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Chapter 9 (2).pdf

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Chapter 9: Formulation of National Trade Policies
two principle issues have shaped the debate on appropriate trade policies
1. Whether a national government should intervene to protect the country's domestic
firms by taxing foreign goods entering the domestic market or constructing other
barriers against imports
2. Whether a national government should directly help the country!s domestic firms
increase their foreign sales through export subsides, government-to-government
negotiations, and guaranteed loan programs
Free trade: implies that the national government exerts minimal influence on the
exporting and importing decisions of the private firms and individuals
Fair trade: sometimes called managed trade suggests that the national government
should actively intervene to ensure that domestic firms! exports receive an equitable
share of foreign markets and that imports are controlled to minimize losses of domestic
jobs and market share in specific industries.
some fair traders also argue that the government should ensure a level playing field
on which foreign and domestic firm can compete on equal terms
policies individual companies adopt affect the size and profitability of foreign markets
and investments
as well as the degree to which firms are threatened by foreign imports in their
domestic markets
debate also affects consumers in every country, influencing the prices they pay for
foreign goods
the argument for free trade follows Adam Smith!s analysis
voluntary exchange makes both parties to the transaction better off and allocates
resources to their highest valued use
welfare of a country and its citizens is best promoted by allowing self-interested
individuals regardless of where they reside to exchange goods, services and assets
as they see fit
we review the primary arguments against free trade
National Defense Argument
reason to support government protection of specific industries
holds that a country must be self-sufficient in critical raw materials, machinery, and
technology or else be vulnerable to foreign threats
appeals to the general public which is concerned that its country will be pushed
around by other countries that control critical resources
special interest groups used this politically appealing argument to protect their
industries from foreign competition
Infant Industry argument:
first US secretary of treasury ALexander Hamilton articulated this point
newly developed infant industries possess comparative advantage that will ultimately
allow it to thrive in international markets

Only pages 1-3 are available for preview. Some parts have been intentionally blurred.

however young nation!s manufacturers would not survive infancy and adolescence
because of fierce competition from more mature European firms
so he fought for imposition of tariffs on numerous imported manufactured goods to
give US firms temporary protection
determination of which industries deserve infant industry protections is often done on
a political and not economic basis
once an industry is granted protection it may be reluctant to give it up
Maintenance of Existing Jobs
to maintain existing employment levels firms and workers often petition to their
governments for relief from foreign competition
assistance may come in the form of tariffs, quotas, or other barriers
however assistance may be temporary
Strategic Trade Theory
economists who claim that such intervention ultimately harms the economy
they base this claim on theoretical predictions of classical trade theories- absolute
advantage and comparative advantage
these theories assume that firms operate in perfectly competitive markets
theories also assume that each country!s consumers are able to buy goods and
services at the lowest possible prices from the world!s most efficient producers
Strategic trade theories: these models provide new theoretical justification for
government trade intervention, thereby supporting firms! requests for protection
makes very different assumptions about the industry environment in which firms
operate than do classical theories
applies to those industries capable of supporting only a few firms worldwide
might be because of high product development costs or strong experience curve
firm can earn monopoly profits id it can succeed in becoming one of the few firms
theory suggests that a national government can make its country better off if it adopts
trade policies that improve the competitiveness of its domestic firms in such
oligopolistic industries
assume that became of economies of scale, the market will be extremely profitable if
only one firm decides to enter
Example: assume there are two firms competing for foreign market in (to develop
technology), they are both from different countries, following payoff matrix would apply
(shows profits in billions):

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Now supposed that the government in Company A!s home country gives the firm a
subsidy, following would be payoff matrix (shows profits in
Subsidy is in blue font
Company A will develop the technology regardless of what Company B does because
they will make more money by developing than not developing
What has this subsidy accomplished?
1. It has induced Company A to develop new technology
2. It has induced other country!s firm (Company B) to stay out of the market
3. It has succeeded in allowing it!s firm to make $12 billion profit at the cost of its
taxpayers contributing only $2 billion
however strategic theory applies only to markets that are incapable of supporting more
than a handful of firms on a worldwide basis
most global industries are more competitive than this
country!s wholesale adoption of strategic trade policies to cover a broad group of
industries may actually reduce the country!s overall international competitiveness
the benefit of the subsidy could be neutralized if another country adopts a similar
If Company B!s home country were to provide a $3 billion subsidy the payoff matrix
would change
After assessing the needs of the national economy the government then adopts
industry-by-industry policies to promote the country!s overall economic agenda
Economic Development Programs:
International commerce can play a major role in economic development programs
Countries that depend on a single export often choose to diversify their economies to
reduce the impact
-1+2= +1
10 + 2= 12
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