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BUS201

Introduction tointernational business

Lecture 3Political economy of trade and investment

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Some assignment issuesfor you to note S tudents need to ensure that the two articles

are reporting on issues relevant tointernational business

The subject matter of each article should be

distinct from the other The date of each article must be clear Your 12 references do not include the two

newspaper articles As a guide, you should arrange your essay as

follows: Question 1 900-1000 words Question 2 900-1000 words

Plus introduction and conclusion 3-2

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Some assignment issuesfor you to note As the format of your paper is an E SSAY you

need to include an introduction and conclusion As the format of your paper is an E SSAY there

is no requirement for a table of contents or aexecutive summary

Your reference list (listing all the references youhave used to develop your essay) is not part of your word count: but your in-text citations are

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Some assignment issuesfor you to note

The items detailed in the previous two slideshave been loaded up on Blackboard under thetitle Internal assessment issues

There is also a document explaining theHarvard Referencing S ystem

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K ey topics

Instruments of trade policy W hy governments intervene in trade? W hy governments intervene in FDI?

G overnment policy instruments and FDI Trade and FDI liberalisationRegional economic integration

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Wh at is free trade?

Free trade refers to a situation w h ere agovernment does not attempt to restrict w h at itscitizens can buy from anot h er country or w h atth ey can sell to anot h er country.Wh ile many nations are nominally committed tofree trade, t h ey tend to intervene in internationaltrade to protect t h e interests of politicallyimportant groups: W e touc h ed on t h ese issues last week w h en we looked

at mercantilism

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Instruments of trade policy

Th ere are several instruments of tradepolicy: T ariffs S ubsidies Import quotas Voluntary export restraints Local content requirements A dministrative policies A ntidumping policies

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Tariffs A tariff is a tax levied on imports that effectively

raises the cost of imported products relative todomestic products.

Specific tariffs are levied as a fixed charge for eachunit of a good imported. Ad valorem tariffs are levied as a proportion of the

value of the imported good.

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Subsidies A subsidy is a government payment to a domestic

producer. S ubsidies help domestic producers in two ways:

They help them compete against low-cost foreign importsT hey help them gain export markets

Consumers typically absorb the costs of subsidies

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Instruments of trade policy A n import quota is a direct restriction on the

quantity of some good that may be imported into acountry.

Tariff rate quotas are a hybrid of a quota and atariff where a lower tariff is applied to imports within

the quota than to those over the quota. Voluntary export restraints are quotas on trade

imposed by the exporting country, typically at therequest of the importing countrys government.

U SA requested VERs on Japanese motor vehicles duringthe 1980s:

why would the Japanese government agree to this?

A quota rent is the extra profit that producers makewhen supply is artificially limited by an import quota.

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Local content requirements A local content requirement demands that some

specific fraction of a good be produceddomestically.

Local content requirements benefit domesticproducers, but consumers face higher prices.

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Administrative policies Administrative trade polices are bureaucratic

rules that are designed to make it difficult for imports to enter a country.

T hese polices hurt consumers by denying accessto possibly superior foreign products.

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Antidumping policies Dumping is defined as selling goods in a foreign

market below their costs of production, or as sellinggoods in a foreign market at below their fairmarket value.

Dumping is viewed as a method by which firmsunload excess production in foreign markets.

S ome dumping may be predatory behaviour. Antidumping polices (or countervailing duties )

are designed to punish foreign firms that engage indumping and protect domestic producers fromunfair foreign competition.

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Wh y governments intervene intrade

Th ere are two types of arguments for government intervention: political &economic

Political arguments are concerned with protectingthe interests of certain groups within a nation(normally producers), often at the expense of other groups (normally consumers).

Economic arguments are typically concerned with

boosting the overall wealth of a nation (to thebenefit of all, both producers and consumers).

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Political arguments for intervention Protecting jobs and industries

T he most common political reason for trade restrictions is

protecting jobs and industries.U sually this results from political pressures by unions or industries that are threatened by more efficient foreignproducers, and have more political clout than the consumersthat will eventually pay the costs.

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Political arguments for intervention (contd) National security

Protecting industries such as aerospace or electronics because theyare important for national security is another argument for traderestrictions.

