BAFIN LESSON 6 Pressure against protectionism among workers in industries dependent on imports

GOVERNMENT INFLUENCES ON TRADE Import restrictions indirectly cause loss of export income

Learning Objectives Potential costs of import restrictions include both higher prices and higher taxes

 To explain the rationales for governmental policies that enhance and restrict trade  Such costs should be compared with those of unemployment
 To show the effects of pressure groups on trade policies
2. INFANT-INDUSTRY ARGUMENT
 To describe the potential and actual effects of governmental intervention on the free flow of
 trade Government should guarantee an emerging industry a large share of the domestic market until it
 To illustrate the major means by which trade is restricted and regulated becomes efficient enough to compete against imports
 To demonstrate the business uncertainties and business opportunities created by governmental
trade policies Initial output costs may make products non-competitive in world markets

Conflicting Results of Trade Policies Output costs will decrease due to:

Why governments intervene?  Greater economies of scale

 Greater worker efficiency
 Governments intervene trade for the good of the citizens (or, does it really?)
Problems with argument
 Arguments for and against trade policies

Hard to identify industries with high probability of success - even when
Protectionism refers to those government restrictions and incentives specifically designed to
industries can be identified, not clear that government should provide protection
help a county's domestic firms compete with foreign competitors at home and abroad.
 Protection may serve as disincentive for managers to
WHY GOVERNMENTS INTERVENE IN TRADE adopt innovations needed to become competitive
3. INDUSTRIALIZATION ARGUMENT
Economic Rationales
Use of surplus workers - many workers can leave the agricultural sector without affecting output
 Fighting unemployment
 Protecting infant industries Influx of workers into industrial sector may result in several problems heavy demands on social
 Promoting industrialization and political services

Non-Economic Rationales  Agriculture may be a better means of effecting additional output than industry
 Government must decide which industry to protect to minimize consumer price
 Maintaining essential industries and tax increases
 Dealing with unfriendly countries  Development possibilities in the agricultural sector may be overlooked
 Maintaining or extending spheres of influence
 Preserving national identity Promoting investment flows-import restrictions may increase foreign direct investment

 Influx of foreign companies may hasten industrialization

1. UNEMPLOYMENT
 Investment inflows may add to employment
Unemployed can form effective pressure group for import restrictions.
Diversification - price variations due to uncontrollable factors can wreak havoc on economies
Problems stemming from restricting imports to create jobs in the domestic economy ……………………..dependent on exports

Retaliation by other countries  Change from agriculture to industry in emerging economies may simply shift the
 less tendency to retaliate against small countries dependence from a few agricultural products to a few industrial products
 restricting country will gain jobs in one place and lose them somewhere else  Greater growth for manufactured products
 Terms of trade - quantity of imports that a given quantity of a country's exports can buy Nontariff barriers (NTBs) – represent administrative regulations, policies, and procedures, i.e.,
 Prices of raw material and agricultural commodities do not rise as fast as prices of quantitative and qualitative barriers, that directly or indirectly impede international trade.
finished goods
 Deterioration in emerging economies
 Demand for primary products grows more slowly INSTRUMENTS OF TRADE CONTROL: NONTARIFF BARRIERS (NTB)
Import substitution - restricting imports in order to produce for local consumption goods that Nontariff Barriers: Direct Price Influences
………………………….formerly were imported
Subsidies - direct government payments to domestic companies to compensate them for losses
 Not the best way to develop new industries incurred from selling abroad
 An initial response to industrialization
 Other types of government assistance make it cheaper or more profitable to sell abroad
MAINTAINING ESSENTIAL INDUSTRIES
 Potential exporters provided with an array of services
Protecting domestic industries during peacetime so that country is not dependent on foreign sources of
Aid and loans - given to other countries with the provision that the funds be spent in the donor
supply during war
country
Countries Must:
Customs valuation-procedures for assessing value when customs agents levy tariffs
 Determine which industries are essential
 May be based on;
 Consider costs and alternatives
 invoice price
 Consider political consequences
 Value of identical goods
DEALING WITH "UNFRIENDLY" COUNTRIES  similar goods coming in at the same time
Prevention of exports that might be acquired by potential enemies  final sales value or on reasonable cost
 May lead to retaliation that prevents securing other essential goods valuation problems created by the large number of products that are traded

