CHAPTER 4 - The Political Economy of International Trade

Instruments of Trade Policy

Seven Main Instruments of Trade Policy

1. Tariffs
2. Subsidies
3. Import Quotas
4. Voluntary Export Restraints
5. local content requirement
6. Administrative Policies
7. Antidumping Duties

Tariff
- is a tax levied on imports (or exports).

● Specific Tariff
- are levied as a fixed charge for each unit of a good imported
- example: $10.00 per barrel of oil

● Ad Valorem Tariff
- are levied as a proportion of the value of the imported good

- The important thing to understand about an import tariff is who suffers and who gains.
- government gains through revenue
- domestic producers through protection against foreign competitors.

Subsidy
- is a government payment to a domestic producer.
- take many forms, including cash grants, low-interest loans, tax breaks, and government equity
participation in domestic firms.
- By lowering production costs, subsidies help domestic producers in two ways:

1. Competing against foreign imports; and

2. Gaining export markets

Import Quotas
- is a direct restriction on the quantity of some good that may be imported into a country
- For example, the United States has a quota on cheese imports. The only firms allowed to import
cheese are certain trading companies, each of which is allocated the right to import a maximum
number of pounds of cheese each year. In some cases, the right to sell is given directly to the
governments of exporting countries.
Voluntary Export Restraint
- is a quota on trade imposed by the exporting country, typically at the request of the importing
country's government.
- Famous historical example is the limitation exports to the US by Japanese automobile producers
in 1981. A response to direct pressure from US government, this VER limited Japanese imports
to no more than 1.68 million vehicle per year.
- Both import quotas and VERs benefit domestic producers by limiting import competition. As
with all restrictions on trade, quotas do not benefit consumers.

● Quota rent
- the extra profit that producers make when supply is artificially limited by an import
quota.

Local Content Requirement

- is a requirement that some specific fraction of a good be produced domestically.
- The requirement can be expressed either in physical terms (eg. 75% of component parts for this
must be produced locally) or in value terms (eg. 75% of the value of this product must be
produced locally)
- This is used to shift the manufacturing base from the simple assembly of products whose parts are
manufactured elsewhere into the local manufacture of component parts.
- Also been used in developed countries to try to protect local jobs and industry from foreign
competition
- Local content regulations provide protection for a domestic producer of parts in the way an
import quota : by limiting foreign competition.
- So with all trade policies, local content regulations tend to benefit producers and not consumers.

Administrative Policies
- Are bureaucratic rules designed to make it difficult for imports to enter a country.
- With all trade policies, administrative instruments benefit producers and hurt consumers, who are
denied access to possibly superior foreign products.

Antidumping Policies
- Dumping is variously defined as selling goods in a foreign market at below their cost of
production or as selling goods in a foreign market at below their “fair” market value.

● Fair market value

- is normally judged to be greater than the cost of producing that good because the former
includes a “fair” profit margin.

- Antidumping policies are designed to punish foreign firms that engage in dumping. The ultimate
objective is to protect domestic producers from unfair foreign competition. Although
antidumping policies vary somewhat from country to country, the majority are similar to those
used in the US.
The Case of Government Intervention

Political Arguments for Intervention

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

Economic Arguments for Intervention

- are typically concerned with boosting the overall wealth of a nation (to the benefit of all, both
producers and consumers)

Political Arguments for Intervention

1. Protecting jobs and industries
2. National Security
3. Retaliation
4. Protecting Consumers
5. Furthering Foreign Policy Objectives
6. Protecting Human Rights

Economic Arguments for Intervention

1. The Infant Industry Argument
2. Strategic Trade Policy

World Trade Organization

The Global Police

- its policing and enforcement mechanisms are having positive effects.

WTO
- represents an important vote of confidence in the organization’s dispute resolution procedures.

