Chapter 1


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Chapter 1

  1. 1. International trade is the exchange of goods and services across international borders. In most countries, it represents a significant share of GDP. While international trade has been present throughout much of history (see Silk Road, Amber Road), its economic, social, and political importance have been on the rise in recent centuries, mainly because of Industrialization, advanced transportation, Globalization, Multinational corporations, and outsourcing. In fact, it is probably the increasing prevalence of international trade that is usually meant by the term "globalization". International trade is also a branch of economics, which together with International finance, forms the larger branch of International economics. Regulation of international trade Traditionally trade was regulated through bilateral treaties between two nations. For centuries under the belief in Mercantilism most nations had high tariffs and many restrictions on international trade. In the nineteenth century, especially in Britain, a belief in free trade became paramount and this view has dominated thinking among western nations for most of the time since then. In the years since the Second World War multilateral treaties like the GATT and World Trade Organization have attempted to create a globally regulated trade structure. Communist and socialist nations often believe in autarchy, a complete lack of international trade. Fascist and other authoritarian governments have also placed great emphasis on self-sufficiency. No nation can meet all of its people's needs, however, and every state engages in at least some trade. Free trade is usually most strongly supported by the most economically powerful nation in the world. The Netherlands and the United Kingdom were both strong advocates of free trade when they were on top, today the United States, the European Union and Japan are its greatest proponents. However, many other countries - including several rapidly developing nations such as India, China and Russia - are also becoming advocates of free trade. Traditionally agricultural interests are usually in favour of free trade while manufacturing sectors often support protectionism. This has changed somewhat in recent years, however. In fact, agricultural lobbies, particularly in the United States, Europe and Japan, are chiefly responsible for particular rules in the major international trade treaties which allow for more protectionist measures in agriculture than for most other goods and services. During recessions there is often strong domestic pressure to increase tariffs to protect domestic industries. This occurred around the world during the Great Depression leading to a collapse in world trade that many believe seriously deepened the depression. The regulation of international trade is done through the World Trade Organization at the global level, and through several other regional arrangements such as MERCOSUR in South America, NAFTA between the United States, Canada and Mexico, and the European Union between twenty five independant states. There is also the newly established Free Trade Area of the Americas (FTAA), which provides common standards for almost all countries in the American continent.
  2. 2. Risks in international trade The risks that exist in international trade can be divided into two major groups: Economic risks • Risk of insolvency of the buyer, • Risk of protracted default - the failure of the buyer to pay the amount due within six months after the due date, and • Risk of non-acceptance • Surrendering economic sovereignty Political risks • Risk of cancellation or non-renewal of export or import licences • War risks • Risk of expropriation or confiscation of the importer's company • Risk of the imposition of an import ban after the shipment of the goods • Transfer risk - imposition of exchange controls by the importer's country or foreign currency shortages • Surrendering political sovereignty Trading Internationally involves heavy costs because on top of the price of the product or service, the nation's government will usually impose tariffs, time costs and the many other costs involved in moving (usually) the goods across into another country where language, system, culture and rules are considered a big hindrance. One of the largest movers in the International trading world that we have today is China where labor is plentiful and cheap. Many labor-intensive products designed and produced by United States and other European countries are assembled or manufactured in China where labor is inexpensive. This is typical because it's a move that can save the original country a lot of time and money. Furthermore, with the opening of door of China, citizens now have more income opportunities to make life better. However, when a country deals a lot with International trade, although it creates exponential income opportunities for the locals, by importing or exporting too much of something can cause damage to the local scene. During recession, countries suffer local pressure to change laws governing International trade to protect the local industries. The most painful and memorable of such incident is the Great Depression. Each country dealing with International trade have their
