CHAPTER 7: Governmental Influence on Trade What is Protectionism? Why do overnments of countries intervene in trade?

The governmental framework of restrictions and incentives to trade is known as protectionism. Governments want to protect their own industries and get them ready to compete with the world. Governments also want to promote exports at the same time. After 70s, India changed from an import oriented economy to an export oriented economy. Governmental measures may limit your a!ility to sell a!road, such as !y prohi!iting the export of certain products to certain countries, or !y making it difficult for you to !uy what you need from foreign suppliers. Governments routinely influence the flow of imports and exports, and put a cap on "#I, otherwise the country will not produce anything. Also governments directly or indirectly su!sidi$e domestic industries to help them engage foreign producers at home or challenge them a!road. All nations interfere with international trade to varying degrees. Governments intervene in trade to attain economic, social or political o!%ectives. Governments pursue political rationality when trying to regulate trade. Governmental officials apply trade policies that they reason have the !est chance to !enefit the nation and its citi$en and in some case their personal political longevity. What is the role of the overnment as far as trade !rotectionism is concerned? The role of the government is as follows& '( Interest articulation& since different interest groups co exist, so different interests need to !e put forward. )( Interest aggregation& take all stakeholders view into account *( +olicy making ,( Implementation and ad%udication What are the economic rationales for overnmental intervention? The economic rationales are as follows& "# $nem!loyment: -ne of the social o!%ectives of government is to prevent unemployment. The government can do that through import restriction. -ne difficulty with restricting imports to create %o!s is that other countries normally retaliate with their own restrictions. In the long run, exports might also reduce which might lead to further employment. Two factors can ease the effects of retaliation& a( .mall trading countries are less important in the retaliation process. !( /etaliation that decreases employment in a capital intensive industry may not affect employment as much as the value of the trade loss would imply. If import restrictions do increase domestic employment, then fellow citi$ens will have to !ear the cost of higher prices or higher taxes. Government officials should compare the costs of higher prices with the costs of unemployment and displaced production that would result from freer trade. In addition, they must consider the costs of policies to ease the plight of displaced employees, such as for unemployment !enefits or retraining. The employment issue can slow trade li!erali$ation !ecause displaced workers are often the ones who are least a!le to find alternative work at a compara!le salary. .o, persistent unemployment pushes many groups to call for protectionism. 0owever, evidence

suggests that efforts to reduce unemployment through import restrictions are usually ineffective. 1nemployment, in and of itself, is !etter dealt with through fiscal and monetary policies. %# Infant industry !rotection: In '72), Alexander 0amilton presented infant industry argument. This theory holds that a government should shield an emerging industry from foreign competition !y guaranteeing it a large share of the domestic market until it is a!le to compete on its own. Government protects these industries through su!sidies, and in time, due to the learning curve, productivity improves and the industries !ecome competitive. The govt protects those infant industries for which the country has either comparative or competitive advantage !ased on country attractiveness factors. .o the companies of those industries will !ecome ma%or exporters. They !ecome strong in the home market also. Govt needs to protect its potential stars as well as sunrise industries, which are industries that are coming up worldwide, which does not exist as of present. Govt needs to invest in sunrise industries as they are the future. The infant industry argument presumes that the initial output costs for a small scale industry in given country may !e so high as to make its output non competitive in world markets. -nce the infant industry !ecomes glo!ally competitive, the government can then recoup the costs of trade protection through !enefits like higher domestic employment, lower social costs and higher tax revenues. It is reasona!le to expect production costs to decrease over time, !ut they may never fall enough to create internationally competitive products. .o there are two risks for protecting an infant industry& a( Governments must identify those industries that have a high pro!a!ility of success. !( 3ven if policy makers can determine those infant industries likely to succeed, it does not necessarily follow that companies in those industries should receive governmental assistance. Infant industry protection re4uires some segment of the economy to incur the higher cost of inefficient local production. Typically either consumers or tax payers take the !urden. 1ltimately the validity of the infant industry argument rests on the expectation that the future !enefits of an internationally competitive industry will exceed the costs of the associated protectionism. &# Promote Industriali'ation: 5ountries with a large manufacturing !ase generally have higher per capita incomes than those that do not. 0ence many emerging economies try to develop an industrial !ase !y largely regulating imports from foreign producers using trade protection to spur local industriali$ation. As development increases, services increase. +roductivity and man power play a greater role in services compared to the manufacturing and agriculture sector. Ideally a larger share of the G#+ should !e from the manufacturing and services sector as the price fluctuations are not much. There should !e control on imports so that there is an impetus to manufacture within the country. The following are the effects of promoting industriali$ation& a( 1se of surplus workers. !( +romoting investment inflows. c( #iversification d( Greater growth for manufactured products

