Trade regulations and industrial policies

CHAPTER 7

TRADE REGULATIONS AND INDUSTRIAL POLICIES

 

SYNOPSIS OF CHAPTER CONTENT

This chapter moves beyond the economic analysis of tariffs and nontariff trade barriers developed in previous chapters to examine the actual trade policies and regulations that have been employed by the United States and other nations throughout history.

The first tariff legislation in the United States, passed in 1789, was designed primarily to achieve revenue objectives.  This remained an important goal of tariffs through the early 1800s, but with industrialization and diversification of the U.S. economy the federal and state governments began to rely more heavily on income, property, and sales taxes as sources of revenue to finance government spending.  Today tariffs constitute a negligible source of government tax revenue in the United States.  In 1791 Alexander Hamilton presented his famous argument in support of tariffs to protect emerging U.S. industries.  This classic infant-industry argument for tariffs motivated tariff legislation in the 1820s, and by that time the protective argument for tariffs was well established in the United States. 

The average level of tariff protection has fluctuated significantly in the United States, reaching levels between 40 and 50 per-cent during the 1890s, falling to 27 per-cent with the trade liberalization movement of the early 1900s, and rising to a record 53 per-cent in 1930 as the Smoot-Hawley Tariff Act was passed by Congress and approved by President Hoover in an effort to protect the United States from the emerging economic depression.  The Smoot-Hawley Act was futile and counterproductive, as other nations throughout the world responded with similar measures, either in retaliation or to protect their own economies, and the resulting collapse in world trade only prolonged and deepened the global economic depression of the 1930s.

The Reciprocal Trade Agreements Act of 1934 signaled a trend toward trade liberalization in the United States.  This act of Congress granted authority to the President to reduce U.S. tariffs, provided that other important trading nations would reciprocally lower their tariffs on imports of similar goods.  The most-favored-nation (MFN) clause also was incorporated, guaranteeing that each exporting nation would receive similar treatment to that of the "most favored" nation, thereby ensuring equal treatment for all exporters of any particular product.  Presently, the United States grants MFN status to all but a handful of nations which are not included for various foreign policy reasons.

After World War II, most of the major industrial nations signed the General Agreement on Tariffs and Trade (GATT), which established a framework and an international institution designed to promote nondiscrimination among nations in international trade, multilateral import tariff reductions, and elimination of import quotas except in specified circumstances.  The United States was one of the original 23 signatories, and the GATT has expanded to include more than 100 member nations today.

In addition to its day-to-day surveillance of trade policies, the GATT membership has undertaken a series of specific "rounds" of multilateral trade negotiations.  The Tokyo Round, completed in 1979 after 5 years of talks, achieved large percentage reductions in tariffs, but because tariff levels already had been reduced to relatively low levels the impact of these additional cuts was not significant.  Of greater importance were the agreements to reduce a variety of nontariff barriers to trade, including arbitrary customs valuations procedures, health and safety standards that operated primarily to exclude imports, government subsidies and countervailing duties, restrictive licensing requirements, and government procurement practices that favored domestic suppliers or excluded foreign firms from bidding on government contracts.  Benefits from the Tokyo Round perhaps were more limited and difficult to assess than those of earlier negotiations such as the Kennedy Round, both because tariffs already had been reduced to low levels and because agreements to reduce NTBs are more subjective, more difficult to monitor and verify, and more difficult to measure than is the case with tariffs. 

In 1986, GATT members entered into the Uruguay Round of trade negotiations.  As with the Tokyo Round, the focus was primarily on nontariff barriers.  However, the goals were more ambitious, extending into areas not covered before.  Protection of intellectual property relating to patents and copyrights was one objective, affecting products ranging from movies to medicine and computer software.  Moving beyond the traditional focus on products to eliminate trade barriers against imports of services in areas such as transportation and finance was another goal.  A major focus was on agriculture, with the United States pressing the European Community and other nations to end domestic subsidies, export subsidies, and import barriers that have been used to provide substantial support and protection for domestic farmers.  Another objective was to increase the participation of developing nations in GATT talks and to recognize more effectively the special needs and circumstances of these nations.  The Uruguay Round was scheduled to be completed by 1990, but intense disagreement, especially relating to agriculture, led many to fear that the negotiations would fail.  The talks collapsed, deadlines were extended, and only at the last possible moment, in mid-December 1993, was agreement reached. 

