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Commercial Policy

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Commercial Policy
Welcome everyone to our course of International Business. So, today we will be startingon a new unit which is called Commercial Policy, before I start this lecture, I would giveyou an insight which is happened recently. The US has you know withdrew the zero dutyexports for the Indian exporters, right. So, this has made a loss of 5.6 billion worth ofrevenue to the Indian exporters; on the contrary the Indian government has levied aretaliatory you know tariff on 29 US products.So, what I am talking today and we are going discuss today is on a topic calledcommercial policy. Now what commercial policy is all about and how it affects thetrade, international trade, we will be discussing in this lecture, ok.(Refer Slide Time: 01:23)So, what is commercial policy? As you can see, commercial policy is an umbrella termthat describes the regulations and policies that dictate how companies and individuals inone country conduct commerce or trade with companies and individuals in anothercountry. It is also referred to as trade policy or international trade policy, ok.So, commercial policy is part of a country’s economic policy, that is related withmeasures and instruments that influence the export and import, either through quantities,prices or which goods will be traded and which one not. Commercial policy consists oftariffs and other restrictions on international trade; it could be tariff, it could be non tariffalso, right. In simple terms we can understand it as the government’s policy related to theinternational trade. It can be either free trade or protectionist policy.So, the government can be you know might be trying to encourage more free trade or itcould be trying to have some protection, make some protection for its domestic players,right. What is it cover? It covers the export policy, the import policy of the government,foreign collaboration agreements and the balance of payment etcetera. So, these are someof the things that the commercial policies encompass, right. So, what is the objective?.(Refer Slide Time: 02:52)Now if you start thinking a bit; when we are talking about international trade and youknow growth of international trade, so the objectives of commercial policies starts likethis.First is, the first and foremost point is to increase the quantity of trade with other nations,with foreign nations. So, the government; for example, India would like to do more ofbusiness with other countries like Belgium, Denmark, Japan, you know China and othercountries, so that more the trade; we have seen in our earlier lectures that as trade grows,it is a benefit to every player involved in the trade, right.Second is to preserve the essential raw material for encouraging the development ofdomestic industries. Sometimes it becomes important for the government to preserve theessential raw materials which are maybe you know exclusive to a country, and so that ithelps in the development of domestic industries. So, policies are made, commercial,commerce policies are made according keeping those things in mind, right.To protect the domestic market prevailing in the country; it is very important that,although we talk a free trade, sometimes some protection is required in order to saveyour domestic players as I said. Why? Because, the you know there is a difference in theincome, in the among the people of the developed and the developing countries, right.So, because of this difference in revenue, in income and all; it becomes important for thegovernment to take some action to protect their own domestic market.To stimulate the export of particular goods and products with a view to increase theirscale of production at home. So, some products are being exported; the governmentwants to export a few products, which actually helps in the growth or you know in theincrease of the you know production of some other components which are used for theexport item, right.For example, let me say if you, one is producing a product called A; then to make thisproduct A, may be few other components are required or few parts are required, let ussay B and C.So, when the export of A will increase, automatically this things which are made locallywould, there would be a raise in demand B and C. So, automatically this tends to growth,give a raise to the domestic industries, right. So, it helps in the increasing the scale ofproduction at home, that is what it is saying.Fourth, to prevent the import of some goods for giving protection to infant industries ordeveloping key industry or saving foreign exchange. Sometimes it becomes important tosave the infant industries; infant industries means we are saying, the industries which arenot very capital intensive or they are new to the market and they are young players.So, if some protection is not given to them, then it is possible that their idea might getcompletely taken away by some large players and these infant industries might not beable to compete with them; they may you know they may circum to the pressure, theymay die down, right. So, the government needs to give some protection right; in terms ofprice in, you know and you know some, some benefits, right.Or developing the key industry; for example, defense could be a key industry where thegovernment wants to you know grow rapidly, right. Or even save the foreign exchange;the