Chapter III

Formulation
of National
Trade Policies
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Rationales for Trade Intervention

 Politicians, economists and business

people have been arguing for centuries
over government policy toward
international trade. Two principal issues
have shaped the debate on appropriate
trade policies:
1. Whether a national government should
intervene to protect the country’s
domestic firms by taxing foreign goods
entering the domestic market or
constructing other barriers against
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Cont.

2. Whether a national government

should directly help the country’s
domestic firms increase their foreign
sales through export subsidies,
government-to-government
negotiations, and guaranteed loan
programs.
 The trade policy debate has recently
focused on the issue of whether the
government should promote “free” or
“fair” trade.
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Cont.

Free Trade implies that the national

government exerts minimal influence
on the exporting and importing
decisions of private firms and
individuals.
Fair Trade/managed trade suggests
that the national government should
actively intervene to ensure that
exports of domestic firms receive an
equitable share of foreign markets
and that imports are controlled to
minimize losses of domestic jobs and
market share in specific industries..
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 a) Industry-Level Trade Theories
The argument for free trade: follows Adam
Smith’s analysis; voluntary exchange makes both
parties to the transaction better off and allocates
goods to their highest valued use. The welfare of a
country and its citizens is best promoted by
allowing self-interested individuals, regardless of
where they reside, to exchange goods, services,
and assets as they see fit.
The National Defense Argument: a country must
be self-sufficient in critical raw materials,
machinery, and technology or else be vulnerable to
foreign threats.
This argument appeals to the general public,
which is concerned that its country will be pushed
around by other countries that control critical
resources.
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Many special-interest groups have used 5
Cont.

The Infant Industry Argument: the young

nation’s manufacturers would not survive their
infancy and adolescence because of fierce
competition from more mature firms.
Government nurturing of domestic industries that
will ultimately have a comparative advantage can
be a powerful economic development strategy.
However, determining which industries deserve
infant industry protection is often done on a
political, rather than an economic basis.
Firms, workers, and shareholders are not shy
about using the infant industry argument to bolster
support for import protection or export subsidies
for their industries. Moreover, once an industry is
granted protection, it may be reluctant to give it
up.
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 Cont.

Maintenance of Existing Jobs: well-established firms and

their workers, particularly in high-wage countries, are often
threatened by imports from low-wage countries. To
maintain existing employment level, firms and workers
often petition their governments for relief from foreign
competition.
Government officials, eager to avoid the human and
economic misery inflicted on workers and communities
when factories are shut down, tend to lend a
sympathetic ear to such pleas. Assistance may come in
the form of tariffs, quotas, or other barriers. The
assistance may be temporary or it may be long-lived.
Strategic Trade Theory: it assumes that firms operate
in perfectly competitive markets of the sort that exist
only in economics textbooks. They also assume that
each country’s consumers are able to buy goods and
services at the lowest possible prices from the world’s
most efficient producers.
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Cont.

According to the classical theories, any

governmental intervention that denies
consumers these buying opportunities will
make the country as a whole worse off,
although it could make certain groups within
the society better off.
It considers those industries capable of
supporting only a few firms worldwide, perhaps
because of high product development costs or
strong experience curve effects.
A firm can earn monopoly profits if it can
succeed in becoming one of the few firms in
which a highly concentrated industry.
It suggests a national government can make its
country better off if it adopts trade policies that
improve the competitiveness of its domestic
firms in such oligopolistic industries…/
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 b) National Trade Policies
A national government may develop trade
policies that begin by taking a broader
perspective on the needs of the economy and
society as a whole. After assessing these
needs, the government then adopts industry-
by-industry policies to promote the country’s
over all economic agenda.
Economic Development Programs:
international commerce can play a major role
in economic development programs.
Countries dependent on a single export often
choose to diversify their economies in order
to reduce the impact of, say, a bad harvest or
falling prices for the dominant export.
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
Cont.
Industrial Policy: an important element of
this task is determining which industries
should receive favorable governmental
treatment.
Public Choice Analysis: the special interest
will often dominate the general interest on
any given issue because special-interest
groups are willing to work harder for the
passage of laws favorable to their interests
than the general public is willing to work for
the defeat of laws unfavorable to its interest.
According to Public Choice Analysis,
domestic trade policies that affect
international business do not stem from some
grandiose vision of a country’s international
responsibilities but rather from the mundane/
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 Barriers to International Trade
Domestic politics often cause countries to try to
protect their domestic firms from foreign
competitors by erecting barriers to trade. Such
forms of government intervention can be divided
in to two categories: Tariffs and Non-tariff
barriers.
Tariffs:
Export tariffs
Transit tariff
Import tariff- ad valorem, specific,
compound
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Cont.