After ratification by GATT member nations, the Uruguay Round took effect in January 1995.  This also transformed the GATT into the World Trade Organization (WTO). While GATT was an accord among nations, the WTO is a more formal membership organization with a wider scope and greater authority than GATT.  Experience during the coming months and years will determine the actual influence and effectiveness of this new institution for promoting freer trade among nations.

U.S. firms that export or compete with imports have access to various remedies if they believe that foreign competition is unfair or imposes undue hardship on them.  The escape clause in U.S. trade legislation provides temporary relief for U.S. companies if it can be shown that the domestic industry is suffering serious injury, that imports are increasing, and that the imports constitute a substantial cause of the injury.  In such cases it need not be shown that foreign firms or governments are engaging in "unfair" trade practices.  In cases where export subsidies from foreign governments are deemed to provide unfair competitive advantages, the United States or other importing nations may impose countervailing duties to offset or nullify such advantages, under the terms of GATT.  Such countervailing duties clearly offer protection for the domestic industry, although foreign export subsidies generally benefit the importing nation as a whole in the form of less expensive imports;  thus, countervailing duties may not serve the best interest of society in the importing nation.  Finally, antidumping legislation in the United States is designed to authorize duties or tariffs to offset any advantage gained by foreign firms that export products to the United States at prices below cost or below prices charged in their home markets.  Again, injury caused by such dumping practices must also be demonstrated before antidumping duties may be imposed.        

An additional trade policy tool used by the United States is Section 301 of the Trade Act of 1974, authorizing the United States Trade Representative to respond directly to trade practices of other nations that place "unreasonable" or "discriminatory" burdens on U.S. export firms.  This unilateral track was established because of Congressional dissatisfaction with the often lengthy and ineffective multilateral resolution of trade disputes within GATT.  Supporters contend that the mere threat of imposing Section 301 sanctions often induces other nations to eliminate unfair trade practices, while critics maintain that such forceful unilateral tactics violate the U.S. commitment to work through the multilateral channels that it accepted as a signatory to GATT.

Another subject of increasing attention in trade negotiations is the protection of intellectual property rights.  Copyrights, patents, and trademarks traditionally have been used to protect such rights.  When foreign firms imitate or produce a modified version of a protected product, without permission from or compensation to holders of copyrights or patents, they gain an unfair advantage.  If they appropriate the trademark of another firm, they may gain sales unfairly and perhaps also damage the reputation of the trademark holder if their product is inferior to the original.  The Omnibus Trade and Competitiveness Act, passed by the United States in 1988, provides more recourse or protection for holders of intellectual property rights, and the Uruguay Round of GATT trade negotiations also established more multilateral protection of such rights.

In contrast with measures intended to protect domestic firms from intense or unfair foreign competition, trade adjustment assistance is designed to facilitate a transition into other industries for companies and workers displaced by foreign competition.  The rationale for such an approach is that if free trade and specialization according to comparative advantage increase the economic welfare of a nation, it is better to accept such gains and compensate specific groups who may lose from foreign competition, enabling firms and workers to move into areas in which the nation does have a comparative advantage.  The alternative would be to protect and perpetuate jobs and investments in industries in which the nation is less efficient, thereby sacrificing the potential gains from free trade.  

