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The modern world is characterized by unprecedented levels of interaction between people of different nations and cultures. This phenomena has been promoted by globalization, which is a process typified by the immense integration of economies and cultures.
As globalization has increased, the volume of international trade has risen with all nations in the world expanding their list of international trade partners. To promote fairness in international trade, various trade-governing bodies have been established to deal with trade rules among nations. One of the issues that these trade-governing bodies such as the World trade Organization (WTO) have had to deal with is subsidies.
Most nations regard subsidies as important policy instruments for ensuring their economic well-being in a competitive world market. However, economists contend that subsidies lead to many negative results and adversely affect world trade. This paper will discuss the politics of subsidies and world trade so as to demonstrate that while subsidies have positive and negative impacts, pervasive subsidization is harmful to world trade.
Definition of Subsidies
The WTO defines a subsidy as “a financial contribution by a government or any public body within the territory of a Member” (Ryan, 2006, p. 126). Subsidies may be implemented when the government is involved in the direct transfer of such funds as grants or loans to an industry or when the government forgoes taxes that had already been accrued by an industry.
Subsidization can also occur when the government provides goods or services that do are not necessary for the entire public but rather beneficial for specific industries. Ryan (2006) states that another way in which subsidies can exist is if a government reduces the price of a primary product with the aim of giving the country a greater share of the export. Whatever the form they take, subsidies represent assistance from the government to producers or distributors in specific industries.
Need for Subsidies
Subsidies are an important policy instrument in the international trade system. They provide individual governments with the means through which to pursue industrial development and ensure the livelihoods of their citizens. Subsidies help to prevent the decline of an industry due to intense external competition or high production costs (Anderson, 2010).
World trade has exposed local producers in most countries to immense pressure. Sectors such as agricultural production in developed countries have faced stiff competition leading to significant reduction in competitive advantages.
Subsidies are crucial for the industrial development of a country since they enable new technology to compete favorably with mature technologies. Historically, subsidies were responsible for the initial growth and development of commercial air transport (Kim, 2007).
When commercial airline were first introduced, they had to compete with well established modes of transportation such as automobiles, ships, and trains. Because of the huge cost of air transport and the safety concerns, the private investors could not succeed in the industry without government support. Huge government subsidies helped the airline industry to develop in its initial stages and become self-reliant.
Impacts of Subsidies
- Positive Impacts
Subsidies ensure the survival of vital industries in a country. In most developed nations, the agricultural industry is not competitive since most people are involved in the manufacturing and service industry. In addition to this, the local farmers cannot compete with farmers from developing nations who have low production costs leading to cheap food products in the international market.
Governments argue that agricultural subsidies are an issue of national concern since food self-sufficiency is integral to national security. Goodman (2010) notes that food security in the US is ensured through farm subsidies, which allow US farmers to stay in business. Without these subsidies, the industry would collapse and the nation would be forced to rely on other countries for its food greatly compromising the independence of the nation.
Subsidies help to ensure stability in the market and protect consumers from the volatility of the international trade environment. For example, the world oil prices are constantly fluctuating due to the changing demand for the commodity. Oil is integral for the energy needs of all countries but since most countries do not have this resource, they have to rely on the foreign oil-producing nations.
Through subsidization, governments are able to keep petroleum costs low and stable therefore promoting industrial development in the country (Kim, 2007). Without subsidization, the economic growth and development of the country would be deterred since operation costs for industries would be markedly higher.
Subsidies have promoted the development of alternative energy technologies, therefore increasing the likelihood of energy sustainability in the future. Kim (2007) reveals that subsidies have played a major role in the development of solar power and accelerated the adoption of less polluting technology by industry. Subsidies in alternative energy technologies are offered under the assumption that as the technologies mature and become mainstream; the cost of products will move downwards making governmental assistance unnecessary.
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- Negative Impacts
Subsidization in the agricultural sector is harmful to the economic well-being of developing nations. Agriculture has emerged as the most sensitive topic in world trade and subsidization. Shumaker (2007) suggests that the sensitivity of agriculture can be attributed to the vast potential for trade that this industry presents. Each country therefore exhibits a drive to maximize the economic advantages available through agricultural trade for social, economic, and political reasons.
Shumaker (2007) observes that most developing countries have few opportunities other than agriculture for trade and development and most of their exports consist of agricultural products. In spite of this reality, developed nations engage in subsidizing to protect their local producers. Farmers in developed nations such as the US exert great political pressures on their government to sustain subsidization and farm protectionist measures.
