International Trade
The buying and selling of goods and services between and among countries. When goods or services are bought from another country this is called import trade and the reverse is export trade.
Trade in goods is referred to as visible trade while that of services is called invisible trade.
The theory of comparative advantage
- The theory of comparative advantage was first presented by David Ricardo, an economist. A country has a comparative advantage in producing a good if the opportunity cost of producing that good in terms of other goods is lower in that country than it is in other countries.
- Trade between two countries can benefit both countries if each country exports the goods in which it has a comparative advantage. Is this true? It is a statement of the possibility not what actually happens in the real world.
- In the real world, there is no central authority deciding which country should produce roses and which should produce computers. Nor is there anyone handing out roses and computers to consumers in both places. Instead, international production and trade is determined in the marketplace where
supply and demand rule.
Criticism of the theory of comparative advantage (CA)
- CA states that all countries gain trade; and this may not necessarily be true
- While two countries engaged in trade do benefit from it, they do not benefit equally. E.g., the greater the price of cut flower in world trade, the greater the gains for cut flower exporters
- CA states that a country gains from trade in the aggregate; it does not say that every citizen benefits. There is a temptation to suppose that the ability to export a good depends on your country having an absolute advantage in productivity, yet an absolute productivity advantage over other countries in producing a good is neither a necessary nor a sufficient condition for having a comparative advantage in that good (Krugman & Obstfeld, 2003).
- It does not take into account the need for diversification and self-reliance (which tends to disagree with the principle of specialization) where a country should aim to produce most of its domestic market requirements.
- It assumes the practice of free trade in the world yet in the real world there are trade restrictions with trade barriers. Most markets do not easily allow trade and countries are always in endless meetings negotiating trade arrangements. The EU and USA have negotiated more trade agreements than any country on the globe.
- The opportunity cost of producing a product and export it should not ignore the costs associated with ensuring that the product reaches the market; e.g., it ignores such costs as transport, other logistics, and handling that influence the benefits from international trade.
- It is possible for a country to have absolute advantage in more than one product. It should not necessarily focus only on one product.
The theory of absolute Advantage: A country should have one or more products it produces more efficiently (at less input costs) than anyone else. There has been a tendency to confuse comparative advantage with absolute Advantage. According to Krugman and Obstfeld (2003), it is comparative advantage (not absolute advantage) that determines who will and should produce a good.
Endogenous Advantage: International trade has always had its beginning on the premise that many goods are traded because they are unavailable from local production. They cannot be produced locally. Endogenous advantage arises from economic interaction of nations.This advantage usually co-exists with comparative advantage. Endogenous advantage results from economies of scale. Economies of
scale can lead producers to produce more quantities of a product at a lower cost. The country that has companies enjoying economies of scale will end up realizing low prices. This has positive indicators for economic growth.
Benefits of international trade
- Enables a country to get what they cannot produce, either due to, among others, seasonal or geographical factors.
- Enables a country sell what it produces but does not consume domestically. Uganda, Kenya and
Zimbabwe, for example produce rose flowers but they don’t have a big domestic market – and so they export them to other countries mainly via the Dutch auction market in the Netherlands. - Opportunity Cost: In order to produce the winter roses, USA will have to produce less of other goods such cars or computers. Instead of USA producing roses during winter, it can produce more computers and sell in different countries. This is the opportunity that a country can enjoy in international trade. The opportunity cost of roses in terms of computers is the number of computers that could have been produced with the resources used to produce a given number of roses.
- Increasing employment opportunities: new jobs opportunities can be created in industries producing for export and associated services firms (in transport, logistics, handling, etc.)
- It provides a market for the surplus production, over a country’s total domestic consumption. What
cannot be purchased and consumed domestically can be exported. - Increases trade taxes: It generates government revenue in form of export and import duties.
- Widened consumers’ choice: International trade enables consumers in one country to get a variety of goods to choose from. This variety is composed of local and import goods.
- During a crisis (after war or natural disaster), the country can obtain imported goods to cover the shortage of the total domestic consumption.
- International, though mainly associated with exchange of goods, also involves exchange of ideas, and values by different parties involved in trade.
