International Business

Chapter Seven
Governmental Influence
on Trade
Chapter Objectives
• To realize the rationales for government policies
that enhance and restrict trade
• To interpret the effects of pressure groups on trade
policies
• To understand the comparison of protectionist
rationales used in high-income countries with those
used in low-income countries’ economies
• To comprehend the potential and actual effects of
government intervention on the free flow of trade
• To understand the major means by which trade is
restricted and regulated
• To grasp the business uncertainties and business
opportunities created by government trade policies

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Introduction
Protectionism refers to those government restrictions
and incentives specifically designed to help a
county’s domestic firms compete with foreign
competitors at home and abroad.
• Governments intervene in the trade process to attain
economic, social, and/or political objectives.
• Whenever governments impede the flow of imports
and/or encourage the flow of exports, they simul-
taneously provide direct and/or indirect subsidies for
their domestic firms.
Protectionist measures are likely to lead to retaliation
by affected stakeholders.

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 Fig. 7.2: Physical and Societal
Influences on Protectionism and
Companies’ Competitive
Environment

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Fig. 7.1: Import Market Shares
of Clothing in the U.S. before
and after the Multifiber
Arrangement

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Rationales for Government
Intervention in Trade
ECONOMIC RATIONALES NONECONOMIC RATIONALES

Prevent Maintain essential

unemployment industries
Protect infant Deal with unfriendly
industries countries
Promote Maintain or extend
industrialization spheres of influence
Improve position com- Preserve national
pared to other identity
countries 7-6
Economic Rationales for Government
Intervention:
Prevent Unemployment
By limiting imports, local jobs are retained as firms
and consumers are forced to purchase
domestically produced goods and services.
• Unless the protectionist country is relatively small, such
measures are usually ineffective.
• Such measures are likely to lead to retaliation unless either the
protectionist or the affected country is relatively small.
• Such measures may decrease export-related jobs because of
(i) price increases for components or (ii) lower incomes abroad.
Governments must carefully balance the costs of higher prices
with the costs of unemployment and the displaced production
that would result from freer trade.

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Economic Rationales for Government
Intervention:
Protect Infant Industries
Infant Industry Argument [Alexander Hamilton, 1792]:
A government should temporarily shield emerging
industries in which the country may ultimately possess a
comparative advantage from international competition
until its firms are able to compete in world markets.
Hamilton reasoned that eventual competitiveness would result
from: • movement along the learning curve
• the efficiency gains from achieving the economies of large-
scale production
Ultimately, the validity of the argument rests on the expectation that the
future benefits of an internationally competitive industry will exceed the
costs of the associated protectionist measures.

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Economic Rationales for Government
Intervention:
Promote Industrialization
Industrialization Argument:
The development of national industrial output should
be supported, even though domestic prices may not
be competitive on the world market.
• Terms of trade describes the quantity of imports that a
given quantity of a country’s exports can buy.
• Export-led development encourages national economic
development by harnessing a country-specific advantage
and building a vibrant manufacturing sector through the
stimulation of exports.
Many of today’s emerging economies emulate historical practices
and use protectionism to spur local industrialization.
[continued]

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Supporters of the industrialization argument
claim that:
• surplus workers can more easily increase manufacturing
output than agricultural output
• foreign investment inflows promote sustainable growth
• fluctuating prices are a major detriment to those
economies that depend on just a few commodities
• demand for and prices of raw materials and agricultural
commodities do not rise as fast as the demand for and
prices of finished goods
• export promotion, and possibly import substitution, lead
to sustainable economic development
• industrialization helps the nation-building process

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Economic Rationales for Government
Intervention:
Improve Relative Economic
Position
Countries may impose trade restrictions
to improve their relative competitive
posi-tions. Their primary motivations
are:
• balance-of-payments adjustments
• comparable access, i.e., “fairness”
• leverage as a bargaining tool
• price-control objectives
[continued]

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• The comparable access argument, i.e., “fairness,”
promotes the idea that a country’s firms are
entitled to the same access to foreign markets as
foreign firms have to its market.
• Dumping refers to the practice of pricing exports
below cost, or below their home-country prices, i.e.,
below their “fair market value.”
• The optimum-tariff theory claims that a foreign
producer will lower its prices if the destination
country places a tariff on its products. So long as
the price is reduced by any amount, some shift in
revenue goes to the importing country, and the
tariff is deemed an optimum one.

