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A 6 Pages Term Paper on The Impact of Government Intervention

In Private Sector Economy

In an increasingly integrated global economy, it is important to have a clear understanding of the costs and benefits of unilateral economic sanctions for the United States. Most of the analysis of the effectiveness of economic sanctions suggests they have limited utility for changing the behavior or governments of target countries.

Nine reasons for government intervention:

  1. Competition policy: to encourage competition between firms so that the consumer gains through efficiency and choice. Also to prevent the abuses characteristically associated with monopolies such as the abuse of power and the deliberate restriction of output to raise prices.
  2. Market forces: if the market is not working properly owing to anti-competitive practices, the government may intervene to stop (for example) price fixing; rigging.
  3. Protect consumers: this may be done through legislation and/or through the work of ’watchdogs'.
  4. Environmental considerations: polluters may be fined, taxed punitively, legislated against, banned and/or their competition could be favored.
  5. Macro-economic objectives: intervention to achieve low inflation, falling unemployment or rising growth.
  6. Direct measures to help reduce unemployment: Windfall Tax on utilities.
  7. Stimulate consumer demand: fiscal/monetary policies to encourage demand.
  8. Ensure a 'level playing field': through government regulating agencies which may monitor the activities of banks, advertisers and trading companies.
  9. To encourage social policies: health warnings on cigarette packets; the banning of tobacco sponsorship.

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Types of government interventions

There are four usual means by which governments might interfere with free trade or private sector.

1. Protective tariffs

      Protective tariffs are exercise taxes or duties placed on imported goods. Most are design to shield domestic producers from foreign competition. They impede free trade by increasing the prices of imported goods, shifting demands towards domestic products. An excise tax on imported shoes, for example, would make domestically made shoes more attractive to consumers.

2. Import quotas

      These are limits on the quantities or total value of specific items that may be imported. Once a quota is “filled” it chokes off imports of that product. Import quotas can be more effective than tariffs in retarding international commerce. A particular product could be imported in large quantities despite high tariffs; a low import quota completely prohibits imports once the quota is filled.

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3. Non tariffs barriers

      Non tariffs barriers include licensing requirements, unreasonable standards pertaining to product quality, or simply unnecessary bureaucratic red tape in customs procedures. Some nations require that their domestic importers of foreign goods obtain licenses, imports can be effectively impeded.

4. Export subsidies

     Export subsidies consist of governmental payments to domestic producers of export goods. The payment reduces their production cost, permitting them to charge lower prices and thus sell more exports to world market. The United States and some other nations have subsidized domestic farmers, boosting domestic food supply. This has reduced the market price of food, artificially decreasing export prices on agricultural products.

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Impact of government intervention

     In addition to the immediate impact of government sanctions on trade with the target, many American businessmen claim that the effects of even limited unilateral US sanctions go well beyond targeted sectors. They also argue that the effects linger long after they are lifted because US firms come to be regarded as "unreliable suppliers." Sanctioned countries may avoid buying from US exporters even when sanctions are not in place, thus giving firms in other countries a competitive advantage in those markets. ww.minneapolisfed.org)

     Exports lost today may mean lower exports after sanctions are lifted because US firms will not be able to supply replacement parts or related technologies. Foreign firms may also design US intermediate goods and technology out of their final products for fear of one day being caught up in a US sanction episode. These indirect effects may well extend beyond the sanctioned products and even beyond the time period sanctions are imposed.

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     To preview the results, we find that US sanctions in 2000 may have reduced US exports to 26 target countries by as much as $15 billion to $19 billion. If there was no offsetting increase in exports to other markets that would mean a reduction of more than 200,000 jobs in the relatively higher-wage export sector and a consequent loss of nearly $1 billion annually in export sector wage premiums. This suggests a relatively high cost to the US economy while sanctions are in place. However, we find only limited evidence that the negative impact of sanctions lingers long after they are lifted. This may reflect the highly aggregated nature of the data we use. Long-term effects of sanctions might be expected to be relatively more severe for particular sectors, such as sophisticated equipment and infrastructure, than for exports in the aggregate. And, as noted, continued use of extraterritorial sanctions could increase the effect for these sectors in the future. We also find, not surprisingly, that foreign firms have replaced US firms in Cuba and that Canada, Australia, and Germany export more to China than size, income, and geography would suggest. (www.imf.org)    

