Chapter 7: Commercial Policy

Dr. Jennings Byrd

ECO 4451 – Economics of Globalization
Learning Objectives
• Give at least three reasons why economists favor further trade opening even
as
• the estimated gains are relatively small in terms of world GDP.
• List the sectors where tariffs tend to be higher.
• Draw a supply and demand diagram and use it to show the costs to
consumers and the net welfare costs of tariffs and quotas.
• Explain why countries resort to protectionism and analyze each reason.
• Discuss the paths to protection in the United States.
• Define each form of legal protection granted by the U.S. government.
Introduction: Commercial Policy, Tariffs, and
Arguments for Protection
• In this chapter, we look at the data on tariff levels and consider the
most frequently given arguments for protection:
• Jobs argument
• Infant Industry argument
• National Security argument
• Retaliation argument
• This chapter offers a deeper look into the reasons given for
protection and sets forth criteria showing that trade barriers are not
usually an optimal policy tool for achieving those goals.
• Protection against anti-competitive behavior
US Tariff Profiles, 2019

Source: WTO, World Tariff Profiles 2019

TABLE 7.1 Applied Tariffs for Major World Traders
Tariff Rates in the World’s Major Traders
Table 7.1 shows several patterns.
• First, agriculture is relatively highly protected compared to other industries
• Food security
• Food disputes
• Income transfers to farmers
• Second, overlap between countries in the sectors they protect most
rigorously
• Clothing and textiles
• Third, overall levels of tariff rates (top part of the table) are relatively low,
particularly for non-agricultural goods and especially in high-income
countries
• Gains in lower income countries are substantial with reductions in tariffs.
• Diminishing returns in tariff protection may lead to lesser income gains but is still a substantial
improvement.
The Costs of Protectionism
There are several reasons why further trade opening is beneficial even if the
dollar values of the gains are not that high.
1.Keep their markets open when there is a severe downturn avoids
protectionist and retaliation behavior and no one gained an advantage.
• Smoot-Hawley Tariff

2.Trade increases exposure of countries to each other, and in the process, it

leads to new knowledge.
• Gains from economies of scale, product differentiation
• Increased risks from disease

3.Trade protection is grossly inefficient in achieving the goals it seeks

• Consumers pay more without realizing it
TABLE 7.2 Costs of Tariffs and Quotas in High-Income Countries
(Current US Dollars)
The Logic of Collective Action
• Given that the costs of tariffs and quotas are high to consumers, why
do consumers tolerate them?
• Economist Mancur Olson’s studies make two points:
1. The costs of tariffs and quotas are borne by a great many people: everyone
pays a little for protection
2. The benefits of protection is concentrated in a few industries: few benefit a lot
from protection
Thus, there is an asymmetry in the incentives to oppose the policy: those
benefiting from protection have much greater incentives than those hurt by it to
lobby for it
Why Nations Protect Their Industries: Revenue
• In a developing country’s economy, a large percentage of
economic activity is unrecorded making income taxes and sales
taxes are difficult if not impossible to impose.

• Tariffs, can be relatively easily collected at the ports and border

crossings.

• Before the income tax was established, the U.S. relied heavily
on tariffs for its revenue.
Why Nations Protect Their Industries: Revenue
• Poorer regions (Africa, South Asia, parts of the Middle East)
rely more on tariffs as a source of government revenue.
• In many instances, a poorer country will not keep track of
transactions as closely as a richer one, making it difficult for the
government to tax its citizens income and production.
• Tariffs may still be used for other purposes, but for some
countries, the primary goal is to generate income for the
operation of government services.
US Tariff Revenue 1792-1950
TABLE 7.4 Tariffs as a Share of Government Revenue,
By Region
Why Nations Protect Their Industries: The Labor
Argument
• The Labor Argument: Protection must be used against imports from countries
where wages are much lower
Problem: Does not consider differences in productivity between different
workforces: As productivity rises, so will wages.
The U.S. is more productive than many other countries due to high levels of
physical and human capital, technology etc. Remember, output=income
One other issue:
Job losses in export industries
Job gains in import industries
Why Nations Protect Their Industries: The Infant
Industry Argument
• Infant Industry Argument: mainly associated with the tariff policies of developing
nations to protect their “infant” industries against the competition of more mature
firms in industrial countries.
Assumes:
(1)market forces do not allow for the development of a certain industry because
competition is too well established.
(2)the industry has positive externalities—spillover benefits (valuable linkages to
other industries or technologies) that benefit the nation as a whole
Problems:
Does not demonstrate that there is some inherent advantage in making something as
opposed to buying it
Airbus revisited
Airbus began in the early 1970’s under the agreement of several
European countries to create an aircraft manufacturing industry that
could compete with Boeing.

