Chapter 7: Government Intervention and Regional economic integration

Common market

(aka single market): trade barriers are reduced or removed, customs barriers are established, and products, services, and factors of production are allowed to move freely among the member countries. • Also establishes a common trade policy with nonmember countries • Ex: EU common market, gradually reduced or eliminated restrictions on immigration and cross-border flow capital→ worker in EU has right to work In any other EU nation

Tariff

(also known as a duty) is a tax government imposes on imported products, effectively increasing the cost of acquisition for the customer.

1) Current account

The current account consists of Four Sub-Accounts: Goods (Merchandise) Trade: Services Trade: Investment Income: On portfolio investment and FDIs Unilateral Transfers: Foreign Aids/grants: Government: Economic Development Aid, Humanitarian Aid, & Military Aid Private charitable contributions:

European parliament

consists of elected representatives and develops EU legislation, supervises EU Institutions and makes decisions about the EU Budget.

Levels of regional integration is like a

continuum

National security

countries impose trade restrictions on products viewed as critical to national defense and security. Include: military technology and computers that help maintain domestic production in security-related products. a. Export Controls: government measures intended to manage or prevent the exports of certain products or trade with certain countries. Ex: prohibit exports of plutonium in North Korea because it can be used to make nuclear weapons.

Eu's common agriculatural policy

is a system of agricultural subsidies and programs that guarantees a minimum of price to EU farmers and ranchers. CAP consumes half of the EU's annual budget and complicates negotiations with the WTO for reducing trade barriers.

Economic union

members enjoy all the advantages of early stages but also strive to have common fiscal and monetary policies. o At extreme rate, each member country adopts identical tax rates. o This bloc aims for standardized monetary policy, which requires establishing fixed exchange rates and free convertibility of currencies among the member states, allowing the free movement of capital. o This standardization helps estimate discriminatory practices that might favor one member state over another.

Protectionism

national economic policies designed to restrict free trade and protect domestic industries from foreign competition leading manifestation of government intervention in IB

what two categories does offensive rationale fall into

national strategic priorities and increasing employment

Types of non-tariff barriers and define:

o Customs: the checkpoints at the ports of entry in each country where government officials inspect imported products and levy tariffs which traded barriers are enforced as products pass. o Quota- often used for nontariff trade barrier, a quantitative restriction placed on imports of a specific product over a specified period.

• The EU steps to become an economic union:

o Market access: Tariffs and most nontariff barriers have been eliminated for trade in products and services. Rules of origin favor manufacturing using inputs produced in the EU. o Common market: barriers to the cross-national movement of production factors - labor, capital, technology—have been removed. o Trade Rules: customs procedures and regulations have been eliminated, streamlining transportation and logistics within Europe. o Standards harmonization: technical standards, regulations, and enforcement procedures related to products, services, and commercial activities are being harmonized.

National culture and identity

occupations, industries, and public assets are seen as central to national culture and identity in most countries. Governments may impose trade barriers to restrict imports or products or services seen to threaten such national assets.

The european comission

proposes legislation and policies and is responsible for implementing the decisions of the European Parliament and the Council of the EU.

Defensive rationale: four types

protection of the nation's economy, protection of an infant industry, national security, and national culture and identity.

Government investment incentives

related to subsidies, transfer payments or tax concessions made directly to individual foreign firms to entice them to invest in the country

Who do trade barriers benefit?

special interest groups: domestic firms, industries, and labors.

dumping

subsidies may allow a manufacturer to practice this, to charge an unusually low price for exported products, typically lower than that for domestic or third country customers, or even lower than the cost to manufacturer good. • Dumping violates WTO rules b/c it amounts to unfair competition, but hard to prove because companies do not reveal data on their cost structure.

Regional economic integration

the growing economic interdependence that results when two or more countries within a geographic region form an alliance aimed at reducing barriers to trade and investment. o Regional integration increases economic activity and makes doing business easier among nations within the alliance. o At a minimum, the countries in an economic bloc become parties to a free trade agreement, a formal arrangement between two or more countries to reduce or eliminate tariffs, quotas and other barriers to trade in products and services. o Regional integration results from the formation of a regional economic integration bloc, or simply, an economic bloc.

