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Between free trade and protectionism: strategic trade policy and a theory of corporate trade demands

  • Helen V. Milner (a1) and David B. Yoffie (a2)

Conventional theories of the political economy of trade argue that industries in import-competing businesses favor protectionism, while multinational firms and export-dependent corporations advocate unconditional free trade. However, many multinational industries have recently advocated “strategic” trade policies: that is, they are willing to support free trade at home only if foreign markets are opened or foreign governments reduce subsidies to their firms. If demands for strategic trade policy were adopted by the United States, they could represent a threat to the General Agreement on Tariffs and Trade (GATT) and the multilateral trading system. This article seeks to explain the emergence of these new corporate trade demands and thereby broaden theories of the political economy of trade. The article begins with the widely supported position that multinational and export-oriented firms prefer unconditional free trade. Building on concepts from theories of industrial organization and international trade, the article then hypothesizes that rising economies of scale and steep learning curves will necessitate that these firms have access to global markets via exports. If growing dependence on world markets is combined with foreign government subsidies or protection, the trade preferences of firms will shift from unconditional free trade to demands that openness at home be contingent on openness overseas. The manner in which firm demands then get translated into industry demands will vary with the industry's structure. If the industry consists of firms with symmetric strategies, it will seek strategic trade policy; but if the industry is highly segmented, it will turn toward protectionism. The article concludes with a preliminary test of these hypotheses in four brief studies of the politics of trade in the semiconductor, commercial aircraft, telecommunications equipment, and machine tool industries.

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1. See Schattschneider, E. E., Politics, Pressures, and the Tariff (Englewood Cliffs, N.J.: Prentice-Hall, 1935) ; Bauer, Raymond, de Sola Pool, Ithiel, and Dexter, Lewis, American Business and Public Policy (Chicago: Aldine, 1972) ; McKeown, Timothy, “Firms and Tariff Regime Change: Explaining the Demand for Protection,” World Politics 36 (01 1984), pp. 215–33 ; and Baldwin, R., The Political Economy of U.S. Import Policy (Cambridge, Mass.: MIT Press, 1986) .

2. Aggarwal, V., Keohane, R., and Yoffie, D., “The Dynamics of Negotiated Protectionism,” American Political Science Review 81 (06 1987), pp. 345–66 .

3. Keohane, Robert, “Reciprocity in International Relations,” International Organization 40 (Winter 1986), pp. 128 .

4. See Evans, John, The Kennedy Round in American Trade Policy: The Twilight of GATT? (Cambridge, Mass.: Harvard University Press, 1971), chap. 2 ; and Keohane, “Reciprocity in International Relations.”

5. Schelling, T., The Strategy of Conflict (Cambridge, Mass.: Harvard University Press, 1960), pp. 910 .

6. Porter, Michael, “The Structure Within Industries and Companies’ Performance,” Review of Economics and Statistics 61 (05 1979), pp. 214–27 .

7. There is a very large theoretical and empirical literature on the subject of which domestic groups seek protection. See, for example, Stolper, W. and Samuelson, P., “Protection and Real Wages,” Review of Economic Studies 9 (11 1941), pp. 5873 ; and Kxueger, A., “Political Economy of the Rent-Seeking Society,” American Economic Review 64 (06 1974), pp. 291303 . For empirical tests of similar theories, see, for example, Caves, Richard, Multinational Enterprise and Economic Analysis (Cambridge: Cambridge University Press, 1976) ; Baldwin, Political Economy of U.S. Import Policy; Pincus, J., Pressure Groups and Politics in Antebellum Tariffs (New York: Columbia University Press, 1977) ; Ray, E., “Determinants of Tariff and Nontariff Trade Restrictions in the U.S.,” Journal of Political Economy 81 (02 1981), pp. 105–21 ; and Lavergne, R., The Political Economy of U.S. Tariffs (Toronto: Academic Press, 1983) .

