The Political Economy of Trade and

Investment

1-1

Overview

Instruments of trade policy

Arguments for political intervention
Government intervention in FDI
Trade liberalisation, GATT and the
WTO
Implications for international
business
1-2

Instruments of Trade Policy

Tariffs
Subsidies
Import quotas
Voluntary export restraints
Local content requirements
Administrative policies
Anti-dumping policies
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Tariffs
Taxes on imports - is a tax levied on imports
that effectively raises the cost of imported
products relative to domestic products
Specific tariff - are levied as a fixed

charge for each unit of a good imported

Ad valorem tariff - are levied as a
proportion of the value of the imported
good
1-4

Who gains:
Government
Domestic producers (short run)
Employees of protected industries
Who loses:
Consumers who pay higher prices
The economy which remains inefficient
Employees of protected industries who
dont develop new skills
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Domestic Market Without

International Trade
P
S
P*

D
Q*

Q
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Domestic Market With

International
Trade
P
S

Pw
imports

qs

qd

D
Q
1-7

Effects of Protection
P
S
Pw + T

tariff

qs qs2 qd2 qd

Pw
D
Q
1-8

Subsidies
Government support to domestic producers
Cash grants, low-interest loans, tax breaks,
equity participation, government purchases
Aim to achieve lower costs to
Compete against cheaper imports
Gain export markets
Increase domestic employment
Help local producers achieve first-mover
advantage in emerging industries
1-9

Quotas
An import quota is a direct restriction on the quantity
of some good that may be imported into a country.
A tariff rate quota is a hybrid of a quota and a tariff
where a lower tariff is applied to imports within the
quota than to those over the quota.
A voluntary export restraint is a quota on trade
imposed by the exporting country, typically at the
request of the importing countrys government.

1-10

Price Floor in Domestic Market

Price

Pf

Price Floor

Pe

Qd

Qe

Qs

D
Quantity
1-11

Price Floors in Agricultural

Markets
(a)European Common Agricultural
Policy
(b) United States - Export
Enhancement Program
(c) Japan
1-12

Results of a Price Floor

1.
2.
3.
4.
5.
6.

A surplus
Storage costs
Disposal policy
Misallocation of resources
Higher Domestic prices
Lower World prices
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Other Protection Measures

Anti-dumping laws - Dumping is variously
defined as selling goods in a foreign market
below their costs of production
Voluntary restraint
Local content rules - demands that some specific
fraction of a good be produced domestically
Health & quarantine
Other administrative measures - are bureaucratic
rules and red tape that by default or design
make it difficult for imports to enter a country.
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Political Arguments for Intervention

National security
Individual industries and jobs protected
Retaliation
Consumer protection (health, safety)
Foreign policy objectives

1-15

Economic Arguments for

Intervention
Infant industry protection - suggests that an
industry should be protected until it can
develop and be viable and competitive
internationally
Strategic trade policy - suggests that in cases
where there may be important first mover
advantages, governments can help firms
from their countries attain these advantages

1-16

The Politics of Trade in Steel

March 2002 President George Bush imposes sweeping
tariffs ranging from 8% to 30% on a range of steel imports
from foreign producers
November 2003, the Institute for International Economics
estimated the costs to steel users due to the steel tariffs
amounted to $600 million in lost profits and 26,000 jobs.
The benefit to the steel industry due to the tariffs was $240
million and saved 5,000 jobs

1-17

An example: one of the conditions (for supporting an

Australian government out of the hung parliament in
2010) that independent Bob Katter had was
protection for agriculture and a ban on Filipino
banana imports.
Katter believes that this will benefit the constituents
of his North Queensland district and, notionally,
regional Australia more broadly.
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1-19

The president of the South Australian Farmers' Federation

hopes Queensland independent Bob Katter considers the big
picture of Australia's agricultural industries when making a
decision on which government he'll support.
Peter White thinks the independent's views to change the
competition laws could be devastating for grain growers and
livestock producers who rely on selling their produce overseas.
He says while tariff changes may benefit rural industries in
Bob Katter's seat of Kennedy, the independent needs to
consider all farmers across the country.
"If you're going down that very strong protectionist avenue,
while there might be a few benefit from it overall that could
very well work against them.
Source: Farm lobby group challenges Katter's views on tariffs Thursday, 26/08/2010, ABC Australia
1-20

