CHAPTER 2

The Environment of International Trade

Chapter Objective

• You should learn about:• The basis for establishing international trade• The importance of balance-of-payments• The effect of protectionism on trade• Seven types of trade barriers• GATT and WTO• IMF and the World Bank• The keiretsu system

Trade: 20th to the 21st Century

• Over time countries have become more interdependent. The depression (helped by the Smoot-Hawley 1930 law raising tariffs) occurred over the first half of the 20th century in between two major wars.

• That last half of the 20th century marked by competing systems - free trade/capitalism versus socialism/Marxism. This disrupted world-wide trade patterns.

World Trade

• After WWII, U.S. assistance and GATT (General Agreement of Tariffs and Trade) caused world trade to expand.

• With the Uruguay Round agreement - GATT gave way to the WTO with 117 members.

Trade & US Multinationals

• After WWII US multi-nationals dominated: exports and direct foreign investments.

• Countries sought to limit effect through expropriation (Latin America), joint ventures & investment limits (Europe).

US Share of World Trade

• US share of world markets declined after 1960s.

• In 1959 US had 39% of World Gross National Product (GNP) down to 26% in 1995.

• See P. 31 Exhibit 2-2

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US Firms and World Trade

• In 1953 US accounted for about 45 % of world manufacturing output. By 1990 the output was about 22%.

• Of course the world output in 1990 was much larger than the 1953 amount. However, output in other countries grew and competition resulted to where the US has only 24 (1996) of the worlds largest industrial firms - down from 67 in 1963.

US Firms and World Trade

• Between 1888 and 1970 the US had a favorable balance of trade (greater exports than imports in dollars).

• Since 1971 the US has had a trade deficit (see P. 32 - Exhibit 2-3).

• How should the US maintain a competitive edge & avoid domination of US markets by foreign multinationals?

US Firms and World Trade

• US competitive position in capital goods eroding - From 19983 to 1987 about 70% of the growth in the merchandise trade deficit was in capital goods and autos.

• The rise of trading blocks (EC, NAFTA, APEC) may dominate future trade patterns.

• SEE “World Bank says Big Five Could Re-draw Global Economic Map in 25 Years): http://www.worldbank.org

Balance of Payments

• Balance of Payments: System of accounts that record a nation’s international financial transactions with the rest of the world for some time period.

• The balance of payment is an overall view of a country’s economic position. It’s a record of condition.

Balance of Payments

• Balance of Payments has three accounts:

• 1. Current Account - record of all goods and services imported and exported plus unilateral transfer of funds.

• 2. Capital Account - record of direct investments to and from all countries

• 3. Official Reserve Account - record of imports & exports of gold & changes in foreign exchange.

Current Account

• The Current Account includes record of all international trade (imports and exports) in merchandise and service.

• The difference between imports and exports called the Trade Balance.

• The Balance of Trade can be favorable (a surplus = exports > imports) or unfavorable (negative = exports < imports).

Balance of Trade

• Balance of trade affects balance of payments (amount of money owed to other countries). The Trade Balance affects the wealth of a country and the value of its currency. For these reasons, the trade balance is an important indicator of the economic well-being of a country.

Protectionism

• Should countries protect indigenous industries from foreign competition or should there be “free trade.”

• What is free trade and what is protectionism?

Free Trade & Protectionism

• Free Trade - unrestricted movement of goods, services and currencies in an out of a country.

• Protectionism - the use of various measures (tariffs, quotas, non-tariff barriers) to restrict the unrestricted movement of goods, services and currency in and out of a country. The aim is generally to protect the local economy or firms in the country.

Protection - Pros

• Arguments in Support of Protectionism:• Protect an infant industry• Protect home market• Keep money (foreign exchange) at home• Encourage savings and capital investment• maintain standard of living & wages• Conserve natural resources• Promote local industrialization

Protection - Pros

• Maintain employment or reduce unemployment

• National defense

• Increase size of businesses

• Retaliation

• Economist view (1) protecting infant industry (2) industrialization, and (3) national defense as the only good arguments for protectionism.

Protection - Cons

• Customers bear cost of protectionism

• Cost too much to protect inefficient industries.

• Consumers have to pay more and not many jobs saved (Costs about $170,000 per year to save one job).

