UNIT I FOREIGN TRADE AND POLICY OBJECTIVES To give broader understanding of the foreign trade and it‘s policy. This unit given students an understanding of the aspects that how the various theories explain the development of foreign trade between the nations. The main objectives of this unit are: To analysis similarities and differences between internal and international trade. To provide an overview of various theories in foreign trade. To evaluate the terms of trade between the nations. To analysis the concept of Balance of Payment and Adjustment Mechanism in Balance of Payment. STRUCTURE 1. Introduction 1.1 Meaning of International Trade 1.2 Similarities and Differences between Internal and International Trade 1.3 Gains from International Trade 1.4 Adam Smith‘s Theory of Absolute Differences in Cost 1.5 David Ricardo‘s Theory of Comparative Cost 1.6 Haberler‘s Theory of Opportunity Cost in International Trade 1.7 Heckscher-Ohlin Theory or Modern Theory of International Trade 1.8 Terms of Trade 1.9 International Trade in Services 1 1.10 Meanings of Balance of Payment 1.11 Structure of Balance of Payment 1.12 Balance of Payments Disequilibrium 1.13 Adjustment Mechanism in balance of Payments Account 1.14 Summary 1.15 Self-Assessment Questions 1. Introduction:- The international trade has been growing faster than world output indicates that the international market is expanding faster than the domestic markets. There are indeed many Indian firms too whose foreign business is gro wing faster than the domestic business. Business, in fact, is increasingly becoming international or global in its competitive environment, orientation, content and strategic intent. This is manifested/ necessitated/ facilitated by the following facts: (a) The Competitive business Environment (b)Globalisation of management (c) The universal liberlisation Policy by member countries. Table - 1 Growth of World Merchandise Exports Value of merchandise exports Year (in billions of US $) 1950 55 1960 113 1970 280 1980 1846 1990 3311 2000 6350 2002 6272 2 Table-1 shows the growth of world merchandise exports. The table indicates that during 1950-60, the value of world exports more than double. In the next decade it increased nearly 2 ½ times. During the 1970s, the value of the world exports increased by about 5 ½ times. Worldwide inflation, particularly the successive hikes in oil prices, significantly contributed to this unprecedented sharp increase in the value of world exports. During 1980-90, the value of world exports increased by 80 per cent. Between 1990 and 2000, it increased by over 90 per cent. In fact, exports of developing countries have been increasing faster than those of the developed. Historically, trade growth consistently outpaced overall economic growth for at least 250 years, except for a comparatively brief period from 1913 to 1950 characterised by heavy protectionism which was almost a by-product of the two World Wars. Between 1720 and 1913, trade growth was about one-and- a-half times the GDP growth. Slow GDP growth between 1913 and 1950 - the period with the lowest average economic growth rate since 1820 – was accompanied by even slower trade growth, as war and protectionism undermined international trade. This period was also plagued by the great depression. The Second half of the twentieth century has seen trade expand substantially faster than output. In the last two decades of the twentieth century, world trade has grown twice as fast as world real GDP (6 per cent versus 3 per cent). That trade has been growing faster than world output means that a growing proportion of the national output is traded internationally. The foreign trade-GDP ratio (i.e., the value of the exports expressed as a percentage of the 3 value of GDP) generally rises with economic development. This ratio has been generally high for the economically advanced countries when compared with that of the less developed countries. However, by the beginning of the 1990s, the developing countries overtook the developed countries in the trade-GDP ratio and today it is substantially high for developing countries over the developed ones. There are some extreme cases like Singapore and Hong Kong with exceptionally high foreign trade-GDP ratio of well over 200 per cent. Because of the faster trade growth, by the beginning of the 1990s, the developing countries overtook the developed countries in the trade-GDP ratio and today it is substantially high for developing countries over the developed ones. In 2001, the trade-GDP ratio was 38 per cent for high income economies and 49 per cent for the developing countries. The developing countries, thus, are much more integrated than the developed ones with the global economy by trade. Among he developing countries, it was 51 per cent for middle income economies and 39 per cent for low income economies. India presented an interesting case. There was near stagnation in its foreign trade-GDP ratio for about four decades since the commencement of development planning. During this period it hovered around 15 per cent. The inward looking economic policy, import compression and very slow progress on the export front were responsible for this. Since the economic liberalization, ushered in 1991, there has, however, been an increase in India‘s foreign trade- GDP ratio – it is about 20 per cent now. This unit concentrate on the main dimension of foreign trade and policy namely various trade theories, Terms of Trade, Balance of Payments and Adjustment Mechanism in Payments. 4 1.1 Meanings of International Trade:- Internal trade or domestic trade refers to the exchange of goods and services between the buyers and sellers within the political boundaries of the same country. It may be carried on either as a wholesale trade or a retail trade. External trade or international trade, on the other hand, is the trade between different countries i.e. it extends beyond the political boundaries of the countries engaged in it. In other words, it is the trade between two countries. Hence, it is also known as foreign trade. The need for international trade was not so compelling in those days. Trading with nations beyond the seas was not, however unknown to ancient Indians. Evidences about our international trade are found in the ancient literatures of our country particularly in our Sangam Literatures. There was a regular ―Trade Route‖ across the seas to the distant Jawa and Sumatra islands in the east and up to the Arabian Peninsula in the west. But the volume of such trade was insignificant and continued to remain so tight through the middle ages and up to the advent of the British rule in India. It is only after the establishment of the British rule that India‘s foreign trade took a definite shape. International trade on large scale has become a phenomenon of the 20th century especially after the Second World War. There is practically no country today, which is functioning as a closed system. Even socialist countries like Russia and China are now taking concrete steps to capture foreign markets for the products produced in their country. International trade, thus, has become as essential ingredient of the normal economic life of any country. In terms of economic development, international trade is a potentially effective engine of growth. 5 1.2 Similarities and Differences between Internal and International Trade:- In this section similarities and differences between the internal and international trade are focused. The general procedure, mechanism and operations are similar to both internal trade and international trade. The following are the basic similarities between the two. 1. Satisfaction of Consumer: Both in domestic trade and in international trade, success depends upon effectively satisfying the basic requirements of the consumers. 2. Goodwill Creation: It is necessary to build goodwill both in the domestic market as well as in the international market. If a firm is able to develop goodwill of the consumers, its task will be much simpler than the one, which is not able to build up its own reputation. In both the cases, the seller should take all positive measures to gain the confidence of the consumers in his product. 3. Market Research: The marketing programme should be formulated after a careful market research and survey. This proposition shall hold good in both the cases. Failure to assess the target market shall ultimately bring failure in the task of marketing. 4. Product Planning and Development: Research and development with a view to product improvement and adaptation is necessary in both internal and international trade. Particularly. The marketer should keep a constant watch over the market situation and the changes occurring in the consumer‘s tastes and the preferences and develop or modify his product to suit the needs of his customers. 6 However, there are certain special features, which differentiate internal trade from international trade. They are explained as following manner: 1. Demand and Supply: Demand and supply cannot work out their full effects where foreign trade is concerned. Where as such factors can work out their full efforts in the case of internal trade. 2. Physical Obstacle to Commerce: Where international trade is carried on, a far greater degree of inequality between conditions of production in different countries is necessary to stimulate trade when the countries are widely separated than when they are adjoining. 3. Artificial Barriers to Trade: The natural difficulties may be increased by artificial barriers to trade, either through prohibitive laws as in war time of through customs duties or protective tariffs in the context of international trade. 4. Obstacles to Migration of Labour: Serious obstacles to the migration of labour from country to country such as language differences are often prohibitive, while feelings of patriotism help to keep men in their own country.