Instruments of Trade Policy

Instruments of Trade Policy

• Governments use tariffs, subsidies, import quotas, voluntary export restraints (VERs), local content requirements (LCRs), administrative policies, and anti-dumping duties to influence international trade flows.

Tariffs

• Taxes on imported goods are classified as ad valorem (proportional to the value) or specific tariffs (fixed charge per unit).

Subsidies

• Government payments to domestic producers lower production costs and increase competitiveness, including cash grants, low-interest loans, tax breaks, and equity participation.

Import Quotas and VERs

• Import quotas directly limit the quantity of imports, often through licenses and VERs are agreements limit exporting and importing countries.

Economic Arguments for Intervention

• New industries in developing countries use temporary protection through tariffs, quotas, and subsidies, which helps grow strong enough to compete internationally.
• Strategic trade policy: governments intervene in order to support domestic firms in gaining a competitive advantage in global markets, which includes subsidies and protectionist measures to help firms become first-movers in their industries.
• Critics argue strategic trade policy can lead to beggar-thy-neighbor policies and is vulnerable to manipulation by politically influential interest groups.

Political Arguments for Intervention

• Governments protect jobs and industries from perceived unfair foreign competition, especially when foreign producers receive subsidies.
• Certain industries are considered vital for national security, and governments use tariffs or trade barriers to protect these industries.
• Countries can use trade sanctions to enforce intellectual property laws or fair trade practices.
• Regulations protect consumers from unsafe products and can serve as trade barriers, several countries banned U.S. beef imports following a mad cow disease case.
• Preferential trade terms and sanctions build strong international relationships or penalize nations that violate international norms.
• Trade policies promote human rights internationally through economic sanctions against governments with poor human rights records.

The GATT and WTO

• The General Agreement on Tariffs and Trade (GATT) and the World Trade Organization (WTO) promote trade liberalization and arbitrate trade disputes.
• The WTO includes agreements on services (GATs) and intellectual property rights (TRIPs).
• 1947-1979: GATT led to trade liberalization and economic growth
• 1980-1993: Increased protectionist trends.
• 1986-1995: The Uruguay Round resulted in the establishment of the WTO.
• Issues within the WTO: anti-dumping actions, protectionism in agriculture, protection of intellectual property, and market access for non-agricultural goods and services.

Trade Barriers and Firm Strategy

• Businesses adapt to trade barriers by sourcing locally to comply with LCRs or using subsidies to reduce costs.

Policy Implications

• Governments must balance protecting domestic industries with ensuring competitive markets while avoiding protectionist policies.

Key Definitions

• Flow of FDI: Amount of FDI undertaken over a specific period.
• Stock of FDI: Total accumulated value of foreign-owned assets at any given time.
• Outflows of FDI: Investments made by a country abroad.
• Inflows of FDI: Investments made by foreign entities into a country.

Types and Forms of FDI

• FDI occurs as greenfield investments and mergers and acquisitions (M&A).
• Greenfield investment: establishing new operations in a foreign country.
• This benefits host countries via new facilities and employment.
• Mergers and Acquisitions: involve purchasing or combining with an existing firm in the host country.
• This faster than Greenfield investments.
• Greenfield investments and M&A are chosen based on market conditions, regulatory environment, and strategic objectives.

Theories Explaining FDI

• Internalization theory: firms prefer FDI over licensing to protect intellectual property, maintain control, and reduce transaction costs.
• Eclectic Paradigm: combines ownership-specific, location-specific, and internalization advantages to explain why firms undertake FDI and prefer certain locations.

Political Ideologies Shaping FDI

• Political ideologies shape a government's attitude towards FDI.
• Radical View: rooted in Marxist theory, and perceive multinational enterprises (MNEs) as tools for capitalist exploitation and undermine economic sovereignty.
• Free Market View: international production should be distributed according to comparative advantage, that benefits both home and host countries by fostering efficient resource allocation and specialization.
• Pragmatic Nationalism: FDI can bring capital, technology, and jobs and also leads to economic and political concerns like loss of control over critical industries.

Benefits and Costs of FDI

• FDI has varied impacts on both host and home countries, with distinct benefits and costs.

Host Country Benefits

• Resource-Transfer Effects: FDI brings in capital, technology, and managerial expertise.
• Employment Effects: Job creation enhances local employment.
• Balance-of-Payments Effects: FDI improves payments by providing external financial resources.
• Effect on Competition and Growth: Stimulates local competition and economic growth.

