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Datamatrix – Economic Trade Policies

Suite 306

ECONOMIC TRADE POLICIES


Protectionism

Current World Trends

Import Substitution

Free Trade

Offshore Outsourcing

Dumping

Illegal Drugs Trade

306.01 PROTECTIONISM

Protectionism is the economic policy of protecting a nation's manufacturing base from the effects of foreign competition (including Dumping) by means of high tariffs on imported goods, restrictive quotas, and other means of reducing importation. This contrasts with free trade, in which foreign products are exempted from tariffs, allowing foreign producers to access a domestic market without the tax burden incurred by domestic manufacturers.

Protectionism has frequently been associated with mercantilism, the belief that it is beneficial to maintain a positive trade balance; and import substitution; There are two main variants of protectionism, depending on whether the tariff is intended to be collected (traditional protectionism) or not (modern protectionism).

Modern protectionism

Most modern views of protectionism call for placing tariffs at such a high level as to compel the consumer to buy the domestic product. In this version of protectionism, no tariff revenue is generated for the government and the consumer is burdened both with high prices on the domestic product and no income or other domestic tax relief. So in other words the intervention in the trade system through tariffs, quotas, regulations, etc., in order to support domestic industries is known as protectionism.

In the modern trade arena many other initiatives besides tariffs have been called protectionist. For example some commentators, such as Jagadish Bagwatti, see developed countries' efforts in imposing their own labor or environmental standards as protectionism. Also, the imposition of restrictive certification procedures on imports are see in this light.

Recent examples of protectionism are typically motivated by the desire to protect the livelihoods of individuals in politically important domestic industries, such as farmers in the United States and European Union, who in the absence of tariffs might be unable to compete with both lower-cost and untaxed foreign producers.

Whereas formerly blue-collar jobs were being lost to foreign competition, in recent years there has been a renewed discussion of protectionism due to offshore outsourcing and the loss of white-collar jobs. Most economists view this form of protectionism as a disguised transfer payment from consumers (who pay higher prices for food or other protected goods) to local high-cost producers.

Traditional protectionism

In its historic sense, protectionism is the economic policy of relying on revenue tariffs for government funding in order to reduce or eliminate taxation on domestic industries and labor (e.g., corporate and person income taxes). In protectionist theory, emphasis is placed on reducing taxation on domestic labor and savings at a cost of higher tariffs on foreign products. This contrasts with the free trade model, in which first emphasis is placed on exempting foreign products from taxation, with the lost revenue to be compensated domestically.

Traditional protectionism sees revenue tariffs as a source of government funding, much like a sales tax that can be used to reduce other domestic forms of taxes. The goal of traditional protectionism is to maximize tax revenue from the purchase of foreign products with the goal of being able to reduce or eliminate other forms of domestic taxation (income taxes, sales taxes, etc) as a result. Tariffs were the predominant source of tax revenue in the United States from its founding through World War II, allowing the country to operate through most of that period without income and sales taxes. Traditional protectionism remains highly dependent on large amounts of imports. It also requires tariffs to be kept at reasonable rates to ensure maximum government revenue.

Traditional protectionists fault the free trade model as being reverse protectionism in disguise, that of using tax policy to protect foreign manufacturers from domestic competition. By ruling out revenue tariffs on foreign products, government must fully rely on domestic taxation to provide its revenue, which falls heavily disproportionately on domestic manufacturing.

While traditional protectionists differ from modern protectionists in that they are very much pro-import (based on their belief that a country should rely on imports as much as possible to pay the taxes), they nonetheless disagree with free traders in that they believe the primary focus should be on exempting domestic, rather than foreign manufacturing, from the various forms of taxation.

306.02 CURRENT WORLD TRENDS

It is the stated policy of most First World countries to eliminate protectionism through free trade policies enforced by international treaties and organizations such as the World Trade Organization. Despite this, many of these countries still place protective and/or revenue tariffs on foreign products to protect some favored or politically influential industries, or to reduce the taxation demands on their internal domestic manufacturing, making their products more competitive. The elimination of these tariffs remains a contentious political and diplomatic issue. China and Japan have been accused of protectionist policies that peg their currencies to the dollar and, thus, set prices of their exports lower than they would be if the market determined the relative prices of each currency.

Protectionist quotas can cause foreign producers to become more profitable, mitigating their desired effect. This happens because quotas artificially restrict supply, so it is unable to meet demand; as a result the foreign producer can command a premium price for its products. These increased profits are known as quota rents.

