Trade Policies & Global Movements

Introduction

Modern era of free trade began in 1944, with the coming together of the great minds of liberal economics at Bretton Woods in the middle of the world war II. Center at everyone’s mind then was world peace; an economy that will foster and necessitate world peace. This brought about the idea of Economic Interdependence (the ideology that nations dependent on each other for its supply chain, can’t go to war with each other). The outcome of this meeting, four years later gave birth to GATT (General Agreements on Tariffs & Trade), which brought about globalization or global movements, outsourcing, and the multinational enterprises. GATT brought with it, prosperity from 1948 to the late 70s. Between the late 70s to the early 80s, another group of liberal economists met. This time, the focus was on Global efficiency (how to boost the global economy), bringing about the “non-tariff barriers”. In 1995, GATT was replaced by the WTO (world trade organization), but before and even after the establishment of the WTO, there were various trade agreements (NAFTA, EU, APEC & OPEC) and lots of Bilateral trade treaties all governed by the “non-tariff barriers” philosophy.

This assignment focuses on Trade Policies for the Developing Nations, Regional Trading Arrangements, and International Factors Movements and Multinational Enterprises as laid out in chapters 7, 8, and 9 respectively in the book: International Economics by Robert Carbaugh. The objective of this assignment is to demonstrate an understanding of the above-mentioned topics via providing accurate answers to the examination questions in related topics.

Trade Policies for the Developing Nations: This chapter looks at what characterizes the developing nations, and what differentiates them from the advanced nations (with particular reference to the GDP), why these nations consider the current international trading scheme not beneficial to them, the factors (unstable export markets, worsening trading terms, and limited market access) affecting them, and the institutions (IMF and the World Bank) and trade policies put in place to support these developing nations. Some of these trade policies include the International commodity agreements, import substitutions and exportation promotion (to promote industrialization), enhancing the workforce (as is done in the East Asia), and the free trade (to encourage foreign investment and an accelerated economic growth).

Regional Trading Arrangements, which is one of the two trade liberalization approaches (the other being “a reciprocal reduction of trade barriers on a nondiscriminatory basis” (p.271)), is a system which permits member states to trade with each other on mutually beneficial terms (free trade zones, common markets, customs unions, economic & monetary unions) to the exclusion of the non-member states. This chapter focuses on the operation and effects (trade creation effect & trade diversion effect) of regional trading arrangements also known as regional trade agreements.

International Factors Movements and Multinational Enterprises: International factor movements concerns the movement of labor and capital across nations. It looks at the international labor migration, permanent and temporary migration, and reasons for migration (push and pull factors). Multinational enterprises play a key role in international factor movements which contributes to the global economy. This chapter looks at “the role of international capital flows as a substitute for trade in capital-intensive products” (p.231), it also covers what constitutes and characterizes the multinational enterprises, and the major factors that determine the possibilities of undertaking a foreign direct investment (p.337).

ANSWERS FOR CHAPTER 7

1. Major reasons for the skepticism and reservations of many developing nations regarding the comparative advantage and free trade was because they saw it as less beneficial to them and more beneficial to the developed nations as reflected in the following facts:

- Concentration of exports of developing nations on mainly primary products to the international markets;
- High importation dependence by developing nations on developed nations;
- The deliberate ploy to hinder the industrialization of many developing nations through the adoption of the protectionist trading policies by advanced nations against developing nations;
- The poor or non-active participation of developing nations in the multilateral trade liberalization agreements which tended their products to be omitted from the sharp reductions in tariffs made in those rounds;
- The unstable export markets of developing nations, which is worsening terms of trade, and limited access to the markets of advanced nations;
- Trade among the developing nations is relatively minor, although it has increased in recent years;
- Many developing nations are handicapped by poor infrastructure, inadequate education, rampant corruption, and high trade barriers;
- Transport costs to advanced-nation markets are often higher than the tariffs on their goods, making these transport costs even more of a barrier to integration than the trade policies.

2. Major methods adopted by many primary-product nations to achieve price stabilization of commodities include the following:

- The introduction of international commodity agreements (ICAs). These agreements are between leading producing and consuming nations of commodities such as cash crops;
- Agreements on production and export controls. An agreement in which member nations agree on the target price of a commodity.
- The buffer stocks technique, it consists of supplies of a commodity (in large quantity) financed and held by the producers’ association;
- The use of Multilateral contracts, a method which stipulates a minimum price at which importers will purchase guaranteed quantities from the producing nations, and a maximum price at which producing nations will sell guaranteed amounts to the importers.

3. Examples of International Commodity Agreements includes:

- International Tin Agreement,
- the International Sugar Agreement,
- the International Wheat Agreement.

