Governmental Influence on Trade

Protectionism
The governmental restrictions and incentives to trade are known as protectionism. Governments want to protect their own industries. Governments also want to promote exports at the same time. After 70s, India changed from Import substitution to export oriented. Governmental measures may limit your ability to sell abroad, such as by prohibiting the export of certain products to certain countries, or by making it difficult for you to buy what you need from foreign suppliers. Governments routinely influence the flow of imports and exports. Also governments directly or indirectly subsidize domestic industries to help them engage foreign producers at home or challenge them abroad.
All nations interfere with international trade to varying degrees. Governments intervene in trade to attain economic, social or political objectives. Governments pursue political rationality when trying to regulate trade. Governmental officials apply trade policies that they reason have the best chance to benefit the nation and its citizen and in some case their personal political longevity.
Role of Government

• Interest articulation: since different interest groups co-exist, so different interests need to be put forward.
• Interest aggregation: take all stakeholders view into account
• Policy making
• Implementation and adjudication

The Economic Rationales for governmental intervention

1.Unemployment

One of the social objectives of government is to prevent unemployment. The government can do that through import restriction. One difficulty with restricting imports to create jobs is that other countries normally retaliate with their own restrictions. Two factors can ease the effects of retaliation

• Small trading countries are less important in the retaliation process.
• Retaliation that decreases employment in a capital-intensive industry may not affect employment as much as the value of the trade loss would imply.

If import restrictions do increase domestic employment, then fellow citizens will have to bear the cost of higher prices or higher taxes. Government officials should compare the costs of higher prices with the costs of unemployment and displaced production that would result from freer trade. In addition, they must consider the costs of policies to ease the plight of displaced employees, such as for unemployment benefits or retraining. The employment issue can slow trade liberalization because displaced workers are often the ones who are least able to find alternative work at a comparable salary. So persistent unemployment pushes many groups to call for protectionism. However, evidence suggests that efforts to reduce unemployment through import restrictions are usually ineffective. Unemployment, in and of itself, is better dealt with through fiscal and monetary policies.

2.Infant industry protection

In 1792, Alexander Hamilton presented infant industry argument. This theory holds that a government should shield an emerging industry from foreign competition by guaranteeing it a large share of the domestic market until it is able to compete on its own. Government protects these industries through subsidies. The govt protects infant industries where the country has either comparative or competitive advantage. So the companies of those industries will become major exporters. They become strong in the home market also. Govt needs to protect its potential stars. The infant industry argument presumes that the initial output costs for a small scale industry in given country may be so high as to make its output non competitive in world markets. Once the infant industry becomes globally competitive, the government can then recoup the costs of trade protection through benefits like higher domestic employment, lower social costs and higher tax revenues.
It is reasonable to expect production costs to decrease over time, but they may never fall enough to create internationally competitive products. So there are two risks for protecting an infant industry.

• Governments must identify those industries that have a high probability of success.
• Even if policy makers can determine those infant industries likely to succeed, it does not necessarily follow that companies in those industries should receive governmental assistance.

Infant industry protection requires some segment of the economy to incur the higher cost of inefficient local production. Typically either consumers or tax payers take the burden. Ultimately the validity of the infant industry argument rests on the expectation that the future benefits of an internationally competitive industry will exceed the costs of the associated protectionism.

3. Promote Industrialization

Countries with a large manufacturing base generally have higher per capita incomes than those that do not. Hence many emerging economies try to develop an industrial base by largely regulating imports from foreign producers using trade protection to spur local industrialization.
The following are the effects of promoting industrialization

• Use of surplus workers.
• Promoting investment inflows.
• Diversification
• Greater growth for manufactured products
• Import substitution versus export promotion
• Nation building

Use of surplus workers

Surplus workers can more easily increase manufacturing output than agricultural output. Since agricultural output per person is low, so many people can migrate from agricultural sectors to industrial sectors and in turn increase industrial output. The industrialization argument presumes that the unregulated importation of lower priced products prevents the development of a domestic industry. However the industrialization rationale asserts that the industrial output will increase, even if the prices are not globally competitive, because local consumers must buy local goods from local producers.