government wants to save the foreign exchange, so it wants to you know control theimport and export of the items.Next is to assist or prevent the export or import of goods and services for achieving thedesired rate of exchange. So, here the government deliberately wants to have a desiredrate of exchange to control the rate of exchange. So, for that it wants to have a policy tomake the, you know to control the flow of import and export, ok.Next is to encourage the import of capital goods for speeding up the economicdevelopment of the country. So, some goods may be for example, India is a labourintensive country and more dependent on the capital from other developed countries. So,and there are some technology, some you know-how which India does not have. So,India would like to import those capital goods and bring it to our own market, so that ithelps in speeding up the economic development.For example, shipping; now shipping, defense these are some areas where India is yet tocatch up with the developed countries; it is we are doing well there is no doubt about it,but then there is lot to achieve. So, in such conditions, it helps to encourage the import ofcapital goods right; German for example, engineering right; the precision instruments,right.To restrict the import of the goods with a view to correct the unfavorable balance ofpayment. Now I hope what is balance of payments you must be slightly aware; balanceof payments is nothing like a balance sheet of the country, right. So, how to correct theunfavorable balance of payment? For that reason, the government tries to restrict theimport of goods with a view to correct it, ok.Last, the last objective is to enter into trade agreements with other nations for stabilizingthe foreign trade. So, the Indian government has been into several trade agreements withneighboring countries and other countries too, so that to it would improves the foreigntrade, the business done with other countries and this would create a equilibrium, a stateof equilibrium, right and growth.(Refer Slide Time: 08:18)What are the instruments? What are the instruments involved in the commercial policies?As you can see, so there are two ways of understanding; first is from the tradecontraction and the trade expansion mechanism, right. So, trade contraction means whenthe trade is contracting or there is a fall or there is a slowdown; there is a recession.Trade expansion means, where there is a boom in the market, where there is a growth inthe market, ok. So, in terms of price and quantity right both sides; during tradecontraction and trade expansion, we follow certain you know policies, some measures.For example, tariff export tax are some of the tariff related measures which is aninstrument during trade contraction period. Import quota, Voluntary Export Restraint(VER); what is said as VER right, then are some of the instruments.Similarly, in terms of during trade expansion, we use import subsidy, export subsidy as ameasure; then voluntary import expansion as a measure. So, we will learn all of thesethings in detail now, right.(Refer Slide Time: 09:27)So, let us go one by one. First let us understand this contraction and expansion first.During any business cycle, there is a natural rise and fall of the economic growth. So,you must have heard about several recessions and several boom periods; for example, theworld market has had seen a very serious you know depression in the thirties and thenwe found one during 2007-08, because of the financial market and the real estate market.So, now, because of such kind of time periods, there is a growth, sudden growth in themarket and sometimes there is a period of lull or a you know slowdown in the market.So, this period of growth is the period of expansion, right. So, what did we saying; this isthe peak, this is the trough, trough means the lowest point.So, this movement is called the expansion and this fall is called the contraction. So, whathappens is, the business cycle is the natural rise and fall of economic growth right, thatoccurs overtime.So, with time, there is nothing permanent; whatever kind of you know business ismaybe; that is why the countries, there is always a criticism for the developed countriesis that developed countries sometimes, this criticism goes for them is that, they useglobalization as a measure to always escape from the period of contraction.They want to exploit the resources of other countries, other markets, so that they canavoid this situation of contraction and they would be on a expansion mode all the time.So, this is a criticism for globalization; some social scientist economist have a thoughtthat, because of globalization, poor countries are becoming more poorer and richcountries are becoming richer. So, this an argument, right.So, what it is says? The cycle is a useful tool for analyzing the economy. How youanalyze the economy? It can help in making better financial decisions. So, during aperiod of expansion what could what should be your strategy, your decision how shouldyou take a decision, during a period of contraction or lull or slowdown.So, the phases of a business cycle follow a wave like pattern right; this is a wave likepattern, so this is what we talk. So, what are the two axis? The one is time versus theoutput GDP, right. So, how, what happens to the output during a particular time period,right?.