Chapter 6 business government trade relations

6 Business–Government Trade Relations

Learning Objectives

After studying this chapter, you should be able to

1 Describe the political, economic, and cultural motives behind governmental intervention in trade.

2 List and explain the methods governments use to promote international trade.

3 List and explain the methods governments use to restrict international trade.

4 Discuss the importance of the World Trade Organization in promoting free trade.

 A LOOK BACK

Chapter 5 explored theories that have been developed to explain the pattern that international trade should take. We examined the important concept of comparative advantage and the conceptual basis for how international trade benefits nations.

 A LOOK AT THIS CHAPTER

This chapter discusses the active role of national governments in international trade. We examine the motives for government intervention and the tools that nations use to accomplish their goals. We then explore the global trading system and show how it promotes free trade.

 A LOOK AHEAD

Chapter 7 continues our discussion of the international business environment. We explore recent patterns of foreign direct investment, theories that try to explain why it occurs, and the role of governments in influencing investment flows.

Lord of the Media

Hollywood, California — Time Warner (www.timewarner.com) is the world’s leading media and entertainment company and earns around $46 billion annually. Its businesses include television networks (HBO, Turner Broadcasting), publishing (Time, Sports Illustrated), and film entertainment (New Line Cinema, Warner Bros.). As Time Warner marches across the globe, people in almost every nation on the planet view its media creations.

New Line Cinema’s The Lord of the Rings trilogy (based on the tale by J.R.R. Tolkien) is the most successful film franchise in history. The final installment in the trilogy, The Lord of the Rings: The Return of the King, earned more than $1 billion at the worldwide box office. The entire trilogy earned nearly $3 billion worldwide and won 17 Academy Awards. New Line is now producing the prequel to The Lord of the Rings series, The Hobbit.

Source: David James/Warner Bros/Courtesy of Warner Bros./Bureau L.A. Co./CORBIS-NY.

Warner Bros.’s ongoing Harry Potter films, based on the novels of former British schoolteacher J.K. Rowling, have been magically successful. Kids worldwide snatched up Harry Potter books in every major language and now pour into cinemas to watch young Harry on the silver screen. Warner Bros. also hit it big in 2008 with the Batman film, The Dark Knight—one of the highest-grossing films ever. The company also produces mini-movies and games exclusively for its Web site.

Yet Time Warner must tread carefully as it expands its reach. Some governments fear that their own nations’ writers, actors, directors, and producers will be drowned out by big-budget Hollywood productions such as The Lord of the Rings and Harry Potter. Others fear the replacement of their traditional values with those depicted in imported entertainment. As you read this chapter, consider all the cultural, political, and economic reasons why governments regulate international trade.1

Chapter 5 presented theories that describe what the patterns of international trade should look like. The theory of comparative advantage says that the country that has a comparative advantage in the production of a certain good will produce that good when barriers to trade do not exist. But this ideal does not accurately characterize trade in today’s global marketplace. Despite efforts by organizations such as the World Trade Organization (www.wto.org) and smaller groups of countries, nations still retain many barriers to trade.

In this chapter, we investigate business–government trade relations. We first explain why nations erect barriers to trade, exploring the cultural, political, and economic motives for such barriers. We then examine the instruments countries use to restrict imports and exports. Efforts to promote trade by reducing barriers within the context of the global trading system are then presented. In Chapter 8 we discuss how smaller groups of countries are eliminating barriers to both trade and investment.

Why Do Governments Intervene in Trade?

The pattern of imports and exports that occurs in the absence of trade barriers is called free trade. Despite the advantages of open and free trade among nations, governments have long intervened in the trade of goods and services. Why do governments impose restrictions on free trade? In general, they do so for reasons that are political, economic, or cultural—or some combination of the three. Countries often intervene in trade by strongly supporting their domestic companies’ exporting activities. But the more emotionally charged intervention occurs when a nation’s economy is underperforming. In tough economic times, businesses and workers often lobby their governments for protection from imports that are eliminating jobs in the domestic market. Let’s take a closer look at the political, economic, and cultural motives for intervention.

free trade

Pattern of imports and exports that occurs in the absence of trade barriers.