Many of these agreements have broken down due to these reasons:

- The introduction of policies that do not encourage market expansion like imposing limits on production and exports which have only the limits among producing nations;
- Lack of proper structure and strong implementation measures of these agreements, making them less effective;
- The competitive disadvantage of producers of developing nations against producers of developed nations in the international markets.

4. Developing nations are more concerned with commodity price stabilization because it enables them improve their economies and gain access to the global markets. It also provides a fair platform to compete with developed nation’s producers.
5. Import-substitution and export promotion policies could be used to aid the industrialization of developing nations through:

- Complete self-sufficiency;
- Protection of start-up domestic industries to enable them grow and compete with industries of advanced nations;
- Providing more employment opportunities to citizens;
- The extensive use of trade barriers to protect domestic industries from import competition and has oriented trade and industrial incentives in favor of production for the domestic market over the export market;
- It promotes economic growth through the export of manufactured goods.

6. With its rich diversity in natural resources, populations, cultures, and economic policies, East Asian nations adopted a strong strategy 1970s to the 1990 which allowed them performed high rate of economic growth. These strategies may include:

- Investing in human resources and providing a favorable competitive climate for private enterprise to foster competitiveness;
- They kept their economies open to international trade as well;
- They actively sought foreign technology, such as licenses, capital goods imports, and foreign training;
- The prevention of minimum-wage legislation, and sustained free and competitive labor markets by generally discouraging the organization of trade unions (either by deliberate suppression, government paternalism, or by the implementation of a laissez-faire policy);
- The introduction of import substitution through levying high tariffs and quantitative restrictions on imported goods so as to develop their consumer goods industries;
- Subsidizing some manufacturing industries such as textiles;
- Adopting the strategy of outward orientation and export promotion;
- Initiating policies to promote exports while protecting domestic producers from import competition

As to whether this Asian miracle would continue in the new millennium?

In my opinion, the East Asian economies could withstand the new era of challenges if only they minimize pollution by relocating some of their industries to other developing countries, and explore new markets as well as reducing their high dependence on the United States which is applying protectionism policy against them.

7. China has managed to achieve the status of a high performing Asian economy through adopting the following step-by-step changes to minimize economic disruption and political opposition:

- Implementing reforms in the agricultural and industrial sectors, by increasing the role of the producing unit, increasing individual incentives, and reducing the role of state planners;
- The sale of goods at a market-determined (not state-controlled) prices;
- Encouraging competition between new private firms and state-owned firms (by 2000, non-state firms manufactured about 75 percent of China’s industrial output);
- Opening its economy to foreign investment and joint ventures.
- Establishing economic zones where firms could keep foreign exchange earnings and hire and fire workers.

China’s normal-trade-relation status have been a source of controversy in the United States for the following reasons:

- Reluctance by China to limit subsidies for agricultural production to 8.5 percent of the value of farm output and not maintain export subsidies on agricultural exports;
- Its refusal to grant full trade and distribution rights to foreign enterprises (majority of which are American companies) in China, and to fully open the banking system to foreign financial institutions and to protect the intellectual property of foreigners according to the internationally agreed-upon standards.
- The non-provision of a safe business environment;
- The issue of water-pollution by the American companies in China thereby violating China’s water-pollution laws.

China’s entry into the WTO has resulted into a trade war between member nations from developed and developing nations since China has not fulfilled its commitments regarding the country’s refusal to significantly reduce trade and Investment barriers: reduce its average tariff for industrial goods to 8.9 percent and to 15 percent for agricultural goods.

8. India abandoned the import-substitution system in the 1990s because, not only did it isolate India from the mainstream, its economy achieved only a modest growth rate and poverty was widespread thereby strangling the economy.

The new strategy adopted was to switch toward an outward-oriented, market-based economy strategy through government approval of industrial investment expenditures, abolishing quotas on imports, removing export subsidies, and slashing the import tariffs (from an average of 87 percent in 1990 to 33 percent in 1994). Furthermore, Indian companies were permitted to borrow from international markets.

ANSWERS FOR CHAPTER 8

1. The trade liberalization cannot exist effectively while it is based on both nondiscriminatory and discriminatory basis. The reason is that, the nnon discriminatory approach is a reciprocal reduction of trade barriers between two-member states, of which is extended to other member states. For example, when two members of the World Trade Organization agree to reduce trade barriers in their transactions, this is going to be extended to all WTO member states.

And the discriminatory approach occurs when a small group of nations, typically on a regional basis, form a regional trading arrangement. Under this system, member nations agree to impose lower barriers to trade within the group than to trade with nonmember nations. Each member nation continues to determine its domestic policies, but the trade policy of each includes preferential treatment for group members.

