Economic assignment of international trade (usama shehzad sr ii-s) (2)
Qs.1.What is balance of payments ?
Ans. Balance of payments (BoP) accounts are an accounting record of all
monetary transactions between a country and the rest of the
world. These transactions include payments for the country's exports and
imports of goods, services, financial capital, and financial transfers. The
BoP accounts summarize international transactions for a specific period,
usually a year, and are prepared in a single currency, typically the
domestic currency for the country concerned. Sources of funds for a
nation, such as exports or the receipts of loans and investments, are
recorded as positive or surplus items. Uses of funds, such as for imports
or to invest in foreign countries, are recorded as negative or deficit items.
Qs.2.What is exchange rate ?
Ans. The price of one country's currency expressed in another country's
currency. In other words, the rate at which one currency can be
exchanged for another. For example, the higher the exchange rate for one
euro in terms of one yen, the lower the relative value of the yen.
Qs.3.What is floating exchange rate and what are its causes ?
Ans. Floating exchange rate system means that the exchange rate is
allowed to fluctuate according to the market forces without the
intervention of the Central bank or the government
Causes of fluctuation in currency value :
Changes in the imports and exports of the country :
An increase in exports of a country will lead to an increase in demand for
the currency and thus the value rises.
Changes in Interest rate :
Higher interest rate will attract more foreign investors to invest in the
country and thus the demand for currency will rise, resulting in
appreciation in value of the currency.
Changes in Inflation rate :
Higher inflation rate will make the country uncompetitive in the
international market. The exports will fall resulting in decreased demand
for the currency and hence lower value.
Rise in domestic income relative to incomes abroad :
Investment opportunities :
if bright lead to appreciation.
Speculative sentiments :
Individuals and institutions invest in currency markets with the sole
intention to get short term gains. This is quiet like investing in stock
exchange. Whenever a currency is going strong, people will invest more in
an expectation to gain from it. This fuels the demand for that particular
currency and it appreciates further.
Global trading patterns :
if strong global presence in trade then the currency appreciates.
Changes in relative inflation rates :
high inflation rate leads to exports becoming less competitive in
Qs.4.What is fixed exchange rate ?
Ans. Fixed Exchange Rate : A fixed exchange rate system refers to the case
where the exchange rate is set and maintained at same level by the
government irrespective of the market forces.
Qs.5.How to correct negative balance of payment ?
Ans. Restricting economic activity
To correct a current account deficit a government needs to boost exports,
restrain imports, or increase net investment income.
From the 1880s the first policy practised by the government was to cut its
own spending and encourage banks to restrict credit. This would reduce
demand for imports and allow the country to meet its international
In 1938, for the first time, the Labour government intervened directly by
imposing controls on imports and foreign exchange.
For most of the period between 1938 and 1992, import controls were
usually implemented through a licensing regime: governments issued
licences to individuals and firms authorising the annual import of a
specific quantity of a type of good.
Though effective in reducing imports, the licensing regime could also be
inefficient. Long waiting lists developed for the purchase of certain
desirable imports such as cars. Licences were allocated on an arbitrary
basis, rather than on the value that firms and individuals placed on an
import. Worse, import licences could increase the likelihood of a
payments crisis because, anticipating a licensing regime – or a more
stringent one – individuals might import much more than their current
requirements. This occurred in 1957 – import licensing had been
suspended in 1952, but was reintroduced in 1958.
Since foreign debts were usually settled in foreign currency, for most of
the period between 1938 and 1984 New Zealand governments operated a
system of exchange controls to maintain adequate reserves of foreign
currency. Exporters had to convert their foreign earnings to New Zealand
currency with the Reserve Bank, and, in turn, the bank supplied foreign
exchange only for approved purchases. New Zealanders travelling
overseas could only take limited amounts of foreign currency, and no
bank outside New Zealand would deal in New Zealand currency.
A more important and effective tool New Zealand governments used to
correct payments imbalances was to devalue the country’s currency
against foreign currencies. This made New Zealand exports cheaper and
therefore more competitive in international markets, and it discouraged
imports by making them more expensive in New Zealand. Usually, New
Zealand assets also became more attractive to foreign investors following
devaluations, and the resulting capital inflows made a crisis less likely.
