International Trade

I INTRODUCTION

International Trade, the exchange of goods and services between nations. “Goods” can be defined as finished products, as intermediate goods used in producing other goods, or as raw materials such as minerals, agricultural products, and other such commodities. International trade commerce enables a nation to specialize in those goods it can produce most cheaply and efficiently, and sell those that are surplus to its requirements. Trade also enables a country to consume more than it would be able to produce if it depended only on its own resources. Finally, trade encourages economic development by increasing the size of the market to which products can be sold. Trade has always been the major force behind the economic relations among nations; it is a measure of national strength.

II EMERGENCE OF MODERN INTERNATIONAL TRADE

Although international trade was an important part of ancient economies, it acquired new significance after about 1500; with the establishment of empires and colonies by European countries, trade became an arm of governmental policy. The wealth of a country was measured in terms of the goods it possessed, particularly gold and precious metals. The objective of an empire was to acquire as much wealth as possible in return for as little expense as possible. This form of international trade, called mercantilism, was commonplace in the 16th and 17th centuries.

International trade began to assume its present form with the establishment of nation states in the 17th and 18th centuries. Heads of state discovered that by promoting foreign trade they could mutually increase the wealth, and thus the power, of their nations. During this period new theories of economics, in particular of international trade, also emerged.

III ADVANTAGES OF TRADE

In 1776 the Scottish economist Adam Smith, in The Wealth of Nations, proposed that specialization in production leads to increased output. Smith believed that in order to meet a constantly growing demand for goods, a country’s scarce resources must be allocated efficiently. According to Smith’s theory, a country that trades internationally should specialize in producing only those goods in which it has an absolute advantage, that is, those goods it can produce more cheaply than can its trading partners. The country can then export a portion of those goods and, in turn, import goods that its trading partners produce more cheaply. Smith’s work is the foundation of the classical school of economic thought.

Half a century later, the English economist David Ricardo modified this theory of international trade. Ricardo’s theory, which is still accepted by most modern economists, stresses the principle of comparative advantage. Following this principle, a country can still gain from trading certain goods even though its trading partners can produce those goods more cheaply. The comparative advantage comes if the mathematics of production costs and price received work out so that each trading partner has a product that will bring a better price in another country than it will at home. If each country specializes in producing the goods in which it has a comparative advantage, more goods are produced, and the wealth of both the buying and the selling nations increases.

Besides this fundamental advantage, further economic benefits result when countries trade with one another. International trade leads to more efficient and increased world production, thus allowing countries (and individuals) to consume a larger and more diverse bundle of goods. A nation possessing limited natural resources is able to produce and consume more than it otherwise could. As noted earlier, the establishment of international trade expands the number of potential markets in which a country can sell its goods. The increased international demand for goods translates into greater production and more extensive use of raw materials and labour, which in turn leads to growth in domestic employment. Competition from international trade can also force domestic firms to become more efficient through modernization and innovation.

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Within each economy, the importance of international trade varies. Some nations export chiefly to expand their domestic market or to aid economically depressed sectors within the home economy. Other nations depend on trade for a large part of their national income and to supply goods for domestic consumption. International trade is also viewed as an important means to promote growth within a nation’s economy; developing countries and international organizations have increasingly emphasized such trade.

IV GOVERNMENT RESTRICTIONS

Because international trade is such an integral part of a nation’s economy, governmental restrictions are sometimes introduced to protect what are regarded as national interests. Government action may occur in response to the trade policies of other countries, or it may be taken in order to protect specific industries. All nations seek to achieve and maintain a favourable balance of trade—that is, to export more than they import, or at least to keep the surplus of imports over exports to a minimum.

In a money economy, goods are not merely bartered for other goods; rather, products are bought and sold in the international market with national currencies. In an effort to improve its balance of payments (that is, to increase reserves of its own currency and reduce the amount held by foreigners), a country may attempt to limit imports by controlling the amount of currency that leaves the country.

A Import Quotas

One method of limiting imports is simply to close the ports of entry into a country. More commonly, maximum allowable import quantities may be set for specific products. Such quantity restrictions are known as quotas. These may also be used to limit the amount of foreign or domestic currency that is permitted to cross national borders. Quotas are imposed with the aim of stopping or even reversing a negative trend in a country’s balance of payments. They are also used as a means of protecting domestic industry from foreign competition. Modern economic thought tends to condemn both quotas and the aims they serve as economically damaging protectionism.

B Tariffs

The most common way of restricting imports today is by imposing tariffs, or taxes on imported goods. A tariff, paid by the buyer of the imported product, makes the price higher for that item in the country that imported it. The higher price reduces consumer demand and thus effectively restricts the import. The taxes collected on the imported goods also increase revenues for the nation’s government. Furthermore, tariffs serve as a subsidy to domestic producers of the items so taxed; the higher price that results when a tariff is imposed encourages the competing domestic industry to expand production.