Non-tariff barriers: any government

regulation, policy, or procedure other
than a tariff that has the effect of
impeding international trade.
Quotas
Numerical export controls
Product and testing standards
Restricted access to distribution
networks
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Cont.
Public-sector procurement policies
Local purchase requirements
Regulatory controls
(environmental regulations, health
and safety inspections…)
Currency controls
Investment controls!!!!!!

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 Promotion of International Trade

Subsidies

Establishment of foreign trade

zones

Export financing programs

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Subsidies
Countries often offer a variety of subsidies
to firms operating within their borders in
order to increase economic activity and
job creation. These subsidies include:
Favorable tax breaks for investment, R
& D spending, and employee training
Direct payments to producers
Product price supports
Sales of publicly owned property at less
than fair market value
Public services provided at below cost

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Cont.

Because subsidies reduce the cost of

doing business, they may affect
international trade by artificially
improving a firm’s competitiveness in
export markets or by helping domestic
firms to fight off foreign imports.
Subsidies, however, can grow so large
as to disrupt the normal pattern of
international trade..
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Foreign Trade Zones (FTZ)
It is a geographical area in which
imported or exported goods receive
preferential tariff treatment.
Through utilization of an FTZ a firm
typically can reduce, delay, or sometimes
totally eliminate customs duties.
Generally, a firm can import a component
into an FTZ, process it further, and then
export the processed good abroad and
avoid paying customs duties on the value
of the imported component..

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Export Financing Programs

Because of the importance of the

financing package, most major
trading countries have created
government-owned agencies to assist
their domestic firms in arranging
financing of export sales, both large
or small.
Government aid often goes beyond
mere financing- commercial
insurance, political-risk insurance!!!
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 Controlling Unfair Trade Practices
Focuses on two types of unfair trade practices:
government subsidies that distort trade and
unfair pricing practices.
Countervailing Duties (CVD): most countries
protect local firms from foreign competitors
that benefit from subsidies granted by their
home governments. A CVD is an ad valorem
tariff on an imported good that is imposed by
the importing country to counter the impact of
foreign subsidies. It is calculated to just offset
the advantage that the exporter obtains from
the subsidy.
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Cont.
In this way, trade can still be driven by
the competitive strengths of individual
firms and the laws of comparative
advantage rather than by the level of
subsidies governments offer domestic
firms.
Not all government subsidies give a
foreign firm an unfair advantage in the
domestic market. Most countries impose
CVDs only when foreign subsidization of a
product leads to a distortion of
international trade. CVDs are controversial
and may lead to international conflict.
Economic development incentives may
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Cont.

Antidumping Regulation: Many

countries are also concerned about
their domestic firms being
victimized by discriminatory or
predatory pricing practices of
foreign firms, such as dumping.
Dumping occurs when a firm sells
its goods in a foreign market at a
price below what it charges in its
home market. This type of dumping
is a form of international price
discrimination.
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Cont.
Another type of dumping involves the firm is
selling its goods below cost in the foreign
market, in which case the dumping is a form of
predatory pricing.
Antidumping laws protect local industries
from dumping by foreign firms.
Determining whether the first type of
dumping-price discrimination- has actually
occurred is not always easy.
 Retail prices are irrelevant in determining
whether dumping has occurred.
The comparison should be between the prices
charged foreign customers & domestic
customers at the factory gate; these prices are
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Cont.

The higher retail prices might

reflect the inefficient distribution
system or higher costs of doing
business rather than dumping.
In the second type of dumping-
predatory pricing- defining costs is
complicated, particularly when
dealing with a large, multidivisional
MNC.!!!!!
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Discussion Point
Which Strategy is more
applicable for our country?
Why/How?
Export-promotion
strategy
Import-substitution
strategy
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Discussion Point
Should we develop
protective trade
policy or not?
Why/Why Not?
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