Unit 6: International Trade PDF

# Unit 6: International Trade ## UNIT 6: INTERNATIONAL TRADE **International trade** is the exchange of goods and services between countries. International trade is the exchange of capital, goods, and services across international borders. ### 6.1 The Importance of International Trade - The worl...

# Unit 6: International Trade ## UNIT 6: INTERNATIONAL TRADE **International trade** is the exchange of goods and services between countries. International trade is the exchange of capital, goods, and services across international borders. ### 6.1 The Importance of International Trade - The world's economy is gradually becoming a single economy. This is known as **globalization**. - Consequently, the world is called a **global economy** or **global market**. **Benefits of international trade** - All countries benefit from international trade as surpluses are sold and shortages are bought into the country. - International trade expands the markets and the business. - International trade gives competitive advantage to the countries by making them specialist in what they are best at. - It gives a better standard of living to nationals and more variety to customers. - It also increases revenue for the government in the form of taxation. - International trade has also created better and strong relations between countries. - Local shortages can be complemented. - More foreign exchange reserves (in case of export). - More employment is created (all three sectors in case of export and the tertiary sector in case of import). - In case of imports, increases competition and thus quality of local production. **Disadvantages of foreign trade** - Loss of employment in the primary and secondary sector in case of import. - Loss to the local producers. - Loss of foreign exchange (in case of import). - Importing country can become dependent. - Dumping can occur (selling products at a loss). - Harmful goods can enter the country. - Increase in price level. - Exploitation of importing country. - Depreciation of currency of importing country. ### Types of International/Foreign Trade #### Export Trade - Sales of goods and services to another country. - Foreign exchange enters the country (i.e. money comes to the country). #### Import Trade - Purchases of goods and services from another country. - Foreign exchange leaves the country (i.e. money goes out of the country). ### Visible and Invisible Trade #### Visible Trade - Sales of goods to another country is called visible export (tangible items). - Purchases of goods from another country is called visible import (e.g., any imported merchandise, imported cars, shampoos made by foreign companies etc.). - Visible exports are the goods sold abroad, e.g., sale of steel by an Indian firm in European markets etc. #### Invisible Trade - Sales of services to another country is called invisible export (intangible items). - Purchases of services from another country is called invisible import (e.g., using airline services of foreign companies, inviting a lecturer from a foreign university to deliver a lecture in a local university etc.). - Invisible exports are the services sold to overseas buyers (e.g. insurance sold by a local company to some off-shore customers, ex-pats working abroad etc.). #### Similarities between Home Trade and Foreign Trade 1. Buying and selling of goods for making a profit. 2. Serve people by satisfying needs and wants. 3. Require aids to trade. 4. Require surplus to be created. 5. Work on the principle of specialization. #### Differences between Home Trade and Foreign Trade | Home Trade | Foreign Trade | |--------------------------------------------------------|------------------------------------------------| | Done within national boundaries | Done across the globe | | Same currency is involved | Different currencies are involved | | Same units of measurement | Different units of measurement | | Same government policies | Different government policies | | No taxes are involved | Import/Export taxes are involved | | Simple documents | Complex documents | | Same culture and language | Different culture and languages | | Mode of payment is cash, cheque etc. | Mode of payment is online transfer, bill of exchange etc. | #### Interdependence of countries One country has to depend on the other country for goods and services. Countries are becoming increasingly dependent upon one another i.e. they are becoming interdependent. #### Reasons for interdependence: - Some countries produce goods at a low price. - Countries are promoting international trade. - Increase in multinational companies. ## 6.2 Balance of Trade and Balance of Payments ### Balance of Payment International Transaction | Credit transactions (Money Coming into the country) | Debit transactions (money going out of country) | |--------------------------------------------------------------------|----------------------------------------------------| | **Earnings** | **Expenses** | | Non-Earnings | Non-Expenses | | Visible Exports (good & exported) | Visible imports (good & import) | | Invisible exports | Invisible Imports | | Capital Inflows (money brought is by migrants) | Capital outflow (money taken by migrants) | | Financial inflow (loan received) | Financial outflow (Loans given) | | Incomes (interest divided) | Incomes (Interest) | | Services (tourism, education) | Services (banking, remittances, Airlines) | | Transfers (remittances, aids) | Transfers | ### Balance of Trade - The difference between the visible exports and visible imports is called balance of trade. - If visible exports exceed visible imports (called surplus), then it is favorable and if visible imports exceed visible exports (called deficit), then it is unfavorable. - **Balance of trade = Visible exports - visible imports.