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Chapter 8 Government Intervention in
International Business
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Learning Objectives
In this chapter, you will learn about the following:
1. The nature of government intervention
2. Rationale for government intervention
3. Instruments of government intervention
4. Consequences of government intervention
5. Evolution of government intervention
6. How firms can respond to government intervention
MyManagementLab®
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Source: Luciano Mortula/Shutterstock
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India’s Transition to a Liberal Economy
India is a study in contrasts. It is the world’s leading emerging economy in
information technology and e-business. However, India is awash in trade
barriers, business regulations, and a powerful bureaucracy. Not only does
the Indian federal government impose countless regulations, standards,
and administrative hurdles on businesses, each of India’s twenty-eight
states also imposes its own local bureaucracy and red tape. Import taxes
and controls on foreign investment are substantial, with tariffs averaging
over 15 percent on many products, compared to less than 4 percent in
Europe, Japan, and the United States. Hundreds of commodities, from
cement to household appliances, can be imported only after receiving
government approval. Licensing fees, testing procedures, and other
hurdles can be costly to importers.
Since the early 1980s, however, India’s government has been liberalizing
the nation’s regulatory regime. The government has abolished many
import licenses and reduced tariffs substantially. It is freeing the economy
from state control by selling many state enterprises to the private sector
and to foreign investors.
India has always had a huge sector of small retailers. The country is home
to 10 million “mom-and-pop” shops scattered across 500,000 cities and
villages. The arrival of big-box retailers triggered a storm of controversy,
sparking widespread protests from small merchants. Although Walmart
(www.walmart.com) opened its first Indian branch in 2009, the store
cannot sell directly to consumers and is restricted to wholesaling. In 2012,
the Indian government yielded to political pressure and denied Walmart,
Carrefour, and other foreign retailers the opportunity to participate in the
country’s huge retailing sector. In a joint venture with the Indian firm Bharti
Enterprises, Walmart had planned to open numerous stores nationwide.
India’s economic revolution is unleashing the country’s entrepreneurial
potential. The government is establishing Special Economic Zones
(SEZs), virtual foreign territories that offer foreign firms the benefits of
India’s low-cost, high-skilled labor. In a typical SEZ, firms are exempt from
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trade barriers, sales and income taxes, licensing requirements, FDI
restrictions, and customs clearance procedures. Mahindra City is home
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to an 840-acre SEZ that boasts a $277 million software development center
built by Infosys Technologies, India’s leading IT firm.
In Europe and North America, the outsourcing of jobs to India has generated
calls for protectionism—trade barriers and defensive measures intended to
minimize the export of jobs abroad. U.S. and European trade unions host
numerous Web sites that denounce outsourcing and offshoring. Trade barriers
and government bureaucracy in India, as well as calls for protectionism in
Europe and North America, exemplify the complex world of government
intervention.
Sources: Sy Banerjee, Thomas Hemphill, and Mark Perry, “India Doors To Wal-Mart Shut By Crony Capitalism,” Investors
Business Daily, December 28, 2011, p. A13; E. Bellman, “Wal-Mart Exports Big-Box Concept to India,” Wall Street
Journal, May 29, 2009, p. A4; J. Lamont, “Strike-hit India Eyes Fuel Price Cuts,” Financial Times, January 8, 2009,
retrieved from http://www.ft.com; Central Intelligence Agency, World Factbook, 2012, retrieved from
http://www.cia.gov/cia/publications/factbook; “Survey: A World of Opportunity,” Economist, November 13, 2004, p. 15;
Oxford Analytica Daily Brief Service, “India: Civil Service Flaws Obstruct Development,” January 28, 2010, p. 1; United
States Trade Representative, National Trade Estimate Report on Foreign Trade Barriers: India, 2012, retrieved from
http://www.ustr.gov.
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Governments intervene in trade and investment to achieve
political, social, or economic objectives. They often create
trade barriers that benefit specific interest groups, such as
domestic firms, industries, and labor unions. A key rationale is
to create jobs by protecting industries from foreign
competition. Governments also intervene to support homegrown industries or firms.
Government intervention is at odds with free trade, the
unrestricted flow of products, services, and capital across
national borders. Market liberalization and free trade are best
for supporting economic growth and national living standards.1
One study of more than one hundred countries in the 50 years
after 1945 found a strong association between market
openness—that is, unimpeded free trade—and economic
growth. Countries with an open economy enjoyed average
annual per-capita GDP growth of 4.49 percent, while relatively
closed countries—those with less free trade—grew at only
0.69 percent per year.2
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EXHIBIT 8.1 Benefits of Free Trade: Outward Shift of
Production Possibilities Frontier for Products
and Services
Exhibit 8.1 shows how increasing free trade translates into
an expanded production possibilities frontier, moving from
PPF1 to PPF2. Let’s use Poland as an example. Over time,
Poland lowered trade barriers and participated more freely in
international trade, adopting the principle of comparative
advantage.3 As Poland expanded its free trade, the country
focused on producing and exporting goods it was best suited
to produce, and importing those goods that other nations
produce more efficiently. The end result was that Poland’s
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production possibilities frontier for products and services
shifted outward (Exhibit 8.1 ). Due to growing free trade,
Poland began
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to use its resources more efficiently, generating more overall
profits for firms and workers, and, in turn, acquiring more
resources with which to import the goods that Polish
consumers desire.
EXHIBIT 8.2 Government Intervention as a Component of
Country Risk
As it gradually embraced free trade, Poland’s average annual
income rose, from about $1,625 in 1990 to more than $14,000
in 2012. These gains did not occur without some
turmoil—unemployment in Poland increased in some
industries as jobs producing certain goods shifted to other
countries better suited to make those goods. However, free
trade’s positive effects substantially outweighed the negative
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ones.4 Free trade provides enormous benefits for economic
growth and the welfare of nations worldwide.
In reality, however, governments intervene in business and
the international marketplace in ways that obstruct the free
flow of trade and investment. Intervention alters the
competitive position of companies and industries and the
status of citizens. As highlighted in Exhibit 8.2 , intervention
is an important dimension of country risk. In this chapter, we
examine the nature, rationale, and consequences of
government intervention. We also describe what companies
can do to enhance international performance in the face of
government intervention worldwide.
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The Nature of Government Intervention
Protectionism
National economic policies designed to restrict free trade and
protect domestic industries from foreign competition.
Tariff
A tax imposed on imported products, effectively increasing the
cost of acquisition for the customer.
Nontariff trade barrier
A government policy, regulation, or procedure that impedes
trade through means other than explicit tariffs.
Customs
Checkpoints at the ports of entry in each country where
government officials inspect imported products and levy tariffs.
Government intervention is often motivated by protectionism
, which refers
to national economic policies designed to restrict free trade and protect
domestic industries from foreign competition. Protectionism is typically
manifested by tariffs, nontariff barriers such as quotas, and arbitrary
administrative rules designed to discourage imports. A tariff
(also known as
a duty) is a tax imposed by a government on imported products, effectively
increasing the cost of acquisition for the customer. A nontariff trade
barrier
is a government policy, regulation, or procedure that impedes trade
through means other than explicit tariffs. Trade barriers are enforced as
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products pass through customs
, the checkpoints at the ports of entry in
each country where government officials
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inspect imported products and levy tariffs. An often-used form of nontariff trade
barrier is a quota
, a quantitative restriction placed on imports of a specific
product over a specified period of time. Government intervention may also
target FDI flows via investment barriers that restrict the operations of foreign
firms.
Quota
A quantitative restriction placed on imports of a specific
product over a specified period of time.