(Refer Slide Time: 11:52)Now let us see this, the difference between expansion and contraction. So, business cycleis the natural fluctuation of the economy between periods of expansion and contraction,right. So, an expansion is between the trough and the peak, so we saw that. Contractionrefers to the phase of the business in which the economy is in a decline, ok.An expansion is characterized by increasing employment. So, when there is a growth,there is a time of growth; so employment also grows right, economic growth happensand there is upward pressure on prices, right.On the other hand, when this in contraction or a recession period, the business generallyoccurs after the business cycle peaks; so that means it has reach the top position and thenit starts falling, but before it becomes a trough. So, this is the period, we are talking aboutthis difference, right.So, this is the trough, this is the peak; so we are talking about this, this position, right.What happens during in the expansion stage you see? Debtors generally pay the debts ontime which leads to the velocity to the money supply and investment to be high. So, thereis a faster money supply, and naturally the investments also becomes faster, so it growsfaster, right.On the other hand this is the case of the recession of the 2007-09; when a period ofsubstantial contraction spurred by an unsustainable bubble in real estate and the financialmarkets. So, it has been seen that when there is a contraction, many companies tend toreduce their production; because they feel there is a slow down and people would notbuy, so the inventories would lie idle.Some countries even spend a very little on their brand building or you know onadvertisement and all. So, during this contraction we see, there is a fall in jobs; becauseobviously when the production is going to stop, so obviously job will come down andnatural spending of people will fall.So, if you remember in a last class when I was talking about multiplier effect or trademultiplier and employment multiplier; so we were talking about this the strategies thatthe government uses generally during this kind of a depression or a recession, right.So, when there is a recession; it is advised or it is you know suggested that thegovernment should inject some amount of money into the system, so that people whohave become little scared and they are avoiding spending, they would tend to get moremoney. And, as they get more money, they would tend to spend; and as they spend againin the economy would become natural, become normal, ok.(Refer Slide Time: 14:32)So, instruments of trade policy sorry, commercial policy or trade policy right are of twotypes; tariffs versus non-tariff, let us see what is tariff first. A tariff is a tax levied on animported or exported good. So, tariffs are basically monetary, right. So, it is a tax leviedon imported or exported goods. There are 2 types of tariffs- unit tariffs and value tariffs.So, what is a unit tariff saying? It consists of a fixed amount per unit traded, it consists ofa fixed amount per unit traded. So, number of units into a fixed amount, right. A valuetariff consists of a proportion of the value of the traded goods, right. So, the proportion ofthe value; 10 percent or let us say 5 percent, when we say a percentage or a proportion ofthe value of the traded goods.(Refer Slide Time: 15:28)Let us see, tariff mechanism between two countries, generally governments imposetariffs especially on the imports; when you are importing something, the governmentwould tend to impose tariffs.Very rarely it has been connected with exports right; until and unless it is a very preciousraw material that the government does not want it to go out or something, but that is thevery rarity. So, generally when we import; the government tries to you impose tariffs, sothat the cost of the goods goes up and it you the, it tries to discourage import, so that thelocal domestic players can make the production. So, how it is happening you see.There are two countries A and B; producing a towel in the country A cost 12 dollars,producing in the B 10 dollars. Now automatically, that means it is a understandable that,if it is a10 dollars right; if you would have been reading, if you as we are read in thetrade theories, so it there is a clear cut advantage of country B in terms of the production.So, but trade theory is not that simple. So, what happens here? So, country B towel sellsfor now 12 dollar in country A. Now, why? Because this is country 12 dollar; so whathappens, why it is 12 dollar now?.The country B, there is a 20 percent tariff of 2 dollar is added to the price. So, thegovernment of the importing country puts in a tariff of 20 percent to make it again 12dollar as it is in the country A, right. So, when now both that countries will have 12dollars; so the price unfair advantage or the price advantage will not be there, right. Butthere is criticism for such kind of mechanisms also, right.So, if there is an unfair advantage given to the; you know for example, like the there issubsidies given in the country B, because of which the cost of production has comedown, then it is fine to give a, to impose a tariff, right. But if the real cost of producingwithout any subsidy or support is 10 dollars because of the factor endowments or thefactors of production; so in that case, the imposing a tariff is not competitive in nature,right.