Hayden Economics
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Last Updated on Wed, 16 Dec 2015 | Foreign Exchange
Another claim for protection is that imported goods benefit from unfair trade practices. These allegations include products that are dumped at unfairly low prices in foreign markets and those that benefit from government subsidies. In fact, the World Trade Organization recognizes that actions to offset such unfair practices can be entirely consistent with a member's WTO commitments. Each of these areas raises important intellectual questions with respect to the circumstances when they will be consistent with a set of principles that maximize world welfare. Complaints about dumping are far more prevalent than complaints about subsidies, however, as illustrated by the fact that in 2001, 347 antidumping cases were initiated worldwide, compared to 27 countervailing duty cases to address foreign subsidies.15 Therefore, we do not elaborate the comments on subsidization presented in Chapter 5, and we focus on dumping.
Because transport costs and border regulations do separate national markets, firms may choose to discriminate across markets and charge different prices in different countries. When the firm chooses to charge a higher price in the home market and a lower price in the foreign market, economists refer to the practice as dumping. We first demonstrate how dumping represents a profit-maximizing strategy for the firm and then consider the effects of dumping on the importing country.
The firm will distinguish between markets because the elasticity of demand is not the same in each market. The firm often benefits from protection in the home market, due either to high transport costs or various tariff and nontariff barriers that keep out foreign competitors. In the category of nontariff barriers, we include tradition and business practices that limit competition from firms outside established business groups. Because foreign substitutes are not available, demand is less elastic than in foreign markets where the firm's product must compete with producers from many other countries.
Figure 6.4 presents an extreme example of this situation. The firm faces a downward sloping demand curve, denoted D, in the home market but must act as a perfectly competitive firm in the foreign market and face a horizontal demand curve, denoted D'. If there is no foreign trade, the firm will produce Q1 of output and charge the price P1. Now suppose the firm has the opportunity to export its output at the fixed world price P2. If it can prevent the exported output from being brought back into the domestic market, to maximize its profit the firm will now raise its domestic price to P3 and reduce its domestic sales to Q3 and export the quantity Q2-Q3 at the world price P2. At first glance it may seem paradoxical that the firm would reduce its sales in the higher-priced market, but it turns out that the firm is simply following the general rule of profit maximization: it equates marginal revenue and marginal cost, and does so in each market. The marginal revenue curve for sales in the domestic market is downward-sloping, but it becomes horizontal at P2 for export sales at D' = MR'. Therefore no output will be sold in the home market that yields a marginal revenue less than P2. On the other hand, exports are profitable out to the point at which MR = MC. The opportunity to sell in foreign markets at the lower world price increases the firm's profits by
0 Q3 Qj Q2
Figure 6.4 Dumping can increase profits - an example of price discrimination. This firm charges a price of P3 and sells a volume Q3 in the home market. It then exports volume Q2 - Q3 at a price of P2, thereby maximizing total profits from the two separate markets.
the amounts indicated by the shaded areas in Figure 6.4 - the difference between MR' and MC for the output that is exported. Again, this whole argument depends on the assumption that the two markets can be kept separated: the exported output cannot be returned to the home market. If it could be returned, the domestic price would fall to P2 and the country would become a net importer.
This result is a special case of a general proposition about price discrimination. A firm that sells its output in two or more distinct and separate markets will maximize its profits by equating MC and MR in each market. For the given MC, the price will be higher the smaller the elasticity of demand in each market.
The WTO recognizes dumping as an unfair trade practice and allows action to be taken against it. In the United States, for example, legal action follows a two-step procedure. If a charge of dumping is formally made, the Department of Commerce is required to investigate. If dumping is found to exist, the International Trade Commission (ITC) determines whether the domestic industry is being injured by the dumping. If it is, an antidumping duty equal to the margin of dumping is imposed.
One might think that importing countries would welcome the opportunity to obtain imports at bargain prices and that the exporting countries would be the ones to object. After all, trade improves consumer welfare by reducing the price of imported goods. However, it is usually the importing country that protests against dumping. Competing firms in the importing country recognize that low-priced imports are adversely affecting their sales and profits, and they are quick to claim that foreigners are engaging in unfair competition. Governments do have a valid interest in preventing predatory dumping. This occurs when foreign firms cut prices temporarily in order to drive domestic firms out of business, after which they will raise prices to exploit a monopoly advantage. Predatory dumping is more likely in industries in which start-up costs are high or in which other barriers to entry of new firms exist. Although national antitrust or competition laws are intended to address such practices, enforcing them against foreign firms may not always be feasible. In the vast majority of dumping cases, however, offending foreign producers account for small shares of the relevant market, which makes the predatory outcome unlikely.