Government intervention affects the normal operation of economic activity in a
nation by hindering or helping the ability of its indigenous firms to compete
internationally. Often companies, labor unions, and other special interest
groups convince governments to adopt policies that benefit them. For
example, in the 2000s, the Bush administration imposed tariffs on the import of
foreign steel into the United States. The rationale was to give the U.S. steel
industry time to restructure and revive itself following years of decline due to
tough competition from foreign steel manufacturers. The action may have
saved hundreds of U.S. jobs. On the downside, however, the tariffs also
increased production costs for firms that use steel, such as Ford, Whirlpool,
and General Electric. Higher material costs made these firms less competitive
and reduced prospects for selling their products in world markets.5 The steel
tariffs were removed within two years, but in the process of attempting to do
good, the government also did some harm.
Another example of intervention was the U.S. government’s response to the
growing threat of Japanese car imports in the 1980s, when it established
“voluntary export restraints” on the number of Japanese vehicles that could be
imported into the United States. This move helped insulate the U.S. auto
industry for several years. In a protected environment, however, Detroit
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automakers had less incentive to improve quality, design, and overall product
appeal. Government intervention motivated by protectionism has been one of
several factors that, over time, weakened Detroit’s ability to compete in the
global auto industry.
Protectionist policies may also lead to price inflation because tariffs can restrict
the supply of a particular product. Tariffs may also reduce the choices
available to buyers by restricting the variety of products available for sale.
These examples illustrate that government intervention may lead to adverse
unintended consequences—unfavorable outcomes of policies or laws. In a
complex world, legislators and policymakers cannot foresee all possible
outcomes. The problem of unintended consequences suggests that
government intervention should be planned and implemented with great care.
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Rationale for Government Intervention
Why does a government intervene in trade and investment activities? There
are four main motives.
Tariffs and other forms of intervention allow governments to:
1. Generate revenue. For example, the “Hamilton Tariff,”
enacted July 4, 1789, was the second statute passed by the
newly founded United States, providing revenue for the federal
government. Today, Ghana and Sierra Leone generate more
than 25 percent of their total government revenue from tariffs.
2. Ensure citizen safety, security, and welfare. For example,
governments pass laws to prevent importation of harmful
products such as contaminated food.
3. Pursue economic, political, or social objectives. In most
cases, tariffs and similar forms of intervention are intended to
promote job growth and economic development.
4. Serve company and industrial interests. Governments may
devise regulations to stimulate development of home-grown
industries.
Special interest groups often advocate trade and investment barriers that
protect their interests. Consider the recent trade dispute between Mexico and
the United States over Mexican cement. The U.S. government imposed duties
of about $50 per ton on the import of Mexican cement after U.S. cement
makers lobbied Congress. The stakes were huge, as Mexican imports can
reach 10 percent of U.S. domestic cement consumption. Mexico proposed
substituting import quotas in place of the tariffs. The two governments have
negotiated for years to resolve the dispute.6
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Trade and investment barriers can be considered either defensive or
offensive. Governments impose defensive barriers to safeguard industries,
workers, and special interest groups and to promote national security.
Governments impose offensive barriers to pursue strategic or public policy
objectives, such as increasing employment or generating tax revenues. Let’s
review the specific rationale for government intervention.
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Defensive Rationale
Four major defensive motives are particularly relevant: protection of the
nation’s economy, protection of an infant industry, national security, and
national culture and identity.
Protection of the National Economy
Proponents argue that firms in advanced economies cannot compete with
those in developing countries that employ low-cost labor. In the opening story,
labor activists called for government intervention to prevent the outsourcing of
jobs from Europe and North America to India. Protectionists demand trade
barriers to curtail the import of low-priced products, fearing that advancedeconomy manufacturers will be undersold, wages will fall, and home-country
jobs will be lost.
In response, critics counter that protectionism is at odds with the theory of
comparative advantage, according to which nations should engage in more
international trade, not less. Trade barriers interfere with country-specific
specialization of labor. When countries specialize in the products they can
produce best and then trade for the rest, they perform better in the long run,
delivering superior living standards to their citizens. Critics also charge that
blocking imports reduces the availability and increases the cost of products
sold in the home market. Industries cannot access all the input products they
need. Finally, protectionism can trigger retaliation, resulting in foreign
governments imposing their own trade barriers, which reduces sales prospects
for exporters.
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Protection of an Infant Industry
In an emerging industry, companies are often inexperienced and lack the
latest technologies and know-how. They may also lack the scale typical of
larger competitors in established industries abroad. An infant industry may
need temporary protection from foreign competitors. Governments can impose
temporary trade barriers on foreign imports to ensure that young firms gain a
large share of the domestic market. Protecting infant industries has allowed
some countries to develop a modern industrial sector. For example,
government intervention allowed Japan and South Korea to become dominant
players in the global automobile and consumer electronics industries.
Once in place, such protection may be hard to remove. Industry owners and
workers tend to lobby to preserve government protection. Infant industries in
many countries (especially in Latin America, South Asia, and Eastern Europe)
have shown a tendency to remain dependent on government protection for
many years. Protected companies may become inefficient, costing the nation’s
citizens higher taxes and higher prices for the products produced by the
protected industry.7
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National Security
Countries impose trade restrictions on products viewed as critical to national
defense and security, such as military technology and computers that help
maintain domestic production in security-related products. For example,
Russia blocked a bid by German engineering giant Siemens to purchase the
Russian turbine manufacturer OAO Power Machines, on grounds of national
security. The Russian government has strict legislation that limits foreign
investment in sectors considered vital to Russia’s national interests.8
Countries may also impose export controls
, government measures
intended to manage or prevent the export of certain products or trade with
certain countries. For example, many countries prohibit exports of plutonium to
North Korea because it can be used to make nuclear weapons. The United
States generally blocks exports of nuclear and military technology to countries
it deems state sponsors of terrorism, such as Iran, Libya, and Syria.
Export control
A government measure intended to manage or prevent the
export of certain products or trade with certain countries.
Ethical Connections
North Korea is a dictatorship with a poor record of human rights and
one of the world’s lowest living standards. Australia, Canada, the
European Union, and the United States have long imposed trade
embargos against North Korea, due to national security concerns.
International trade is known to improve economic conditions in poor
countries, and foreign government sanctions are making North
Korea’s terrible poverty even worse.
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National Culture and Identity
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National Culture and Identity
Should foreign entities, say the Japanese or the Saudis, be allowed to
purchase national landmarks such as the Eiffel Tower or Rockefeller Center?
In most countries, certain occupations, industries, and public assets are seen
as central to national culture and identity. Governments may impose trade
barriers to restrict imports of products or services seen to threaten such
national assets. Switzerland has imposed trade barriers to preserve its longestablished tradition in watchmaking. In the United States, authorities opposed
Japanese investors’ purchase of the Seattle Mariners baseball team, because
it is viewed as part of the national heritage. France does not allow significant
foreign ownership of its TV stations because of concerns about foreign
influence on French culture.
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To safeguard its national culture, the French government prevents foreign
companies from owning television and movie companies in France. Shown
here is Cannes, the site of France’s popular film festival.
Source: © Guillaume Tunzini/Fotolia
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Offensive Rationale
Offensive rationales for government intervention fall into two categories:
national strategic priorities and increasing employment.
National Strategic Priorities
Government intervention sometimes aims to encourage the development of
industries that bolster the nation’s economy. It is a proactive variation of the
infant industry rationale and related to national industrial policy. Countries with
many high-tech or high value-adding industries, such as information
technology, pharmaceuticals, car manufacturing, or financial services, create
better jobs and higher tax revenues than economies based on low valueadding industries, such as agriculture, textile manufacturing, or discount
retailing. Accordingly, governments in Germany, South Korea, and numerous
other countries have devised policies that promote the development of
relatively desirable industries. The government may provide financing for
investment in high-tech or high value-adding industries, encourage citizens to
save money to ensure a steady supply of loanable funds for industrial
investment, and fund public education to provide citizens the skills and
flexibility they need to perform in key industries.9
Increasing Employment
Governments often impose import barriers to protect employment in
designated industries. Insulating domestic firms from foreign competition
stimulates national output, leading to more jobs in the protected industries.
