International Trade

INTERNATIONAL
TRADE
Dr.M.MADHAVAN

INTRODUCTION
• International economics deals with the economic relations among nations.
The resulting interdependence is very important to the economic well-being
of most nations of the world and is on the increase.
• The economic relations among nations differ from the economic relations
among the various part of a nation. This gives rise to different problems,
requiring somewhat different tools of analysis, and justifies International
Economics as a distinct and separate branch of “Applied” Economics.

International economics deals with …
1. The pure Theory of Trade. This examines the basis for trade and the gains from trade.
2. The Theory of Commercial Policy. This studies the reasons for and the results of
obstructions to the free flow of trade.
3. The Balance of Payments. This examines a nation’s total payments to and total receipts
from the rest of the world. These involve the exchange of one currency for others.
4. Adjustment in the Balance of Payments. This deals with the mechanism of adjustment
to balance of payments disequilibria under different international monetary systems.
• Topics 1 and 2 represent the microeconomic aspects of international economics. Topics 3 and
4 are concerned with macroeconomic aspects.

• International trade is a part of International Economics, which is concerned,
with the exchange of goods between one country and another.
• It is the movement of goods and services from one political boundary or
territory to another.
• It is trading with foreign countries.

Differences between Internal and
International Trade
• Internal or domestic refers to the exchange of goods and services within the geographical boundaries
of a nation while international trade refers to exchange of goods and services between two or more
countries.
• Movement of labour between regions of a country will be easy and common. But this will not be so
in the case of international trade. The reasons are obvious. Barriers connected with language,
national habits and sentiments and in recent times stringent legal restrictions obstruct the free flow of
labour between different countries. The result of this is very important. Because of the free
movement of labour internally, there is a tendency towards equality of wages for a given intensity and
skill. But great differences in the rates of wages may prevail in different countries.
• Each country has a different currency. As India has the rupee, U.S.A. has its Dollar, Germany the
mark, Japan the yen and Spain the peso. Hence international trade gives rise to many currency
complications.

International Trade …. ….. ……
• The citizens of one country are subject to the same system of national and local taxation.,
to the same regulations and laws, regarding industry and labour. Even if capital and labour
moved freely between countries so that wages, interest charges, profits etc., were the same
every where, the general level of real costs might be lower in one country than another
because of certain superior advantages provided by the system of government.
• People posses a very good knowledge of the conditions of trade in their own country. But
they cannot be so conversant with the conditions obtained in other countries. This lack of
knowledge may hinder international trade.
• Trade between countries is not free as in the case of different regions of the same country.
Very often trade restrictions are imposed by customs duties, exchange restriction, quotas and
tariff barriers.

International Trade …. ….. ……
• Each country is under the control of a separate banking system government
by the central bank of the country having a separate monetary policy which
will vitally affect the foreign trade.

THE TERMS OF TRADE
• Benham states that the “terms of trade of a country are the relation between
two sets of world price: the price of the kinds of goods she exports and the
price of the kinds of goods she imports”. The gain to a country from
international trade depends upon he terms of trade: that is, on the rate at
which a quantity of exports exchanges for a quantity of imports.
• The extent of actual gain depends on the following two factors.
• Cost ratios in the two countries and
• The terms of trade.

THE TERMS OF TRADE… …. …..
The terms of trade can be put in the following equation.
Value of imports
Terms of trade = -----------------------------
Value of exports
Price of imports X Volume of imports
Terms of trade = -------------------------------------------------
Price of exports X Volume of exports

BALANCE OF TRADE AND PAYMENTS
• International trade is essential in the nature of barter where the imports of goods of certain
value have to be paid for by an equivalent value of exports.
• The gap between imports and exports has to be eventually filled up by means of payments.
• The difference between exports and imports will have to be settled in gold or in a foreign
currency accepted as medium of exchange by the creditor country.
• Since a country cannot have unlimited quantities of gold or command unlimited quantities
of foreign currencies to pay off its international obligations, it is essential that the value of
imports should not exceed the value of exports.
• In the long run exports must pay for imports.