  3. 3. very own laws and bylaws which governs their trading policies but on a global level, trading activities are monitored and done through the World Trade Organization. The role of WTO is to ensure that there is peaceful and mutually benefiting business atmosphere. Trading amongst each other can cause minor unwanted rifts between parties concerned and if left to sizzle can cause major problems on the International front. In the event such problems are detected or voiced, the WTO can step in and take precedence over the disputes by holding talks, discussions and finding ways of solving the International trading problems amicably. One of the ways to do this is to sign agreements or multilateral agreements not unlike the FTAA between the Buenos Aires on the Free Trade Area of the Americans. Benefits of intl trade: B enhances the domestic competitiveness B Takes advantage of international trade technology B Increase sales and profits B Extend sales potential of the existing products B Maintain cost competitiveness in your domestic market B Enhance potential for expansion of your business Gains a global market share Reduce dependence on existing markets Stabilize seasonal market fluctuations Importance of International Trade The buying and selling of goods and services across national borders is known as international trade. International trade is the backbone of our modern, commercial world, as producers in various nations try to profit from an expanded market, rather than be limited to selling within their own borders. There are many reasons that trade across national borders occurs, including lower production costs in one region versus another, specialized industries, lack or surplus of natural resources and consumer tastes. One of the most controversial components of international trade today is the lower production costs of “developing” nations. There is currently a great deal of concern over jobs being taken away from the United States, member countries of the European Union and other “developed” nations as countries such as China, Korea, India, Indonesia and others produce goods and services at much lower costs. Both the United States and the European Union have imposed severe restrictions on imports from Asian nations to try to stem this tide. Clearly, a company
  4. 4. that can pay its workers the equivalent of dollars a day, as compared to dollars an hour, has a distinct selling advantage. Nevertheless, American and European consumers are only too happy to lower their costs of living by taking advantage of cheaper, imported goods. Even though many consumers prefer to buy less expensive goods, some international trade is fostered by a specialized industry that has developed due to national talent and/or tradition. Swiss watches, for example, will never be price-competitive with mass produced watches from Asia. Regardless, there is a strong market among certain consumer groups for the quality, endurance and even “snob appeal” that owning a Rolex, Patek-Philippe or Audemars Piguet offers. German cutlery, English bone China, Scottish wool, fine French silks such as Hermes and other such products always find their way onto the international trade scene because consumers in many parts of the world are willing to foster the importation of these goods to satisfy their concept that certain countries are the best at making certain goods. One of the biggest components of international trade, both in terms of volume and value of goods is oil. Total net oil imports in 2005 are over 26 million barrels per day (U.S. Energy Information Administration figures) (Note: Imports include crude oil, natural gas liquids, and refined products.) At a recent average of $50 per barrel, that translates to $1billion, three hundred million, PER DAY. The natural resources of a handful of nations, most notably the nations of OPEC, the Organization of Petroleum Exporting Countries, are swept onto the international trade scene in staggering numbers each day, and consumer nations continue to absorb this flow. Other natural resources contribute to the movement of international trade, but none to the extent of the oil trade. Diamonds from Africa, both for industrial and jewelry use, wheat and other agricultural products from the United States and Australia, coal and steel from Canada and Russia, all flow across borders from these nations that have the natural resources to the nations that lack them. Despite complaints about trade imbalances, effects on domestic economies, currency upheavals, and loss of jobs, the reality of goods and services continually crossing borders will not go away. International trade will continue to be the engine that runs most nations.
  5. 5. Basis of International Trade? International trade can be defined as either the buying (importing) or selling (exporting) of goods or services on a global basis. Thanks in great measure to the Internet, many starting businesses can enrich their prospects of success by incorporating IT into their overall business plan. In some cases, a business can be enhanced by incorporating IT marketing to supplement a domestic operation. In other cases, a business can depend solely on international trade. Let’s review some examples: Exporting Quality Naturally Foods, Inc., in the City of Industry, California, manufactures prepared bakery mixes for its sister companies Yum Yum Donuts and Winchell Donuts. These and similar mixes are now sold to outlets in Japan. The added volume has reduced costs of production which has benefited all customers., the preeminent online marketer (and inspiration for thousands of online entrepreneurs) has a home page toolbar called “International”. Amazon says: “Around the World, wherever you are, get what you want—fast—from our family of Web sites.” Importing Good Tables, Inc. of Carson, California, formerly manufactured furniture in its California plant but was losing sales due to cheaper foreign made products. The manufacturing was moved to Mexico in a “maquiladoras” factory. Funrise, Inc. Woodland Hills, California, has become a world leading marketer of toys. Design, packaging and production are outsourced, primary to vendors in China. Hollow Corporations International trade is especially appropriate for the rapidly growing number of “hollow corporations.” Session one of this course refers to a hollow corporation as a business without a factory and with a minimum number of employees in which manufacturing is performed by outside suppliers. A hollow corporation might depend on outside suppliers for virtually all of its products, such as an American toy company importing product from China. Or, it might depend on outside suppliers for selected components in its overall product line, such as The Boeing Company. (Boeing is using Japanese firms for components of the new 787 airliner.) Is International Trade Appropriate for Small Businesses? The answer is definitely yes! According to the U.S. Department of Commerce, big companies make up about 4 % of U.S. Exports. Which means that 96% of exporters are small companies.