Promoting investment inflows

Inflows of foreign investment in the industrial area promote sustainable growth. Import restrictions, applied to spur industrialization, may also increase foreign direct investment. Foreign investment inflows may also add to local employment, which is attractive to policymakers.

Diversification

Prices and sales of agricultural products and raw materials fluctuate very much, which is a detriment to economies that depend on few of them. Price variations due to uncontrollable factors, such as weather affecting supply or business cycles abroad affecting demand, can wreak havoc on economies that depend on the export of primary products. A greater dependence on manufacturing does not either guarantee diversification of export earnings.

Greater growth of manufactured products

Markets for industrial products grow faster than markets for agricultural products. The terms of trade are the quantity of imports that a given quantity of a country’s exports can buy. The prices of raw materials and agricultural commodities do not rise as fast as the prices of finished products. Hence, overtime it takes more low priced primary products to buy the same amount of high priced manufactured goods. So, emerging nations that depend on primary products have become increasingly poorer relative to industrial countries.

Import substitution versus export promotion

Traditionally emerging economies promoted industrialization by restricting imports in order to boost local production for local consumption. Some countries have achieved rapid economic growth by promoting the development of industries that export their output. This approach is known as export led development. Industrialization may result initially in import substitution, yet export development of the same products may be feasible later.

Nation Building

Industrial activity helps the nation building process. The performance of free markets suggests a strong relationship between industrialization and aspects of the nation building process. Industrialization helps countries to build infrastructure, advance rural development, enhance rural proples’ social life and boost the skills of the workforce.

4. Increasing country’s economic power relative to other countries

Countries monitor their absolute economic welfare as well as track how their performance compares to other countries. Governments impose trade restrictions to improve their relative trade positions. They also try to charge higher export and lower import prices. To remain competitive and perform better economically, the countries adopt the following five methods.

• Improving Balance of payments (BOP) through Balance of Trade
• Restrictions as a Negotiating tool
• Price control on exports
• Fair access/Reciprocity
• Optimal tariff theory

Improving Balance of payments through BOT

Governments can improve BOP by improving their balance of trade. If BOP difficulties arise and persist, a government may restrict imports or encourage exports to balance its trade account. One way to do this is to devalue the currency of the country, which makes all the products cheaper in relation to foreign products.

Restrictions as a Negotiating tool

The imposition of import restriction may be used as a means to persuade other countries to lower their import barriers. To successfully use restriction as a bargaining tool required careful consideration of what products to target. Basically the restrictions need to be believable and important to the influential parties in the other country. Believable implies that there are either alternative sources to buy the same product or that consumers are willing to do without it.

Price control on exports

Countries sometimes withhold goods from international markets in an effort to raise prices abroad. This policy may also encourage other countries to develop technology that will provide either substitute products or different ways of producing the same product. A country may limit exports of a product that is in short supply worldwide in order to favour domestic consumers. Companies sometimes export below cost or below their home country price, a practice called dumping. Companies do dumping to build a market abroad.

Fair access/Reciprocity

Companies and industries often argue that they are entitled to the same access to foreign markets as foreign industries and companies have to their markets. Economic theory supports this idea, reasoning that producers operating in industries where increased production leads to steep cost decreases, but which lack equal access to a competitor’s market will struggle to gain enough sales to be cost competitive.

Optimal tariff theory

This theory states that a foreign producer will lower its prices if the importing country places a tax on its products. If this occurs, benefits shift to the importing country because the foreign producer lowers its profits on the export sales.

Noneconomic rationales for government intervention

Governments are involved in the following noneconomic rationales.

