Trade Policies

Any economics text book will present the case for free trade: both countries benefit by having more goods and services available when each country produces those products where it has a comparative advantage and exchanges for products produced by a trading partner who has a comparative advantage in producing the products exchanged for. However, it takes a leap of faith on the part of a country to eliminate trade barriers. Trade barriers are traditionally used to protect the industries within the country. Eliminating trade barriers tradeoffs possible detriment to specific industries and their employees with the desired benefit of improving the standard of living for the general population. Trade barriers can include tariffs, import quotas, voluntary export restrictions, local content requirements, or administrative policies.

For businesses, a high level of imports indicates a willingness and ability to move production to lowest cost locations. Trade barriers are a constraint on the firmís ability to disperse its production in such a manner. A high level of exports indicates the ability to market products internationally and the competitiveness of the companyís products. Voluntary export restrictions and local content requirements may limit a firmís ability to serve a country from locations outside of that country. The firm may set up production facilities in that country -- even though it may result in higher production costs.

Foreign Investment

Foreign direct investment (FDI) occurs when a firm invests directly in new facilities to produce a product in a foreign country or when a firm buys controlling interest in an existing enterprise in a foreign country. FDI can benefit a host country by bringing capital, skills, technology, and jobs; but those benefits often come at a cost. When a foreign company rather than a domestic company produces products resulting from an investment, the profits from that investment go abroad. A foreign-owned manufacturing plant may import many components from its home country, which has negative implications for the host countryís balance-of-payments position. Direct entry of foreign firms into host country markets could be detrimental to the development and growth of the host countryísí domestic industry and technology.

There appears to be no consensus as to whether either inbound or outbound FDI is positive or negative for a country. A countryís attitude will often vary given the economic and political climate at the time.

Foreign portfolio investment (FPI) is investment by individuals, firms, or public bodies in foreign financial instruments (e.g., government bonds, foreign stocks). FPI does not involve taking a controlling interest in a foreign business entity. Policies accommodating inbound FPI can be positive in that FPI can reduce the cost of capital and enhance liquidity by providing worldwide markets for bonds and stocks. The level of inbound FPI can indicate either positive or negative factors. A high level may indicate confidence in a countryís economic and political policies or it may indicate bargain hunting due to the depressed nature of the host economy. Likewise a high level of outbound FPI can indicate a high level of capital availability for investment or it can indicate a lack of confidence in the subject countryís economic or political climate. What is meaningful is whether or not there are restrictions on inbound and outbound FPI.

Regional Economic Integration

Regional economic integration can be seen as an attempt to achieve additional gains from the free flow of trade and investment between countries beyond those that are attainable under international agreements such as the General Agreement on Trade and Tariffs. It is easier to get a limited number of countries to agree to a common set of rules. Economic integration can consist of several levels:

Free trade area in which all barriers to the trade of goods and services among member-countries are removed.
Customs union in which all trade barriers among member-countries are removed and a common external trade policy is established.
Common market in which factors of production are also allowed to move freely between member-countries. Thus labor and capital are free to move, as there are no restrictions on immigration, emigration, or cross-border flows of capital between member-countries.
Economic union which includes a common currency, harmonization of tax rates, and a common monetary and fiscal policy.
Political union which makes a coordinating bureaucracy acceptable to and accountable to the citizens of member-nations.

The primary regional integration activities today include the following:

European Union (EU) is a union between 16 European countries. The aim is to become an economic union with some elements of a political union. The member-countries include Ireland, United Kingdom, Denmark, Netherlands, Belgium, Luxembourg, France, Spain, Portugal, Italy, Greece, Germany, Austria, Finland, Sweden, and Norway. The European Union momentum is currently stumbling somewhat and there is speculation on whether it will stay on schedule.
North American Free Trade Agreement (NAFTA), a free trade area among Canada, United States and Mexico.
Andrean Pact, a customs union between Bolivia, Columbia, Ecuador, Venezuela, and Peru, which aims to establish free trade between member-countries and to impose a common tariff, of 5 to 20%, on products imported from outside.
MERCOSUR, a free trade agreement among Argentina, Brazil, Paraguay, and Uruguay.
Association of Southeast Asian nations (ASEAN) which has negotiated tariff reduction among the member nations. ASEAN includes Brunei, Indonesia, Malaysia, Philippines, Singapore, Thailand and Vietnam.