  6. 6. Why is international trade so important to starting small businesses? In some cases the products or services you may wish to market are not available or made in your home country. For example, think about selling cashmere sweaters. You may need to become an importer in order to compete with imported products sold by your competitors. International trade is enormously beneficial for entrepreneurs and enables producers of goods and services to move beyond the U.S. market of 280 million people to the world market of 6.2 billion. While international trade accounted for 5% of U.S. economic growth in 1950, today it has become an integral part of business, accounting for more than 25% in 2002. For many small companies importing and exporting is becoming an essential cornerstone in achieving success, yet it requires knowledge of business disciplines far beyond the basic do’s and don’ts of operating a domestic business. Advantages and Disadvantages of International Trade Advantages to consider: • Enhance your domestic competitiveness • Increase sales and profits • Gain your global market share • Reduce dependence on existing markets • Exploit international trade technology • Reduce dependence on existing markets • Exploit international trade technology • Extend sales potential of existing products • Stabilize seasonal market fluctuations • Enhance potential for expansion of your business • Sell excess production capacity • Maintain cost competitiveness in your domestic market Disadvantages to keep in mind: • You may need to wait for long-term gains • Hire staff to launch international trading • Modify your product or packaging • Develop new promotional material • Incur added administrative costs • Dedicate personnel for traveling • Wait long for payments • Apply for additional financing • Deal with special licenses and regulations
  7. 7. Online Resources Since international trade necessarily requires interaction with governmental agencies, and most all governments wish to expand their country's role in international trade, entrepreneurs can look to governments themselves for a great deal of information. The U.S. government provides many valuable resources of information and these will be generously referred to in this session. The U.S. Small Business Administration offers aid to small international businesses through two major programs: business development assistance and financial assistance. Our first recommended resource is therefore the U.S. Small Business Administration’s Office of International Trade. The SBA Web site is the place to begin. Resources are offered in four building blocks: Education, Technical Assistance, Risk Management, and Finance. • General export information and development assistance including legal assistance. • Small Business Guide to Exporting. • An online trade mission: a search engine for foreign firms and U.S. businesses seeking partners or suppliers. See • Information on export financing. Other valuable resources from the U.S. government include • The Department of Commerce Web site furnishes trade opportunities for U.S. Business and export related assistance and market information. • The U.S. Government Export Portal provides online trade resources and one-on-one assistance for your international business. • The International Trade Administration (ITA) offers market information, trade leads and overseas business contacts. Trade professionals can assist you every step of the way with information counseling that reduce the cost, risk and mystery of exporting. • BISNIS is the U.S. Government’s primary market information center for companies exploring opportunities in Russia and other newly independent states. • Counterfeiting and Piracy cost the world economy approximately $650 billion per year. You can find articles and initiatives about protecting your Intellectual Property abroad at as well as toolkits for Brazil, China, Korea, Malaysia, Mexico Peru, Russia and Taiwan.
  8. 8. Here are some non-governmental resources to expand your knowledge about international trade: • Search engines such as Google or Yahoo or provide a huge database of information (type in “international trade”) that will require selectivity to retrieve the most helpful information. • The Federation of International Trade Associations provides portals to trade leads, market research, a global trade shop and even a job bank. • is a large network of international trade market places, providing trade leads and new business contacts. • A large database of suppliers can be found at Users can either find suppliers or sell products. • is a business to business center matching buyers and sellers in most all industries throughout the world. • - Non-profit marketplace enabling you to purchase directly from artisans all over the world. • - Catalog authoring tool for e-commerce. Common Mistakes Made in International Trade A detailed guide on international trade can be found in Exporting, Importing and E-Commerce by Sharon T. Freeman, Ph.D., President of the All American Small Business Exporters Association. Another book of interest would be Conversations With Women Who Export.” Following is a condensed version of Dr. Freeman’s “how-to” guide in avoiding the ten common export start-up mistakes Common Export Mistakes Solutions 1. Failure to obtain qualified export counseling and Obtain Export Counseling to develop a master international marketing plan before starting an export business. 2. Insufficient commitment by top management to Determine Export Readiness exporting. 3. Failure to have a solid agent/distributor’s Understand Agent/Distributor Contracts agreement 4. Blindly chasing “E-orders” from around the Avoid Accidental Exporting world. 5. Failure to understand the connection Understand Export Financing between country risk and securing export financing.
  9. 9. 6. Failure to understand Intellectual Property Understand Intellectual Property Rights Rights (IPR) 7. Insufficient attention to marketing and Pay Attention to Overseas Marketing advertising requirements. and Advertising 8 . Lack of attention to product preparation needs. Pay Attention to Product Preparation Requirements 9. Failure to consider legal aspects of going global. Understand Licensing and Joint Ventures 10. Failure to know the rules of trade. Understand Export Regulations 1. Failure to obtain export counseling and to develop a master international marketing plan before starting an export business. Utilize Government and Association Resources for Export Counseling: It is also important for new exporters to seek legal counsel. Hire a Lawyer to Help You Structure Your Export Operations for the Long Run: Lawyers are concerned with issues of compliance on both ends of the transaction, therefore they are instrumental in helping you to make sure that your recordkeeping system is planned correctly, that your legal documents are structured correctly, and to advise you on a broad range of compliance issues before the sale, during the sale, and after the sale. 2. Insufficient commitment to overcome the initial difficulties and financial requirements of exporting. To be successful in exporting, firms have to establish an export department to which they dedicate personnel and a budget, and for which they develop appropriate procedures, preferably in consultation with a qualified trade lawyer. A recommended resource for helping firms to assess their “readiness” to export is cited below: Michigan State University’s Center for International Business Education and Research—CIBER: MSU has an Export Academy that has developed a state-of-the-art system to assess export readiness. Called CORE V™, it is a Windows-based managerial tool for self-assessment of organizational readiness to export. (See 3. Failure to have a solid agent and or distributor’s agreement.