That is the reason developing nations are pushing for change into the World Trade Organization (WTO) system, because such an international approach encourages a gradual relaxation of tariffs throughout the world.

2. Economic integration is a process of eliminating restrictions on international trade, payments, and factor mobility. It results in the uniting of two or more national economies in a regional trading arrangement.

The various stages of economic integration include:

- Regional Trade Arrangement which is an agreement between a group of nations to remove or lower barriers to trade within the group with the exclusion of non-members;
- Free Trade Area which is an agreement to completely remove tariffs and nontariff barriers on goods and some services between the member states (e.g. NAFTA);
- Customs Union which is a free trade agreement, but in which members also adopt common external tariff on non-member nations’ goods (e.g. Benelux);
- Common Market is a group of trading nations that permit the free flow of labor and capital between member states with common external tariffs and free movement of goods and services;
- Monetary Union which is a common market in which member states also share a common currency, monetary policy, and a central bank (e.g. USA & Eurozone);
- Economic Union in which national, social, taxation, and fiscal policies are harmonized and administered by a supranational institution.

3. The movement toward freer trade under a customs union affects world welfare in two opposing ways:

- A welfare-increasing trade-creation effect
- A welfare-reducing trade-diversion effect.

The general consequence of a customs union on the welfare of its members, as well as on the world as a whole, depends on the relative strengths of these two opposing forces. Trade creation occurs when some domestic production of one customs-union member is replaced by another member’s lower-cost imports. The welfare of the member countries is increased by trade creation because it leads to increased production specialization according to the principle of comparative advantage. The trade-creation effect consists of a consumption effect, and a production effect.

4. European Union has had its controversies with the so-called common agricultural policy because the EU members differ in agricultural efficiencies as such it poses a problem to the EU’s price support programs thereby encouraging inefficient farm production by EU farmers and restricting food imports from more efficient non-member producers. This trade diversion has had a welfare-decreasing effect on the EU.
5. The welfare effects of trade creation and trade diversion for the European Union are:

- the high degree of uniformity in price inflation, money supply growth, and other key economic factors;
- the specific convergence criteria as mandated by the Maastricht Treaty such as Price stability;
- Low long-term interest rates; Stable exchange rates and Sound public finances.

ANSWERS FOR CHAPTER 9

1. The diversification approaches used by multinational enterprises worldwide are: vertical diversification, horizontal diversification, and the conglomerate lines within the host and source countries.

The Vertical diversification often occurs when the parent multinational enterprises decides to establish foreign subsidiaries to produce intermediate goods or inputs that go into the production of a finished good whereas the Horizontal diversification, occurs when a parent company producing a commodity in the source country sets up a subsidiary to produce an identical product in the host country. These subsidiaries are independent units in productive capacity and are established to produce and market the parent company’s product in overseas markets.

The Multinational Enterprises may also practice forward diversification in the direction of the final consumer market or backward diversification where they may include the extraction and processing of raw materials.

Besides making horizontal and vertical foreign investments, MNEs may diversify into nonrelated markets, in what is known as conglomerate diversification.

This conglomerate diversification, also known as foreign direct investment typically occurs when:

- the parent company obtains sufficient common stock in a foreign company to assume voting control (the U.S. Department of Commerce defines a company as directly foreign owned when a “foreign person” holds a ten percent interest in the company);
- the parent company acquires or constructs new plants and equipment overseas;
- the parent company shifts funds abroad to finance an expansion of its foreign subsidiary;
- earnings of the parent company’s foreign subsidiary are reinvested in plant expansion.

2. The major foreign industries in which United States businesses have chosen to place direct investments is the manufacturing sector.

The major industries in the United States in which foreigners place direct investments are manufacturing, petroleum, and wholesale trade facilities.

3. Rate of return on U.S. direct investments in developing nations surpasses when compared to the rate of return on its investments industrial nations due to many factors which include cheap foreign labor, low tax, and its strong hold on foreign markets via suppressing the local industries,
4. Important motives behind an enterprise’s decision to undertake foreign direct investment may include the following:

- Good climatic conditions;
- Cutting down cost through locating part or all of their productive facilities abroad;
- The low transportation costs advantage , especially in industries where transportation costs are a high fraction of product value such raw materials which is often significantly higher than the cost of shipping its finished products to markets;
- Access to markets, by bringing production facilities close to their markets;
- Low manufacturing cost;
- A means to circumvent import tariff barriers.