In recent years, a number of policymakers and analysts have urged the U.S. government to take a more assertive and proactive role in promoting domestic industry, responding in part to the perceived loss of U.S. competitiveness relative to other nations such as Japan and Germany.  This approach, known as industrial policy, involves the use of specific incentives such as tax reductions, loan guarantees, low-interest government loans, and subsidies to fund research and infrastructure development.  Although the U.S. government has intervened in the economy over the years to subsidize agriculture, support aircraft manufacturers and provide loan guarantees for auto firms, this runs counter to the prevailing free-market tradition of the U.S. economy.  The U.S. government has not developed an explicit, comprehensive industrial policy designed to target support for specific industries or to promote "national champions."  Other nations, especially France and Japan, have developed and implemented more formal and aggressive industrial policies.  Whether government agencies such as Japan's Ministry of International Trade and Industry (MITI) have been successful in systematically picking winners is a topic of intense debate, as is the questions of whether such an approach would succeed in the United States. 

One variant of industrial policy that has received growing attention since the 1980s is strategic trade policy.  This relates to industries in which imperfect competition, rather than perfect competition, prevails.  Industries with a small number of dominant firms, high fixed costs, and economies of large-scale production create conditions under which firms assisted by government subsidies can gain market share from foreign competitors, reduce unit costs, and capture benefits for themselves and their nation.  High-technology industries, in which production experience or learning-by-doing reduces unit production costs, also would qualify as strategic industries deserving of government support.  As with other forms of industrial policy, critics of strategic trade policy question the ability and political will of governments to pick industries carefully and successfully, and note also that strategic trade policy invites foreign retaliation and the risk of escalating government support and protection for industries. 

The welfare effects of strategic trade policy are difficult to estimate and depend on the specifics of each case.  In general, taxpayers in the nations using strategic trade policy to promote exports lose because of higher taxes to fund subsidies, export firms gain higher profits, and consumers in importing nations gain through lower prices resulting from the subsidies.  However, if strategic trade policy succeeds in eliminating competition, the remaining dominant firm might well charge higher monopoly prices, with net losses to consumers.

Despite the debate over explicit industrial policy, it is clear that more general government support policies can significantly affect the international competitiveness of a nation's industry.  Policies to increase saving and investment, to promote education, training, and research and development, and to provide competitive export credit terms as with the U.S. Export-Import Bank may serve to strengthen a nation's economy and thus enable its industry to compete against imports and succeed in export markets. Another advantage of this approach is that it does not invite the retaliation or charges of unfair trade policies that often result from the more interventionist industrial or strategic trade policies.

As the relative importance of the service sector in the U.S. economy has increased, trade policies relating to service exports have received growing attention.  Although many services by their very nature cannot be exported or imported, others offer such potential.  The United States has been a consistent net exporter of services, and has pressed its trading partners to reduce their barriers to service imports in industries ranging from banking and insurance to motion pictures and computer services.  Trade barriers to service imports often are subtle and difficult to verify or measure, and protection of domestic services frequently is a socially and politically sensitive issue.  Indeed, France and other EC nations have resisted U.S. efforts to reduce trade barriers in the motion picture industry, and ultimately prevailed in excluding this industry from the final agreement in the Uruguay Round of trade negotiations.

Finally, nations sometimes use trade policy not to protect or promote domestic industry but to impose economic sanctions on other nations in order to achieve certain foreign policy objectives.  Such sanctions usually take the form of limiting exports from the sanction-imposing nation, limiting imports from the target nation, or controlling financial flows into the target nation.  The economic impact of sanctions usually requires that they be imposed with multilateral cooperation rather than unilaterally by one nation, and even if they impose economic hardship their effectiveness in achieving the desired foreign policy objectives depends on generating a positive response from friendly government or private interest groups within the target nation rather than provoking a hardline response from an adversarial government with authoritarian domestic power.  It should be recognized that, just as free trade is said to bring mutual gains to all parties, the imposition of sanctions generally brings welfare losses not only to the target nation but also to the sanction-imposing nation.  Even if the sanctioning nation is willing to accept such losses, the historical record contains more instances of mixed results or failures than of clear successes in achieving the foreign policy objectives of economic sanctions.

KEY CONCEPTS AND TERMS  (Define each concept, and briefly explain its significance.)