     A common method in economics for analyzing bilateral trade flows (exports plus imports and exports alone) is the so-called "gravity model." Applying an even more common statistical technique, "ordinary least squares" regression analysis, to the gravity model allows us to isolate the effect of sanctions on bilateral trade flows while holding other factors constant, such as size and distance. The gravity model and the OLS technique permit us to analyze the indirect as well as direct effects of economic Sanctions across a large number of countries.

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     This approach should be contrasted with the case study approach to estimating the trade effects of economic sanctions. A case study approach calculates trade interruptions that are identified by competent observers--for example, affected firms or responsible government agencies. The case study approach best captures anecdotal eye-witness reports but it may miss less visible secondary effects. In addition, it is difficult to reach general conclusions from a handful of cases. (McConnell Brue 764-800)


With foundations in the physical sciences, the gravity model has consistently proved to be a useful tool for the analysis of bilateral trade flows. Isaac Newton originally devised the model to explain gravitational force in the universe. His theory states that the gravitational pull between two celestial bodies is positively related to the product of their masses and inversely related to their distance apart. Similarly, in its simplest form, the gravity model as applied to trade predicts that the amount of trade between two countries will be positively related to the product of their outputs (a measure of size or mass), and negatively related to the distance between them. The gravity model has been applied to bilateral trade since at least the 1960s and it has enjoyed resurgence in the 2000s as an empirical tool for analyzing regional trading areas. (McConnell Brue 764-800)

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     Most applications of the gravity model include other variables besides size and distance that might be expected to influence trade flows. The model used in this study predicts that bilateral trade will increase as combined size and per capita incomes increase, decrease as the distance between two countries increases, and increase if the two countries share a common border or a common language, or are both members of the same trade bloc (for example, the North American Free Trade Area or the European Union).3 In addition, we have added a series of dummy variables to capture the effect of trade sanctions. The following sections specifically define the variables and briefly describe their hypothesized effect on trade flows.

Dependent variable

The dependent variable in this model--the variable to be explained-- is bilateral merchandise trade (Trade), which is defined as exports plus imports expressed in current dollars, in each of three separate years: 1990, 1995, and 1998. Exports alone are available for 1995 and we also use those data as the dependent variable in some tests. Our data set includes 88 countries, which results in 3,827 different country pairs. For several statistical tests, selected subsets of the 3,827 country pairs were examined. The source for trade information is the International Monetary Fund's Direction of Trade Statistics. GNP and population figures are primarily taken from the International Monetary Fund's International Financial Statistics, supplemented when necessary by data from the World Bank's World Development Report and the CIA World Fact book.

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As in Frankel (1997), the basic gravity model variables--size, income, distance, adjacency, and language--all have the expected sign and are all highly significant statistically (at the 99 percent confidence level or better). The trade bloc dummy is highly significant in 1985 and 1990, but only marginally so in 1995. The equation as specified, including the sanctions dummies, explains 70 percent or more of the variation in observed bilateral trade flows. Of primary interest here is the impact of economic sanctions on bilateral trade flows. As expected, when they are in place, extensive sanctions have a large impact on bilateral trade flows, consistently reducing them by around 90 percent. There is more variance in the estimated impact of moderate and limited sanctions and the results are not quite as robust, but they suggest an average reduction in bilateral trade of roughly a quarter to a third. The coefficients on the dummy variables
Representing the presence of sanctions in the base years, 1990, 1995, and 1998, are highly significant statistically (at the 99 percent confidence level or better) with just two exceptions, moderate sanctions in 1990, which are still significant at the 95 percent level, and limited sanctions in 1995, which are statistically significant just below the 90 percent level.