(Refer Slide Time: 17:40)Next is export taxes, now export taxes are taxes on goods or services that becomepayable when the goods leave the economic territory or when the services are deliveredto non-residents. They include ad valorem tax, specific tax, progressive tax etcetera right;some of the taxes, the government when a product is being exported, right. So, at thattime, a tax it is a taxes on the goods are that become payable, when the goods are leavingthe country, right.Similarly export taxes raise money for government and help in controlling the exports ofvaluable resources; that is what the government is afraid that, valuable resources shouldnot go out. So, it levies a tax. Example, Indonesia applies taxes on palm oil exports; palmoil is a natural ingredient which happens lot in Indonesia. So, to avoid palm oil exports;because what happened, why this I was just going through the discovery just day beforeyesterday when I happen to see this example.Indonesia, because of the palm oil exports and there is been heavy demand of palm oil;the there is a large production of palm oil and there is a plantation you know goes on.So, what happens is; the natural forestry and all they are being cut down, depilated and inthere palm trees are being planted, so that the export can be done. But as a result whathas happen; the impact of cutting down of the trees and having larger units of productioncapacity plants for palm oil production has resulted in destroying the you know theclimate in these countries, right.So, the government tries to now stop it, so that there is a restriction on the export. So, ifthere is a restriction means what? There will be lesser of exports. So, if there is a lesserexport, means lesser production; lesser production means not cutting too many trees, youknow such kind of chain effect is there, and Madagascar on vanilla, coffee, pepper andcloves example.The main role of export taxation is to provide a government with funds to finance itsoperations like road, infrastructure, defense etcetera, right. So, the government uses itsmoney for its development, but also to save the climate; I can mention here, to save theclimate also, because it affects the climate of that place because of ramped production,right.(Refer Slide Time: 20:08)Then the next is subsidies. What is subsidy? It is a cash given to the producer either lumpsum or per unit, right. Lump sum is at one time payment, while per unit is a certainamount of cash for every product produced. Governments can subsidize certainindustries which replace imports or increase the exports.So, the government tries to give subsidies to those, for examples agriculture. Nowsuppose the country is going to import agricultural items; it is better to avoid that andgive some kind of subsidy to our own farmers and agriculturist, so that they can do ittheir own, and so that dependency is reduced, ok. Some of the subsides are; for example,in India are on fertilizers, petroleum products, power etcetera.So, for example, you must have seen, the power given to farmers in Punjab and someother states is highly subsidized, may be it is free of cost also or it is very very less, right.So, the rest, the amount of cost; the cost does not go anywhere. So, who bears it? It is agovernment. So, this is a subsidy given by government, ok.(Refer Slide Time: 21:20)Export subsidy versus import subsidy. Export subsidy is a government policy toencourage export of goods and discourage sale of goods on the domestic market right,through direct payments, low cost loans, tax relief for exporters or government financedinternational advertising.So, what it is saying? It is a government policy to encourage the export of goods. So,government gives you subsidies, so that you produce more and you can export it to othercountries. On the other hand import subsidy says, it consists of subsidies on goods andservices that become payable to resident producers; that means the local producers, whenthe goods cross the frontier of the economic territory.So, when the services are delivered to resident institutional units, so this subsidy is givenduring import; when somebody imports an item right, the subsidy is given to theinstitutional units, right. Now what happens here let us see. What is the effect of this?Export subsidies can cause inflation; why? Let us see. When the government subsidisesthe industry based on cost. So, the government has subsidised, so that it could becomemore healthier and they can export better.But in increase in the subsidy is directly spent on wage hikes demanded by theemployees, right. So, when this money, extra money is there, it goes to the employeeswho demand their higher salary. Now the wages in the subsidised industry are higherthan elsewhere.So, this the salary in this sector has grown up, so that automatically makes a you knowcompetitive environment, and people from the other sectors they also demand a highersalary right; so which causes the other employees demand higher wages right, which arethen reflected in prices, resulting in inflation everywhere in the economy.So, this is one important you know effect that export subsidies when given too much canlead to inflation, so the government needs to understand this. Second, on the importsubsidy part if you see, what is the problem? It is rarely used due to an overall loss ofwelfare for the country due to an decrease in price of the product. So, when I importedand I have been given a subsidy; so the price of the product for the consumers hasdecreased.Thus affecting a fall in the domestic production; so when thus, when the imported itemhas become cheaper, so the government has borne the subsidy, has borne the money. So,what happens is it is a cheaper product and the consumers will demand more of thatproduct, so automatically the domestic production, the other substitute products in thedomestic market they would find it very costly for them. And that would result in a fallin the domestic production.