Most people have participated in some kind of trade, whether it was buying something on the overseas market or swapping a candy bar for a toy on the playground when they were kids. No one cares how much you purchase or sell abroad as long as you pay the right taxes and fill out the right documents. Occasionally, the government takes notice and imposes regulations to influence trading. It usually has legitimate reasons for its regulations, and the paperwork isn’t just there to be a hassle for importers and exporters. We guarantee it! Perhaps this explanation sheds some light on those trade policies.
Let’s dive right into the definition of trade policy. A government establishes a trade policy, which influences the volume of commodities and services that a country exports and imports. Policymakers may wish to implement a trade policy in order to promote the domestic market and its industries.
There is a range of trade policies in an economy. On one end of the spectrum, there is free trade, and on the other, there is protectionism. A free trade policy involves no or minimal government intervention in a country’s trading practices. Protectionism is the practice of regulating commerce entering and leaving a country in order to protect home businesses and reduce reliance on other countries. Most countries are not one or the other but are located somewhere on this spectrum.
Why would a government want to interfere in trade? Under trade regimes like free trade, where there is little to no government intervention, the domestic economy will tend to specialize, meaning it focuses on only producing what it is good at and allocates its resources as such. The problem is that smaller industries will shrink and die out, to which people who work in those industries will be opposed. The government then steps in to help the affected industry by using some instrument of trade policy.
Now, if trade policy is used to restrict trade, like under protectionism, the domestic producer may benefit but the consumer pays the price. Protectionism is associated with increasing the price of the good the policy protects because it creates a shortage of that good in the domestic market.
For example, U.S. trade policy aims to strengthen the competitiveness of U.S. industries.
Trade policies can be aimed at a number of issues related to importing and exporting, such as foreign retaliation, jobs, or tariffs; or they may focus on protecting intellectual property, setting standards that promote collaboration and reduce trade barriers, or establishing trade agreements and trade laws.
For example, in the U.S., the Export Trading Company Act (ETCA) enables U.S. firms to work together to reduce export costs, increase exporting efficiency, and better compete in the global market, among other initiatives. It provides antitrust protection and other benefits to U.S. firms that collaborate on exporting activities. As a result, these firms get the advantage of, for example, reduced shipping costs, better negotiating power, and the ability to fill larger export orders.
How a Trade Policy Works
Trade policy is established when a government sets standards and laws regarding international trade.
In some cases, a nation will pursue a more aggressive protectionist policy designed to favor its domestic industries over international competitors. Protectionism policies can include setting quotas on the number of imported goods allowed in a country, imposing tariffs on imported goods, and offering subsidies for domestic producers.
On the other hand, a nation may want to increase international investment and pursue a free trade policy (sometimes called an “open trade policy”) that reduces the barriers to doing business. Many countries establish trade policies between the two extremes, adjusting them as the global economy and domestic political pressures change.
A trade agreement occurs when two or more countries agree to the terms of trade, which can include the amount of tariffs and quotas, among other terms. Here are some examples of foreign trade agreements:
- The U.S.-Mexico-Canada Agreement (USMCA): The USMCA, which replaced the North American Free Trade Agreement (NAFTA) in 2020, aims to eliminate trade barriers between the U.S., Mexico, and Canada while including some restrictions on importing and exporting.5
- The Dominican Republic-Central America Free Trade Agreement (CAFTA-DR): The CAFTA-DR is a trade agreement between the U.S. and Central America countries El Salvador, Costa Rica, Honduras, and Guatemala, as well as the Dominican Republic. It aims to promote stronger investment ties and stability.
What is International Trade Policy?
International trade is the buying and selling of goods between foreign countries. International trade exposes a country’s market to goods and services they would have been locked out of if they had kept their borders closed. A country must have international trade policies to participate in international trade.
International trade policies are rules that define how exports and imports are conducted. It can be defined as the government’s rules and regulations guiding and controlling trade with foreign countries. Standards of trading like tariffs, subsidies, and regulations are different since each country determines its way of doing business.
The government trade policy interests in international trade are influenced by two factors; political and economic motivations. The political reasons include; protecting jobs and industries, national security, retaliating against foreign policies, and protecting their consumers. Their economic motivations include protecting new industries from competition and building strategic trade policies.
- Protecting jobs and industries — The government protects the jobs of its citizens by minimizing the number of exports the country trades. When imports saturate a country, the country’s local industries cannot counter the competition. However, when the company balances international trade, it can market its local produce and provide employment opportunities for its citizens.
- National security — The government aims to maintain national security at all times, irrespective of whether the country is at war. In protecting the economy, certain goods like weapons that may endanger the country’s safety may have restrictions like imposing heavy tariffs. Heavy tariffs encourage the local production of services, not imports, that may provide leverage to weaken the nation’s defense.
- Retaliating against foreign policies — The government may intervene in trade to get back at a country for handling a crisis differently or against their beliefs. The government sets up trade restrictions to harm the other country’s economy.
