itf 1st unit

8/6/2019 ITF 1st Unit

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Meaning

The economic interaction among different nations involving the exchange of goods

and services, that is, exports and imports. The guiding principle of international

trade is comparative advantage, which indicates that every country, no matter theirlevel of development, can find something that it can produce cheaper than another

country. International finance, the study of payments between nations, is a related

area of international economics. A summary of international trade undertaken by a

particular nation is given with the balance of trade.

Benefits of International TradeInternational 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 services, goods, and capital among various countries and regions, without

much hindrance. The international trade accounts for a good part of a countrys

gross domestic product. It is also one of important sources of revenue for a

developing country.With the help of modern production techniques, highly advanced transportation

systems, transnational corporations, outsourcing of manufacturing and services,

and rapid industrialization, the international trade system is growing and spreading

very fast.

Mary Low


2/19

International trade among different countries is not a new a concept. History

suggests that in the past there were several instances of international trade.

Traders used to transport silk, and spices through the Silk Route in the 14th

and 15th century. In the 1700s fast sailing ships called Clippers, with special

crew, used to transport tea from China, and spices from Dutch East Indies to

different European countries.

The economic, political, and social significance of international trade has been

theorized in the Industrial Age. The rise in the international trade is essential

for the growth of globalization. The restrictions to international trade would limit

the nations to the services and goods produced within its territories, and they

would lose out on the valuable revenue from the global trade.

The benefits of international trade have been the major drivers of growth for

the last half of the 20th century. Nations with strong international trade have

become prosperous and have the power to control the world economy. The

global trade can become one of the major contributors to the reduction of

poverty.

David Ricardo, a classical economist, in his principle of comparative advantage

explained how trade can benefit all parties such as individuals, companies, and

countries involved in it, as long as goods are produced with different relative

costs. The net benefits from such activity are called gains from trade. This is

one of the most important concepts in international trade.

Mary Low


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Adam Smith, another classical economist, with the use of principle of absolute

advantage demonstrated that a country could benefit from trade, if it has the

least absolute cost of production of goods, i.e. per unit input yields a higher

volume of output. According to the principle of comparative advantage, benefits of trade are

dependent on the opportunity cost of production. The opportunity cost of

production of goods is the amount of production of one good reduced, to

increase production of another good by one unit. A country with no absolute

advantage in any product, i.e. the country is not the most competent producer

for any goods, can still be benefited from focusing on export of goods for whichit has the least opportunity cost of production.

Benefits of International Trade can be reaped further, if there is a

considerable decrease in barriers to trade in agriculture and manufactured

goods.

Some important benefits of International Trade

Enhances the domestic competitiveness

Takes advantage of international trade technology

Increase sales and profits

Extend sales potential of the existing products

Maintain cost competitiveness in your domestic market

Mary Low


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Enhance potential for expansion of your business

Gains a global market share

Reduce dependence on existing markets

Stabilize seasonal market fluctuations

Basis of international trade

The basis for international trade is that a

nation can import a particular good or

service at a lower cost than if it were

produced domestically- In other words, if you can buy it cheaper than

you can make it you buy it

- This maxim is true for individuals and nations

- This is called specialization and exchange.

Balance of trade

The difference between a country's imports and its exports. Balance of trade isthe largest component of a country's balance of payments. Debit items include

imports, foreign aid, domestic spending abroad and domestic investments

abroad. Credit items include exports, foreign spending in the domestic

economy and foreign investments in the domestic economy. A country has a

trade deficit if it imports more than it exports; the opposite scenario is a trade

surplus. Mary Low


5/19

The balance of trade is one of the most misunderstood indicators of the U.S.

economy. For example, many people believe that a trade deficit is a bad thing.

However, whether a trade deficit is bad thing is relative to the business cycle

and economy. In a recession, countries like to export more, creating jobs anddemand. In a strong expansion, countries like to import more, providing price

competition, which limits inflation and, without increasing prices, provides

goods beyond the economy's ability to meet supply. Thus, a trade deficit is not

a good thing during a recession but may help during an expansion

The balance of trade forms part of the current account, which includes other

transactions such as income from the international investment position as wellas international aid. If the current account is in surplus, the country's net

international asset position increases correspondingly. Equally, a deficit

decreases the net international asset position.

The trade balance is identical to the difference between a country's output and

its domestic demand (the difference between what goods a country produces

and how many goods it buys from abroad; this does not include money re-spent on foreign stock, nor does it factor in the concept of importing goods to

produce for the domestic market).

