The Nature of International Business – Part 3
Welcome to the sixth session of the International Socio-Economic Context Course. This class finishes the review of The Nature of International Business Chapter that aims for the general comprehension of enterprises which have international activities.
In this session, the role of Central Governments in establishing trade policy and providing environments that support or restrict international trade will be reviewed. This is important because for a MNC Manager it is important to realize that any MNC has different constraints in a house country than those prevalent in their origin country.
So, by the end of this class you will know how significant is the Government for the operation of a MNC, the different ways it has to promote or inhibit the development of international commercial operations and how this might directly affect the decisions of the enterprises.
Government Involvement in Trade Restrictions and Incentives
According to Ajami R., & Goddard J. G. (2015), all governments attempt to restrict or support international trade or transfers of resources. This intervention can take the form of controlling the flow of trade and transfer of goods, controlling the transfer of capital flows, or controlling the movement of personnel and technology. Rationales for intervention vary but fall into several patterns, all of which are based on the notion that the governmental actions will promote the best interests of the nation.
Governments may be motivated by economic goals, such as increasing revenues or the supply of hard currency in the country. They also may have economic or monetary considerations in equalizing balances of trade or keeping inflation to a minimum. They may cite country objectives, such as maintaining self-sufficiency, economic independence, and national security. There may be specific concerns in the country regarding the welfare of the populace, such as health and safety considerations or full employment goals. Political objectives also play a major role in establishing trade policy by governments.
Protectionism refers to government intervention in trade markets to protect specific indus- tries in its economy. Impetus for protecting industries comes from special-interest groups within different sectors of the economy who plead their case for protecting domestic capacity and production facilities. Many believe that calls for protectionism should be interpreted as a need for the country to make structural changes in its industrial base in order to increase its competitiveness in foreign markets, rather than have the government intervene in order to support inefficient industries.
One rationale promulgated for protecting industry is to ensure full employment. This argument holds that the substitution of imports for domestic products causes jobs to be lost at home and that protecting industries is necessary for a strong domestic employ- ment base.
A second rationale is protecting infant industries, which is especially true in less- developed and developing countries. The infant-industry justification holds that newly established industries cannot compete effectively at first against established giants from industrialized nations. Consequently, the industry is protected (theoretically) until such time as it can grow to achieve economies of scale and operational efficiencies matching those of its major competitors. Under this scenario, difficulties occur when the time comes to withdraw such protection, which by then has become institutionalized and is vocifer- ously defended by industry participants. This argument was first made by Alexander Hamilton, the first US secretary of the Treasury, in 1792. Hamilton wanted to protect the fledgling industries of the new nation from European competition (he also advocated the idea of not recognizing foreign patents and copyrights for similar competitive reasons).
A third rationale for protecting specific industries is that the industrialization objectives of a country justify a promotion of specific sectors of the economy in order to diversify the economic structure. Thus, protection and incentives are given to those industries that are expected to grow quickly, bring in investment dollars, and yield high marginal returns. For this reason, many developing countries attempt to promote the growth of industries that provide high value-added materials and emphasize the use of agricultural or locally available primary raw materials.
The ultimate rationale for protectionism is more accurately based in emotionalism than in sound economic arguments, and its cost is high. Protectionism leads to higher prices for consumers for imported products and components. It may lead to retaliation by importing countries, which may reduce the home country’s exports abroad and employment in local markets. Protectionism also may increase opportunity costs by allocating the resources of a country inappropriately and at the expense of other sectors of the industrial base of the economy.
Governmental intervention in markets takes several different forms. The primary and most direct method is through the application of tariffs to exports or imports. A less direct method is the application of non tariff barriers.
Tariffs or duties are a basic method of intervention that may be used to protect industries by raising the price of imports, to bring import prices even with domestic prices, or to generate revenues. Tariffs may be placed on goods leaving the country as export duties or on goods entering the country as import duties. They are the most typical controls on imports. Tariffs are assessed in three different ways:
- Ad valorem duties are assessed on the value of the goods and are levied as a percentage of that value.
