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The Dynamic Environment of International Trade

The Dynamic Environment of International Trade

Chapter 2

The Dynamic Environment of International Trade

The teaching objectives of this chapter is to understand

1. The basis for the reestablishment of world trade following World War II

2. The importance of balance-of-payment figures to a country’s economy

3. The effects of protectionism on world trade

4. The seven types of trade barriers

5. The provisions of the Omnibus Trade and Competitiveness Act

6. The importance of GATT and the World Trade Organization

7. The emergence of the International Monetary Fund and the World Bank Group


·         explosion of trade and emergence of the global economy

·         Intensification of global competition

·         More emerging markets

·         Developments in technology allow communications with global consumers and movement of goods

The 20th to the 21st Century

·         First World War

·         Worldwide economic depression

·         Second world war

·         Cold war and divide between communist-socialist-capitalist approach to economic development

·         The Marshall Plan for rebuilding Europe

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World Trade and U.S. Multinationals

  1. Rapid growth of underdeveloped countries and new global marketing opportunities
  2. Rising living standards have created marketing opportunities for U.S. firms
  3. Resistance over domination of U.S. multinationals
  4. Expropriation and domestication of U.S. investments in Latin America
  5. In the Europe, U.S. multinationals were controlled tightly by protectionism laws

World Trade and U.S. Multinationals

  1. Resurgence of competition from all over the world challenged the supremacy of American industry
  2. Newly industrialized countries (NICs) such as Brazil, Mexico, South Korea, Taiwan, Singapore, and Hong Kong experienced rapid industrialization
  3. Economic power evenly distributed with growth of MNCs from other countries (see Exhibit 2-2)
  4.  Establishment of the WTO
  5. Integration of European Union countries
  6. Creation of NAFTA, AFTA, and APEC

21st Century: The First Decade and Beyond

·         With exception of China, slower economic growth in U.S. and other countries is currently evident.

·         Faster growth rates expected in developing countries such as Brazil, China, India, Indonesia, and Russia.

·         More trade expected in emerging markets, regional trade areas, and the established markets in Europe, Japan, and U.S.

·         Companies need to be more efficient, improve productivity, expand global reach, and respond quickly.

·         Greater growth in international sales expected by smaller firms.

Globalization of the U.S. economy

America’s involvement in the global economy has passed through two distinct periods:

·         A development era: during which the United States sought industrial self-sufficiency in the eighteenth and nineteenth centuries,

·         A free-trade: in the early and middle twentieth century during which open trade was linked with prosperity.

·         Now America has entered a third, more dangerous era: an age of global economic interdependence.

The United States has shifted from relative economic self-sufficiency to global interdependence.

Differentiate among the current account, balance of trade, and balance of payments


“When countries trade, financial transactions among businesses/consumers of different nations occur, Products and services are exported and imported, monetary gifts are exchanged, investments are made, cash payments are made and cash receipts received, and vacation and foreign travel occurs. In short, over a period of time, there is a constant flow of money into and out of a country. The system of accounts that records a nation’s international financial transactions is called its balance of payments.”

Main points of the definition:

1.      When countries trade there are financial transactions among businesses or consumers of different nations

2.      Money constantly flows into and out of a country

3.      The system of accounts that records a nation’s international financial transactions is called its balance of payments (BP)

4.      It records all financial transactions between a country’s firms, and residents, and the rest of the world usually over a year

5.      The BP is maintained on a double-entry bookkeeping system

“The BP is the difference between receipts and payments”

BP Receipts

•                     Merchandise export sales.

•                     Money spent by foreign tourists.

•                     Transportation.

•                     Payments of dividends and interest from FDI abroad.

•                     New foreign investments in the U.S.

BP Payments

•         Costs of goods imported.

•         Spending by U.S. tourists overseas.

•         New overseas investments.

•         Cost of foreign military and economic aid.

The BP includes three accounts:

(1)   current account—a record of all merchandise exports, imports, and services plus unilateral transfers of funds;

(2)   capital account—a record of direct investment, portfolio investment, and short-term capital movements to and from countries;

(3)   The official reserves account—a record of exports and imports of gold, increases or decreases in foreign exchange, and increases or decreases in liabilities to foreign central banks;


The current account is important because it includes all international trade and service accounts, i.e., accounts for the value of all merchandise and services imported and exported and all receipts and payment from investments. The balance of trade reflected in the current account is the single most important factor in any economy.