Mary Low


6/19

Measuring the balance of trade can be problematic because of problems with

recording and collecting data. As an illustration of this problem, when official

data for all the world's countries are added up, exports exceed imports by

almost 1%; it appears the world is running a positive balance of trade withitself. This cannot be true, because all transactions involve an

equal credit ordebit in the account of each nation. The discrepancy is widely

believed to be explained by transactions intended to launder money or evade

taxes, smuggling and other visibility problems. However, especially for

developed countries, accuracy is likely.

Factors that can affect the balance of trade include:

The cost of production (land, labor, capital, taxes, incentives, etc.) in the

exporting economy vis--vis those in the importing economy;

The cost and availability of raw materials, intermediate goods and other inputs;

Exchange rate movements;

Multilateral, bilateral and unilateral taxes or restrictions on trade;

Non-tariff barriers such as environmental, health or safety standards;

The availability of adequate foreign exchange with which to pay for imports;

and

Prices of goods manufactured at home (influenced by the responsiveness of

supply)

Mary Low


7/19

Balance of payment

Balance of payments accounts are an accounting record of all monetary

transactions between a country and the rest of the world.[1] These transactions

include payments for the country'sexports and imports ofgoods, services,and financial capital, as well as financial transfers. The BOP accounts

summarize international transactions for a specific period, usually a year, and

are prepared in a single currency, typically the domestic currency for the

country concerned. Sources of funds for a nation, such as exports or the

receipts of loans and investments, are recorded as positive or surplus items.

Uses of funds, such as for imports or to invest in foreign countries, arerecorded as negative or deficit items.

When all components of the BOP accounts are included they must sum to zero

with no overall surplus or deficit. For example, if a country is importing more

than it exports, its trade balance will be in deficit, but the shortfall will have to

be counter-balanced in other ways such as by funds earned from its foreign

investments, by running down central bank reserves or by receiving loans fromother countries.

While the overall BOP accounts will always balance when all types of

payments are included, imbalances are possible on individual elements of the

BOP, such as the current account, the capital account excluding the central

bank's reserve account, or the sum of the two.

Mary Low


8/19

Imbalances in the latter sum can result in surplus countries accumulating

wealth, while deficit nations become increasingly indebted. The term balance

of payments often refers to this sum: a country's balance of payments is said

to be in surplus (equivalently, the balance of payments is positive) by a certainamount if sources of funds (such as export goods sold and bonds sold) exceed

uses of funds (such as paying for imported goods and paying for foreign bonds

purchased) by that amount. There is said to be a balance of payments deficit

(the balance of payments is said to be negative) if the former are less than the

latter.

The two principal parts of the BO

Paccounts are the current account andthe capital account.

The current accountshows the net amount a country is earning if it is in

surplus, or spending if it is in deficit. It is the sum of the balance of trade (net

earnings on exports minus payments for imports),factor income (earnings on

foreign investments minus payments made to foreign investors) and cash

transfers. It is called the currentaccount as it covers transactions in the "hereand now" - those that don't give rise to future claims.[2]

Mary Low


9/19

The capital accountrecords the net change in ownership of foreign assets. It

includes the reserve account (the foreign exchange market operations of a

nation's central bank), along with loans and investments between the country

and the rest of world (but not the future regular repayments/dividends that theloans and investments yield; those are earnings and will be recorded in the

current account). The term "capital account" is also used in the narrower sense

that excludes central bank foreign exchange market operations: Sometimes the

reserve account is classified as "below the line" and so not reported as part of

the capital account.

Barriers to internatonal trade Free trade refers to the elimination of barriers to international trade. The most

common barriers to trade are tariffs, quotas, and nontariffbarriers.

A tariff is a tax on imports, which is collected by the federal government and

which raises the price of the good to the consumer. Also known as duties or

import duties, tariffs usually aim first to limit imports and second to raise

revenue. A quota is a limit on the amount of a certain type of good that may be imported

into the country. A quota can be either voluntary or legally enforced.

EconoTalk

Mary Low


10/19

A tariffis a tax on imported goods, while a quota is a limit on the amount of

goods that may be imported. Both tariffs and quotas raise the price of and

lower the demand for the goods to which they apply. Nontariff barriers, such

as regulations calling for a certain percentage of locally produced content inthe product, also have the same effect, but not as directly.

EconoTip

You may wonder why a nation would ever choose to use a quota when a tariff

has the added advantage of raising revenue. The major reason is that quotas

allow the nation that uses them to decide the quantity to be imported and let

the price go where it will. A tariff adjusts the price, but leaves the post-tariffquantity to market forces. Therefore, it is less predictable and precise than a

quota.

