Foreign Trade in the World Economy

The world economy is increasingly becoming a single economic unit. Individual national economies are developing closer linkages through trade, capital investment, and financial institutions. Multinational corporations spread their activities across national boundaries, and the international banking system carries on banking activities throughout the world.

During the last two decades, while world output has been growing about 4% per year, world trade has been growing about 8% and production by foreign subsidiaries has been growing by some 10%. Export and import shares of output have increased considerably in practically all industrial sectors. A growing percentage of world trade is becoming intra-industry trade (reflecting economies of scale and increased demand for differentiated products) and even intra-firm trade by transnational firms (reflecting decomposition of production activities around the world).

As nations engage in world trade, some of them end up with a favourable balance of trade, in which exports exceed imports, and others have an unfavourable balance of trade, in which imports exceed exports.

Economists today recognize that a nation that sells abroad must also buy from foreign nations, in order to give them its currency to use in purchasing its goods.

History also reveals a correlation between the economic development of a nation and the status of its balance of trade. Emerging or developing nations are generally heavy importers especially of machinery, equipment, and various types of finished goods. Exports in a nation's early stages of economic growth generally consist largely of raw materials from the nation's natural resources. A developing nation, lacking aid and investment capital, must finance imports by diverting sufficient quantities of natural resources and agricultural commodities from domestic to foreign (export) uses. As a country develops and is able to produce more of its own capital and finished goods, it will have less need for imports and an even balance of trade may come about. Finally, with its debts liquidated, a fully developed industrial nation tends to be a large exporter of capital. Consequently, a nation may shift from being a longtime debtor to being a creditor as its balance of trade shifts from one side to another.

More important than balance of trade in international economics is the balance of payments. Although the flow of merchandise constitutes a major category on international transactions, it constitutes only part of a nation's balance of payments.

The balance of payments is a statistical account (current and capital) of the financial transactions between nations over a period of 1 year.

Most transactions in the current account involve the purchase and sale of goods and services: income from merchandise trade and income generated from services performed by one country for another. The current accounts include investment income, interest, dividends, corporate profits and military transactions. The final item in the current account consists of unilateral transfers (foreign aid, emergency relief etc.).

The capital account depicts the flow of capital investments between nations: the purchase and sale of physical assets and financial assets.

Any international transaction that provides a claim for payment from another country is entered as a credit in the balance of payments of a given country and recorded with a + sign. Conversely, a debit is recorded whenever a transaction gives rise to a claim by foreign countries for payment from a given country. Debit transactions are designated by a -sign.

1. What is the balance of trade and how is it correlated with the economic development of a nation?

2. What is the balance of payment and why is it more important than balance of trade in international economies?

3. What is the current account and what is the capital account?

4. What is debit and credit?

Text 3

Read the text. Be ready to speak on the four basic methods of payment. Characterize each of them. Retell the text.