e( Import su!stitution versus export promotion f( 6ation !uilding a# $se of sur!lus (or)ers: .urplus workers can more easily increase manufacturing output than agricultural output. .ince agricultural output per person is low, so many people can migrate from agricultural sectors to industrial sectors and in turn increase industrial output. The industriali$ation argument presumes that the unregulated importation of lower priced products prevents the development of a domestic industry. 0owever the industriali$ation rationale asserts that the industrial output will increase, even if the prices are not glo!ally competitive, !ecause local consumers must !uy local goods from local producers. *# Promotin investment inflo(s: Inflows of foreign investment in the industrial area promote sustaina!le growth. Import restrictions, applied to spur industriali$ation, may also increase foreign direct investment. "oreign investment inflows may also add to local employment, which is attractive to policymakers. c# +iversification: +rices and sales of agricultural products and raw materials fluctuate very much, which is a detriment to economies that depend on few of them. +rice variations due to uncontrolla!le factors, such as weather affecting supply or !usiness cycles a!road affecting demand, can wreak havoc on economies that depend on the export of primary products. A greater dependence on manufacturing does not either guarantee diversification of export earnings. d# Greater ro(th of manufactured !roducts: 7arkets for industrial products grow faster than markets for agricultural products. The terms of trade are the 4uantity of imports that a given 4uantity of a country8s exports can !uy. The prices of raw materials and agricultural commodities do not rise as fast as the prices of finished products. 0ence, overtime it takes more low priced primary products to !uy the same amount of high priced manufactured goods. .o, emerging nations that depend on primary products have !ecome increasingly poorer relative to industrial countries. As an economy progresses from agricultural to manufacture oriented to service oriented, the negotia!ility improves, and the country can earn more. The country needs to decide the ,uantity of e-!orts it (ants. When ,uantity of e-!orts re,uired is less than the relative ,uantity of im!orts it *uys/ the terms of trade is more favoura*le. e# Im!ort su*stitution versus e-!ort !romotion: Traditionally emerging economies promoted industriali$ation !y restricting imports in order to !oost local production for local consumption. .ome countries have achieved rapid economic growth !y promoting the development of industries that export their output. This approach is known as export led development. Industriali$ation may result initially in import su!stitution, yet export development of the same products may !e feasi!le later. f# 0ation 1uildin : Industrial activity helps the nation !uilding process. The performance of free markets suggests a strong relationship !etween industriali$ation and aspects of the nation !uilding process. Industriali$ation helps countries to !uild infrastructure, advance rural development, enhance rural peoples8 social life and !oost the skills of the workforce.