The effect of tariffs and quotas is the same: to limit imports and protect

domestic producers from foreign competition. A tariff raises the price of the

foreign good beyond the market equilibrium price, which decreases the

demand for and, eventually, the supply of the foreign good. A quota limits thesupply to a certain quantity, which raises the price beyond the market

equilibrium level and thus decreases demand.

Mary Low


11/19

Tariffs come in different forms, mostly depending on the motivation, or rather

the stated motivation. (The actual motivation is always to limit imports.) For

instance, a tariff may be levied in order to bring the price of the imported good

up to the level of the domestically produced good. This so-called scientifictariffwhich to an economist is anything buthas the stated goal of

equalizing the price and, therefore, leveling the playing field, between foreign

and domestic producers. In this game, the consumer lose

Trade barriers include tariff and and trade blocks with international

trade.[1] The barriers can take many forms, including the following terms that

include many restrictions in international trade within multiple countries thatimport and export any items of trade:

Tariffs

Non-tariff barriers to trade

Import licenses

Export licenses Import quotas

Subsidies

Voluntary Export Restraints

Local content requirements

Embargo

Mary Low


12/19

Most trade barriers work on the same principle: the imposition of some sort

ofcost on trade that raises the price of the traded products. If two or more

nations repeatedly use trade barriers against each other, then a trade

warresults. Economists generally agree that trade barriers are detrimental and decrease

overall economic efficiency, this can be explained by the theory of comparative

advantage. In theory, free trade involves the removal of all such barriers, except

perhaps those considered necessary for health or national security. In practice,

however, even those countries promoting free trade heavily subsidize certain

industries, such as agriculture and steel. Trade barriers are often criticized for the effect they have on the developing

world. Because rich-country players call most of the shots and set trade policies,

goods such as crops that developing countries are best at producing still face

high barriers. Trade barriers such as taxes on food imports or subsidies for

farmers in developed economies lead to overproduction and dumping on world

markets, thus lowering prices and hurting poor-country farmers. Tariffs also tendto be anti-poor, with low rates for raw commodities and high rates for labor-

intensive processed goods. The Commitment to Development Index measures

the effect that rich country trade policies actually have on the developing world.

Mary Low


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WTO

The World Trade Organization (WTO) is the only global international

organization dealing with the rules of trade between nations. At its heart are

the WTO agreements, negotiated and signed by the bulk of the worlds tradingnations and ratified in their parliaments. The goal is to help producers of goods

and services, exporters, and importers conduct their business.

Who we are

What we do

What we stand for

There are a number of ways of looking at the World Trade Organization. It is

an organization for trade opening. It is a forum for governments to negotiate

trade agreements. It is a place for them to settle trade disputes. It operates a

system of trade rules. Essentially, the WTO is a place where member

governments try to sort out the trade problems they face with each other.

Where countries have faced trade barriers and wanted them lowered, the

negotiations have helped to open markets for trade. But the WTO is not just

about opening markets, and in some circumstances its rules support

maintaining trade barriers for example, to protect consumers or prevent the

spread of disease.

Mary Low


14/19

At its heart are the WTO agreements, negotiated and signed by the bulk of the

worlds trading nations. These documents provide the legal ground rules for

international commerce. They are essentially contracts, binding governments

to keep their trade policies within agreed limits. Although negotiated andsigned by governments, the goal is to help producers of goods and services,

exporters, and importers conduct their business, while allowing governments

to meet social and environmental objectives.

The systems overriding purpose is to help trade flow as freely as possible

so long as there are no undesirable side effects because this is important

for economic development and well-being. That partly means removingobstacles. It also means ensuring that individuals, companies and

governments know what the trade rules are around the world, and giving them

the confidence that there will be no sudden changes of policy. In other words,

the rules have to be transparent and predictable.

Trade relations often involve conflicting interests. Agreements, including those

painstakingly negotiated in the WTO system, often need interpreting. Themost harmonious way to settle these differences is through some neutral

procedure based on an agreed legal foundation. That is the purpose behind

the dispute settlement process written into the WTO agreements.

Mary Low


15/19

Foreign trade

Little has been said about foreign trade. Yet growth in most economies is very

much dependent upon imports and the ability to export in order to pay for

imports. The fact that some economies recovered relatively quickly from World

War II and grew much more rapidly in the postwar period than others has

stimulated a great deal of comparative analysis in growth theory. The

exceptionally high growth rates in Japan and Germany compared to the

general sluggishness of the British economy are related to foreign trade.

