Big Drive Auto: Foreign Trade Coursework

The Effect of Tariffs and Quotas

Both tariffs and quotas reduce imports from the targeted country. The difference is that quotas set quantitative restrictions while tariffs are usually raised as a disincentive to further imports.

Thus, if Big Auto had advertised helium-powered Prius’ from Japan and ultra-cheap compacts from China for sale after New Year, an FTC measure imposing an annual quota of 10,000 units on those very same car makes would restrict the number of fully-assembled cars that could be shipped in from both countries. There is nothing to be done about the reduced supply which Big Auto and rival chains of dealers will now have to parcel out among themselves.

Tariffs reduce the price differential between U.S. brands and those enjoying the advantage of lower manufacturing costs abroad. If a Chinese model could be brought in for the equivalent landed cost of $10,000 per unit versus $18,000 for the lowest-priced American-made car, a punitive tariff of 80 percent would instantly wipe out the price advantage of the import and “level the playing field”.

Foreign Trade Payment Systems and Managing Foreign Exchange Volatility

Commercial and merchant banks are the usual intermediaries for all foreign trade. When a U.S. importer like Big Auto needs to replenish inventories of parts or completely-knocked-down (CKD) kits for local assembly, the company will open a letter of credit in favor of Asian, South American or European suppliers. Even if the overseas supplier has never had a transaction with Big Auto, it can rely on the “full faith and credit” of the U.S. bank Big Auto has deposited money to pay for the shipment when the goods arrive at a U.S. port (the typical arrangement). The same holds in reverse when, say, a Canadian dealer wishes to import some of Big Auto’s assembled cars for sale in Ontario.

Given that Big Auto takes a foreign exchange risk in a floating regime versus the Canadian dollar when it quotes a price in U.S. dollars and waits some days while the goods are in transit north, the company can have recourse to either buying hedging cover from a third party, speculating by taking a short/long position with forex traders, or accepting foreign currency and “parking” it until such time as the Canadian currency appreciates against the American greenback (Pugel, 2003).

On Identifying Comparative Advantage

In principle, comparative advantage assuming two goods X and Y both produced by countries A and B can be calculated based on the opportunity cost of one good in terms of the other in both countries. For simplicity’s sake, if labor were the sole input as L in the following expressions:

• In country A, the opportunity cost of X in terms of Y is: L^X_A/L^Y_A;
• In country A, the opportunity cost of Y in terms of X is: LY_A/L^X_A;
• In country B, the opportunity cost of X in terms of Y is: L^X_B/L^Y_B;
• In country B, the opportunity cost of Y in terms of X is: L^Y_B/L^X_B

Then, nation A enjoys a comparative advantage in item X if opportunity cost in terms of Y is less than in country B but the latter boasts comparative advantage in product Y. Both countries then benefit by trading in the respective goods for which they have comparative advantage (Gandolfo, 2007).

Why Import Prices are Less Volatile than Associated Currencies in Use

The price of goods and built-up units imported by Big Auto from foreign suppliers does not necessarily follow exchange rate movements vis-à-vis the U.S. dollar because there are other market forces at work. There is first of all, transfer pricing. Even if the landed price of a Volkswagen Beetle made in Mexico should rise at least 15% when the dollar lost that much value against the Mexican peso, company headquarters in Germany might decide to engage in transfer pricing, i.e., declaring a low unit value when shipping goods from one subsidiary to another. Marginal pricing may also be at work, such as when Toyota decides it has covered all fixed and most variable costs after selling two million Prius’ worldwide and can therefore absorb the appreciation of the yen by pricing at marginal cost, what a U.S. regulator might call below “home consumption value” (McCarthy, 2006).

Managing Domestic Resistance to Imports from Nations with Comparative Advantage

In my job as a production manager, I can mitigate resistance to the flood of imports in two ways:

• Reduce costs by negotiating with suppliers, finding substitute raw materials or components that work just as well but cost less, using “Lean Production” methods to raise productivity markedly, ask Finance to reduce dependence on loans, etc.
• Address the real comparative advantage of foreign competitors by working with the union to put more competitive wage scales and benefits in place.
• Compete head-on and urge R & D to design cars that are more competitive: roomier than imports, just as fuel-efficient, still safer and even more attractive in styling.

References

Gandolfo, G., (2007). International trade theory and policy. New York: Springer.

McCarthy, J. (2006). Pass-through of exchange rates and import prices to domestic inflation in some industrialized economies. Federal Reserve Bank of New York.

Pugel, T. (2003). International economics 12^th ed. Columbus (OH): McGraw-Hill Higher Education.