The International Business Environment Introduction and overview International trade theory and policy: three months in three hours.

The International Business Environment

Introduction and overview

International trade theory and policy: three months in three hours

Schedule

• Classical and neoclassical trade theory

• Conclusions and institutional solutions– ITO, GATT, WTO

• Why it’s all wrong: modern trade theory

• Conclusions and institutional solutions– Airbus, MITI, regional integration, FDI

Technology differences

• Labor only factor of production

• Cross-country differences in technology (differences in labor requirements)

• Adam Smith 1776, absolute advantages provide possibilities for mutually beneficial trade

• David Ricardo 1815, comparative advantages sufficient to generate trade

Absolute advantages

(labor requirements per unit of output)

Wine Cloth

England 20 10

Portugal 10 20

Absolute advantages

• Relative price of cloth in England: 0.5 wine

• Relative price of cloth in Portugal: 2 wine

=> Better with international trade if England produces and exports cloth and Portugal exports wine, and the international price of cloth is

0.5 wine < cloth < 2 wine

(or 0.5 cloth < wine < 2 cloth)

Comparative advantages

Wine Cloth

England 20 30

Portugal 10 20

Comparative advantages

• Relative price of cloth in England: 1.5 wine

• Relative price of cloth in Portugal: 2 wine

=> better with international trade if England exports cloths and Portugal exports wine, and the relative prices are

1.5 wine < cloth < 2 wine

(or 0.5 cloth < wine < 0.67 cloth)

Comparative advantages

• There is a potential for profitable trade as soon as the relative prices differ

• Rule: focus on production and exports of the good with comparative advantages (i.e. the lowest opportunity cost)

Differences in factor abundance

• Rapid technology diffusion from mid-1800s: are technology differences sufficient explanations for international trade?

• Heckscher-Ohlin model, 1920s: cross-country differences in relative factor abundance may result in differences in factor prices that explain differences in relative goods prices.

The H-O model

• Industries differ in factor intensity (the use of production factors)

• Capital abundant countries will have relatively cheap capital, and will therefore be well positioned to export goods from capital-intensive industries

• Still a very useful general equilibrium model

Conclusions

• More trade => more profits and more welfare

• Free trade better than protectionism

=> Reduce trade barriers and generate more international trade

• ITO, GATT, WTO

The principles of GATT

• Non-discrimination: The Most Favored Nation principle

• Transparency: All protection in the form of tariffs

• Liberalization: Tariff reductions

= Fair Trade (and lots of trade)

(+ Reciprocity: You scratch my back and I’ll scratch yours)

The Uruguay round

• World Trade Organization

• Lower tariffs for industrial products

• Agriculture

• Textiles and clothing

• Services

• Intellectual Property

• Dispute settlement

World Trade Organization - WTO

• Permanent institution to perform GATT functions - first ministerial meeting in Singapore December 1996

• Standing councils for goods, services, and TRIPS, with continuous negotiations on further liberalization

• More efficient dispute settlement

Tariff reductions

• Developed country tariffs reduced by a third within 5-10 years, to about 3%

• Tariff binding -national lists to include almost all products

• Eliminated tariffs– Pharmaceuticals– Paper– Steel– Construction machinery– Agricultural machinery– Medical equipment– Furniture– Toys– Beer & brown alcohol

Agriculture

• Tariffization of agricultural protection

• Tariff reductions– 36% average reduction in first round

• Market access guarantees– imports at least 3% of domestic consumption

• Reductions in public subsidies– cuts by 20-36 % of subsidy levels

Textiles and clothing

• Phasing out of MFA over ten-year period

• Integration of half of imports into GATT system during transition process

• Liberalization of remaining quotas during transition process

General Agreement on Trade in Services - GATS

• Framework of GATT-related rules– National treatment, MFN, transparency,

progressive liberalization, dispute settlement

• Annexes with rules for specific sectors

• National schedules – liberalization commitments– exceptions from GATS principles

• Successful continuing negotiations on telecom and finance

TRIPS and TRIMS

• Protection of trade-related intellectual property (TRIPS) - copyrights, trade marks, patents

• Including trade-related investment measures (TRIMS) under GATT rules

• Clearer principles for use of safeguards

Problem areas

• High tariffs outside OECD

• Undisciplined use of contingent protection, + agressive unilateralism (EU and US)

• Gray zone of Non-Tariff Barriers (NTBs) that are not fully addressed by the GATT framework.

