International Trade: Concepts and Theory

CHAPTER 2

Early trade was conducted via over-land routes. The many stories of Marco Polo are well known. Human and geographic barriers affected the relative of size of markets and trade. However, trading exists because it is beneficial to all involved. Why do countries trade? What are the social and economic advantages of trading?

Historically the role of the merchant trade has been held in low regard. Merchant traders seen as intruders who produce nothing of value. Experience has shown, however, that merchant traders provide a very import service to their communities.

World War II devastated the economies of Europe. Post WWII reconstruction created increased trade between Europe & the US. The depression caused countries to protect markets leading to worldwide problems. WWII disrupted trade but lifted others out of the worldwide depression. After the war colonial powers declined and many newly independent countries created new markets. At about the same time countries started banding together to promote internal trade (EFTA – European Free Trade Area, CARIFTA).

In 1947, the General Agreement on Tariffs and Trade (GATT) was negotiated as a voluntary agreement. Member countries were voluntary associates in the promotion of idea exchange to facilitate trade and prevent protectionism. The agreement was aimed at encouraging trade and reducing tariffs and other restrictive market practices.

From the 18th century to the 1920s’s the UK dominated world trade. After the 1920’s (helped by WWII) the US became the leader in world trade. Developments in Europe, Asia, and the developing world created new marketing opportunities and led to the development of the multinational firm. The rise of US multinational corporations (MNCs) caused concern among nations that felt that MNSc dominates the economies of smaller countries. By the late 1970’s US MNCs started having competition from firms from developing countries. In some cases international subsidiaries of the parent firm started competing for world markets. As economic power became more evenly distributed among developed countries, the US lost some of its global competitive edge. In 1971 the US ran its first merchandise trade deficit (imports greater than exports = $2b). By 1986 the deficit was $168b and rose to $191 in 1996.

Trade and Economic Well-being

Gains in international trade caused by local production advantages. This is often the result of capital availability, specialization of labor, abundance of natural resources, skilled labor and management. Specialization leads to increased standard of living by allowing the fullest possible use of local advantages and the use of resources at the highest level of productivity.

In the short run imports can cause local unemployment – the main reason for trade barriers. However, there are many advantages to international trade: 1. International trade also results in an increase in the amount of foreign exchange flowing into the country. This can lead to a satisfactory balance-of-payment position. 2. Imports save money by eliminating or increasing the efficiency of local firms. 3. Maintains downward pressure on domestic prices 4. Facilitates innovation 5. Promotes fashion 6. Supply merchandise not produced locally.

Balance of Payments Balance of payment is a measure of the extent of trade among countries. It tells about the trade situation in a country at a specific point in time. With trade money moves in and out of the country (imports, exports, investments, payments, aid, unilateral transfers). The balance of payments is the accounting system that records a nation’s international financial transactions. The balance of payment is a double entry accounting system that records transactions between residents and persons in the rest of the world for a specified period. It is a record, not a determinant of trade conditions.

Balance of payment affect trade policies, monetary value and domestic economic policies to include wages, employment, and investments. It also affects the value of the local currency and nation’s ability to acquire foreign currency.

The balance of payment represents the difference between receipts (inflows) and payments (outflows). If payments are greater than receipts a deficit results. In assessing the balance of payments consider the three major accounts: 1. Current Account – a record of merchandise and service trade, plus unilateral transfers of funds. 2. Capital Account – direct and portfolio investment and short-term capital movement to and from other countries. 3. Official Reserves Account – exports and imports of gold, increases & decreases in foreign exchange, and increases and decreases in liabilities to foreigners.

Balance of Trade

The balance of trade can be favorable or unfavorable. It focuses on the relationship between imports and exports. A negative balance of trade means that imports exceed exports. This can lead to negative balance of payments. As a country’s wealth declines standard of living is reduced.

Why does Trade take place? The theory of relative advantage states that one nation can produce a produce more efficiently than another country. The notion of an absolute advantage indicates that goods can be produced more efficiently (cheaply) in one place than in another. Comparative advantage suggests that even if one country can produce goods more cheaply than another, both countries would be better off if they each produce and trade the goods in which they each have an advantage (rather than trying to produce everything themselves). With comparative advantage gains come from concentrating production effort (specializing) on what one can do best. This leads to the production of a surplus (of better quality0 which can then be traded.

In addition to demand, there are other conditions needed for trade to occur. Trade may or may not occur for the following reasons: 1. Gains in trading and shipping greater than local production. 2. Product from foreign producers more acceptable to traders and consumers. 3. Traders aware of the costs of goods at different locations 4. Cost differences across nations large enough to be profitable. 5. Artificial barriers do not restrict trade or increase the cost of trading. 6. Government must not restrict trade