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Chapter 7

Commercial

Policy

Copyright © 2011 Pearson Addison-Wesley. All rights reserved.

Chapter Objectives

• Examine the dollar cost of the effects of tariffs and quotas in the European Union, U.S. and Japan in the agriculture, clothing, and textile industries

Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 7-2

and textile industries

• Analyze the most common reasons for countries to protect certain industries

• Discuss the mechanisms used to provide protection

Introduction: Commercial Policy and Jobs

• This chapter examines the dollar value of the effects of tariffs and quotas in the European Union (EU), Japan, and the United StatesUnited States

• It is important to compare the costs and benefits of trade barriers and examine the most common reasons given for protecting specific industries


Protection in the European Union, Japan,

and the United States

• Since the end of WWII, average tariff rates around the world have fallen substantially

• By 2002, average nominal rates were 3.9% in US, 3.3% in Japan, 4.4% in EU

• However, all nations have higher levels of protection in


• However, all nations have higher levels of protection in particular industries they deem “sensitive”

• In addition to tariffs and quotas, many countries provide generous subsidies to some of their agricultural producers, particularly among developed nations

Direct Costs and Jobs Saved in

Agriculture, Clothing, and Textiles

• Since the phase in of the Uruguay Round tariff cuts, average tariffs have fallen 40%—but few sectors are average

• For example, agriculture, clothing and textiles experience


• For example, agriculture, clothing and textiles experience much smaller reductions in tariffs and quotas (12%, 14%, 14% respectively)

• In addition, all of these sectors in the EU, Japan, and US have significant non-tariff barriers applied to them including large government subsidies in the case of agriculture

TABLE 7.1

EU, Japanese, and U.S. Protection in Three Sectors (Mid-1990s, Millions of US$)


TABLE 7.1 (continued)

EU, Japanese, and U.S. Protection in Three Sectors (Mid-1990s, Millions of US$)


TABLE 7.2

Jobs Saved through Tariffs and Quotas


TABLE 7.2 (continued)

Jobs Saved through Tariffs and Quotas


Direct Costs and Jobs Saved in Agriculture, Clothing, and Textiles (cont.)

• Trade policy is a grossly inefficient mechanism to create jobs

– It is a non-transparent job-creation program

– It relies on too many intervening variables, and does not


– It relies on too many intervening variables, and does not go directly to the heart of the problem

– If job creation is the goal, tariffs and quotas are very expensive

-Better job-creation tools: (1) sound macroeconomic polices and (2) flexible labor markets

The Logic of Collective Action

• Given that the costs of tariffs and quotas are high to consumers, why do consumers tolerate them?

• Mancur Olson´s Logic of Collective Action– The costs of tariffs and quotas are borne by a great


– The costs of tariffs and quotas are borne by a great many people: everyone pays a little for protection

– The benefits of protection is concentrated in a few industries: few benefit a lot from protection

– Thus, there is an asymmetry in the incentives to oppose the policy: those benefiting from protection have much greater incentives than those hurt by it to lobby for it

Table 7.3 Agricultural Subsidies, 2007


Why Nations Protect Their Industries: The Labor Argument

• The Labor Argument: Protection must be used against imports from countries where wages are much lower


-Problem: Does not consider differences in productivity between different workforces: As productivity rises, so will wages

Why Nations Protect Their Industries: The Infant Industry Argument

• Infant Industry Argument: Developing countries have nascent industries that must be protected against competition from industrial countries

-Assumes: (1) market forces do not allow for the development of a certain industry and (2) the industry has


development of a certain industry and (2) the industry has positive externalities—spillover benefits (valuable linkages to other industries or technologies)

-Problems: (1) may increase inefficiency and result in negative linkage effects and (2) technological externalities are difficult to measure—which industries should be protected?

Why Nations Protect Their Industries: The National Security Argument

• National Security Argument: Certainindustries must be protected in order to guard national security (military security, cultural values)


values)-Problems: (1) Vital mineral resources, for example, can be purchased cheaply abroad during peacetime; and (2) how to assess the effects of, say, U.S. television programs on Canadian culture?

Why Nations Protect Their Industries: The Retaliation Argument

• Retaliation Argument: Another country's trade barriers must be countered with trade barriers


-Problems: Although retaliation can provide an incentive for trade negotiations, it can also lead to escalating trade wars

The Politics of Protection in the United States

• Protectionist pressures have increased in the U.S.