- It promotes competition, with domestic industries improving on the quality of their goods to match the standard of imports
- International trade, particularly exporting, is a way of generating the needed foreign exchange that may be used to import what a country does not produce. In most developing countries who export less or more of cheap raw products from agriculture – there is a lot of dependency for foreign aid. More exports would help reduce the donor dependency.
- Trade helps reduce the risk of war between countries: this is a long run claim by people
such as Montesquieu and Immanuel Kant. Montesquieu (1748, The Spirit of the Laws) argues that ‘commerce cures destructive prejudices’. And Immanuel Kant (1724-1804) argues that sustainable peace could be built on a combination of democracy, international organizations and economic interdependence.
Case against international trade
Arguments for trade restrictions/ protectionism
- International trade can adversely affect the owners of resources that are ‘specific’ to industries that compete with inputs, i.e. that cannot find alternative employment in other industries (Krugman &Obstfeld, 2003).
- Trade can also alter the distribution of income between broad groups, such as workers and owners of capital.
- Protection of infant industries.
- Anti-dumping Argument: There is the argument that countries, especially developed nations, sell their commodities in poor countries at a price lower than that charged at home. Dumping makes domestically produced commodities less competitive – after all they are not of the same quality.
- Employment: When a country imports a finished product, it means that it has lost jobs to its people.
- Source of government revenue: Free trade, where taxes on imports are eliminated, denies the country government revenue from taxes.
- Check imported inflation: A country can restrict certain imported goods or goods from certain countries that are facing inflation. If imported, they will increase on the level of inflation in the importing country.
- Reduce foreign aid dependency: The more the country exports and earns more foreign exchange, the better for those countries with regard to reducing aid dependency.
- National welfare arguments against free trade
- The terms of trade argument against free trade: However, the terms of trade argument against free trade has some limitations. Most small countries have very little ability to affect the world prices of either their imports or other exports. In practice, the terms of trade argument is rarely used by governments as a justification for trade policy.
Trade Restrictions (or protectionism?)
Tariff and non-tariff barriers:
These are two (2) types of tariffs:
- Specific tariffs which are levied as a fixed charge for each unit of goods imported. For example $10 per 50kg of sugar
- Ad Varolem tariffs which are taxes levied as a percentage of the value of the imported goods. For example a 10% tariff that country X levies on imported sugar.
Quotas: A country fixes the amount (quantities) or value (x US dollars) of commodities to be imported into a country for a given period of time.
Tariffs: High taxes on imports can be deliberately imposed on goods to discourage their consumption. The taxes imposed can be specific (on the volume of commodities) or ad varolem (value of the commodities)
Foreign exchange control: In non-liberalized countries, the government can determine the amount of foreign exchange that is allocated for importation of goods and services.
Devaluation: It is when the official rate at which a country’s central bank is prepared to exchange the local currency for foreign currency (e.g. US dollar, or UK pound sterling) is abruptly increased. This is a reduction in the value of the currency in terms of other currencies. This makes foreign exchange more expensive – and this will result in imported goods being expensive as result; and exports cheaper. Devaluation policy is usually undertaken to encourage exports
Total ban: A country orders that certain products not imported into in the country. Importation of prohibited goods is a crime. Imports from Cuba, and for over 40 years, to USA have been under a total ban.
Import licenses: Issuing of import licenses may be restricted and therefore issued to few persons; and sometimes at a high price to reduce the number importers.
An export subsidy is a payment to a firm or individual that sells sends/ships a good abroad. A subsidy can be either specific (as a fixed sum per unit) or a percentage of the value exported.
Export Restraints: These are limitations on the quantity of exports, which is usually which is usually imposed by the exporting country at the request of the importing country.
Other trade policy instruments
- Export Credit Subsides: Most countries have a government institution called the Export-Import Bank which provides loan at a subsidized rate with the purpose of aiding export.
- National Procurement or public procurement or a government purchasing. The purchases by the government can be directed towards domestically produced goods even when these goods
are more expensive then imports. To support domestic producers, government owned companies buy from domestic suppliers even when these suppliers charge higher prices than suppliers in other countries - Red-tape barriers (bureaucracy): A government can restrict imports without doing so formally. Such governments find it easy to do so under health and safety reasons and customs procedures.
The classic example is the French Decree in 1982 that all Japanese videocassette recorders must pass through the tiny customs house at Poitiers – effectively limiting the actual imports to a handful.