The relationship between merchandise imports and exports is referred to as the balance of merchandise trade or trade balance. If a country exports more goods than it imports, it is said to have a favorable balance of trade; if it imports more goods than it exports, it is said to have an unfavorable balance of trade. Usually a country that has a negative balance of trade also has a negative balance of payments. Both the balance of trade and the balance of payments do not have to be negative; at times a country may have a favorable balance of trade and a negative balance of payments or vice versa.

EG. This was the case for the United States during the Korean and Vietnam Wars when there was a favorable balance of trade but a negative balance of payments. The imbalance was caused by heavy foreign aid assistance by the United States to other countries and the high cost of conducting the Korean and Vietnam Wars.

In only three years since 1970 has the United States had a favorable balance of trade. This means that for each year there was an unfavorable balance, the United States imported goods with a higher dollar value than the goods it exported. These imbalances resulted primarily from heavy U.S. demand for foreign petroleum, foreign cars, industrial machinery, and other merchandise. Such imbalances have drastic effects on balance of trade, balance of payments, and therefore, the value of local currency in the world marketplace.

The balance of payments always balance even though the balance of trade does not:

The balance of payments must always balance because the record is maintained on a double-entry bookkeeping system. In the balance of payments, debits must off-set the credits. The balance of trade doesn’t have to be in balance. Exports can exceed imports or vice versa or they can be in balance.

Method through  which a nation can overcome an unfavorable balance of trade.

A country can overcome an unfavorable balance of trade by increasing exports or decreasing imports. Temporary aid may also result from infusions of capital, loans, or foreign aid.

Balance of Payments and Exchange Rate

  1. If a country’s expenditures consistently exceed its income, its standard of living falls
  2. Its exchange rate vis-à-vis foreign monies declines
  3. When foreign currencies can be traded for more dollars, U.S. products are less expensive for foreign customers and exports increase
  4. Simultaneously foreign products are more expensive for U.S. buyers and the demand for imported goods is reduced

Role of price as a free market regulator

As a free market regulator, price serves as a primary variable in regulating supply and demand and aids in resource allocation. Prices that are too low deplete product supply, and prices that are too high stop consumer purchases.

“Theoretically, the market is an automatic, competitive, self-regulating mechanism which provides for the maximum consumer welfare and which best regulates the use of the factors of production.”

-Productivity and market demand are the determinants of the standard of living differentials throughout the world as determined by the market if (theoretically) free competition exists. However, many variables pollute this “best of all possible worlds” model. Government interference, cartels and other monopolistic practices, and market barriers all corrupt this market (free) system.

Protectionism: Logic and Illogic

Countries use protectionist measures to shield a country’s markets from intrusion by foreign competition and imports.

Arguments for Protectionism include:

(1)   Infant industry – theoretically this argument has a considerable degree of validity. However, practically, the argument is carried too far. How do you determine which particular potential industries would develop a comparative advantage and be able to withstand foreign competition? When protection is a mistake, it is difficult to remove the protection. Unless there is a definite timetable, the incentive to develop increasing efficiency is weakened. This argument for tariffs has validity if it is used very carefully and controlled closely.

(2)   Protection of the home market – this argument asserts that low costs of production in other countries pauperizes American labor, and foreign goods would flood the American markets. For example, American producers would be forced to lower wage rates approximating foreign wage rates. This argument is invalid because low money wages do not necessarily mean low wage costs per unit of output. The latter is a function of two elements–money wage rates and the productivity of labor. Therefore, since free trade raised productivity rather than lower it, the above argument is invalid.

(3)   Keep money at home – this fallacious reasoning is based on the mercantilist identity of money and wealth. A higher volume of money makes no direct contribution to the real income and wealth of a country. If a country is experiencing monetary problems, central bank and fiscal policies are much more potent weapons of monetary control than is manipulation of trade balance. Therefore, this argument is invalid.

(4)   Capital accumulation – a country indeed does increase capital accumulation by imposing tariffs, but this gain is at the expense of other countries and retaliation soon follows which in the end leaves everybody losing, including the original tariff imposer. Therefore, this argument is invalid.

(5)   Standard of living and real wage – this argument is parallel to number (4), except that the imposition of tariffs eventually leads to a lower national income and wage level due to retaliation. This argument is self-defeating and invalid.

(6)   Conservation of natural resources – tariffs tend to cause extreme dependence on national resources and, therefore, our economy actually depletes its resources more quickly than if free trade existed and other countries bought our resources. Instead of conservation, there is depletion of natural resources; therefore, this argument is invalid.

