INTERNATIONAL BUSINESS TEST 2

NEW TRADE THEORY

The key premise of old or neoclassical trade theory is the argument for free trade that all countries participating in international trade will be better off. However, critics of free trade contend that in real world-where governments protect and promote domestic industries-things are far more complex and complicated than in David Ricardo’s model. The key question is, “Is free trade best to exploit comparative advantage?” As some economists question the validity of comparative advantage as discussed above, it becomes increasingly evident that the government can play a critical rile in changing the terms and conditions of trade in favor of its domestic companies and reap greater trade benefits. In the early 1970s, Paul Krugman advanced a new trade theory that contended not all countries will gain the same degree of benefit from trade as the role of government would make a significant difference in determining how much benefit is accrued from trade. The intellectual foundation of this argument is based on two key concepts: First-mover advantage and economies of scale. While old trade theories assume constant returns to specialization, the new trade theory presumes increasing returns to specialization. This means that the units of resources required to produce a certain good are assumed to decrease over a period due to the first-mover advantage and economies of scale. The first mover advantage refers to the benefits that an early entrant into a new industry can enjoy over latecomers, particularly when the industry can accommodate only a few competitors. Economies of scale describe economic advantages generated when a large scale of output results in substantial savings in unit production costs mainly by spreading fixed costs over a larger volume. In this type of industry, late entrants will face a tough challenge in matching the efficient cost structure of the first mover who benefits from economies of scale without the existence of competitors. The commercial aircraft industry dominated by Boeing and Airbus, i.e., duopoly, well illustrates such industry structure. First, the entry barrier is high due to enormous fixed costs and huge capital investments in R&D. It would be very difficult to overcome such high fixed costs of entry by late comers without government support. Next, the first mover also benefits from economies of scale achieved through learning-by-doing process over the years. Doubling aggregate output in aircraft manufacturing would result in a 20% fall in unit cost. Both the US and the EU governments recognize how critical a role they play in helping domestic companies gain first-mover advantage by providing subsidies such as low-interest loans and tax breaks. The significance of new trade theory makes us realize that trade will open a new opportunity for a company to increase volume across countries and thus achieve economies of scale with would have been unavailable without trade. Consumers will benefit from free trade as different companies can now produce different types of products even in the same industry as long as sufficient demand exists for each product to enable the company to attain economies of scale. As such, the new trade theory can explain why intra-industry trade occurs while old trade theories only focused on the phenomenon of inter-industry trade. While companies such as Mercedes-Benz and BMW can produce high-quality, luxurious cars targeting affluent consumers across countries, other automobile companies can serve the needs of consumers in developing countries who can only afford low-end cars. This explains why extensive trade between similar countries can occur.

GOVERNMENT INTERVENTION IN FREE TRADE

Globalization is not just about trade and technology, but it is also about politics. Although the benefits of free trade have been well recognized, the reality is that government intervention in free trade is almost inevitable. What are the typical arguments used to support government protectionist measures from both political and economic perspectives?

POLITICAL ARGUMENTS FOR GOV INTERVENTION IN FREE TRADE

The rationale behind protectionism is often driven by political objectives rather than economic reasons. The government may justify its intervention in free trade for the following reasons.

One of the consequences of global disruptions such as the rise of geopolitical tensions and the COVID-19 pandemic has deepened protectionism and nationalism, resulting in increased government intervention in the free market economy in the form of industrial policy.

Industrial policy is a deliberate attempt by the government to nurture strategically important sectors. The main objective of any industrial policy is to increase industrial production and thereby enhance industrial growth which leads to economic prosperity through the optimum utilization of resources. The recent passage of Inflation Reduction Act (IRA) and Creating Helpful Incentives to Produce Semiconductors and Science Act of 2022 (CHIPS Act) made it clear that security concerns and the promotion of domestic economies through industrial policy has overtaken traditional trade priorities in a non-discriminatory way.

1) Saving jobs and industries

Although this argument appears to constitute an economic reason at first glance, as it concerns the loss of jobs and industries, it indeed represents one if the most cited political reasons. Many politicians often use this argument to seek political support from their electorates in exchange for promising to keep the jobs for those who are engaged in industries whose comparative advantage in these businesses. While it argues that countries are better off from trading, that isn’t always true for all people—such as the Canadian dairy farmers who were adversely affected by the conclusion of the USMCA. The US forced Canada to yield a larger market share for American dairy farmers. It is not difficult to understand why these farmers expect the government to save their jobs through protectionist measures. The substantial farming subsidies prevailing in developed countries such as US and Japan can be perceived as politically motivated government efforts to gain support from the farmers.

2) Protecting Consumer Health

Some governments use the protection of consumer health as an excuse for justifying their intervention in free trade. The advances in biotechnology have allowed great progress in producing genetically modified agricultural and meat products. Hormone-treated beef is a well-publicized case in point. When the EU banned the importation of hormone-treated beef from teh US in 1989, US exports declined from $231 million in 1988 to $98 million in 1994. In response, the US filed a complaint with the WTO in 1995, and the WTO panel ruled that the EU’s ban on hormone-treated beef was illegal. As a result, the WTO allowed the US to impose punitive tariffs valued at $120 million on hundreds of EU products in 1999. In 2012, the EU reached a deal with the US to continue with the ban but increase its import quota of high-quality non-hormone-treated beef from the US. While Europeans are very reluctant to accept genetically modified organism (GMO) products, Americans seem to be more tolerant of them. Consequently, the EU has some of the strictest regulations in the world concerning GMOs, based on the precautionary principles to protect consumer health and the environment. Since different people have different attitudes and preferences towards GMO products, a trade dispute is expected to occur whenever there is a cultural clash between two counties involved in trading GMO products. Another example is Russia’s restriction on certain food imports from regions affected by radiation after the 2011 Fukishima nuclear disaster in Japan. This measure limits imported food that may pose a risk to consumers due to radiation contamination, illustrating how trade restrictions can aim to protect public health in times of environmental crises.