Economists have pointed to the periodic balance of payments crises

experienced by Britain and the lack of such crises in Germany. During a

boom, as incomes rise the demand for imports will rise also as a natural

feature of prosperity. But if exports do not also rise at the same time, the

authorities may be forced to take fiscal or monetary countermeasures and

slow down the economy in an effort to bring imports and exports back into

balance. Or exports may fail to grow sufficiently because labour costs are

rising very rapidly and pushing up prices of exports faster than in competing

countries.

Mary Low


16/19

A policy of encouraging growth has the effect of keeping the demand for

imports high and making labour markets tight, thereby tending to push up

money wage rates. At the same time, such a policy also tends to encourage

innovations and investment projects that are very productive, particularly if the

demand pressures are sustained. A stop policy naturally has just the oppositeeffects, both good and bad from the point of view of a countrys balance of

payments. The question is which policy will in the long run result in less rapidly

rising costs and prices. Many writers have argued that if demand pressures are

maintained the response or adjustment of productivity and therefore of supply to

these pressures will be such that the country will soon find itself in a more

competitive position. Running an economy flat out, however, is likely to causea short-run balance of payments crisis and lead to devaluation of currency.

Mary Low


17/19

Impact of foreign trade in economic growth

by V S Rama Rao on October 9, 2007

Foreign trade enlarges the market for a countrys output. Exports may

lead to increase in national output and may become an engine ofgrowth. Expansion of a countrys foreign trade may energize an

otherwise stagnant economy and may lead it on to the path of economic

growth and prosperity. Increased foreign demand may lead to large production

and economies of scale with lower unit costs. Increased exports may also lead

to greater utilization of existing capacities and thus reduce costs which may

lead to a further increase in exports. Expanding exports may provide greateremployment opportunities. The possibilities of increasing exports may also

reveal the underlying investment in a particular country and thus assist in its

economic growth.

Mary Low


18/19

Rising exports and the consequent increase in domestic output may lead to an

increase in domestic income and employment. This will lead to the creation of

new effective demand for a number of commodities in the domestic market. As a

result, all the industries producing for the domestic market will also get a big

boost. Some of the infrastructure specially erected for the development of export

industries like new transport facilities; training facilities etc may also assist the

development of domestic industries. In recent years, newly industrializing

economies (NIC) of Asia namely Hong Kong, Singapore, Taiwan, Malaysia,

Thailand and South Korea have achieved remarkable growth by exports of

manufacturers. Thus foreign trade has a multiplier effect on economic growth.

India also has had its share of prosperity due to the development of foreign

trade. From times immemorial, India was considered as the workshop of the

world. Articles produced by India s skilled artisans were considered worth their

weight in gold. That explains why, even in the absence of plentiful gold mines,

India was a repository of gold.

The opening of Suez Canal in 1869 led to a reduction of distance between India

and Europe which led to an increase in the demand for India commercial crops.As a result, production and exports of commercial crops increased. The process

was encouraged by the import of foreign capital for the provision of irrigation

facilities and railway lines to connect the interior with the port towns. The rise in

the output of such agricultural crops as oilseeds, cotton, jute and tea, was

largely due to a flourishing export trade. This initiated the process of economic

growth in India, albeit on not very desirable lines.

Mary Low


19/19

Even now foreign trade continues to engender growth in India. For example,

many export processing zones and special economic zones have been

established to facilitate manufacture or reprocessing for export. All such efforts

create a lot of employment opportunities and lead to an increase in incomes

which lead to the demand for many new products which are very oftenmanufactured in the country itself.

Foreign trade induces economic growth in other ways too. The appearance of

imported commodities in a country invariably creates new demands. This

provides an inducement to the people in general to work hard and earn enough

money to be able to purchase some of the imported articles. This necessarily

leads to economic growth. Again, there is an urge in enterprising industrialists

to produce the things imported in the country itself. Japan provides an excellent

example of this type. It is said Japan never imports a manufactured article

twice. This has happened in almost all countries including India. In fact, this

natural urge for import substitution provides a strong stimulus to economic

growth. The strategy behind India earlier development plans was mainly one of

import substitution. The existence of a large domestic market also provides astrong incentive for import substitution as, for example, consumer industries in

India. In the case of basic and strategic industries, economic independence and

self reliance have been the motive force behind import substitution, and in these

cases cost becomes a secondary consideration. In many a case, successful

import substitution adds to the export potential. Many of the new industrial

products manufactured in India are exported. Mary Low

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