- Specific duties are assessed according to a physical unit of measurement,such as per ton, per bushel, or per meter, and are stipulated at a specific monetary value.
- Compound tariffs are a combination of ad valorem and specific duties.
World Trade Organization
The purpose of the WTO is to establish an umbrella under which its signatory members can meet to establish reciprocal reductions in tariffs and the liberalization of trade in a mutual and nondiscriminatory manner. A major objective of the body is to extend tariff accords and most-favored-nation status to all members. Under the WTO, methods and rules of trade liberalization are established with provisions for monitoring trade activity, enforcement, and the settling of disputes. WTO rules allow for certain exceptions to reduce trade barriers, such as allowing countries to continue to provide support for domestic agriculture and for developing countries to protect infant industries.
Reductions in trade barriers are achieved through the meeting of the signatories in nego- tiating sessions, or trade rounds. These meetings are held periodically to discuss the further lowering of barriers to trade. In recent rounds, WTO members have attempted to deal with nontariff problems and other current issues, such as trade in agriculture and services, technology transfer, and non monetary barriers put up by countries to discourage free trade.
Regional Trade Groups
Trade groups organized along regional or political lines are less pervasive and influential. Two major regional trading groups are the European Union (EU), which is composed of twenty-eight European countries, and the North American Free Trade Agreement (NAFTA), which consists of the United States, Canada, and Mexico.
Traditionally, trade groups have also been organized according to specific commodity types and agreements that allow for monitoring and/or controlling the supply of those com- modities. Ten such basic commodities have been identified by the United Nations: coffee, cocoa, tea, sugar, cotton, rubber, jute, sisal, copper, and tin. Some of these commodities are traded on open and free markets, where their prices fluctuate to a great degree. Sales of other commodities—such as sugar, rubber, tin, cocoa, and coffee—have historically come under the aegis of international commodity agreements that promote use of import and export quotas and a system of buffer stocks. In today’s marketplace, prices are subject to market pressure, so these types of groups are less meaningful than they have been in the past. Other trade groups are organized among producers, consumers, or both.
Generally, under these agreements prices are allowed to move up and down within a certain range, but if the price moves above or below that range, an outside collective agency is authorized to buy or sell the commodity to support its price. Similarly, a com- modity agreement may provide for quotas on exports from individual supply countries to limit supplies of the commodities on world markets, thus shoring up prices.
Another form of a commodity agreement group is the cartel, in which a group of com- modity-producing countries join forces to bargain as a single entity in world markets. A cartel can be formed only when there is a relatively small group of producers who hold an oligopoly position—that is, they control the bulk of the commodity supply. The most notable cartel in recent years has been the Organization of Petroleum Exporting Coun- tries (OPEC), which has a membership of twelve oil-producing nations. It is composed of six Middle Eastern countries—and six other oil-producing countries in the world.
Frequently, cartels fail because members violate their agreements by dropping prices or raising production and forcing the other members back into a competitive position.
Nontariffs Barriers to Merchandise Trade
Nontariff barriers have become a controversial topic in trade activity over the past decade. They are a matter of concern because they are not traditional methods of discouraging imports through the application of duties. Instead, they work to slow the flow of goods into a country by increasing the physical and administrative difficulties involved in importing.Nontariff barriers can take a number of forms that provide effective restraints on trade.
- Government discrimination against foreign suppliers in bidding procedures • Highly involved and rigorous customs and country-entry procedures
- Excessively severe inspection and standards requirements
- Detailed safety specifications and domestic testing requirements
- Required percentages of domestic content material
Some nations regulate the consumption of certain products that they deem harmful to their citizens. Canada, for example, has strict entry requirements for individuals and companies that are bringing tobacco products into the country. Other countries attempt to control the amount of a certain product being imported by returning entire shipments of goods just because one sample failed to meet the acceptable standards.
