IB NOTES TRADE

2.1 Globalisation of Trade (part of module 2) Literally, globalisation is the phenomenon or process of overcoming all barriers towards transforming the world into a single unit. This means that the process of globalisation has socio-political-economiccultural-environmental-technological-legal dimensions. In this sense, the process of globalisation is centuries old. During the dynastic rule, it was more of a political process fought on the battle-fields. Today, the perspective has changed and the economic dimension occupies the centre stage. The theories, the measurement tools, the infrastructure (framework and technology), the policies and legislations which shape the globalisation process are embedded in economic fundamentals. Although, the perspecitive of today's globalisation process is economic, its implications have socio-politicalcultural-environmental-technological-legal dimensions. Globalisation of trade is one of the dimensions of Globalisation. There are several Trade theories, Events, Organisations, Policies which have dominated at the globalisation process over various time periods. 2.1.1 Trade Theories Several economic trade theories have come up at various periods. The theories serve two purposes. On the one hand, they aim to explain the dynamics of trade as they happen; on the other hand they also set the direction for the policies to be adopted by countries in future. 2.1.1.1 Theory of Mercantilism One important trade theory which dominated the colonial period was Theory of Mercantilism. During this period countries traded goods for gold and silver. On exporting goods, countries earn gold and on importing goods, countries deplete their gold reserve. As per this theory, the wealth of countries was determined by the stock of gold and silver which they hold. So the goal of trading was to export as much as possible and import as little as possible. 2.1.1.2 Theory of Absolute Advantage The argument for free trade was first voiced by Adam Smith in 1776 through the book 'The Wealth of Nations', in which he put forward the Theory of Absolute Advantage in trade of goods between countries. His theory states that countries should produce (and export) goods which they have absolute advantage in production when compared to another country. Countries should import goods which they do not have absolute advantage in production from the other country. Labour productivity was the factor in consideration for measuring the absolute advantage. 2.1.1.3 Theory of Comparative Advantage This theory was put forward by David Ricardo in 1817. This was an improvement of Adam Smith's theory. The Theory of Comparative Advantage states that even if country A has absolute advantage in both goods when compared to another country, it should be producing more of the good which it has more absolute advantage and should import the other good from the other country.

The limitations of both of the above theories are mainly that they considered only 2 countries and 2 goods and also transportation costs and other factors of production were not considered. 2.1.1.4 Heckscher-Ohlin Theory Heckscher put forward this theory in 1917 which was later improved upon by Ohlin in 1933. While Ricardo stressed productivity for comparative advantage, they proposed the parameter National Factor Endowments (land, labour, capital, resources) for measuring comparative advantage. This theory could explain why USA with its surplus land has been exporter of agricultural goods. Leontief later pointed out that this theory could not explain why USA which has surplus capital is not exporting capital intensive goods. 2.1.1.5 Product Life-Cycle Theory This theory put forward by Raymond Vermon in 1960, could find an explanation to Leontief's paradox. He explained that USA was innovating and hence not producing capital intensive goods. These innovated products were first launched in home markets and they had a life-cycle. They would be exported only after the product life in the US market reaches the saturation phase. 2.1.1.6 New Trade Theories New Trade theories are Strategic Trade Theories which dominated the 1970s. These theories call for Government intervention in certain strategic areas. Government intervention was needed to augment national factor endowments so that the country acquires advantage in the production of these goods. The economists who proposed these theories were trying to explain how Japan became a leading exporter of automobiles with a pro-active government role. Economies of scale was a prime concern and government intervention was needed for the country to be a location economy. In high value but limited market segment like manufacture of aircrafts, government intervention was desirable for the domestic industries to get a First Mover advantage and thereafter capture the global market. 2.1.1.7 Porter Diamond Theory This theory by Porter in 1990, explained that for nations to have a competitive advantage in a particular industrial segment, four factors should mutually re-inforce. The 4 factors are Firm strategy, structure & rivalry --> Strong presence of related and supportive industries --->Demand conditions in the home market ---> National Factor endowments. He drew a diamond structure for his factors. Government intervention and Chance can externally influence this Porter's Diamond. Porter's theory called for a mix of private entrepreneurial initiative and government intervention for nations to have a competitive advantage in international trade. Again, Porter modelled his studies mainly on Japan. The various theories cited above explain how the perspectives and policies of government changed with varying times. Note : for more reading on Trade Theories refer “International Business” by Charles W.L Hill & “Elements of International Business” by S.N. Chary