Other direct price influences

MAINTAINING SPHERES OF INFLUENCE
 Special fees
Governments may:
 Customs deposits
 Provide aid and credits to, and encourage imports from, countries that are political allies
 Minimum price levels
 Impose trade restrictions to coerce foreign countries to follow certain political actions
Nontariff Barriers: Quantity Controls
PRESERVING CULTURES AND NATIONAL IDENTITY Quotas-limits the quantity of a product allowed to be imported in a given year
Countries have a common sense of identity that separates them from other nationalities
 May limit foreign products and services to protect their separate identity  Most-common restriction based on quantity
 Amount frequently reflects guarantee that domestic producers will have access to a
certain percentage of the domestic market
INSTRUMENTS OF TRADE CONTROL  Problems with quotas
 Transshipping goods among countries
Duties are taxes levied on (internationally) traded products.
 Transforming product into one for which there is no quota
• Levied By The Country Of Destination On Imported Products  Export quotas
• A Specific Duty Is A Tariff That Is Assessed On A Per Unit Basis. An Ad  Assure domestic consumers a supply of goods at low price
Valorem Tariff Is Assessed As A Percentage Of The Value Of An Item.  Prevent depletion of natural resources
 Raise export prices
  Embargo-quota that prohibits all trade BAFIN LESSON 8
Nontariff Barriers: Quantity Controls EXCHANGE RATE DETERMINATION

• Reciprocal requirements-governmental requirements that Foreign Exchange

 Exporters take merchandise in lieu of money  Foreign Exchange refers to the mechanism of the ways and means by which payment in
 Exporters promise to buy merchandise or services in the country to which they export connection with International Trade are effected.
 Countertrade or offset-barter transaction
• Restriction on services-exist for three reasons  Foreign exchange refers to all currencies other than the domestic currency of a given country.
 Essentiality-countries do not want to depend on foreign companies for strategic
services For example: India's domestic currency is Indian Rupee and all other currencies like US dollar, British
 Standards—ensure qualifications of providers Pound etc are foreign exchange.
 Little reciprocal recognition in licensing from one country to another
 Immigration-protect employment of country's own citizens  The rate of exchange is the price of one currency expressed in terms of another currency, it is
 Require local search for qualified personnel before hiring a foreigner the reflection of the external value of the domestic currency.
What measures firms can take to deal with governmental intervention
 It should also be noted here that exchange rate is not always constant, it goes on changing from
• Move operations to lower-cost countries time to time o account of change in demand for and supply. of foreign currency.
• Concentrate on market niches that attract less international competition
• Opt for internal innovations leading to greater efficiency and/or superior products FACTORS INFLUENCING EXCHANGE RATES
• Try to secure government protection
1. Differentials in Inflation.
Companies may require assistance of government to limit imports or open foreign markets
2. Differentials in Interest Rates.
• Governments deny some requests for assistance companies attitudes differ toward 3. Public Debt.
protectionism 4. Terms Of Trade.
• Companies likely to lose from protectionism 5. Political Stability And Economic Performance.
 those that depend heavily on trade
 those that have integrated production in different global locations WHY IS IT NEEDED?
• Companies likely to gain from protectionism have single or multidomestic production
facilities  Different countries have different currencies with different values.

Example: India - Rupees

America-Dollar

 When trade takes place, the persons of these countries have to convert their currencies to other
country's currencies to make payments. For this purpose the concept of foreign exchange come
into operation.

Foreign Exchange Rate

 It refers to the rate at which one currency is exchanged for the other.
 It represents the price of one currency in terms of another currency.