(Refer Slide Time: 24:12)Now coming to different types of tariff barriers; so we said, one of them was specificduty. Now what is specific duty? Taxes that are levied as a fixed charge; for example, aspecific tariff for example, for 10 of 10 dollar on each unit right, imported bicycle with aprice of 100, means that the custom officials collect the fixed sum of 10 dollar per cycle,ok.In case of some goods, duty is payable on the basis of units, length, weight, volumeetcetera. Example, duty payable on cigarettes is on the basis of length and not units,right; matches per 100 boxes or packs, sugar per quintal, so these are the examples ofspecific duty, right.(Refer Slide Time: 25:03)Now, what is ad valorem duty? So, another kind of a tariff barrier; these duties areimposed according to the value. So, the earlier one was on units, here on value; when afixed percent of value of a commodity is added as a tariff, it is known as ad valoremduty.Generally used for property tax on real estate, sales tax on consumer goods, value addedtax on final products and services, right. Let us see this case. If the market value of a2,000 square foot home is 100000. Let us say the market value of a 2000 square foothome is 100000; the ad valorem tax levied will be based solely on the homes 100000value, regardless of its relative physical size.So, suppose some expansion has been done in the house, it immaterial. So, on the marketvalue, on only this the ad valorem taxes levied; it is less or more, it does not matter. So,the municipality property taxes are an example of ad valorem tax, ok.(Refer Slide Time: 26:08)Let us see some of the more examples; however, a specific duty it says cannot besometimes levied on articles like works of art. How do you levy taxes on a work of art?.For instance a painting cannot be tax on the basis of weight and size, right. If you startdoing it, then an M F Husain’s painting might not cost you, should not cost you morethan thousand rupees right, but then it sells in crores, ok.So, ad valorem duty ignores the consideration of weight, size or volume of commodity,ok. The imposition of ad valorem duty is more justified in case of those goods whosevalues cannot be determined on the basis of their physical and chemical characteristics,such as work of art, rare manuscripts etc, right.So, there are certain manuscripts which for a suppose a one paged letter of MahatmaGandhi somewhere written during 1930s or 40s or letter of Einstein, where he hadwritten his formulas will be so costly that, you cannot equate it through weight and size,ok.(Refer Slide Time: 27:18)Some other types of tariff barriers, combined or compound duty; it is a combination ofthe specific and ad valorem duty on a single product it is a combination. For examplethere can be combined duty when 10 percent of value and rupees 1 on every meter ofcloth is charged as duty. So, it is a combined; ad valorem + specific.Sliding scale duty is something called as seasonal duties also. What it says? The importduties which may vary with the prices of commodities are called sliding scale. What it issaying? The import duties may vary with the prices of the commodities; these may eitherbe on specific or ad valorem basis.Historically these are confined to agricultural products; since as their products frequentlyvary mostly due to natural factors. So, these are also sometimes called as seasonal duties.It is basically on the prices of commodities, ok. So, this is the, we are talking about thetariff barriers.(Refer Slide Time: 28:22)Now one more tariff barrier we will talk about is the protective tariff. In order to protectdomestic industries from stiff competition of imported goods, protective tariff is leviedon imports.What it is saying? In order to protect domestic industries from stiff competition ofimported goods, protective tariff is levied on imports. Normally, a very high duty isimposed which leads to either discourage the import; so one would not like to get theproduct or to make the imports more expensive so as that of domestic products.The tariffs may be imposed by the government to protect the home industries from cutthroat competition from the foreign based goods. A high rate of protective tariff canmake the domestic producers more lethargic and inefficient and unable to face foreigncompetition. So, when protective, too much of protection is also dangerous and bad. So,it might create more lethargic and inefficient, you know develop lethargic and inefficientyou know producers in the domestic market.US products include paper clips, tobacco and sneakers may rely on protective tariffs tosurvive in the competitive market. So, it is an example that these products will survive inthe competitive market only if they are given a protective tariff.So, what I will do is, we will stop here today because of paucity of time and in the nextlecture, in the next class we continue from the tariff barriers, from protective tariff againand then we will get into the other things of you know commercial policy, right. Thankyou very much, have a nice day.Thank you very much.