• Regional integration?

What’s contingent protection?

• Countervailing duties - if foreign exporter is subsidized by foreign government.

• Antidumping tariffs - if foreign exporter is dumping goods on our markets.

• Most common in the US and EU. More frequent since the early 1980s: lobbies growing smarter?

Aggressive unilateralism• Not protectionism, but aggressive export

promotion: open your markets for our exports, or else...

• Mainly found in US legislation: – Section 301: essentially GATT consistent, wait

for GATT panel statement– Super 301: unilateral definitions of unfair trade,

unilateral decisions to retaliate – Special 301: same for intellectual property

rights issues

Modern trade theory

• Some of the assumptions in the H-O model are not realistic (perfect competition, identical preferences, constant returns to scale)

• Empirical findings have contradicted the predictions of the H-O model: lots of trade between similar countries, large amounts of intra-industry trade (exports and imports of the same goods)

Modern trade theory

• The Linder-hypothesis: birds of a feather

• Economies of scale and preferences for variation

• Reciprocal dumping

• Strategic trade policy

Economies of scale and competitive strategies

• Not fun to fight with bigger companies

• Alternative 1. Product differentiation: make something that’s slightly different– specialization and intra-industry trade

• Alternative 2. Make sure that you grow large as soon as possible– government intervention - Boeing vs Airbus– regional integration - big home market

Conlusions for economic policy

• Free trade and GATT may be good for potato chips…

• …but other solutions look tempting for micro chips

• Trade conflicts between Japan and the USA

• Problem: how do you pick the winners?

More conclusions• GATT not sufficient to guarantee free trade

in strategic industries

• Individual European countries will rarely manage to compete with American and Japanese larger firms

• Regional integration necessary for Europe: competition with the USA and Japan requires larger market with fair rules

• Foreign direct investment sometimes more important that international trade?

Schedule

• What is regional integration?

• Effects of regional integration– static– dynamic

• A look around: what’s happening on the RI front?

• RI and GATT: complements or substitutes?

Regional integration now aglobal phenomenon

• Widening and deepening of European integration

• American alternatives: CUSFTA and NAFTA plus MERCOSUR (Argentina, Brasil, Paraguay, Uruguay)

• A larger ASEAN, emergence of AFTA and APEC? Indian Ocean FTA?

• Regional integration in Africa?

• Except Eastern Europe

What is regional integration?

1. Free Trade Area

2.Customs Union = 1 + common external tariff

3.Common market = 2 + harmonization + free factor mobility

4.Economic Union = 3 + fixed exchange rate + policy coordination

5.Economic and Monetary Union (EMU) = 4 + common currency and central bank + closer policy coordination

Why integrate?• Offensive arguments

– Regional Integration is a step toward free trade– RI promotes growth– Integrated countries don’t start wars– RI cements ”positive” policies, both at home and

abroad

• Defensive arguments– RI is necessary because GATT/WTO doesn’t

work– We must practice RI because others do

Economic effects of integration

• Free Trade Areas and Customs Unions– trade creation and trade diversion

• Common Markets and Economic Integration– the costs of non-Europe

Static effects of integrationTrade creation

Before: Tariff protection allowed domestic firms to supply market

After: Imports from RI-area replace less efficient domestic producers

Trade diversion

Before: Efficient foreign producers supplied market in spite of tariffs

After: Relief from tariffs allows less efficient firms from RI-area to take over market shares from other foreigners

In addition, dynamic effects

• Trade creation increases production and income, and may also lead to– economies of scale– new entries and tougher competition– faster technology transfer

• But a Customs Union is usually not enough, because of various remaining NTBs

Gains from deeper integration

• Border controls

• Technical standards

• Scale economies

• Competition

• Public procurement

Border controls

• Administrative burden on firms– big problem for SMEs

• Delays at borders– administration & delays cost 2% of trade value in

Europe; much more elsewhere

• Welfare losses of trade that doesn’t occur– 1 to 4 % of trade lost in Europe?