(7)   Industrialization of low wage nation – quite pertinent to underdeveloped countries. However, many times the foreign competition isn’t the problem, but the paucity of capital and technical knowledge are problems. The danger of tariffs for this argument lies in the fact that the wrong kind of industries will be created. The types of industries which the underdeveloped areas can economically create and maintain are generally those which don’t require protection on any large scale because they are based on natural advantages. Again, this argument is valid if it is used very carefully and closely controlled.

(8)   Maintain employment and reduce unemployment – this argument becomes useless upon retaliation of other countries. The problem compounds itself. Also, if countries don’t retaliate, there is still a gross inefficient allocation of resources in the tariff-setting country. Alternative policies are available which would relieve unemployment at home while encouraging greater employment abroad and a larger volume of international trade. Therefore, this argument is invalid.

(9)   National defense – in particular instances there may be merit to this argument, but it becomes invalid if applied indiscriminately. We must trade to get the proper resources and conserve ours. (See #6). If the economy weakens, the military strength weakens. “National Security depends upon many factors, not the least of which is a community of economically healthy nations devoted to living in harmony and tied together by mutually beneficial trade.”[1]

(10)  Increase business size – with fully employed resources, aggregate domestic production can’t be expanded by protective tariffs; expansion in one area of the economy must be at the expense of reduced output in other fields. Tariffs tend to draw resources away from previous employments into protected industries; hence, an inefficient allocation of resources. Also some of these reallocated resources are likely to be drawn away from production of export goods. Domestic expansion would be at the expense of the export market. Therefore, this argument is invalid.

(11)  Retaliation and bargaining – retaliation doesn’t recover the losses that are suffered due to foreign tariffs. Retaliation further reduces the volume of trade. Bargaining as a reciprocal tool; i.e., tariffs are raised and then offered to be lowered if the other countries will lower theirs. If the reciprocal agreement isn’t reached, then the tariffs usually remain. These arguments are sometimes a front for other reasons for erecting tariffs. Therefore, most of the time, this argument is invalid.

In general, protectionism contributes to industrial inefficiency and makes a nation uncompetitive

Protectionism is implemented through the imposition of trade barriers, which include tariff barriers and non-tariff barriers

The Impact of Tariff (Tax) Barriers

Tariff Barriers tend to Increase:

  1. Inflationary pressures
  2. Special interests’ privileges
  3. Government control and political considerations in economic matters
  4. The number of tariffs they beget via reciprocity

Tariff Barriers tend to Weaken:

  1. Balance-of-payments positions
  2. Supply-and-demand patterns
  3. International relations (they can start trade wars)

Tariff Barriers tend to Restrict:

  1. Manufacturer’ supply sources
  2. Choices available to consumers
  3. Competition

Six Types of Non-Tariff Barriers

(1) Specific Limitations on Trade:

  1. Quotas
  2. Import Licensing requirements
  3. Proportion restrictions of  foreign to domestic goods (local content requirements)
  4. Minimum import price limits
  5. Embargoes

(2) Customs and Administrative Entry Procedures:

  1. Valuation systems
  2. Antidumping practices
  3. Tariff classifications
  4. Documentation requirements
  5. Fees

(3) Standards:

  1. Standard disparities
  2. Intergovernmental acceptances of testing methods and standards
  3. Packaging, labeling, and marking

(4) Government Participation in Trade:

  1. Government procurement policies
  2. Export subsidies
  3. Countervailing duties
  4. Domestic assistance programs

(5) Charges on imports:

  1. Prior import deposit subsidies
  2. Administrative fees
  3. Special supplementary duties
  4. Import credit discriminations
  5. Variable levies
  6. Border taxes

(6) Others:

  1. Voluntary export restraints
  2. Orderly marketing agreements

Monetary Barriers

In addition to the Six Types of Non-Tariff Barriers, monetary barriers are also used by countries

Three types of monetary barriers include:

  1. Blocked currency: Blockage is accomplished by refusing to allow importers to exchange its national currency for the sellers’ currency.
  2. Differential exchange rates: It encourages the importation of goods the government deems desirable and discourages importation of goods the government does not want by adjusting the exchange rate. The exchange rate for importation of a desirable product is favorable and vice versa
  3. Government approval: In countries where there is a severe shortage of foreign exchange, an exchange permit to import foreign goods is required from the government

The Omnibus Trade and Competitiveness Act (OTCA) 1988

  1. Many countries are allowed to trade freely with the United States but do not grant equal access to U.S. products in their countries.
  2. To ease trade restrictions, the OTCA focused on correcting perceived injustice in trade practices.
  3. It dealt with trade deficits, protectionism, and the overall fairness of trading partners.