RetaliationRetaliation is when governments take, or threaten to take, specificactions so that, for example, other countries may remove tradebarriers:

this can be a risky strategy eg. U SA attempts to persuade Chinato strengthen its IP laws

Protecting consumersConsumer protection can also be an argument for restricting importseg. the effect of mad cow disease & genetically modified crops

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Political arguments for intervention (contd) Furthering foreign policy objectives

T rade policy can help build strong relations with other nations.T rade policy can punish rogue states that do not abide byinternational laws.T rade policy can help advance human rights and politicalfreedom in trading partners (this method has attracted somecritics)

eg. trade bans or embargoes against S outh A frica in 1980s

to change its policy on apartheid

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Economic arguments for intervention T he infant industry argument

T he infant industry argument suggests that an industryshould be protected until it can develop and be viable andcompetitive internationally

It has been accepted as a justification for temporary traderestrictions under the WTO

Critics argue that if a country has the potential to develop aviable competitive position its firms should be capable of raising necessary funds without additional support from thegovernment

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Economic arguments for intervention(contd)

S trategic trade policyS trategic trade policy suggests that in cases where there

may be important first mover advantages, governments canhelp firms from their countries attain these advantages.S trategic trade policy also suggests that governments canhelp firms overcome barriers to entry into industries whereforeign firms have an initial advantage.

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Wh y governments intervene in FDI

Host-country benefits of FDI Resource-transfer effects

FDI can make a positive contribution to a host economy bysupplying capital, technology, and management resources

that would otherwise not be available. Employment effects

FDI can bring jobs to a host country that would otherwise notbe created there.

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Host-country benefits of FDI (contd) Balance-of-payments effects

A countrys balance-of-payments account is a record of acountrys payments to and receipts from other countries.T he current account is a record of a countrys export andimport of goods and services.G overnments typically prefer to see a current account surplusthan a deficit.

FDI can help a country to achieve a current account surplus.

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Host-country benefits of FDI (contd) Effect on competition and economic growth

FDI in the form of greenfield investment increases the levelof competition in a market, driving down prices and improving

the welfare of consumers.Increased competition can lead to increased productivitygrowth, product and process innovation, and greater economic growth.

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Host-country costs of FDI (contd) A dverse effects on competition

S ubsidiaries of foreign MNEs operating in a host country mayhave greater economic power than indigenous competitors.

A dverse effects on balance of paymentsW ith the initial capital inflows that come with FDI must be thesubsequent outflow of capital as the foreign subsidiaryrepatriates earnings to its parent country.W hen a foreign subsidiary imports a substantial number of itsinputs from abroad, there is a debit on the current account of the host countrys balance of payments.

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Host-country costs of FDI (contd) National sovereignty and autonomy

Many host governments worry that FDI is accompanied bysome loss of economic independence.

T here is a concern that key decisions that may affect the hostcountrys economy will be made by a foreign parent that hasno real commitment to the host country, and over which thehost countrys government has no real control.

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Wh y governments intervene in FDIHome-country benefits of FDI Balance of payments effect

T he balance of payments benefits from the inward flow of repatriated foreign earningsT he foreign subsidiary creates demands for home-country

exports Employment effects

Positive employment effects arise when the foreign subsidiarycreates demand for home-country exports

Reverse resource-transfer effectBenefits arise when the home-country MNE learns valuableskills from its exposure to foreign markets that cansubsequently be transferred back to the home country

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Home-country costs of FDI Balance of payments effects

T he current account of the balance of payments suffers fromthe initial capital outflow required to finance the FDI.

T he current account of the balance of payments suffers if thepurpose of the foreign investment is to serve the home marketfrom a low-cost production location.T he current account of the balance of payments suffers if theFDI is a substitute for direct exports.

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Home-country costs of FDI (contd) Employment effects

The most serious concerns arise when FDI is a substitute for domestic production.

This concern gets expressed in terms such as exporting jobs and offshoring.If the home country is suffering from unemployment, concernabout the export of jobs intensifies.

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G overnment policy instrumentsand FDI

Home-country policies Encouraging outward FDI

Many investor nations now have government-backedinsurance programs to cover major types of foreign

investment risk. Restricting outward FDI

Virtually all investor countries, including the U nited S tates,have exercised some control over outward FDI from timeto time.

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G overnment policy instrumentsand FDIHost-country policies

Encouraging inward FDIG overnments offer incentives to foreign firms to invest in their countries.

Incentives are motivated by a desire to gain from theresource-transfer and employment effects of FDI, and tocapture FDI away from other potential host countries.

Restricting inward FDIO wnership restraints and performance requirements.