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C Non-Tariff Barriers to Trade

In recent years the use of non-tariff barriers to trade has increased. Although these barriers are not necessarily administered by a government with the intention of regulating trade, they nevertheless have that result. Such non-tariff barriers include government health and safety regulations, business codes of conduct, and domestic tax policies, or even “austerity” campaigns aimed at cutting the consumption of (frequently imported) luxury goods. Direct government support of various domestic industries is also viewed as a non-tariff barrier to free trade because such support gives the supported industry an additional advantage versus non-assisted industries in local or even international markets.

V 20TH-CENTURY TRENDS

In the first half of the 20th century, many countries levied differential tariffs (charging lower tariffs to favoured nations) and established other restrictive trading practices as weapons to fight unfriendly nations. Free trade was subordinated to geopolitical strategies. An example of such a policy was that of “Imperial Preference” for the British Empire, to promote internal trade between its member countries. “Tariff wars” also contributed to the climate of growing international tension preceding World War I. Trade policy became the source of many international economic, or even political, disputes. The Great Depression of the 1930s gave a lasting lesson in the importance of international trade policies when the failure to remove tariffs defended by entrenched economic interest groups helped to delay economic recovery from the trade slump that followed the Wall Street Crash.

A Trade Negotiations

Attempts were first made in the 1930s to coordinate international trade policy. At first, countries negotiated bilateral treaties. Later, following World War II, international organizations were established to promote trade by, for example, liberalizing tariff and non-tariff trade barriers. The General Agreement on Tariffs and Trade, or GATT, signed by 23 non-Communist nations in 1947, was the first such agreement designed to reduce barriers to international trade; growing to well over 100 signatories, and affecting about 80 percent of international commerce. From 1947 GATT sponsored a number of specially organized rounds of multilateral trade negotiations, culminating with the Uruguay Round, completed in 1994. This set the stage for its replacement as a world trade body by the World Trade Organization (WTO).

B Trading Communities and Customs Unions

Several trading communities have been established to promote trade among countries that have common economic and political interests or are located in a particular region. Within these trade groups, preferential tariffs are administered that favour member countries over non-members. One early example of a trading community is the Commonwealth of Nations; it was established under the provisions of the Ottawa Agreements of 1932, which allowed preferential tariffs to be levied among members of the Commonwealth, articulating the “Imperial Preference” policy. Non-Communist countries encouraged trade-promoting programmes to stimulate the redevelopment of economies ruined during World War II.

In the customs union known as Benelux, operative since 1948 and consisting of Belgium, the Netherlands, and Luxembourg, customs duties on trade among the three members were abolished, and uniform duties were established on imports from non-member states. In 1951 France, West Germany (now part of the united Federal Republic of Germany), and the Benelux countries joined to form the European Coal and Steel Community. In 1957 these six countries established the European Economic Community, or EEC (now the European Union), aimed at reducing trade barriers among member countries. The EEC was expanded after its creation, with other nations joining the original members. The Communist counterpart to these groups was the Council for Mutual Economic Assistance (COMECON). Established in 1949, it was dissolved in 1991 as a consequence of the political and economic changes in the Communist world.

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Many economists foresee the development of three major trading blocs in the developed world—the EU, the members of the North American Free Trade Agreement (NAFTA), and a Pacific-Asian bloc. Trade within each bloc will be encouraged by the removal of trade restrictions, but difficult negotiations may be required to reduce trade barriers between the trading blocs.

VI WORLD TRADE

In 2003 the value of world trade was US$9,100 billion. This was more than double the 1994 figure, and between 1965 and 1985 world trade had increased nearly tenfold. Dramatic trade growth occurred in the oil-exporting developing countries in the 1970s and 1980s. Furthermore, world trade continued to increase in the 1980s, driven by economic recovery in the major industrial nations. After a pause in the early 1990s, caused by the recession in Europe and Japan, trade growth resumed in the mid-1990s.

By 1973 existing agreements limiting the rise of one currency’s value in relation to that of another, notably those reached at the Bretton Woods Conference in 1944, had been replaced by floating currency exchange rates. In the 1970s and early 1980s, price competition between trading partners was augmented by the resulting fluctuations in exchange rates. Attempts to manage these have rarely been successful, as shown by the mixed fortunes of the European Exchange Rate Mechanism. In the short run, the depreciation of a nation’s currency makes its exports cheaper and its imports more expensive.

In the 20th century, international trade increased tremendously as a proportion of the world’s total economic activity. It is expected that the trend towards increasing interdependence among national economies will continue into the future, albeit countered by the tendency towards regional blocs, which will make some groups of countries more interdependent than others. There has been much debate on whether the new regional trading communities, such as the Asia-Pacific Economic Cooperation grouping or the Mercosur group of Latin American countries, promote or restrict international trade overall. Evidence so far suggests that, although such groups can inhibit trade with countries outside their circle of mutually preferential arrangements, they can also serve as halfway houses towards broader free trade agreements, unless protectionist interests within the groupings force changes of policy.