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Noneconomic Rationales for
Government Intervention
• Maintenance of essential industries
Essential industry argument: a government applies
restrictions to protect essential domestic industries
(particularly defense) so that the country is not
dependent on foreign sources of supply
• Prevention of shipments to “unfriendly”
countries
• Maintenance or extension of spheres of
influence
• Preservation of national identity

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Instruments of Trade
Control
Instruments of trade control can:
-directly limit the amount that can be traded
-indirectly affect the amount traded by directly
influencing prices
• Tariffs (also called duties) are taxes levied on
(internationally) traded products.
• Nontariff barriers (NTBs) represent administrative
regulations, policies, and procedures, i.e.,
quantitative and qualitative barriers, that directly
or indirectly impede international trade.
While tariff barriers directly affect prices and subsequently
the quantity demanded, nontariff barriers may directly
affect price and/or quantity.

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Fig. 7.4: Comparison
of Trade Restrictions

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Instruments of Trade Control:
Tariffs
Tariffs, i.e., taxes levied on (internationally)
traded products, include:
• exports tariffs, levied by the country of
origin on exported products
• transit tariffs, levied by a country through
which goods pass en route to their final
destination
• import tariffs , levied by the country of
destination on imported products
A tariff increases the delivered price of a product, and,
at the higher price, the quantity demanded will be less.
[continued]

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• A specific duty is a tariff that is assessed on
a per unit basis.
• An ad valorem tariff is assessed as a
percentage of the value of an item.
If both a specific duty and an ad valorem tariff
are assessed on the same product, it is known as
a compound duty.
While raw materials frequently enter industrial countries
tariff free, an ad valorem tariff is often applied to the
total value of manufactured goods. Critics argue that
the effective tariff on the manufactured portion, i.e.,
the value-added portion, is higher than the published
tariff.

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Instruments of Trade Control:
Nontariff Barriers—Direct Price
Influences
• Subsidies: direct or indirect financial assistance
from governments to their domestic firms to help
them overcome market imperfections and thus
make them more competitive in the marketplace.
• Aid and loans: tied aid and loans require that the
recipient spend the funds in the donor country
• Customs valuation: determining the true value
and/or origin of traded products
• Other direct price influences: special fees, deposits,
minimum price levels

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Instruments of Trade Control:
Nontariff Barriers—Quantity Controls

• Quota: a numerical limit on the quantity of a

product that may be imported or exported in
a given period of time
– Voluntary export restraints (VERs): negotiated
limitations of exports from one country to another
– Embargo: an outright ban on imports from or
exports to a particular country
Because of the increase in the equilibrium price,
a quota may increase per unit revenues for participants
within the protected market.
[continued]

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• “Buy local” legislation
• Specific permission requirements
– Import and export licenses
– Foreign exchange controls
• Administrative delays
• Reciprocal requirements
– Barter
– Offset
• Restrictions on services
– Essentiality
– Professional standards
– Immigration

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Dealing with Government
Intervention

Firms can deal with trade restrictions by:

• moving operations to lower-cost countries
• concentrating on market niches that attract less
international competition
• adopting internal innovations that lead to greater
efficiency and/or superior products
• trying to secure government protection

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Implications/Conclusions
• When governments choose to impede the
flow of imports and encourage the flow of
exports, they simultaneously provide direct
and/or indirect subsidies for their domestic
industries.
• It is difficult to determine the real effects
of trade barriers due to the likelihood of
retaliation and the fact the imports and
exports can both have positive effects.

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• Much government interference in the international
trade process is motivated by political rather than
economic factors.
• A company’s particular international strategy will
determine the extent to which it might benefit from
protectionist measures.

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