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Development of th e world trading system S ince W orld W ar II, an international trading

framework has evolved to govern and manageworld trade: in its first fifty years, the framework was known as

the G eneral A greement on T ariffs and T rade(GATT )

S ee - www.ciesin.org/ TG /PI/ T R A DE/gatt.html

since 1995, the framework has been known as theW orld T rade O rganisation ( WTO )

S ee -http://www.wto.org/english/tratop_E/dispu_e/dispu_status_e.htm

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Most Favoured Nation principle

The basis for the development of the globaltrading system is the MFN (Most FavouredNation) principle:

all member nations are treated in the same way:a requirement that members extend the same favourableterms of trade to all members that they extend to any singlemember

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Progressive liberalisation in G ATTmultilateral negotiating rounds

Early trade rounds: A nnecy 1949

T orquay 1950-1 G eneva 1956

These early rounds focused almost exclusivelyon tariff issues

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1961-62 Dillon Round: 4,400 tariff concessions were exchanged, but

agriculture was not covered.

1964-67 Kennedy Round : 50 developed countries covering 75% of world

trade made reciprocal tariff cuts on manufacturedproducts :

again, no reduction of import barriers for farm products

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1973-79 T okyo Round : average tariff on manufactures in major developed

countries reduced from 7% to 4.7Progressive liberalisation of T C&F sector

1986-1994 U ruguay Round: S ee next slide

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Th e Uruguay Round andth e W orld Trade Organisation

The U ruguay Round (1986-1994) focused on:1. S ervices and Intellectual Property:

trade issues related to services and intellectual property andagriculture were emphasised

2. T he W orld T rade O rganisation: WTO was established as a more effective policeman of the

global trade rules WTO encompassed GATT and the G eneral A greement on

T rade in S ervices ( GATS ) and the A greement on T radeRelated A spects of Intellectual Property Rights ( T RIP S )

http://www.wto.org/english/forums_e/students_e/students_e.htm

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Future of t h e W TO: unresolvedissues

A new round of talks: Doha Round (2001 to????):

the WTO launched a new round of talks in 2001to focus on:

cutting tariffs on industrial goods and servicesphasing out subsidies to agricultural producersreducing barriers to cross-border investmentlimiting the use of anti-dumping laws

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Regional economic integrationTh e move towards regional economic

integration Regional economic integration refers to agreements

between countries in a geographic region to reducetariff and non-tariff barriers to the free flow of goods,services and factors of production between each other.

Despite the rapid spread of regional trade agreementsdesigned to promote free trade, there are those whofear that the world is moving towards a situation inwhich a number of regional trade blocks compete

against each other. Free trade will exist within each bloc, but each bloc

will protect its market against outside competition withhigh tariffs.

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Regional economic integrationLevels of economic integration

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Regional economic integration

Levels of economic integration Free trade area (F TA )

In a free trade area all barriers to the trade of goods andservices among member countries are removed, but

members determine their own trade policies with regard tonon-members.

Examples of free trade areas include the European FreeT rade A ssociation (between Norway, Iceland, Liechtensteinand S witzerland), and the North A merican Free T rade A greement (between the U S , Canada and Mexico)

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Levels of economic integration (contd) Customs union

T he customs union is one step further along the road to fulleconomic and political integration. It eliminates trade

barriers between member countries and adopts a commonexternal trade policy.

T he A ndean Pact (between Bolivia, Columbia, Ecuador andPeru) is an example of a customs union.

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Levels of economic integration (contd) Common market

T he common market has no barriers to trade betweenmember countries, a common external trade policy, and thefree movement of the factors of production.

MERC OS U R (between Brazil, A rgentina, Paraguay, andU ruguay) is aiming for common market status.

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Levels of economic integration (contd) Economic union

A n economic union involves the free flow of products andfactors of production between members, the adoption of a

common external trade policy, and in addition, a commoncurrency, harmonisation of the member countries tax rates,and a common monetary and fiscal policy.

T he European U nion (E U ) is an economic union, although animperfect one since not all members of the E U have adopted

the euro.

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Levels of economic integration (contd) Political union

In a political union , independent states are combined into

a single union.T he E U is headed toward at least partial political union,and the U nited S tates is an example of an even closer political union.

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Regional economic integrationTh e case for regional economic integration

T he economic case for integrationRegional economic integration is an attempt to achieveadditional gains from the free flow of trade and investmentbetween countries beyond those attainable under internationalagreements such as the WTO .

T he political case for integrationBy linking countries together, making them more dependenton each other, and forming a structure where they regularly

have to interact, the likelihood of violent conflict and war willdecrease.By linking countries together, they have greater clout and arepolitically much stronger in dealing with other nations.

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Th e case for regional economic integration(contd) Impediments to integration

W hile a nation as a whole may benefit from a regional free

trade agreement, certain groups may lose.T here are concerns over the loss of national sovereignty.

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Th e case against regional integration Regional economic integration only makes sense

when the amount of trade it creates exceeds theamount it diverts.