Subsidy

In economics, a subsidy is generally a monetary grant given by government to lower the price faced by producers or consumers of a good, generally because it is considered to be in the public interest. Subsidies are also referred to as corporate welfare by those who oppose their use. The term subsidy may also refer to assistance granted by others, such as individuals or non-government institutions, although this is more usually described as charity. A subsidy normally exemplifies the opposite of a tax, but can also be given using a reduction of the tax burden. These kinds of subsidies are generally called tax expenditures or tax breaks.

Subsidies protect the consumer from paying the full price of the good consumed, however they also prevent the consumer from receiving the full value of the thing not consumer – in that sense, a subsidized society is a consumption society because it unfairly encourages consumption more than conservation. Under free-market subsidized economy however, consumers are denied the benefit of conservation and as a result, subsidized goods have an artificially higher value than expenditures which do not consume. Subsidies are paid for by taxation which creates a deadweight loss for that activity which is taxed.

In standard supply and demand curve diagrams, a subsidy will shift either the demand curve up (subsidized consumption) or the supply curve down (subsidized production). Both cases result in a new, higher equilibrium quantity. Therefore, it is essential to consider the price elasticity of demand when estimating the total costs of a planned subsidy: it equals the subsidy per unit (difference between market price and subsidized price) times the higher equilibrium quantity. One category of goods suffers less from this effect: Public goods are – once created – in ample supply and the total costs of subsidies remain constant regardless of the number of consumers; depending on the form of the subsidy, however, the number of producers demanding their share of benefits may still rise and drive costs up.

Tax breaks and corporate welfare

As previously stated, a common form of subsidy is via a tax break. This is a reduction in the normal rate of a particular class of taxes targeted towards an individual or group of companies. Often this is described as “corporate welfare”, although that term is also used as a blanket term for all other forms of subsidies. Larger companies who are planning to open a new factory, for example, shop around for a location which will provide them with the biggest tax breaks in a process called a race to the bottom. Locations provide these tax breaks because they often feel that the benefits of job creation will more than offset the decline in tax revenues.

Another way that the government subsidizes industry is by failing to regulate externalities. For example, when a company pollutes it generates savings for itself at public expense, in the form of environmental degradation and public health costs. Thus a cost of production is absorbed by the public. Some economists argue that this is a form of subsidy of producers since producers are not paying the full social cost of production.

Subsidies due to the effect of debt guarantees

Another form of subsidy is due to the practice of a government guaranteeing a lender payment if a particular borrower defaults. This occurs in the United States , for example, in certain airline industry loans, in most student loans, in small business administration loans, in Ginnie Mae mortgage backed bonds, and is alleged to occur in the mortgage backed bonds issued through Fannie Mae and Freddie Mac. A government guarantee of payment lowers the risk of the loan for a lender, and since interest rates are primarily based on risk, the interest rate for the borrower lowers as well.

Controversy

One of the most controversial subsidies, especially in publications like The Economist , are the subsidies used in first-world countries and targeted towards farmers. Charitable institutions lie Oxfam often criticize the high subsidies dumping millions of surplus commodities (like sugar) on world markets destroying opportunities for farmers in developing and poor countries, especially in Africa. For example, currently, the EU is spending (3.30 eu's in subsidies to export sugar worth 1. eu). These subsidies have remained in place even though many international accords have reduced other forms of subsidies or tariffs.

Many developing nations who are dependent on exports of farm produce argue that subsidies given to farmers in rich nations are the biggest single contributor to their continued poverty. The subsidies drive down the global market price to the point where farmers in poor nations, who do not receive subsidies, can no longer earn a living by selling their products. As a result not only are they unable to work their way out of poverty by selling their products, but they also become dependent on imports of subsidised goods because they are cheaper than locally produced goods. Most rich nations are reluctant to change their policy of giving subsidies though, because their inherently higher labour costs make their domestic farmers unable to compete globally without the subsidies. Removing the subsidies would mean lost jobs, and with powerful lobby groups and popular support to consider, few politicians are willing to change the status-quo in favour of poor farmers abroad, at the expense of local farmers.

Conversely, many poor people consume subsidized produce, which would become more expensive without subsidies.

Another view, held by Austrian economists and other free-marketers, is that subsidies do, in general, more harm than good by distorting natural economic signals.

