International Business College

* A subsidy – a government payment to a domestic producer
* Subsidies help domestic producers
* compete against low-cost foreign imports
* gain export markets
* Consumers typically absorb the costs of subsidies
Tariffs
* Tariffs
* increase government revenues
* provide protection to domestic producers against foreign competitors by increasing the cost of imported foreign goods
* force consumers to pay more for certain imports
* So, tariffs are unambiguously pro-producer and anti-consumer, and tariffs reduce the overall efficiency of the world economy Local content requirements
* A local content requirement demands that some specific fraction of a good be produced domestically
* can be in physical terms or in value terms
* Local content requirements benefit domestic producers and jobs, but consumers face higher prices Trade Policy
* Administrative trade polices – bureaucratic rules that are designed to make it difficult for imports to enter a country

 These polices hurt consumers by denying access to possibly superior foreign products Dumping

* Dumping – selling goods in a foreign market below their cost of production, or selling goods in a foreign market at below their “fair” market value * a way for firms to unload excess production in foreign markets * may be predatory behavior, with producers using substantial profits from their home markets to subsidize prices in a foreign market with a view to driving indigenous competitors out of that market, and later raising prices and earning substantial profits Comparative and Absolute Advantage

* comparative advantage – a country should specialize in the production of those goods that it produces most efficiently and buy the goods that it produces less efficiently from other countries * A country has an absolute advantage in the production of a product when it is more efficient than any other country in producing it Regional Integration Pros and Cons

Pro
* Expand market size
* Achieve scale economies and enhanced productivity
* Attract investment from outside the bloc
* Acquire stronger defensive political postures
Con
* Trade creation
* Trade diversion
* Loss of national identity
* Sacrifice of autonomy
* Failure of small or weak forms etc.
Effects of trade barriers
* Trade theory suggests why dispersing production activities globally can be beneficial * However, trade barriers may limit a firm’s ability to do so * trade barriers raise the cost of exporting

* quotas limit exports
* firms may have to locate production activities within a country to meet local content regulations * the threat of future trade barriers can influence firm strategy * All of these can raise costs above what they may have been in a world of free trade Mercantilism

* Mercantilism (mid-16th century) – it is in a country’s best interest to maintain a trade surplus – to export more than it imports * it advocated government intervention to achieve a surplus in the balance of trade * it viewed trade as a zero-sum game (one in which a gain by one country results in a loss by another) * Mercantilism is problematic and not economically valid, yet many political views today have the goal of boosting exports while limiting imports by seeking only selective liberalization of trade Eclectic theory

* Product life cycle – Vernon (mid-1960s ) proposed the product life-cycle theory – as products mature both the location of sales and the optimal production location will change affecting the flow and direction of trade New trade theory

New trade theory (1970s) suggests
1. Because of economies of scale (unit cost reductions associated with a large scale of output), trade can increase the variety of goods available to consumers and decrease the average cost of those goods 2. In those industries when the output required to attain economies of scale represents a significant proportion of total world demand, the global market may only be able to support a small number of firms New trade theory suggests

* nations may benefit from trade even when they do not differ in resource endowments or technology * a country may predominate in the export of a good simply because it was lucky enough to have one or more firms among the first to produce that good * So, new trade theory provides an economic rationale for a proactive trade policy that is at variance with other free trade theories Hecksher-Ohlin

* Heckscher and Ohlin – comparative advantage arises from differences in national factor endowments (the extent to which a country is endowed with resources such as land, labor, and capital) * the more abundant a factor, the lower its cost

* countries will export goods that make intensive use of those factors that are locally abundant, and import goods that make intensive use of factors that are locally scarce Leontief
* Leontief (1953) – since the U.S. was relatively abundant in capital, it would be an exporter of capital intensive goods and an importer of labor-intensive goods * Leontief found however, that U.S. exports were less capital intensive than U.S. imports * Possible explanations for these findings include

* that the U.S. has a special advantage in producing products made with innovative technologies that are less capital intensive * differences in technology lead to differences in productivity which then drives trade patterns Pragmatic nationalism

* The pragmatic nationalist view is that FDI has both benefits, such as inflows of capital, technology, skills and jobs, and costs, such as repatriation of profits to the home country and a negative balance of payments effect * According to this view, FDI should be allowed only if the benefits outweigh the costs * countries in the European Union try to attract beneficial FDI flows by offering tax breaks and subsidies

Political and economic arguments in favor of government intervention * Political arguments for government intervention include 1. protecting jobs
2. protecting industries deemed important for national security 3. retaliating to unfair foreign competition
4. protecting consumers from “dangerous” products
5. furthering the goals of foreign policy
6. protecting the human rights of individuals in exporting countries * Economic arguments for government intervention in international trade include 7. The infant industry argument

8. Strategic trade policy
1. The infant industry argument – suggests that an industry should be protected until it can develop and be viable and competitive internationally * this has been accepted as a justification for temporary trade restrictions under the WTO * However, this argument has been criticized because

* it is useless unless it makes the industry more efficient * if a country has the potential to develop a viable competitive position, its firms should be capable of raising necessary funds 2. Strategic Trade Policy – suggests that in cases where there may be important first mover advantages, governments can help firms from their countries attain these advantages * also suggests that governments can help firms overcome barriers to entry into industries where foreign firms have an initial advantage NAFTA

The North American Free Trade Agreement (NAFTA) is an agreement signed by the governments of Canada, Mexico, and the United States, creating a trilateral trade bloc in North America. The agreement came into force on January 1, 1994. It superseded the Canada – United States Free Trade Agreement between the U.S. and Canada. In terms of combined GDP of its members, as of 2010 the trade bloc is the largest in the world. WTO

The World Trade Organization (WTO) is the only global international organization dealing with the rules of trade between nations. At its heart are the WTO agreements, negotiated and signed by the bulk of the world’s trading nations and ratified in their parliaments. The goal is to help producers of goods and services, exporters, and importers conduct their business. The World Trade Organization (WTO) deals with the global rules of trade between nations. Its main function is to ensure that trade flows as smoothly, predictably and freely as possible. Samuelson

The Samuelson Critique — (very important that you understand this!) * Globalization argues against the validity of the Theory of Competitive Advantage for developed nations. * Similar to mass inward migration into the U.S.