Chapter 6

OUTLINE OF CHAPTER 6: THE POLITICAL ECONOMY OF INTERNATIONAL

TRADE
Opening case: Agricultural Subsidies and Development
Instruments of Trade Policy
Tariffs/ Subsidies/ Import Quotas and Voluntary Export Restraints/ Local
Content Requirements/ Administrative Policies/ Antidumping Policies
The Case for Government Intervention
Political Arguments for Intervention/ Economic Arguments for
Intervention
The Revised Case for Free Trade
Retaliation and Trade War/ Domestic Politics
Development of the World Trading System
From Smith to the Great Depression/ 1947–1979: GATT, Trade

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Liberalization, and Economic Growth/ 1980–1993: Disturbing Trends/

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The Uruguay Round and the World Trade Organization/

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WTO: Experience to Date

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The Future of the WTO: Unresolved Issues and the Doha Round

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Implications for Business
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Trade Barriers and Firm Strategy/ Policy Implications
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Chapter Summary
Critical Discussion Questions
Closing Case: Is a Tax Break an Export Subsidy?
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 ANSWERS TO CRITICAL DISCUSSION QUESTIONS IN CHAPTER 5

QUESTION 1: Do you think that governments should take human rights considerations
into account when granting preferential trading rights to countries? What are the
arguments for and against taking such a position?

ANSWER 1: The answer to the first question clearly is a matter of personal opinion, but
reference should be made to the status of China as a most favored nation. In stating their
opinions, students should consider the following points. Trade with the US is very
important to China, as China views the US as an important market. The US is also an
important source of certain products. Thus, the US has some leverage with trade when
trying to influence China’s human rights policies. For this policy to have much effect,
however, other nations important to China must adopt similar policies. Otherwise China
will simply choose to work with other countries, and U.S. consumers and producers may
be more negatively impacted than the Chinese. Another concern with tying MFN status
to human rights is that denying MFN may make the human rights situation worse rather

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than better. By engaging in trade, the income levels in China will increase, and with that
greater wealth the people may be able to demand and receive better treatment.

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QUESTION 2: Whose interests should be the paramount concern of government trade

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policy - the interests of producers (businesses and their employees) or those of
consumers? rs e
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ANSWER 2: The long run interests of consumers should be the primary concern of
governments. Unfortunately consumers, each of whom may be negatively impacted by
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only a few dollars, are less motivated and effective lobbyists than a few producers that
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have a great deal at stake. While in some instances it could be argued that domestic
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consumers will be better off if world-class domestic producers are nurtured and allowed
to gain first mover advantages in international markets, it is doubtful that the government
will be better than international capital markets at "picking winners", and will more likely
pick the firms with the greatest political clout. While employees may well lose jobs if
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there are more efficient foreign competitors, some would argue that this is just the nature
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of competition, and that the role of government should be to help these employees get
jobs where they can be efficiently employed rather than to protect them from reality in
inefficient firms.
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QUESTION 3: Given the arguments relating to the new trade theory and strategic trade
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policy, what kind of trade policy should business be pressuring government to adopt?

ANSWER 3: The implications of the new trade theory and strategic trade policy for
businesses are that firms in “new” industries should seek subsidies and other forms of
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governmental assistance to help them achieve economies of scale and first mover
advantages. It appears clear that the best policy is to press for the unabated free flow of
goods across national boundaries.

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 QUESTION 4: You are an employee of an U.S. firm that produces personal computers in
Thailand and then exports them to the U.S. and other countries for sale. The personal
computers were originally produced in Thailand to take advantage of relatively low labor
costs and a skilled workforce. Other possible locations considered at that time were
Malaysia and Hong Kong. The US government decides to impose punitive 100% ad
valorem tariffs on imports of computers from Thailand to punish the country for
administrative trade barriers that restrict U.S. exports to Thailand. How do you think
your firm should respond? What does this tell you about the use of targeted trade
barriers?

ANSWER 4: As long as the manufacturing requirements haven't changed significantly,

looking at Malaysia or Hong Kong again for production would appear obvious. By the
U.S. government introducing a specific ad valorem tariff on Thai computer imports, it
forces manufacturers to get around these restraints by looking at other locations. Hence,
such targeted trade barriers can often be easily circumvented without having to locate
production facilities in an expensive country like the U.S. Targeted trade barriers, like

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most forms of government intervention, are usually ineffective.