8. Milner, Helen, “Resisting the Protectionist Temptation,” Ph.D. diss., Harvard University, 1986 ; Odell, John and Destler, I. M., The Politics of Anti-Protection (Washington, D.C.: Institute for International Economics, 1987) ; and Pugel, T. and Walter, I., “U.S. Corporate Interests and the Political Economy of U.S. Trade Policy,” Review of Economics and Statistics 67 (08 1985), pp. 465–73 .

9. Milner, Helen, Resisting Protectionism: Global Industries and the Politics of International Trade (Princeton, N.J.: Princeton University Press, 1988) .

10. In addition to direct investment in the competitors' market and investing in other lowwage countries, a third strategy was to license technology and earn a royalty on the firm's fixed research and development investment. As long as multinational firms could earn a substantial return with any of these three strategies, one should expect them to remain committed to free trade.

11. The key variable in this analysis is mobility of factors of production. In the absence of mobility, such as in most agricultural production, it is not surprising that foreign protectionism would produce domestic demands for retaliation or reciprocity. However, in industries in which key factors (such as capital) are mobile and multinational firms have unique products that could not be easily replicated by domestic producers, foreign trade barriers could even be the preferred option. Since protectionism increases local prices, a multinational firm might be able to earn excessive returns behind tariff or quota barriers.

12. Yoffie, David B., “Zenith and the Color Television Fight,” Harvard Business School Case no. 9–383–070, rev. 04 1986 .

13. Stein, Arthur, “The Hegemon's Dilemma,” International Organization 38 (Spring 1984), pp. 355–86 ; and Keohane, “Reciprocity in International Relations.”

14. See Brander, J. and Spencer, B., “Tariffs and the Extraction of Foreign Monopoly Rents Under Potential Entry,” Canadian Journal of Economics 14 (08 1981), pp. 371–89 ; Dixit, A., “International Trade Policies for Oligopolistic Industries,” Economic Journal 94 (Supplement 1984), pp. 116 ; Spencer, B. and Brander, J., “International R&D Rivalry and Industrial Strategy,” Review of Economic Studies 50 (10 1983), pp. 707–22; Auquier, A. and Caves, R., “Monopolistic Export Industries, Trade, Taxes, and Optimal Competition Policy,” Economic Journal 89 (09 1979), pp. 559–81 ; Eaton, J. and Grossman, G., “Optimal Trade and Industrial Policy Under Oligopoly,” Quarterly Journal of Economics 101 (05 1986), pp. 383406 ; DeMeza, D., “Commercial Policy Toward Multinational Monopolies,” Oxford Economic Papers 31 (07 1979), pp. 334–37 ; and Krugman, Paul, Strategic Trade Policy and the New International Economics (Cambridge, Mass.: MIT Press, 1986) .

15. Brander, J., “Rationales for Strategic Trade and Industrial Policy,” in Krugman, , Strategic Trade Policy, p. 25 .

16. Krugman, Strategic Trade Policy, chaps. 2 and 4.

17. The third condition, rising R&D requirements, also creates market imperfections. However, these imperfections are not internal to the firm, like scale and learning; rather, they are “external economies” that are typically captured by other parties—not the individual firm— through “spillover” effects. Hence, while strategic trade policy for an industry with high R&D requirements can be used to increase a nation's welfare, there is no reason to believe that high R&D requirements will change the incentives for individual firms to demand strategic trade policy.

18. This assumes that market size is limited and that no technological innovation would make existing products or processes obsolete. See Ghemawat, Pankaj, “Sustainable Advantage,” Harvard Business Review 64 (0910 1986), pp. 5358 .

19. Ceteris paribus refers here to the reputation of the foreign government for successfully intervening in its domestic industries. For decades, governments around the world have intervened in their economies. However, most of these interventions, especially by Latin American and European countries, have failed. Numerous factors, including poor government policies and inept management, have produced these failures. Hence, multinational firms that face large economies of scale or steep learning curves would not want to fight half the governments in the world just because those governments were intervening in their own industries. In the absence of some competitive loss, the costs would outweigh any benefits. On the other hand, if a foreign government had a reputation for successful industrial intervention, firms might seek strategic trade policy preemptively, even before their competitive positions suffered.

