Faculty of Business Administration
Academy of Economic Studies
Table of Contents
1. Introduction .......................3
3. Trade basics........................3
2. The International Economy..................6
3. What is International Economics.............. 9
4. Some Trade Terminology.................10
5. Valuable Lessons of International ...............11
6. International Agreements.................11
Trade center and
9. Governing Global Trade...................16
10. Trade in low income countries................19
Take a minute and
look around. You might be surprised to discover how many of the everyday items
in your life are made overseas. Your shirt might be made in
The importing and exporting of goods is big business in today's global economy. When goods are produced in one country and sold in another, international trade occurs. It is so common to find items produced worldwide that people rarely even think about it. Not too long ago, countries consumed goods predominately produced within their borders. As transportation has become increasingly less expensive and telecommunications have improved, international trade has flourished.
In general, international trade allows countries to focus on the industries in which they can be most productive and efficient. In this way, trade often raises the standard of living of both producers and consumers. International trade also has a dark side.
This project will address many of the questions about international trade that are probably looming in your mind. Why should countries trade? How does trade work? What is the effect of international trade? How do exchange rates affect trade? Can the government interfere in free trade? What is the trade deficit?
The benefits and pitfalls of trade affect the economy at its core. Everything from output to standard of living to interest rates remains under the partial control of international trade. By understanding international trade, we will uncover one of the most important real life applications of macroeconomics.
Why should countries trade? Simply put, if a country can produce a good for less than another country, then the opportunity for advantageous trade exists. Of course, the opportunity for advantageous trade also exists when a country can produce a good that another country is unable to produce. In each of these cases, both the consuming country and the producing country will be better off with trade than without it.
Advantages in Trade
A country may have two advantages over another country (or countries) regarding trade. Absolute advantage occurs when a producer can use the smallest amount of inputs to produce a given amount of output compared to other producers. Absolute advantage may apply to many countries. Comparative advantage happens when a producer has a lower opportunity cost of production than another producer. Comparative advantage may also apply to many countries, but in this esay it will be restricted to cases of two countries and two goods.
The producer with the lower opportunity cost of production is said to have the comparative advantage. Notice that in a case with two producers and two products, each producer must have a comparative advantage in one, and not both, products. Simply represent the opportunity cost of one product in terms of the other product for both producers, and then compare these numbers. Whichever producer has the lower opportunity cost has the comparative advantage and should produce that product.
Absolute advantage and comparative advantage are theoretically straightforward. When a producer has an absolute advantage, he can produce a given output by using fewer inputs than any competing producer. When a producer has a competitive advantage, he can produce one product with a smaller amount of inputs than the competition. He therefore must produce another product with a greater amount of inputs than the competitor, hence the designation of comparative advantage. When either an absolute advantage or a comparative advantage exists, benefits from trade are guaranteed.
The Means of Trade
Flows of Capital and Goods
We will use the identity Y = C + I + G + NX to describe the output of an economy. In this equation, Y is the nominal output, C is money spent on consumption, I is money spent on investment, G is money spent by the government, and NX is net exports or exports less imports. The sum of these costs is the total amount of both income and output in a country.
To understand how capital and goods flow in and out of countries, we should keep the Y = C + I + G + NX identity in mind. NX is of particular interest. NX is defined as the total amount of ex 545d31f ports less the total amount of imports. NX is positive if a country exports more than it imports, negative if a country imports more than it exports, and zero if exports and imports are equal.
Let's work through each of these examples in turn. First we'll examine the simplest case, in which exports and imports are equal. In this example, there are two countries, Country A and Country B. If Country A exports 1 million dollars worth of coconuts to Country B and imports 1 million dollars worth of bananas from Country B, then the NX for both countries is equal to zero since exports equal imports. In this case, goods are traded for goods and at the end of the term, the trade balance is equal.
When countries import less than they export or import more than they export, the situation becomes significantly more complicated. Now let's examine the case when a country imports more than it exports. If Country A exports 0.5 million dollars worth of coconuts to Country B and imports 1 million dollars worth of bananas from Country B, then Country A has a negative trade balance, called a trade deficit. In this case, Country A owes Country B money for the imported bananas beyond the 0.5 million dollars worth of exported coconuts. If this is a short-term debt, nothing of consequence would occur since Country A has the ability to export more coconuts quickly to make up for the difference.