** ### Balance of Payments - It is the summary of a country's total payments and receipts with the rest of the world. It includes all items of visible trade, visible trade and capital movement over a specific period of time. - The balance of payments (BOP) is the method countries use to monitor all international monetary transactions at a specific period. Usually, the BOP is calculated every quarter and every calendar year. - All trades conducted by both the private and public sectors are accounted for in the BOP to determine how much money is going in and out of a country. If a country has received money, this is known as a credit, and if a country has paid or given money, the transaction is counted as a debit. Theoretically, the BOP should be zero, meaning that assets (credits) and liabilities (debits) should balance, but in practice, this is rarely the case. - Thus, the BOP can tell the observer if a country has a deficit or a surplus. - If total payments exceed total receipts, then it is called a **balance of payment deficit**, which is undesirable. - If total receipts exceed total payments, then it is called a **balance of payment surplus**, which is desirable. - **BOP = (Visible exports + invisible exports) – (visible imports + visible imports)** The BOP is divided into three main categories: the current account, the capital account, and the financial account. #### (i) The Current Account - The current account is used to mark the inflow and outflow of goods and services into a country. Earnings on investments, both public and private, are also put into the current account. - Within the current account are credits and debits on the trade of merchandise, which includes goods such as raw materials and manufactured goods that are bought, sold or given away (possibly in the form of aid). - Services refer to receipts from tourism, transportation, engineering, business service fees (e.g. from lawyers consulting), and royalties and copyrights. When combined, goods and services together make up a country's current account. The current account is typically the biggest bulk of a country's balance of payments as it makes up total imports and exports. If a country has a balance of trade deficit, it imports more than it exports, and if it has a balance of trade surplus, it exports more than it imports. Receipts from income-generating assets such as stocks (in the form of dividends) are also recorded in the current account similarly worker's remittances, which are salaries sent back into the home country of a national working abroad, as well as foreign aid that is directly received is also included in it. #### (ii) The Capital Account - The capital account is where all international capital transfers are recorded. - This refers to the acquisition or disposal of assets (e.g., a physical asset such as land or a mine used for the extraction of diamonds, debt forgiveness, and the transfer of goods by migrants leaving or entering a country, sale or purchase of equipment used in the production process to generate income). #### (iii) The Financial Account - In the financial account, international monetary flows related to investment in business, real estate, bonds and stocks are recorded. - Also included are government-owned assets such as foreign reserves, private assets held abroad and direct foreign investment and assets owned by foreigners. - The balance of payments is divided into the current account, capital account, and financial account. Theoretically, the BOP should be zero. ### Why deficit in Balance of Payments and Balance of Trade is undesirable 1. Loss of foreign exchange. 2. Depreciation of currency. 3. Imports will become expensive and it can create inflation. ## 6.3 Customs Authorities - Customs is an authority or agency in a country responsible for collecting and safeguarding customs duties and for controlling the flow of goods (like animals) and hazardous items in and out of a country. **Duties of Customs Authorities** - Collect revenue in the form of import duties. - Keep the record of goods imported and exported. - Supervise the movement of goods across borders. - Import duties are of two types: ad valorem (duties charged as a percentage of the value of total goods imported) and specific duties (duties charged on quantity of goods imported irrespective of their price and values). - Customs authorities supervise bonded warehouses (where dutiable goods are kept until duty on them is paid). - Enforce rules and regulations. - Prevent smuggling and other crimes. - Supervise even non-dutiable goods in free trade zones and containers to ensure that trade regulations are obeyed. - One of the main duties of customs authorities is supervision of bonded warehouses as they are owned by port authorities or private sectors. Customs authorities make sure that the dutiable goods are stored there and are not released unless the duties are paid. ## 6.4 Free Trade, Trading Blocs