20. Caves, , Multinational Enterprise and Economic Analysis, pp. 4344. Caves also discusses in this book the alternative approach of technology licensing. However, like direct investment, simply earning royalties would not be attractive in industries that have large economies of scale or significant learning effects.

21. Caves, R. E. and Porter, M. E., “From Entry Barriers to Mobility Barriers: Conjectural Decisions and Contrived Deterrence to New Competition,” Quarterly Journal of Economics 91 (05 1977), pp. 241–61 .

22. While this footwear example is hypothetical, it has some similarities to the actual structure of the American footwear industry. See Yoffie, David B., Power and Protectionism: Strategies of the Newly Industrializing Countries (New York: Columbia University Press, 1983), chap. 5. Although there are over 200 American shoe companies, footwear is a highly segmented industry. In Resisting Protectionism, Milner also describes how these types of differences within the American footwear industry impeded the creation of a unified trade position.

23. Porter, , “The Structure Within Industries,” p. 215 .

24. Strategic groups have been defined by economists in various ways. The dimensions of strategic groups could range from marketing strategies to dimensions that are only important for international trade (such as global versus domestic production strategies) or for specific product segments. Our analysis of strategic groups focuses only on dimensions of industries that are related to the firms' positions in international trade and competition. For an operational definition, see footnote 26.

25. For a discussion of reputation, see footnote 19.

26. Measures for these variables come from the literature on industrial organization. For economies of scale, we use minimum efficient scale when possible; otherwise, we use capital expenditure as a percentage of total sales. For learning effects, we use declining average production costs per unit over time. Changes in any one variable alone would increase market imperfections and thereby predispose firms to become more strategic about trade; simultaneous changes in both variables would greatly intensify the demand for strategic trade policy.

For indicators of strategic groups, we have not used conventional concentration ratios, since we do not believe they adequately capture the concept of strategic groups. We define strategic groups in terms of the key structural variables of each industry, which can range from different end uses to different manufacturing strategies. See Caves and Porter, “From Entry Barriers to Mobility Barriers”; and Porter, “The Structure Within Industries.”

27. Milner, , “Resisting the Protectionist Temptation,” p. 347 .

28. Grunwald, J. and Flamm, K., The Global Factory: Foreign Assembly in International Trade (Washington, D.C.: The Brookings Institute, 1985) .

29. The chief executive officer of one of the largest merchant semiconductor firms reported in an interview that elimination of tariffs allowed his firm to cut the positions of twenty-one full-time bookkeepers who were responsible for reporting to the U.S. Customs Department on the firm's imports from its overseas assembly operations. He noted that getting tariff cuts from Japan was much less important than his firm's ability to import freely.

30. Yoffie, David B., “The Global Semiconductor Industry,” Harvard Business School Case no. 9–388–052, 1987 .

31. Okimoto, Dan, Sugano, T., and Weinstein, F., eds., Competitive Edge: The Semiconductor Industry in the U.S. and Japan (Stanford, Calif.: Stanford University Press, 1985) .

32. Instat, Inc., “Information Company for the Electronics Industry,” mimeograph, Semiconductor Industry Conference, New York, 4 06 1987 . By 1987, the Japanese market had reached 49 percent of the world market, compared to 39 percent for the United States.

33. Semiconductor Industry Association (SIA), “Japanese Market Barriers in Microelectronics,” memorandum in support of a petition pursuant to Section 301 of the Trade Act of 1974 as Amended, 14 06 1985 .

34. Yoffie, “The Global Semiconductor Industry.”

35. SIA, “Japanese Market Barriers.”

36. In 1984, a small semiconductor manufacturer, Micron Technology, also filed a dumping suit against Japanese producers of 64K DRAMs. This suit, however, was not widely supported.

37. Coleman, J. and Yoffie, D., “The Semiconductor Industry Association and the Trade Dispute with Japan,” Harvard Business School Case no. 0–387–205, 1987 .