Trade creation occurs when low-cost producers withinthe free trade area replace high-cost domesticproducers.Trade diversion occurs when high-cost suppliers withinthe free trade area replace low-cost external suppliers.

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Th e trend towards bilateralism Australias case Australia has long had a free trade agreement

(FTA ) with New Zealand and althoughtraditionally a GATT /WTO multilateral purist,

has recently negotiated bilateral tradeagreements effective from 2003 or 2005: S ingapore (2003) T hailand (2005)

U SA (2005)

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Australia-New ZealandA

ustralia-New Zealand Closer EconomicRelations and T rade A greement (known as A NZCER TA or the CER A greement): originally N A FTA (NZ- A ustF TA ) in 1965

re-negotiated in 1984, since updated several times

its central provision is the creation of a WTO -consistent FreeT rade A rea consisting of A ustralia and New Zealand a comprehensive agreement on free trade in goods the worlds first agreement to cover also trade in services

AS E A N & A ustralia-New Zealand Free T rade A greement ( AA NZF TA ): Negotiations concluded at the end of A ugust 2008 S igned on 27 th February 2009

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Australia-Singapore The S ingapore- A ustralia Free T rade A greement ( SA FTA ) in force from mid-2003: strong trade growth since:

strengthens trade and investment links between the two

In addition to tariff elimination, it guarantees

increased market access for A

ustralianexporters of services, particularly education,environmental, telecommunications andprofessional services: it also provides a more open and predictable

business environment, for example in competitionpolicy, government procurement, intellectualproperty, e-commerce, customs procedures andbusiness travel:

S ee: http://www.dfat.gov.au/trade/negotiations/australia_singapore_agreement.html

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Australia-T h ailand The T hailand- A ustralian Free T rade A greement

(TA FTA ), in force since 01/01/2005: trade up by 30% since then

The most significant feature for A ustralianbusiness is the removal by 2010 of virtually allof T hailand's tariff and quota barriers on importsfrom A ustralia the agreement also includes initiatives to free up and

facilitate trade in services and two-way investment:includes rules to promote cooperation and best practice in awide range of areas such as competition policy, e-commerce,industrial standards and quarantine procedures,

S ee: http://www.dfat.gov.au/trade/negotiations/aust-thai/index.html

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Australia-United States

Negotiated in 2004, in force since 01/01/2005: some A ustralian analysts were critical or even hostile the (then) Labor O pposition (now in government)

demanded changes re T V content

Highly politicised because it involves sensitiveissues: local content on T V, pharmaceutical benefits scheme

(PB S ) and because no U SA market access was

achieved for important A

ustralian export industries likesugar:A ustralian export results to the U SA so far have not been

impressive - time will tell if benefits are more tangible

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M anagerial implications

Barriers and firm strategy T rade and investment barriers are a constraint upona firms ability to disperse its productive activities andare likely to raise the firms costs above the level thatcould be achieved in a world without such barriers.

Policy implications MNEs need to be aware of the political sensitivities

towards FDI in many host countries when calling for a freer foreign trade and investment regime.

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Opportunities of regional economicintegration Creation of a single market offers significant

opportunities because markets that were formerlyprotected from foreign competition are opened.

T he free movement of goods across borders, theharmonisation of product standards, and thesimplification of tax regimes, makes it possible for firms to realise potentially enormous cost economies

by centralising production in those locations where themix of factor costs and skills is optimal.

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Opportunities of regional economicintegration (contd) Note that enduring differences in culture and

competitive practices between nations can oftenlimit the ability of companies to realise costeconomies.

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Th

reats of regional economic integration Business environment becomes more competitive Lowering of trade and investment barriers can lead

to increased price competition.

Firms trading outside the area find they have toreduce their cost structures to be competitive. Firms outside of the area can be shut out of the

market by the creation of a trade fortress. Less opportunity for foreign investors to exploit

differences in regulations or enforcing of regulations.

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Summary of main t h emes

The goal of this chapter was to explain how thepolitical and economic realities of internationaltrade and FDI impact on businesses as theyventure across international borders.

W e discussed the various instruments of trade andFDI policy and reviewed the political and economicarguments for government intervention.

W e also described attempts to liberalise

international trade and investment. A t themultilateral level we have examined the progressof liberalisation at the WTO .

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Summary of main t h emes

Following an account of how the various levels of economic integration differ, we reviewed theeconomic and political debates surroundingregional economic integration.

The lecture concluded with an assessment of howbusiness may be affected by the variousgovernment interventions in international tradeand investment and the various attempts to

liberalise trade and investment at the multilateraland regional levels.

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