If the debt is long term, however, Country A must somehow repay Country B for the imported bananas. The easiest way to think of this exchange is to imagine Country A giving Country B interest in the future coconuts produced by Country A. To repay the debt that Country A owes to Country B, Country B becomes invested in Country A. Any amount of exports that exceeds the total amount of imports results in foreign investment. The opposite occurs when exports exceed imports as the exporting country becomes a foreign investor in the importing country.
This leads us to another important international trade identity: NX = NFI where NX is net exports or exports less imports and NFI is net foreign investment. Simply put, the difference between what a country exports and imports is equal to the amount of foreign investment. The trade balance can remain fairly even if a country imports more than it exports--it must make up the difference through foreign investment.
If net exports remain equal to net foreign investment, a few tendencies arise:
countries with few imports and many exports will tend to have significant foreign investment
countries with few exports and many imports will also tend to have significant foreign investment
countries with exports equal to imports will tend to have little investment in foreign countries and little foreign investment Understanding the identity NX = NFI and the means by which capital and goods flow between countries helps to clarify the workings of international trade.
Trade and the Country
Barriers to Trade
It may seem odd, but governments often step in to restrict trade. Why might a government want to restrict trade? If domestic industries cannot compete against foreign industries, the government will restrict trade to help the domestic industries develop. Governments may also restrict trade to foster business at home rather than encouraging business to move out of the country. These protectionist policies encourage prices to stay high and help domestic industries to develop.
Governments three primary means to restrict trade: quota systems; tariffs; and subsidies.
A quota system imposes restrictions on the specific number of goods imported into a country. Quota systems allow governments to control the quantity of imports to help protect domestic industries.
Tariffs are fees paid on imported goods. Tariffs increase the price that consumers pay for the good, thus reducing the quantity of the good demanded and making the price more in line with the price charged by domestic producers. Tariff profits may go to the government or to developing industries.
Subsidies are grants given to domestic industries to help them develop and compete with foreign producers. Through subsidies, domestic producers can charge less for their goods without losing money due to outside grants.
Through judicious use of quotas, tariffs, and subsidies, governments are able to improve the domestic economy. This may increase the price that domestic consumers pay for goods, though this small annoyance is usually outweighed by significantly bolstered overall economic levels and long-term economic growth.
In the section on net exports we learned that net exports equal exports minus imports. The difference between exports and imports is referred to as the trade deficit or the trade surplus. When exports exceed imports, a trade surplus exists. When imports exceed exports, a trade deficit exists.
There often talk about the effects of the trade deficit on the economy. What is the actual effect of the trade deficit though? Remember that when there is a trade deficit, net foreign investment fills the gap between exports and imports, as NX = NFI. Thus, if a large trade deficit exists, foreign investment must be high. This is slightly problematic as domestic companies often enjoy domestic ownership--a large trade deficit threatens this condition. A trade deficit is often matched with a large governmental budget deficit. Though the specific effects of a trade deficit are nebulous, in general a large trade deficit is thought to stunt long-term economic growth slightly.
How can the trade deficit be resolved? First, exports can be increased to make annual net exports positive. When employed, this method will cause a trade deficit decrease over time. Second, funds can be used to pay off foreign investors, reducing balance due from trade and causing a lower trade deficit.
International economics is growing in importance as a field of study because of the rapid integration of international economic markets. More and more, businesses, consumers and governments realize that their lives are increasingly affected, not just by what goes on in their own town, state or country, but by what is happening around the world. Consumers can buy goods and services from all over the world in their local shops. Local businesses must compete with these foreign products. However, these same businesses also have new opportunities to expand their markets by selling in a multitude of other countries. The advance of telecommunications is rapidly reducing the cost of providing services internationally and the internet will assuredly change the nature of many products and services as it expands markets even further than today.
Markets have been going global, and everyone knows it.
One simple way to see this is to look at the growth of exports in the world during the past 50+ years. The following figure shows overall annual exports measured in billions of US dollars from 1948 to 2005. Recognizing that one country's exports are another country's imports, one can see the exponential growth in trade during the past 50 years.