Smoot-Hawley Tariff Act

Reciprocal Trade Agreements Act

Most-favored-nation (MFN) clause

General Agreement on Tariffs and Trade (GATT)

Tokyo Round of GATT talks

Uruguay Round of GATT talks

World Trade Organization (WTO)

 

Escape clause

Countervailing duty

Section 301 of the 1974 U.S. Trade Act

Intellectual property rights

Trade adjustment assistance

Industrial policy

Export trading company

U.S. Export-Import Bank

Japanese Ministry of International Trade and Industry (MITI)

Strategic trade policy

Economic sanctions

TRUE OR FALSE?  (On an exam, be prepared to explain why each statement is true or false.)

T  F  1.             The initial tariff laws in the United States, established in the late 1700s, were established primarily to raise revenue.

T  F  2.             In 1791, Alexander Hamilton advocated tariffs to protect new industries, using the infant-industry argument.

T  F  3.             The Smoot-Hawley Act of 1930 was the first major effort in the United States to reduce tariffs and move toward free trade.

T  F  4.             The most-favored-nation clause allows nations to preserve favored tariff treatment for historical allies.

T  F  5.             The General Agreement on Tariffs and Trade, established in 1947, remains the primary international forum for negotiating trade agreements.

T  F  6.             The Uruguay Round of GATT trade talks focused primarily on agriculture, services, and intellectual property.

T  F  7.             The escape clause in U.S. trade law permits key industries to escape permanently the competitive effects of reduced trade barriers.

T  F  8.             Countervailing duties are designed to promote fair trade by offsetting the effects of foreign export subsidies.

T  F  9.             Strategic trade policy involves government targeting of key industries for export promotion, as MITI has done in Japan.

T  F10.             Economic sanctions are most successful if imposed unilaterally, by a single nation.

MULTIPLE CHOICE

1.         The Smoot-Hawley Act of 1930
a.         represented a turning point toward lower tariffs
b.         represented the highest tariff levels in U.S. history
c.         helped the United States recover from the Great Depression
d.         prompted other industrial nations to reduce their tariff barriers against U.S. exports

2.         The rationale for a scientific tariff is to
a.          provide revenue for the government
b.         protect an infant industry against foreign competition
c.         improve a nation's balance of payments
d.         raise import prices to the extent that foreign production costs are lower than domestic costs

3.         The Reciprocal Trade Agreements Act of 1934
a.         restricted the ability of the President to negotiate tariff reductions
b.         made reductions in U.S. tariffs contingent on the willingness of trading partners to lower their tariffs
c.         provoked a trade war that raised tariffs dramatically
d.         eliminated the most-favored-nation clause in trade negotiations

 

4.         Compared with the Tokyo Round, the Uruguay Round of GATT negotiations focused primarily on
a.         import tariff reductions
b.         government procurement policies
c.         trade in professional services and agricultural products
d.         product standards relating to health and safety

5.         The escape clause is part of trade remedy law designed to
a.          provide temporary relief for workers and firms disrupted by reductions in tariffs or other trade barriers
b.         offset the effects of unfair trade practices in other countries
c.         help U.S. firms escape the effects of export subsidies provided by foreign governments
d.         retaliate against foreign firms that dump exports at prices below cost of production

6.         A countervailing duty
a.         is the same as a scientific tariff
b.         protects firms from injury caused by foreign export subsidies
c.         is a retaliatory response to foreign tariffs
d.         is designed to generate revenue to offset a budget deficit

7.         A Japanese government export subsidy would
a.         be beneficial to U.S. producers of similar products
b.         be harmful to U.S. consumers
c.         create an overall welfare loss for the United States, as U.S. firms would lose more than U.S. consumers would gain
d.         create an overall welfare gain for the United States, as U.S. consumers would gain more than U.S. firms would lose

8.         U.S. industrial policy includes all of the following except:
a.         export financing from the Export-Import Bank
b.         nationalization of key industries such as steel
c.         tariffs to protect industries facing growing foreign competition
d.         legislation to allow for export trade associations