Host Country Costs

• Adverse Effects on Competition: MNEs may outcompete local firms.
• Adverse Effects on Balance of Payments: Profit repatriation can harm the host country's balance of payments.
• National Sovereignty: can lead to loss of control over critical sectors.

Home Country Benefits

• Resource Transfer: Home country firms get skills and innovations developed in foreign subsidiaries.
• Employment Effects: Creates new jobs related to international operations.
• Balance of Payments and Investment: Earnings repatriated from overseas boost the home country's balance of payments.

Home Country Costs

• Outflow of Capital: Initial investments and ongoing commitments can strain financial resources.
• Employment Effects: Offshoring can lead to job losses in the home country.

Government Policies Towards FDI

• Governments employ tools to encourage or restrict FDI based on their economics and national interests.
• Encouraging FDI: includes incentives like tax breaks, subsidies, and regulatory support through simplified regulations.
• Restricting FDI: limitations on foreign ownership and sectoral caps, and bureaucratic hurdles with stringent regulatory requirements.

Recent Trends in the FDI Landscape

• Decline in Radical Policies: move away from radical ideologies towards market-oriented policies.
• Shift towards Hostile FDI Approaches: Some countries are more resistant to FDI, reflecting concerns over national autonomy and economic sovereignty.
• Regional Focus: Increased focus on Asian markets like China and India as attractive FDI destinations due to their liberalized economic policies.

Implications for Managers

• Managers navigate the complexities of FDI with a clear understanding of benefits and potential pitfalls:

Strategic Decisions

• Balancing Greenfield investments and acquisitions based on strategic objectives.
• Regulatory Compliance: Ensuring compliance with local regulations through understanding political ideologies.
• Long-term Planning: Considering long-term impacts of FDI on both home and host countries, including shifts in government policies and market conditions.

Globalization and Regional Economic Integration

• Aims to enhance economic integration via reduction or elimination of trade barriers, strengthens ties between neighboring countries and promotes political cooperation/stability.

Levels of Economic Integration

• Free Trade Area: Removal of barriers to the free movement of goods/services among member countries, and each country maintains its external trade policies.
• Customs Union: Builds on an FTA with a common external trade policy, where member countries have harmonized tariffs/trade regulations with non-member countries.
• Common Market: Allows the free flow of goods/services and the free movement of factors of production among member countries, which pursue a common external trade policy.
• Economic Union: Deeper integration by harmonizing economic policies, including a common currency and synchronized tax rates.
• Political Union: unification of economic, social, and foreign policies under a central political authority.

Case for Regional Integration

• Aims to achieve benefits from the free flow of trade and investment that are not attainable under global agreements.
• Trade creation: Lower-cost producers replace high-cost domestic producers.
• Economies of scale: Access to larger markets allows firms to produce more efficiently.
• Political cooperation reduces the potential for conflict via the linking of neighboring economies is promoted.

Case Against Regional Integration

• Not all sectors of an economy benefit equally from integration.
• Sovereignty Concerns: Nations are hesitant to cede control over critical sectors or policy areas.

Regional Agreements

European Union (EU)

• A unique example of an economic and political union, it features the Single European Act which is aimed at creating a single market by removing trade barriers.
• Euro: adopted by 19 of the 27 EU member states, leading to significant cost savings/efficiencies.

NAFTA and CUSMA

• NAFTA: signed by the US, Canada, and Mexico, and sought to create an enlarged and efficient production base.
• CUSMA: concerns over job losses and environmental impacts were significant.

MERCOSUR

• Formed by Brazil and Argentina, later joined by Paraguay, Uruguay, and Venezuela (suspended).

ASEAN

• Promotes economic cooperation and industrial development, the Association of Southeast Asian Nations (ASEAN) includes the ASEAN Free Trade Area (AFTA) and comprehensive trade agreements with China,

African Trade Blocs

• Africa hosts regional trade agreements such as the East African Community (EAC) and AfCFTA.

Implications for Business

• Economic integration can create both opportunities (access to markets, reduced tariffs, economies of scale) and threats ( increased competition) for businesses.