• Politically popular but rarely leads to renewed growth in declining industry.

Are There any Truly FREE MARKETS?

• There are NO truly “free markets’ in the world. All countries protect their home markets to a greater or lesser extent. Therefore, discussions about protectionism and “open” markets need to take this into consideration.

Trade Barriers

• Two main types: (1) Tariff (2) Non-tariff• Tariffs - tax or duty imposed on goods entering a

country. Can be use to provide revenue or discourage imports.

• Tariffs can increase inflation, protect industries, weaken balance-of-payment position, alter supply & demand patterns, cause trade wars, restrict competition, product choice & supply.

Non-Tariff Barriers

• Quotas - import restriction based on currency value or quantity.

• Voluntary Export Restraint - limitation of exports to a foreign country set by the country doing the exporting (often done under threat by the importing country).

• Boycotts - absolute restriction of trade with a specified country.

Non-Tariff Barriers

• Monetary Barriers - regulation of trade by restricting/controlling currency exchange. Options include blocked currency, differential exchange rate, currency exchange approval.

• Standards - restrictions concerning health, safety, and product quality & material input.

Easing Trade Restrictions

• Omnibus Trade & Competitiveness Act of 1988 - aims at correcting perceived trade injustices & increasing the global competitiveness of US firms. The act deals with protectionism, trade deficits & fairness by dealing with 3 areas: (1) Market Access, (2) Export Expansion, and (3) Import Relief.

General Agreement on Tariffs & Trade (GATT)

• GATT was an agreement designed to foster trade. GATT covered 3 main areas:

• Trade shall be nondiscriminatory

• Domestic industries protected via tariffs, not via import quotas

• Consultation to be the means of solving trade problems.

• The Uruguay Round (1994) established the World Trade Organization (WTO).

WTO

• Unlike GATT which it replaced, WTO is an institution not an agreement.

• WTO will set rules governing trade & provide a panel of experts to hear & rule on trade issues. The rulings will be binding on members.

IMF & World Bank

• IMF & World Bank established to keep countries economically viable. IMF used to help overcome problems related to inadequate reserves & unstable currencies.

• IMF aimed to stabilization of exchange rates, & establishment of freely convertible currencies. IMF also loans money to members who cannot meet financial obligations.

IMF

• IMF developed Special Drawing Rights (SDRs) to help countries cope with floating exchange rates. Firms can quote prices in terms of SDRs (the average value of a group of currencies) as this is less affected by changes in exchange rates.

• The World Bank - aimed at reducing poverty & improving standards of living via sustainable growth & investment in people.

World Bank

• Five institutions in the World Bank:• 1. IBRD - Int’l Bank for Reconstruction &

Development• 2. IDA - Int’l Development Association• 3. IFC - Int’l Finance Corporation• 4. MIGA - Multilateral Investment Guarantee

Agency• 5. ICSID - Int’l Center for the Settlement of

Investment Disputes

Keiretsu: A Formidable Competitor?

• While GATT helped lower tariff, unfair trade practices persist. Firms may gain a sustainable competitive advantage by: protection, or by channel relationships.

• Keiretsus are collections of major firms spanning several industries held together by cross-shareholding, networks, interlocking directorates, lon-term relationships, & social & historical links.

Keiretsus

• There are 6 major and 11 minor Keiretsus (order or system) in Japan. Sales for the group is substantial.

• Types of Keiretsus:

• Financial Keiretsus - group of powerful independent firms clustered around a core bank that provides funds to a trading company & member firms.

Production Keiretsus

• Production or vertical Keiretsus - web of interlocking relationships between a big manufacturer and its main suppliers. This forms a pyramid of companies serving a single large firm that dictates everything to the suppliers who are often prohibited from doing business with others.

Sales-distribution Keiretsus

• Sales-distribution Keiretsus - fully integrated manufacturing and distribution companies. The trading company is the heart of the grouping & coordinates a complex manufacturing web with numerous small firms that sell only to the distribution company. The distributing firm controls its own retail system and is able to dictate prices, profit margins, exclusive representation.

Criticisms of Keiretsus

• Restricts the flow of imported goods.

• Results in higher consumer prices.

• Results in less variety for consumers.

• However, a major advantage is that the system may result in less waste and duplication of effort across members.