2.1.2 Why Governments intervene in International Trade ? Although there were advocates for free trade with no government intervention at all like Adam Smith, this was not the reality. As the countries operate in a political economy, Government interventions do happen. The reasons are mainly the following 1. Creation and protection of Jobs 2. Protecting Domestic Producers 3. Balance of Payment concerns 4. Strategic intervention in future technology segments 5. Protecting consumers's health 6. Livelihood concerns in agricultural sector 7. Ethical issues like environment, animal protection, child labour 8. National Security concerns 9. To implement foreign policy objectives 10. As a bargaining and retaliatory tool in disputes settlement 2.1.3 Instruments of Government intervention in international trade Governments intervene by creating barriers for free trade. Trade barriers are of 2 types 1. Tariff Barriers 2. Non-Tariff Barriers 2.1.3.1 Tariff Barriers Tariff is a tax of duty levied by Government on an imported good as it enters the country. It has 2 effects 1. It raises the price of the good in the market 2. It generates revenue to the government There are 3 types of import tariffs. 1. Specific tariff : will be a specific amount per quantity eg: Rs.30 per Kg 2. Ad valorem : varies according to value, ie, as % of import value, eg : 30% of FOB price 3. Compound tariff : a combination of the above two Export duty is also a kind of tariff barrier. Duty is charged on exports. This is to prevent exports so that the good is reserved for domestic consumption or to prevent over exploitation of natural resources , or to encourage foreign direct investment. 2.1.3.2 Non-Tariff Barriers Initially government intervention was in the form of high tariffs only. As the negotiations for free trade started to catch up through GATT, tariff lines had to be gradually brought down. Governments started to introduce non-tariff barriers. Basically NTB are of 2 types  

Price influencing NTB Quantity influencing NTB

Price influencing NTB : The net effect of these NTB is that they influence the price of the good in the market like TB. The common forms are 1. Subsidies : These include direct subsidies given to agriculture and industries, indirect subsidies in the form of concessions to utilities/tax breaks/soft loans/grants, export subsidies and any sort of conditional subsidies 2. Countervailing duty : If the importing country feels that the goods being imported are being subsidised in the exporting country, they may charge a countervailing duty which is a disputable NTB 3. Anti-dumping duty : If the importing country feels that the goods being imported are being dumped at a very low price than production cost with the aim of wiping out the domestic industry in the importing country, then the importing country charges anti-dumping duty which is a disputable NTB. This subject first came up in the Kennedy round of GATT negotiations 4. Customs valuation : If the importing country feels that the goods being imported are under valued in invoice, they may subject the goods to customs valuation and re-fix the price. 5. Adminstered minimum price : Countries may fix a minimum price for certain items which is a disputable NTB 6. Customs special fees : Some countries create financial hurdles to imports like asking for advance duty or special customs fees which will raise the financing cost for the exporter. 7. Tied Aid : Developed countries give tied aid to developing countries and insist that the developing country should import only from the aid giving country. Quantity influencing NTB : The net effect of these NTB is that they influence the quantity of imports in the domestic market. The common forms are 1. Quotas : This comes as restrictions on the quantity of imports by quantity or by import value. Multi Fibre Arrangement (MFA) imposed by USA and EU on Textile import is a form of quota NTB which was phased out in 2005. WTO permits quota if the importing country faces a BoP problem. Export quotas also exist which is aimed at restricting exports to a particular country (like sanctions or embargo) 2. Rules of Origin : Due to quotas being imposed by certain countries on imports from a particular country only, the exporters of the second country re-route their products through non-quota restricted country. Realising this, the importing country will insist on Rules of Origin of the goods being imported. 3. Voluntary Export Restrictions (VER) : This is arrangement between importing country and exporting country asking the exporting country to voluntarily restrict exporting some goods. USA and Japan entered into a VER where Japan conceded to US request to restrict Japanese automobiles from being exported to USA. In such cases disputes dont reach GATT or WTO 4. Domestic Content Requirements : In case of importing parts of equipment, the importing countrty will demand that the final product should contain specified % of parts sourced from domestic industries. 5. Domestic industry safeguards : These are safeguard mechanisms aimed at protecting a segment of the domestic industry 6. Sanitary and PhytoSanitary measures (SPS) : Health concerns of the consumers are specified here and certain imports are restricted. Eg: EU restricted Beef saying that they are Hormone Treated beef products. 7. Government procurement : Government procurement is big enough to influence trade.If government specifies tender conditions favouring domestic suppliers, that is a form of NTB. 8. Environment standards : Some countries claim that the exporting country doest not confine to

