Chapter 5

The Political Economy of

International Trade
 Why Do Governments Intervene in Trade?
Political Motives
 Protect jobs
✓ Governments intervene when free trade creates job losses at home.
✓ e.g. Relocating textile manufacturing to developing countries (cheap foreign labor cost)
contributed to job losses in USA.
 Preserve national security
✓ Industries like aerospace or electronics are often protected because they are deemed
important for national security
✓ Governments also have national security motives for banning certain defense-related
goods from export to other nations.
 Respond to unfair trade
✓ If one government thinks another nation is not “playing fair,” it will often threaten to
retaliate unless certain concessions are made.
✓ – e.g. To protect their own industries - developed countries sue developing countries that
dumping their products.
 Gain influence
✓ Big nations may use power of trade intervention to influence small nations.
✓ e.g. The United States has banned all trade and investment with Cuba since 1961 in the
hope of exerting political influence against its communist leaders.
 Why Do Governments Intervene in
Trade?
Economic Motives
 Protect infant industries
The infant industry argument which suggests that an industry should be protected until
it can develop and be a viable and competitive industry internationally.
 Pursue strategic trade policy
✓ Strategic trade policy suggests that in cases where there may be important first mover
advantages, governments can help firms achieve these advantages.
✓ So, U.S. support of Boeing in the 1950s and 60s probably helped the company become
one of the firms to survive in the industry.
✓ Governments can also intervene in the markets to help domestic firms overcome
barriers to entry in industries where foreign firms have an advantage.
 Why Do Governments Intervene in
Trade?
Cultural Motives
 Achieve cultural objectives and Protection of national identity
✓ Nations often restrict trade in goods and services to achieve cultural
objectives, the most common being protection of national identity.
✓ Many countries have laws that protect their media programming for
cultural reasons.
✓ e.g. Canada tries to mitigate the cultural influence of entertainment
products imported from the United States.
 Instruments of Trade Promotion
Trade Promotion
 Subsidies
✓ Governments give financial assistance to domestic producers in
various ways including cash grants, low interest loans, tax breaks,
product price supports, etc.
✓ Help domestic producers compete against low cost foreign imports,
and gain export markets.
 Export Financing
✓ Governments promote exports by helping companies finance their export
activities through loans or loan guarantees.
✓ Two agencies help U.S. companies gain export financing: Export-Import
Bank and the Overseas Private Insurance Corporation (OPIC).
 Instruments of Trade Promotion
 Foreign Trade Zones
✓ Foreign Trade Zone (FTZ) - a specific location within a country in which
merchandise is not subject to duties / charge lower customs duties
(taxes).
✓ Benefits - importer pays lower duty rate and avoid lengthy customs
procedure.

 Special Government Agencies

✓ Government set up agencies that offers various exporters development
programmes and organise export promotion activities for SMEs.
✓ e.g., Export promotion agencies -The Japan External Trade Organization
(JETRO), Malaysia External Trade Development Corporation (MATRADE)
 Instruments of Trade Restriction
Trade Restriction
 Tariffs
✓ Export tariff is levied by the government of a country that is exporting a
product.
✓ Export taxes raise money for governments and help control the exports of
valuable resources.
✓ Many resource-rich countries charge export taxes on high-value products,
such as oil or minerals. For example, Mozambique charges export taxes on
diamonds.
✓ Transit tariff is imposed by the government of a country that a product is
passing through on its way to final destination.
Example: India imposes tariffs on goods that Bangladesh exports to Nepal
through the Indian Territory.
 Instruments of Trade Restriction
✓ Import tariff is levied by the government of a country that is importing a product.
✓ There are three subcategories of import tariff:
▪ Ad valorem tariff - levied as a percentage of the value of the imported
product.
e.g. 10% of the value of the vehicle.
▪ Specific tariff -computed based on the unit/quantity of the imported product
(measured by number, weight, etc.). Example: $300 tariff on each computer
imported.
▪ Compound tariff - tax levied on imported goods that is a combination of a fixed
amount and an amount based on the value of the goods (include both ad
valorem and specific tariff).
Example: Pakistan charges Rs. 0.88 per liter of some petroleum products plus 25
percent of the product price.
 Instruments of Trade Promotion
 Quotas
✓ Restriction on the amount (measured in units or weight) of a good that can enter
or leave a country during a certain period of time.
✓ e.g. U.S set quota on cheese imports.
• Tariff-Quotas - a hybrid of a quota and a tariff where a lower tariff rate is applied
to imports within the quota a higher rate for quantities that exceed the quota
• Voluntary Export Restraint (VER) – arrangements between exporting and
importing countries in which the exporting country agrees to limit the quantity of
specific exports below a certain level in order to avoid imposition of mandatory
restrictions by the importing country. Typically at the request of the importing
country’s government.
 Embargoes
✓ An official ban or order of a government prohibiting trade (imports and exports) of
one or more products with a particular country.
✓ In 2006, the United nation imposed embargo on supplies for uranium production and
ballistic missile development, harming Iran’s economy
 Instruments of Trade Promotion
 Local Content Requirements
✓ Government demands that some specific fraction of a good be
produced domestically.
✓ Can be in physical terms or in value terms.
✓ e.g. 15% of the value of the good must come from domestically
produced components

 Administrative Delays
✓ Regulatory controls or bureaucratic rules that are designed to make it
difficult for imports to enter a country.