However, rapid growth in the value of exports does not necessarily indicate that trade is becoming more important. Instead, one needs to look at the share of traded goods in relation to the size of the world economy. The adjoining figure shows world exports as a percentage of world GDP for the years 1970 to 2005. It shows a steady increase in trade as a share of the size of the world economy. World exports grew from just over 10% of GDP in 1970 to almost 30% by 2005. Thus, trade is not only rising rapidly in absolute terms, it is becoming relatively more important too.
One other indicator of world interconnectedness can be seen in changes in the amount of foreign direct investment (FDI). FDI is foreign ownership of productive activities and thus is another way in which foreign economic influence can affect a country. The adjoining figure shows the stock, or the sum total value, of FDI around the world taken as a percentage of world GDP between 1980 and 2004. It gives an indication of the importance of foreign ownership and influence around the world. As can be seen, the share of FDI has grown dramatically from around 5% of world GDP in 1980 to over 20% of GDP just 25 years later.
The growth of international trade and investment has been stimulated partly by the steady decline of trade barriers since the Great Depression of the 1930s. In the post World War II era the General Agreement on Tariffs and Trade, or GATT, was an agreement that prompted regular negotiations among a growing body of members to reduce tariffs (import taxes) on imported goods on a reciprocal basis. During each of these regular negotiations, (eight of these rounds were completed between 1948 and 1994), countries promised to reduce their tariffs on imports in exchange for concessions, or tariffs reductions, by other GATT members. When the most recent completed round was finished in 1994, the member countries succeeded in extending the agreement to include liberalization promises in a much larger sphere of influence. Now countries would not only lower tariffs on goods trade, but would begin to liberalize agriculture and services market. They would eliminate the many quota systems - like the multi-fiber agreement in clothing - that had sprouted up in previous decades. And they would agree to adhere to certain minimum standards to protect intellectual property rights such as patents, trademarks and copyrights. The WTO was created to manage this system of new agreements, to provide a forum for regular discussion of trade matters and to implement a well-defined process for settling trade disputes that might arise among countries.
As of 2006, 149 countries were members of the WTO
'trade liberalization club' and many more countries were still
negotiating entry. As the club grows to include more members, and if the latest
round of trade liberalization discussion called the
Another international push for trade liberalization has come in the form of regional free trade agreements. Over 200 regional trade agreements around the world have been notified, or announced, to the WTO. Many countries have negotiated these with neighboring countries or major trading partners, to promote even faster trade liberalization. In part these have arisen because of the slow, plodding pace of liberalization under the GATT/WTO. In part it has occurred because countries have wished to promote interdependence and connectedness with important economic or strategic trade partners. In any case, the phenomenon serves to open international markets even further than achieved in the WTO.
These changes in economic patterns and the trend towards ever increasing openness are an important aspect of the more exhaustive phenomenon known as globalization. Globalization more formally refers to the economic, social, cultural or environmental changes that tend to interconnect peoples around the world. Since the economic aspects of globalization are certainly one of the most pervasive of these changes, it is increasingly important to understand the implications of a global marketplace on consumers, businesses and governments. That is where the study of international economics begins.
There are two broad sub-fields within international economics: international trade and international finance.
What is International Economics
International trade is a field in economics that applies microeconomic models to help understand the international economy. Its content includes the same tools that are introduced in microeconomics courses, including supply and demand analysis, firm and consumer behavior, perfectly competitive, oligopolistic and monopolistic market structures, and the effects of market distortions. The typical course describes economic relationships between consumers, firms, factor owners, and the government.
The objective of an international trade course is to understand the effects on individuals and businesses because of international trade itself, because of changes in trade policies and due to changes in other economic conditions. The course will develop arguments that support a free trade policy as well as arguments that support various types of protectionist policies. By the end of the course, students should better understand the centuries-old controversy between free trade and protectionism.
International finance applies macroeconomic models to help understand the international economy. Its focus is on the interrelationships between aggregate economic variables such as GDP, unemployment rates, inflation rates, trade balances, exchange rates, interest rates, etc. This field expands macroeconomics to include international exchanges. Its focus is on the significance of trade imbalances, the determinants of exchange rates and the aggregate effects of government monetary and fiscal policies. Among the most important issues addressed are the pros and cons of fixed versus floating exchange rate systems.