environmental standards while producing goods. Eg: shrimps from countries like India were banned by USA claiming that fishing practices in India don't use turtle excluding devices and endanger turtle species. This is a disputable NTB. 9. Labour standards : Some countries claim that the exporting country doest not confine to labour standards while producing goods. Eg: Developed countries argue that Carpet industry in India uses child labour which is against ILO rules. This is a disputable NTB. 10. Bureaucratic delays : Some countries have many bureacratic procedures while importing. This is a camouflaged form of NTB. Japan had a notorious history in this regard. Note : for more reading on Trade Barriers refer “International Business” by Francis Cherunilam & “Elements of International Business” by S.N. Chary 2.1.4 GATT (General Agreement on Tariffs & Trade) 

As the Second World War was coming to an end, countries led by USA realised the need for a forum for pushing forward free international trade. International Trade Organisation was proposed. But it didn't take off. Finally General Agreement on Tariff and Trade took shape which was a forum and not an organisation. 23 countries came together to form GATT in 1948.

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Since 1948, GATT has held many rounds of discussion (Geneva, Annecy, Torquay, Geneva, Dillon, Kennedy, Tokyo and Uruguay).

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Reduction of Tariff barriers across various product lines was the main agenda of discussion in the first 6 rounds (1948-67) and GATT achieved fair amount of success in this regard.

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In the 6th round which is the Kennedy round, NTB in the form of Anti-dumping Duty came to the agenda of negotiations.This can be said to be the beginning of NTB negotiations.

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In the 7th round which is the Tokyo round (1973-79), various other forms of NTB were brought to the agenda. Agreements could not be arrived suiting all countries. Certain 'codes' were laid down to which many countries agreed to.

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The path breaking Uruguary round which was the 8 th round (1986-94) could achieve success in tarrification of many NTB. However the Uruguary roundfor the first time brought Services and Intellectual Property Rights to the agenda. However there could not be agreements as desired. The significance of the Uruguary round is that it resulted in the formation of World Trade Organisation (WTO). Sir Arthur Dunkel who chaired the Uruguary round prepared a draft of agreement called Dunkel Draft which later became GATT 1994 Agreement which is the agreement which led to the formation of WTO. So with the Uruguary round GATT became nonexistent.

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GATT's greatest success is that it created a culture of trade negotiations. Also it brought down tariff lines from a level of 40% to almost 3% on an average basis. It also could bring tarrification to several NTB. It could put the the Non-discrimination principle to the forefront. With the formation of WTO, the slogan became “GATT is dead, Long Live the GATT”.

Note : for more reading on GATT refer “International Business” by Francis Cherunilam & “Elements of International Business” by S.N. Chary

2.1.5 WTO (World Trade Organisation) 1. WTO took off from the Uruguary round of GATT. GATT 1994 agreement is the formation agreement of WTO. There were 6 agreements originally  agreement to form WTO  Multi-lateral agreement on trade in goods and investment measures  General Agreement on Trade in Services (GATS)  Trade Related Intellectual Property Rights (TRIPS)  Dispute Settlement Mechanism  Trade Review Mechanism 2. WTO was formed in January 1995 3. Fundamental Principles of WTO include  Non-discrimination : This has 2 principles 1. Most Favoured Nation principe whereby each member country should treat each other member equally as an MFN 2. National Treatment principle whereby the member country should give national treatment to imports.  Predictability and Transparency  Free Trade  Fair competition  Encouraging Development and growth in developing countries 4. Organisation structure of WTO  Ministerial Conference held every 2 years  General Council comprising all members  GC acts as Dispute Settlement Body (DSB) and Trade Review Body  Underneath the GC there exists Goods Council, GATS Council, TRIPS Council  Underneath the GC there exists several committees like Environment, RTA,NTB, BoP etc.  Reporting to GC is the Ongoing round committee. 5. Consensus preferred in decision making. One country has one vote. Decisions require 3/4 majority in case of vote. New member admission needs 2/3 majority. 6. Trade policy review mechanisms  Countries have to report their Foreign Trade policy to the Council  Developed countries should report every 2 years  Other countries to report every 6 years  Least Developed Countries can take longer period  Trade policies of countries subject to peer review also 7. Dispute Settlement Mechanism  DSB acts like a court of law but preferes out of court settlement in all cases  Defined procedures in place