Key Concepts

• Value Creation: the process increases the value of goods or services as perceived by consumers.
• 2 Primary Conditions to determining a firm’s profits value customer places in the goods and services.
• Strategic Positioning: a strategic emphasis on value creation, whether through differentiation or low cost, aligning with the internal operations to support their emphasis.
• Primary Activities: include the design creation and delivery of a product
• Support Activities: provide the necessary inputs for primary activities

Strategies for Global Expansion

• Global Standardization Strategy: focuses on increasing profitability/growth through cost reductions derived from economies of scale, learning effects, and location economies but lacks local responsiveness.
• Localization Strategy: tailors goods or services to match specific tastes of different national or regional markets in order to better match product.
• Transnational Strategy: achieves low costs while differentiating product offerings across geographic markets and fostering multidirectional skill transfer across different subsidiaries.
• International Strategy: involves taking products created for the domestic market and selling them internationally with minimal local adaptation.

Pressures Influencing Strategic Choice

• Increased liberalization of global trade/investment leads to heightened competition.
• Differences in consumer tastes, infrastructure, traditional practices, distribution channels, and host-government demands affect local responsiveness.

Leveraging Products and Competencies

• Develop goods/services internationally by marketing goods/services developed domestically in international markets.

Strategic Alliances

• Advantages: facilitate entry into foreign markets, sharing of fixed costs/risks for new product development, combining complementary skills/assets, and facilitate technology/expertise sharing.
• Disadvantages: competitors access new technologies and markets, there a risk of one partner benefiting more than the other.
• Key success requires Partner Selection, Alliance Structure and Management.

Basic Entry Decisions

• Which Foreign Markets: The global landscape comprises 195 countries, 61 territories, and 6 disputed areas.
• Revenue Potential: the decision hinges on an assessment of nation is long-term revenue potential.

Costs and Risks

• Firms must evaluate the benefits against the risks of operating in a specific country.

Timing of Entry

• First or Early Mover Advantages: brand recognition, securing sales volume, benefiting from the experience curve.
• First or Early Mover Disadvantages: high pioneering costs, and navigating complex regulations.
• Late Mover or Entrant Advantages: learning from early movers' mistakes and avoiding pioneering costs
• Late Mover or Entrant Disadvantages: switching costs and potential cost disadvantages.

Scale of Entry and Strategic Commitments

• Large-Scale Entry: requires resource commitment and quick market penetration and entails long-term impacts that cannot be easily reversed, but captures first-mover advantages.
• Small-Scale Entry: lowers risk exposure and allows for market learning.

Market Entry Modes

• Exporting: avoids establishment costs in the host country and location economies, but may not be feasible due to lower costs abroad as well as high tariff barriers.
• Turnkey is where Contractors handle all project details for a foreign client and at completion, and provide a ready for operation.
• Licensing : granting rights to intangible property to another entity for a period whilst receiving royalties.
• Franchising is a kind of specialized licensing, selling intangible property with a strict business operation.
• A franchisee assumes costs and risks, and the loss of quality control and no experience curve benefits
• Joint Ventures occurs when establishing a firm jointly owned by two or more independent entities,
• Wholly Owned Subsidiaries :setting up a new operation or acquiring an existing firm
• Greenfield Ventures is tailored subsidiary creation and easy to establish, but slower and has higher risk, and its acquisition leads to a rapid market but leads to cultural clashes.

Strategic Implications for Businesses

• Crucial Market Knowledge, Resource Allocation and Customized Strategies

The Promises and Pitfalls of Exporting

• Increased Revenue and Profit Growth, economies of scale and Competitiveness.
• Export transactions often involve extensive paperwork
• Smaller enterprises may find the logistics of exporting, such as financing, documentation, Intimidating and complex.
• Canada has robust institutional structures supporting exports through entities like MITI and sogo shosha.
• Various information sources: Global Affairs Canada, ISED, Stats Canada, EDC and local chamber.
• Export Management Companies (EMC act as export marketing or international departments for firms and include Freight Forwarders, Customs Brokers, Export Agents, and Merchants.

Export and Import Financing

• Overcome aLack of Trust via Third-Party Intermediaries and Financial Instruments.
• Letter of Credit and Drafts
• Export Assistance through entities like the Export-Import Bank (EXIM), which provide financing and insurance.
• A bill of Lading outlines the terms of transportation

4. Countertrade

• Transactions without Conventional Payment Methods which include
• Barter: Direct exchange without cash
• Counterpurchase
• Switch Trading: third-party trading credits
• Compensation/Buybacks
• Pros: facilitates export deals in developing countries.
• Cons: May involve unusable or poor-quality goods