International Economics 7th Edition

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Chapter 7
Commercial Policy

◼ Outline

Introduction: Commercial Policy Tariffs, and Arguments for Protection

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44 Gerber • International Economics, Seventh Edition

Tariff Rates in the World’s Major Traders

The Costs of Protectionism

The Logic of Collective Action
Case Study: Agricultural Subsidies

Why Nations Protect Their Industries

Revenue
The Labor Argument
The Infant Industry Argument
The National Security Argument
The Cultural Protection Argument
The Retaliation Argument
Case Study: Traditional Knowledge and Intellectual Property

The Politics of Protection in the United States

Antidumping Duties
Countervailing Duties
Escape Clause Relief
Section 301 and Special 301
Case Study: Economic Sanctions

◼ Learning Objectives
After studying this chapter, students will be able to:

7.1 Describe the differences in tariffs across economic sectors and over time.

7.2 Cite at least three reasons why economists favor trade openings.

7.3 Explain why costs to consumers of a tariff or quota are greater than the net
welfare costs to a nation.

7.4 Analyze the economic validity of common justifications for protectionism.

7.5 Define each form of legal protection granted by the U.S. government.

◼ What Students Should Know after Reading Chapter 7

Chapter 7 is focused on protection in three sectors—agriculture, clothing, and textiles—by China, the
European Union, the United States, and Japan. These sectors are chosen because they are among the most
highly protected industries in nearly all industrial regions and because this protection potentially harms
developing countries. Chapter 7 begins with a look at tariff rates in general and then proceeds to estimates

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 Chapter 7 Commercial Policy 45

of the costs based on mid-1990s data, when tariff rates were somewhat higher. From Chapter 6, students
should have a theoretical basis for understanding the costs of protection. This introduction puts real
numbers on the costs of protection. Perhaps for students these costs are just areas on a graph—the real
magnitude should be eye-opening for many.

Trade barriers are an inefficient policy for addressing employment issues, as illustrated by the high cost
per job saved. The point is not to downplay the issue of economic restructuring and job losses, but rather
show that trade policies are too indirect a mechanism to address labor market issues and unemployment,
and that alternative policies (macro and labor market policies) must be used in their place. Students are
likely hearing more in the media about the loss of U.S. manufacturing jobs than about how U.S. cotton
subsidies hurt U.S. consumers and African farmers.

Chapter 7 goes on to summarize the major reasons nations protect industries. The ability to raise
government revenue from tariffs is addressed and most other arguments for protection can be put into one
of the categories listed. The section discussing the arguments for protection ends with a short case study of
traditional knowledge and intellectual property rights. A growing concern in some developing countries
is that market openness is leading to the loss of control over native plants and traditional folk remedies,
such as the use of the Indian spice turmeric as a healing agent. The purpose of this case study is to make
students aware of a growing concern about openness.

Chapter 7 ends with a brief explanation of the paths to protection that are open to American firms and
industries. By far the most important, in terms of usage, are antidumping duties. A case study addresses

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46 Gerber • International Economics, Seventh Edition

the issue of agricultural subsidies. Finally, the issue of economic sanctions is taken up in the last case
study.

◼ Assignment Ideas
1. This material lends itself to case studies of whatever issue is currently getting the most attention
politically and in the media. In the past that has included: patent protection for pharmaceuticals in
developing countries, U.S. steel tariffs, agricultural subsidies when Doha negotiations and development
conferences are taking place, and the loss of U.S. manufacturing jobs or “exporting America.” (Note
that Chapter 13 has a time series graph of the real value added in U.S. manufacturing which clearly
shows an ever-onward and upward trend, except during periods of recession. For convenience, the
number of workers in manufacturing is also plotted for the same time period. It may be useful to refer
to that case study. The Chapter 5 case study on off-shoring by U.S. multinationals may be useful as
well.) Current commercial policy issues can be the basis of a writing assignment, a classroom
discussion, a policy debate—you can ask students to take a position, to counter an argument, or to
provide analysis. For all that trade benefits us, it will never cease to be controversial, so there is
surely something in the news today that you can use to keep this section current.

2. I have students research trade disputes and look up information on the WTO Web site related to those
cases. The huge number of dumping cases relative to other disputes is quite clear with a quick tour
through the Web site. In particular, students with an interest in law school seem to respond well to
the case studies on the WTO site: http://www.wto.org/english/tratop_e/dispu_e/dispu_e.htm.

3. The current status of the Doha Round might be interesting to monitor. While the Doha round seems
moribund (2012), it is still officially under discussion. The Millennium Development Goals and other
global agreements put trade issues front and center in global discussions about development.

