Chapter 5 Outline

Introduction

Our review of the classical trade theories of Smith, Ricardo, and Heckscher-Ohlin in Chapter 4 showed us that in a world without trade barriers, trade patterns will be determined by the relative productivity of different factors of production. Countries will specialize in the production of products that they can produce most efficiently, while importing products that they can produce less efficiently. Chapter 4 also laid out the intellectual case for free trade. Remember, free trade refers to a situation where a government does not attempt to restrict what its citizens can buy from another country or what they can sell to another country. As we saw in Chapter 4, the theories of Smith, Ricardo, and Heckscher-Ohlin predict that the consequences of free trade include both static economic gains (because free trade supports a higher level of domestic consumption and more efficient utilization of resources) and dynamic economic gains (because free trade stimulates economic growth and the creation of wealth).

In this chapter, we look at the political reality of international trade. While many nations are nominally committed to free trade, in practice nations tend to intervene in international trade. The nature of these political realities are amply illustrated in the case that opens this chapter. The case describes how the decision by the European Union (EU) to ban hormone-treated beef in Europe has given rise to a contentious trade dispute between the EU and several beef-producing countries such as Canada and the United States. The EU banned the sale of hormone-treated beef for political reasons--it wanted to soothe concerns in Europe about the potential health effects of such meat, even though such concerns have no basis in scientific fact. However, the EU is also a member of the World Trade Organization and has to abide by its rules if it wants to enjoy the benefits of membership. Unfortunately for the EU, the WTO ruled that the EU ban is illegal. This decision has placed the EU between a rock and a hard place. On the one hand, the EU is under considerable political pressure from consumer groups within Europe to maintain the ban. On the other, it wants to play by the rules of the WTO--rules that have brought significant benefits to the EU (as we shall discuss later in this chapter). Exactly how the EU will solve this dilemma remains to be seen. For the time being, it looks like it will keep the ban, pay a penalty for violating WTO rules, and continue to search for scientific evidence to support its position.

In this chapter, we explore the political and economic reasons for intervening in international trade. When governments intervene, they often do so by restricting imports of goods and services into their nation, while adopting policies that promote exports. Normally their motives for intervention are to protect domestic producers and jobs from foreign competition, while increasing the foreign market for domestic products. However, as the opening case illustrates, in recent years "social" issues have tended to intrude in the decision making. The decision by the EU to ban imports of hormone-treated beef, for example, was only tangentially influenced by a desire to protect the jobs of beef producers in Europe. Rather, it was a political response to social concerns about the health consequences of hormone-treated beef. Social issues are also entering into the trade calculus in other countries. In the United States, for example, there is a movement to ban imports of goods from countries that do not abide by the same labor, health, and environmental regulations as the United States does.

We start this chapter by describing the range of policy instruments that governments use to intervene in international trade. This is followed by a detailed review of the various political and economic motives that governments have for intervention. In the third section, we consider how the case for free trade stands up in view of the various justifications given for government intervention in international trade. Then we look at the emergence of the modern international trading system, which is based on the General Agreement on Tariffs and Trade (GATT) and its successor, the World Trade Organization. The GATT and WTO are the creations of a series of multinational treaties. The most recent was completed in 1995, involved over 120 countries, and resulted in creation of the WTO. The purpose of these treaties has been to lower barriers to the free flow of goods and services between nations. Like the GATT before it, the WTO promotes free trade by limiting the ability of national governments to adopt policies that restrict imports into their nations. In the final section of this chapter, we discuss the implications for business practice.