• Maintenance of essential industries
• Prevention of shipment to unfriendly countries
• Maintenance or extension of spheres of influence
• Protecting activities that help preserve the national identity

Maintenance of essential industries

The essential industries include defence, education. Some of these industries need to be controlled through government. Governments apply trade restriction to protect essential domestic industries during peacetime so that a country is not dependent on foreign sources of supply during war. This is called the essential industry argument. Because of the high cost of protecting an inefficient industry or a higher cost domestic substitute, the essential industry argument should not be accepted without a careful evaluation of costs, real needs and alternatives. Once an industry receives protection, it is difficult to remove the protection.

Prevention of shipment to unfriendly countries

Here the government’s is not to supply goods to rival countries. Countries achieve these political goals using economic means i.e. trade controls. Countries also start blacklisting other countries who supply to their rival countries. Countries concerned about security often use national defence arguments to prevent the export, even to friendly countries, of strategic goods that might fall into the hands of potential enemies or that might be in short supply domestically. Export constraints may be valid if the exporting country assumes there will be no retaliation that prevents it from securing even more essential goods from the potential importing country. Trade controls on nondefense goods also may be used as a weapon of foreign policy to try to prevent another country from meeting its political objectives.

Maintenance or extension of spheres of influence

Governments give aid and credits to, and encourage imports from countries that join a political alliance or vote a preferred way within international bodies. It is about exporting to another country and in turn generating employment and BOP. A country’s trade restrictions may coerce governments to follow certain political actions or punish companies whose governments do not.

Protecting activities that help preserve the national identity

Govt's role is not only to govern the country but also to protect the country and put it together. For this the country requires national identity and a sense of belongingness. Countries are held together partially through a unifying sense of identity that sets their citizens apart from those in other nations. To sustain this collective identity, countries limit foreign products and services in certain sectors.

Instruments of Trade Control

The following are some of the instruments of trade control

1. Tariffs
2. Subsidies
3. Tied Aid to countries
4. Custom valuation
5. Consular fees
6. Quotas
7. “Buy Local” Legislation
8. Standards and Labels
9. Specific permission requirements
10. Administrative delays
11. Reciprocal Requirements
12. Restrictions on services

1. Tariffs

A tariff (duty) is the most common type of trade control and is a tax that governments levy on a good shipped internationally. Governments charge a tariff when a good crosses its official boundary. Trade blocks also charge common tariff rates to non member countries.

• Export Tariff: Tariffs collected by the exporting country are called an export tariff. Export tariffs are imposed because these items going out would affect local industries. Export tariffs put essential items useful locally.
• Transit Tariff: Tariffs collected by a country through which the goods have passed are called a transit tariff.
• Import Tariff: Tariffs collected by an importing country are called import tariff. Import tariffs are imposed to make local production more attractive and competitive.

Import tariffs raise the price of imported goods, thereby giving domestically produced goods a relative price advantage. Tariffs also serve as a source of governmental revenue. Although, revenue tariffs are most commonly collected on imports, many countries that export raw materials charge export tariffs. Tariffs are basically three types namely specific duty, ad valorem duty and compound duty.

• When the government assess a tariff on a per unit basis, then it is called specific duty.
• When the government assesses a tariff as a percentage of the value of the item, then it is called ad valorem duty.
• When the government assesses a tariff based on both specific and ad valorem duty, then it is called compound duty.

2. Subsidies

Govt pays in various ways to local players in order to make them competitive globally and in turn expect them to become exporters. Governments sometimes also provide other types of assistance like business development services (market information, trade expositions and foreign contacts) to make it cheaper or more profitable to sell overseas. However trade frictions result from disagreement on the definition of a subsidy. Subsidies make local players compete domestically as well as in foreign markets. Ultimately public pays for these subsidies in terms of taxes subsidizing less efficient/less competitive industries.

3. Tied Aid to countries

When governments give aid and loans to other countries with precondition that the recipient is required to spend the funds in the donor country, then it is known as tied aid or tied loan. Tied aid helps win large contracts for infrastructure, such as telecommunications, electric power projects etc. Tied aid can slow the development of local suppliers in developing countries and shield suppliers in the donor countries from competition.