In trade policy discussions terms such as protectionism, free trade, and trade liberalization are used repeatedly. It is worthwhile to define these terms at the beginning. One other term is commonly used in the analysis of trade models, namely national autarky, or just autarky.
Two extreme states or conditions could potentially be created by national government policies. At one extreme, a government could pursue a 'laissez faire' policy with respect to trade and thus impose no regulation whatsoever that would impede (or encourage) the free voluntary exchange of goods between nations. We define this condition as free trade. At the other extreme, a government could impose such restrictive regulations on trade as to eliminate all incentive for international trade. We define this condition in which no international trade occurs as national autarky. Autarky represents a state of isolationism. (See Figure).
Probably, a pure state of free trade or autarky has never existed in the
real world. All nations impose some form of trade policies. And probably no
government has ever had such complete control over economic activity as to
eliminate cross-border trade entirely. The real world, instead, consists of
countries that fall somewhere between these two extremes. Some countries, such as
Most policy discussions are not about whether governments should pursue one of these two extremes. Instead, discussions focus on which direction a country should move along the trade spectrum. Since every country today is somewhere in the middle, discussions focus on whether policies should move the nation in the direction of free trade or in the direction of autarky.
A movement in the direction of autarky occurs whenever a new trade policy is implemented if it further restricts the free flow of goods and services between countries. Since new trade policies invariably benefit domestic industries by reducing international competition, it is also referred to as protectionism.
A movement in the direction of free trade occurs when regulations on trade are removed. Since the elimination of trade policies will generally increase the amount of international trade, it is referred to as trade liberalization.
Trade policy discussions typically focus, then, on whether the country should increase protectionism or whether it should pursue trade liberalization.
Note that, according to this definition of protectionism, even policies that encourage trade, such as export subsidies, are considered protectionist since they alter the pattern of trade that would have prevailed in the absence of government intervention. This implies that protectionism is much more complex than can be represented along a single dimension (as suggested in the above diagram) since protection can both increase and decrease trade flows. Nevertheless, the representation of the trade spectrum is useful in a number of ways.
In this section some of the most important lessons in international trade theory are briefly presented. Often, the lessons that are most interesting and valuable are those that teach something either counterintuitive, or at least contrary to popular opinions. A number of these are represented below. Each explanation also provides links to the pages where the arguments are more fully explained. (Note: For most students, following the links initially may be more confusing than helpful. However, once reading through many of the chapters, review of these lessons may help reinforce them).
F. Although protection can be beneficial, the case for free trade remains strong.
Goods and services are sold every day across national boundaries. These transactions are subject to a myriad of laws, regulations, restrictions and special arrangements. This complex web of laws and regulations is comprised of unilateral measures, meaning national or domestic laws, and further complicated by the international law expressed in trade agreements. There are basically three levels of international trade agreements: bilateral relationships (Canada-United States Free Trade Agreement), multilateral arrangements (GATT and the WTO), and regional agreements (NAFTA, MERCOSUR).
Andean Community. Based on the Cartagena Agreement, this pact seeks to harmonize the trade and investment regimes of its members. Its web page contains information about the community, legislation and jurisprudence, and publications and documents. Some of the pages are available only in Spanish.
CARICOM (Caribbean Common Market). Established in 1973 to from a common market for trade and to promote economic cooperation among its member states. The site contains information about CARICOM, documents, projects and news.
MERCOSUR (Southern Cone Common Market Treaty). Its aim is to dismantle trade barriers and encourage cross-border investment. Most of the important documents are in Spanish. See also the International Development Research Centre (IDRC) of Canada MERCOSUR site. This is a very comprehensive site that contains treaties related to MERCOSUR, statistical information, recent developments on integration, and country profiles.
NAFTA Secretariat. Trilateral
free trade agreement between the
sites include NAFTANET which contains a good deal of information related to
NAFTA - text of the agreement, links to other sites, etc. See also the NAFTA
Home Page (U.S. Dept. of Commerce), and LANIC's (
on Contracts for the International
World Trade Organization (WTO). The WTO agreements provide for the legal framework for
international commerce and trade policy. In the past getting the documents from
the GATT was always a challenge unless you had access to the GATT microfiche
(which most folks did not have). Now the WTO has entered the electronic age and
the web site is the mechanism the WTO has chosen for disseminating information.