Government Intervention in FDI

Home and Host Country

Resource transfer effects,
The employment effects,
The balance of payments effects,
Effects on competition and
economic growth,
And national sovereignty
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Inward and Outward FDI

Inward Foreign direct investment occurs when
foreign capital occurs in introduced into a domestic
economy (typically referred to as the host country).
Outward FDI refers to the other side of this
transaction, i.e. local capital is introduced into a
foreign economy (typically referred to as the home
country).
Of course there is by definition an inward and
outward perspective on any FDI.

1-22

Benefits of Inward FDI

Host Country Benefits: The main potential benefits of inward FDI

for a host country are: The resource transfer effect, i.e. the
countrys pool of capital is increased by capital injections from
the investing country.
The employment effect, which simply refers to an increase in
local jobs resulting from the foreign investment.
The balance of payments effect, i.e. FDI helps finance imports of
goods (and perhaps other non-investment capital) from abroad.
Effects on competition and economic growth, i.e. FDI increases a
countrys domestic and international competitiveness and,
through that, increases national GDP growth. Often this effect is
through new and improved (from a local perspective) technology
and know-how.

1-23

Costs of Inward FDI

Host Country Costs: There are three main costs of inward
FDI: The possible adverse effects of FDI on competition
within the host nation which can include a crowding out of
domestic investment by more sophisticated and
powerful foreign investors.
Adverse effects on the balance of payments, which is
dependent mainly on how many of the benefits from FDI
(especially profits) are repatriated (i.e. leave the host
country and returned to the investing country)
But also include if the new enterprise buys inputs from
the home country as oppose to the hosts domestic
market
The perceived or actual loss of national sovereignty and
autonomy and control.
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Benefits and Costs of Outward FDI

Home-Country Costs and benefits include:
Reverse Resource Transfer Effect home countries
MNE learns valuable new skills from exposure to
foreign markets
Balance-of-Payments Effects, i.e. the direct cost of the
initial capital outflow required to finance the FDI also if
production is moved offshore to low cost location.
Alternatively the benefit of profits being repatriated
and if the new investment creates demand for home
country product.
Employment Effects, which occurs when FDI is a
substitute for domestic production (i.e. offshoring). If
the home country is suffering from unemployment, concern about the export of
jobs intensifies
1-25

Trading Blocs and Trading

Agreements
When certain countries integrate
economically, or form an agreement, to:
trade freely with each other, or
reduce trade barriers between each other
Members of blocs or agreements impose
trade restrictions against non-member
countries, reducing free trade

1-26

Promoting Free Trade

World resource use would be more

efficient, and consumer prices would be
lower
The World Trade Organization (formerly
the General Agreement of Tariffs and
Trade - GATT) promotes free trade and
works toward gaining agreements to
reduce tariff protection world-wide

1-27

International Trade Institutions

WTO
World Bank
IMF
United Nations
-ILO, UNESCO etc
NGOs
1-28

Trade Blocks
European Union (EU)
North American Free Trade Association
(NAFTA)
Asia Pacific Economic Cooperation
(APEC)
Closer Economic Relations (CER)

1-29

GATT/WTO
MFN
-any preferential treatment offered to one
member country must be extended to all
other members
Exceptions
-regional arrangements such as NAFTA
-GSP (Generalized System of
Preferences) for LDCs
-countries still use NTBs, other loopholes
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Uruguay Round
Tariffs cut further
Agricultural Policy Modified:
cut price supports 20%, export
subsidies 36%
Services given prominence: developed
set of principles
IP rights protected further
WTO created to implement Uruguay
round
1-31

Doha Round
Main focus has been on the reduction of domestic
support, and increasing export competition and
market access
Negotiations with respect to agriculture stalled in
mid 2005
Reduction of domestic support
Increasing export competition and market access
Reduction of protection to agriculture

1-32

Implications For Business

Trade barriers affect firm strategy
Government policy has direct
impact on a firms business

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