Firms are likely to find dumping an attractive strategy even when they have no likelihood of driving foreign competitors out of the market. Rather, when markets can be separated within a country, domestic firms are likely to follow the same practice. A firm that has many gasoline stations in one part of the country, but hopes to enter the market in another part of the country, is unlikely to charge the same price for gasoline in each market. Instead, the firm will charge a lower price in the new market, to attract customers away from existing firms which already dominate the market. Lowering the price in the market where it makes few sales initially is a successful strategy, because the percentage reduction in price to existing customers represents a small loss in revenue compared to the large percentage gain in sales it will achieve when demand is quite elastic. In the market where it already is well established, a comparable price reduction represents a loss of revenue from a much larger number of customers, and the prospective percentage increase in sales is smaller given the less elastic demand. This line of reasoning implies that dumping makes sense as a domestic competitive strategy, and by extension as an international competitive strategy, too. Within a country, a domestic firm cannot be restricted from competing in any region, but internationally, competitors may not have a comparable ability to dump in each other's markets.
A further controversial aspect of antidumping laws is that in many countries they prohibit sales below the average cost of production. As a result foreign firms can be found guilty of dumping even when they charge the same price in all markets. Because average cost of production is interpreted to include an average rate of return to capital, this rules out sales below a full-cost price, which commonly take place during business downturns. The domestic practice of holding a sale to clear out overstocked merchandise is not legal by this standard. This form of dumping can be observed in competitive markets where individual firms have no power to set prices and discriminate against some buyers and favor others; both foreign and domestic firms sell at a lower price, which still covers their variable costs of production, and hope for more favorable conditions in the future that will allow them to earn an average rate of return. Yet, the dumping law says this strategy is legal for the domestic firm and illegal for the foreign firm.
Aside from these qualifications regarding the theory of dumping determinations, the actual practice of calculating dumping margins raises further concerns. Foreign firms are required to provide enormous amounts of accounting data in computer-readable form to defend themselves against such charges. If they cannot do so within a brief period of time, administrators use the "best information available," which often means figures submitted by those who bring the complaint, to determine the existence of dumping. Given those circumstances, negative decisions in the United States typically do not rest on a finding of no dumping but instead on the ITC finding that serious injury to the US industry has not resulted.
Even when cases are rejected by either the Department of Commerce or the ITC, the firm accused of dumping must cover the high legal costs of a defense, which may deter it or other foreign firms from competing aggressively in the US market. Thomas Prusa provides another insight for interpreting this process.16 He cites US evidence from the early 1980s which shows industries that win dumping cases (roughly one-third) do much better than industries that lose dumping cases (roughly one-third); imports fall roughly 36 percent for the former but rise 9 percent for the latter. When cases are withdrawn (roughly one-third), however, industries do roughly as well as when they win. Withdrawal often results from successful private negotiations, which may come closer to approximating the monopoly cartel solution identified above. Thus, some dumping actions appear to serve as a signal to foreign competitors to collude.
During the 1980s, Australia, Canada, the European Union, and the United States accounted for 96 percent of all dumping cases filed. The larger the country, the more likely that measures to prevent dumping will benefit domestic producers rather than other foreign producers. Table 6.1 summarizes the US and EU experience. In both cases the steel and chemical industries have been the primary users of these provisions. The column labeled "number successful" includes cases where antidumping duties were imposed and also where cases were withdrawn. Average dumping margins were much higher than the roughly 7 percent tariff rates for trade in manufactured goods as bound under international agreements by the European Union and the United States. Because EU practice allows for a duty smaller than the dumping margin, where the protection granted is proportional to the injury caused, the EU actions were less restrictive than implied by the average margin reported in the final column. Nevertheless, these barriers still are significant, and not surprisingly, Patrick Messerlin found that EU imports fell 36 percent 3 years after antidumping protection was granted.17
Table 6.1 Dumping cases in the United States and European Community, 1979-89
Nonelectrical machinery
Four industry total
Source: Patrick Messerlin and Geoffrey Reed, "Antidumping Policies in the United States and the European Community," The Economic Journal, 1995, pp. 1565-75.
The popularity of this policy tool is spreading. In the 1990s, many more countries came to rely on antidumping duties to protect domestic industries. The WTO secretariat reports that from 1995 to 2001 the four largest initiators of antidumping cases were the United States (257), India (248), the European Community (247) and Argentina (166). The countries most often named in such complaints were China (261), Korea (139), the United States (103) and Taiwan (96).18 Some commentators regard dumping cases as a substitute for tariffs and alternative trade barriers now constrained by the WTO. Others consider a country's reliance on dumping actions as part of a broader approach to trade and competition policy; some countries may effectively limit imports through collusive business practices rather than resort to dumping laws. Therefore, progress in negotiating tighter limits on the way antidumping restrictions are used is likely to require simultaneous attention to other uncompetitive practices.
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