Not only does this site have information about various trade topics (goods,
services, development, etc.), more importantly, it contains the full-text of
most documents distributed by the WTO since its creation in January 1995. The legal
texts (Uruguay Round agreements) are also available. Another important feature
of this site the dispute settlement section (including panel reports). The
International Trade Monitor has a nice collection of WTO agreements and other
documents. For information on print and electronic sources related to WTO
dispute resolution, see WTO Panel Decisions, compiled by Lyo Louis-Jacques,
International Trade center and Romania
ITC has worked on trade development in
From wood products to information technology (IT) and fashion, ITC, working closely with Romanian partners, has helped prepare a range of key sectors for greater international export success. This has implied involvement at every level - from macro-level assistance in the development of a national strategy for export development and the creation of a related trade support network, to the strengthening and fostering of private sector networks, to micro-level assistance aimed at promoting the international competitiveness of individual enterprises.
Now, with accession to the European Union (EU) on the horizon in 2007, and with the
myriad challenges and tremendous commercial opportunities this presents, exporters, producers and providers of goods and services need to continue their journey up a steep learning curve to ensure that they make the most of new markets.
In fact, Romanian authorities are so aware of the need for the population to understand the complexities of EU regulations and standards that they approved the transmission of a 12-part television series this year called Ulita spre Europa. The programme sought not only to entertain, but also to inform
For ITC, efforts to help
1. promoting a culture shift and change in mentality amongst Romanian companies to boost their understanding of the need for exporters to deal promptly, thoroughly and systematically with international market requirements;
2. an appreciation among Romanian producers in selected sectors (notably, garments and textiles, and wood products) of the range of analytical tools (including key tools developed by ITC) that allow exporters to understand, adopt and adapt to the demands of new markets; and
3. enhancing local capacity to build in greater value-added in products offered and, at the same time, developing the manufacturing flexibility that can adjust to changing fashions and tastes to meet the needs of more demanding markets.
ITC's work in
ITC played a vital role in setting up the RTPC by giving advice on how to structure the organization and providing training. It was also the main contributor to a specialized trade information library for the business sector and academia. ITC provided access to the Internet and assisted in the redesign of RTPC's web site, which included access to ITC's online databases and analytical tools tailored to allow exporters to make the most of new international opportunities.
Once the RTPC was up and running, ITC worked with the new centre to focus on
private sector competitiveness. The key to success lay in finding the right
local counterparts to work with. In-country research and assessments saw
ITC/RTPC develop a relationship with the
Today, through the sale of products that ITC helped it to develop, RTPC is approximately 40% self-financing and the success of the partnership has attracted further public and private sector interest for ITC activities in the region.
In 2001, an independent evaluation of ITC's cooperation with
The Romanian Foreign Trade Centre (now the RTPC), established in 1995, is now recognized as the country's best provider of trade information services. In 1996, in-country experts established the Romanian Association of Purchasing and Supply Management, following a series of ITC training sessions. Since the mid-1990s hundreds of specialists from Romanian companies have undergone training through the association. The training has introduced modern purchasing and supply management techniques and shifted attitudes in many companies to enhance business efficiency.
The success of ITC's trade development work with
GDP > PPP
GDP > Real growth rate
Gross National Income
Human Development Index
Population below poverty line
SOURCES: CIA World Factbook,
Governing Global Trade
The multilateral system that has underpinned world trade for over 50 years is facing serious challenges.
Measured by actual trade flows, the multilateral trading system would appear to have been very successful. Today, WTO members account for more than 90 percent of world trade in goods (including oil). Trade grew, on average, almost twice as fast as GDP between 1990 and 2005 (World Bank, World Development Indicators). Global trade is expected to hit about $16 trillion in 2008, equal to 31 percent of world GDP. At the same time, stocks of foreign direct investment grew almost five times as fast as world GDP. The domestic sales of foreign affiliates are larger than world exports and rely critically on trade in intermediate goods, further underscoring the importance of trade integration in modern economic activity.