The effect is usually strongest in import-intensive industries that employ much
labor. For example, the Chinese government has traditionally required foreign
companies to enter its huge markets through joint ventures with local Chinese
firms. This policy creates jobs for Chinese workers. A joint venture between
Shanghai Automotive Industry Corporation (SAIC) and Volkswagen created
jobs in China.
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Instruments of Government Intervention
Principal instruments of trade intervention and the traditional forms of
protectionism are tariffs and nontariff trade barriers. Individual countries or
groups of countries, such as the European Union (http://www.europa.eu),
can impose these barriers. In aggregate, barriers constitute a serious
impediment to cross-border business. The United Nations estimated that trade
barriers alone cost developing countries more than $500 billion in lost trading
opportunities with developed countries every year.10 Exhibit 8.3
highlights
the most common forms of government intervention and their effects.
Tariffs
Some countries impose export tariffs, taxes on products exported by their own
companies. For example, Russia charges a duty on its oil exports with the
intention of generating government revenue and maintaining high oil stocks
within Russia. The most common type of tariff, however, is the import tariff, a
tax levied on imported products.
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EXHIBIT 8.3 Types and Effects of Government Intervention
Source: Based on the Office of the United States Trade Representative, retrieved from http://www.ustr.gov.
Import tariffs are usually ad valorem—that is, they are assessed as a
percentage of the value of the imported product. Or a government may impose
a specific tariff—a flat fee or fixed amount per unit of the imported
product—based on weight, volume, or surface area, such as barrels of oil or
square meters of fabric. A revenue tariff is intended to raise money for the
government. A tariff on cigarette imports, for example, produces a steady flow
of revenue. A protective tariff aims to protect domestic industries from foreign
competition. A prohibitive tariff is one so high that no one can import any of the
items.
The amount of a tariff is determined by examining a product’s harmonized
code. Products are classified under about 8,000 different unique codes in the
harmonized tariff or harmonized code schedule, a standardized system used
worldwide. Without this system, firms and governments might have differing
opinions on product definitions and the tariffs charged.
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EXHIBIT 8.4 A Sampling of Import Tariffs, Percentages
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EXHIBIT 8.4 A Sampling of Import Tariffs, Percentages
Source: Based on World Tariff Profiles 2011, World Trade Organization, retrieved from www.wto.org.
Note: Exhibit shows the average, most favored nation applied tariff.
Import tariffs can generate substantial revenue for national governments. This
helps explain why they are common in developing economies. Even in
advanced economies, tariffs provide a significant source of revenue for the
government. The United States charges tariffs on many consumer,
agricultural, and labor-intensive products. The U.S. typically collects high
tariffs (often 48 percent) on imports of basic, low-quality shoes, and low tariffs
(just 9 percent) on luxury shoes. Low-income shoe buyers end up paying the
highest tariffs. The European Union applies tariffs of up to 191 percent on
meat, 118 percent on cereals, and 106 percent on sugar and confectionary
products.11
Exhibit 8.4
provides a sample of import tariffs in selected countries.
Despite its reputation as a challenging market to enter, Japan maintains
average tariffs for nonagricultural products at low levels. Under the North
American Free Trade Agreement (NAFTA), Canada, Mexico, and the United
States have eliminated nearly all tariffs on product imports from each other.
However, Mexico maintains significant tariffs with the rest of the world—21.5
percent for agricultural products and 7.1 percent for nonagricultural goods.
India’s tariffs are relatively high, especially in agriculture, where the average
rate is 31.8 percent. India’s tariff system lacks transparency, and officially
published tariff information is sometimes hard to find. China has reduced its
tariffs since joining the World Trade Organization (WTO, www.wto.org) in
2001, but trade barriers remain high in some areas.
In Africa, over half of all workers are employed in agriculture. Significant tariffs
and other trade barriers in the advanced economies hinder imports of
agricultural goods from Africa, which worsens already-severe poverty in many
African countries.
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Because high tariffs inhibit free trade and economic growth, governments have
tended to reduce them over time. This was the primary goal of the General
Agreement on Tariffs and Trade (GATT; now the WTO). Countries as diverse
as Chile, Hungary, Turkey, and South Korea have liberalized their previously
protected markets, lowering trade barriers and subjecting themselves to
greater competition from abroad. Exhibit 8.5
illustrates trends in average
world tariff rates over time. Notice that developing economies have been
lowering their tariff rates since the early 1980s. Continued reductions
represent a major driver of market globalization.
Nontariff Trade Barriers
Nontariff trade barriers are government policies or measures that restrict trade
without imposing a direct tax or duty. They include quotas, import licenses,
local content requirements, government regulations, and administrative or
bureaucratic procedures. The use of nontariff barriers has grown substantially
in recent decades. Governments sometimes prefer them because they are
easier to conceal from the WTO and other organizations that monitor
international trade.
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EXHIBIT 8.5 Trends in Average Tariff Rates, Percentages
Source: Based on The World Bank, http://www.data.worldbank.org.
Quotas restrict the physical volume or value of products that firms can import
into a country. In a classic type of quota, the U.S. government imposed an
upper limit of roughly 2 million pounds on the total amount of sugar that can be
imported into the United States each year. Sugar imports that exceed this level
face a tariff of several cents per pound. The upside is that U.S. sugar
producers are protected from cheaper imports, giving them a competitive edge
over foreign sugar producers. The downside is that U.S. consumers and
producers of certain types of products, such as Hershey’s and Coca-Cola, pay
more for sugar. It also means companies that manufacture products
containing sugar may save money by moving production to countries that do
not impose quotas or tariffs on sugar.
Governments can impose voluntary quotas, under which firms agree to limit
exports of certain products. These are also known as voluntary export
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restraints, or VERs. For example, import quotas in the European Union led to
an impasse in which millions of Chinese-made garments piled up at ports and
borders in Europe. The EU impounded the clothing because China had
exceeded the voluntary import quotas it had negotiated with the EU. The
action created hardship for European retailers, who had ordered their clothing
stocks several months in advance.12
Governments occasionally require importing firms to obtain an import
license
, a formal permission to import, which restricts imports in a way that
is similar to quotas. (Do not confuse import licenses with “licensing,” a strategy
for entering foreign markets in which one firm allows another the right to use
its intellectual property in return for a fee.) Governments sell import licenses to
companies on a competitive basis or grant the licenses on a first-come, firstserved basis. This tends to discriminate against smaller firms, which typically
lack the resources to purchase them. Obtaining a license can be costly and
complicated. In some countries, importers must pay hefty fees to government
authorities. In other countries, they must deal with bureaucratic red tape. In
Russia a complex web of licensing requirements limits imports of alcoholic
beverages. Until the 1990s, the government of India imposed the “license raj,”
an especially elaborate system of licenses that regulated establishing and
running businesses in the country.
Import license
Government authorization granted to a firm for importing a
product.
Local content requirements require manufacturers to include a minimum of
local value added—that is, production that takes place locally. Local content
requirements are usually imposed in countries that are members of an
economic bloc, such as the EU and NAFTA. The so-called rules of origin
requirement specifies that a certain proportion of products and supplies, or of
intermediate goods used in local manufacturing, must be produced within the
bloc. For a car manufacturer, the tires or windshields it purchases from
another firm are intermediate goods. When the firm does not meet this
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requirement, the products become subject to trade barriers that member
governments normally impose on nonmember countries. Thus, producers
within the NAFTA zone of Canada, Mexico, and the United States pay no
tariffs on the products and supplies they obtain from each other, unlike
countries such as China or the United Kingdom that
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are not part of NAFTA. Roughly 60 percent of the value of a car manufactured
within NAFTA must originate within the NAFTA member countries. If this
condition were not met, the product became subject to the tariffs charged to
non-NAFTA countries.
Country Realities
Construction and zoning rules vary from country to country. In the United
Kingdom, a law restricts new buildings from blocking sunlight received by
neighboring structures. The law was passed in the twelfth century, when
everything was lit with candles. Developers must negotiate with neighbors
and pay steep compensation when new buildings block their sunlight. The
law deters foreign FDI in Britain’s construction industry.
