Unit four

International Trade

LEAD-IN

Read the text and answer the questions that follow

International trade has flourished over the years due to the many benefits it has offered to different countries across the globe. International trade is the exchange of capital, goods and services across international borders or territories. In most countries, such trade represents a significant share of GDP. While international trade has been present throughout much of history, its economic, social and political importance has been on the rise in recent centuries.

With the help of modern production techniques, highly advanced transportation systems, multinational corporations, outsourcing of manufacturing and services, and rapid industrialization, the international trade system is growing and spreading very fast. Increasing international trade is crucial to the continuance of globalization. Global trade allows wealthy countries to use their resources - whether labour, technology or capital - more efficiently. As countries are endowed with different assets and natural resources (land, labour, capital and technology), some countries may produce the same goods more efficiently and therefore sell them more cheaply than other countries. If a country cannot efficiently produce an item, it can obtain the item by trading with another country that can. This is known as specialization in international trade.

International trade not only results in increased efficiency but also allows countries to participate in a global economy, encouraging the opportunity of foreign direct investment (FDI), which is the amount of money that individuals invest into foreign companies and other assets. In theory, economies can therefore grow more efficiently and can more easily become competitive economic participants.

For the receiving government, FDI is a means by which foreign currency and expertise can enter the country. These raise employment levels, and, theoretically, lead to a growth in the GDP. For the investor, FDI offers company expansion and growth, which means higher revenues.

International trade is, in principle, not different from domestic trade as the motivation and the behaviour of parties involved in a trade do not change fundamentally regardless of whether trade is across a border or not. The main difference is that international trade is typically more costly than domestic trade. The reason is that a border typically imposes additional costs, such as tariffs, time costs due to border delays and costs associated with country differences such as language, the legal system or culture.

Another difference between domestic and international trade is that factors of production such as capital and labour are typically more mobile within a country than across countries. Thus international trade is mostly restricted to trade in goods and services, and only to a lesser extent to trade in capital, labour or other factors of production. Trade in goods and services can serve as a substitute for trade in factors of production.

Instead of importing a factor of production, a country can import goods that make intensive use of that factor of production and thus embody it. An example is the import of labour-intensive goods by the United States from China. Instead of importing Chinese labour, the USA imports goods that were produced with Chinese labour.

Imports, along with exports, form the basis of international trade. Imports are the amount or value of goods and services that are brought from one country into another over a period of time. The amount or value of goods and services that are sold, sent or supplied to other countries over a period of time is called exports. Trade in goods is known as merchandise trade or “visible” trade; trade in services is known as “invisible” trade. Imports and exports are accounted for in a country's trade balance or balance of trade. A positive balance is known as a trade surplus which shows that the total value of exports exceed the total value of imports. A negative balance is referred to as a trade deficit or a trade gap, when the total value of imports is greater than the total value of exports.

International trade has two contrasting views regarding the level of control placed on trade: free trade and protectionism. Free trade is a system in which goods, capital and labour flow freely between nations, without barriers which could hinder the trade process. According to the law of comparative advantage, the policy permits trading partners mutual gains from trade of goods and services. The main idea is that supply and demand factors, operating on a global scale, will ensure that production happens efficiently. Therefore, nothing needs to be done to protect or promote trade and growth, because market forces will do so automatically.

In contrast, protectionism holds that regulation of international trade is important to ensure that markets function properly. Advocates of this theory believe that market inefficiencies may hamper the benefits of international trade and they aim to guide the market accordingly. Protectionism exists in many different forms, but the most common are tariffs, subsidies and quotas. These strategies attempt to correct any inefficiency in the international market.

A tariff decreases the supply of the imported goods. The decrease in imports to the domestic economy means that foreigners can buy less from that economy. Therefore, the value of domestic exports decreases by an amount equal to the drop in the value of domestic imports. If two or more states raise or impose tariffs on each other in retaliation for other trade barriers, a trade war may begin. Poor countries are more vulnerable than rich countries in trade wars, because many poor countries do not have the ability, for example, to raise subsidies and in raising protections against dumping of cheap products, a government risks making the product too expensive for its people to afford.

Nontariff barriers include quotas and voluntary export restraints. Quotas are quantitative restrictions on the maximum amount of goods that can be produced, and voluntary export restraints are agreements between governments in which the exporting nation agrees to limit the volume of its exports. For example, the worldwide lifting of textile quotas (by WTO agreement) caused major concerns on the part of U.S. textile manufacturers, who feared an avalanche of low-cost Chinese imports into the United States. After the potential threat of import tariffs emerged, the Chinese government agreed to a so-called voluntary quota, establishing self-imposed restrictions on textile exports to the United States. This was a way to gradually move from a quota-directed to a free-trade-based system for textiles.

Like tariffs, nontariff barriers raise the prices of imported goods and decrease the quantities imported. Unlike the situation with a tariff, however, the government gets no revenue from a nontariff barrier. For quotas, the revenue from the higher price goes to importers, and in the case of voluntary export restraints it goes to foreign exporters.

Although many reasons are given for protection, most of the suggested protective measures raise the cost of doing business substantially. Since the mid-20th century, nations have increasingly reduced tariff barriers and currency restrictions on international trade. Most countries in the world are members of the World Trade Organization, which limits in certain ways but doesn’t eliminate tariffs and other trade barriers. Some countries are also members of regional free trade areas that lower trade barriers among participating countries. The European Union and the North American Free Trade Agreement (NAFTA) are the world’s largest free trade areas.

There is no denying that international trade is beneficial for the countries involved in trade, if practised properly. International trade opens up the opportunities of global market to the entrepreneurs of the developing nations. It also makes the latest technology readily available to the businesses operating in these countries. It results in increased competition both in the domestic and global fronts. To compete with their global counterparts, the domestic entrepreneurs try to be more efficient and this in turn ensures efficient utilization of available resources. Open trade policies also bring in a host of opportunities for the countries that are involved in international trade.

However, it is important to consider that international trade alone cannot bring about economic growth and prosperity in any country. There are many other factors like flexible trade policies, favorable macroeconomic scenario and political stability that need to be there to complement the gains from trade.

NOTES

1. World Trade Organization (WTO). WTO, the only global international organization dealing with the rules of trade between nations, was established on 1 January 1995.At its heart are the WTO agreements, negotiated and signed by the bulk of the world’s trading nations and ratified in their parliaments. The goal is to help producers of goods and services, exporters, and importers conduct their business.

2. North American Free Trade Agreement (NAFTA). NAFTA is an agreement signed by the governments of Canada, Mexico, and the United States, creating a trilateral trade bloc in North America. The agreement came into force on 1 January 1994 and encourages free trade between these North American countries. It superseded the Canada–United States Free Trade Agreement between the U.S. and Canada. NAFTA has two supplements: the North American Agreement on Environmental Cooperation (NAAEC) and the North American Agreement on Labor Cooperation (NAALC).

Answer the questions:

What is international trade and why is it important?

What makes it grow and spread very fast nowadays?

What is specialization in international trade?

What benefits does international trade give to the participants?

What part does FDI play for the recipient and the investor?

What is the difference between international trade and domestic trade?

What forms the basis of international trade?

When does a country post a trade surplus and in which case does it run a trade deficit?

What is known as “visible” and “invisible” trade?

What is the essence of the two theories concerning the level of control imposed on trade?

What protective measures do countries take and why?

When is a trade war likely to break out?

Who suffers more in trade wars and why?

What factors should complement the gains from trade?