Chapter 5 Outline

Implications for Business

Why should the international manager care about the political economy of free trade, about the relative merits of arguments for free trade and protectionism? There are two answers to this question. The first concerns the impact of trade barriers on a firm's strategy. The second concerns the role that business firms can play in promoting free trade and/or trade barriers.

Trade Barriers and Firm Strategy

To understand how trade barriers affect a firm's strategy, consider the material we covered in Chapter 4. Drawing on the theories of international trade, we discussed how it may make sense for the firm to disperse its production activities to countries where they can be performed most efficiently. It may make sense for a firm to design and engineer its product in one country, to manufacture components in another, to perform final assembly operations in yet another country, and then export the finished product to the rest of the world.

Trade barriers constrain a firm's ability to disperse its productive activities in such a manner. First, and most obviously, tariff barriers raise the costs of exporting products to a country (or of exporting partly finished products between countries). This may put the firm at a competitive disadvantage vis-à-vis indigenous competitors in that country. In response, the firm may then find it economical to locate production facilities in that country so it can compete on an even footing with indigenous competitors. Second, voluntary export restraints may limit a firm's ability to serve a country from locations outside of that country. The firm's response might be to set up production facilities in that country--even though it may result in higher production costs. Such reasoning underlay the rapid expansion of Japanese automaking capacity in the United States during the 1980s. This followed the establishment of a VER agreement between the United States and Japan that limited imports of Japanese automobiles. For details, see the accompanying Management Focus, which describes how Toyota responded to threats of greater protectionism by opening auto assembly plants in the United States and Europe.

Third, to conform with local content regulations, a firm may have to locate more production activities in a given market than it would otherwise. From the firm's perspective, the consequence might be to raise costs above the level that could be achieved if each production activity was dispersed to the optimal location for that activity. And fourth, even when trade barriers do not exist, the firm may still want to locate some production activities in a given country to reduce the threat of trade barriers being imposed in the future.

All the above effects are likely to raise the firm's costs above the level that could be achieved in a world without trade barriers. The higher costs that result need not translate into a significant competitive disadvantage, however, if the countries imposing trade barriers do so to the imported products of all foreign firms, irrespective of their national origin. But when trade barriers are targeted at exports from a particular nation, firms based in that nation are at a competitive disadvantage vis-à-vis the firms of other nations (VERs are targeted trade barriers). The firm may deal with such targeted trade barriers by moving production into the country imposing barriers. Another strategy may be to move production to countries whose exports are not targeted by the specific trade barrier.

Policy Implications

As noted in Chapter 4, business firms are major players on the international trade scene. Because of their pivotal role in international trade, business firms exert a strong influence on government policy toward trade. This influence can encourage protectionism or it can encourage the government to support the WTO and push for open markets and freer trade. Government policies with regard to international trade also can have a direct impact on business.

Consistent with strategic trade policy, examples can be found of government intervention in the form of tariffs, quotas, and subsidies helping firms and industries to establish a competitive advantage in the world economy. In general, however, the arguments contained in this chapter suggest that a policy of government intervention has three drawbacks. Intervention can be self-defeating, since it tends to protect the inefficient rather than help firms become efficient global competitors. Intervention is dangerous because it may invite retaliation and trigger a trade war. Finally, intervention is unlikely to be well-executed, given the opportunity for such a policy to be captured by special interest groups. Does this mean that business should simply encourage government to adopt a laissez-faire free trade policy?

Most economists would probably argue that the best interests of international business are served by a free trade stance, but not a laissez-faire stance. It is probably in the best long-run interests of the business community to encourage the government to aggressively promote greater free trade by, for example, strengthening the WTO. Business probably has much more to gain from government efforts to open protected markets to imports and foreign direct investment than from government efforts to support certain domestic industries in a manner consistent with the recommendations of strategic trade policy.

This conclusion is reinforced by a phenomenon that we touched on in Chapter 1, the increasing integration of the world economy and internationalization of production that has occurred over the past two decades. We live in a world where many firms of all national origins increasingly depend for their competitive advantage on globally dispersed production systems. Such systems are the result of free trade. Free trade has brought great advantages to firms that have exploited it and to consumers who benefit from the resulting lower prices. Given the danger of retaliatory action, business firms that lobby their governments to engage in protectionism must realize that by doing so they may be denying themselves the opportunity to build a competitive advantage by constructing a globally dispersed production system. Also, by encouraging their governments to engage in protectionism, their own activities and sales overseas may be jeopardized if other governments retaliate.