Source: Bloomberg Businessweek, “The Trouble with London’s Right to
Light,” April 23–29, 2012, pp. 25–26.
Government regulations and technical standards are another type of nontariff
trade barrier. Examples include safety regulations for motor vehicles and
electrical equipment, health regulations for hygienic food preparation, labeling
requirements that indicate a product’s country of origin, technical standards for
computers, and bureaucratic procedures for customs clearance, including
excessive red tape and slow approval processes. The European Union strictly
regulates food that has been genetically modified (GM), a policy that blocks
some food imports into Europe from the United States. In China, the
government requires foreign firms to obtain special permits to import GM
foods. Chinese government censorship of material it considers subversive has
hindered Google’s attempts to enter China’s huge Internet market.13
Governments may impose administrative or bureaucratic procedures that
hinder the activities of importers or foreign firms. For example, the opening
story revealed how India’s business sector is burdened by countless
regulations, standards, and administrative hurdles at the state and federal
levels. In Mexico, government-imposed bureaucratic procedures led United
Parcel Service to temporarily suspend its ground delivery service across the
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U.S.-Mexican border. Similarly, the United States barred Mexican trucks from
entering the United States on the grounds that they were unsafe. Business
regulations vary worldwide. Many countries in Africa and Latin America
impose countless bureaucratic procedures that hinder commercial activities
and business start-ups. By contrast, Australia, Canada, Ireland, New Zealand,
Singapore, and the United Kingdom impose relatively few such procedures.14
Saudi Arabia is home to various restrictive practices that hinder international
trade. Every foreign business traveler to the Arab kingdom must hold an entry
visa that can be obtained only by securing the support of a sponsor—a Saudi
citizen or organization who vouches for the visitor’s actions. Because few
Saudis are willing to assume such responsibility, foreigners who want to do
business in Saudi Arabia face great difficulty.15
Convoluted administrative procedures are widespread in national customs
agencies. The revenue generated by tariffs depends on how customs
authorities classify imported products. Products often appear to fit two or more
tariff categories. For example, a sport utility vehicle could be classified as a
truck, a car, or a van. Each of these categories can entail a different tariff.
Depending on the judgment of the customs agent, the applicable tariff might
end up being high or low. Because thousands of categories exist for customs
classification, a product and its corresponding tariff can be easily misclassified,
by accident or intent.
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Investment Barriers
As we saw in the opening story on India, countries also impose restrictions on
FDI and ownership that restrict the ability of foreign firms to invest in some
industry sectors or acquire local firms. Excessive restrictions in India prevent
the approval of countless investment proposals that could produce billions of
dollars in revenue to the local economy and government. Worldwide, FDI and
ownership restrictions are particularly common in such industries as
broadcasting, utilities, air transportation, military technology, and financial
services, as well as industries in which the government has major holdings,
such as oil and key minerals. The Mexican government restricts FDI by foreign
investors to protect its oil industry, which is deemed critical to the nation’s
security. The Canadian government restricts foreign ownership of local movie
studios and TV networks to protect its indigenous film and TV industries from
excessive foreign influence. FDI and ownership restrictions are particularly
burdensome in the services sector because services usually cannot be
exported and providers must establish a physical presence in target markets
to conduct business there. Occasionally, governments impose investment
barriers aimed at protecting home-country industries and jobs.
Currency controls
restrict the outflow of widely used currencies, such as
the dollar, euro, and yen, and occasionally the inflow of foreign currencies.
Controls can help conserve especially valuable currency or reduce the risk of
capital flight. They are particularly common in developing economies. Some
countries employ a system of dual official exchange rates, offering exporters a
relatively favorable rate to encourage exports, while importers receive a
relatively unfavorable rate to discourage imports.
Currency control
Restrictions on the outflow of hard currency from a country or
on the inflow of foreign currencies.
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Currency controls both help and harm firms that establish foreign subsidiaries
through FDI. They favor companies when they export their products from the
host country but harm those that rely heavily on imported parts and
components. Controls also restrict the ability of MNEs to repatriate their
profits—that is, transfer revenues from profitable operations back to the home
country.
As an example, in Venezuela, currency controls have led to a shortage of
dollars and other hard currencies. Multinational firms avoid doing business in
Venezuela because strict currency rules limit the amount of profits they can
take out of the country or limit their ability to receive payment for imports at
reasonable prices. Venezuela imposed the controls to keep imports
inexpensive and maintain a base of hard currencies in the country.16
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State-owned oil company PEMEX (Petroleos de Mexico) benefits from
investment barriers in Mexico that prevent foreign firms from gaining control of
Mexican oil companies.
Source: © Keith Dannemiller/Alamy
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Subsidies and Other Government Support Programs
Subsidies
are monetary or other resources that a government grants to a
firm or group of firms, intended either to encourage exports or simply to
facilitate the production and marketing of products at reduced prices, to help
ensure the involved companies prosper. Subsidies come in the form of outright
cash disbursements, material inputs, services, tax breaks, the construction of
infrastructure, and government contracts at inflated prices. For example, the
French government has provided large subsidies to Air France, the national
airline.
Subsidy
Monetary or other resources that a government grants to a
firm or group of firms, usually intended to encourage exports
or to facilitate the production and marketing of products at
reduced prices, to ensure the favored firms prosper.
The Closing Case focuses on European government support of Airbus, the
leading European manufacturer of commercial aircraft. Perhaps the ultimate
examples of subsidized firms are in China. Several leading corporations, such
as China Minmetals ($39 billion annual sales) and Shanghai Automotive ($34
billion annual sales), are in fact state enterprises wholly or partly owned by the
Chinese government, which provides them with huge financial resources.
Indeed, state-owned enterprises account for more than 40 percent of China’s
economic output.17
Critics argue that subsidies confer unfair advantages on recipients by reducing
their cost of doing business. In India, the government provides massive
subsidies to state-owned oil companies, which allow them to offer gasoline at
very low prices. Foreign MNEs such as Royal Dutch Shell cannot compete
profitably against rivals that offer such prices and consequently avoid doing
business in the market.18 The WTO prohibits subsidies when it can be proven
that they hinder free trade. Subsidies, however, are hard to define. For
example, when a government provides land, infrastructure,
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telecommunications systems, or utilities to the firms in a corporate park, this is
technically a subsidy. Yet many view this type of support as an appropriate
public function.
In Europe and the United States, governments frequently provide agricultural
subsidies to supplement the income of farmers and help manage the supply of
agricultural commodities. The U.S. government grants subsidies for more than
two dozen commodities, including corn, soybeans, wheat, cotton, and rice.19
In Europe, the Common Agricultural Policy (CAP) is a system of subsidies that
represents about 40 percent of the EU’s budget, amounting to tens of billions
of euros annually. The CAP and U.S. subsidies have been criticized for
promoting unfair competition and high prices because they tend to prevent
developing economies from exporting their agricultural goods to Europe and
the United States. Subsidies encourage overproduction and therefore lower
food prices at home, making agricultural imports from developing countries
less competitive.20
Governments sometimes retaliate against subsidies by imposing
countervailing duties
, tariffs on products imported into a country to offset
subsidies given to producers or exporters in the exporting country. In this way,
the duty serves to cancel out the effect of the subsidy, eliminating the price
advantage the exporters would otherwise obtain.
Countervailing duty
Tariff imposed on products imported into a country to offset
subsidies given to producers or exporters in the exporting
country.
Dumping
Pricing exported products at less than their normal value,
generally less than their price in the domestic or third-country
markets, or at less than production cost.
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Subsidies may allow a manufacturer to practice dumping
—that is, to
charge an unusually low price for exported products, typically lower than that
for domestic or third-country customers,
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or even lower than the cost to manufacture the good.21 The European Union
has provided billions of euros in subsidies every year to EU sugar producers,
which allowed Europe to become one of the world’s largest sugar exporters at
artificially low prices. Without the subsidies Europe would be one of the world’s
biggest sugar importers.