- Protecting their consumers — The government ensures the safety of consumers by banning imports that may negatively affect their lives. Banned imports include edible products, inedible products like plastics, and products made by endangering animals like an ivory bracelet.
- Protecting new industries from competition — New industries face a lot of competition from already established industries, and the government works to protect the infant industries by creating tariffs. The tariffs are created to increase the import taxes, which motivate the citizens to purchase locally. Tariffs give the new industries the chance to nourish away from stiff competition from the international market
- Building strategic trade policies — The government creates strategic policies to help regulate international trade. The strategic policies only allow a limited amount of international trade while promoting their local industries, affecting firms that are early entrants into a new product.
What do Trade Policies Affect?
The government’s trade policy can have an impact on your firm by making cross-border trading easier or more difficult.
Imposition of import taxes, limits on imports and exports of specific items, and subsidies to local manufacturers to help them against worldwide competition are all examples of trade policy. Governments frequently enter into bilateral trade agreements with other nations in order to reduce tariffs and economic obstacles and form a free trade zone or common market. This can be advantageous for some businesses, but it can also result in increasing competition from abroad.
Trade sanctions or an embargo on another country may also be used to raise barriers.
The government’s economic policies have a number of implications for your business. The government’s economic policy will affect your business directly via taxes and interest rates, and indirectly via public spending.
Tax laws can increase or decrease the amount of tax you have to pay, and therefore will change your net profit. Special rules or exemptions may affect certain business sectors. Tax regulations can become very complex, causing you to hire a specialist tax adviser. Higher interest rates will increase what you’ll have to pay to borrow money. Both tax and borrowing policies will also affect the income of your customers, which could have an indirect impact on your sales.
Government spending on infrastructure such as roads could help your business on a practical level, and investments in education could improve the quality of the available labor force.
Foreign affairs encompass the different ways in which a country seeks to promote and protect its own interests internationally. It’s often directly focused on facilitating trade across international borders, including cutting import and export tariffs and promoting investment in international trade. In the case of disputes with countries, these agreements may be suspended, or in extreme cases, embargoes may be imposed, which restrict trade altogether.
Foreign affairs can also target other areas of international cooperation, such as climate change, human rights, and armed conflicts. However, these will almost always have consequences for international trade too, because trade agreements are so often used as a bargaining tool when securing international agreements on these issues.
Business markets, where businesses trade in raw materials, resources, and components, can be subject to significant changes as a result of both domestic and international politics. This can be due to both the direct consequences of political decisions and the effects of uncertainty or speculation about political issues.
Changes in trade policies, for example, can alter the costs of raw materials and the import and export tariffs to which they’re subject. This will change their price and profitability on business markets and could lead to attempts to find alternative sources or materials.
Political uncertainty can also cause instability in business markets. A major example is the impact on the price of oil due to political instability in the Middle East.
Diplomatic events are more likely to affect your business if you trade internationally.
Diplomatic disputes can trigger the suspension of trade agreements and the imposition of trade embargoes, which could result in your exports being blocked or subject to high tariffs. Even if you don’t trade directly with the country subject to the embargo, you might be forced to ship your goods via a different route.
The suspension of trade into the UK can have an impact on all businesses, as it could make it difficult to obtain certain raw materials or wholesale products. Diplomatic events can also have an impact on the stock markets, meaning that your investments or share price could be hit.
Reforms since World War II have substantially reduced government-imposed trade barriers. But policies to protect domestic industries vary. Tariffs are much higher in certain sectors (such as agriculture and clothing) and among certain country groups (such as less developed countries) than in others. Many countries have substantial barriers to trade in services in areas such as transportation, communications, and, often, the financial sector, while others have policies that welcome foreign competition.
Moreover, trade barriers affect some countries more than others. Often hardest hit are less developed countries, whose exports are concentrated in low-skill, labor-intensive products that industrialized countries often protect. The United States, for example, is reported to collect about 15 cents in tariff revenue for each $1 of imports from Bangladesh (Elliott, 2009), compared with one cent for each $1 of imports from some major Western European countries.
Yet imports of a particular product from Bangladesh face the same or lower tariffs than do similarly classified products imported from western Europe. Although the tariffs on Bangladesh items in the United States may be a dramatic example, World Bank economists calculated that exporters from low-income countries face barriers on average half greater than those faced by the exports of major industrialized countries.
Under the rules-based international trading system centered in the WTO, trade policies have become more stable, more transparent, and more open. And the WTO is a key reason why the global financial crisis did not spark widespread protectionism. However, as seen most recently with the Doha Round of WTO trade negotiations, the institution faces big challenges in reaching agreements to open global trade further.
Despite successes, restrictive and discriminatory trade policies remain common. Addressing them could yield hundreds of billions of dollars in annual global benefits. However narrow interests have sought to delay and dilute further multilateral reforms. A focus on the greater good, together with ways to help the relatively few that may be adversely affected, can help to deliver a fairer and economically more sensible trading system.