Political Motives

Government officials often make trade-related decisions based on political motives because a politician’s career can depend on pleasing voters and getting reelected. Yet a trade policy based purely on political motives is seldom wise in the long run. The main political motives behind government intervention in trade include protecting jobs, preserving national security, responding to other nations’ unfair trade practices, and gaining influence over other nations.2

Protect Jobs

Short of an unpopular war, nothing will oust a government faster than high rates of unemployment. Thus practically all governments become involved when free trade creates job losses at home. Ohio lost around 215,000 manufacturing jobs in the 14 years between 1994 and 2008. Most of those jobs went to China and the nations of Central and Eastern Europe. The despair of unemployed workers and the pivotal role of Ohio in the presidential election of 2008 lured politicians to the state who promised Ohio lower income taxes, expanded worker retraining, and greater investment in the state’s infrastructure.

But politicians’ efforts to protect jobs can draw attention away from free trade’s real benefits. General Electric (GE) sent many jobs from the United States to Mexico over the years. GE now employs 30,000 Mexicans at 35 factories that are manufacturing all sorts of its appliances and other goods. But GE also sold Mexican companies $350 million worth of its turbines made in Texas, 100 of its locomotives made in Pennsylvania, and dozens of its aircraft engines. Mexico specializes in making products that require less expensive labor and the United States specializes in producing goods that require advanced technology and a large investment of capital.3

Preserve National Security

Industries considered essential to national security often receive government-sponsored protection. This is true for both imports and exports.

NATIONAL SECURITY AND IMPORTS

Certain imports are often restricted in the name of preserving national security. In the event that a war would restrict their availability, governments must have access to a domestic supply of certain items such as weapons, fuel, and air, land, and sea transportation. Many nations continue to search for oil within their borders in case war disrupts its flow from outside sources. Legitimate national security reasons for intervention can be difficult to argue against, particularly when they have the support of most of a country’s people.

Some countries claim national security is the reason for fierce protection of their agricultural sector, for food security is essential at a time of war. France has been criticized by many nations for ardently protecting its agricultural sector. French agricultural subsidies are intended to provide a fair financial return for French farmers, who traditionally operate on a small scale and therefore have high production costs and low profit margins. But many developed nations are exposing agribusiness to market forces and prompting their farmers to discover new ways to manage risk and increase efficiency. Innovative farmers are experimenting with more intensive land management, high-tech precision farming, and greater use of biotechnology.

Yet protection from import competition does have its drawbacks. Perhaps the main one is the added cost of continuing to produce a good or provide a service domestically that could be supplied more efficiently from abroad. Also, a policy of protection may remain in place much longer than necessary once it is adopted. Thus policy makers should consider whether an issue truly is a matter of national security before intervening in trade.

NATIONAL SECURITY AND EXPORTS

Governments also have national security motives for banning certain defense-related goods from export to other nations. Most industrialized nations have agencies that review requests to export technologies or products that are said to have dual uses—meaning they have both industrial and military applications. Products designated as dual use are classified as such and require special governmental approval before export can take place.

Products on the dual-use lists of most nations include nuclear materials; technological equipment; certain chemicals and toxins; some sensors and lasers; and specific devices related to weapons, navigation, aerospace, and propulsion. Bans on the export of dual-use products were strictly enforced during the Cold War years between the West and the former Soviet Union. Whereas many countries relaxed enforcement of these controls in recent years, the continued threat of terrorism and fears of weapons of mass destruction are renewing support for such bans.

Protesters from the civic initiative called “compact.de” protest against genetically modified foods in front of the Bundestag in Berlin, Germany. All types of crops today, including corn, soybeans, and wheat, are grown with genetically enhanced seed technology to resist insects and disease. Many people in Europe fiercely resist U.S. efforts to export GM crops to their markets. Do you believe Europeans are right to be wary of the importation of genetically modified crops?

Source: Getty Images.

Nations also place certain companies and organizations in other countries on a list of entities that are restricted from receiving their exports. In 2008, the owner of an electronics firm pleaded guilty to charges of conspiracy to illegally export dual-use items from the United States to India for possible use in ballistic missiles, space launch vehicles, and fighter jets. Parthasarathy Sudarshan admitted that he provided the components to government entities in India including two companies on the U.S. Department of Commerce’s “Entity List.” Sudarsham was sentenced to 35 months in a U.S. federal prison and was fined $60,000.4

Respond to “Unfair” Trade

Many observers argue that it makes no sense for one nation to allow free trade if other nations actively protect their own industries. Governments often threaten to close their ports to another nation’s ships or to impose extremely high tariffs on its goods if the other nation does not concede on some trade issue that is seen as being unfair. In other words, if one government thinks another nation is not “playing fair,” it will often threaten to retaliate unless certain concessions are made.