The Ministry of Economy, Trade, and Industry in Japan is typical of national
federal agencies that promote international trade and investment.
Source: SeanPavonePhoto/Shutterstock
Dumping violates WTO rules because it amounts to unfair competition. But
dumping is hard to prove because firms usually do not reveal data on their
cost structures. A large MNE that charges very low prices could conceivably
drive competitors out of a foreign market, achieve a monopoly, and then raise
prices later. Governments in the importing country often respond to dumping
by imposing an antidumping duty
—a tax imposed on products deemed to
be dumped and thereby causing injury to producers of competing products in
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the importing country. The WTO allows this practice.22 The duties are
generally equal to the difference between the product’s export price and their
normal value.
Antidumping duty
A tax imposed on products deemed to be dumped and
causing injury to producers of competing products in the
importing country.
Government subsidies are not always direct or overt. For example,
governments may support home-country businesses by funding R&D, granting
tax exemptions, and offering business development services such as market
information, trade missions, and privileged access to key foreign contacts.
Most countries have agencies and ministries that provide such services to
facilitate the international activities of their own firms. Examples include the
Department of Foreign Affairs and International Trade in Canada (www.dfaitmaeci.gc.ca), U.K. Trade & Investment in the United Kingdom
(www.uktradeinvest.gov.uk), and the International Trade Administration of
the U.S. Department of Commerce (www.doc.gov).
Related to subsidies are governmental investment incentives , transfer
payments or tax concessions made directly to individual foreign firms to entice
them to invest in the country. Hong Kong’s government put up most of the
cash to build the Hong Kong Disney park
(www.park.hongkongdisneyland.com). While the park and facilities cost about
$1.81 billion, the government provided Disney an investment of $1.74 billion to
develop the site.
Investment incentive
Transfer payment or tax concession made directly to foreign
firms to entice them to invest in the country.
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Recently, Austin, Texas, and Albany, New York, competed for the chance to
have the Korean manufacturer Samsung Electronics (www.samsung.com)
build a semiconductor plant in their regions. Austin offered $225 million worth
of tax relief and other concessions in its successful bid to attract Samsung’s
$300 million plant, estimated to create nearly 1,000 new jobs locally. To entice
MNEs to establish local production facilities, the country of Macedonia offers
such incentives as low corporate taxes, immediate access to utilities and
transportation, and financial support for training workers (see
www.investinmacedonia.com).
Such incentives often help the economic development in a particular region or
community. In the 1990s, Germany encouraged foreign companies to invest in
the economically disadvantaged East German states by providing tax and
investment incentives. The government of Ireland has undertaken various
initiatives aimed at promoting Ireland as a place to do business. It targeted
foreign companies in the high-tech sector—including medical instruments,
pharmaceuticals, and computer software—and offered preferential corporate
tax rates of 12 percent. These targeted efforts paid dividends by creating
substantial new employment and helping diversify the Irish economy away
from agricultural activities.
Governments also support domestic industries by adopting procurement
policies that restrict purchases to home-country suppliers. Several
governments require that air travel purchased with government funds be
booked with home-country carriers. Such policies are especially common in
countries with large public sectors, such as China and Russia. In the United
States, government agencies favor domestic suppliers unless their prices are
high compared to foreign suppliers. In Japan, government agencies often do
not even consider foreign bids, regardless of pricing. Public procurement
agencies often impose requirements that effectively exclude foreign suppliers.
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Consequences of Government Intervention
As illustrated in Exhibit 8.5
, average tariffs have declined over time.
Simultaneously, as shown in Exhibit 8.6
, world trade and GDP have
flourished. Decreasing trade barriers are a major factor in the growth of global
commerce and consequently in rising incomes around the world. Firms that
participate actively in international trade and investment not only improve their
performance but also contribute to reducing global poverty.23
One way of evaluating the effects of government intervention is to examine
each nation’s level of economic freedom, defined as the “absence of
government coercion or constraint on the production, distribution, or
consumption of goods and services beyond the extent necessary for citizens
to protect and maintain liberty itself. In other words, people are free to work,
produce, consume, and invest in the ways they feel are most productive.”24
The Index of Economic Freedom measures economic freedom in 179
countries.
Exhibit 8.7
shows the degree of economic freedom for each country in the
Index for 2012, based on criteria such as the level of trade barriers, rule of law,
level of business regulation, and protection of intellectual property rights.25
The Index classifies virtually all the advanced economies as “free,” all the
emerging markets as either “free” or “mostly free,” and all the developing
economies as “mostly unfree” or “repressed,” underscoring the close
relationship between limited government intervention and economic freedom.
Economic freedom flourishes when government supports the institutions
necessary for that freedom and provides an appropriate level of intervention
and regulation. In 2010 for the first time, the United States fell into the second
highest category, due to increased U.S. federal government intervention in
that nation’s economy, following the recent global financial crisis. The United
Kingdom scores especially well on business freedom and property rights.
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Canada has been a strong proponent of the Anti-Counterfeiting Trade
Agreement (ACTA), which established an international framework for
combating infringement of intellectual property rights.26
EXHIBIT 8.6 Relationship between Tariffs, World GDP, and the Volume of
World Trade
Sources: Based on International Monetary Fund World Economic Outlook Database, at www.imf.org; UNCTAD, at
http://www.unctadstat.unctad.org; World Bank, http://www.data.worldbank.org.
Note: Tariffs given as average percent (red line), World GDP given in billions
of U.S.$ (blue column), and Volume of World Trade given in billions of U.S.$
(purple column). Left axis measures Tariffs. Right axis measures World GDP
and Volume of World Trade.
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EXHIBIT 8.7 Countries Ranked by Level of Economic Freedom, 2012
Sources: Based on 2012 Index of Economic Freedom, The Heritage Foundation, Washington, DC, and the Wall Street
Journal, New York, accessed at http://www.heritage.org.
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Government intervention and trade barriers raise ethical concerns for
developing economies. For example, United States import tariffs on clothing
and shoes often exceed 20 percent. The tariffs hurt poor countries like
Bangladesh, Pakistan, India, and several nations in Africa, where clothing and
shoe exporters are concentrated. United States’ tariffs on imports from
Cambodia are far higher than on imports from the United Kingdom. The tariffs
that confront less-developed economies are often several times those faced
by the richest countries.27
Government intervention can also offset harmful effects. For example, trade
barriers can create or protect jobs. Subsidies can help counterbalance harmful
consequences that disproportionately affect the poor. In Denmark, for
example, globalization has affected thousands of workers whose jobs have
been shifted to other countries with lower labor costs. The Danish government
provides generous subsidies to the unemployed, aimed at retraining workers
to upgrade their job skills or find work in other fields.28
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Evolution of Government Intervention
A century ago, trade barriers worldwide were relatively high. The trading
environment worsened through two world wars and the Great Depression. In
1938, the United States passed the Smoot-Hawley Tariff Act, which raised
U.S. tariffs to near-record highs of more than 50 percent, compared to only
about 4 percent today. Tariffs that other countries imposed to retaliate against
Smoot-Hawley choked off foreign markets for U.S. agricultural products,
leading to plummeting farm prices and many bank failures. In an effort to
revive trade, governments began to reduce restrictive tariffs. By the late
1940s, prudent policymaking had begun to substantially reduce tariffs
worldwide.
In the 1950s, Latin America and other developing nations adopted
protectionist policies aimed at industrialization and economic development.
Governments imposed high tariffs and quotas on imports from the developed
world, established government-supported enterprises to make the products
they formerly imported, and sought to substitute local production for imports.
Known as import substitution, the approach did not succeed. Companies
enjoyed big government subsidies and the protection of high tariffs and
quotas. However, these enterprises never became competitive in world
markets or raised living standards to the levels of free-trading countries.