3) National Security

In this Information Age, the US government is suspicious of China’s massive cyber campaign to steak trade secrets and intellectual property from American companies. Recent legislation in the US House of Reps highlights the national security risks from the

ECONOMIC ARGUMENTS FOR GOV INTERVENTION IN FREE TRADE

GLOBAL TRADE GOVERNING SYSTEMS: GATT

GENERAL ARGUMENT ON TARIFFS AND TRADE (GATT) AND THE URUGUAY ROUND

GLOBAL TRADE GOVERNING SYSTEMS: WTO

WORLD TRADE ORGANIZATION (WTO) AND DOHA AGREEMENT

REGIONAL TRADE AGREEMENT VS. MULTILATERAL TRADING AGREEMENT

IC: TARIFFS

IC: SUBSIDIES

IC: IMPORT QUOTAS AND VOLUNTARY EXPORT RESTRAINTS

IC: LOCAL CONTENT REQUIREMENTS

IC: ADMINISTRATIVE POLICIES

IC: ANTIDUMPING POLICIES

CONCEPTS OF FDI

TYPES OF FDI

GREENFIELD INVESTMENT

BROWNFIELD INVESTMENT

MERGERS AND ACQUISITION

PRODUCT LIFE CYCLE THEORY

ONE OF THE CLASSICAL THEORETICAL VIEW ON FDI

INTERNALIZATION THEORY

ONE OF THE CLASSICAL THEORETICAL VIEW ON FDI

IMPACTS AND GOVERNMENT POLICIES ON HOST COUNTRY FROM FDI

IMPACTS AND GOVERNMENT POLICIES ON HOME COUNTRY FROM FDI

IC: WHY DO FDI?

IC: THE PATTERN OF FDI

IC: PRODUCT LIFE CYCLE THEORY

IC: HOST COUNTRY BENEFITS OF FDI

IC: HOST COUNTRY COSTS OF FDI

IC: HOME COUNTRY BENEFITS OF FDI

IC: HOME COUNTRY COSTS OF FDI

REGIONAL ECONOMIC INTEGRATION

OVERVIEW OF DEGREES OF ECONOMIC INTEGRATION

EX OF ECONOMIC INTEGRATION BY REGION: EUROPE

EX OF ECONOMIC INTEGRATION BY REGION: NORTH AMERICA

EX OF ECONOMIC INTEGRATION BY REGION: SOUTH AMERICA

EX OF ECONOMIC INTEGRATION BY REGION: AFRICA

EX OF ECONOMIC INTEGRATION BY REGION: ASIA PACIFIC

EX OF ECONOMIC INTEGRATION BY REGION: TRANSREGIONAL

IC: LEVELS OF ECONOMIC INTEGRATION

IC: THE CASE FOR REGIONAL INTEGRATION: ECONOMIC

IC: THE CASE FOR REGIONAL INTEGRATION: POLITICAL

IC: IMPEDIMENTS TO INTEGRATION

IC: THE CASE AGAINST REGIONAL INTEGRATION

REGIONAL ECONOMIC INTEGRATION IN EUROPE

THE ESTABLISHMENT OF THE EURO

REGIONAL ECONOMIC INTEGRATION IN THE AMERICAS

THE NORTH AMERICAN FREE TRADE AGREEMENT

THE FOREIGN EXCHANGE MARKET

KEY FUNCTIONS OF THE FOREIGN EXCHANGE MARKET: CURRENCY CONVERSION

KEY FUNCTIONS OF THE FOREIGN EXCHANGE MARKET: INSURING AGAINST FOREIGN EXCHANGE RISK

KEY FACTORS THAT INFLUENCE CHANGE IN EXCHANGE RATES

PURCHASING POWER PARITY (PPP) THEORY

UNDERVALUATION VS. OVERVALUATION

FISCHER EFFECT (FE) AND INTERNATIONAL FISCHER EFFECT

INVESTOR PSYCHOLOGY AND BANDWAGON EFFECTS

MNCs’ STRATEGIES TO DEAL WITH EXCHANGE RATE FLUCTUATION

INTERNATIONAL MONETARY SYSTEM: BRETTON WOODS AGREEMENT AND FIXED EXCHANGE RATE SYSTEM

INTERNATIONAL MONETARY SYSTEM: PRIMARY RESPONSIBILITIES OF THE IMF

INTERNATIONAL MONETARY SYSTEMS: IMF’s CONDITIONALITY AND AUSTERITY MEASURES

INTERNATIONAL MONETARY SYSTEM: EVALUATION OF THE IMF’s PRESCRIPTION AND ITS FUTURE PROSPECT

IC: EXCHANGE RATE REGIMES IN PRACTICE: PEGGED EXCHANGE RATES

IC: EXCHANGE RATE REGIMES IN PRACTICE: CURRENCY BOARDS

IC: THE GOLD STANDARD: MECHANICS OF THE GOLD STANDARD

IC: THE GOLD STANDARD: STRENGTH OF THE GOLD STANDARD

IC: FIXED VERSUS FLOATING EXCHANGE RATES: THE CASE FOR FLOATING EXCHANGE RATES

IC: FIXED VERSUS FLOATING RATES: THE CASE FOR FIXED EXCHANGE RATES

CRISIS MANAGEMENT BY THE IMF: THE ASIAN FINANCIAL CRISIS