38. Interviews with SIA officials, April 1987, Washington, D.C.

39. Salter, M., “Turbulent Skies: Airbus vs. Boeing,” Harvard Business School Case no. 0–386–193, 1987 .

40. Phillips, Laurence, “Air Carrier Activity at Major Hub Airports and Changing Interline Practices in the United States' Airlines Industries,” Transportation Research 21A (05 1987), pp. 215–21 .

41. We have excluded Lockheed from this discussion for two reasons. First, Lockheed did not compete directly with Airbus in the 1970s; its major competitor was McDonnell Douglas. Second, scandals, bribes, and bankruptcy of Lockheed's core business meant that Lockheed's position on trade policy was relatively unimportant for the commercial aircraft industry.

42. Testimony of Robert Bateman (Washington representative, Boeing Co.), in U.S. Congress, Senate Committee on Commerce, Hearings Before the Subcommittee on Foreign Commerce and Tourism, 92d Congress, 2d sess., 1972, p. 350.

43. Testimony of James Worsham (vice president, McDonnell Douglas), in U.S. Congress, House Committee on Energy and Commerce, Hearings Before the Subcommittee on Commerce, Consumer Protection, and Competitiveness, 23 06 1987, unpublished draft.

44. “Aircraft Industry Survey,” The Economist, 1 June 1985; and Howard Banks, “Airbus Comes of Age,” Forbes, 23 02 1987, pp. 3637 .

45. Toh, Rex and Higgins, Richard, “The Impact of Hub and Spoke Network Centralization and Route Monopoly on Domestic Airline Profitability,” Transportation Journal 24 (Summer 1985), pp. 1627 .

46. Airbus's share of the world market was approximately 17 percent between 1980 and 1985. See U.S. Department of Commerce, U.S. Industrial Outlook, 1987 (Washington, D.C.: GPO, 1987), pp. 3437. However, Airbus reportedly grabbed 44 percent of all new orders during the first quarter of 1987, according to the Dow Jones News Service, 7 May 1987.

47. Testimony of Jack Pierce (treasurer, Boeing Co.), in U.S. Congress, Senate Committee on Commerce, Hearings Before the Subcommittee on Export-Import Bank Extension, 97th Congress, 2d sess., 1978, p. 551; and testimony of James McMillan (vice president, McDonnell Douglas), in U.S. Congress, Senate Committee on Commerce, Export Policy, Part 4, Banking, Housing and Urban Affairs: Hearings Before the Subcommittee on International Finance and Commerce, 97th Congress. 2d sess., 1978.

48. Testimony of T. A. Wilson (chairman, Boeing Co.), in U.S. Congress, House Committee on Ways and Means, Competitive Conditions in the U.S. Civil Aircraft Industry and Forest Products Industry: Hearings Before the Subcommittee on Trade, 98th Congress, 2d sess., 1984, pp. 35.

49. Testimony of Roetman, O. M. (vice president, Boeing Co.), in Hearings, 23 06 1987.

50. Lewis, Paul, “Airbus Group Acts to Mollify U.S.,” The New York Times, 24 12 1985 .

51. “America Turns Up Heat on Airbus,” The Economist, 5 07 1986, p. 62.

52. “Airbus Soars on American Anger,” Sunday Times, 8 02 1987.

53. The Economist, 5 July 1986; and Salter, “Turbulent Skies.”

54. Testimony of Worsham, James, in Hearings, 23 06 1987 .

55. Brock, Gerald, The Telecommunications Industry: Dynamics of Market Structure (Cambridge, Mass.: Harvard University Press, 1981), p. 235 .

56. Ibid., pp. 235–36.

57. See the Carterphone decision, in U.S. Congress, Senate Committee on Finance, The Telecommunications Trade Act of 1984: Hearings Before the Committee on Finance, 98th Congress, 2d sess., 1984, pp. 1–3.

58. U.S. International Trade Commission (USITC), Changes in the U.S. Telecommunications Industry and the Impact on U.S. Telecommunications Trade, no. 1542 (Washington, D.C.: USITC, 1984), p. 19 .

