Chapter Five: Government Intervention in International Business

Chapter Five: Government Intervention in International Business

Learning objectives: in this chapter, you will learn about the nature of government intervention, the rationale for government intervention, the instruments of government intervention, the evolution of government intervention, intervention and the global financial crisis, and how firms can respond to government intervention.

1. The Nature of Government Intervention

Despite the value of free trade, governments often intervene in trade and investment. This intervention is often motivated by protectionism, which refers to national economic policies designed to restrict free trade and protect domestic industries from foreign competition. Protectionism is typically manifested by tariffs, nontariff barriers such as quotas, and arbitrary administrative rules designed to discourage imports.

2. The Rationale for Government Intervention

Governments impose trade and investment barriers to achieve political, social, or economic objectives. Such barriers are either defensive or offensive

Defensive Rationale

Four major defensive motives are essentially relevant:

Protection of the National Economy:In cases where domestic firms cannot compete with foreign firms.

Protection of an Infant Industry: Governments impose temporary trade barriers on foreign imports to ensure that young firms acquire new technologies and know-how.

National Security: Countries impose trade restrictions on products viewed as critical to national defense and security. The Russian government, for example, has strict legislation that limits foreign investment in sectors considered vital to Russia’s national interests. Countries may also impose export controls. For example, many countries prohibit exports of plutonium to North Korea because it can be used to make nuclear weapons.

National Culture and Identity: In most countries, certain occupations, industries, and public assets are seen as central to national culture and identity. France, for instance, does not allow significant foreign ownership of its TV stations because of concerns about foreign influence on French culture.

Offensive Rationale

Offensive rationales for government intervention fall into two categories:

National Strategic Priorities: Government intervention sometimes aims to encourage development of industries that bolster the nation’s economy. Countries with many high-tech or high-value-adding industries, suc.h as information technology, pharmaceuticals, car manufacturing, or financial services, create jobs and higher tax revenues than economies based on low-value-adding industries, such as agriculture, or textile manufacturing.

Increasing Employment: Governments often impose import barriers to protect employment in designated industries.

3. Instruments of Government Intervention

Intervention Definition Effects on Customers, Examples

Type Firms or Govts

Tariff Tax imposed on Increases cost to the importer, Switzerland charges a tariff

imported products. exporter and buyer of the of 40°/° on agricultural

products. Discourages imports product imports.

of products. Generates govt

revenue.

Quota Quantitative restriction Benefits early importers, giving Brazil has imposed a

on imports of a product them monopoly power and the quota on the nb of

during a specified period ability to charge higher prices. foreign films.

of time.

Local content Requirement that a ma- Discourages imports of raw The Nigerian gvt requires

requirements nufacturer include a materials, parts, components, that products and services

minimum percentage and supplies, thereby reducing used by foreign firms in

added value that is sourcing options available to the oil industry in Nigeria

derived from local manufacturers. May result in must contain over 50°/°

sources. higher costs and lower product Nigerian content.

quality for importers and buyers.

Regulations and Safety, healthy, or May delay or block the entry of The EUrequires extensive

technical technical regulations; imported products; and reduce testing on different impor-

standards labeling requirements. the quantity of available products, ted chemicals.

resulting in higher costs.

Administrative Complex procedures Slows the import of products or Russia imposes a series of

bureaucratic imposed on importers services. Hinders or delays firms’ inspections & bureaucratic

procedures or foreign investors. investment activities. procedures for the import

of alcoholic beverages.

FDI & Ownership Rules that limit the ability Reduces the amount of money Switzerland requires fore-

restrictions of foreign firms to invest that a foreigner can invest in a ign firms seeking to sell

in certain industries or country, and/or the proportion insurance there to do so

acquire local firms. of ownership that a foreigner by establishing a local

can hold in an existing or new subsidiary or branch

firm in the country. office, via FDI. Brazil

restricts foreign invest-

ment in its media industry

and certain

transportation industries.

Subsidy Financing or other resources Increases the competitive Turkey grants an export

that a gvt grants to a firm advantage of the grantee, subsidy of up to 20°/° for

or group of firms, intended to while diminishing the local producers of wheat

ensure their survival or competitive advantages of and sugar.

success. those that do not receive the

subsidy.

Countervailing Increased duties imposed on Reduces or eliminates the India imposes counter-

duty products imported into a competitive advantages veiling duties on the

country to offset subsidies provided by subsidies. Import of numerous

given to producers or exporters products.

in the exporting country.