  10. 10. Firms that intend to enter and to expand in exporting will likely need an agent or distributor at some point. Key considerations include Understanding the Role of Agents: The NTDB Web site at ( provides information on agents and distributors. As explained on this Web site, agents receive commission on their sales rather than buying and selling for their own account. As agents do not own the products they sell, the risk of loss remains with the company the agent represents (the principal). Understanding the Role of Distributors: The key legal distinctions between an agent and distributor are • A distributor takes title to the goods and accepts the risk of loss. A distributor makes profits by reselling the goods. • Distributors cannot contractually bind the company producing the goods. • Distributors establish the price and sales terms of the goods. Contract Drafting Considerations for Agent/Distributor Agreements: The first and most important consideration when drafting an agreement is to ensure that the agreement clearly states whether there is an agent or a distributor relationship. The agreement should also clarify the terms and conditions for selling the products. For example: • Determine whether the relationship is exclusive versus non-exclusive. • Specify which geographic regions are to be covered. • Outline issues of payment and payment schedules for the products (in the case of a distributor) and for payments of commissions (in the case of agents). • Determine the currency in which payments are to be made and address currency fluctuation issues. • Provide specific provisions regarding renewal of the agreement, including specific parameters for performance, promotional activity and notice of desire to renew. • Establish a specific provision for termination of the agreement and terms for such termination. (Some foreign countries restrict or prohibit termination without just cause or compensation.) • Outline the termination process for the end of the agreement period. • Provide for workable and acceptable dispute settlement clauses. • Assure that the agreement addresses whether or not intellectual property rights are being licensed or reserved. • Do not allow, without seller’s consent, the contract to be assigned to another party (sub- agents or sub-distributors) to be used to fulfill obligations in the contract or the contract to be transferred with a change of ownership or control over the agent/distributor. • Assure that your contract complies with both U.S. and foreign laws. The Commercial Service of the Commerce Department provides a service to identify qualified agents, distributors, and representatives for U.S. firms. For each Agent/Distributor Service,
  11. 11. ( Commercial officers abroad identify up to six foreign prospects that have examined the U.S. firm's product literature and expressed interest in representing the U.S. firm's products. 4. Blindly chasing orders from around the world You may be in your office when suddenly and unexpectedly someone from a foreign country contacts you electronically and wants to buy a line of your products. What do you do next? Make sure the order is not on the denied list: Go to the Bureau of Industry and Security’s Web site to view the entire list of denied orders ( Business considerations in checking out the firm making the inquiry: Make sure the opportunity is a reasonable one and involves something that can reasonably be handled by your firm, without spending countless hours researching the requirement. The Department of Commerce Commercial Service has a number of services to assist you. • International Company Profile (ICP) – The ICP service, referred to earlier, helps firms investigate the reliability of prospective trading partners. • Country Directories of International Contacts (CDIC)Provides the name and contact information for directories of importers, agents, trade associations, government agencies, etc., on a country-by-country basis. The information is available on the National Trade Data Bank. Competitive considerations in checking out the market for the product: By reviewing industry sector information, firms can obtain useful data to assess the probability that the inquiry they are investigating is real. One resource that may be helpful is the Department of Commerce, Commercial Service’s Industry Sector. The U.S. Department of Commerce’s Commercial Service Officers are a valuable resource for information about firms overseas. Access this service to learn if a particular deal sounds legitimate and whether the agency has any information on the firm making the inquiry. For the e- mail addresses of Commercial Service Offices go to 5. Failure to understand the connection between country risk and the probability of getting export financing. The best source of information about whether a country is in good standing with the U.S. is the U.S. Export-Import Bank’s Country Limitation Schedule. ( Access the Export Financing Options: The SBA, ExIm, and the Agriculture Department are three of the biggest providers of export financing in the federal government. A list of the strategic banking partners of the ExIm and SBA export financing and credit insurance programs can be obtained from ExIm and SBA.
  12. 12. Check out SBA’s Export Financing Products: The SBA’s Export Working Capital Program (EWCP) provides short-term working capital for up to one year. Consult the ExIm’s Export Financing Products: The ExIm’s Working Capital Guarantee Program allows commercial lenders to make working capital loans to U.S. exporters for various export-related activities by substantially reducing the risks associated with these loans. Access ExIm’s Export Credit Insurance: The Export Credit Insurance program provides protection against losses associated with foreign buyers or other foreign debtor default for political or commercial reasons. 6. Failure to understand Intellectual Property Rights (IPR). Intellectual property rights refer to the legal system that protects patents, trademarks, copyrights, trade secrets. It is important for exporters to understand how and whether intellectual property rights are protected in different countries. See the U.S. Department of Commerce’s Legal Counsel Web site at: ( 7. Insufficient attention to marketing and advertising requirements. Key considerations include Trade Shows and Trade Missions: Trade shows and missions may be in the virtual form or entail traveling to the foreign country. All Department of Commerce-sponsored shows and trade missions are listed in the Export Promotion Calendar, available on the TIC Web site; the NTDB or by mail from a TIC trade specialist. Information is also usually posted on the Internet pages for industry offices accessible from the International Trade Administration ( For an additional source of information on upcoming trade shows visit the Internet Web site for Trade Show Central ( the Trade Show Center ( Web site which lists trade shows around the world. Advertising: Exporters can advertise U.S.-made products or services in Commercial News USA, a catalog-magazine published 10 times a year to promote U.S. products and services in overseas markets. Commercial News USA is disseminated to business readers worldwide via U.S. embassies and consulates and international electronic bulletin boards, and selected portions are also reprinted in certain newsletters. U.S. Pavilions: About eighty to one hundred worldwide trade fairs are selected annually by the Commerce Department for recruitment of a USA pavilion. Selection priority is given to events in viable markets that are suitable for new-to-export or new-to-market, "export ready" firms. 8. Lack of attention to product adaptation and preparation needs