59. Ibid., p. 22.

60. Ibid., p. 19.

61. U.S. Congress, Senate Committee on Finance, Private Advisory Committee Reports on the Tokyo Round of the Multilateral Trade Negotiations, 96th Congress, 1st sess., 1979 ; and USTIC, no. 1542, pp. 8–9.

62. Paul, J., ed., High Technology, International Trade and Competition: Robotics, Computers, Telecommunications, and Semiconductors (Park Ridge, N.J.: Noyes Press, 1984), p. 115 ; and Standard and Poor's Industry Survey: Telecommunications (New York: Standard & Poor, 08 1986), p. 34 .

63. The Washington Post, 20 May 1984, pp. Gl and Gl1; and The New York Times, 1 June 1984, pp. Dl and D33.

64. National Journal 17 (16 03 1985), p. 590 .

65. Adams, W., ed., The Structure of American Industry, 6th ed. (New York: Macmillan, 1982), pp. 307–14 ; and Organization for Economic Cooperation and Development (OECD), Telecommunications (Paris: OECD, 1983), p. 15 .

66. Aronson, J. and Cowhey, P., When Countries Talk: Global Telecommunications for the 1980s (New York: Ballinger, 1988), pp. 1618 .

67. The industry structure was complicated by its multinationality. Several foreign-owned firms, including Northern Telecom (Canadian), Mitel (Canadian), Siemens (German), and NEC (Japanese), had American manufacturing operations. Northern Telecom, in particular, was a large player in the United States and was occasionally considered an American company in international trade negotiations. For the purposes of this article, however, we are considering the “industry” to be U.S.-owned companies.

68. Lenway, S., The Politics of U.S. International Trade (Boston: Pitman, 1985), p. 174 .

69. Lenway (ibid., pp. 179–80) describes a split in preferences among U.S. firms, claiming some wanted greater access and some closure of the U.S. market. Timothy Curran, on the other hand, suggested that it was the U.S. Trade Representative, not the industry, that pushed for the negotiations with NTT. He implied that U.S. firms wanted closure of the U.S. market., But this is odd, given that the U.S. firms visited Japan to discuss the NTT case before and during the actual negotiations. See Curran, Timothy, “Politics and High Technology: The NTT Case,” in Destler, I. M. and Sato, Hideo, eds., Coping with U.S.-Japanese Conflicts (Lexington, Mass.: Lexington Books, 1982) ; and U.S. Congress, House Committee on Ways and Means, Trade with Japan: Hearings Before the Committee on Ways and Means, 97th Congress, 2d sess., 1980, pp. 151–61 .

70. Lenway, , Politics of U.S. International Trade, p. 186 .

71. Yoffie, David B., “Motorola and Japan,” Harvard Business School Case no. 9–383–070, 1983 .

72. International Trade Administration (ITA), The Telecommunications Industry (Springfield, Va.: Department of Commerce, 1983), pp. 1213 and 31 ; and Paul, , High Technology, pp. 120–25 .

73. Testimony of J. McDonnell (telecommunications group spokesman for the Electronics Industry Association), in U.S. Congress, Telecommunications Trade Act of 1984: Hearings, p. 38 .

74. Testimony of E. W. Weeks (spokesman for AT&T), ibid., pp. 35–37.

75. U.S. Congress, Senate Committee on Finance, Export of U.S. Telecommunications Products: Hearings Before the Committee on Finance, 99th Congress, 1st sess., 1985, pp. 5767 .

76. Business Week, 17 June 1985, p. 112a.

77. Business Week, 21 May 1984, pp. 179–81.

78. Early in 1981, IBM and ITT both objected to reciprocity legislation; but by 1983, neither openly opposed it. In fact, only two firms, both foreign-owned—Northern Telecom and NEC—testified against the reciprocity legislation. See U.S. Congress, Telecommunications Trade Act of 1984: Hearings, pp. 81109 ; and U.S. Congress, Export of U.S. Telecommunications Products:Hearings, pp. 230–38 .

79. Carlsson, B., “Firm Strategies in the Machine Tool Industry in the U.S. and Sweden,” unpublished working paper, 10 1984 ; and Collis, D., “The Machine Tool Industry,” Harvard Business School Case no. 9–387–087, 1986 .

