Chapter 5 Outline

Chapter Summary

This chapter described how the reality of international trade deviates from the theoretical ideal of unrestricted free trade that we reviewed in Chapter 4. In this chapter, we reviewed the various instruments of trade policy, reviewed the political and economic arguments for government intervention in international trade, reexamined the economic case for free trade in light of the strategic trade policy argument, and looked at the evolution of the world trading framework. We concluded that, while a policy of free trade may not always be the theoretically optimal policy (given the arguments of the new trade theorists), in practice it is probably the best policy for a government to pursue. The long-run interests of businesses and consumers may be best served by strengthening international institutions such as the WTO and the GATT. Given the danger that isolated protectionism might escalate into a trade war, business probably has far more to gain from government efforts to open protected markets to imports and foreign direct investment (through the WTO) than from government efforts to protect domestic industries from foreign competition.

This chapter made the following points:

1. The effect of a tariff is to raise the cost of imported products. Gains accrue to the government (from revenues) and to producers (who are protected from foreign competitors). Consumers lose because they must pay more for imports.

2. By lowering costs, subsidies help domestic producers compete against low-cost foreign imports and gain export markets. However, subsidies must be paid for by taxpayers. They also tend to be captured by special interests who use them to protect the inefficient.

3. An import quota is a direct restriction imposed by an importing country on the quantity of some good that may be imported. A voluntary export restraint (VER) is a quota on trade imposed from the exporting country's side. Both import quotas and VERs benefit domestic producers by limiting import competition, but they result in higher prices, which hurts consumers.

4. A local content requirement demands that some specific fraction of a good be produced domestically. Local content requirements benefit the producers of component parts, but they raise prices of imported components, which hurts consumers.

5. An administrative policy is an informal instrument or bureaucratic rule that can be used to restrict imports and boost exports. Such policies benefit producers but hurt consumers, who are denied access to possibly superior foreign products.

6. There are two types of arguments for government intervention in international trade: political and economic. Political arguments for intervention are concerned with protecting the interests of certain groups, often at the expense of other groups, or with promoting goals with regard to foreign policy, human rights, consumer protection, and the like. Economic arguments for intervention are about boosting the overall wealth of a nation.

7. The most common political argument for intervention is that it is necessary to protect jobs. However, political intervention often hurts consumers and it can be self-defeating.

8. Countries sometimes argue that it is important to protect certain industries for reasons of national security.

9. Some argue that government should use the threat to intervene in trade policy as a bargaining tool to open foreign markets. This can be a risky policy; if it fails the result can be higher trade barriers.

10. The infant industry argument for government intervention is that governments should temporarily support new industries to let manufacturing get a toehold. In practice, however, governments often end up protecting the inefficient.

11. Strategic trade policy suggests that with subsidies, governments can help domestic firms gain first-mover advantages in global industries where economies of scale are important. Government subsidies may also help domestic firms overcome barriers to entry into such industries.

12. The problems with strategic trade policy are twofold: (i) Such a policy may invite retaliation, in which case all will lose, and (ii) strategic trade policy may be captured by special interest groups, who will distort it to their own ends.

13. The Smoot-Hawley tariff, introduced in 1930, erected an enormous wall of barriers to US imports. Other countries responded by adopting similar tariffs, and the world slid further into the Great Depression.

14. The GATT was a product of the post-war free trade movement. The GATT was successful in lowering trade barriers on manufactured goods and commodities. The move toward greater free trade under the GATT appeared to stimulate economic growth.

15. The completion of the Uruguay Round of GATT talks and the establishment of the World Trade Organization have strengthened the world trading

    system by extending GATT rules to services, increasing protection for intellectual property, reducing agricultural subsidies, and enhancing monitoring and enforcement mechanisms.

16. Trade barriers constrain a firm's ability to disperse its various production activities to optimal locations around the globe. One response to trade barriers is to establish more production activities in the protected country.

17. Business may have more to gain from government efforts to open protected markets to imports and foreign direct investment than from government efforts to protect domestic industries from foreign competition.