  13. 13. The selection and preparation of a firm’s product for export requires not only knowledge of the product, but also knowledge of the unique characteristics of each market being targeted. Key considerations include Product Adaptation to standards requirements: As tariff barriers (tariffs, duties, and quotas) are eliminated around the world in accordance with the requirements of participation in the World Trade Organization (WTO), other non-tariff barriers, such as product standards, are proliferating. Exporters must understand conformity requirements to operate on an international basis. The DOC’s National Center for Standards and Certification Information (NCSCI) provides information on U.S. and foreign conformity assessment procedures and standards for non- agricultural products. You can visit their Web site by going to Product Engineering and Redesign: The factors that may necessitate re-engineering or redesign of U.S. products may include differences in electrical and measurement systems. Branding, Labeling and Packaging: Cultural considerations and customs may influence branding, labeling and package considerations. • Are certain colors used on labels and packages attractive or offensive? • Do labels have to be in the local language? • Must each item be labeled individually? • Must each item be labeled individually? • Are name brands important? Installation: Another important element of product preparation is to ensure that the product can be easily installed in the foreign location. Importers and exporters need to know they may also consider providing training or providing manuals that have been translated into the local language along with the product. Warranties: In order to compete with competitors in the market, firms may have to include warranties on their products. Servicing: The service that U.S. companies provide for their products is of concern to foreign consumers. Foreign consumers want to know whether they can access spare parts, technicians who can service the product, and distributors of the products in their countries. 9. Failure to obtain legal advice While it is virtually impossible for any firm, no matter how big or small, to know all of the laws that pertain to exporting from the U.S., as well as the relevant laws of other countries, there are measures that can be taken by firms in the planning process to minimize the probability that they will make unnecessary errors that have grave legal consequences. Some of the measures that can be taken in the planning process are
  14. 14. Utilize SBA’s ELAN service: Under the Export Legal Assistance Network (ELAN), your local SBA office can arrange a free initial consultation with an attorney to discuss international trade questions. Consult the Commerce/ITA Legal Web page: the DOC, International Trade Administration’s (ITA) legal Web site: ( 10. Failure to understand export licensing requirements. Businesses that are new to the export arena may confuse the local and state rules regarding business taxes, zoning and other issues, i.e., legal registrations, with the federal requirements governing export licenses. In order to export an item that may be on the restricted list, an export license is required. This allows the federal government to control the export of the goods. The license is not required for every item exported. The U.S. Department of Commerce Bureau of Export Administration (BXA) is the primary licensing agency for dual-use exports (commercial items that could have military applications). The first step in determining your license requirements is to classify your product using the Commerce Control List (CCL). Once the product’s classification is determined, the following five questions will determine your obligations under the EAR: • What is the item you intend to export or re-export? • Where is it going? • Who will receive it? • What will they do with it? • What are the recipient's other activities? Importance of a Business Plan for International Trade Once your decision is made to export or import, it is important that your overall business plan includes provisions for international trade. A downloadable template for this purpose is furnished at the end of this session. Suggested Activities: 1. Make a list of your potential competitors and make a tabulation of their principal products or services. Determine the county of origin of each product or service. Determine the cost of each product or service. 2. Evaluate your own capabilities to compete with these products or services.
  15. 15. Top Ten Do's and Don'ts TOP TEN DO'S 1. Take international trade classes at the college level. 2. Visit trade shows and trade missions. See 3. Join an international trade association specializing in your business. 4. Personally visit your offshore suppliers (or customers). 5. Take advantage of online resources such as 6. Inspect and approve merchandise before it is shipped. 7. Consider hiring an international trade consultant. 8. Become personally familiar with all monetary transactions. 9. Use a trade lawyer for agent and distributor agreements and licensing requirements. 10. To begin, start on a very small scale. TOP TEN DON'TS 1. Investigate the potential opportunities and benefits of international trade. 2. Rely on a single source of supply (or customer). 3. Have an understanding of intellectual property rights. 4. Have an understanding of import/export financing. 5. Learn how your best competitors are handling international trade. 6. Provide dispute settlement provisions. 7. Make assumptions as to vendor's compliance with your specifications. 8. Check out your suppliers/customers before establishing relationship. 9. Rely on handshake agreements. 10. Rely solely on others including employees for importing/exporting expertise. Foreign Trade Policy of India
  16. 16. This site provides comprehensive information on Foreign Trade Policy of India . The site also focuses on India's achievements as a result of its well designed Foreign Trade Policy. To become a major player in world trade, a comprehensive approach needs to be taken through the Foreign Trade Policy of India . Increment of exports is of utmost importance, India will have to facilitate imports which, are required for the growth Indian economy. Rationality and consistency among trade and other economic policies is important for maximizing the contribution of such policies to development. Thus, while incorporating the new Foreign Trade Policy of India, the past policies should also be integrated to allow developmental scope of India’s foreign trade. This is the main mantra of the Foreign Trade Policy of India. Objectives of the Foreign Trade Policy of India - Trade propels economic growth and national development. The primary purpose is not the mere earning of foreign exchange, but the stimulation of greater economic activity. The Foreign Trade Policy of India is based on two major objectives, they are - m To double the percentage share of global merchandise trade within the next five years. To act as an effective instrument of economic growth by giving a thrust to employment generation. Strategy of Foreign Trade Policy of India - entrepreneurship, industrialization and trades. e Simplification of commercial and legal procedures and bringing down transaction costs. e Simplification of levies and duties on inputs used in export products. e e Generating additional employment opportunities, particularly in semi-urban and rural areas, and developing a series of ‘Initiatives’ for each of these sectors. s Facilitating technological and infrastructural upgradation of all the sectors of the Indian economy, especially through imports and thereby increasing value addition and productivity, while attaining global standards of quality. t Neutralizing inverted duty structures and ensuring that India's domestic sectors are not disadvantaged in the t Free Trade Agreements / Regional Trade Agreements / Preferential Trade Agreements that India enters into in order to enhance exports. Upgradation of infrastructural network, both physical and virtual, related to the entire Foreign Trade chain, to global standards.