The bill covers three areas for improving U.S. trade:

  1. market access,
  2. export expansion, and
  3. import relief

Market Access

There has been growing concern that U.S. business does not have the same access to foreign markets that foreign business has to U.S. markets. There are many barriers restricting or prohibiting goods from entering a foreign market: unnecessarily restrictive technical standards, compulsory distribution systems, customs barriers, tariffs, quotas, and restrictive licensing requirements are just a few.

The Act gives the President authority to deal with countries where specific barriers unfairly keep U.S. products from entering those countries’ markets. If a country violates a trade agreement, the President can retaliate by restricting the country’s products in U.S. markets.

Two other issues addressed under the market access section of the law are Government procurement procedures and market access to telecommunications markets.

1.      Foreign government procurement procedures must not discriminate against U.S. firms; if they do, the President has the authority to impose a ban on U.S. Government procurement of goods and services from that country.

2.      Deregulation and the divestiture of American Telephone and Telegraph assured foreign telecommunications suppliers full access to the American market. By contrast, U.S. companies enjoy limited access to the major foreign telecommunications markets, most notably in Europe. The 1988 Act clearly indicates that the United States regards telecommunications market access a top priority of U.S. trade policy and, when negotiation fails to open foreign markets, the government will take retaliatory action.

Export Expansion

In addition to making foreign markets more accessible to U.S. goods, the 1988 Act reflects on awareness that some problems with U.S. export competitiveness stemmed from obstacle for trade imposed by U.S. regulations and export disincentives.

Export controls, the Foreign Corrupt Practices Act (FCPA), and export promotion were specifically addressed.

The new regulations make it easier and speed up the process for obtaining export licenses for products on the export control list.

Much of the ambiguity in the FCPA was removed by clarifying the legality of most types of payments. In addition, the act reaffirmed the government’s role in the promotion of export trade in general, agricultural trade in particular, and the continued financial assistance to small businesses engaged in exporting.

Import Relief

Export trade is a two way street; that is, we must be prepared to compete with imports in the home market if we force foreign markets to open to exports. The Act provides a menu of remedies for U.S. businesses adversely affected by imports; it recognizes that foreign penetration of U.S. markets can cause serious competitive pressure, loss of market share and, occasionally, severe injury.

Measures dealing with antidumping, countervailing duty and intellectual property protection laws are designed to redress competitive advantages obtained by foreign companies through unfair trade practices. The Act also provides temporary relief from competition to firms injured by fairly traded imports.

Difference between Tokyo Round of GATT & the Uruguay Round

·         The Tokyo Round considered nontariff barriers as having become one of the major obstacle to international trade. Earlier rounds of negotiations by GATT members had been successful in reducing tariffs but nontariff barriers are considered to be insidious protectionist devices and the Tokyo Round focused on the reduction of nontariff barriers.

·         The Tokyo Round made a good start at addressing a number of nontariff barriers that have become more serious in recent years. Despite the success of these past rounds, high tariffs have not disappeared entirely and nontariff barriers are still widely used.

·         There are also areas that, until now, GATT has not addressed such as services, intellectual property rights, and investment. Specifically, GATT negotiations in this round are to address key areas of importance in international trade which are not now under the scope of GATT rules.

·         For example, GATT rules do not apply to the international trade of services which represent an increasing percentage of international trade flows. Similarly, GATT rules have little influence over government investment policies affecting international trade or on policies concerning the protection of intellectual property rights such as patents, trademarks, and copyrights. Agricultural trade is another area where GATT rules either do not apply or are not effective.

·         Finally, the dispute settlement mechanism is seen to be increasingly ineffective at resolving conflicts among GATT members.

The impact of GATS, TRIMS, AND TRIPS on global trade.

An important objective of the United States in the Uruguay Round was to reduce or eliminate barriers to international trade in services. While there is still much progress to be made before free trade in services will exist throughout the world.

General Agreement on Trade in Services (GATS):

1.      It is the first multilateral, legally enforceable agreement covering trade and investment in services sector.

2.      It provides a legal basis for future negotiations aimed at eliminating barriers that discriminate against foreign services trade and deny them market access.

3.      Specific market-opening concessions from a wide range of individual countries were achieved and provision was made for continued negotiations to further liberalize telecommunications and financial services.