and Protectionism ### Free Trade Free trade is trading between countries without customs or other barriers. This exploits home industries as there is no regulation aimed at protecting home industries. #### Advantages of Free Trade: - Specialization - Increased efficiency - Reduced cost of production - Greater choice for consumers - Increased trade - More employment - Greater prosperity Besides the fact, people are in favor of free trade because it is in favor of all countries overall, but it has the greatest disadvantage of lack of protection to home industry by the government. ### Trading Blocs A bloc is a group of counties which promotes trade in between them. - They make a free trade agreement between each other and discourage trade with countries outside the trading bloc. - Therefore, they have a common tariff to discourage imports from outside member countries. - Some renowned training blocs are ASEAN, European Union, SAARC, SADC etc. #### Advantages of joining a trading bloc: - Increase in trade - Free trade between members enabling customers to enjoy lower prices. - Consumers get a variety of goods to choose from. - Better opportunities to cater member country's markets (more exports). - Enables businesses to operate in other countries. - Improved relations between the countries in the trading bloc. - Produce products at a lower price. - Overall standardization making products able to be sold easily. - Free mobility of labor from one country to the other. - Financial aids to improve infrastructure. - May adopt common currency (e.g. – EURO). #### Disadvantages of joining a trading bloc: - A country may lose its national identity. - No protection offered by government (e.g. grants, subsidies etc). - The companies operating in high cost of production areas may become uncompetitive and wiped out of the market. - Bad relations with countries outside the trading bloc. - Countries may have to implement policies which are not in national interests. - Local businessmen might suffer if a country in the trading bloc is providing the same good at a reduced price. - The annual contribution in the form of membership fee by the government may add burden to the poor economies. - Countries buying from outside trading bloc will have to pay more money because of external tariff. ### Importance of free ports in international trade - Free port is a geographical area where production, processing and trade can take place without the payment of taxes. Hence no duties or tariffs are paid on the free ports. - Free ports encourage trade. Goods are stored in the free port and then transported again after processing (packaging, sealing or making final goods for consumption). ### Protectionism - It is a process of placing some rules and regulations on trade such as import/export duties, quotas, embargoes, and exchange controls etc. #### How to protect from imports-to make balance of payment surplus? - **Tariffs or duties** – imposing import duties on goods to make them more expensive than home produced goods. - **Quotas** – imposing limits on the amount of imports allowed into a country in a given year. - **Embargoes / Import ban** – total exclusion of certain types of goods. This is often applied to harmful goods e.g., firearms. - **Exchange control** – limiting the amount of currency that can leave the country. - **Increased documentation and bureaucracy at point of entry** – making importing more difficult by increasing the rules and regulations for imports. - **Giving subsidies to local producers.** - **Discrimination to home producers by directly buying from home producers for all types of public projects.** - **Exemption of duties on imported raw materials to encourage home producers.** #### Effects of protectionism - Reduction in trade and reduced output. - Less specialization within a country. - Sometimes it makes production inefficient as producers seek subsidies on high production costs. - Less jobs for export industries as other countries may restrict trade in turn of duties imposed by home country. - Extra revenue for government by charging import duties. - Reduction in living standards as consumers have less choice and high prices. - Supporting declining industry put another burden on government but offers employment. ## 6.5 Difficulties faced by importers and exporters Producers may find it difficult to sell in other countries mainly due to the distance, but there are large profits to be made. These difficulties may include different languages and culture. Additional cost of transportation, additional cost of packing and insurance, excessive documentation, government rules in importing country, import and export duty, different units of measurement, trade barriers like trade embargo and strict quota, payment can be delayed, more risks involved and exchange rate fluctuations. Producers may wish to offer their products in foreign markets for expansion of business, to diversify, take advantage of favorable market conditions, extend life of the product, increase market power, or extend repute of the business. ### Difficulties faced by exporters | | | | | | |---|---|---|---|---| | Different currencies and exchange rate | Different Measuring units | Different customs | Increased cost | Political Scenario | | Different legislation | Language barriers | Transportation | More competition | Risk of non-payment | | | | | | Import restrictions | In which market to sell the products is the main question to be answered before offering the products to be sold. The following factors are normally considered. - Economic conditions (Size of market, market trends, standard of living, taste and trends of population, currency restrictions etc.) - Competitions likely to be faced in foreign markets. - Economy of importing country. - Political factors (Government policies, government stability) - Cultural factors (Public Demand, lifestyle, customs, and rituals in the country) - Commercial Factors (Signing contracts with the buyer or authorities, finance available, insurance, transportation facilities, infrastructure to communication) - Risks involved (risk of not being paid, delays in payments) - Cost to operate in foreign markets - Peoples' and economics acceptability towards foreigners and foreign investments. - Current economic situation of the county. #### Difficulties faced by exporters: As discussed earlier, the biggest and major difficulty faced by exporters is **Distance** and the additional costs that lead to numerous other problems for the exporters. Some problems faced by the exporters are explained now. - **Different Currencies and exchange rates:** Most commonly used currencies in international trade are Euro, U.S dollars, and Japanese Yen. Each of them has different and varying exchange rate (Exchange rate is the rate at which one currency is converted into another currency, and it is defined as: the price of one country's currency expressed in terms of another country's currency e.g. the price of U.S dollars against Euro). - **Different Legislations:** Some countries have restricted safety measures and worked a lot for safeguarding their consumers. They all have to be considered by an exporter too. It is also possible that when they planned to trade with some country abroad, the legislation were different while, when they started to operate, the host country may change the laws and regulations further. - **Different measuring units, Technical specifications** There are different measuring units applied in different countries e.g., grams and kilograms vs. pounds and ounces, meters and centimeter vs. inches, feet, and yards. They all also add to the cost of manufacturing. - **Language Barriers**: Exporters have to deal with different language packaging and instructions to consumers and labels. - **Different Customs:** Exporters have to keep in mind, different customs and national holidays when selling their products. E.g. even the big fast-food chains like McDonald's cannot sell pork products in Muslim countries. - **Transportation:** International trade is normally carried out through sea and air transport. While the role of road transport and railways is very less significant. Exporters have to consider the problems related to transportation, especially when quoting approximate delivery time. - **Increased administration costs:** Because of a lot of paperwork to deal with international trade, the overall cost of production is increased as exporters have to keep in mind the additional administration cost as well. - **More competition** The exporters always face severe competition from local producers. They have to set up their distribution network in some other country and that is only worth setting if there is a large market to capture abroad. Normally exporters have to make use of agents to find buyers. While some exporters make their own sales outlets in the countries in which they wish to trade. - **Political Scenario** A country may face a certain political unrest resulting in economic downfall and make it difficult for exporters to sell their products which cannot even be called back to producers because of high transportation costs. - **Risk of Non Payment** As credit is always related to creditworthiness of the customers, international trade is normally carried out on credit terms. It becomes very difficult for the exporter to establish a credit worthiness of the importer and hence, the risk of nonpayment increases. - **Import restrictions:** Almost in all countries, imported items are levied with duties. The sale of products in other countries become expensive and may make the imported items. ## Exporters and Aids to Trade: Aids to trade help exporters and reduce the difficulties of trading aboard - **Banking** Banking helps exporters by advising and information, making the transfer of payments easier and travelling services like a credit card, travelers' cheques etc. are also offered. - **Warehousing:** Goods are stored before they are moved and keep them fresh to be used by the customers. - **Advertising and Promotions:** Fairs, exhibitions, and advertisements through different means help exporters to reach global markets. - **Transportation:** Better road infrastructure, railways, containerization, and other modes of transports have speeded up transportation of goods. - **Communication:** Internet services in particular have speeded up trade. Now orders are accepted and placed through emails, telephones and videoconferencing have also helped. - **Insurance:** Insurances have lessened the risk of loss and nonpayment of goods. However, despite all the problems mentioned earlier, foreign markets are highly profitable and are very vast. Many businesses therefore, find it worthwhile to export.