The Essential Principles of International Trade

The basic economic process is the allocation of scarce resources to different uses in order to satisfy wants and needs. Advances in technology and transport have made possible the use of more kinds of resources, from all parts of the world. The growth of advanced economies has been based on the exploitation of resources on a global scale, in other words on the process of international trade.

There are potential benefits from specialization and trade. International trade has the effect of enabling countries to consume some goods and services cheaply by importing them, as well as gaining access to some products which would otherwise be unavailable. It also has the effect of encouraging the reallocation of resources away from activities best served by imports into activities where the country has achieved a comparative cost advantage.

The benefits of world trade are optimized in conditions of Free Trade, where no artificial barriers to the flow of goods, services, labour or capital occur. Completely free trade conditions have never existed, but since 1945, as a result of the work of the General Agreement on Tariffs and Trade (GATT) and successively the World Trade Organisation (WTO), relatively free conditions have existed, resulting in the growth of trade and of world GDP.

Governments seek to protect key industries from competition by imports from countries with a cost advantage. It is undertaken particularly when such industries are seen as having key strategic or political significance. Such significance may be military or in terms of employment. Protectionism will also be undertaken when a country feels that its competitors are penetrating its markets by “unfair” means. One example is “dumping” products at below cost in order to earn hard currency. Protectionism is also often undertaken to protect “infant” industries. These are newly developed industries which are unable to compete on equal terms in world trade due to a lack of economies of scale. Third world countries may seek to induce growth by industrialization. India has been a case in point. Conversely mature economies may seek to protect old and inefficient industries either for strategic reasons, or to lessen the pains of structural change involved in running them down; European textile industries are a case in point.

Protection takes a number of forms. The most obvious is the use of tariffs on imports and quotas. In manufacturing industries these are less easy to use as a result of GATT and WTO agreements. Tariffs and quotas have been largely replaced by “covert” measures which are not covered by agreements. Such measures include the use of direct government subsidies to industries, government procurement policies favoring domestic suppliers and other measures. Protectionism is motivated by self interest, and is damaging to trading partners. If continued, it could stifle world trade and economic growth.

A country’s balance of payments is the financial record of trade and capital flows between this country and the rest of the world. It is divided into Current and Capital accounts. The Current Account is a summary of trade transactions with other countries in goods (visibles) and services (invisibles). The Capital Account records all transactions in assets, real or financial. Movements of official reserves and other official currency flows are the total of Official Financing, which is required after the summation of the current and capital accounts.

A balance of payments surplus is effectively an injection of money into the economy. A balance of payments deficit is a withdrawal of money from the economy. A balance of payments deficit cannot be sustained indefinitely. In the short term it will be financed by running down reserves or borrowing from abroad. But persistent deficits will soon exhaust these resources and other measures will have to be taken, e.g. deflation, devaluation or depreciation. Among other measures are those we have already mentioned: tariffs, quotas, voluntary export restraint agreements (VERs). Governments also try to make it more difficult for capital to leave the country or encourage exports by generous credit facilities.

International trade requires buyers to make payments in different currencies: in the seller’s currency, in the buyer’s currency or in a third hard currency. Here comes the problem of exchange rates. An exchage rate is the rate at which one country’s currency is exchanged for another. It is clearly of great importance to all businesses, but especially to those dependent on exports or using imported inputs. Movements in the exchange rate may wipe out profit margins, even where a firm has sought to anticipate or limit such fluctuations by using the forward markets.

Comprehension

4.4.1 Answer the questions using the active vocabulary.

1. How can you define the basic economic process?

2. What do you think facilitated the development of international trade?

3. W hat are the reasons for international trade?

4. What are the benefits of specialization and trade?

5. How can you define the concept of ‘comparative cost advantage’?

6. What is Free Trade? Describe the main features of it.

7. Does Free Trade really exist? Why or why not?

8. What was the mission of GATT? What organization succeeded to it?

9. How can you define the concept of ‘protectionism’?

10. What are the reasons for governments’ seeking to protect domestic industries?

11. What is dumping? Do you think it is legal to use dumping in free trade?

12. Could you give your own examples of protectionism in different countries?

13. What are the most widely used forms of protectionism?

14. Protectionism is ‘a mixed blessing’, isn’t it? Sum up the advantages and disadvantages of it.

15. What is a country’s Balance of Payments?

16. What is the difference between the Current Account and the Capital Account?

17. Does the balance of payments surplus mean that there is a net inflow of money into the economy?

18. How can a balance of payments deficit be eliminated?

19. What measures can governments take to remove the balance of payments deficit after the reserves have been exhausted?

20. What currencies can be used to make payments in international trade?

21. What is an exchange rate? Why is it of great importance to all businesses?

 