80. Collis, , “The Machine Tool Industry,” p. 21 .

81. National Machine Tool Builders’ Association (NMTBA), Economic Handbook of the Machine Tool Industry (Washington, D.C.: NMTBA, various years) .

82. Milner, , “Resisting the Protectionist Temptation,” pp. 320–42 .

83. Collis, D., “The Machine Tool Industry and Industrial Policy, 1955–82,” Harvard Business School Business History Seminar, 02 1987, pp. 1021 ; and Sciberras, E. and Payne, B., Machine Tool Industry: Technical Change and International Competitiveness (Essex: Longman, 1985), chap. 8 .

84. Collis, , “The Machine Tool Industry” (1986) .

85. Sciberras, and Payne, , Machine Tool Industry, pp. 153–55 .

86. Collis, , “The Machine Tool Industry” (1986), pp. 1318 .

87. Sciberras and Payne, Machine Tool Industry; and Guenther, G., Machine Tools: Imports and the U.S. Industry, Economy, and Defense Industrial Base (Washington, D.C.: Congressional Research Service, 07 1986) .

88. Collis, , “The Machine Tool Industry” (1986), pp. 811 .

89. Imports into the United States rose from 10 percent of consumption in 1973 to 25 percent in the early 1980s, with the Japanese share rising to about 45 percent of all of these imports. See NMTBA, Economic Handbook, p. 126 . The Japanese controlled about 70 percent of all U.S. imports of NC lathes and machining centers by 1985. See Asian Wall Street Journal, 15 September 1986, p. 4. Moreover, the Japanese share of world exports of machine tools grew from 3.5 percent in 1970 to 15 percent in 1983, while the U.S. share fell from 11.7 to 4.8 percent over the same period. See Collis, , “The Machine Tool Industry” (1986), p. 22 .

90. Testimony of R. Blakeman (spokesman for NMTBA and Iowa Precision Industries), in U.S. Congress, Joint Economic Committee, Machine Tool Industry and the Defense Industrial Base: Hearings Before the Joint Economic Committee, 99th Congress, 1st sess.. 1985 .

91. Gutfleish, R., “Why Protection? U.S. Corporate and State Responses to a Changing World Economy,” Ph.D. diss., University of California at Berkeley, 1987, chap. 7 .

92. U.S. Congress, Machine Tool Industry: Hearings; and U.S. Congress, House Committee on Ways and Means, U.S.-Japan Trade Relations: Hearings Before the Committee on Ways and Means, 98th Congress, 1st sess., 1983 .

93. Carlsson, , “Firm Strategies,” p. 17 ; and Sciberras, and Payne, , Machine Tool Industry, p. 93 .

94. Collis, , “The Machine Tool Industry” (1986), p. 14 .

95. Sciberras, and Payne, , Machine Tool Industry, p. 49 .

96. In 1981, one-third of all U.S. machine tool exports went to three countries: Mexico, Canada, and the United Kingdom. The industry was not asking for restrictions on imports from any of these countries. Moreover, Japan and West Germany—two of the countries affected by U.S. export restraints—took less than 10 percent of all U.S. machine tool exports. See USITC, Foreign Industrial Targeting, no. 1517 (Washington, D.C.: USITC, 1984), p. 223 and Table B-25 ; and testimony of Latona, Jack (spokesman for Houdaille Industries), in Machine Tool Industry: Hearings, p. 144 .

97. Porter, Michael, ed., Competition in Global Industries (Boston: Harvard Business School Press, 1986), chap. 1 .

98. Scott, Bruce and Lodge, George, eds., U.S. Competitiveness in the World Economy (Boston: Harvard Business School Press, 1985), chap. 1 .

99. Baldwin, Political Economy of U.S. Import Policy; and Aggarwal, Keohane, and Yoffie, “Dynamics of Negotiated Protectionism.”

100. Yoffie, David B., “Protecting World Markets,” in McCraw, Tom, ed., America Versus Japan: A Comparative Study in Business Government Relations (Boston: Harvard Business School Press, 1986) .

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