Subsidies have contributed to the poverty experienced by farmers in developing nations. Rivoli (2009) agrees that rich country subsidies to their local farmers have a role to play in the difficulties experienced by farmers in the third world countries. Due to aggressive subsidization by developed nations, prices for agricultural products are kept artificially low since subsidies lead to an overproduction of commodities hence decreasing world market prices.
Anderson (2010) reveals that foreign exchange from farming in most developing countries has been depressed by subsidies by governments of richer countries to their local farmers.
This statement is corroborated by Rivoli (2009) who documents that a primary effect of US government subsidies for cotton producers is the increase in supply of cotton grown in the US and a decline in world cotton prices by up to 15%. The US domestic subsidy program puts downward pressure on the world price therefore penalizing other exporting countries.
Subsidies promote inefficiencies in the market since producers are not penalized for engaging in inefficient practices. Kim (2007) asserts that subsidies prolong the life of inefficient firms and increase the tax burden on the nation’s citizenry. Subsidies guarantee producers that they will make a profit even if they engage in inefficient practices. The market is prevented from working in its natural way and the producers gain an unfair competitive advantage.
Subsidies give unfair advantages to some countries on the international market. The EU and the US engage in export subsidization to promote local production of some goods. While such moves are beneficial to the producers, they lead to trade distorting (Rivoli, 2009).
Producers from the subsidizing countries have an unfair advantage over producers from countries that do not subsidize their products. This unfair advantage created by subsidies has the potential to damage international trade as nations take up protectionist measures in retaliation to export subsidies by other nations. These retaliations might include trade restrictions and imposition of high tariffs on imports to protect the local market. Such measures are against the trade liberalization efforts of world trade.
Addressing the Subsidies Issue
The negative effects of subsidies present significant problems in the development of world trade. To address the negative impacts of subsidies on world trade, the WTO has a well-defined political framework for resolving issues between countries and negotiating trade rules for the trading member states. This organization also has an Agreement on Subsidies and Countervailing Measures, which aims to restrict the use of subsidies by individual countries (Ryan, 2006).
The WTO has set up rules that prohibit member countries from aggressive subsidization that might hurt other nations. Measures have been taken to address the issue of trade distorting caused by rampant subsidization. WTO member states have been provided with a forum for presenting cases against nations that are considered to be engaging in aggressive subsidization. Using the
Discussion and Conclusion
Government policy makers and economists agree that international trade is crucial for the economic development of a country and it is one of the ways through which poverty can be eradicated especially in developing nations. However, for this to occur international trade has to be fair and beneficial to all the parties engaged in trading.
Most subsidies lead to unfair trade and reduce the economic advantages that world trade might offer to a country. For example, excessive agricultural subsidies by developed nations have led to a reduction of national and global economic welfare and led to trade restriction.
This paper set out to highlight the politics of subsidies and world trade with special focus on the impacts of subsidization. The discussions provided in this paper highlight that subsidies have beneficial and damaging impacts on the individual country’s economy and world trade. The paper has noted that subsidies are necessary to promote industrial growth, encourage new technologies, and protect local industries from volatile markets.
However, aggressive subsidizing leads to trade distorting in the international trade arena therefore depriving third world countries of export currency in agriculture. From the arguments provided in this paper, it is clear that subsidies cannot be dismissed since they are a tool that countries can take to protect their own economic interests and the wellbeing of their citizens. However, steps should be taken to deal with subsidies that lead to negative trade outcomes in order for all nations to benefit mutually from world trade.
Anderson, K. (2010). Can the WTO reduce agricultural trade distortions? The Journal of International Trade & Economic Development, 19(1), 109–134.
Goodman, R. (2010). A five-Point Defense of Farm Subsidies. Retrieved from: http://alfafarmers.org/programs/
Kim, K.H. (2007). The Impact of Subsidies on Global Markets. Proceedings of the Northeast Business & Economics Association, 12(1), 28-31.
Rivoli, P. (2009). The Travels of a T-Shirt in the Global Economy: An Economist Examines the Markets, Power, and Politics of World Trade. NY: John Wiley & Sons
Ryan, L. (2006). Dogfight: Criticizing the Agreement on Subsidies and Countervailing Measures Amidst the Largest Dispute in World Trade Organization History. North Carolina Journal of International Law & Commercial Regulation, 32(1), p115-157
Shumaker, M.J. (2007). Tearing the Fabric of the World Trade Organization: United States – Subsidies on Upland Cotton. North Carolina Journal of International Law & Commercial Regulation, 32(3), 547-603.