns.
Learning Objective 1: To explain the rationales for governmental policies that enhance and restrict trade.
This Table shows the reasons for government intervention in trade. Notice that there are both economic and noneconomic reasons for intervention.
Learning Objective 2: To show the effects of pressure groups on trade policies.
Unemployed people are one of the most effective pressure groups for restrictions on imports. But, trying to fix employment problems using trade policy can create new challenges.
Costs that are often associated with import restrictions include higher prices and higher taxes. Governments must balance the potential for these costs with the benefits of creating new jobs. Fiscal and monetary policies may be more effective at correcting unemployment problems.
Learning Objective 3: To describe the potential and actual effects of governmental intervention on the free flow of trade.
According to the infant industry argument, production becomes more competitive over time because of increased economies of scale and greater work efficiency. Therefore, if an emerging industry is protected during its infancy it has a greater chance for success.
Many developing countries use this argument as a rationale for implementing protectionist policies.
Keep in mind though that production costs may never fall far enough to make an industry competitive making it important to clearly identify those industries with the greatest chance for success. Even then, because of the costs involved, protectionism may not be automatic.
Generally, countries with higher per capita GDP have larger manufacturing bases. So, countries that are trying to develop an industrial base may intervene in trade flows. The United States for example, has restricted imports to grow its manufacturing base.
According to the industrialization argument, the development of a domestic industry is hampered by unregulated imports of lower-priced products. This argument is based on several assumptions.
Many people can shift out of agriculture without much effect on total output. However, it’s important to keep in mind that when this type of shift occurs, not only does demand on social and political services in cities increase, development possibilities in the agricultural sector could also be overlooked.
Inward investment could occur if import restrictions keep out foreign-made goods. Moreover, developing an industrialization basis is an important step in diversifying an economy.
Countries may also seek to develop their industrial base in order to improve their terms of trade – the prices of agricultural commodities and raw materials has historically grown more slowly than prices of manufactured goods.
Finally, countries like Taiwan that have shown tremendous growth have followed policies known as export led development making protectionism attractive. Moreover, industrialization and the nation-building process seem to be linked. Industrialization emphasizes products to sell domestically or products to export.
Countries can use trade controls to improve their relationships with other countries. In addition to using trade restrictions to improve the nation’s balance of payments, governments may also intervene in trade to ensure that domestic producers have the same access to other markets as foreign companies have to their markets, to encourage countries to change their policies, and to control prices.
Keep in mind that governments have to be careful when using trade restrictions to control prices. If prices get too high, it could result in smuggling or substitution. Similarly, if prices get too low, there’s an incentive to produce less or to shift foreign production and sales.
Trade restrictions can be used to prevent a practice known as dumping which involves exporting below cost or below home country prices, and to get foreign producers to lower their prices. According to the optimum tariff theory, a foreign producer will lower its prices if the importing company places a tax on its products.
Sometimes governments may intervene in trade for political reasons including maintaining essential industries, promoting acceptable practices abroad, maintaining or extending spheres of influence, or preserving national culture.
The essential industry argument of protecting certain industries to avoid dependency on foreign supplies can be appealing, but keep in mind that in theory almost any product could be deemed essential.
Governments can use trade policy to encourage or discourage certain types of behavior by other countries.
Trade restrictions can also be used to support a country’s sphere of influence.
Sustaining the collective identity that sets their citizens apart from those in other nations, is another reason why countries intervene in trade flows. Rice imports were strictly limited for years in Japan for example, because rice farming was considered to be a historically cohesive force in the country.
Learning Objective 4: To illustrate the major means by which trade is restricted and regulated.
There are many different ways to intervene in trade flows. It’s important to choose the right instrument to achieve a particular objective.
Tariffs directly influence prices, while nontariff barriers affect either price or quantity. When a country assesses a tariff on a per unit basis it’s applying a specific duty. A tariff that’s assessed as a percentage of the item’s value is an ad valorem tariff. A compound duty is due when both a specific and an ad valorem tariff are assessed.
Nontariff barriers can affect either quantity sold or price. Subsidies are one of the most common ways to influence price.
In addition to subsidies which help companies be more competitive, other policies that affect price include aid and loans to help companies win contracts, arbitrary customs valuations, and other special fees and requirements that ultimately result in higher priced goods.
The most common type of nontariff barriers that directly influence the quantity of imports are quotas which limit the quantity of a product that can be exported or imported. Voluntary export restraints and embargoes that prohibit all trade are types of quotas.
Other nontariff barriers affecting quantity include “buy local” legislation, special standards and labels, specific permission requirements, administrative delays, and reciprocal requirements.
Keep in mind that trade restrictions affect services as well as manufactured and agricultural products. Countries deciding whether to restrict trade in services consider essentiality, not-for-profit-preference, standards, and immigration.
Learning Objective 5: To demonstrate the business uncertainties and business opportunities created by governmental trade policies.
Companies facing losses because of import competition have several options.
The tactics for dealing with import competition vary according to industry and business. It’s not always possible, for example, to simply shift production to another location or find new suppliers.
The development of an international strategy can help determine whether a company will benefit more from protectionist measures or from some other method of countering foreign competition.
Looking forward, there is likely to be both support for freer trade, and also support for more protectionism.