• Cost of maintaining border controls and customs administration

Differing technical standards

• Keeps small firms out of int’l trade, and adds to production costs in large firms

• Top-down harmonization and mutual recognition the two replies in Europe– harmonization where health and safety matter– Cassis-de-Dijon general principle in most other

areas

Scale economies

• Fragmentation of EU market obstacle for reaching MES in many industries

• Leading EU firms smaller than American and Japanese leaders although EU market is equally large or larger

• Costs saving from reaching MES in all industries estimated to 2 % of GDP

Lack of competition• Fragmentation and trade barriers give market

power in home country– leads to higher prices, smaller production

volumes, and X-inefficiency

• Not only important for sectors with large firms, but also for growth in new sectors with many SMEs

• Contradiction between ambitions to increase competition and reach scale economies

Public procurement policies

• Public purchasing corresponds to about 15% of EU’s GDP

• Only 2% of government contracts awarded to other EU nationals in mid-1980s, when imports in general reached 20%

• Liberalization should increase competition and bring lower prices

Estimated gains from the European Single Market

Source of gains Billion USD % of EU GDP

Barriers to trade 8-9 0.2-0.3

Barriers to production 57-71 2.0-2.4

Economies of scale 61 2.1

Increased competition 46 1.6

Estimate EC-12 174-258 4.3-6.4

More dynamic gains?

• The Single Market leads to increases in productivity and output

• This will raise savings and investment

• The optimal long-run capital-output ratio will also be higher

• The gains from integration may be much higher when this effect is taken into account

Where is Europe?

• Treaty of Rome (1957) created Customs Union with ambitions

• Werner Plan (1970) failed attempt to introduce EMU

• EMS, ERM, and ECU (1978) steps towards EI from CU

• Single European Act (1987) creates CM

• EMU from 1999

• Next step: taxes and welfare?

European Union

• Common Market with 15 member states - all of Western Europe except Switzerland, Norway, and Iceland - based on Treaty of Rome (1957) and Single European Act (1987)

• Enlarged several times, Eastern enlargement expected within the next decade

• Monetary Union from year 1999

• Large impact on trade and investment

Chrystal ball: EU in 15 years?

• Widening versus deepening:– accession of EFTA

countries made deepening harder but not impossible

– accession of Central and Eastern Europe tougher question

• Federalism versus confederalism:– all power in Brussels

or a Union of independent states?

– deepening requires federalism, but EFTA accession probably strenthened con-federalism

NAFTA

• Free Trade Area including Canada, Mexico and the US, established 1994

• Phasing in period of 10 years

• Rules of origin important

• Includes competition policy and environmental issues

• Significant impact, especially on Mexico

MERCOSUR

• Customs Union / Common Market including Argentina, Brazil, Paraguay, Urugua (associated member: Chile)

• Decided 1991 to be completed 2005. Customs Union from 1995 already covers 85% of trade

• Temporary exceptions for cars, telecom, computers (300 tariff lines per country)

• Marked effects on trade and investment

ASEAN

• Agreement from 1967 including Brunei, Indonesia, Laos (from 1998), Malaysia, Myanmar (from 1998) the Philippines, Singapore, Thailand, and Vietnam (from 1995)

• Preparations for Free Trade Area - AFTA - in progress, to be completed year 2003

• Tensions because of Asian crisis

APEC

• Discussion club (?) with 18 members - ASEAN + NAFTA + Australia, New Zealand, China, Japan, Hong Kong, South Korea, Taiwan, PNG, and Chile

• Objective: Common Market by year 2020

• Means: open (i.e. GATT-consistent) regionalism and voluntary liberalization

• Uncertain future - dominant if realized

Are GATT and regional integration compatible?

• Regional integration violates GATT´s MFN principles

• Article XXIV allows integration if– substantially all trade– not more restrictive

• GATT has accepted integration even in unclear cases

Regional integration is a step on the way to global free trade

• Easier to agree about reforms within geographically limited regions

• Easier to negotiate globally when there are fewer around the table

• Regional cooperation may cement political reforms

• Integration may stimulate growth and trade

Regional integration is an obstacle to global free trade

• A major motive for integration has been the slow progress of GATT

• Tariffs - i.e., what GATT can handle - are not the most serious trade restrictions

• Small interest groups - French peasants? - may yield too much power

• Big trading blocks may be less interested in global free trade