Lecture 12:

Barriers to
international trade
 Contents

I. Trade barriers

II. Factors influencing a company’s

decision to invest

III. Types of international investments

 I. Trade barriers

1. Why do governments intervene in

trade?
Governments intervene in trade for a
combination of different reasons
– political
– economic
– social
– cultural
 I. Trade barriers
1a. Governments intervene
- Political reason
• Politically, a country’s government may seek to protect jobs or
specific industries. Some industries may be considered
essential for national security purposes, such as defense,
telecommunications, and infrastructure—for example, a
government may be concerned about who owns the ports
within its country.
• National security issues can impact both the import and
exports of a country, as some governments may not want
advanced technological information to be sold to unfriendly
foreign interests. (e.g. see link in notes)
• Some governments use trade as a retaliatory measure if
another country is politically or economically unfair. On the
other hand, governments may influence trade to reward a
country for political support on global matters.
 I. Trade barriers
1b. Governments intervene –
Economic reason

• Governments are also motivated by economic factors to

intervene in trade.
• They may want to protect young industries or to preserve
access to local consumer markets for domestic firms.
 I. Trade barriers
1c. Governments intervene –
Social and cultural reasons

• Cultural and social factors might also impact a

government’s intervention in trade.
• For example, some countries’ governments have tried to
limit the influence of American culture on local markets
by limiting or denying the entry of American companies
operating in the media, food, and music industries
 I. Trade barriers

2. How do governments intervene in

trade
– While the past century has seen a major shift
toward free trade, many governments
continue to intervene in trade.
– Governments have several key policy areas
that can be used to create rules and
regulations to control and manage trade.
 I. Trade barriers

2. How do governments intervene in trade

– Tariffs. Tariffs are taxes imposed on imports. Two kinds
of tariffs exist—
• specific tariffs (i.e. taxes or tariffs that are levied as a fixed
charge, regardless of the value of the product or service) and
• ad valorem tariffs (i.e. tariffs that are calculated as a
percentage of the value of the product or service).
Many governments still charge ad valorem tariffs as a way to
regulate imports and raise revenues for their coffers.
– Subsidies. A subsidy is a form of government payment
to a producer.
• Types of subsidies include tax breaks or low-interest loans;
both of which are common.
• Subsidies can also be cash grants and government-equity
participation, which are less common because they require a
direct use of government resources.
 I. Trade barriers

2. How do governments intervene in trade

– Import quotas and VER. Import quotas and voluntary export
restraints (VER) are two strategies to limit the amount of imports
into a country. The importing government directs import quotas,
while VER are imposed at the discretion of the exporting nation in
conjunction with the importing one.
– Currency controls. Governments may limit the convertibility of
one currency (usually its own) into others, usually in an effort to
limit imports. Additionally, some governments will manage the
exchange rate at a high level to create an import disincentive.
 I. Trade barriers

2. How do governments intervene in trade

– Local content requirements. Many countries continue to require
that a certain percentage of a product or an item be manufactured
or “assembled” locally. Some countries specify that a local firm
must be used as the domestic partner to conduct business.
– Antidumping rules. Dumping occurs when a company sells
product below market price often in order to win market share and
weaken a competitor.
– Export financing. Governments provide financing to domestic
companies to promote exports.
 I. Trade barriers

2. How do governments intervene in trade

– Free-trade zone. Many countries designate certain geographic
areas as free-trade zones. These areas enjoy reduced tariffs,
taxes, customs, procedures, or restrictions in an effort to promote
trade with other countries.
– Administrative policies. These are the bureaucratic policies and
procedures governments may use to deter imports by making
entry or operations more difficult and time consuming
• Example: Government intervention in China
Textbook: Chapter 2 (p.51-53)
 II. Factors influencing
a company’s decision to invest

• Let’s look at why and how companies choose to

invest in foreign markets.
• Simply purchasing goods and services or deciding
to invest in a local market depends on a business’s
needs and overall strategy.
• Direct investment in a country occurs when a
company chooses to set up facilities to produce or
market their products; or seeks to partner with,
invest in, or purchase a local company for control
and access to the local market, production, or
resources.
 II. Factors influencing
a company’s decision to invest
Many considerations influence its decisions:
• Cost. Is it cheaper to produce in the local market than elsewhere?
• Logistics. Is it cheaper to produce locally if the transportation costs
are significant?
• Market. Has the company identified a significant local market?
• Natural resources. Is the company interested in obtaining access
to local resources or commodities?
• Know-how. Does the company want access to local technology or
business process knowledge?
• Customers and competitors. Does the company’s clients or
competitors operate in the country?
• Policy. Are there local incentives (cash and noncash) for investing in
one country versus another?
 II. Factors influencing
a company’s decision to invest
Many considerations influence its decisions:
• Ease. Is it relatively straightforward to invest and/or set up
operations in the country, or is there another country in which setup
might be easier?
• Culture. Is the workforce or labor pool already skilled for the
company’s needs or will extensive training be required?
• Impact. How will this investment impact the company’s revenue and
profitability?
• Expatriation of funds. Can the company easily take profits out of
the country, or are there local restrictions?
• Exit. Can the company easily and orderly exit from a local
investment, or are local laws and regulations cumbersome and
expensive?
 II. Factors influencing
a company’s decision to invest
• These are just a few of the many factors that might
influence a company’s decision.
• Keep in mind that a company doesn’t need to sell in the
local market in order to deem it a good option for direct
investment.
• For example, companies set up manufacturing facilities
in low-cost countries but export the products to other
markets.
 III. Types of
international investments
• There are two main categories of
international investment:
– portfolio investment
– foreign direct investment (FDI)
 III. Types of
international investments
1. Portfolio investment