Sometimes people believe profitable companies to be ‘bullying' governments for subsidies and rescue packages; this is the case with Australian rail operator Pacific National that threatened the Tasmanian Government with a pull out of rail services unless a subsidy was made. Despite the fact Pacific National is owned by Toll Holdings an extremely profitable multi-national company.

306.03 IMPORT SUBSTITUTION

Import substitution industrialization also called ISI is a trade and economic policy based on the premise that a developing country should attempt to substitute

products which it imports, mostly finished goods, with locally produced substitutes. The theory is similar to that of mercantilism in that it promotes high exports and minimal imports to increase national wealth.

The policy has three major tenets: an active industrial policy to subsidize and orchestrate production of strategic substitutes, protective barriers to trade (namely, tariffs), and a monetary policy that keeps the domestic currency overvalued. Hence import substitution policies are not favored by advocates of absolute free trade.

In those Latin American countries where ISI was successful it was accompanied by structural changes to the government. Old neo-colonial governments came crashing down replaced by more or less democratic governments. Banks and utilities and certain foreign owned companies were nationalized.

Perceived failure

The policy began to fail in the early 1980s, as a result of overspending by the governments involved, mostly from spending government reserves trying to keep the currency stable. As the Latin American governments failed, they began to default on their debts and were forced to turn to the International Monetary Fund for help. The failure of ISI led to the rise of the Washington Consensus.

However, some economists have pointed out that the failure of import substitution should not necessarily be taken as an endorsement of globalization. They note that most East Asian countries while rejecting import substitution also maintained high tariff barriers. The strategy followed by those countries was to focus subsidies and investment on industries which would make goods for export. The focus on export markets allowed them to create competitive industries, although these policies later created inefficiencies and other problems, as seen during the Asian financial crises.

By the end of the 1990's, the Washington consensus was being questioned. Nevertheless, there has not been a return to import substitution as a developmental strategy.

306.04 FREE TRADE

Free trade is the untaxed flow of goods and services between countries, and is a name given to economic policies and parties supporting increases in such trade.

Free trade is a concept in economics and government that refers to:

  • International trade of goods without tariffs (taxes on imports) or other trade barriers (e.g.,quotas on imports)
  • International trade in services without tariffs or other trade barriers
  • The free movement of labor between countries
  • The free movement of capital between countries
  • The absence of trade-distorting policies (such as taxes, subsidies, regulations or laws) that give domestic firms, households or factors of production an advantage over foreign ones.
  • Government protection of property rights to enforce the above conditions

The term free trade has become very politically based, and it is not uncommon for so-called “free trade agreements” to impose additional trade restrictions. Such restrictions on trade are often due to domestic political pressure by powerful corporate, environmental or labor interest groups seeking special protections of their perceived interests.

Free trade agreements are a key element of customs unions and free trade areas.

Intellectual property and free trade

Historically, the free trade movement was sceptical and even hostile to the notion of intellectual property, regarded as monopolistic and harmful to a free, competitive economy. Indeed, during the late 19yth century, free trade advocates succeeded in reducing the length of the patents available in many European countries.

It is thus remarkable (some would even say ironic) that corporations lobbying for expanded intellectual property rights have succeeded in including TRIPS, a very strong treaty on intellectual property rights, as a membership requirement for the World Trade Organization, the international organization dedicated to furthering the cause of free trade.

306.05 OFFSHORE OUTSOURCING

Offshore outsourcing is the practice of hiring an external organization to perform some or all business functions in a country other than the one where the product or service will be sold or consumed. It can be contrasted with offshoring, in which the functions are performed in a foreign country, whether by the foreign subsidiary of the same company or a third-party. Opponents point out that this sends work overseas, thereby reducing domestic employment and domestic investment. Many jobs in the infotech sectors – such as data entry, and customer support – have been or are potentially affected.

The general criteria for a job to be offshore-able are:

  • The job does not require direct customer interaction;
  • The job can be telework;
  • The work has a high information content;
  • The work can be transmitted over the internet;
  • The work is easy to set up
  • There is a high wage difference between the original and offshore countries
  • The work is repeatable.

The driving factor behind this development has been the need to cut costs during the recession that began before the events of September 11, 2001 and deepened since then, while the enabling factor has been the global electronic network that allows digital data to be access and shipped instantly, from and to anywhere in the world.

The object is to minimize the risks and maintain the benefits of an economic globally-based, enterprise that deals with software producers in off shore nations

that would otherwise be barred by adverse risks associated with such global enterprises.