4.4.2 Mark these statements T(true) or F(false) according to the information in the text. If they are false say why.

1. All nations have sufficient amounts of resources to satisfy their wants and needs.(F)

2. Exploitation of resources on a global scale is impossible without international trade.)T)

3. The more the country is involved in international trade the less advanced it is. (F)

4. International trade is impossible without specialization. (T)

5. Different economies specialize in what they can do best and cheapest. Thus they derive a comparative cost advantage and benefit from it. (T)

6. International trade has the effect of enabling countries to import some expensive goods and services rather than export them cheaply.(F)

7. Since 1945, as a result of the work of the General Agreement on Tariffs and Trade (GATT) and successively the World Trade Organization (WTO), completely free conditions have existed, resulting in the growth of trade and of world GDP.(F)

8. Governments with a cost advantage seek to protect key industries from competition by imports from other countries.)F)

9. Dumping is an example of protectionism.(F)

10. Dumping is an example of ‘unfair’ competition.(T)

11. Third world countries may seek to induce growth by protecting their ‘infant’ industries.(T)

12. European textile industries have been protected by governments for strategic reasons.(T)

13. Tariffs and quotas have been largely covered by the WTO agreements.(T)

14. Direct government subsidies to industries, government procurement policies favoring domestic suppliers and other ‘covert’ measures have replaced tariffs on imports and quotas.(T)

15. The Current Account is a summary of all transactions in assets, real or financial.(F)

16. A balance of payments deficit is an imbalance in a nation's balance of payments in which payments made by the country exceed payments received by the country.(T)

17. A balance of payments proficit is considered unfavorable because more currency is flowing out of the country than is flowing in. (F)

18. Deflation, devaluation or depreciation are used to fight against a persistent balance of payments deficit.(T)

19. Governments also try to make it more difficult for capital to leave the country or encourage exports by generous credit facilities to fight against a persistent balance of payments deficit.(T)

20. An exchange rate is the price of one currency expressed in another currency.(T)

21. Movements in the exchange rate facilitate international trade.(F)

Language practice

4.5.1 Match the English terms in the left-hand column with the definition in the right-hand column.

 

	An exchange rate(F)	A	It refers to a globally traded currency that can serve as a reliable and stable store of value.
	A cost advantage(L)	B	An accounting record of all monetary transactions between a country and the rest of the world.
	A forward market(N)	C	An imbalance in a nation's balance of payments in which payments made by the country exceed payments received by the country.
	A real asset(J)	D	A type of exchange rate regime wherein a currency's value is allowed to fluctuate according to the foreign exchange market.
	A hard currency (A)	E	A decrease in the value of a particular currency relative to other currencies.
	A financial asset(M)	F	Price for which the currency of a country can be exchanged for another country’s currency.
	A comparative cost advantage(O)	G	A reduction in the value of a currency with respect to those goods, services or other monetary units with which that currency can be exchanged.
	Deflation(K)	H	The pricing of a product below its cost of production.
	A balance of payments deficit (C)	I	A system of trade policy that allows traders to act and or transact without interference from government.
	A floating exchage rate (D)	J	Physical or identifiable assets such as gold, land, equipment, patents, etc.
	Depreciation(E)	K	A decrease in the general price level of goods and services.
	Free trade(I)	L	Superiority achieved through factors such as access to cheaper inputs, efficient processes, favorable location, skilled workforce, superior technology, and / or waste reduction.
	A Balance of Payments (B)	M	An asset that derives value because of a contractual claim e.g. stocks, bonds, bank deposits, and the like.
	Dumping(H)	N	The over-the-counter financial market in contracts for future delivery, so called forward contracts.
	Devaluation(G)	O	The ability of an individual, country, region, or group to produce a good or service at a lower opportunity cost than that of a competing group/individual.

 

4.5.2 Complete the following text using suitable words or phrases from the box below.

 

A	supply of money (4)	F	currency (3)
B	balance of payments (10)	G	deficit (2)
C	inflation (6)	H	source (9)
D	imbalance (1)	I	economy (7)
E	trade (8)	J	exchange rate (5)