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MGT520 - International Business - Lecture Handout 27

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Economic Rationales for Government Intervention:


There is probably no more effective pressure group than the unemployed, because no other group has the time and incentive to picket or write letters in volume to government representatives. By limiting imported goods, consumers are forced to consume more goods produced domestically. This helps boost domestic employment. However, placing restrictions on imports normally results in retaliatory tariffs by other countries. In such instances, domestic jobs related to exports may be lost. Even if import restrictions do increase domestic employment, there will still be costs to some people in the domestic society in the form of higher prices or higher taxes.

Infant Industry Argument:

The infant industry argument holds that a government should guarantee an emerging industry a large share of the domestic market until it becomes efficient enough to compete against imports. However, governments have a hard time identifying which industries merit protection. Furthermore, protection for any particular industry means higher costs for local consumers, which can reduce the profitability of other domestic industries.

Industrialization Argument:

Many developing countries limit imports in an attempt to stimulate inward FDI. For example, if imported cars have to pay a high tariff, the foreign firm may decide to produce the car locally and thereby avoid the import tariff. In so doing, the auto manufacturer would help industrialize the host country’s economy. The benefits of industrialization are based on several factors, as described below.
Use of surplus workers: Shifting workers from agricultural jobs to industrial jobs tends to promote economic growth since individual agricultural productivity tends to be low in less developed countries.
Promoting investment inflows: Foreign direct investment tends to accelerate the move from agriculture to industry by creating new manufacturing jobs.
Diversification: Economies based largely on the export of a single product are very vulnerable to price changes in global markets for that product or crop. Foreign investment in multiple industries helps reduce the country’s dependence on a single crop or product.
Greater growth for manufactured products: The price of raw materials and agricultural commodities do not rise as fast as the prices of finished products, so over time it takes more primary products to buy the same amount of manufactured goods. Therefore, most emerging economies have become increasingly poorer compared to developed countries.
Import substitution versus export promotion: So far we have discussed why emerging economies promote industrialization. They may do so by restricting imports in order to produce locally for local consumption (import substitution). If the locally produced goods are intended to be exported (instead of consumed locally), the country still benefits in that it now has more jobs, diversification, and greater hard currency revenues from exports.
Economic Relationships with Other Countries:
Balance of payments adjustments: Most countries would prefer to have a balanced trading position with other countries. For years, the trade deficit the United States has with Japan has been a sore spot in the relationship between the two countries. Often governments intervene to help correct these imbalances.
Comparable access or “fairness”: Many countries demand comparable access for their goods. For example, the U.S. government permits foreign financial service companies to operate in the United States, but only if their home governments allow U.S. financial service firms to operate there. However, restricting trade—even on the grounds of fairness—still leads to higher prices for domestic consumers.
Price control objectives: Countries sometimes withhold supplies from international markets (restrict trade) in order to raise prices abroad. The Organization of Petroleum Exporting Countries (OPEC) is a good example. However, restricting exports leaves unmet demand which competitors will be happy to meet.

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