Expanding Trade Agreements

- negotiations extended global trading rules to cover trade in services.
- It was given the role of brokering future agreements to open up global trade in services. (WTO)

WTO
- was also encouraged to extend its reach to encompass regulations governing foreign direct
investments.

● 2 first industries targeted for reform

1. global telecommunication
2. financial services industries
Antidumping actions
- allow countries to impose antidumping duties on foreign goods that are being sold cheaper than at
home.
Protectionism in Agriculture
- WTO has been the high level of tariffs and subsidies in the agricultural sector of many economies
- A high tariff on agricultural products reflect a desire to protect domestic agriculture and
traditional farming communities from foreign competition.

Protecting Intellectual Property

- The Trade-Related Aspects of Intellectual Property Rights or TRIPS regulations oblige
WTO members to grant and enforce patents lasting at least 20 year and copyrights lasting 50
years

Market Access for Non-agricultural Goods and Services

- WTO would like to bring down tariff rates on imports of non-agricultural goods into developing
nations. Many of these nations use the infant industry argument to justify the continued
imposition of high tariff rates, however, ultimately these rates need to come down for these
nations to reap the full benefits of international trade.
CHAPTER 5 - Foreign Direct Investment

Foreign Direct Investment in the World Economy

Foreign Direct Investment (FDI)

- occurs when a firm invests directly in facilities to produce or market a product in a foreign
country.
- everything is transferred except sa ownership

● Two Forms of FDI

1. Greenfield Investment
- involves the establishment of a new operation in a foreign country.

2. Involves acquiring the establishment of a new operation in a foreign country

- existing already

The Flow of FDI

- refers to the amount of FDI undertaken over a given time period. (normally a year)
1. inflow
2. outflow

The Stock of FDI

- refers to the total accumulated value of foreign-owned assets at a given time.
● basta yung accumulated na flow of FDI

Preliminary estimates in Q1 2023 show global FDI flows

1. tripled from very low levels recorded in Q4 2022, reaching USD 440 billion.

2. However, on a year-on-year basis, global FDI flows remained 25% below the level recorded in
Q1 2022.
 ● Change in the rate in 2020(?)(di ba 2022?) is due to inflation and foreign exchange rate
Top recipients of FDI inflows worldwide in the first quarter of 2023 were the United States (USD 109
billion), Brazil (USD 21 billion), and China (USD 21 billion).

Top sources of FDI outflows worldwide were the United States (USD 110 billion), Germany (USD 57
billion) and China (USD 50 billion).

OECD FDI outflows increased sevenfold in Q1 2023, to USD 359 billion, compared to historically low
levels recorded in Q4 2022.2 However, on a year-on-year basis, OECD FDI
outflows decreased by 25% compared to Q1 2022.

OECD FDI inflows reached USD 185 billion in Q1 2023, up from negative levels recorded in Q4 2022.2
However, they were 38% below their level recorded in Q1 2022.

Theories of Foreign Direct Investment

Exporting
- involves producing goods at home and then shipping them to the receiving country.

● import > export = trade deficit

● export > import = trade surplus

PAYMENT: (if mas mataas ang;)

● inflow - surplus
● outflow - deficit

Licensing (franchising)
- involves granting a foreign entity (the licensee) the right to produce and sell the firm’s product in
return for a royalty fee on every unit sold.
- intellectual property is transferred

Limitation of Exporting

1. Transportation Cost
- added to the production cost, it becomes unprofitable to ship some products over a large
distance.

2. Trade Barrier
- by placing tariffs on imported goods, the government can increase the cost of exporting
relative to foreign direct investment.
Limitation of Licensing

● Internationalization theory
- a branch of economic theory that seeks to explain why firms often prefer foreign direct
investment over licensing as a strategy for entering foreign markets.
- kung ano ang meron sa kanila, sa kanila lang yun

● Marketing Imperfections

Three major drawbacks as a strategy for exploiting foreign market opportunities.