The advent of the Internet has enabled individuals and small businesses to contract freelancers from all over the world to get projects done at a minimum cost. This trend runs in parallel with the tendency towards big corporations' outsourcing, and may in the future serve to strengthen small business' capacity to compete with their bigger competitor's capable of setting up offshore locations or of arriving at major contracts with offshore companies.

306.06 DUMPING

In economics, “dumping” can refer to any kind of predatory pricing, and is by most definitions a form of price discrimination. However, the word is now generally used only in the context of international trade law, where dumping is defined as the act of a manufacturer in one country exporting a product to another country at an unfairly low price. The term has negative connotation, but advocates of free markets see “dumping” as beneficial for consumers and believe that allowing it makes the global economy more efficient. Advocates for workers and laborers however, believe that safeguarding businesses against predatory practices, such as dumping, help alleviate some of the harsher consequences of free trade between economies at different stages of development.

A standard technical definition of dumping is the act of charging a lower price for a good in a foreign market, than one charges for the same good in a domestic market. True dumping (by a technical definition) is actually very difficult under free trade, and is also made illegal by the WTO.

As countries rule domestically on whether native industries are in danger, and whether foreign firms' prices are below the cost of production, and since the foreign cost of production cannot by easily known by domestic courts, the institutional process surrounding the investigation and determinations can be very unpredictable. Member to the World Trade Organization can file complaints against anti-dumping measures.

306.07 ILLEGAL DRUG TRADE

In jurisdictions where legislation restricts or prohibits the sale of certain popular drugs, it is common for an illegal drugs trade to develop. For example, the United States Congress has identified a number of controlled substances which each have corresponding illegal drug trades.

For some drugs, large-scale drug production is not located where those drugs are illegal—rather, those drugs are smuggled into the region for illegal trade. Other drugs are often produced locally either because they can be grown surreptitiously or manufactured with common ingredients.

In recent years many prescription drugs are being illegally counterfeited and sold by unsuspecting dealers. Many of these drugs have no medical content with others being manufactured with little to no medical content. Most are manufactured in very unhygienic environments. This is a very profitable field for criminals and is increasingly hard for regulatory bodies to detect. Consequently, it is an ongoing problem for pharmacists.

Regardless of the source, high demand for illegal drugs on the black market leads to the formation of complex illegitimate production, smuggling, and distribution networks that span national borders and generate billions of dollars of revenue.

Please see ‘ Acknowledgements ' for sources of research

AID TO TRADE
UNDERSTANDING TRADE
WHAT IS TRADE?
THE ORIGIN OF TRADE
THEORY OF INTERNATIONAL TRADE
ORGANIZATION OF TRADE
CURRENCY AND THE TRADING LANGUAGE
THE HISTORY OF CURRENCY
CURRENCY A UNIT OF EXCHANGE
THE LANGUAGE OF INTERNATIONAL TRADE
IMPORT / EXPORT TERMINOLOGY
TRADE ETHICS, TRENDS AND POLICIES
ETHICAL TRADING
RISKS AND REWARDS
ECONOMIC TRADE POLICIES
AGENCY FOR INTERNATIONAL DEVELOPMENT
GETTING STARTED
EXPORTING ? THE START
ASSESSING YOUR EXPORT POTENTIAL
PREPARING YOUR PRODUCT FOR EXPORT
PRICING, QUOTATIONS AND TERMS
MARKETING
MARKET RESEARCH
MARKET INFORMATION
MARKET ENTRY
THE MARKETING PLAN
STRATEGY, PORTS AND WAREHOUSES
EXPORT LICENCE
IMPORTING
AN EXPORT STRATEGY
SHIPPING
DOCUMENTATION, FOOD, DRUG AND ENVIRONMENT
DOCUMENTATION
BONDED WAREHOUSE
LEGAL CONSIDERATIONS
FOOD, DRUG & ENVIRONMENT
PAYMENT, CREDIT AND FINANCE PROGRAMS
METHODS OF PAYMENT
EXPORT CREDIT
EXPORT FINANCE PROGRAMS
EXPORT FINANCE PROTECTION
REPRESENTATION AND INTELLIGENCE
TRADE ASSISTANCE PROGRAMS
OFFSHORE REPRESENTATION
EXAMPLE FORMS
INTELLECTUAL PROPERTY
THE PENTHOUSE - INTERACTION
FINANCE
THE DIRECTORS CLUB
THE CONFERENCE ROOM
THE SITE?S BONUS FEATURES


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