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QUESTION 5: Some economists argue that reducing barriers to trade in agricultural
products will do more to stimulate the economic development of the world’s less

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developed countries than foreign aid could ever do. Is this view correct? Who will
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benefit from free trade in agricultural products? Who will lose?
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ANSWER 5: When developed nations reduce barriers to trade of agricultural goods, and
when they stop subsidizing their agricultural sector, then and only then can the
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developing countries stand to gain from trade. As long as the poorer countries are asked
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to open their markets to the free flow of subsidized agricultural products from the
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developed world they are doomed. Example. When Korea faced a financial crisis in 1997
Korea asked the IMF and other international agencies for standby loans to the tune of
20billion dollars to bail them out In exchange the IMF ordered deep spending cuts, lower
import tariffs on agricultural goods, higher domestic taxes, taking over of shaky Korean
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banks by foreign banks and forfeiting some national decision making power to lenders.
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These policies allowed for a flow of agricultural goods from the developed world sold at
prices below the cost of domestic production almost wiping out the farming sector in
Korea. To protest the WTO’s agricultural policies and to bring attention to the desperate
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situation of his countrymen and farmers around the world, a South Korean farmer and
head of South Korea’s Federation of Farmers and Fishermen, Kun Hai Lee, committed
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ritual suicide during the WTO’s opening day in Cancun to protest the WTO’s agricultural
policies. http://www.alternet.org/story.html?StoryID=16755, http://www.hartford-hwp.com/archives/50/index-a.html

TEACHING SUGGESTIONS FOR THE CLOSING CASE

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QUESTION 1: How does the FSC item in the U.S. tax code constitute a tax subsidy?

ANSWER 1: The FSC tax break allows exporters to avoid paying corporate income tax
on exports of manufactured goods, the sales of which are channeled through shell
companies, known as Foreign Sales Corporations, which are registered in offshore tax

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 havens such as Bermuda. While this sounds fairly arcane, the benefits are not. Estimates
suggest that some 6,000 U.S. companies saved about $3.5 billion in income taxes in 1998
as a result of the FSC. Two of the major beneficiaries include Boeing and General
Electric. Boeing saved $130 million in taxes in 1998 as a result of the FSC, 12 percent of
its total earnings that year, while General Electric saved $150 million.

QUESTION 2:Do you think that “internal matters” such as tax codes and food safety
laws should be excluded from consideration by the World Trade Organization?

ANSWER 2: It would be preferable. This is the reason why many people oppose the
policies of the WTO because they fear that the rulings impose on the sovereignty of
nations.

QUESTION 3: Why do you think the U.S. Congress was apparently so reluctant to scrap
the FSC? 
ANSWER 3: Congress was of the opinion that the FSC would offset to some extent the

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surging deficit. In addition all politicians want to keep special interest groups and large
corporations happy. For more information read the article at

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http://www.freetrade.org/pubs/FTBs/FTB-004.pdf The ETI is a successor to the FSC.

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QUESTION 4: What do you think might occur if the U.S. government fails to amend its
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tax laws? Would the EU impose sanctions? What would the US response be?
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ANSWER 4: The EU threatened to impose sanctions on March 1 2004 if Congress did
not abide by the WTO ruling against Extra territorial taxes. Many call this tax a blatant
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subsidy. It is a tax break for large multinationals who sell their domestically
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manufactured products overseas. On March 1 of this year, European Union trade chief
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Pascal Lamy said that time had run out for the United States to change its tax law and
began imposing up to US$4 billion in trade sanctions authorized two years ago by the
World Trade Organization. This marks the first time in history that the EU has imposed
sanctions on US exports under the WTO, US farmers now face higher tariffs on sales to
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Europe as a result of these sanctions. Congress is being urged to move quickly on

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legislation to bring the U.S. export tax program, the Extraterritorial Income Exclusion
(ETI), into conformity with the World Trade Organization obligations. The ETI is a
successor to the FSC.
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