Antidumping Tax charged on an imported Reduces or eliminates the The US has imposed

duty product whose price is below competitive advantage of antidumping duties

the cost of making the product. Imported products priced at on the import of low-

abnormally low levels. Cost steel in order to

support US based steel

manufacturers.

4. Evolution of Government Intervention

Intervention has a long history. In the late 1800s, many countries imposed substantial protectionism. From the 1930s onward, countries reduced trade barriers worldwide. The most important development for reducing trade barriers was the GATT[1], replaced in 1995 by the WTO.

4. Intervention and the Global Financial Crisis

The crisis arose from inadequate regulation in the banking and finance sectors. In response, governments are implementing new regulations. Governments are also increasing protectionism, to safeguard jobs and wages levels, and providing new subsidies to their countries’ industries

5. How Firms Can Respond to Government Intervention

Firms devise various strategies to manage harmful government intervention.

* One, firms should conduct research, gather knowledge and intelligence, to understand the extent and nature of trade and investment barriers abroad.

* Two, firms should choose the most appropriate entry strategies, such as FDI, licensing, and joint-ventures that allow them to operate directly in the target market, avoiding import barriers.

*Three, firms should take advantage of Foreign Trade Zones (FTZ). A FTZ (also known as free trade zone or a free port) is an area within a country that receives imported goods for assembly or other processing and subsequent re-export. Products brought into an FTZ are not subject to duties, taxes, or quotas until they, or the products made from them, enter the non-FTZ commercial territory of the country where the FTZ is located.

*Four, firms should seek favorable customs classifications for exported products. Many products can be classified within two or more categories, each of which may imply different tariffs. Or the manufacturer may modify the exported product in a way that helps minimize trade barriers. South Korea faced a quota on the export of non-rubber footwear to the US. By shifting manufacturing to rubber soled shoes, Korean firms greatly increased their footwear exports.

*Five, firms should take advantage of investment incentives and other government support programs.

*Six, firms should lobby for the home and foreign governments for freer trade and investment. European automakers have obtained various concessions lobbying individual state governments in the US. In China, domestic and foreign firms lobby the government to relax protectionist policies and regulations that make China a difficult place to do business.

Closing Case

Government Intervention at Airbus and Boeing

In the 1960s, United States companies such as Boeing and McDonnell Douglas were the dominant players in global aircraft manufacturing. Boeing was founded in 1916 in Seattle, and had many years to develop the critical mass necessary to become the world’s leading aerospace manufacturer. During World War II and the subsequent Cold War years, Boeing was the recipient of many lucrative contracts from the US Department of Defense.

In Europe, no single country possessed the means to launch an aerospace company capable of challenging Boeing. Manufacturing commercial aircraft is complex and capital-intensive and necessitates a highly skilled workforce. In 1970, the governments of France and Germany formed an alliance, supported with massive government subsidies, to create Airbus S.A.S. The governments of Spain and Britain joined Airbus later. By 1981, the four-country alliance succeeded in becoming the world’s number-two aircraft manufacturer. Airbus launched the A300, among the best-selling commercial aircraft of all time. Airbus also created the A320, receiving more than 400 orders before its first flight and becoming the fastest-selling large passenger jet in aviation history. By 1992, Airbus had captured roughly one-third of the global commercial aircraft market.

Government Support for Airbus

Since the 1940s, European governments have pursued public policies based on democratic socialism. Under this system, the government plays a strong role in the national economy and provides key services such as health care, mass transit, and sometimes banking and housing. Most Europeans are accustomed to government playing a significant role in guiding the national economy.

In this context, Airbus has benefited enormously from the support of various governments. The firm has received tens of billions of euros of subsidies and soft loans from the four founding country governments and the EU. Airbus must repay the loans only if achieves profitability. Government aid has financed, in whole or in part, every major Airbus aircraft model. European governments have forgiven Airbus’s debt, provided huge equity infusions, dedicated infrastructure support, and financed R&D for civil aircraft projects.

Airbus is currently a stock-held company jointly owned by the British, Germans, French, and Spanish. It is based in Toulouse, France, but has R&D and production operations scattered throughout Europe. European governments justify their financial aid to Airbus on several grounds. First, Airbus R&D activities result in new technologies of considerable value to the EU. Second, Airbus provides jobs to some 53,000skilled and semiskilled Europeans. Third, its value-chain activities attract massive amounts of capital into Europe. Finally, Airbus generates enormous tax revenues?

Complaints about Unfair Government Intervention

Boeing and the US government have long complained about the massive subsidies ans soft loans that were responsible not only for Airbus’s birth, but also for its ongoing success. The outcry became louder in the 2000s, when Airbus surpassed Boeing in annual sales, becoming the world’s leading commercial aircraft manufacturer. Boeing has argued that Airbus never would have gotten this far without government support.