  17. 17. Foreign Capital and Economic Growth Presentation by Raghuram Rajan, Economic Counsellor and Director of the Research Department, based on a paper written by Eswar Prasad, Raghuram Rajan, and Arvind Subramanian1 At a Conference Organized by the Federal Reserve Bank of Kansas City Jackson Hole, Wyoming August 25, 2006 Good morning. Let me say at the outset that what follows are the authors' views and should not be seen as the views of the International Monetary Fund or its management. The essential question our paper asks is, "Does foreign capital play a helpful, benign, or malign role in the process of economic growth?" The theory is simple — First, capital should flow from rich countries to poor countries — because in the neoclassical model, the marginal product of a unit of capital is much higher in poor countries that are typically labor abundant and capital poor. Second, more productive poor countries should attract more foreign capital because they have the ability to use it better. And third, because it adds investible resources, and because of the collateral benefits of foreign capital such as bringing in new technologies of production and control, greater use of foreign capital should be associated with more growth. What is the evidence? In what follows, I will show you evidence that capital does not flow from rich to poor countries in the relative quantities it used to — surprising given that financial markets have been getting better. Moreover, it is not also true that amongst non-industrial countries, the most productive get the most capital inflows. Finally, for non- industrial countries, there does not seem to be a positive association between growth and reliance on foreign capital. In fact, there is generally a negative correlation suggesting that non-industrial countries that are more reliant on foreign capital grow less. For industrial countries, though, there is a positive association. Correlation is not causation, and indeed there are both benign and malign explanations of these correlations. What seems to be clear is that non-industrial countries do not have tremendous absorptive capacity for foreign capital in general, though particular forms of foreign capital such as FDI may be useful. Put differently, the relatively low use of foreign capital by successful developing countries may have more to do with their low demand for foreign capital than with a willingness of developed country creditors to supply it. One reason for the low demand may be their financial system is underdeveloped so that when they have growth opportunities, the extra domestic savings they generate are largely adequate to cover the investment that can profitably be financed. This is a benign explanation for the limited role of foreign capital in development. More malign is if foreign capital inflows cause overvaluation of the exchange rate, thus reducing the competitiveness of the economy, and thus reducing manufacturing exports and undermining a traditional stepping stone to growth. There are also concerns about foreign capital we do not address, such as its potentially higher volatility, which may make countries other than the really
  18. 18. needy stay away from it. Our conclusion is therefore that in the long run, capital account opening is unlikely to help poor countries grow by providing resources in excess of what is available in the domestic economy — notwithstanding examples of foreign capital led booms and busts -- though it may help in other ways. Foreign capital is no panacea for capital-poor countries. Put differently, the current patterns of flow of capital in the global economy, though seemingly perverse, may not be so, at least given the financial and institutional constraints non- industrial countries have. That does not mean these flows are either optimal, safe, or sustainable in the long run. Let me now turn to the evidence. The paradox Lucas noted was that capital does not flow in the requisite quantities from rich to poor countries. Indeed, matters have gotten worse recently. Capital seems to be flowing uphill as the next slide shows. The dark line represents weighted average relative incomes of countries exporting capital (that is, running current account surpluses). Income is measured relative to the richest country in that year, and the weight on each country's income is the size of its surplus relative to the total surplus. The dark line has been falling while the dotted line, representing the weighted average income of countries using capital (that is, running current account deficits), has been rising. The dotted line is now significantly above the dark line — simply put, the poor are now exporting capital to the rich. Note that this is not new. It was also true in the mid 1980s. Since these periods are also when the U.S. was running large deficits, what does the picture look like when we drop the U.S. from deficit countries. On the next slide, the picture looks similar with a narrowing of the income gap between capital exporters and capital receivers
  19. 19. in the mid 1980s, and again since the late 1990s. What we have seen so far are overall flows. Foreign Direct Investment (FDI) flows by themselves do behave more in accordance with the models as the next slide suggests--the weighted-average relative income of countries experiencing net FDI inflows is generally lower than that of FDI-exporting countries, though the relative income of senders has been trending down while the relative income of recipients has been moving up since the mid 1990s. So in sum, rich countries are increasingly net users of foreign capital while poorer countries are increasingly net suppliers. The next question is who amongst poor countries gets the most capital. This is an