Free trade area

the simplest and most common arrangement in which countries agree to eliminate tariffs and other barriers to trade in products and services within the bloc. Each member country maintains an independent international trade policy with countries outside the bloc. Ex: NAFTA • emphasizes the pursuit of comparative advantage for a group of countries rather than individual states. Goverments may impose local content requirements: they specify that locally produced products must contain a minimum proportion of locally manufactured parts and components. If not met, product becomes subject to tariffs

Why do governments intervene?

to achieve political, social, and economic objectives.

Free trade

unrestricted flow of products, services, and single items across national borders.

Four main reasons why governments impose tariffs

1) To generate revenue 2) To ensure citizen safety, security, and welfare 3) To pursue economic, political, or social objectives 4) To serve company and industrial interests

offensive reasons

1) generate revenues 2) Promote national strategic prioties 3) Create domestic employment

Managerial implications of regional integration

1) internationalization inside the bloc 2) Restructuring operations 3) Regional products and marketing 4) Internationalization from outside the bloc

Defensive reasons

1) protect domestic employment 2) prevent domestic job losses 3) Protect national economy 4) Protetc infant industries 5) protect national security interests 6) Protect natural culture and identity

Net unilateral current transfers

Assume: Current Transfers Receipts= $450 Billion Assume: Current Transfers Payments=$325 Billion In 2017, Country X has incurred a surplus in net unilateral transfers Receipts>Payments

Goods Trade Balance (Balance of trade)

Assume: Goods Exports=$1500.00 billion. Assume: Goods Imports=$2300.00 billion) In 2017, Country: X had incurred a goods/merchandise trade deficit (-) Imports>Exports

Net investment income

Assume: Investment Income Receipts=$775.00 billion. Assume: Investment Income Payments=$550.00 billion In 2017, Country: X had generated a net investment income Surplus Receipts>Payments

Services of trade balance

Assume: Services Trade Exports: $650 billion. Assume: Services Trade Imports: $450 billion) In 2017, Country: X had generated a Services Trade Surplus Exports>Imports

Trade and investment barriers can be considered two things?

Defensive or offensive

The european union

In 1957, 6 countries—Belgium, France, Italy, Luxembourg, the Netherlands and West Germany—formed an alliance called the European Economic Community. Its successor it today's European Union established in 1992. Features 28 countries from eastern and western Europe, largest and advanced economic bloc, home to half a billion people, total GDP $18 trillion.

BOP Accounts four types:

Current Account: Capital & Financial Account: Official Reserves Account: Net Errors and Omissions Account:

Capital and Financia A/C

Capital Account: Of minor significance now a days Financial Account: It is maintained to record and summarize investment transactions

Financial account

Consists of three subaccounts: Foreign Portfolio Investment: Portfolio Investment: Inflows Portfolio Investment: Outflows Foreign Direct Investment: FDI FDI: Inflows FDI: Outflows Other Investments: Assets Liabilities

Protection of the nations economy

Firms in advanced economies cannot compete with those in developing countries that employ low-cost labor. Protectionist demand trade barriers to curtail the import of low-priced products. This action is intended to protect jobs and ensure higher wages for workers in advanced economies. Protectionism defies comparative advantage: nations should engage in more international trade, not less. a. Trade barriers interfere with country specific specialization of labor, when countries specialize in products they can produce the best and trade the rest, they delivery superior living standards. b. Blocking imports can reduce the availability and increase the cost of products sold in the home market. c. Protectionism can trigger retaliation; this results in foreign governments imposing their own trade barriers, which reduces sales prospects for exporters.

Political rational for GI

Foreign policy, national security, human rights violations, political repression, genocide, ethnic cleansing

Levels of regional integration

Free trade area, customs union, common market, economic union

Current account balances

Goods Trade Balance (Balance of Trade): (Goods Exports minus Goods Imports) Surplus or Deficit Services Trade Balance: (Services Exports minus Services Imports) Surplus or Deficit Investment Income: (Investment Income Receipts minus Investment Income Payments) Net Investment Income Unilateral Transfers: (Unilateral Transfers Receipts minus Unilateral Transfers Payments) Net Unilateral Transfers

