The Political Economy of International Trade

The opening case examines why global food prices are rising significantly. For more than two decades, improvements in agricultural productivity and output have contributed to lower food prices, but in 2007, the price of wheat was double its price of just a few months earlier, and the price of corn had risen some 60 percent. Two explanations for the phenomenon are increased demand, and the effects of tariffs and subsidies for bio-fuels. Discussion of the case can revolve around the following questions: Food prices have risen dramatically since 2007.

Reflect on the reasons for the price increase, and discuss the implications of higher prices for consumers in developed and developing countries. For decades, consumers have enjoyed the benefits of increased productivity and output in the global food industry. In 2007, however, everything changed. The price of wheat reached its highest point ever, and the price of corn rose 60 percent over its 2006 price. Two factors contributed to this situation. The first was the increased demand for food from China and India. The second factor involved tariffs and subsidies for bio-fuels.

Farmers in the European Union and in the United States are currently the recipients of subsidies for the production of crops used in bio-fuels. As a result, land that might be used for growing food is being converted to bio-fuel crops, pushing up prices on food. While some experts believe that sugar cane may be a better product for bio-fuel production than corn, tariffs on imported sugar cane effectively are keeping the crop out of the market. While all consumers are feeling the pain of higher food prices, the situation is especially dire for consumers in poor countries where calorie intake could be reduced by as much as -8 percent by 2020.

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How has demand for bio-fuels affected the price of food? What are the implications of this trend? Reflect on the role of government in pushing prices up. What role do tariffs and subsidies play in the situation? In your opinion, should the governments of the United States and the European Union bear any responsibility for bringing food prices back down?  In an effort to slow global warming, both the European Union and the United States have adopted policies designed to increase the production of ethanol and bio-diesel.

The policies involve providing subsidies to farmers. The net effect of the subsidies is to encourage farmers to produce less food, and more crops that can be used in bio-fuel production. The situation is exacerbated by high tariffs on alternative products that can be used for bio-fuel production – particularly sugar cane. Most students will recognize that the combined effect of the subsidies and tariffs are creating a difficult situation for consumers, while at the same time protecting producers. Some students may note the irony of the situation.

Consumers, hit by higher prices at the pump are putting more pressure on companies to develop cheaper and more environmentally friendly sources of energy, but in doing so are actually contributing to higher prices at the grocery store. Some students may wonder whether it makes more sense to consider non-food related sources of energy.

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. While many nations are nominally committed to free trade, they tend to intervene in international trade to protect the interests of politically important groups. The major objective of this chapter is to describe how political realities have shaped, and continue to shape, the international trading system. In this section, the text reviews seven main instruments of trade policy.

These are: tariffs, subsidies, import quotas, voluntary export restraints, local content requirements, antidumping policies and administrative policies.  A tariff is a tax levied on imports (or exports) that effectively raises the cost of imported (or exported) products relative to domestic products. Specific tariffs are levied as a fixed charge for each unit of a good imported, while ad valorem tariffs are levied as a proportion of the value of the imported good. The important thing to understand about a tariff is who suffers and who gains. The government gains, because the tariff ncreases government revenues. Domestic producers gain, because the tariff affords them some protection against foreign competitors by increasing the cost of imported foreign goods. Consumers lose since they must pay more for certain imports. Thus, tariffs are unambiguously pro-producer and anti-consumer, and tariffs reduce the overall efficiency of the world economy. A subsidy is a government payment to a domestic producer. By lowering costs, subsidies help domestic producers in two ways: they help producers compete against low-cost foreign imports and they help producers gain export markets.

However, many subsidies are not that successful at increasing the international competitiveness of domestic producers. Moreover, consumers typically absorb the costs of subsidies. Country Focus: Subsidized Wheat Production in Japan Summary This feature explores the subsidies Japan continues to pay its wheat farmers. Tens of thousands of Japanese farmers continue to grow wheat despite the fact that the wheat grown in North America, Argentina, and Australia is far cheaper and of superior quality. The Japanese farmers stay in business thanks to the hefty subsidies paid by the Japanese government.