• Portfolio investment: refers to the investment in a

company’s stocks, bonds, or assets, but not for the
purpose of controlling or directing the firm’s operations or
management.
• Typically, investors in this category are looking for a
financial rate of return as well as diversifying investment
risk through multiple markets.
 III. Types of
international investments
2. Foreign Direct Investment
• Foreign direct investment (FDI): refers to an investment in or
the acquisition of foreign assets with the intent to control and
manage them.
• Companies can make an FDI in several ways, including:
– purchasing the assets of a foreign company
– investing in the company or in new property, plants, or
equipment
– participating in a joint venture with a foreign company, which
typically involves an investment of capital or know-how.
• FDI is primarily a long-term strategy. Companies usually
expect to benefit through access to local markets and
resources, often in exchange for expertise, technical know-
how, and capital.
 III. Types of
international investments
2. Foreign Direct Investment – Main form
There are two forms of FDI:
• Horizontal FDI: occurs when a company is trying to open up a new
market—a retailer, for example, that builds a store in a new country
to sell to the local market.
• Vertical FDI: occurs when a company invests internationally to
provide input into its core operations usually in its home country.
– If the firm brings the goods or components back to its home
country (acting as a supplier), then it is called backward vertical
FDI.
– If the firm sells the goods into the local or regional market (acting
more as a distributor), then it is referred to as forward vertical
FDI.
– The largest global companies often engage in both backward
and forward vertical FDI depending on their industry.
 III. Types of
international investments
2. Foreign Direct Investment
How governments encourage FDI:
– Governments seek to promote FDI when they are eager to
expand their domestic economy and attract new technologies,
business know-how, and capital to their country.
– In these instances, many governments still try to manage and
control the type, quantity, and even the nationality of the FDI to
achieve their domestic, economic, political, and social goals.
 III. Types of
international investments
2. Foreign Direct Investment
How governments encourage FDI:
 Financial incentives. Host countries offer businesses a combination of
tax incentives and loans to invest. Home-country governments may
also offer a combination of insurance, loans, and tax breaks in an effort
to promote their companies’ overseas investments. The opening case
on China in Africa illustrated these types of incentives.
 Infrastructure. Host governments improve or enhance local
infrastructure—in energy, transportation, and communications—to
encourage specific industries to invest. This also serves to improve the
local conditions for domestic firms.
 Administrative processes and regulatory environment. Host-
country governments streamline the process of establishing offices or
production in their countries. By reducing bureaucracy and regulatory
environments, these countries appear more attractive to foreign firms.
 III. Types of
international investments
2. Foreign Direct Investment
How governments encourage FDI:
 Invest in education. Countries seek to improve their workforce
through education and job training. An educated and skilled
workforce is an important investment criterion for many global
businesses.
 Political, economic, and legal stability. Host-country governments
seek to reassure businesses that the local operating conditions are
stable, transparent (i.e., policies are clearly stated and in the public
domain), and unlikely to change.
 III. Types of
international investments
2. Foreign Direct Investment
How governments discourage FDI
• In most instances, governments seek to limit or control foreign direct
investment to:
– protect local industries and key resources (oil, minerals, etc.),
– preserve the national and local culture,
– protect segments of their domestic population,
– maintain political and economic independence,
– manage or control economic growth. A government use various policies
and rules:
 III. Types of
international investments
2. Foreign Direct Investment
How governments discourage FDI
• A government use various policies and rules:
– Ownership restrictions. Host governments can specify ownership
restrictions if they want to keep the control of local markets or industries
in their citizens’ hands. Some countries, such as Malaysia, go even
further and encourage that ownership be maintained by a person of
Malay origin, known locally as bumiputra. Although the country’s
Foreign Investment Committee guidelines are being relaxed, most
foreign businesses understand that having a bumiputra partner will
improve their chances of obtaining favorable contracts in Malaysia.
– Tax rates and sanctions. A company’s home government usually
imposes these restrictions in an effort to persuade companies to invest
in the domestic market rather than a foreign one.