Protection of an infant industry

In emerging industry, companies are often inexperienced and lack the latest technologies and know-how. They also may lack the large size typical of competitors in established industries abroad. A very young industry might need protection from foreign competitors, a government may impose temporary trade barriers on foreign imports to ensure that young firms gain a large share of domestic market. Protecting infant industries has allowed some countries to develop a modern industrial sector. EX: Japan and South Korea to become dominant players in automobile and consumer electronics. a. Once in place, protection can be hard to remove. Industry owners and workers tend to lobby to preserve government protection. Infant industries in many countries have shown a tendency to remain dependent on government protection for many years. b. Protected companies are often less efficient than unprotected firms that compete in free markets. Faced with few or no competitors, protected companies may produce lower quality products or charge higher prices for them, which can harm domestic consumers

Official reserves account

Metallic Reserves: Gold, Silver, Platinum, etc. Foreign Currency Reserves: Convertible (Hard) Currency reserves In the case of the U.S.: Yen, Pound, Euro, Swiss Franc, Aus. $, Canadian $, & other currency holdings Reserve Position with the IMF: Of Special Drawing Rights (SDR) SDR is an index (accounting) currency created by the IMF SDR is an weighted index of a number of major convertible currencies

o Why would a nation opt to be a member of an economic bloc instead of working toward a system of worldwide free trade?

It is much easier to reach agreement on free trade with a handful of countries than will all the nations in the world. This is why there are hundreds of regional economic blocs today.

Socio-cultural rational for GI

Protecting national cultural heritage and identity (e.g., Canada), Human rights, underage (child) labor, prison labor

natural environment

Protecting tropical rain forests, protecting endangered species, reducing global warming, and protecting biosphere, ozone layer, air and water

Economic rationale for GI

Spur economic growth, create jobs, protect jobs, reduce job loss, national industrial policy, generate government revenues, protect infant industry

How does protectionism arise in forms of?

Tariffs and non tariffs

What are the instruments of trade intervention and protectionism>

Tariffs and non tariffs

Leading economic blocs

The European Union and NAFTA

Net errors and omission accounts

This account is maintained for making adjustment entries for errors and omissions made during recording of the transactions

Economic bloc

a geographic area that consists of two or more countries that agree to pursue economic integration by reducing tariffs and other restrictions to the cross-border flow of products, services capital and in more advanced stages, labor. o EX: European Union and North American Free Trade Agreement(NAFTA): Canada, Mexico, and US. o EU harmonizes monetary policy, fiscal policy, and integrating economies of its member nations.

Council of europeon union

a representative body that makes decisions on economic policy, budgets, foreign policy, and admission of new member countries

Customs union

a stage of regional integration in which member countries agree to adopt common tariff and nontariff barriers on imports from nonmember countries. • Adopt external trade policies • EX: MERCOSUR

Subsidies

are monetary or other resources that a government grants to a firm or group of firms, intended either to encourage exports or simply to facilitate the production and marketing of products at reduced prices, to help ensure that the involved companies prosper. o Come in the form of outright cash disbursements, material inputs, services, tax breaks, the construction of infrastructure, and government contracts at inflated prices. o Critics argue that subsidies give unfair advantages to recipients by reducing their cost of doing business. o The WTO prohibits subsidies when it can be proven that they hinder free trade however, subsidies are hard to define • Subsidy can be misconstrued for an appropriate public function. o The US government grants subsidies for more than two dozen commodities, including corn, soybeans, wheat, cotton, and rice.

National strategic priorities

government intervention sometimes aims to encourage the development of industries that bolster the nation's economy. It is a proactive variation of the infant industry rationale and related to national industrial policy. a. Countries with many high-tech/high-value adding industries, such as information technology, pharmaceuticals, car manufacturing, create better jobs and higher tax revenue. b. Countries with low-tech/value added industries, such as agriculture, textile manufacturing, or discount retailing create lower value adding jobs and less tax revenue.

Increasing employment

governments often impose barriers to protect employment in designated industries. Insulating domestic firms from foreign competition stimulates national output, leading to more jobs in the protected industries. The effect is usually strongest in import-intensive industries that employ much labor.