2# Increasin country3s economic !o(er or im!rovin country3s com!etitive !ositionin relative to other countries& 5ountries monitor their a!solute economic welfare as well as track how their performance compares to other countries. Governments impose trade restrictions to improve their relative trade positions. They also try to charge higher export and lower import prices. To remain competitive and perform !etter economically, the countries adopt the following five methods. a( Improving 9alance of payments :9-+( through 9alance of Trade !( /estrictions as a 6egotiating tool c( +rice control on exports d( "air access;/eciprocity e( #umping f( -ptimal tariff theory a( Im!rovin 1alance of !ayments throu h 14T: Governments can improve 9-+ !y improving their !alance of trade. If 9-+ difficulties arise and persist, a government may restrict imports or encourage exports to !alance its trade account. -ne way to do this is to devalue the currency of the country, which makes all the products cheaper in relation to foreign products. !( Restrictions as a 0e otiatin tool: The imposition of import restriction may !e used as a means to persuade other countries to lower their import !arriers. To successfully use restriction as a !argaining tool re4uired careful consideration of what products to target. 9asically the restrictions need to !e !elieva!le and important to the influential parties in the other country. 9elieva!le implies that there are either alternative sources to !uy the same product or that consumers are willing to do without it. c( Price control on e-!orts: 5ountries sometimes withhold goods from international markets in an effort to raise prices a!road. This policy may also encourage other countries to develop technology that will provide either su!stitute products or different ways of producing the same product. A country may limit exports of a product that is in short supply worldwide in order to favour domestic consumers. 5ompanies sometimes export !elow cost or !elow their home country price, a practice called dumping. 5ompanies do dumping to !uild a market a!road. d( 5air access6Reci!rocity: 5ompanies and industries often argue that they are entitled to the same access to foreign markets as foreign industries and companies have to their markets. 3conomic theory supports this idea, reasoning that producers operating in industries where increased production leads to steep cost decreases, !ut which lack e4ual access to a competitor8s market will struggle to gain enough sales to !e cost competitive. e( +um!in : #umping is the selling of goods !elow the cost at which they are sold in the home country. Com!anies resort to dum!in / due to the follo(in reasons: i( 3xcess production.

5ompanies using scale economies, enter a market at a low price, capture the market and wipe out the local competitors at short term loss. As soon as competition is wiped out, they start earning profits. The <T- acts against dumping. The affected company must first make a representation to its home country, and take permission from it. The commerce ministry of the country would then forward the grievance to the <T-, which then gives the home country government the lead to levy anti dumping duty. f( 4!timal tariff theory: Import or export duties are classified under tariffs. This theory states that a foreign producer will lower its prices if the importing country places a tax or duty on its products. If this occurs, !enefits shift to the importing country !ecause the foreign producer lowers its profits on the export sales. A company having comparative advantage to produce a particular product at a lower cost and good 4uality, will price it goods on the lower side. To reduce the disparity !etween the price of these good and local goods, the country increases import duty so that those cheap goods !ecome little expensive. They attempt to make the imported goods e4ually, if not less attractive, compared to local goods. What are the noneconomic rationales for overnment intervention? Governments are involved in the following noneconomic rationales& '( 7aintenance of essential industries )( +revention of shipment to unfriendly countries *( 7aintenance or extension of spheres of influence ,( +rotecting activities that help preserve the national identity "# 7aintenance of essential industries: The essential industries include defence, space research, media, education etc. .ome of these industries need to !e controlled through government. Governments apply trade restriction to protect essential domestic industries during peacetime so that a country is not dependent on foreign sources of supply during war. This is called the essential industry argument. 9ecause of the high cost of protecting an inefficient industry or a higher cost domestic su!stitute, the essential industry argument should not !e accepted without a careful evaluation of costs, real needs and alternatives. -nce an industry receives protection, it is difficult to remove the protection. %# Prevention of shi!ment to unfriendly countries: 0ere the government issues em!argo or trade sanctions against rival countries i.e. companies are not allowed to export goods to those countries. 5ountries achieve these political goals using economic means i.e. trade controls. 5ountries also start !lacklisting other countries who supply to their rival countries. 5ountries concerned a!out security often use national defence arguments to prevent the export, even to friendly countries, of strategic goods that might fall into the hands of potential enemies or that might !e in short supply domestically. 3xport constraints may !e valid if the exporting country assumes there will !e no retaliation that prevents it from securing even more essential goods from the potential importing country. Trade controls on nondefense goods also may !e used as a weapon of foreign policy to try to prevent another country from meeting its political o!%ectives. 3.g. 1. does not export to 6orth =orea.