4. Custom valuation

While imposing tariffs on exports or imports, custom officials first use the declared invoice price. If officials doubt the authenticity, then they impose tariff on the basis of the value of identical goods. If not possible, then officials may compute a value based on final sales value or on reasonable cost. Sometimes officials use their discretionary power to assess the value too high, thereby preventing the importation of foreign made products.

5. Consular Fees

Some countries require consular fees. It is a very high amount and delays the proceedings. It makes the import to the country less attractive.

6. Quotas

The quota is the most common type of quantitative import or export restriction. BY implementing quotas the countries increase BOP and BOT by decreasing imports and increasing exports. An import quota prohibits or limits the quantity of a product that can be imported in a given year. Quotas usually increase the consumer price because there is little incentive to use price competition to increase sales. Tariffs generate revenue for the government. However quotas generate revenues for the companies that are able to obtain and sell the intentionally limited supply.
There are different variations of quotas.
Voluntary export restraint (VER)

Here the government of country A asks the government of country B to reduce its companies’ exports to country A voluntarily. Here either country B volunteers to reduce its exports or country A may impose tougher trade regulations.
Advantages of VER

• A VER is much easier to switch off than an import quota.
• The appearance of “voluntary” choice by a country, does not damage the political relations between those countries as much as an import quota does.

Export Quotas
A country may establish export quotas to assure domestic consumers of a sufficient supply of goods at a low price to attempt to raise export prices by restricting supply in foreign markets. The typical goal of an export quota is to raise prices to importing countries.
Embargo
It is a specific type of quota that prohibits all forms of trade between the countries. Countries or group of countries may place embargoes on either imports or exports, on whole categories of products or specific products with specific countries. Governments impose embargoes in the effort to use economic means to achieve political goals.

7. “Buy Local” Legislation

Sometimes governments specify a domestic content restriction-that is , a certain percentage of the product must be of local origin. Govt has the option of buying locally as well as internationally. So by buying locally, the govt gives protection to the local players. Sometimes they favour domestic producers through price mechanisms. Many nations prescribe a minimum percentage of domestic content that a given product must have for it to be sold legally in their country. By doing this the local market develops. Technology up gradation happens in the local market. Exports also happen on the component parts.

8. Standards and Labels

Countries devise classification, labelling and testing standards to allow the sale of domestic products but obstruct that of foreign made ones. In case of labels, the companies have to indicate on a product where it is made. Labels provide information to consumers who may prefer to buy products from certain nations. The purpose of standards is to protect the safety or health of the domestic population. However some foreign companies argue that standards are just another means to protect domestic producers.

9. Specific permission requirements

Some countries require that potential importers or exporters secure permission from governmental authorities before conducting trade transactions. This requirement is known as import license. This procedure can restrict imports or exports directly by denying permission or indirectly because of the cost, time and uncertainty involved in the process. A foreign exchange control is a similar type of control.

10. Administrative delays

International administrative delays create uncertainty and raise the cost of carrying inventory. Competitive pressure, however, moves countries to improve their administrative systems.

11. Reciprocal Requirements

Governments sometimes require that exporters take merchandise in lieu of money or they promise to buy merchandise or services, in place of cash payment, in the country to which they export. These sorts of barter transactions are called countertrade or offsets. More frequently, however, reciprocal requirements are made between countries with ample access to foreign currency that want to secure jobs or technology as part of the transaction.

12. Restrictions on services

Services are the fastest growing sector in international trade. Countries restrict trade in services for three reasons
Essentiality

Countries sometimes prohibit private companies, foreign or domestic, in some sectors because they feel the services should not be sold for profit. In other cases they set price controls for private competitors or subsidize government owned service organizations, creating disincentives for foreign private participation. Mail, education, hospital, media are often not for profit sectors.
Standards

Governments limit foreign entry into many service professions to ensure practice by qualified personnel.
Immigration

Governmental regulations often require that an organization, domestic or foreign, search extensively for qualified personnel locally before it can even apply for work permits for personnel it would like to bring in from abroad. Even if no one is available, hiring a foreigner is still difficult.