1. Licensing may result in a firm's giving away valuable technological know-how to a potential
foreign competitor.

2. Licensing does not give a firm the tight control over manufacturing, marketing, and strategy in a
foreign country that may be required to maximize its profitability.

3. Licensing arises when the firm's competitive advantage is based not as much on its products as on
the management, marketing, and manufacturing capabilities that produce those products.

Advantages of FDI

It follows that a firm will favor foreign direct investment over exporting as an entry strategy when
transportation costs or trade barriers make exporting unattractive.

Furthermore, the firm will favor foreign direct investment over licensing (or franchising) when it wishes
to maintain control over its technological know-how or over its operations and business strategy, or when
the firm's capabilities are simply not amenable to licensing, as may often be the case.

Political Ideology and FDI

Multinational enterprise (MNE) is an instrument of imperialist domination.

● imperialist - idea ng western

They see the MNE as a tool for exploiting host countries to the exclusive benefit of their
capitalist_x0002_imperialist home countries.

Three reasons of abolishing radical views of FDI

1. The collapse of communism in Eastern Europe

 2. The generally abysmal economic performance of those countries that embraced the radical
position, and a growing belief by many of these countries that FDI can be an important source of
technology and jobs and can stimulate economic growth; and
3. The strong economic performance of those developing countries that embraced capitalism rather
than radical ideology (e.g.,Singapore, Hong Kong, and Taiwan).

Benefits and Costs of FDI

1. Resource-Transfer Effects
- Foreign direct investment can make a positive contribution to a host economy by
supplying capital, technology, and management resources that would otherwise not be
available and thus boost that country's economic growth rate.

2. Employment Effects
- Beneficial employment effect claimed for FDI is that it brings jobs to a host country that
would otherwise not be created there. The effects of FDI on employment are both direct
and indirect.

■ Direct effects arise when a foreign MNE employs a number of host-country

citizens.

■ Indirect effects arise when jobs are created in local suppliers as a result of the
investment and when jobs are created because of increased local spending by
employees of the MNE.

3. Balance-of-Payments Effects
- track both its payments to and its receipts from other countries.

○ Current Account
- tracks the export and import of goods and services.

- Governments typically prefer to see a current account surplus than a deficit. The only
way in which a current account deficit can be supported in the long run is by selling off
assets to foreigners.

Effect on Competition and Economic Growth

- Efficient functioning of markets depends on an adequate level of competition between producers

- In turn, this can increase the level of competition in a national market,thereby driving down prices
and increasing consumers' economic welfare. Increased competition tends to stimulate capital
investments by firms in plant, equipment, and R&D as they struggle to gain an edge over their
rivals. The long-term results may include increased productivity growth, product and process
innovations, and greater economic growth.
The Theory of FDI

The implications of the theories of FDI for Business practices are straightforward. First, it is worth noting
that the location-specific advantages argument does help explain the direction of FDI. However, the
location-specific advantages argument does not explain why firms prefer FDI to licensing or to exporting.

The theories suggest that exporting is preferable to licensing and FDI so long as transportation costs are
minor and trade barriers are trivial.

As transportation costs or trade barriers increase, exporting becomes unprofitable, and the choice is
between FDI and licensing. Since FDI is more costly and more risky than licensing, other things being
equal, the theories argue that licensing is preferable to FDI. Other things are seldom equal, however.

Although licensing may work, it is not an attractive option when one or more of the following conditions
exist.

Firms for which licensing is not a good option tend to be clustered in three types of industries

1. High-technology industries in which protecting firm-specific expertise is of paramount

importance and licensing is hazardous.

2. Global oligopolies, in which competitive interdependence requires that multinational firms

maintain tight control over foreign operations so that they have the ability to launch coordinated
attacks against their global competitors (as Kodak has done with Fuji).

3. Industries in which intense cost pressures require that multinational firms maintain tight control
over foreign operations (so they can disperse manufacturing to locations around the globe where
factor costs are most favorable in order to minimize costs).