ii(

&# 7aintenance or e-tension of s!heres of influence: It deals with the principle of neo mercantilism. Governments give aid and credits to, and encourage imports from countries that %oin a political alliance or vote a preferred way within international !odies like the 16 mainly to gain advantage or mem!ership. Thus they increase dependence of other countries on them and increase their sphere of influence. It is a!out exporting to another country and in turn generating employment and 9-+. A country8s trade restrictions may coerce governments to follow certain political actions or punish companies whose governments do not. 2# Protectin activities that hel! !reserve the national identity: Government>s role is not only to govern the country !ut also to protect the country and put it together. "or this the country re4uires national identity and a sense of !elongingness. 5ountries are held together partially through a unifying sense of identity that sets their citi$ens apart from those in other nations. 1nity is re4uired to collectively fight the aggression of other countries. To sustain this collective identity, countries limit foreign products and services in certain sectors. -ur national flag, culture, films, sports etc are manifestations of our patriotism, which preserves the distinct identity of the country. What are the instruments of Trade Control? The following are some of the instruments of trade control& '( Tariff 1arriers& A tariff :duty( is the most common type of trade control and is a tax that governments levy on a good shipped internationally. Governments charge a tariff when a good crosses its official !oundary. Trade !locks also charge common tariff rates to non mem!er countries. a( E-!ort Tariff& Tariffs collected !y the exporting country are called export tariffs. 3xport tariffs are imposed !ecause these items going out would affect local industries. 3xport tariffs are put on essential items useful locally. !( Transit Tariff& Tariffs collected !y a country through which the goods have passed are called a transit tariff. c( Im!ort Tariff& Tariffs collected !y an importing country are called import tariff. Import tariffs are imposed to make local production more attractive and competitive. Import tariffs raise the price of imported goods, there!y giving domestically produced goods a relative price advantage. Tariffs also serve as a source of governmental revenue. Although, revenue tariffs are most commonly collected on imports, many countries that export raw materials charge export tariffs. <T- has a ruling to reduce customs duty gradually. Tariffs can !e specific duty, ad valorem duty and compound duty. a( .pecific :per unit, e.g. ?@ per unit(& where per unit !asis duty is charged !( Ad Aalorem :3.g. '0@ of value(& i( Bust 7anufactured& 3x <orks ii( 9ought till port :local transportation(& "ree on 9oard :"-9( iii( 9ought till destination port :ocean freight and transit insurance(& 5ost, Insurance and "reight :5I"( iv( #ownloaded at port :customs duty(& Canded cost v( #elivered to shop;customer :Inland transport(& +rice for customer 0ere,

5I" D 3x <orks E "-9 E -cean "reight E Transit Insurance Ad Aalorem is applied on 5I" 5I" Aalue E #uty D Canded cost Canded 5ost E Inland Transport D +rice for 5ustomer c( 5ompound :com!ination of specific and ad valorem( Cevying duties is one way through which government regulates trade and tries to make imports unattractive. )( 0on8Tariff 1arriers 90T1#& They are as follows& a( .u!sidies !( Fuota c( Tied Aid to countries d( 9uy local legislation e( 5onsular "ees f( 5ustoms procedures g( .tandards and Ca!els h( .pecial +ermission :Import license( i( "oreign exchange controls %( Administrative delays k( 5ounter Trade; /eciprocity l( /estrictions on services a# :u*sidies: 0ost country government provides su!sidies for a certain period in various ways to infant industries and local players as they need time to achieve scale economies and also learning curve. This is done in order to make them competitive glo!ally and to increase their productivity and gradually make them exporters. Governments sometimes also provide other types of assistance like !usiness development services :market information, trade expositions and foreign contacts( to make it cheaper or more profita!le to sell overseas. 0owever trade frictions result from disagreement on the definition of a su!sidy. .u!sidies make local players compete domestically as well as in foreign markets. 1ltimately the pu!lic pays for these su!sidies in terms of taxes. 1., 31 and other developed nations provide farm su!sidies !ecause they want to make other genuine competitors non competitive and loose competitive edge, as developing countries can8t give much su!sidies. *# ;uota: The 4uota is the most common type of 4uantitative import or export restriction. 9y implementing 4uotas the countries increase 9-+ and 9-T !y decreasing imports and increasing exports. An import 4uota prohi!its or limits the 4uantity of a product that can !e imported in a given year. Fuotas usually increase the consumer price !ecause there is little incentive to use price competition to increase sales. Tariffs generate revenue for the government. 0owever 4uotas generate revenues for the companies that are a!le to o!tain and sell the intentionally limited supply. It !asically gives local players a chance to compete !y reducing the 4uantity of imports. 6o duties are levied, and no transactions take place. There are different variations of 4uotas. <oluntary e-!ort restraint 9<ER# is one such type. 0ere the government of country A asks the government of country 9 to reduce its companies8 exports to country A voluntarily. 0ere either country 9 volunteers