 Currency Controls
✓ Restrictions on the convertibility of a currency into other currencies.
Global Trading System
 How Has The Current World Trading System
Emerged
 Until the Great Depression of the 1930s, most countries had
some degree of protectionism
➢ Smoot-Hawley tariff (1930)
 After WWII, the U.S. and other nations realized the value of freer
trade
 Established the General Agreement on Tariffs and Trade (GATT)
- a treaty designed to promote free trade by reducing both
tariff and nontariff barriers to international trade.
General Agreement on Tariffs and Trade

Uruguay Round of Negotiations (1986-1994)

 Agreement on services
 Agreement on intellectual property
 Agreement on agricultural subsidies
 Creation of the WTO
 World Trade Organization (WTO)
 The World Trade Organization (WTO): International organization
that regulates trade among nations
 The WTO has emerged as an effective advocate and facilitator
of future trade deals, particularly in such areas as services.
 So far, the WTO’s policing and enforcement mechanisms are
having a positive effect.
 Most countries have adopted WTO recommendations for trade
disputes.
 Main goals of the WTO :
1. Help the free flow of trade
2. Help negotiate further opening of markets
3. Settle trade disputes among its members
 Regional Economic Integration & Economic
Blocs

 While regional trade agreements are designed to

promote free trade, there is some concern that the
world is moving toward a situation in which a number of
regional trade blocks compete against each other
if this scenario materializes, the gains from free trade
within blocs could be offset by a decline in trade
between blocs
 Levels of Regional Economic Integration
There are five levels of economic integration
1. Free trade area - Eliminates all barriers to the trade of goods and
services among member countries. Each nation determining its
own barriers against nonmembers
 European Free Trade Association (EFTA) - Norway, Iceland, Liechtenstein,
and Switzerland
 North American Free Trade Agreement (NAFTA) - U.S., Canada, and
Mexico
2. Customs union - eliminates trade barriers between member
countries and adopts a common external trade policy against
nonmembers
 Andean Pact (Bolivia, Columbia, Ecuador and Peru)
3. Common market – has no barriers to trade between member
countries, a common external trade policy, and the free
movement of the factors of production (labor and capital)
➢ can be difficult to achieve and requires significant harmony among
members in fiscal, monetary, and employment policies
 MERCOSUR (Brazil, Argentina, Paraguay, and Uruguay)
 Levels of Regional Economic Integration
4. Economic union - has the free flow of products and factors
of production between members, a common external trade
policy, a common currency, a harmonized tax rate, and a
common monetary and fiscal policy
➢ involves sacrificing a significant amount of national sovereignty
 European Union (EU)

5. Political union - independent states are combined into a

single union
➢ involves a central political apparatus that coordinates the economic,
social, and foreign policy of member states
 The EU is headed toward at least partial political union, and the
United States is an example of even closer political union
Levels of Regional Economic Integration
Levels of Economic Integration
 Regional Economic Integration
The Case for Regional Integration
 Trade Creation
 Greater Consensus
 Political Cooperation
 Employment Opportunities
 Corporate Savings
The Case Against Regional Integration
 Trade Diversion
 Shifts in Employment
 Loss of National Sovereignty
 Trade Creation and Trade Diversion
 Regional economic integration is only beneficial if 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 creation will occur when there is a reduction in tariff barriers,
leading to lower prices.
✓ One result of trade creation is that consumers and industrial buyers in
member nations are faced with a wider selection of goods and services
not previously available.
▪ Trade diversion occurs when a less-efficient producer within the free
trade area (trading bloc) replace a more efficient non-member
producer by the formation of a free trade agreement.
The World’s Main Regional Trading Blocs
 European Union (EU)
 European Free Trade Association (EFTA)
 North American Free Trade Agreement (NAFTA)
 Central American Free Trade Agreement
 Andean Community
 MERCOSUR
 Caribbean Community and Common Market (CARICOM)
 Free Trade Area of the Americas (FTAA)
 Association of Southeast Asian Nations (ASEAN)
 Asia Pacific Economic Cooperation (APEC)