TYPES OF FOREX RATE

1. Fixed exchange rate system DEMAND FOR FOREIGN EXCHANGE
2. Flexible exchange rate system  The demand (or outflow) of foreign exchange comes from those people who need it to make
3. Managed floating rate system payment in foreign currency.
 It is demanded by the domestic residents for the following reasons:
CURRENCY DEPRECIATION VS. CURRENCY APPRECIATION
1. Imports of Goods and services.
DEPRECIATION APPRECIATION
2. Tourism
3. Unilateral transfer sent abroad
L It refers to decrease in the value of domestic L It refers to increase in the value of domestic 4. Purchase of assets in foreign countries
currency in terms of foreign currency. currency in terms of foreign currency. 5. Speculation

Demand Curve Of Foreign Exchange

II. It makes domestic goods cheaper in foreign Π. It makes foreign goods cheaper in domestic
country as more and more of goods can now be country as more and more of goods can now be
purchased with same amount of foreign purchased with same amount of domestic Demand curve of foreign exchange slopes downwards
currency. So, it leads to increase in exports. currency. So, it leads to increase in imports. due to inverse relationships between demand for foreign
exchange and foreign exchange rate.

III. A change from $1=55 to $1=60 represents III. A change from $1=60 to $1=55 represents
that Indian Rupees is depreciating. that Indian Rupees is appreciating.
SUPPLY OF FOREIGN EXCHANGE
 The supply (or inflow) of foreign exchange comes from those people who receive it due to
following reasons.
FIXED VS. FLEXIBLE VS. MANAGED ECHANGE RATE SYSTEM
Fixed Exchange Rate Flexible Exchange Rate Managed Floating Rate 1. Exports of Goods and services.
System System System 2. Foreign investment
It refers to a system in which It refers to a system in which It refers to a system in which 3. Unilateral transfer from abroad
exchange rate for a currency is exchange rate is determined by foreign exchange rate is 4. Speculation
fixed by the government. forces of demand and supply of determined by market forces
different currencies in foreign and central bank influences the
Supply Curve Of Foreign Exchange
exchange market. exchange rate through
intervention in foreign
exchange market.
Basic purpose of adopting this There is no official It is a hybrid of a fixed Supply curve of foreign exchange slopes upwards due to
system is to ensure stability in (government) intervention in exchange rate and a flexible positive relationships between supply for foreign
foreign trade and capital foreign exchange market. exchange rate system. exchange and foreign exchange rate.
market.
Under this system, each Also known as 'floating Aim is to keep exchange rate
country keeps value of its exchange rate. close to desired targets value.
currency fixed in terms of Also known as 'Dirty floating'.
some external Standard'.
DETERMINATION OF EXCHANGE RATE

Exchange rate is determined by the interaction of

the forces of demand and supply.

The equilibrium exchange rate is determined at a

level where demand for foreign exchange is equal
to the supply of foreign exchange.

Any Exchange Rate (other than OR) is not the equilibrium exchange rate:
 If the exchange rate rises to OR2, then demand for foreign exchange will fall from OQ2 and
supply will rise to OQ1. It will be a situation of excess supply. As a result, exchange rate will
fall till it again reaches the equilibrium level of OR.

 If the exchange rate falls to or₁, then demand for foreign exchange will rise from oq, and supply
will fall to oq2. It will be a situation of excess demand. It will push up the exchange rate till it
reaches OR.

FOREIGN EXCHANGE MARKET

Foreign Exchange Market is the market in which foreign currencies are bought and sold.
 The buyers and sellers include individuals, firms, foreign exchange brokers, commercial banks
and the central bank.
 Largest market in the world.
 Market with no central trading location and no set hours of trading.
 Prices and other terms of trade are determined by computerized negotiations.

KINDS OF FOREIGN EXCHANGE MARKETS

Spot Market Forward Market
It refers to the market in which sale and
It refers to the market in which the receipts and
purchase of foreign currency is settled on a
payments are made immediately.
specific future date at a agreed upon today.