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     Keep in mind that all of the results described above apply to total bilateral trade, the sum of exports and imports between each pair of countries. Data for exports alone are also available in the data set, but only for 1995. In order to narrow the focus to the impact on the exports of the major users of sanctions, we also ran the regression using the logarithm of OECD exports and then of US exports alone as the dependent variable. The latter regression excludes all the pairs that do not have the United States as the exporter, reducing the number of observations to 84.

     The results for OECD exporters are similar to those for the broader sample using total bilateral trade, except that the BLOC dummy is not significant and even has a negative sign. (www.worldbank.org)

     The results for the US sample are also broadly similar to those for the larger sample, but because the model has substantially fewer data points it performs less well than before. The key gravity variables--size and distance--have the expected signs and are statistically significant at the 95 percent confidence level, as is the dummy for a common language. But per capita income, adjacency, and the bloc dummy are no longer significant. The coefficient for limited sanctions suggests they have an impact on US exports similar to that for other OECD exporters, but we cannot have great confidence in this result since the Coefficient is no longer statistically significant. The coefficients for the extensive and moderate sanction variables are much larger for the US sample than either for the sample as a whole or for the OECD sample, suggesting that the United States imposes relatively broader or tougher sanctions that have a greater adverse impact on its exports than the sanctions of most other OECD countries.

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     Because the United States is by far the largest user of unilateral economic sanctions, one might expect to find more robust evidence in US export patterns for lingering effects of sanctions after they have been lifted. Another argument frequently heard in the debate is that US competitors move in and capture the business when the United States imposes unilateral sanctions. One way to explore this hypothesis is by examining the country pairs with "positive residuals" in their regression equations. Positive residuals indicate cases where actual trade is higher than the model would predict. If the "business capture" argument is correct, one would expect to find positive residuals for observations that pair major industrial countries such as France, Germany, and Japan, for example, with sanctions targets such as Iran, Libya, and China. This is, indeed, the case with respect to Cuba where the "positive residuals" indicate that Belgium, Canada, France, Germany, Ireland, Italy, Mexico, the Netherlands, and Spain trade more with Cuba than expected given size, income, and distance. In addition, Australia, Canada, and Germany export more to China than predicted by the model. (www.imf.org)


These above mention calculation suggest that US exports were $15 billion to $19 billion lower than they would have been if not for the direct and indirect effects of sanctions in place in 1995. The estimated reduction in annual US exports to countries targeted by sanctions would be expected to continue as long as sanctions of similar intensity are in place. In fact, the impact probably would grow over time since, in the absence of sanctions, exports to these countries would normally rise as they increase their income levels. (www.imf.org)

Jobs and wages effect of government sanctions

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The United States is now enjoying full employment, and in a full employment economy, lower exports do not spell an overall drop in employment. However, it does mean that fewer workers are employed in the export sector of the economy, and more workers are employed elsewhere. According to the most recent US Department of Commerce study (1996), in the year 1992, $1 billion of goods exported supported 15,500 jobs, both directly in the exporting firms and indirectly in their suppliers. Taking into account productivity growth, the figure in 1995 was probably about 13,800 jobs. If the $15 billion to $19 billion estimated reduction in US exports in 1995 was not offset by exports to other markets, the loss of jobs in the export sector (if not in the economy as a whole) was between 200,000 and 260,000 positions. What these figures mean is that, as a consequence of US sanctions, workers probably lost somewhere between $800 million and $1 billion in export sector wage premiums in 1995.

The US practice of using economic sanctions extensively has become a fixture of US foreign policy at least since President Carter (1977-1980). In some periods during the past twenty years, when the US economy did not enjoy full employment, and when jobs were not readily available, the loss of exports may have added to the unemployment rolls. But even if the loss of exports had zero effect on total employment, it certainly reduced the number of good paying jobs. If the next twenty years see the same frequent application of sanctions, the cumulative loss of wage premiums could exceed $20 billion (20 years times roughly $1 billion a year, not taking into account the rising annual loss of exports). This is a heavy cost.

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Works cited




R. McConnell, Stanley L. Brue McConnell Brue, fourteenth edition


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