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Procedures time bound (6 to 9 months) Procedures automatic Legally binding verdicts Arbitration and Appeal mechanism Allows compensation or retaliatory measures by grieved party

8. GATS Council  Telecommunication, Banking, Tourism, Professional Services, IT, ITES etc.  There are 4 Modes (or categories) defined 1. Cross border supply (eg: telephone calls) 2. Consumption abroad (eg: Tourism) 3. Commercial presence (eg: starting a subsidiary) 4. Presence of persons  WTO allows exemptions to MFN and National Treatment principles in case of services (countries can specify conditions especially in visa regulations, domestic stay conditions, tax treatment, medical practice conditions etc.  WTO also honours Regional and bilateral agreements in case of services for 10 years  India wants opening up of IT/ITES, medical services, hospitality sectors in developed countries while it is willing to open up its capital intensive telecom, banking, insurance sectors. Tourism is another growing prospect for India. 9. TRIPS Council  IPR means rights given to persons over the creation of their minds. It gives the creator exclusive right and commercial protection over his creation for a certain period.  This is considered significant in emerging knowledge economy  Forms of IPR include patents, copy rights, trade marks, trade secrets, design etc.  Developed countries want other countries to implement IPR laws  Pharmaceutical, Software, Biotechnology are areas of contention  India has process patent in Pharmaceutical industry. USA insisting for product patents  Lok Sabha has amended Patents Bill in 2005 due to WTO compulsions  GM crops is another area where IPR becomes significant  WTO allows exemptions to MFN principle in case of IPR  WTO also honours Regional and bilateral agreements in case of IPR 10. TRIMS  WTO aims at removing Local Content requirement conditions, Trade balancing requirement conditions, BoP based restrictions, Domestic sale requirement conditions which various countries impose. 11. WTO ministerial conferences  Singapore (1995), Geneva, Seattle, Doha, Cancun, Hongkong, Bali (2013)  Doha round launched in 2001 is in progress.China became a member in 2001.  Developed countries insist on accelerating Singapore issues which include investment, government procurement, fair competition, labour laws, environment, TRIPS.  Seattle conference saw demonstrations of environmental activists and labour activists which turned violent.  Developing countries led by India insist on implementing removal of agricultural

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subsidies in developed countries and also want patent laws to be kept aside in case of public health policy. Bali conference arrived at a consensus. However India raised food security subsidy requirement later which toppled the discussions. Other Major issues raised in WTO include Shrimps- Turtle dispute between India and USA and the phasing out of MFA by EU and USA

12. WTO monitors agreements and sees to it that they are implemented 13. WTO co-operates and co-ordinates with agencies like IMF, World Bank 14. WTO upholds Montreal and Basel convention in environmental issues 15. WTO upholds ILO legislations in labour issues Note : for more reading on WTO refer “International Business” by Francis Cherunilam & “Elements of International Business” by S.N. Chary, Wikipedia on WTO which is attached. 2.1.6 RTA (Regional Trade Agreements) 1. Also referred to as Regional Economic Integration, Regional Integration Agreements, Regional Trade Integration. 2. Agreements among countries in a geographic region to reduce and ultimately remove trade barriers to the free flow of goods, services and factors of production 3. It is comfortable for countries to regionally enter into agreement rather than globally through GATT or WTO. 4. Normally political considerations lead to formation of RTA, like fear of a super power, fear of war in the region etc. 5. WTO ensures that RTA are compliant with WTO agreements and insist this aggressively in case of goods 6. WTO is more liberal in the case of RTA in the domain of services and IPR legislations 7. Regional agreements in a sense accelerate global free trade. 8. Trade Creation : When a regional agreement increases the net volume of global trade in the region we say the RTA has had a positive effect i e, Trade Creation 9. Trade Diversion : When a regional agreement diverts competitive trade from the region from non-members, we say the RTA has had a negative effect , ie, Trade Diversion 10. There are different levels of Economic Integration  Free Trade Area : here there is no trade barriers among member countries  Customs Union : In addition to no trade barriers among member countries, countries