As a result, wheat prices in Japan are substantially higher than they would be if a free market were allowed to operate.  Who are the winners and who are the losers from Japanese wheat subsidies? Students will probably recognize that, as is usually the case with protectionist measures, the subsidies Japan pays its wheat farmers benefit the farmers, but cost the average consumer in the form of higher wheat prices. In fact, in 2004, Japanese consumers covered $700 million in subsidies!

The subsidies also limit imports of wheat, which negatively affects foreign wheat farmers.  Why does Japan continue to subsidize its wheat farmers when cheaper wheat is readily available in international markets?  Thanks to subsidies, wheat prices in Japan are between 80 and 120 percent higher than they are in world markets. In fact, if the subsidies were eliminated, Japanese wheat production would cease entirely. However, at least for now, because politicians count on the votes of the wheat farmers, there appears to be no plan to end the subsidies.

An import quota is a direct restriction on the quantity of some good that may be imported into a country. A tariff rate quota is a hybrid of a quota and a tariff where a lower tariff is applied to imports within the quota than to those over the quota. A voluntary export restraint is a quota on trade imposed by the exporting country, typically at the request of the importing country’s government. While import quotas and voluntary export restraints benefit domestic producers by limiting import competition, they raise the prices of imported goods. The extra profit that producers make when supply is artificially limited by an import quota is referred to as a quota rent. A local content requirement demands that some specific fraction of a good be produced domestically.

As with import quotas, local content requirements benefit domestic producers, but consumer face higher prices. Administrative trade polices are bureaucratic rules that are designed to make it difficult for imports to enter a country. The effect of these polices is to hurt consumers by denying access to possibly superior foreign products. Dumping is variously defined as selling goods in a foreign market below their costs of production, or as selling goods in a foreign market at below their “fair” market value.

Dumping is viewed as a method by which firms unload excess production in foreign markets. Alternatively, some dumping may be the result of predatory behavior, with producers using substantial profits from their home markets to subsidize prices in a foreign market with a view to driving indigenous competitors out of that market. Once this has been achieved the predatory firm can raise prices and earn substantial profits. J) Antidumping polices (also known as countervailing duties) are policies designed to punish foreign firms that engage in dumping. The ultimate objective is to protect domestic producers from “unfair” foreign competition.

This feature explores the dumping charged levied by U. S. Magnesium against Chinese and Russian producers. According to U. S. Magnesium, the sole American producer of magnesium, Russian and Chinese producers were selling magnesium significantly below market value in an effort to drive U. S. Magnesium out of business. The company failed a complaint with the International Trade Commission (ITC) which ultimately ruled in favor of U. S. Magnesium. Suggested Discussion Questions 1. What is dumping? Were Chinese and Russian producers guilty of dumping? How did U. S. Magnesium justify its claims against Russian and Chinese producers?  Dumping is defined as selling goods in a foreign market below the cost of production, or below fair market value.

In 2004, U. S. Magnesium claimed that China and Russia had been dumping magnesium in the United States. The company noted that in 2002 and 2003, magnesium imports rose, and prices fell. While the ITC ruled in favor of the American company, some students might question whether the fact that the Chinese could sell their product at low prices might simply reflect the country’s significantly lower wage rates. . What does the ITC’s ruling mean for American consumers of magnesium? In your opinion, was the ruling fair? Discussion Points: The ITC ruled in favor of U. S. Magnesium finding that indeed China and Russia had been dumping their product in the United States. Fines ranging from 50 to 140 percent on imports were imposed against China, and 19 to 22 percent on Russian companies. Most students will note that while the ITC’s decision is a good one for U. S. Magnesium and its employees. for consumers, the ruling means magnesium prices that are significantly higher than those in world markets.

In general, there are two types of arguments for government intervention, political and economic. Political arguments for intervention are concerned with protecting the interests of certain groups within a nation (normally producers), often at the expense of other groups (normally consumers). Economic arguments for intervention are typically concerned with boosting the overall wealth of a nation (to the benefit of all, both producers and consumers). Political Arguments for Intervention B) Political arguments for government intervention cover a range of issues including protecting jobs, protecting industries deemed important for national security, retaliating against unfair foreign competition, protecting consumers from “dangerous” products, furthering the goals of foreign policy, and protecting the human rights of individuals in exporting countries.