Meanwhile, the protected industries required ongoing subsidies. Most
countries that experimented with import substitution eventually rejected it.
By contrast, from the 1970s onward, Singapore, Hong Kong, Taiwan, and
South Korea achieved rapid economic growth by encouraging the
development of export-intensive industries. Their model, known as export-led
development, proved much more successful than import substitution. These
countries, along with others in East Asia, such as Malaysia, Thailand, and
Indonesia, substantially increased living standards and gained strong
international trading links. A rising middle class helped transform these
countries into competitive economies.
Elsewhere in Asia, Japan had launched an ambitious program of
industrialization and exportled development. The country’s rise from poverty in
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the 1940s to one of the world’s wealthiest countries by the 1980s has been
called the Japanese miracle. The feat was achieved with the help of national
strategic policies, including tariffs that fostered and protected Japan’s infant
industries such as automobiles, shipbuilding, and consumer electronics.
India once embraced a model of high trade and investment barriers, state
intervention in labor and financial markets, a large public sector, heavy
business regulation, and central planning. The model contributed to the
nation’s poor economic performance over several decades. Beginning in the
early 1990s, however, India began to open its markets to foreign trade and
investment. Trade liberalization and privatization of state enterprises have
progressed slowly, but reforms have fueled much progress. Between 1992
and 2012, India’s average annual income rose from about $330 in real terms
to more than $1,400 in 2012, an impressive achievement.
After adopting communism in 1949, China relied on centralized economic
planning, in which agriculture and manufacturing were controlled by state-run
industries. The country remained relatively closed to international trade until
the 1980s, when it began to liberalize its economy. In 2001, China joined the
WTO and committed to reducing trade barriers. Trade has stimulated the
Chinese economy. By 2012, its GDP was more than ten times the 1995 level,
and the value of exports had reached nearly $1.9 trillion. China has become a
leading exporter of manufactured products and home to numerous large
MNEs that compete with Western firms.
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General Agreement on Tariffs and Trade
In 1947, twenty-three nations signed the General Agreement on Tariffs and
Trade (GATT), the first major effort to systematically reduce trade barriers
worldwide. The GATT created: (1) a process to reduce tariffs through
continuous negotiations among member nations; (2) an agency to serve as
watchdog over world trade; and (3) a forum for resolving trade disputes.
The GATT introduced the concept of most favored nation (renamed normal
trade relations in 1998), according to which each signatory nation agreed to
extend the tariff reductions covered in a trade agreement with a trading partner
to all other countries. Thus, a concession to one country became a concession
to all. Eventually, the GATT was superseded by the WTO in 1995 and grew to
include about 150 member nations. The organization proved extremely
effective and resulted in the greatest global decline in trade barriers in history.
The Global Trend feature highlights the founding and current progress of the
WTO.
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Bangladesh is a major clothing exporter that faces high tariffs. Here, women
work at Dhaka, the Bangladesh capital and a center of garment
manufacturing.
Source: Liba Taylor/Alamy
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Global Trend
The World Trade Organization and Collapse of the Doha Round
Based in Geneva, Switzerland, the World Trade Organization
(www.wto.org) is the main watchdog for world trade and counts some
150 countries as its members. The WTO works to ensure world trade
operates smoothly, fairly, and with as few restrictions as possible. Since
joining the WTO in 2001, for example, China has gradually reduced import
tariffs and quotas. Most recently, the WTO has been working to reduce
trade barriers in the agricultural and services sectors.
Services like the expertise of a lawyer or an accountant are intangible.
Consequently, as they do not pass through ports or customs stations,
governments usually cannot impose tariffs on them. Thus, services are
subject to various nontariff trade barriers. For example, some countries in
Europe refuse to license foreign insurance companies. In transportation,
the United States and numerous other nations require their own
merchandise fleets to carry their country’s cargo, creating a barrier to
foreign-based cargo handlers.
Governments also restrict services by setting licensing and professional
standards that may be difficult for foreigners to meet. Regulations usually
ensure that law, medicine, accounting, and other professions are
undertaken by people who are educated locally, speak the national
language, and are socialized according to local standards and norms.
Standards in one country are usually not recognized by other countries.
Thus, lawyers, doctors, accountants, and many other professionals face
restrictions when attempting to do business abroad.
The Doha Development Agenda was a round of WTO negotiations
launched in Qatar in 2001 that sought to reduce barriers in the services
sector. The WTO wants to ensure that banks, hotel chains, insurance
firms, tour operators, transport companies, and other service firms enjoy
the same trade and investment freedoms that apply to goods producers.
The Doha Agenda also sought freer trade in agricultural goods, where
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restraints are particularly burdensome to developing countries. Free
global trade in agricultural products is the best way to ensure widespread
access and lower prices for food. Doha was the first round of WTO
negotiations in which big emerging markets, especially Brazil, China, and
India, played a strong role. The unique circumstances of such countries
have increased the complexity of negotiations.
Unfortunately, the talks collapsed in 2008 when trade negotiators were
unable to reach agreement. The main reason was that, under WTO rules,
all nations were required to agree to all parts of the final deal. This proved
impossible for various reasons. For example, China and India insisted on
protecting the agricultural sectors in their countries. India alone has more
than 200 million farmers, and the Indian government is reluctant to expose
them to international competition. In the wake of Doha’s collapse, many
nations are choosing to concentrate on negotiating bilateral (two-country)
and regional trade deals instead. As of mid-2012, the Doha round of talks
had not yet restarted.
Sources: P. Coy, “Free Trade: After the Impasse,” BusinessWeek, August 11, 2008, p. 29; “Beyond Doha,”
Economist, October 11, 2008, pp. 30–33; Carolyn Evans, “Bilateralism, Multilateralism, and Trade Rules,” FRBSF
Economic Letter, January 9, 2012, pp. 1–5; Oxford Analytica Daily Brief Service, “International: Stalled Doha Spurs
Trade Discrimination,” February 12, 2010, p. 1; United States Trade Representative, “National Trade Estimate
Report,” 2011, retrieved from http://www.ustr.gov; World Trade Organization, 2007, retrieved from
http://www.wto.org.
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Intervention and the Global Financial Crisis
The recent global recession and financial crisis have raised new questions
about government’s role in business and the world economy. The crisis arose
largely from inadequate regulation and insufficient enforcement of current
regulations in the banking and finance sectors. In response, governments
worldwide increased regulation and examined ways to improve enforcement.
For example, the U.S. government has increased the power of its Treasury
Department, Federal Reserve System, and Federal Deposit Insurance
Corporation (FDIC). The European Central Bank is creating a new agency that
aims to take aggressive action in needed areas. The European Union has
increased oversight of multinational banks and supervision of financial
institutions. The United Nations has called for greater transparency in financial
activities and closure of loopholes that allow excessive speculation in global
finance.29
Some governments increased protectionism in an effort to safeguard jobs and
wage levels. Argentina and Brazil, for example, increased import tariffs on
numerous products. Russia raised tariffs on dozens of goods, including cars
and combine harvesters.30 Hoping to jumpstart economic growth,
governments also increased subsidies to their own industries. The EU granted
more than $50 billion in aid to Daimler (Germany), Skoda (Czech Republic),
and other struggling carmakers in Europe. The government of the United
Kingdom provided substantial subsidies to U.K. banks and financial
institutions. China has pumped hundreds of billions of dollars into its own
economy.31
In addition to the harmful fallout of the recession and financial crisis, rising
protectionism impacted international commerce. Ripple effects of government
reforms are extending beyond the banking and financial areas.32
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How Firms Can Respond to Government
Intervention
Although managers’ initial tendency might be to avoid markets with high trade
and investment barriers or excessive government intervention, this course is
not usually practical. Depending on the industry and country, firms generally
must cope with protectionism and other forms of intervention. In extractive
industries such as aluminum and petroleum, for example, companies may
have little choice but to operate in nations that impose formidable barriers. The
food-processing, biotechnology, and pharmaceutical industries also encounter
countless laws and regulations abroad.