  20. 20. important question because some have argued that the reason poor countries export capital is because private investors there do not see good investment opportunities in their own countries and therefore invest abroad — for example, invest in the US, which then invests it back as FDI. Some therefore call the U.S. the global venture capitalist. There are problems with this argument taken at face value, including the fact that private investors in many poor countries do not have access directly to foreign investment opportunities — they invest in domestic banks, which invest in the central bank, which then invests abroad. It is not clear that private investors in these countries should have substantially greater confidence in domestic financial institutions (or in their governments) than in corporations. Be that as it may there is a deeper problem. In the next slide, we divide non-industrial countries based on growth into three groups, each with approximately the same total population. We keep aside populous India and China. The theory would say that the high growth countries should attract the most capital because they have the best investment opportunities (and also are the most credit worthy). The reality is very different. The Allocation of Capital Flows to Non-Industrial Countries 1970-2004 High growth countries use less foreign capital than even low growth countries. China, the fastest growing country of them all, is a net exporter of capital between 1970 and 2004. In fact, if you turn to the next slide, both in the heyday of capital flows to poor countries from 1985 to 1997, and in the most recent years, the flows have been inversely proportional to growth. Between 2000 and 2004, we see the well known phenomenon of reserve build up as all but the slowest growing poor countries export capital. The Allocation of Capital Flows to Non-Industrial Countries 1985-1997 and 2000-2004
  21. 21. Note again in the next slide that FDI is different. Here it does seem that over long periods, more FDI goes to the faster growing countries, but again there is a reversal in the most recent years, with the fastest growing countries getting less FDI than slower growing countries. It is suggestive that in the period 2000-2004, countries are taking in FDI, even while exporting savings on net, suggesting that FDI has benefits over and above simply augmenting the resource base. The Allocation of Net FDI Flows to Non-Industrial Countries
  22. 22. This immediately leads to the question: Do countries that rely more on foreign capital grow faster in the long run? It turns out, that this is not so. Indeed , as the next slide shows, if you plot growth over a 30 year period against current account balances, you find a positive correlation for non-industrial countries. Countries that use less foreign finance, or export more savings, grow faster. Clearly, one might expect this for the countries that are development disasters and totally reliant on foreign aid. To check for this possibility, we drop countries that got annual aid of more than 10 percent of GDP. It turns out the correlation is even stronger.
  23. 23. The positive association between current account balances and growth holds in a more formal setting. As the next slide shows, in a standard regression of long run growth a la Bosworth and Collins, the coefficient on the current account balance is positive and statistically significant even after controlling for typical determinants of growth (initial income, trade policy, fiscal policy, institutional quality, life expectancy, and dummies for oil exporters and sub-Saharan Africa).
  24. 24. Is this relationship robust? Turning to the next slide, even if we drop countries that have high levels of official financing (aid-to-GDP ratio greater than 10 percent), we find that the relationship holds for the whole sample and also for the three regions separately—Asia, Africa, and Latin America. Current Account Balances and Growth in Non-Industrial Countries 1970-2000 - Excluding Countries with Aid/GDP>10 Percent So far, we have looked just at non-industrial countries. The table in the next slide suggests
  25. 25. when we include industrial countries to see if the association between current accounts and growth is different for these two countries, we find that indeed that is the case. The correlation is negative for industrial countries (a 1 percentage point increase in the ratio of the current account balance to GDP decreases growth by 0.14 percent per year); while this correlation is positive for both emerging markets and developing countries. Finally, a very simple way of assessing whether foreign capital matters is to look at countries with high and low investments and high and low savings, to see what combination of savings and investment matter for growth. The chart in the next slide shows that countries that invest more grow more than countries that invest less; but it is countries that invest more and save more (that is rely less on foreign capital) that do the best of all. In fact, within countries that invest more, those that save more (and thus run lower current account deficits) grow at a rate of about 1 percent a year more than countries that save less. Current Account, Investment and Growth in Non-Industrial Countries
  26. 26. All this suggests that domestic savings rather than foreign savings are critical for growth. Indeed, turning to the table in the next slide, we find in the second column that controlling for domestic savings in our baseline regression eliminates the effect of the current account on growth but controlling for investment does not. We have conducted a number of robustness checks given that savings or investment could be mismeasured to verify this finding is robust. This suggests that domestic savings are an important correlate with growth.