The most common political reason for trade restrictions is "protecting jobs and industries. " Usually this results from political pressures by unions or industries that are threatened by more efficient foreign producers, and have more political clout than the consumers who will eventually pay the costs. Protecting industries because they are important for national security is another argument for trade restrictions. The U. S. overnment protects industries like steel, aerospace, and electronics, on the basis of this argument, and has made special arrangements to protect the semiconductor industry. Lecture Note: In the United States, the Bureau of Export Administration enhances the nation's security and its economic prosperity by controlling exports for national security, foreign security, foreign policy, and short supply reasons.

Government intervention in trade can be used as part of a "get tough" policy to open foreign markets. By taking, or threatening to take, specific actions, other countries may remove trade barriers. But when threatened governments do not back down, tensions can escalate and new trade barriers may be enacted.  Consumer protection can also be an argument for restricting imports. The Country Focus below suggests that the European Union’s concern over beef was, in part, due to an interest in protecting consumers. Since different countries do have different health and safety standards, what may be acceptable in one country may be unacceptable in others.  On occasion, governments will use trade policy to support their foreign policy objectives.

One aspect of this is to grant preferential trade terms to countries that a government wants to build strong relations with. Trade policy has also been used several times as an instrument for pressuring punishing “rogue states” that do not abide by international laws or norms. In recent years the United States has imposed trade restrictions against Libya, Iran, Iraq, North Korea, Cuba, and other countries where governments were pursuing policies that were not viewed favorably by the U. S. government.

A serious problem with using trade as an instrument of foreign policy is that other countries can undermine any unilateral trade sanctions. The U. S. Congress has passed two acts, the Helms-Burton Act and the D’Amato Act, in an effort to protect American companies from such actions. Protecting Human Rights H) Concern over human rights in other countries plays an important role in foreign policy. Governments sometimes use trade policy to improve the human rights policies of trading partners. Governments also use trade policies to put pressure on governments to make other changes.

Unless a large number of countries choose to take such action, however, it is unlikely to prove successful. Some critics have argued that the best way to change the internal human rights of a country is to engage it in international trade. The decision to grant China most favored nation status was based on this philosophy. Country Focus: Trade in Hormone-Treated Beef Summary This feature describes the trade battle between the United States and the European Union over beef from cattle that have been given growth hormones.

It outlines the basic issues that led to the dispute, and shows how the World Trade Organization has treated the case. Suggested Discussion Questions 1. Why is the European Union so concerned about beef from cattle that have been given growth hormones? Discussion Points: Some students may argue that the European Union’s ban on growth hormones in cattle was little more than a thinly veiled form of protectionism. Australia, New Zealand, and Canada, which also use the hormones in their cattle industry, were also affected by the ban.

The European Union claimed that it was merely protecting the health of its citizens, however studies showed that the hormones posed no health issues for people. Why did the WTO rule against the European Union? Discussion Points: The World Trade Organization ruled against the European Union stating that the European Union’s ban on imported hormone treated beef had no scientific justification. Even so, the European Union refused to lift the ban, which had strong public support, and in the end, the European Union was assessed punitive tariffs.

The European Union held on to its principles though, and as of 2008, continued to maintain its restrictions on hormone treated beef despite the resulting punitive tariffs.  The WTO maintains a site for students.  Economic arguments for intervention include the infant industry argument and strategic trade policy. The Infant Industry Argument

The infant industry argument suggests that an industry should be protected until it can develop and be viable and competitive internationally. Unless an industry is allowed to develop and achieve minimal economies of scale, foreign competitors may undercut prices and prevent a domestic industry from developing. The infant industry argument has been accepted as a justification for temporary trade restrictions under the WTO. A problem with the infant industry argument is determining when an industry "grows up. " Some industries that are just plain inefficient and uncompetitive have argued they are still infants after 50 years.

The other problem is that given the existence of global capital markets, if the country has the potential to develop a viable competitive position its firms should be capable of raising the necessary funds without additional support from the government.  Strategic trade policy suggests that in cases where there may be important first mover advantages, governments can help firms from their countries attain these advantages. Strategic trade policy also suggests that governments can help firms overcome barriers to entry into industries where foreign firms have an initial advantage.

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