9.         Strategic trade policy
a.         is used most frequently to support firms in perfectly competitive industries
b.         often involves subsidies and other support for high-technology firms in concentrated industries
c.         is practiced by only one major industrial nation today
d.         is designed to provide equal treatment for all industries

10.       Economic sanctions against foreign nations are most successful
a.         if one major nation imposes them unilaterally
b.         when used against historical enemies rather than traditional allies
c.         when influential groups within the target nation support the objectives of the sanction-imposing government
d.         when the sanctions are harsh, comprehensive, and highly publicized

 

 

PROBLEMS AND SHORT ANSWER QUESTIONS

1.         What motivated the United States to impose the record-high Smoot-Hawley tariffs in 1930?  How did other industrial nations respond?  What was the net impact on the global economy, and on each of the domestic economies involved?

 

2.         How did the Reciprocal Trade Agreements Act represent a new direction for U.S. trade policy?  What important role did the most-favored-nation clause play within this context?

3.         What are the basic goals and principles of the General Agreement on Tariffs and Trade?  How has its membership changed since its 1947 origin?

4.         Compare and contrast the Tokyo Round and Uruguay Round of GATT multilateral trade negotiations, as each moved in different ways beyond a simple focus on import tariff reductions.

 

5.         In what ways do the international protection of intellectual property rights and the elimination of barriers against trade in services pose more subtle and difficult challenges than has been the case with barriers against trade in products?

 

6.         Explain how the escape clause, countervailing duties, and antidumping duties each serve distinct functions within the scope of U.S. trade remedy laws.

7.         Suppose that Brazilian firms can produce steel at a cost of $400 per ton, but that at this price U.S. steel firms can supply the entire domestic market, as shown in the following graph.  If the Brazilian government provides a steel export subsidy of $50 per ton in order to gain a share of the U.S. market, show the effects on the graph.  Identify the welfare gains and losses to different groups in the United States.  Why does the U.S. government face a dilemma in deciding how, if at all, to respond to such a subsidy?

 

8.         What is the economic rationale for employing trade adjustment assistance rather than protective measures in response to dislocations caused by foreign competition?  Why has adjustment assistance had only limited success in the United States?

 

9.         Compare and contrast the use of industrial policy by the United States with that of MITI in Japan.  Why is there so much controversy regarding the advisability and effectiveness of industrial policy?

 

10.       Explain how strategic trade policy represents a specific form of industrial policy.  Why is a national government tempted to provide subsidies for a strategic industry, and how does this create pressure for governments in nations with competing firms to provide similar subsidies?  What are the strengths and limitations of strategic trade policy?

11.       If the U.S. government declined to use narrowly defined interventionist industrial or strategic trade policies but still wished to establish policies that would promote the global competitiveness of U.S. firms, what advice would you give?

 

12.       How and why do nations use economic sanctions to achieve various foreign policy objectives?  What conditions must be met for such sanctions to be successful?  Why do some observers believe that the Soviet grain embargo and the Iraqi sanctions were less successful than the sanctions against South Africa?

 

EXPLORATIONS BEYOND THE CLASSROOM

1.         Review and evaluate recent U.S. Congressional debate and testimony regarding the use of industrial policy and strategic trade policy.  How does funding for the Export-Import Bank figure into this debate?

2.         What progress has been made in implementing Uruguay Round trade barrier reductions?  What does our initial experience suggest about the future effectiveness and authority of the new WTO?

3.         Locate and discuss recent newspaper articles or government documents dealing with government subsidies, countervailing duties, and subsidies to strategic industries or firms such as Airbus and Boeing.  What factors have contributed to Boeing’s recent loss of market share to Airbus?  How, if at all, do you think the U.S. government should respond?

4.         How do recent conflicts between Japan and the United States over strategic impediments to imports reflect the trade policy issues negotiated in the Tokyo and Uruguay Rounds?

5.         Locate recent articles dealing with the debate over economic sanctions against China for alleged human rights violations, and apply the criteria for successful sanctions to assess the probable impact of such sanctions against China.