to reduce its exports or country A may impose tougher trade regulations. 3.g. 1. and Bapan. The advanta es of <ER are: i( A3/ is much easier to switch off than an import 4uota. ii( The appearance of GvoluntaryH choice !y a country, does not damage the political relations !etween those countries as much as an import 4uota does. A country may esta!lish e-!ort ,uotas to assure domestic consumers of a sufficient supply of goods at a low price to attempt to raise export prices !y restricting supply in foreign markets. The typical goal of an export 4uota is to raise prices to importing countries. Em*ar o is a specific type of 4uota that prohi!its all forms of trade !etween the countries. 5ountries or group of countries may place em!argoes on either imports or exports, on whole categories of products or specific products with specific countries. Governments impose em!argoes in the effort to use economic means to achieve political goals. c# Tied Aid to countries: It is given externally and is !ased on neo mercantilism. <hen governments give aid and loans to other countries with precondition that the recipient is re4uired to spend the funds in the donor country, then it is known as tied aid or tied loan. Tied aid helps win large contracts for infrastructure, such as telecommunications, electric power pro%ects etc. Tied aid can slow the development of local suppliers in developing countries and shield suppliers in the donor countries from competition. 3.g. 3II7 9ank helps 7alaysia to ena!le imports from India. d# 1uy local le islation: .ometimes governments specify a domestic content restriction i.e. a certain percentage of the product must !e of local origin. Govt has the option of !uying locally as well as internationally. .o !y !uying locally for certain industries like infrastructure and pharmaceuticals, the govt gives protection to the local players. .ometimes they favour domestic producers through price mechanisms. 7any nations prescri!e a minimum percentage of domestic content that a given product must have for it to !e sold legally in their country. 9y doing this the local market develops and technology up gradation happens in the local market. 3xports also happen on the component parts and "#I improves. e# Consular 5ees: .ome countries re4uire consular fees. It is re4uired !ecause& i( #ocumentation is necessary for authentication. ii( .ome countries do not consider the documents genuine until it is stamped and verified from their country em!assy in their country. It is a very high amount and delays the proceedings. iii( It is done with the aim of restricting imports as the increase in exports procedure costs makes the import to the country less attractive. f# Customs valuation and !rocedures: <hile imposing tariffs on exports or imports, custom officials first use the declared invoice price. If officials dou!t the authenticity, then they impose tariff on the !asis of the value of identical goods. If not possi!le, then officials may compute a value !ased on final sales value or on reasona!le cost. .ometimes officials use their discretionary power to assess the value too high, there!y preventing the importation of foreign made products.