Figure 19 Ė Major Regional Integration Activities




European Union

United Kingdom

Economic by 1999 with common currency
Limits on inflation rates, exchange rate fluctuation, and public debt.
Elimination of trade barriers
Common external trade policy.
Unrestricted labor and capital flow
Mutual recognition of standards.
Unrestricted freight transport

North American Free Trade Association

United States

Free Trade
Unrestricted cross-border flow of services
Intellectual property rights protection
Unrestricted foreign direct investment

Andrean Pact


Free trade area
Common external tariff
Common market



Reduced tariffs


Burma (pending)
Laos (pending)

Free trade area
Tariff reduction

Participation in regional alliances was scored according to the perceived size and nature of the alliance. Participants in the European alliance were scored 10; NAFTA Ė 7; Andrean Pact Ė 3; MERCOSUR Ė 3; ASEAN Ė 4; all others or none were scored a zero.

Foreign Company Taxation

Most nations tax the profits from branch operations of foreign countries. This tax is in addition to the taxes paid on these profits by the companies in their home countries. Some nations provide some credit, usually partial credit, for the taxes paid in the home countries. Some nations tax the operations of branches of foreign countries at rates over and above that taxed for domestic companies. This has the effect of discouraging foreign companies from establishing operations in the nation. This is done to protect domestic companies. However it also has negative effects. Foreign companies may be more efficient, may have better technology to produce and distribute goods and services, and may have better management expertise. They may also provide goods and services not provided by domestic companies. Hence the nationís consumers pay higher prices and have less product selection.

wpe57.gif (28318 bytes)The scores for foreign branch taxation were calculated based on the total taxation rate, national and local, for foreign branch operations. A high tax rate merited a low score. Note that Singapore does not tax foreign branch operations. Hong Kong has a low rate. This is another example of how these two countries have successfully used favorable taxation policy to foster growth in their small countries that are otherwise deficient in natural resources.

Japan has a very high foreign branch tax rate. This is an example of how Japan has used various administrative measures to close its markets to foreign companies. Of current interest is Chinaís policy. At 33% it does not appear to be out of line with other nations.

Exports, Imports, and Trade Balance

The level of exports, imports, and the balance between them show the results of a nationís trade policies, its economic policies, and its competitive position.

The level of exports relative to GDP is indicative of the competitiveness of the nationís products in the global market place and the importance of trade to the nationís economy. The level of exports per capital is a means to compare the level of exports among nations. The export growth rate, when compared to other nations, is indicative of whether a nationís products are becoming more or less competitive in the market place and the growth of businesses to provide those exports. Note the high level of exports per capita coupled with a high export growth rate in Hong Kong and Singapore. Also note the high level of growth in Korea, China, and Taiwan. Although Japan is getting a lot of attention from United States politicians for its restrictive import policies and closed markets, Japanís exports per capital and export growth rate pale in comparison to these other countries.

The level of imports relative to GDP results from a nationís trade policies. A high level of imports can demonstrate a willingness to allow consumers to benefit from the best prices and product selection available on a global basis. On the other hand, a high level of imports may result from importing components for incorporation in goods that are subsequently exported. Singapore and Hong Kong are examples of the latter case.

The meaning of trade balance as a measure of policy success is unclear. The United States has had large negative trade deficits for years and the public debate regarding the significance of this has proponents arguing that this represents a crisis and others arguing that it is unimportant. What is clear to me is that a long running trade deficit does put downward pressure on the value of a nationís currency due to the law of supply and demand.

Web site and publication by Howard Woodward Jr.
Copyright ©1997, 2000 by []. All rights reserved.
Revised: 29 Mar 2001 22:24:56 -0500 .