Government Intervention in the Global Business

Government Intervention

•       Governments intervene in trade and investment to achieve political, social, or economic objectives.

•       Governments impose trade and investment barriers that benefit interest groups, such as domestic firms, industries, and labor unions.

•       Government intervention alters the competitive landscape, by hindering or helping the ability of firms to compete internationally.

•       Government intervention is an important dimension of country risk.

•       Protectionism — national economic policies that restrict free trade. Usually intended to raise revenue or protect domestic industries from foreign competition.

Customs — the
checkpoint at national
ports of entry where
officials inspect imported
goods and levy tariffs

Key Instruments

•       Tariff

•       Nontariff trade barrier

•       Import quotas

•       Arbitrary administrative regulations

•       Investment barriers

•       Subsidies

Trade Policy Instruments

•       Tariffs

»        Specific Tariff-fixed charge on each unit of imported good ($3 per barrel of oil)

»        Ad Valorem Tariff – proportion of the value of imported good

•       Why of tariffs? – raise revenue, make foreign goods more expensive, protect infant industries

•       Prohibitive, protective, and revenue tariffs

•       Who wins and who loses? (e.g., recent steel tariffs by the U.S.)

Example of Protectionism: U.S. Steel Industry

•       The Bush administration imposed tariffs on imports
of foreign steel to protect U.S. steel manufacturers from foreign competition, aiming to give the U.S. steel industry time to restructure and revive itself.

•       However. It resulted in:

§  higher steel costs;

§  increased production costs for firms that use steel, such as Ford, Whirlpool and General Electric

§  reduced prospects for selling products in world markets, making U.S. steel firms less competitive.

•       The steel tariffs were removed within two years.

The Politics of the US Steel Tariffs…. 

•       Steel production in the USA is concentrated in states such as - Pennsylvania, West Virginia, and the Carolinas – all which were considered key battle grounds in George Bush’s re-election campaign in 2004 (when he ran for office the second time). 

•       Steel tariffs were introduced in 2002, the affect of which was enjoyed by US steel producers in 2003 (directly before, and   during the re-election campaign).

–      Was government intervention politically   or economically motivated?

Quotas (Non-Tariff Barriers)

•          Quotas

»        Direct restriction on quantity of goods imported into a country (e.g., Sugar)

»        Voluntary Export Restraints (VER): quota imposed by exporting country, at the request of importing country (e.g., Japanese autos in the U.S.)

•          Why of quotas? – protect domestic producers, save jobs

•          Who wins and who loses?

Example of Protectionism: Auto Industry

•       In the 1980s, the U.S. government negotiated a voluntary export restraints (quotas) on imports of cars from Japan, to insulate the U.S. auto industry from Japanese competition.

§  Result 1: Detroit automakers had less of an incentive to improve quality, design, and overall product appeal.

§  Result 2: Detroit’s ability to compete in the global auto industry weakened.

Arbitrary administrative regulations

•          Bureaucratic/administrative processes designed to discourage imports

•          Japanese probably the master:

•          Netherland exports tulip bulb to almost every country in the world

•          Japanese customs check every single bulb by cutting it vertically down the middle

•          Example 2 - FedEx: Japanese customs insist in opening every package

Subsidies

•          Subsidies

»        Government payment to a domestic producer (agriculture, aircraft)

»        Lowering production costs to make imports less and exports more attractive (tax breaks, infrastructure construction, or government contracts at inflated prices).

Examples

•       In China, Shanghai Automotive ($12b ann. sales) and numerous other MNEs are partly owned by the Chinese government and receive huge financial resources.

•       Europe and the U.S. provide huge agricultural subsidies to farmers.  EU subsidies represent 40% of the EU budget.

Trade Policy Instruments: Non-tariff Barriers

•          Local Content Requirements: specific fraction of good to be produced domestically or regionally

•          Dumping: selling goods abroad at prices below that of domestic or costs of production

Consequences of Protectionism

•       Reduced supply of goods to buyers

•       Price inflation

•       Reduced variety, fewer    choices available to buyers

•       Reduced industrial competitiveness

•       Various adverse unintended consequences (e.g., while the home country dithers, other countries can race ahead)

Cost of Protectionism to the USA?

Example..

•       While the USA is one of the most open economies in the world with few import tariffs, a recent study suggested that import protection costs US consumers up to $223.4 billion a year in higher prices!!

–      H.J. Wall, “Using the Gravity Model to Estimate the Costs of Protectionism,”                         Federal Reserve Bank of St         Louis review, Jan-Feb, 1999, pp. 33-40  

General Rationale for Government Intervention

•       Tariffs can generate substantial government revenue.  This is a key rationale for protectionism in undeveloped economies. 

•       Helps ensure the safety, security, and welfare of citizens.  e.g., most countries have basic regulations to protect the national food supply.

•       Helps the government pursue broad economic, political, and social objectives for the nation.

•       Can serve the interests of the nation’s firms and industries.

