Free trade refers to a situation in which a gov t does not attempt to restrict what its citizens can buy from or sell to another country Chapter 7 Introduction Country Focus Trade in Hormone Treated Beef Instruments of Trade Policy Trade policy uses seven main instruments o Tariffs A tax levied on imports or exports Specific tariffs Tariff levied as a fixed charge for each unit of a good imported 3 per barrel of oil Ad valorem tariffs A tariff levied as a proportion of the value of an imported good The gov t gains from an IMPORT tariff because the tariff increases gov t revenues Domestic producers gain because the tariff affords them some protection against foreign competitors by increasing the cost of imported foreign goods Consumers LOSE because they must pay more for certain imports Usually pro producer and anti consumer Import tariffs raise domestic prices Import tariffs reduce the overall efficiency of the world economy They reduce efficiency because a protective tariff encourages domestic firms to produce products at home that in theory could be produced more efficiently abroad Export tariffs raise revenue for the gov t and reduce exports from a sector often for political reasons Take many forms including cash grants low interest loans tax breaks and gov t equity participation in domestic firms By lowering production costs subsidies help domestic producers in two ways 1 competing against foreign imports and 2 gaining export markets Agriculture tends to be one of the largest beneficiaries of subsides in most countries The main gains from subsidies accrue to domestic producers whose international competitiveness is increased as a result Advocates of strategic trade policy favor subsidies to help domestic firms achieve a dominant position in those industries in which economies of scale are important and the world market is not large enough to profitably support more than a few firms They tend to protect the inefficient and promote excess production o Subsidies A gov t payment to a domestic producer o Import Quotas A direct restriction on the quantity of a good that can be imported into a country The restriction is usually enforced by issuing import licenses to a group of individuals or firms For example the US has a quota on cheese imports The only firms allowed to import cheese are certain trading companies each of which is allocated the right to import a maximum number of pounds of cheese each year Tariff rate quota a lower tariff rate is applied to imports within the quota than those over the quota Ex An ad valorem tariff rate of 10 might be levied on 1 million tons of rice imports into South Korea after which an out of quota rate of 80 might be applied Common in agriculture where their goal is to limit imports over quota o Voluntary Export Restraints A quota on trade imposed by the exporting country typically at the request of the importing country s gov t Most famous historical examples limitation on auto exports to the US enforced by Japanese automobile producers in 1981 An import quota or VER always raises the domestic price of an imported good The extra profit that producers make when supply is artificially limited by an import quota is referred to as a quota rent If a domestic industry lacks the capacity to meet demand an import quota can raise prices for both the domestically produced and the imported good o Local Content Requirements A requirement that some specific fraction of a good be produced domestically Can be expressed in physical terms 75 of component parts for this production must be produced locally Or in value terms 75 of the value of this product must be produced locally The Buy America Act specifies that gov t agencies must give preference to American products when putting contracts for equipment out to bid unless the foreign products have a significant price advantage This law specifies a product as American is 51 of the materials by value are produced domestically If a foreign company or an American one for that matter wishes to win a contract from a U S gov t agency to provide some equipment it must ensure that at least 51 of the product by value is manufactured in the US o Administrative Policies Bureaucratic rules designed to make it difficult for imports to enter a country o Antidumping Duties Selling goods in a foreign market at below their costs of production or as selling goods in a foreign market below their fair market value The fair market value of a good is normally judged to be greater than the costs of producing that good because the former includes a fair profit margin Dumping is viewed as a method by which firms unload excess production in foreign markets 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 Antidumping policies are designed to punish foreign firms that engage in dumping The ultimate objective is to protect domestic producers from unfair foreign competition If a domestic producer believes that a foreign firm is dumping production in the U S market it can file a petition with two government agencies the Commerce Department and the International Trade Commission if a complain has a merit the Commerce Department may impose an antidumping duty on the offending foreign imports often called countervailing duties Antidumping duties The Case for Government Intervention Political Arguments for Intervention The most common political argument for gov t intervention is that it is necessary for protecting jobs and industries from unfair foreign competition Common Agricultural Policy CAP was designed to protect the jobs of Europe s politically powerful farmers by restricting imports and guaranteeing prices Companies sometimes argue that it is necessary to protect certain industries because they are important for national security Economic Arguments for Intervention Development of the World Trading System Chapter 8 Opening Case Walmart in Japan Most distribution is done by small trucking enterprises often with a single truck that have few economies of scale or scope There is a lack of cold storage facilities and warehouse capacity in India Introduction FDI takes on 2 forms FDI occurs when a firm invests directly in facilities to produce or market a product in a foreign country According to the U S Department of Commerce FDI occurs whenever a U S citizen organization