Trade-Related Investment Measures (TRIMs)

1.      It established the basic principle that investment restrictions can be major trade barriers and therefore are included, for the first time, under GATT procedures.

2.      An initial set of specific practices were prohibited including: local content requirements specifying that some amount of the value of the investor’s production must be purchased from local sources or produced locally; trade balancing requirements specifying that an investor must export an amount equivalent to some proportion of imports or condition the amount of imports permitted on export levels; and, foreign exchange balancing requirements limiting the importation of products used in local production by restricting its access to foreign exchange to an amount related to its exchange inflow.

3.       As a result of TRIMs, restrictions which prohibit foreign firms from opening their own wholesale or retail distribution channels can be challenged. And so can investment restrictions  that require foreign-owned manufacturers to buy most of their components from high-cost local suppliers and that affiliates of foreign multinationals maintain a trade surplus in Brazil’s favor by exporting more than they sell within.

Trade-Related Aspects of Intellectual Property Rights (TRIPs):

·         The TRIPs agreement establishes substantially higher standards of protection for a full range of intellectual property rights (patents, copyrights, trademarks, trade secrets, industrial designs, and semiconductor chip mask works) than are embodied in current international agreements and it provides for the effective enforcement of those standards both internally and at the border.

Evolution of world trade & the formulation of the WTO.

Since the inception of GATT, there have been eight “rounds” of intergovernmental tariff negotiations. The most recently completed was the Uruguay round which built on the success of the Tokyo Round, the most comprehensive and far-reaching round undertaken by GATT up to that time.

The Tokyo Round resulted in tariff cuts and set new international rules for subsidies and countervailing measures, anti-dumping, government procurement, technical barriers to trade (standards), customs valuation, and import licensing. While the Tokyo Round addressed non-tariff barriers, there were some areas not covered by that round which continued to impede free trade. In addition to market access, there were issues of trade in services, agriculture, and textiles; intellectual property rights; and investment and capital flows.

The Uruguay Round was begun in 1986 in Punta del Este, Uruguay and finally concluded in 1994. By 1995, 80 GATT members including the United States, the European Union (and it member states) Japan, and Canada had accepted the agreement.

Perhaps the most notable achievement of the Uruguay Round was the creation of a new institution as a successor to the GATT, the World Trade Organization (WTO). At the signing of the Uruguay Round trade agreement, U.S. representatives pushed for an enormous expansion of the definition of trade issues. The result was the creation of the World Trade Organization that encompasses the current GATT structure and extends it to new areas not adequately covered in the past.

·         The WTO is an institution—not an agreement as was GATT. It will set the rules governing trade between its 117 members, provide a panel of experts to hear and rule on trade disputes between members and, unlike GATT, issue binding decisions.

·         It will require for the first time, the full participation of all members in all aspects of the current GATT and the Uruguay Round agreements and, through its enhanced stature and scope, provide a permanent, comprehensive forum to address the trade issues of the 21st century global market.

·         Trade disputes will be heard by a panel of experts. A panel of experts, selected by the WTO, will hear both sides and issue a decision; the winning side will be authorized to strike back with trade sanctions if the losing country does not change its practices.

·         While the WTO has no actual means of enforcement, international pressure to comply with WTO decisions from other member countries is expected to force compliance. The WTO ensures that member countries agree to the obligations of all the agreements, countries, including developing countries (the fastest growing markets of the world) will undertake obligations to open their markets and to be bound by the rules of the multilateral trading system.

      The Japanese keiretsu system makes it more difficult for foreign firms to enter the Japanese market.  Groups of companies with no formal legal ties are joined together in a variety of ways into broad and vertical inter-company relationships.  Each company within the keiretsu favors buying products from other firms in the same family.  Thus, Mitsubishi Electric buys only Mitsubishi for its automobile fleet, and so on.

GATT trade rounds



Subjects covered



















Geneva (Dillon Round)




Geneva (Kennedy Round)

Tariffs and anti-dumping measures



Geneva (Tokyo Round)

Tariffs, non-tariff measures, “framework” agreements



Geneva (Uruguay Round)

Tariffs, non-tariff measures, rules, services, intellectual property, dispute settlement, textiles, agriculture, creation of WTO, etc




Doc Snow from Camden, South Carolina on October 08, 2010:

Nice summary. I wasn't aware that Hubs were being used for study guides, which is what this appears to be. (If it were for general consumption, I'd question the lack of mention of the ongoing Doha round.)

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