Rationale for government intervention in international trade

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.