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have a common trade policy towards non-members Common Market : In addition to no trade barriers among member countries and a common trade policy towards non-members, there is free flow of factors of production among member countries Economic Union : In addition to no trade barriers among member countries and a common trade policy towards non-members ands free flow of factors of production among member countries, there is common monetary policy and the ultimate goal of a common currency Political Union : Here the countries desire to become one political union and the economic bureaucracy is accountable to the people

11. The levels of bureaucracy increase with the level of integration 12. European Union :  The first move to form RTA was from Europe in 1951 which gradually tranformed to today's EU. Europe wanted to group themselves to stand up to USA and other countries  Initially there were only 4 countries which gradually grew. In 1957 (Rome Treaty), it grew to the level of a Common Market incorporating more countries. In 1987, Single European Act came into being and in 1994, Maastricht Treaty mooted for Common Currency.  Although EU is now integrated to the level of Economic Union, not all countries have adopted Euro as currency which means it is an evolutionary process.  Adoption of common currency requires countries to peg their monetary system (inflation, interest rates, public debt etc.) to the Union level which is a process.  EU has a bureacratic set up of European Council, Council of Ministers, European Commission, European Parliament and Cout of Justice. Legislations are drafted by European Commission and then through Council of Ministers reach European Parliament 13. NAFTA (North Atlantic Free Trade Area)  USA and Canada came together to form a FTA in 1989  In 1991 Mexico joined and got integrated to the level of a Common Marketing  USA and Canada feared job loss due to cheap labour availability in Mexico  Mexico feared more environmental pollution  USA textile industries shifted to Mexico and thereby competing with cheap textile imports from developing countries after revoking the MFA 14. ASEAN (Association of South East Asian Nations)  Formed in 1967  Now USA, China and India have agreements with ASEAN block  ASEAN countries have geographical conditions similar to Kerala. Hence India's pact with ASEAN has raised protest among Kerala's farming and fisheries community. ButIndia's service industry and FDI segment is due to benefit.  {Read more on ASEAN – India Agreement from additional notes attached} 15. Other agreements include SAARC (1985), APEC(1989), MERCOSUR (1991), Andean Pact(1969), and East Africa Community (1967) {Read more on these agreements by referring

Wikipedia and “International Business” by Francis Cherunilam} Note : Read more on WTO vs RTA debate in the attached article Note : Read more on RTA from “Elements of International Business by S.N.Chary and “International Business” by Charles W.L Hill 2.1.7 International Commodity Agreements    

International Commodity Agreements are inter-governmental arrangements concerning the production and trade in certain primary products with a view to stabilising their prices. Ensure reasonable predictability in export earnings for developing countries also takes into account the interests of the consumers in importing countries by ensuring stable prices of primary commodities 4 types 1. Quota agreements  Export quotas are determined and allocated to participating countries and they restrict their exports to that level  Seek to prevent a fall in commodity prices by regulating their supply  In case of commodities like sugar, coffee, tea, bananas etc.  The critics argue that quota agreements protect inefficient producers and freeze markets  The advantages are that they avoid accumulation of stocks and require no financing  Quota agreements have to be coupled to Buffer stock agreements to safeguard against running short of supply 2. Buffer stock  Seek to stabilise commodity prices by maintaining demand-supply balance  A buffer stock pool is maintained for commodities  International agency sets range of maximum and minimum price for the commodities in the markets  Whenever prices beyond this range, commodity is supplied or absorbed from/by the buffer pool thus maintaining the price range  The buffer stock pool buys the commodity at the minimum price and sells at the maximum  Commodities like sugar, cocoa, rubber, tea, tin, copper etc.  Disadvantage is the financial resources to maintain buffer stock. Effective for commodities with low storage cost and no danger of deterioration. 3. Bilateral contract  Between exporting country and importing country  Agreement to fix upper and lower price of commodities being imported  When the market price is within this range, the agreement has no effect  When the price goes up this range, exporting country is obliged to supply at the maximum fixed price limit. When the price goes below this range, importing country is obliged to buy at the minimum fixed price limit. 4. Multilateral contract  Same as bilateral contract but between multiple countries

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An example is the International Wheat Agreements Free market advocates criticise this agreement as it favours a two price system and also due to government's role

Note : Also read CARTELS and STATE TRADING