Chapter 8: Trade Policy

1. Chapter 8: Trade Policy

2. Outline 1. Overview, Winners & Losers 2. Rationales for Trade Intervention • industry-level & national-level 3. Controlling “unfair” trade practices • Super 301 4. Applications of today’s material to understanding how nations are doing

3. Who are the winners & losers when trade barriers go away? • Multinational corporations usually win • Small regional or local players often lose • Trade unions lose • Whether governments and nations win or lose is a subject of vigorous debate

4. Rationales for Trade Intervention There are two basic issues to consider when developing a national trade policy. • First, should a national government intervene to protect its domestic firms by taxing foreign goods entering the domestic market or constructing other barriers against imports? • Second, should a government help domestic firms increase their foreign sales through export subsidies, government-to-government negotiations, and guaranteed loan programs?

5. "Free" trade or "fair" trade? • A debate has been ongoing in the US whether to favor "free" or "fair" trade. • Those who argue for relatively unfettered trade (free trade) cite the benefits of trade and the incompetence of governments seeking to involve themselves in managing trade policy • Proponents of "fair" or "managed" trade often argue for using government intervention to ensure a "level playing field" in trade.

6. "Free" trade or "fair" trade? • The “level playing field” argument (whereby foreign firms and domestic businesses supposedly compete on “equal” terms) is often used to justify policies that restrict competition from foreign firms • In practice, deciding when the "playing field" can be considered "level" is very difficult

7. Industry-Level Trade Theories The National Defense Argument Suggests that a nation must be self-sufficient in critical raw materials, machinery, and technology, or else be vulnerable to threats from other countries.   It is popular and has been used to protect a variety of industries ranging from electronics to semiconductors to aerospace to steel in the US, as well as foodstuffs production in some other countries.

8. Industry-Level Trade Theories The Infant Industry Argument Based on the idea that some industries could thrive if they are protected from foreign competition during their infancy and adolescence. Policies based on this argument can work; however, industries are often given protection for political reasons. Those that are awarded protection are usually reluctant to give it up.

9. Industry-Level Trade Theories Strategic Trade Theory Based on the idea that a national government can “play games” to make its country better off if it adopts trade policies to ensure that a domestic firm captures the monopoly profits that arise from being one of the few firms in an industry. The example is narrow, but in practice governments routinely play a variety of games to favor certain domestic industries

10. Industry-Level Trade Theories Strategic Trade Theory (cont'd) Strategic trade theory applies only to markets that are incapable of supporting more than one or two firms on a worldwide basis. Since favoring certain industries inevitably hurts other industries, the policy is ineffective for a broad range of industries.

11. Industry-Level Trade Theories Strategic Trade Theory (cont'd) However, the thinking behind strategic trade theory can be applied to any industry which a government believes is important for its economy or for security reasons. The “name of the game” is, simply, to do whatever tips the competitive balance in favor of the “home team”, meaning firms operating in the government’s area of jurisdiction.

12. National Trade Policy “Regimes” In addition to focusing on the needs of specific industries, governments may also implement broad policies designed to consider the needs of the economy and society as a whole. These broad national policies are then followed by specific industry policies.

13. National Trade Policy “Regimes” Economic Development Programs Risk diversification by nations heavily dependent on one or two key industries Export promotion Import substitution The export-promotion strategy has been more successful at stimulating economic development than the import-substitution strategy.

14. National Trade Policy “Regimes” Industrial Policy • An industrial policy is used by a government to promote the competitiveness of key products and industries with high growth prospects in international markets. The policies are formulated based on the needs of the national economy.

15. National Trade Policy “Regimes” Industrial Policy (cont'd) • Critics of industrial policy argue that bureaucrats cannot perfectly identify the right industries to favor. Critics further suggest that political clout will often play a key role in determining which industries are selected.

16. National Trade Policy “Regimes” Industrial Policy (cont'd) • Terutomo Ozawa, a respected scholar regarding international trade and economic development, suggests that when developing nations are trying to catch up to the richest nations, they already have a blueprint to follow and that it is not all that difficult to figure out which industries to select. However, once a nation joins the “economic frontiers” of rich nations, governments cease to be effective at picking which industries should be targeted to receive help.

17. National Trade Policy “Regimes” Public Choice Analysis Public choice analysis suggests that special interests 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 their interests.

18. National Trade Policy “Regimes” Public Choice Analysis (cont'd) • Because of political considerations, Congress frequently endorses special interests. • In broader terms, evidence of public choice analysis can be seen everywhere around the world. • Example: China, WTO accession, and Chinese farmers

19. Controlling “unfair” trade practices Super 301, a section of the 1974 U.S. Trade Act, requires the U.S. trade representative to publicly list those countries engaging in the most flagrant unfair trade practices and to negotiate for the elimination of those practices. If negotiations are unsuccessful, the executive branch is required to take retaliatory measures.   Super 301 has been the target of a great deal criticism from abroad (naturally).

20. Controlling “unfair” trade practices There are good reasons to be concerned about a policy which involves publicly humiliating and threatening US trading partners each and every year. This is particularly true because the US has a long history of doing exactly the same kinds of things for which it condemns others. Other means of carrying out discussions with trading partners over trade-related issues, which make the process less of a public spectacle, could also prove effective.

21. Applications of today’s material to understanding how nations are doing Rationales for trade intervention are closely linked to the economic development process. You can often infer consequences for economic growth and development by formulating judgments about the intelligence, coherence, and likelihood of success or failure of a nation’s portfolio of trade (and investment) policies.

22. Applications of today’s material to understanding how nations are doing • Tip for analysis: • As a general observation, tracking changes over time in the net current account balance (Ch 6, Balance of Payments) on an industry-by-industry basis provides more fine-grained data about ongoing structural changes in a nation’s economy than tracking changes in the net current account balance of the economy as a whole.

23. Applications of today’s material to understanding how nations are doing • In more specific terms, industries which have political and economic importance and which are under pressure from imports are a potential source of economic and political instability. A review of the net current account balance on an industry-by-industry basis to see which industries are coming under greater pressure from imports (ie: through a high and rising net import balance) will often reveal where “public choice analysis” pressures will be particularly strong.

24. An aside for managers If you see rising net imports in your industry in a country to which your firm exports, if that nation has considerable importance to your firm’s overall profitability and global strategy, and if there are no overwhelming disadvantages to producing in that nation, you may be interested in exploring production in that nation as one means of building political influence there *ahead* of when a backlash against imports may occur.

25. An aside for managers At a minimum, if you see rising net imports in your industry for a country in which you compete, you can prepare for the challenges ahead arising from dealing with public choice analysis. In short, “proactive preparation” would seem better than reacting afterwards regarding these issues, and information provided by current account analysis can prove very helpful for anticipating problems before they arrive.