5. Though Chapter 9 (p.309) opines that “there is no universal agreement on the exact definition of a multinational enterprise (MNE)”, Wikipedia defines “a multinational enterprise as a corporate organization which owns or controls production of goods or services in at least one country other than its home country”.
6. Conditions that could encourage a business to enter foreign markets by extending licenses or franchises to local businesses to produce its goods are:

- The financial benefit derived from the loyalty fees paid by the local establishment in exchange for the name and operating procedures provided by the parent organization ;
- The ability of the local establishment to adapt its operations to the standards of the parent organization.

7. Major issues involving multinational enterprises as a source of conflict for the source and host countries include:

- Multinational enterprises often create trade restraints, cause conflict with national economic and political objectives, and have adverse effects on a nation’s balance of payments;
- When the direct investment spending of foreign-based multinational enterprises is used to purchase already existing local businesses rather than to establish new ones;
- The demand for employment of locals into high-level positions as against the foreign managers and other top executives brought in by the multinational enterprises to run the subsidiary in the host country;
- The rapid move of funds by multinational enterprises from one financial center to another to avoid losses from changes in exchange rates also makes it difficult for national governments to stabilize their economies.

8. “International trade theory suggests that the aggregate welfare of both the source and host countries is enhanced when MNEs make foreign direct investments for their own benefit” (p.319).

The theory of multinational enterprise essentially agrees with the predictions of the comparative advantage principle. However, the traditional model of comparative advantage used by multinational enterprises is inconsistent because commodities are traded between independent, competitive businesses, whereas these enterprises are often vertically diversified businesses, with substantial intra firm sales.

9. Some examples of welfare gains include that can result from the formation of international joint ventures among competing business include:

- When the newly established business adds to pre-existing productive capacity and fosters additional competition;
- When the newly established business is able to enter new markets that neither parent could have entered individually;
- When the business yields cost reductions that would have been unavailable if each parent performed the same function separately.

While examples of welfare losses that can result from the formation of international joint ventures among competing business include:

- It giving rise to increased market power, suggesting greater ability to influence market output and price thereby limiting competition, bolstering an upward pressure on prices, and decreasing the level of domestic welfare;
- The result of this market-power effect is a deadweight welfare loss for the domestic economy.

10.The effects of labor migration on the country of immigration are:

- the redistribution of income from labor to capital in the country of immigration;
- It can be viewed as source of cheap labor especially when dealing with unskilled labor;
- It could be considered a drain on government resources;

The effects of labor migration on the country of emigration are:

- they can result in a brain drain (emigration of highly educated and skilled people from developing nations to industrial nations), thus limiting the growth potential of the developing nations;
- the redistribution of income from capital to labor in the country of emigration.

The effect of labor mobility is to increase overall world income.

Conclusion

Studies drawn from chapter 7 indicate that the current trade policies adopted globally is viewed by the developing nations as less beneficial to them and it hinders their economic growth. They view these policies as tools put in place by the developed nations to weaken their industrialization process, control, and keep them under permanent dominance.

Chapter 8 addresses the trade liberalization which is centered on two approaches; a reciprocal reduction of trade barriers on a non discriminatorybasis, and the regional trade arrangement which can be viewed as discriminatory to non-member states. While the first approach involves a setting where member states agree on tariff reductions thereby extending it to other non-member states, in the second approach, the member states adopt a free trade policy, but maintain tariff barriers against non-member states.

Chapter 9 looks at the international mobility factor, its importance and the role it plays in the global economy. An important tool in the international movement is the multinational enterprises or cooperation, while they play key roles in the scheme of things, they also come with controversies. International mobility factor is based on production, comprising labor and capital. International labor migration occurs due to economic and non-economic (social or political) factors. The effect of labor mobility is to increase overall world income and to redistribute income from labor to capital in the country of immigration and from capital to labor in country of emigration.

In conclusion, the lessons learnt from the studies of the three chapters of the book; International Economics by Robert Carbaugh, reveal the nitty-gritties involved and the complexities of the global trading process. A critical observation, also reveals the manipulations by advanced nations to dominate over the developing nations via trade policies, the institutions put in place to control the global economy, and the pretentious aide-support given to these developing nations. While admittedly, some of the approaches and policies put in place are well intended, they have been exploited and manipulated by the develop nations to their advantage.

As long as developing nations are and remain dependent on the developed nations, there won’t be an economic growth or independence of these nations.

Bibliography

Carbaugh, Robert J. "International Economics. 14." Aufl., South-Western (Cengage Learning) (2013).

Multinational Corporation. (n.d.). In Wikipedia online. Retrieved from https://en.m.wikipedia.org/wiki/Multinational_corporation.