In 2005, the US Trade Representative brought its case to the WTO. The case arose because the EU member states approved $3.7 billion in new subsidies and soft loans to Airbus. The case alleged that financial aid for the A350, A380, and earlier Airbus aircraft qualified as subsidies under the WTO’s Agreement on Subsidies and Countervailing Measures (ASCM) and that the subsidies were actionable because they caused adverse effects to international trade. Under the ASCM, subsidies to specific firms or industries from a government or other public bodies are prohibited. Airbus confirmed that it had applied to the governments of Britain, France, Germany, and Spain for launch aid for its model A350. In 2010, the WTO ruled that EU aid to Airbus was illegal. In total, the WTO found that Airbus had received some $20 million in preferential subsidies from the European governments. EU officials have argued that government subsidies to Airbus were permissible and that it was up to individual EU countries to decide whether to provide them.

Government Support for Boeing

The EU argues the US government has indirectly subsidized Boring through massive defense contracts paid via tax dollars. The US government gave Boeing more than $23 billion in indirect government subsidies by means of R&D funding and other indirect support from the Pentagon and NASA, the nation’s space agency. Boeing is at liberty to use the knowledge acquired from such projects to produce civilian aircraft. The state of Washington, Boeing’s primary manufacturing and assembly location, has provided the firm with tax breaks, infrastructure support, and other incentives totaling billions of dollars.

The EU also has a case at the WTO regarding Boeing’s relation with its Japanese business partners. The new Boeing 787 Dreamliner is built in alliance with the heavy-industry divisions of Japanese MNEs like Mitsubishi, Kawasaki, and Fuji. They have provided more than $1.5 billion in soft loans, repayable only if the aircraft is a commercial success.

New Aircraft from Airbus and Boeing

In 2007, Airbus launched the A380, an innovative airplane with an upper deck extending the entire length of the fuselage and a cabin that provides 50 percent more floor space than Boeing’s largest aircraft. The A380 can seat between 555 and 853 passengers, depending on the seating configuration. It has a maximum range of 15,000 (8,000 nautical miles). The total cost of developing and launching the A80 reached 15 billion euros (USD $21), partly supported by funding from the European governments.

Being successfully launched a test version of its Boeing 787 Dreamliner in 2007 and is several years ahead of Airbus in launching innovative and fuel-efficient aircraft. Airbus is developing a mid-sized A350 model due for delivery in 2013, to compete against Boeing’s 787.

In 2008, the government of China established a company to make passenger jumbo jets part of its quest to challenge Boeing and Airbus in the global aircraft industry. China Commercial Aircraft Co. was established in Shangai amid forecasts that China’s domestic market for commercial aircraft will increase fivefold by 2026.

Global Financial Crisis

The recent global financial crisis has adversely impacted Airbus and Boeing. Both companies were forced to reduce output and laid off more than 10,000 workers each. Following sharp drops in passenger traffic, airlines grounded planes and cut routes. Many airlines cancelled or postponed new aircraft orders. Following cuts in US military spending, orders for military hardware also declined. Longer term, Airbus is reorganizing its global operations, outsourcing more manufacturing, and selling all or part of six factories. Airbus and Boeing are generating new business from emerging markets. Recently, India signed a $2.1 billion deal with Boeing to purchase military aircraft.

CASE QUESTIONS

1. Where do you stand? D o you think EU subsidies and soft loans to Airbus are fair? Why or why not? What advantages does Airbus gain from free financial support from the EU governments? Are complaints about EU subsidies fair in light of Europe’s history of democratic socialism?
2. Do you believe US military contracts with Boeing amount to subsidies? Have these types of payments provided Boeing with unfair advantages? Justify your answer.
3. Assuming that Airbus cannot compete without subsidies and loans, is it likely that the EU will discontinue its financial support of Airbus? Is it in the EU’s interests to continue supporting Airbus? Justify your answer.
4. Visit the web site of the WTO ( and enter keywords aircraft or civil aircraft in the search engine. Summarize the current status of the dispute between Airbus and Boeing.
5. In the event the WTO rules against Airbus and tells it to stop accepting subsidies and soft loans, how should Airbus management respond? What new approaches can management pursue to maintain Airbus’s lead in the global commercial aircraft industry?

[1] The GATT introduced the concept of most favored nation, according to which each signatory nation agrees to extend the tariff reductions covered in a trade agreement with a trading partner to all other countries.