◼ Answers to End-of-Chapter Questions

1. Which industries are more heavily protected in the United States and Japan? Are high-income or
low-income nations more affected by American and Japanese trade barriers? Explain.

Answer: In the United States, the most heavily protected industries are textile and apparel
producers and, to a lesser degree, agriculture. In Japan, protection is concentrated on
agriculture and the food and beverage industry. Protection in both countries is in older,
labor-intensive industries where the countries no longer have comparative advantages.
The effects are greatest on low-income countries since these are the industries where they
do have a comparative advantage. The failure of the United States, Japan, and other
industrial nations to open their markets to the agricultural products and apparel from
developing countries has deprived those nations of potential export markets.

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 Chapter 7 Commercial Policy 47

2. What new areas of trade and investment received coverage under the agreement signed in the
Uruguay Round of the General Agreement on Tariffs and Trade?

Answer: The Uruguay Round extended the GATT and created several new agreements. GATT
now covers agriculture, textiles, and apparel, and new agreements were signed for the
first time in the areas of trade in services, treatment of foreign investment, and the
protection of intellectual property rights. In addition, the agreement created the umbrella
organization called the World Trade Organization that will oversee the GATT and related
agreements. The WTO also conducts periodic reviews of each nation’s trade policies, and
has created a streamlined dispute resolution procedure.

3. Given that tariffs and quotas cost consumers and that they are grossly inefficient means for creating
or preserving jobs, why do citizens allow these policies to exist?

Answer: The costs of tariffs and quotas are diffused throughout an entire nation, while the benefits
are concentrated. This creates an asymmetric set of incentives to organize around the
issue of trade policy. Beneficiaries of protection stand to gain a great deal and
consequently find it economically worthwhile to organize in order to receive protection.
Individual consumers lose just a little, so there is only a small economic incentive to
organize against protectionist policies.

4. What four main groups of arguments do nations use to justify protection for particular industries?
Which are economic, and which are noneconomic?

Answer: The arguments are (1) revenue, (2) the labor argument, (3) the infant industry argument, (4)
the national security argument, (5) cultural protection, and (6) the retaliation argument.
The first three arguments are about government revenue, jobs, and manufacturing, so they
are economic arguments. Arguments 4 and 5 have economic components, but are
primarily based on noneconomic considerations. The retaliation argument is perhaps more
explicitly economic as well.

5.Evaluate the labor and infant industry arguments for protection.

Answer: The labor argument is based on the false assumption that lower wages automatically
confer a competitive advantage to a nation. Lower wages are the most visible indicator
of lower productivities. The proponents of the pauper labor argument fail to completely
consider the causes of lower wages and their consequences for trade. The advantages of
lower wages are offset by the lower productivity that inevitably accompanies them.
The infant industry argument requires three conditions in order for it to be valid. First,
there must be a technological externality that cannot be captured by the firms that produce
it. Second, the protection must be limited in time. Third, it must enable the firms
receiving it to experience falling costs so that the initially higher costs disappear and the
low or negative rates of return are converted into normal returns. The latter condition is
equivalent to requiring the policy to pay for itself in the long run.

6. Are tariffs justified as a retaliatory measure against other nations? Justify your answer.

Answer: There is no agreement among economists on this issue. One school says that tariffs make
us less efficient, so they are unwarranted. If others choose to hurt their own economies,
why should we follow suit? Another school says tariffs are justified if they cause the

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48 Gerber • International Economics, Seventh Edition

offending nation to open its markets. Trade is beneficial for all, so if they can lead to
increased trade, they are warranted. The third group sees them as warranted because they
worry about the unfair advantage they may grant the nation levying the tariff, particularly
in high-tech industries where scale economies are important. Tariffs shut out foreign
competition and grant the firms in the country access to a larger market—their own
domestic market plus foreign markets. This may be an economic advantage in some
industries.

7. What are the four legal procedures that American firms have at their disposal for seeking protection?
What are the conditions that would generate a request for each kind of protection?

Answer: The four procedures are (1) countervailing duties, (2) antidumping duties, (3) escape
clause relief, and (4) Section 301 retaliation. Countervailing duties are granted in
response to foreign subsidies; antidumping duties are granted when a foreign firm sells
in the domestic market at a price that is considered too low (less than fair value); escape
clause relief is granted as a temporary protection against sudden surges in imports; and
Section 301 retaliation is used to punish a nation for some other type of practice that is
perceived as conferring an unfair advantage on its firms, or in response to a lack of
openness to American goods.

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