Falling transportation costs and other technological innovations have been key drivers of trade growth, but declining barriers to trade have also contributed. Between 1983 and 2003, average applied tariffs on manufacturing in developing countries dropped from slightly less than 30 percent to about 9 percent (World Bank, 2007). Some two-thirds of this liberalization was undertaken unilaterally, and about one-fourth through multilateral agreements.
Developing countries are key players
A key question now is how to take account of the increasing role of developing countries. These countries have become major participants in world trade: their share of global exports rose from 22 percent in 1980 to 32 percent in 2005 and is expected to reach 45 percent by 2030 (see Chart 1) (World Bank, 2006). About two-thirds of the WTO's members are developing countries.
More aid for trade.
Additional aid to address these constraints-aid for trade-will be an essential complement to any multilateral trade deal. Paradoxically, part of the solution to helping poor countries feel that they have a stake in the trading system lies in the broader development community, with donors supporting countries that highlight trade as a priority in their development strategies. But donors will need to honor their commitments to increase overall aid if trade needs are to be better addressed without competing for resources with existing development priorities.
Agricultural protection. Fifty years of the multilateral trading system has
seen limited progress in reining in agricultural protection. In all regions,
tariffs remain significantly higher in agriculture than in manufactures (see
Chart 2), and trade-distorting subsidies, banned in manufacturing, continue to
be a feature of the agricultural sector. According to the Organization for
Economic Cooperation and Development, rich-country taxpayers (in the form of
subsidies) and consumers (in the form of higher prices because of trade
barriers) pay about $268 billion a year to support agriculture, with the
European Union ($134 billion),
Meanwhile, in developing countries, 73 percent of the poor live in rural areas, and agriculture and agroprocessing account for 30-60 percent of GDP and an even larger share of employment. But agricultural protection is also high in developing countries, to the detriment of their own poor consumers, exporters, and other poor countries, which are increasingly their trading partners.
Protection on manufactures.
Although the remaining high tariffs in developed countries tend to be concentrated in areas of developing country export interest (labor-intensive manufactures, such as clothing), protection in developing countries is some four times higher than in high-income countries. The price of high tariffs in developing countries is, again, paid by their own consumers, exporters (whose competitiveness in world markets and participation in global production chains are harmed by more expensive inputs), and their developing country trading partners (which account for one-fourth of developing country exports).
Protection on services.
But the gains from further liberalization in manufactures are dwarfed by the potential gains from liberalization in services: the increase in real income from halving protection on services would be five times larger than that from comparable liberalization in goods trade. Global trade in services accounts for $2.8 trillion, or not quite one-fifth of world trade (World Bank, World Development Indicators). Access to quality and cost-effective services, such as finance, transport, and telecommunications, plays a key role in determining competitiveness.
TRADE IN LOW INCOME COUNTRIES
Trade has a crucial role to play in low income
economies. The East Asian experience demonstrated the power of trade to drive
growth and generate rapid and lasting reductions in poverty. Similarly, low
income countries' growth prospects depend on their ability to expand and
diversify their exports, and to increase access to key production inputs and
boost productivity through imports. But many countries, particularly in
It is impossible to isolate the impact of trade reform from the impact of the other accompanying far-reaching reforms in precipitating this loss of income. What is clear is that the legal, regulatory and institutional environment was insufficiently developed to manage the adjustment prompted by the whole range of reforms. The performance of the transition economies is now fast improving,3 suggesting that the bulk of the adjustment is over and the region will be able to sustain economic recovery. Export patterns have changed significantly, in terms of both destination markets and products - for example, the share of agricultural exports in Hungary's total exports has decreased from 22 per cent in 1990 to 8 per cent in 1999 (OECD 2001). Nevertheless, the substantial drop in GDP which these countries experienced was a very high price to pay for longer term prosperity - and might have been mitigated through a better designed reform process.
Kaempfer and Maskus, ' International Trade: Theory and Evidence'
A. K. Dixit & V. Norman , "Theory of International Trade: A Dual, General Equilibrium"
Michael E. Porter "The Competitive Advantage of Nations" by
Raymond Vernon and Louis T. Wells, Jr., The Manager in the International Economy
Feenstra, Robert, Advanced International Trade: Theory and Evidence
Krugman, P. 1990, Rethinking International Trade
*J. Markusen, J. Melvin, W. Kaempfer, and K. Maskus, International Trade: Theory and Evidence