Defensive Rationale for Government Intervention

•       Protection of the national economy – weak or young economies sometimes need protection from foreign competitors. e.g., India imposed barriers to shield its huge agricultural sector, which employs millions.

•       Protection of an infant industry – a young industry may need protection, to give it a chance to grow and succeed.  E.g., Japan long protected its car industry.

•       National security – the United States prohibits exports of plutonium and similar products to North Korea.

•       National culture and identity – Canada restricts foreign investment in its movie and TV industries

•       Protecting consumers – e.g., European bans on Hormone treated beef.

•       Early 90’s EU bars growth hormone treated beef.

•       US exports decline form $231mm in ‘88 to $98mm in ‘94.

•       With other countries, US files complaint to World Trade Organization.

•       WTO Panel declares ban to be illegal as no risk to consumer health is found to exist with hormone treated beef.

•       EU reluctant to comply and appeals, but loses the appeal.

•       1999 – US and other  allowed to raise tariffs on     hundreds of EU products to compensate for loss in agricultural trade.

Offensive Rationale for Government Intervention

•       National strategic priorities – protection helps ensure the development of industries that bolster the nation’s economy.  Countries create better jobs and higher tax revenues when they support high value-adding industries, such as IT, automotive, pharmaceuticals, or financial services.

•       Increase employment – protection helps preserve domestic jobs, at least in the short term.  However, protected industries become less competitive over time, especially in global markets, leading to job loss in the long run.

Types and Effects of Government Intervention

 Sample of Import Tariffs

Average Tariff Rates Over Time, %

Relationship between Tariffs, World GDP, and the Volume of World Trade

Tariffs are Widespread

•       Harmonized code – standardized worldwide system that determines tariff amount for about 8000 products.

•       In developing economies, tariffs are common.

•       In advanced economies, tariffs still provide significant revenue.

•       For example, in a given year the U.S. collects more tariff revenue on shoes than on cars (e.g., $1.63 billion versus $1.60 billion).

•       The European Union applies tariffs up to 215% on meat, 116% on cereals, and 17% on tennis shoes.

Import Tariffs Have Been Declining

•       Governments have reduced tariffs over time, mainly via the General Agreement on Tariffs and Trade (GATT), which became the World Trade Organization (WTO).

•       Economic integration also leads to lower tariffs, but only within economic blocs.  E.g., under NAFTA, Mexico eliminated nearly all tariffs on imports from the U.S., but maintains tariffs with the rest of the world.

•       China reduced its tariffs since joining the WTO  in 2001.  

•       Firms bypass tariffs by entering countries via FDI.  E.g., Toyota built factories in the U.S. partly to avoid tariffs.

Import Substitution vs. Export Led Development

•       Import substitution is a policy of restricting imports in order to protect home-country firms.  It was widely tried in Latin America in the 1950s, in an effort to promote industrialization and economic development. But most countries eventually rejected import substitution. 
By contrast,….

•       Export-led development was tried in Singapore, Hong Kong, Taiwan, South Korea, and other Asian countries. This model, which encouraged the development of export-intensive industries, proved very successful and led to rapid economic growth and high living standards.

Evolution of Government Intervention

•       Protectionist tendencies, the Great Depression, and isolationism shaped early 20th century world trade.

•       The Smoot-Hawley Act (1930) raised U.S. tariffs to more than 50% (compared to only 3% today).

•       Progressive trade policies reduced tariffs after WWII.

•       In 1947, 23 nations signed the General Agreement
on Tariffs and Trade (GATT).  The GATT:

§  reduced tariffs via continuous worldwide
trade negotiations;

§  created an agency to supervise world trade; and

§  created a forum for resolving trade disputes.

The GATT

•       The GATT introduced the concept of most favored nation (renamed normal trade relations), according to which each member nation agreed to extend the tariff reductions covered in a trade agreement with one country to all other countries. A concession to one became a concession to all.

•       In 1995 the GATT was superseded by
the World Trade Organization (WTO),
and grew to include 150 member nations. 

•       The GATT and WTO presided over the
greatest global decline in trade barriers
in history.

Market Liberalization in China

•       In 1949, China established communism and centralized economic planning.

•       Agriculture and manufacturing were controlled by inefficient state-run industries.

•       The country was long closed to international trade. 

•       In the 1980s, China liberalized
its economy

•       In 2001, China joined the WTO

•       China is now a key member of
world trading system

Market Liberalization in India

•       Following independence from Britain in 1947, adopted a quasi-socialist model of isolationism and government control

•       High trade barriers, state intervention, a large public sector, and central planning resulted in poor economic performance

•       In the 1990s, markets opened to foreign
trade and investment; state
enterprises were privatized.

•       Protectionism has declined, but
high tariffs (averaging 20%) and
FDI limitations remain.

Intervention and the Global Financial Crisis

•       The crisis raises new questions about government’s role in business and the world economy.

•       The crisis arose largely from inadequate regulation and enforcement of current regulations in the banking and finance sectors.

•       In response, governments around the world are increasing regulation and examining ways to improve enforcement.