Heavy subsidization (protection) was used to keep Airbus afloat as it

was too costly otherwise.

It took nearly two decades before Airbus would turn its first profit.

Since 1991, Airbus has been able to compete with Boeing and other
aircraft manufacturers at a reduce rate of subsidization.
Why Nations Protect Their Industries: The
National Security Argument
• National Security Argument: Certain industries must be
protected in order to guard national security (military security,
cultural values)
- Prohibitions imposed on exports or tariffs on imports to develop domestic
mineral or other resources are often not an optimal policy.
- Usually more efficient to build stockpiles of minerals and other materials
by buying large quantities in peacetime when less expensive.
- China has been accused of protecting rare earth minerals
Why Nations Protect Their Industries: The Cultural Protection
Argument
• The cultural industries include movies, television programming, music, print
media, theater, and art.

• Goal of protecting national cultural values is usually an argument in favor of

protecting a nation’s filmmaking, television programming, and music
production against complete domination by its U.S. counterparts
• Canada and the U.S. have an agreement as to the amount of “Hollywood”
programming that can be exported to Canada.
Why Nations Protect Their Industries: The
Retaliation Argument
• Retaliation Argument: Another country's trade barriers must be
countered with trade barriers
Problems: Although retaliation can provide an incentive for trade
negotiations, it can also lead to escalating trade wars
• For example, the Smoot-Hawley Tariff during the Great
Depression
Economists and Retaliation
Economists view retaliation policies differently:

1. Free trade is beneficial regardless of a country’s actions

• Market protection lowers welfare and retaliating does the same

2. Free trade is beneficial and is in everyone’s interest to see it widely followed

• Considers long run implications more than the first group

3. Closed markets or restricted markets to trade provide an unfair advantage

• The country has its own domestic market plus other foreign markets, but other countries
don’t have access to the closed market.
• The threat of retaliation should be used to open the market
The Politics of Protection in the United States
• The rise of the newly industrialized countries (NICs) increased
competitive pressures on U.S. industries
• Gain in comparative advantage for NICs

• The growth of the U.S. trade deficit in the 1980s spurred fears of
the loss of competitiveness
• Loss of comparative advantage in many industries
The Politics of Protection in the United States
• Protection is obtained through:
(1) direct action by the president
(2) four types of legal procedures
• Countervailing duties
• Antidumping duties
• Escape clause relief
• Section 301 retaliation
• In the case of these four legal procedures, a firm or industry petitions the
federal government to initiate an investigation into foreign country or foreign
firm practices
Countervailing Duties
• Countervailing duty (CVD): A tariff that is granted to a U.S.
industry that has been hurt by a foreign country’s subsidizing its
firms
• Subsidies allow foreign firms to sell their products at lower prices;
countervailing duty seeks to counter the effect of the subsidy
• Problem: defining subsidy is subjective
• Uruguay Round defined subsidies as (1) a direct loan or transfer, (2)
preferential tax treatment, (3) the supply of goods or services other than
general infrastructure, or (4) income and price supports
US Countervailing Duties by Country
• Scope Information by Country

• Currently 49 countries are on the list.