Countervailing duties

governments sometimes retaliate against subsidies by imposing tariffs on products imported into a country to offset subsidies given to producers or exporters in the exporting country. In this way, the duty serves to cancel out the effect of the subsidy, eliminating the price advantage the exporters would otherwise obtain

General agreement on tariffs and trade

in 1947, 23 nations signed this, the first major effort to reduce trade barriers systematically worldwide. The GATT created a process to reduce tariffs through continuous negotiations among member nations, an agency to serve as watchdog over world trade, and a forum for resolving trade disputes. o The GATT introduce the concept of normal trade relations in which each nation agreed to extend the tariff reductions covered in a trade agreement with a trading partner to all countries. A concession to one country become a concession to all. o 1995, the WTO succeeded the GATT and grew to include more than 150 member nations. The organization proved extremely effective and resulted in the greatest global decline in trade barriers in history. o Average tariffs have declined but world trade and GDP flourished, decreasing trade barriers are a major factor in the growth of global commerce and rising incomes in the world. o Ease of doing business: is an index the world bank develops annually- ranks 189 countries and is useful for evaluating the effects of government intervention. • A high ease of doing business ranking means a country's regulatory environment is conducive to starting and operating a company there. The index obtains a total ranking by rating each country in terms of ten variables: starting a business, dealing with construction permits, getting electricity, registering property, getting credit... • Easiest countries are advanced economies that enjoy high living standards and good business. (vice versa ) o Government intervention can also offset harmful effects, trade barriers can create or protect jobs. Subsidies can help counterbalance harmful consequences that disproportionately affect the poor.

The European court of justice

interprets and enforces EU laws and settles legal disputes between member states.

nontariff barrier

is a government policy, regulation, or procedure that impedes trade through means other than explicit tariffs.

Advantages of regional integration

• 1) Expand market size • 2) Achieve scale economies and enhanced productivity • 3) Attract Direct investment from outside the Bloc • 4) Acquire stronger defensive and political posture

How Firms Can Respond to Government Intervention

• 1) Research to gather knowledge and intelligence • 2) Choose the most appropriate entry strategies: If high tariffs are present, managers may consider FDI, licensing, or joint venture that allow the firm to operate directly in the target market and avoid import barriers. o Tariffs vary with the form of an imported product. To minimize, the impact of tariffs, many firms ship manufactured products knocked-down and then assemble them in the target market. • 3) Take advantage of foreign trade zones: (stimulate local economic development) o Foreign trade zones aka free ports: is an area within a country that receives imported goods for assembly or other processing and subsequent re-export. o Products brought into an FTZ are not subject to duties, taxes, or quotas until they, or the products from them, enter the non-FTZ commercial territory of the country where the FTZ is. o Firms use FTZs to assemble foreign dutiable materials and components into finished products, which are then re-exported. To manage inventory of parts, components, or finished products that will be needed in some other location. o Maquiladoras: are export-assembly plants in northern Mexico along the US border that produce components and typically finished products destined for the US on a tariff-free basis. (count for 50% of Mexico export) • Enables firms from US, Asia, and Europe to tap low-cost labor, favorable duties, and government incentives • 4) Seek Favorable customs classifications for exported products: reduce exposure to trade barriers is to have exported products classified in the appropriate harmonized product code. Many products can be classified within two or more categories, each of which may imply a different tariff. • 5) Take advantage of investment incentives and other government support programs: obtaining economic development incentives from host- or home-country governments is another strategy to reduce the cost of trade and investment barriers o incentives: cash outlays, reduced utility rates, employee training programs, tax holidays, and construction of new roads and other infrastructure. • 6) Lobby for free trade and investment: more nations are liberalizing markets to create jobs and increase tax revenues, aimed to lower barriers