.ometimes import clearances are slow in countries like 1. J Bapan to discourage imports. # :tandards and =a*els: 5ountries devise classification, la!elling and testing standards to allow the sale of domestic products !ut o!struct that of foreign made ones. In case of la!els, the companies have to indicate on a product the details, manufacturing;expiry dates content, cost etc in the country8s official language. Ca!els provide information to consumers who may prefer to !uy products from certain nations. The purpose of standards is to protect the safety or health of the domestic population. 0owever some foreign companies argue that standards are %ust another means to protect domestic producers as it re4uires customi$ation and adds to manufacturing cost. h# :!ecific !ermission 9Im!ort licenses#: .ome countries re4uire that potential importers or exporters secure permission from governmental authorities !efore conducting trade transactions. This re4uirement is known as import license. This procedure can restrict imports or exports directly !y denying permission or indirectly !ecause of the cost, time and uncertainty involved in the process. 3.g. in India, ,? days are re4uired for initial clearance of goods. i# 5orei n E-chan e controls: A foreign exchange control is a similar type of control. If there is no foreign exchange, the country cannot import. .ome countries have it only for national priority e.g. "ood etc. ># Administrative delays: International administrative delays create uncertainty and raise the cost of carrying inventory. 5ompetitive pressure, however, moves countries to improve their administrative systems. )# Counter Trade;Reci!rocity: Governments sometimes re4uire that exporters take merchandise in lieu of money or they promise to !uy merchandise or services, in place of cash payment, in the country to which they export. These sorts of !arter transactions are called countertrade or offsets. 7ore fre4uently, however, reciprocal re4uirements are made !etween countries with ample access to foreign currency that want to secure %o!s or technology as part of the transaction or with countries which do not have much foreign exchange. I" the government is involved in the transaction it is called offset. 3.g. 5olum!ia has coffee. 9oeing sells planes. They have a counter trade. 9oeing agrees to sell coffee where it will get !est price. 9oeing converts the aircraft prices to coffee :tonnes(. The transaction is done at the future price of coffee instead of the present. 9oeing takes into account the marketing and distri!ution cost of coffee also. The Govt of 5olum!ia got planes. 9oeing took the risk of selling coffee, !ut got a market for spare parts and pilot training in 5olum!ia as well as good relations with it. 1uy*ac) !olicy is followed when machinery cannot !e afforded, due to non availa!ility of re4uired currency, so pay !ack is done in the material produced. 3.g. A chemical e4uipment manufacturer approaches a potential client, who does not have foreign exchange. The manufacturer agrees and makes an agreement with the client that whatever they manufacture with their machinery should !e sent !ack to them and they would then sell it. This principle is called reciprocity. Around '?@ of the glo!al trade is through counter trade. It helps companies to have transactions which were otherwise not possi!le.

l# Restrictions on services: .ervices are the fastest growing sector in international trade. 5ountries restrict trade in services for , reasons& i# Essentiality: 5ountries sometimes prohi!it private companies, foreign or domestic, in some sectors !ecause they feel the services are essential, e.g. transportation which connects the masses ii# 0ot for !rofit services: 5ertain services should not !e sold for profit. In other cases government sets price controls for private competitors or su!sidi$e government owned service organi$ations, creating disincentives for foreign private participation. 7ail, education, hospital, media, insurance etc are often not for profit sectors. iii# :tandards: Governments limit foreign entry into many service professions to ensure practice !y 4ualified and experienced personnel. Government has standards in terms of 4ualifications for rendering services. 3.g. a certain period of internship for doctors in India, 5A in India and 5+A in 1.A for accounts personnel. iv# Immi ration: Governmental regulations often re4uire that an organi$ation, domestic or foreign, search extensively for 4ualified personnel locally !efore it can even apply for work permits for personnel it would like to !ring in from a!road. 3ven if no one is availa!le, hiring a foreigner is still difficult. These are done to protect employment. What are the im!lications of Government influences on trade for 70Es? The implications are as follows& '( Cook at a country8s attractiveness and select the !est country for operations. )( Cook at the country8s future in the next * , years and likely changes which might come. *( .can the environment correctly ,( 7anufacture certain goods more attractively If the tariff !arriers are too high, then& '( "#I is possi!le as 763 can enter the country easily through BA, wholly owned su!sidiary etc. )( Transportation cost is high sometimes, so "#I is a good option.