However, devaluations often triggered inflation (general price rises) as
import price increases were passed on to consumers.
The New Zealand dollar was floated in 1985. This should, in theory,
ensure that balance of payments crises no longer occur because the
currency would self-correct. For example, a high demand for imports
increases the demand for foreign currency to pay for these imports. This
higher demand increases the price of that currency in New Zealand
dollars – a depreciation of the New Zealand dollar. Consequently, a
balance of payments deficit, which might have been created by the high
import demand under a fixed exchange rate, may be pre-empted by a
depreciating New Zealand dollar making the imports more expensive.
In practice, balance of payments deficits have persisted, but New Zealand
has been able to borrow to cover them, avoiding payments crises of the
kind that were common before the 1980s.
Qs.6.What are the problems of trade surplus ?
Ans. A variety of policies have been used to achieve protectionist goals.
Tariffs : Typically, tariffs (or taxes) are imposed on imported goods.
Tariff rates usually vary according to the type of goods imported.
Import tariffs will increase the cost to importers, and increase the
price of imported goods in the local markets, thus lowering the
quantity of goods imported, to favour local producers. (see Smoot–
Hawley Tariff Act) Tariffs may also be imposed on exports, and in an
economy with floating exchange rates, export tariffs have similar
effects as import tariffs. However, since export tariffs are often
perceived as 'hurting' local industries, while import tariffs are
perceived as 'helping' local industries, export tariffs are seldom
Import quotas : To reduce the quantity and therefore increase the
market price of imported goods. The economic effects of an import
quota is similar to that of a tariff, except that the tax revenue gain
from a tariff will instead be distributed to those who receive import
licenses. Economists often suggest that import licenses be auctioned to
the highest bidder, or that import quotas be replaced by an equivalent
Administrative barriers : Countries are sometimes accused of using
their various administrative rules (e.g. regarding food safety,
environmental standards, electrical safety, etc.) as a way to introduce
barriers to imports.
Anti-dumping legislation :Supporters of anti-dumping laws argue that
they prevent "dumping" of cheaper foreign goods that would cause
local firms to close down. However, in practice, anti-dumping laws are
usually used to impose trade tariffs on foreign exporters.
Direct subsidies : Government subsidies (in the form of lump-sum
payments or cheap loans) are sometimes given to local firms that
cannot compete well against imports. These subsidies are purported to
"protect" local jobs, and to help local firms adjust to the world
Export subsidies :Export subsidies are often used by governments to
increase exports. Export subsidies have the opposite effect of export
tariffs because exporters get payment, which is a percentage or
proportion of the value of exported. Export subsidies increase the
amount of trade, and in a country with floating exchange rates, have
effects similar to import subsidies.
Exchange rate manipulation : A government may intervene in
the foreign exchange market to lower the value of its currency by
selling its currency in the foreign exchange market. Doing so will raise
the cost of imports and lower the cost of exports, leading to an
improvement in its trade balance. However, such a policy is only
effective in the short run, as it will most likely lead to inflation in the
country, which will in turn raise the cost of exports, and reduce the
relative price of imports.
International patent systems : There is an argument for viewing
national patent systems as a cloak for protectionist trade policies at a
national level. Two strands of this argument exist: one when patents
held by one country form part of a system of exploitable relative
advantage in trade negotiations against another, and a second where
adhering to a worldwide system of patents confers "good citizenship"
status despite 'de facto protectionism'. Peter Drahos explains that
"States realized that patent systems could be used to cloak
protectionist strategies. There were also reputational advantages for
states to be seen to be sticking to intellectual property systems. One
could attend the various revisions of the Paris and Berne conventions,
participate in the cosmopolitan moral dialogue about the need to
protect the fruits of authorial labor and inventive genius...knowing all
the while that one's domestic intellectual property system was a
handy protectionist weapon."
Employment-based immigration restrictions,
certification requirements or numerical caps on work visas.
Political campaigns advocating domestic consumption (e.g. the "Buy
American" campaign in the United States, which could be seen as an
extra-legal promotion of protectionism.)
Preferential governmental spending, such as the Buy American Act,
federal legislation which called upon the United States government to
prefer U.S.-made products in its purchases.