Gain Influence

Governments of the world’s largest nations may become involved in trade to gain influence over smaller nations. The United States goes to great lengths to gain and maintain control over events in all of Central, North, and South America, and the Caribbean basin.

The United States has banned all trade and investment with Cuba since 1961 in the hope of exerting political influence against its communist leaders. Designed to pressure Cuba’s government to change, the policy caused ordinary Cubans to suffer and many perished trying to reach the United States on homemade rafts. But change is occurring in Cuba and since 2008 ordinary Cubans can buy DVD players, stay in tourist hotels, and use mobile phones. Even the concept of performance-related pay was introduced. These seemingly trivial freedoms represent monumental change to ordinary Cubans, who now hope for the right to buy cars, travel, and buy and sell property.5

Economic Motives

Although governments intervene in trade for highly charged cultural and political reasons, they also have economic motives for their intervention. The most common economic reasons for nations’ attempts to influence international trade are the protection of young industries from competition and the promotion of a strategic trade policy.

Protect Infant Industries

According to the infant industry argument, a country’s emerging industries need protection from international competition during their development phase until they become sufficiently competitive internationally. This argument is based on the idea that infant industries need protection because of a steep learning curve. In other words, only as an industry grows and matures does it gain the knowledge it needs to become more innovative, efficient, and competitive.

Although this argument is conceptually appealing, it does have several problems. First, the argument requires governments to distinguish between industries that are worth protecting and those that are not. This is difficult, if not impossible, to do. For years, Japan has targeted infant industries for protection, low interest loans, and other benefits. Its performance on assisting these industries was very good through the early 1980s but has been less successful since then. Until the government achieves future success in identifying and targeting industries, supporting this type of policy remains questionable.

Second, protection from international competition can cause domestic companies to become complacent toward innovation. This can limit a company’s incentives to obtain the knowledge it needs to become more competitive. The most extreme examples of complacency are industries within formerly communist nations. When their communist protections collapsed, nearly all companies that were run by the state were decades behind their competitors from capitalist nations. To survive, many government-owned businesses required financial assistance in the form of infusions of capital or outright purchase.

Third, protection can do more economic harm than good. Consumers often end up paying more for products because a lack of competition typically creates fewer incentives to cut production costs or improve quality. Meanwhile, companies become less competitive and more reliant on protection. Protection in Japan created a two-tier economy where in one tier highly competitive multinationals faced rivals in overseas markets and learned to become strong competitors. In the other tier, domestic industries were made noncompetitive through protected markets, high wages, and barriers to imports.

Fourth, the infant industry argument also says that it is not always possible for small, promising companies to obtain funding in capital markets, and thus they need financial support from their government. However, international capital markets today are far more sophisticated than in the past, and promising business ventures can normally obtain funding from private sources.

Pursue Strategic Trade Policy

Recall from our discussion in Chapter 5 that new trade theorists believe government intervention can help companies take advantage of economies of scale and be the first movers in their industries. First-mover advantages result because economies of scale in production limit the number of companies that an industry can sustain.

BENEFITS OF STRATEGIC TRADE POLICY

Supporters of strategic trade policy argue that it results in increased national income. Companies should earn a good profit if they obtain first-mover advantages and solidify positions in their markets around the world. Advocates claim that strategic trade policies helped South Korea build global conglomerates (called chaebol) that dwarf competitors. For years, South Korean shipbuilders received a variety of government subsidies, including low-cost financing. The chaebol made it possible for companies to survive poor economic times because of the wide range of industries in which they competed. Such policies had spin-off effects on related industries. Yet some argue that South Korea’s chaebol must shift their focus from manufacturing to services and become more open organizations to help improve their nation’s competitiveness.6

Hyundai Heavy Industries is one of South Korea’s giant chaebol and the world’s largest shipbuilder. The ship shown here, named Al Gattara, was built by Hyundai and sold to a client in the United States. Al Gattara’s capacity is 216,000 square meters of liquid natural gas, which makes it the largest carrier of the gas in the world. Can you think of other products that are made by the Hyundai group?