Some countries have restrictions on services, such as prohibiting transportation carri- ers from serving specific destinations or only allowing advertising that features models of that country’s nationality.
The most widely used method of restricting quantity, volume, or value-based imports are the imposition of quotas upon imports into a country. These quotas may be unilateral according to commodity and stipulate that only a certain aggregate amount of the import from any source may enter a country. Alternatively, they can be selective on a country or regional basis. A type of quota is an embargo, which prohibits all trade between countries. Another type, encountered only in recent trade history, is the voluntary entry restriction, in which foreign countries that agree to restrict their exports to a country are actually forced into compliance through the use of direct or subtle political pressure by major trading partners.
While the imposition of quotas may impede the flow of imports into a country, it does little to help that country find a level of readjustment; that is, it does nothing in the way of leading to lowered domestic prices. It often leads to higher import prices.
The imposition of quotas also causes serious administrative problems for the authorities of both the importing and exporting countries. Once quotas are imposed, the amount of goods to be sent from the exporting country is not determined by market demand but by an arbitrary ceiling. The quantity of goods allowed to be exported under the quota ceilings are often much lower than the normal export levels, which implies that all exporters of the affected country cannot export at their previous levels. The new levels have to be determined by the authorities, which for large, widespread export industries is an expensive and cumbersome process. Problems arise for the importing country because the imported quantities under the quota rules are not adequate to meet market demand, so the govern- ment has to take over the role of the market in allocating the available goods imported under quota rules. Apart from the expense and delays of the administrative process that is required to accomplish non market distribution of imported goods, there is also the danger of creating inequities, because it is often difficult to verify genuine needs and claims.
Non tariff trade barriers
Nontariff and competitive barriers can also be implemented as adjustments in prices. For example, some countries use subsidies to enhance the competitiveness of their exports in international markets. In a well-known WTO dispute, the United States insisted that Canada had subsidized its softwood lumber industry, a charge that Canada denied. The subsidized industry would have then been able to sell its product in the United States at a much reduced cost, thereby gaining a competitive advantage.
Some countries raise the effective costs of exporting by assessing special fees for importing, requiring customs deposits, or establishing minimum sales prices in foreign markets, thereby making it less profitable for exporters to send goods to their markets. Similarly, the manipulation of exchange rates can affect the position of a country’s goods in overseas markets because undervaluing one’s currency exchange rate will make that country’s goods more competitive abroad. Another type of non tariff price barrier is erected by valuing imports at customs under the ad valorem method of assessing tariffs. Countries can vary their valuation criteria and value goods at their own country’s retail prices rather than at the wholesale/invoice prices being paid by the importer.
In determining the appropriate pricing levels for tariffs in the event of disputes, one would first use the invoice price, then the price of identical goods, then similar goods. A particular problem arises when goods are entering a market-based economy from a centrally planned or non-market economy where there is no established pricing structure or valuation procedure.
Government restrictions on Exports
In addition to controlling or taxing national imports, governments often have laws and regulations that limit certain types of exports generally or to specific countries. Govern- ments apply these limits to maintain domestic supply and price levels of goods, to keep world prices high, or to meet national defense, political, or environmental goals.
A Government can play a key role in the development of trade not only domestically but also internationally. In this session the different ways the Government can control the trade flows were explained and also, some forms of integration in which the nations Governments can act grupally for one same goal.
As a general overview, in this session some of the most important regulatory institutions of global trade were introduced as a complementary source of control. It was explained why Governments are interested in trying to regulate imports and exports and the tools and strategies usually used for those purposes.
- Ajami R., & Goddard J. G. (2015). International Business: Theory and Practice. Routledge (46-53)
- UNCTAD Online (September 25th,, 2019). What are Non-tariff measures (NTMs) https://www.youtube.com/watch?v=-J2lsSVjI0s&ab_channel=UNCTADOnline