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Strategies for Managers
We’ve seen that China, India, and numerous other countries in Africa, Asia,
Latin America, and Eastern and Central Europe feature extensive trade
barriers and government involvement. Yet many firms seek to target emerging
markets and developing economies because of the huge long-term potential
they offer.33 Firms devise various strategies to manage harmful government
intervention.
Research to Gather Knowledge and Intelligence
Experienced managers continually scan the business environment to identify
the nature of government intervention and to plan market-entry strategies and
host-country operations. They review their return-on-investment criteria to
account for the increased cost and risk of trade and investment barriers. For
example, the EU is devising new guidelines that affect company operations in
areas ranging from product liability laws to standards for investment in
European industries.
Choose the Most Appropriate Entry Strategies
Tariffs and most nontariff trade barriers apply to exporting, whereas
investment barriers apply to FDI. Most firms choose exporting as their initial
entry strategy. However, if high tariffs are present, managers should consider
other strategies, such as FDI, licensing, and joint ventures that allow the firm
to operate directly in the target market, avoiding import barriers. For example,
Taiwan’s Foxconn, a contract manufacturer for Apple and other electronics
firms, built a factory in Brazil partly to avoid the country’s high tariffs on
imported goods.
However, even investment-based entry is affected by tariffs if it requires
importing raw materials and parts to manufacture finished products in the host
country. Tariffs usually vary with
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the form of an imported product. To minimize tariff costs, many companies
ship manufactured products “knocked-down” and assemble them in the target
market. In countries with relatively high tariffs on imported personal
computers, importers often bring in the parts and assemble the computers
locally. Eastman Kodak (www.kodak.com) imports parts and components into
the United States, which it then uses to manufacture photographic equipment.
Kodak could produce the finished equipment abroad, but the tariff on parts and
components is lower. By manufacturing in the United States, Kodak avoids
paying higher tariffs.34
Many firms lobby national governments, such as Germany’s parliament
in Berlin, for lower barriers to trade and investment.
Source: © Bernd Kröger/Fotolia
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Take Advantage of Foreign Trade Zones
In an effort to create jobs and stimulate local economic development,
governments establish foreign trade zones (also known as free trade zones or
free ports). A foreign trade zone (FTZ)
is an area within a country that
receives imported goods for assembly or other processing and subsequent reexport.35 Products brought into an FTZ are not subject to duties, taxes, or
quotas until they, or the products made from them, enter into the non-FTZ
commercial territory of the country where the FTZ is located. Firms use FTZs
to assemble foreign dutiable materials and components into finished products,
which are then re-exported. Alternatively, firms may use FTZs to manage
inventory of parts, components, or finished products that the firm will
eventually need at some other location. In the United States, for example,
Japanese carmakers store vehicles at the port of Jacksonville, Florida, without
having to pay duties until the cars are shipped to U.S. dealerships.
Foreign trade zone (FTZ)
An area within a country that receives imported goods for
assembly or other processing and re-export. For customs
purposes the FTZ is treated as if it is outside the country’s
borders.
FTZs exist in more than seventy-five countries, usually near seaports or
airports. They can be as small as a factory or as large as an entire country.
The United States is home to several hundred FTZs used by thousands of
firms. The Colon Free Zone (www.colonfreezone.com), located on the
Atlantic side of the Panama Canal, is an enormous FTZ where products are
imported, stored, modified, repacked, and re-exported without being subject to
tariffs or customs regulations. The many private firms and wholesalers that set
up shop inside the huge zone transship their merchandise from Panama to
other parts of the Western Hemisphere and Europe. Some firms obtain FTZ
status within their own physical facilities.
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A successful experiment with FTZs has been maquiladoras
—export-
assembly plants in northern Mexico along the U.S. border that produce
components and finished products, usually destined for the United States.
Since the 1960s, “maquilas” have imported materials and equipment on a
tariff-free basis for assembly or manufacturing and then re-exported the
assembled products. Today under NAFTA, maquiladoras employ millions of
Mexicans who assemble clothing, furniture, car parts, electronics, and other
goods. The arrangement enables firms from the United States, Asia, and
Europe to tap low-cost labor, favorable duties, and government incentives
while serving the U.S. market. Maquilas account for about half of Mexico’s
exports.
Maquiladoras
Export-assembly plants in northern Mexico along the U.S.
border that produce components and typically finished
products destined for the United States on a tariff-free basis.
Seek Favorable Customs Classifications for Exported Products
One approach for reducing exposure to trade barriers is to have exported
products classified in the appropriate harmonized product code. As noted
earlier in this chapter, many products can be classified within two or more
categories, each of which may imply a different tariff. For example, some
telecommunications equipment can be classified as electric machinery,
electronics, or measuring devices. The manufacturer should analyze the trade
barriers on differing categories to ensure exported products are classified
under the lowest tariff code. Or the manufacturer may be able to modify the
exported product in a way that helps minimize trade barriers. South Korea
faced a quota on the export of nonrubber footwear to the United States. By
shifting manufacturing to rubber-soled shoes, Korean firms greatly increased
their footwear exports.
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Take Advantage of Investment Incentives and Other Government Support
Programs
Obtaining economic development incentives from host- or home-country
governments is another strategy to reduce the cost of trade and investment
barriers. When Mercedes built a factory
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in Alabama, it benefitted from reduced taxes and direct subsidies provided by
the Alabama state government. When Siemens built a semiconductor plant in
Portugal, it received subsidies from the Portuguese government and the EU.
Incentives cover nearly 40 percent of Siemens’s investment and training costs.
In Europe, Japan, and the United States, governments increasingly provide
incentives to entice firms to set up shop within their borders. In addition to
cash outlays, incentives also include reduced utility rates, employee training
programs, tax holidays, and construction of new roads and other
infrastructure.
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Lobby for Freer Trade and Investment
More nations are liberalizing markets to create jobs and increase tax
revenues. The trend results partly from the efforts of firms to lobby domestic
and foreign governments to lower their trade and investment barriers. The
Japanese have achieved much success in reducing trade barriers by lobbying
U.S. and European governments. In China, domestic and foreign firms lobby
the government to relax protectionist policies and regulations that make China
a difficult place to do business. Foreign firms often hire former Chinese
government officials to help lobby their former colleagues.36 European
automakers have obtained various concessions by lobbying individual state
governments in the United States. BMW leased its 1,039-acre factory site in
South Carolina at an annual rent of one dollar. The private sector lobbies
federal authorities to undertake government-to-government trade negotiations,
aimed at lowering barriers. Private firms bring complaints to world bodies,
especially the WTO, to address unfair trading practices of key international
markets.
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Closing Case Government Intervention at Airbus and Boeing
In the 1960s, United States companies such as Boeing (www.boeing.com)
and McDonnell Douglas were the dominant players in global aircraft
manufacturing. Boeing was founded in 1916 in Seattle, and had many years to
develop the critical mass necessary to become the world’s leading aerospace
manufacturer. During World War II and the subsequent Cold War years,
Boeing was the recipient of many lucrative contracts from the U.S. Department
of Defense.
In Europe, no single country possessed the means to launch an aerospace
company capable of challenging Boeing. Manufacturing commercial aircraft is
complex and capital-intensive and requires a highly skilled workforce. In the
1970s, the governments of France, Germany, Spain, and the United Kingdom
formed an alliance, supported with massive government subsidies, to create
Airbus S.A.S. (www.airbus.com). By 1981, the four-country alliance
succeeded in becoming the world’s number-two civil aircraft manufacturer.
Airbus launched the A300, among the best-selling commercial aircraft of all
time. Airbus also created the A320, receiving more than 400 orders before its
first flight and becoming the fastest-selling large passenger jet in aviation
history. By 1992, Airbus had captured roughly one-third of the global
commercial aircraft market.