– Political reforms: reduced Congress’s past insulation from industry lobbyists

– The end of the Cold War: reduced U.S. willingness to


– The end of the Cold War: reduced U.S. willingness to sacrifice domestic political considerations for geopolitical alliances

– The rise of the newly industrialized countries (NICs): increased competitive pressures on U.S. industries

– The growth of the U.S. trade deficit in the 1980s: spurred fears of the loss of competitiveness

The Politics of Protection in the United States: Main Mechanisms

• Protection is obtained through (1) direct action by the president (e.g., VERs) or (2) four types of legal procedures

– Countervailing duties


– Countervailing duties

– Antidumping duties

– Escape clause relief

– Section 301 retaliation

The Politics of Protection in the United States: Main Mechanisms (cont.)

• In the case of these four legal procedures, a firm or industry petitions the federal government to initiate an investigation into foreign country or foreign firm practices


foreign country or foreign firm practices

• Let's analyze each of the four procedures in greater detailL

Countervailing Duties

• Countervailing duty: A tariff that is granted to a U.S. industry that has been hurt by a foreign country’s subsidizing its firms– Subsidies allow foreign firms to sell their products at lower

prices; countervailing duty seeks to counter the effect of the


prices; countervailing duty seeks to counter the effect of the subsidy

– Problem: defining subsidy is subjective

– Uruguay Round defined subsidies as (1) a direct loan or transfer, (2) preferential tax treatment, (3) the supply of goods or services other than general infrastructure, or (4) income and price supports

Antidumping Duties

• Antidumping duty: a tariff levied on an import that is selling at a price below the product’s fair value


-Problem: Defining fair value is subjective; antidumping duties are thus a source of tension between countries

Antidumping Duties (cont.)

• According to the WTO: Dumping occurs when an exporter sells a product at a price below the one it charges in its home market


-Problem: Comparing domestic and foreign market prices is difficult due to differences in the price of transportation, wholesale, and other add-ons


• There are three methods to determine whether a good is being dumped:

1. Comparing the price in third-country markets


2. Estimating the cost of production

3. Estimating the foreign firm’s production costs (dumping occurs if the foreign firm is not selling at a price that provides a normal rate of return on invested capital)


• In order for antidumping duties to be allowed, the country claiming dumping must show that the dumping has caused material injury to its firms


injury to its firms

-If dumping occurs without material injury, antidumping duty is not allowed


• Problems: Economic theory and legal definitions are not in agreement

– If a firm is not earning above average profits somewhere, it cannot maintain a price somewhere else that is below the cost


that is below the cost

– Firms often sell below costs • May sell at below costs in order to penetrate a market

• May go for extended periods selling at prices that do not cover fixed costs as long as the costs of variable inputs (labor and materials) are covered

Antidumping Investigation

• U.S. firms can initiate antidumping actions by filing a petition with the International Trade Administration (ITA) in the Department of Commerce

• If ITA finds dumping (or subsidization in the case of countervailing duty) occurred, the U.S. International Trade


countervailing duty) occurred, the U.S. International Trade Commission (USITC) conducts an additional investigation to determine whether the dumping has posed substantial harm to the domestic industry

• The relative success of U.S. firms in proving foreign dumping has induced a growing number of firms to file petitions with ITA

Escape Clause Relief

• Escape clause relief: Temporary tariff on imports to allow a domestic industry to escape the pressure of imports and thus obtain a period of adjustment


– Refers to a clause in the U.S. and GATT trade rules

– Initiated when a firm or industry petitions the USTIC directly for relief from a surge of imports

– The petitioning firm or industry must show that it has been harmed by imports and not some other factor (e.g., poor management)

Section 301 and Special 301

• Section 301: A section of the U.S. 1974 Trade Act that requires the U.S. Trade Representative (USTR) to take action against any nation that persistently engages


against any nation that persistently engages in unfair trade practices

– U.S. defines the meaning of unreasonable and unfair trade practices

– Action is launched by a request for negotiations with the country in question

Section 301 and Special 301 (con’t.)

• Special 301: Requires the USTR to monitor property rights enforcement around the world


-In 2005, the USTR surveyed 90 countries and identified 52 as lacking adequate enforce or denying market access

Table 7.4 Economic Sanctions since World War I


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