  27. 27. Interestingly, while this is true for non-industrial countries, it is not the case for industrial countries. Why so? There are at least three potential explanations for this finding, all to do with the fact that non-industrial countries do not have much capacity to absorb foreign capital. The first relates to the domestic financial system. In industrial countries that have well developed financial systems, a sustained increase in productivity would not only result in more investment — as firms borrow to take advantage of investment opportunities — but also more consumption as consumers borrow to consume in anticipation of their higher income. This implies more financing from abroad or current account deficits. In non-industrial countries, by contrast, a productivity shock creates higher incomes, but is filtered by a weak financial system into weaker investment growth and greater savings growth because firms are constrained to self-finance investment and households cannot borrow much against higher future income to increase consumption. It is possible that greater productivity growth shrinks the current account deficit, and even results in surplus savings. One implication is that savings should grow more than investment around the time when non-industrial countries experience growth spurts, typically due to surges in productivity. As the next slide suggests, this is what we find for a group of developing countries during such growth spurts (as identified by Hausman, Rodrik and Pritchett). As you can see from the chart below, savings grows faster than investment during a growth spurt, Savings-Investment Balances around Growth Spurts: Non-Industrial Countries 1970-2000
  28. 28. which explains why the current account deficit, narrows.
  29. 29. Another implication is that the correlation between growth and the current account (alternatively, domestic savings) should be stronger in countries with weaker financial systems. This is indeed what we find in the 2nd and 3rd columns in the next slide where countries with indicators of financial development below the median have about twice the coefficient on the current account as countries with financial development above the median.
  30. 30. At the micro level, we find that in countries with weaker financial systems, additional foreign resources do not translate into stronger growth of financially-dependent industries. Again, this suggests countries with low financial development do not have the absorptive capacity for foreign savings. A second explanation of the importance of domestic savings relative to foreign financing relates to the exchange rate. There is increasing evidence that sustained growth has been associated with the development of the domestic manufacturing sector which in turn requires that its competitiveness not be undermined by overvalued exchange rates. We find evidence that developing countries that rely on foreign capital are more prone to overvaluation. Thus, our result of a positive correlation between the current account and growth could be explained as follows: strong capital inflows lead to an overvalued exchange rate, hurting manufacturing exports, which in turn could reduce long run growth — perhaps because manufacturing growth is a key stepping stone to development. By contrast, for industrial countries, we do not find that capital inflows affect the extent of exchange rate overvaluation, nor do we find that overvaluation has any effect on growth. Industrial countries seem to have more absorptive capacity for foreign capital. The next explanation relates to volatility. Capital flows are volatile which in turn lead to financial crises, setting back sustained growth. We have relatively little to add here except to note that a number of studies show that there is no systematic correlation between openness to capital and volatility. Moreover, the volatility argument is not easily squared with the fact that the negative correlation between capital flows and growth is also present for sub-Saharan Africa, which relies on official capital that tends to be less volatile than private capital.
  31. 31. So, to summarize: The implication of our analysis is that successful developing countries have been less reliant on foreign capital because of their limited capacity to absorb it. Our paper suggests that the anomaly of poor countries not attracting capital, or occasionally even financing rich countries, may not really hurt the former's growth, at least conditional on their existing institutional and financial structures. Opening up to foreign capital may not help much unless the domestic financial sector and the tradable sector also develop. But there is a dilemma for policy makers here. Even though reformers in developing countries might want to wait to achieve a certain level of financial development before pushing for financial integration, the prospect of financial integration and ensuing competition may be needed to spur domestic financial development. One approach worth considering might be a firm commitment to integrate financial markets at a definite future date (as China has done in the banking sector in the context of the WTO), thus giving time for the domestic financial system to develop without possible adverse effects from capital inflows, even while giving participants the incentive to press for it by suspending the sword of future foreign competition over their heads. Another possibility is to allow more outflows in a controlled manner, so that the pressure on the exchange rate from inflows is diminished. Finally, our analysis offers an alternative view of the global current account imbalances that have built up recently. In the last decade or so, the U.S. has experienced a tremendous surge in productivity. What is less well known is that non-industrial countries have also experienced a large surge in productivity. There has indeed been a global productivity shock, and the resulting pattern of current accounts might reflect the differing patterns of financial sector development. Countries with strong financial systems have taken advantage by investing and consuming more, running deficits (the US being the best example). Countries with relatively weaker financial systems on the other hand have increased savings and been more conservative on investment, with this tendency accentuated by the experience of the Asian financial crisis and the indiscriminate lending and investment leading up to it. Some industrial countries such as a number in the Euro region have not experienced a similar productivity surge, and thus have been left out of the global tango. Imbalances may therefore be a consequence of deep structural deficiencies, but given these deficiencies might be an equilibrium outcome. Imbalances will come down as productivity growth slows in the United States, and consumption and investment adjust in emerging markets to the higher productivity. Financial sector reform will help here. But there are risks associated with this equilibrium. When a large country runs a trade deficit of 6 percent of GDP for a long time, it will eventually find financing harder to come by. Poor countries who have built up large foreign asset holdings run the risk of large exchange losses at that point. Even if financial markets stay tolerant, protectionist politicians may pull the trigger. A smooth unwinding is in everyone's interest, and to the extent public policy can help, a risk management approach suggests it should. One should not confuse
  32. 32. the words "equilibrium", "stability", and "sustainability