• The list includes: Canada, Mexico, China, Vietnam, Spain, South
Korea, etc.
• Common items include: steel products, agricultural goods, magnesium,
preserved mushrooms, frozen warm water shrimp, certain types of
pasta, etc.
Antidumping Duties
• Antidumping duty: a tariff levied on an import that is selling at a
price below the product’s fair value
– Problem: Defining fair value is subjective; antidumping duties are thus a
source of tension between countries
−In 2014, 18 petitions of countervailing/antidumping covering 31
investigations had been filed.
Antidumping Duties
• According to the WTO dumping occurs when an exporter
sells a product at a price below the one it charges in its home
market
• Problem: Comparing domestic and foreign market prices is
difficult due to differences in the price of transportation,
wholesale, and other add-ons
Antidumping Duties
There are three methods to determine whether a good is being dumped:
1. Comparing the price in third-country markets
2. Estimating the cost of production
3. Estimating the foreign firm’s production costs (dumping occurs if the
foreign firm is not selling at a price that provides a normal rate of return on
invested capital)
Antidumping Duties
• In order for antidumping duties to be allowed, the country
claiming dumping must show that the dumping has caused
material injury to its firms
• If dumping occurs without material injury, an antidumping duty is
not allowed
Antidumping Duties
• Problems: Economic theory and legal definitions are not
in agreement
• If a firm is not earning above average profits somewhere, it
cannot maintain a price somewhere else that is below the cost
• Firms often sell below costs
• May sell at below costs in order to penetrate a market
• May go for extended periods selling at prices that do not cover fixed costs as long as
the costs of variable inputs (labor and materials) are covered
• Predatory pricing is the potentially the worst form of dumping and could fall into this
category.
Antidumping Investigation
• U.S. firms can initiate antidumping actions by filing a petition with
the International Trade Administration (ITA) in the Department of
Commerce
• If ITA finds dumping (or subsidization in the case of countervailing
duty) - the U.S. International Trade Commission (USITC) conducts
additional investigation to determine whether the dumping has
posed substantial harm to the domestic industry
• The relative success of U.S. firms in proving foreign dumping has
induced a growing number of firms to file petitions with ITA
Escape Clause Relief
• Escape clause relief: Temporary tariff on imports to allow a
domestic industry to escape the pressure of imports and thus
obtain a period of adjustment
• Refers to a clause in the U.S. and GATT trade rules
• Initiated when a firm or industry petitions the USTIC directly for relief
from a surge of imports
• The petitioning firm or industry must show that it has been harmed by
imports and not some other factor (e.g., poor management)
Section 301 and Special 301
• Section 301: A section of the U.S. 1974 Trade Act that requires the U.S.
Trade Representative (USTR) to take action against any nation that
persistently engages in unfair trade practices
• Unilateral action occurs from the President to impose tariff on a country
• U.S. defines the meaning of unreasonable and unfair trade practices
• Action is launched by a request for negotiations with the country in question
• Recent cases include: meats from European countries that contained hormones
• Mexico had a retaliatory action against the U.S. in operating trucking across in the U.S.
• Not an oft practiced action. 122 cases have occurred since 1974, with the last occurring
around 1999-2000.
Section 301 and Special 301
• Special 301: Requires the USTR to monitor property rights
enforcement around the world
• In 2015, the USTR surveyed 73 countries and identified 34 as those that
need to be on the priority watch list (11) or watch list (23)
• Those on the priority watch list included: Algeria, Argentina, Chile,
China, India, Indonesia, Kuwait, Russia, Thailand, Ukraine and
Venezuela
China and Special 301 Highlights
• “China continues to present a complex and contradictory environment for protection and enforcement of IPR. Welcome
developments include repeated affirmation of the importance of intellectual property by China’s leadership, an ongoing
intellectual property legal and regulatory reform effort, and encouraging developments in individual cases in China’s
courts.”
• “In 2015, China’s leadership continued to affirm the importance of developing and protecting intellectual property and
emphasized that stronger protection and enforcement of IPR are essential to achieving China’s economic objectives.”
• “Trade secret theft remains a serious and growing problem in China. (See Trade Secrets). Although the misappropriation of
trade secrets and their use by a competing enterprise can have a devastating impact on a company’s business, remedies can
be exceedingly difficult to obtain under current Chinese law and insufficient to match the level of the threat.”
• “Widespread online piracy and counterfeiting in China’s massive e-commerce markets result in great losses for U.S right
holders involved in the distribution of a wide array of trademarked products, as well as legitimate music, motion pictures,
books and journals, video games, and software.”
Canada and Special 301 Highlights
• “Canada remains on the Watch List in 2016. The United States welcomed Canada’s amendment to its
Copyright Act to extend protection for sound recordings to 70 years from the date of the recording. However,
the United States continues to urge Canada to fully implement its commitments pursuant to the WIPO Internet
Treaties and to continue to address the challenges of copyright piracy in the digital age.”

• “With respect to pharmaceuticals, the United States continues to have serious concerns about the
availability of rights of appeal in Canada’s administrative process for reviewing regulatory
approval of pharmaceutical products as well as about the breadth of the Minister of Health’s
discretion in disclosing confidential business information.”
TABLE 7.5 Economic Sanctions since World War I

There were 174 cases from 1915 – 2000. Since 2000, there have been another 13
cases
Source: PIIE