Non tariff trade barriers

• Government policies or measures that restrict trade without imposing a direct tax or duty. They include quotas, import licenses, local content requirements, government regulations, and administrative or bureaucratic procedures. • The use of nontariff barriers has grown substantially in recent decades. • Governments sometimes prefer them because they are easier to hide from WTO that monitor international trade. • Quotas: restrict the physical volume or value of products that firms can import into a country. • Example: US government imposed an upper limit of roughly 2 million pounds on the total amount of sugar that can be imported into the US each year. Sugar imports that exceed this level face a tariff of several cents per pound. US sugar producers are protected from cheaper imports, giving them a competitive edge over foreign sugar producers. Hershey and Coca Cola pay more for sugar, companies that manufacture sugar save money by moving production in other countries that don't have quotas/tariffs. • Import license: a formal permission to import, which restricts imports in a way that is similar to quotas. (Not the same as licensing!) a. Governments sell import licenses to companies on a competitive basis or grant the licenses on a first-come, first-served basis. i. This tends to discriminate against smaller firms, which typically lack the resources to purchase them. Obtaining a license can be costly and complicated • Local content requirements: require manufacturers to include a minimum of local value added—production takes place locally. a. Usually imposed in countries that are members of an economic bloc, such as the EU and NAFTA. The so called rules of origin requirement specifies that a certain proportion of product and supplies, or of intermediate goods used in local manufacturing, must be produced within the bloc. • Government regulations and technical standards: are another type of nontariff trade barriers. Examples: safety regulations for motor vehicles and electrical equipment, health regulations for hygienic food preparation. • Governments may impose administrative or bureaucratic procedures: that hinder the activities of importers or foreign firms. • Saudi Arabia is home to various restrictive practices that hinder international trade.

NAFTA

• Launched in 1994, Canada, Mexico, and US. • Most significant economic bloc in the Americas • NAFTA was smoothed by existence of the maquiladora program under which US firms located factories in northern Mexico to access low-cost labor and avoid tariffs. • What has NAFTA accomplished for its members? Accord increased market access between Canada, Mexico, and US. Eliminated tariffs and most nontariff barriers for products and services traded in the bloc and made it possible for member-country firms to bid for government contracts in all three countries. • NAFTA also established trade rules and uniform customs procedures and regulations. Agreed for investment and intellectual property rights • NAFTA also provides for dispute settlement in such areas as investment, unfair pricing, labor issues, and the environment. • Since bloc's inception, Canada and Mexico have become the most important export market of US, accounting for 1/3 of US exports.

Types of tariffs

• The most common type of tariff is the import tariff: a tax levied on imported products. Import tariffs are usually ad valorem: they are assessed as a percentage of the value of the imported product • A government may impose a specific tariff: a flat fee or fixed amount per unit of the imported product. It is based on weight, volume or surface area. • Revenue tariff: is intended to raise money for the government. • Protective tariff: aims to protect domestic industries from foreign competition • Prohibitive tariff: is one so high that no one can import any of the items. • The amount of a tariff is determined by examining a product's harmonized code. Products are classified under about 8,000 unique codes in the harmonized tariff or harmonized code schedule. The harmonized code is standardized worldwide. Without it, firms and governments might have differing opinions on product definitions and tariff charged. • Import tariffs can generate substantial revenue for national governments: common in developing countries. • Because high tariffs inhibit free trade and economic growth, governments have tended to reduce them over time. This was the primary goal of the general agreement on tariffs and trade.

Investment barriers

• These restrictions hinder the ability of foreign firms to invest in some industry sectors or acquire local firms. Excessive restrictions in India prevent the approval of many investment proposals that could produce billions of dollars in revenue to the local economy and government. o Worldwide, FDI, and ownership restrictions are particularly common in industries such as broadcasting, utilities, air transportation, military technology, and financial services. o The restrictions are also present in industries which the government has major holdings such as oil and key minerals. • FDI and ownership restrictions are particularly burdensome in the services sector because services usually cannot be exported and providers must establish a physical presence in target markets to conduct business there. • Currency controls: restrict the outflow of widely used currencies, such as the dollar, euro and yen, and occasionally the inflow of foreign currencies. o Controls can help conserve especially valuable currency or reduce the risk of capital flight. o They are particularly common in developing economies. o Some countries employ a system of dual official exchange rates, offering exporters a relatively favorable rate to encourage exports, while importers receive a relatively unfavorable rate to discourage imports. o Currency controls both help and harm firms that establish foreign subsidiaries through FDI. • They favor companies when they export their products from the host country but harm those that rely heavily on imported parts and components. Controls also restrict the ability of MNEs to repatriate their profits—that is, transfer revenues from profitable operations back to the home country. • Ex: Venezuela's currency controls