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Government Support for Airbus
Since the 1940s, European governments have pursued public policies based
on democratic socialism. Under this system, the government plays a strong
role in the national economy and provides key services such as health care,
mass transit, and sometimes banking and housing. Most Europeans are
accustomed to government playing a significant role in guiding the national
economy.
In this context, Airbus has benefitted enormously from government support.
The firm has received tens of billions of euros of subsidies and soft loans from
the four founding country governments and the EU. Airbus must repay the
loans only if it achieves profitability. Government aid has financed, in whole or
part, every major Airbus aircraft model. European governments have forgiven
Airbus’s debt, provided huge equity infusions, dedicated infrastructure support,
and financed R&D for civil aircraft projects.
Airbus is currently a stock-held company jointly owned by the British,
Germans, French, and Spanish. It is based in Toulouse, France, but has R&D
and production operations scattered throughout Europe. European
governments justify their financial aid to Airbus on several grounds. First,
Airbus R&D activities result in the development of valuable new technologies.
Second, Airbus provides jobs to some 53,000 skilled and semiskilled
Europeans. Third, its value-chain activities attract massive amounts of capital
into Europe. Finally, Airbus generates enormous tax revenues.
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Complaints about Unfair Government Intervention
Boeing and the U.S. government have long complained about the massive
subsidies and soft loans that were responsible not only for Airbus’s birth, but
also for its ongoing success. The outcry became louder in the 2000s, when
Airbus surpassed Boeing in annual sales, becoming the world’s leading
commercial aircraft manufacturer. Boeing has argued that Airbus never would
have gotten this far without government support.
In 2005, the U.S. Trade Representative brought its case to the WTO. The case
arose because EU member states approved $3.7 billion in new subsidies and
soft loans to Airbus. The case alleged that financial aid for the A350, A380,
and earlier Airbus aircraft qualified as subsidies under the WTO’s Agreement
on Subsidies and Countervailing Measures (ASCM) and that the subsidies
were actionable because they adversely affected international trade. Under
the ASCM, subsidies to specific firms or industries from a government or other
public bodies are prohibited. Airbus had applied to the governments of France,
Germany, Spain, and the United Kingdom for aid to launch its model A350.
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In 2011, the WTO ruled that EU aid to Airbus had caused Boeing to lose
market share in Asia and other markets. EU officials argued that government
subsidies to Airbus were permissible and that it was up to individual EU
countries to decide whether to provide them. However, the WTO also ruled
that Boeing received more than $5 billion in U.S. government subsidies in the
development of the 787 Dreamliner.
Government Support for Boeing
The EU argues the United States government has indirectly subsidized Boeing
through massive defense contracts paid via tax dollars. The U.S. government
gave Boeing more than $23 billion in indirect government subsidies by means
of R&D funding and other indirect support from the Pentagon and NASA, the
nation’s space agency. Boeing is at liberty to use the knowledge acquired from
such projects to produce civilian aircraft. The state of Washington, Boeing’s
primary manufacturing and assembly location, has provided the firm with tax
breaks, infrastructure support, and other incentives totaling billions of dollars.
The EU also has a case at the WTO regarding Boeing’s relations with
Japanese business partners. Boeing entered an alliance with Japan’s
Mitsubishi, Kawasaki, and Fuji to build the 787 Dreamliner. The Japanese
firms provided billions in soft loans, repayable only if the aircraft is
commercially successful.
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New Aircraft from Airbus and Boeing
In 2007, Airbus launched the A380, an innovative airplane with an upper deck
extending the entire length of the fuselage and a cabin that provides 50
percent more floor space than Boeing’s largest aircraft. The A380 can seat
between 555 and 853 passengers, depending on the seating configuration. It
has a maximum range of 15,000 kilometers (8,000 nautical miles). The total
cost to develop and launch the A380 reached 15 billion euros (U.S. $21
billion), partly supported by funding from European governments.
Boeing successfully launched the 787 Dreamliner in 2007 and is ahead of
Airbus in launching innovative and fuel-efficient aircraft. Airbus is developing a
mid-sized A350 model to compete with Boeing’s 787.
In 2008, the government of China established a company to make passenger
jumbo jets, part of its quest to challenge Boeing and Airbus in the global
aircraft industry. China Commercial Aircraft Co. was established in Shanghai
amid forecasts that China’s domestic market for commercial aircraft will
increase fivefold by 2026.
Global Financial Crisis
The recent global financial crisis adversely impacted Airbus and Boeing. Both
companies had to reduce output and lay off thousands of workers. Following
sharp drops in passenger traffic, airlines grounded planes and cut routes.
Longer term, Airbus aims to reorganize its global operations, outsource more
manufacturing, and sell all or part of six factories. It has begun to produce
aircraft in the United States. Airbus and Boeing are generating much new
business from emerging markets, and ramped up production substantially to
meet anticipated demand. In 2012, however, an industry expert warned that
both Airbus and Boeing were producing too many commercial aircraft, risking
a potential global glut.
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AACSB: Reflective Thinking Skills, Ethical Understanding and Reasoning
Abilities
Case Questions
1. Where do you stand? Do you think EU subsidies and soft loans to
Airbus are fair? Why or why not? What advantages does Airbus gain
from free financial support from the EU governments? Are complaints
about EU subsidies fair in light of Europe’s history of democratic
socialism?
2. Do you believe U.S. military contracts with Boeing amount to
subsidies? Have these types of payments provided Boeing with unfair
advantages? Justify your answer.
3. Assuming that Airbus cannot compete without subsidies and loans, is
it likely that the EU will discontinue its financial support of Airbus? Is it in
the EU’s interests to continue supporting Airbus? Justify your answer.
4. In the event the WTO rules against Airbus and tells it to stop
accepting subsidies and soft loans, how should Airbus management
respond? What new approaches can management pursue to maintain
Airbus’s lead in the global commercial aircraft industry?
Sources: Doug Cameron and David Kesmodel, “Warning is Issued about Plane Glut,” Wall Street Journal, February 23,
2012, pp. B6–B6; Corporate profiles of Airbus and Boeing at http://www.hoovers.com; K. Epstein & J. Crown,
“Globalization Bites Boeing,” BusinessWeek, March 24, 2008, p. 32; D. Gauthier-Villars & D. Michaels, “Airbus Buyers
Get French Aid,” Wall Street Journal, January 27, 2009, p. B4; Max Kingsley-Jones, “Throwing Down the Gauntlet,”
Airline Business, October 2011, pp. 28–30; N. Luthra, “Boeing to Sell India $2.1 Billion in Planes,” Wall Street Journal,
January 6, 2009, p. B4; D. Michaels, “Airbus Trims Jumbo Output as Carriers Defer Orders,” Wall Street Journal, May 7,
2009, p. B1; Pilita Clark, Joshua Chaffin, and James Politi, “WTO Rules that Boeing Received $5.3bn in Aid,” Financial
Times, April 1, 2011, p. 19; “China to Make Jumbo Jetliners, Trim Roles of Boeing, Airbus,” Wall Street Journal, May 12,
2008, p. B4; “How Airbus Flew Past Its American Rival,” Financial Times, March 17, 2005, p. 6; J. Lunsford and D.
Michaels, “Bet on Huge Plane Trips Up Airbus,” Wall Street Journal, June 15, 2006, p. A1; Stephan Wittig, “The WTO
Panel Report on Boeing subsidies: A Critical Assessment,” Intereconomics, May 2011, pp. 148–153.
Note: The authors acknowledge the assistance of Stephanie Regales with this case.
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Chapter Essentials
MyManagementLab
Go to mymanagementlab.com to complete the problems marked
with this icon
.
Key Terms
antidumping duty
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202
countervailing duty
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201
currency control
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200
customs
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dumping
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Summary
In this chapter, you learned about:
1. The nature of government intervention
Despite the value of free trade, governments often intervene in international
business. Protectionism refers to national economic policies designed to
restrict free trade and protect domestic industries from foreign competition.
Government intervention arises typically in ...
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