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The International Business Environment
Introduction and overview
International trade theory and policy: three months in three hours
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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
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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
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Absolute advantages
(labor requirements per unit of output)
Wine Cloth
England 20 10
Portugal 10 20
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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)
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Comparative advantages
Wine Cloth
England 20 30
Portugal 10 20
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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)
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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)
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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.
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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
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Conclusions
• More trade => more profits and more welfare
• Free trade better than protectionism
=> Reduce trade barriers and generate more international trade
• ITO, GATT, WTO
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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)
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The Uruguay round
• World Trade Organization
• Lower tariffs for industrial products
• Agriculture
• Textiles and clothing
• Services
• Intellectual Property
• Dispute settlement
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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
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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
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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
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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
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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
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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
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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?
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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?
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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
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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)
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Modern trade theory
• The Linder-hypothesis: birds of a feather
• Economies of scale and preferences for variation
• Reciprocal dumping
• Strategic trade policy
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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
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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?
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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?
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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?
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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
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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
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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
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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
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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
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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
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Gains from deeper integration
• Border controls
• Technical standards
• Scale economies
• Competition
• Public procurement
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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
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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
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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
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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
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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
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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
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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
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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?
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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
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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
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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
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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
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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
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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
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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
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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
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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