BALANCE OF TRADE AND PAYMENTS … … …
• In the goods and services exchanged between countries, some are called visible exports and
imports.
• Some are invisible items. Merchandise and treasure are visible items while shipping freight, port
duties, banking services, insurance charges, interest on loans, profits on capital invested in foreign
countries, expenses on diplomatic services are some of the invisible item’s.
• A nation’s balance of payments is a systematic record of all its economic transactions with outside
world in a given year.
• Its main components are the current account, the capital account and the official settlements
account. Each transaction is entered in the balance of payments as a credit or a debit.
• A credit transaction is one that leads to the receipt of a payment from foreigners. A debit
transition leads to a payment to foreigners.

BALANCE OF TRADE AND PAYMENTS … … …
• Balance of trade refers to adjustment of visible exports to visible imports.
• When the value of imports coming to a country is greater than that of
exports going out of the country, the balance of trace is said to be
unfavorable.
• If the value of visible exports is greater than that of value of visible imports,
the balance of trade is said to be favorable.

BALANCE OF PAYMENTS
• The balance of payments of a country is a record of its monetary
transactions for a year with the rest of the world. The items that
enter into the balance of payments are as following:
• The value of export and import trade;
• Invisible exports and imports; that is payment for transport, financial
services, tourist traffic, salaries of diplomatic corps, remittances sent
home by emigrants, etc. Thus balance of payments is more
comprehensive in scope than balance of trade.

METHODS OF CORRECTING AN
UNFAVORABLE BALANCE OF PAYMENTS
• Before the 19th century, when most of the nations were adopted gold as their medium of
exchange.
• Due to this, the disequilibrium in the balance of payments was corrected automatically.
• Suppose a country had unfavorable balance of payments, gold would flow out of the
country. Immediately that country would deflate her currency and reduce credit facilities.
• This action would reduce prices; export would be stimulated and gold would flow in.
Similarly a country having favourable balance of payment would expand her currency and
increase credit facilities. With the abandonment of gold standard, the automatic mechanism
is not available and countries adopt many methods to rectify the unfavourable conditions in
the balance of payments.

METHODS OF CORRECTING AN UNFAVORABLE
BALANCE OF PAYMENTS … …. …..
• Import restriction and export promotion: Since adverse balance of payments is
the result of excessive imports over exports, the former has to be curtailed to the
maximum extent. Imports can be controlled by means of total prohibition or
imposing import duties or by quota system.
• Deflation: By this method the currency of the country may be contracted in
volume and consequently the price would fall. The value of currency would rise.
When prices fall, the country becomes a good market to buy and not a good market
to sell. Exports would thus increase and imports would be checked and the
disequilibrium could be set right. This method may, however, have some serious
consequences. Because of this practice, the country may face a serious depression
and unemployment.

• Devaluation: Devaluation of currency is another method by which the
disequilibrium of BOP can be rectified. Devaluation is a technical term used
to denote the official decrease in the external value of country’s currency. In
other words the metallic content of the currency is devalued. Its value in
terms of foreign exchange currency decreases. Foreign countries will be able
to buy more goods from the country that devalued the currency. But, at the
same time it has to pay more for imports. In this way we can restrict the
imports of a country.

• Exchange control: Under this method all the export merchants are asked to surrender their
foreign exchange to the Central Bank of the country and it is then rationed out among the
licensed importers. Only the licensed importers are allowed to import goods. The
government may adopt either direct method as well as indirect method to control the
exchange rate.
• Direct Method: The Government may adopt the techniques of intervention and ‘Peg up’
or ‘Peg down’ the exchange rates. It may resort to exchange the clearing agreements,
Blocked accounts, Multiple exchange rates, etc.,
• Indirect Method: The government will try to influence the quantum of exports and reduce
imports by export subsides and import duties, the ultimate object of all these measures is to
set right the unfavourable balance of payments.

• Role of I.M.F. in Setting Right Disequilibrium of BOP : The main
functions of International Monetary Fund are :
• Regulating rate of exchange
• Assistance for meeting balance of payments deficits
• Rationing out scarce currencies
• Elimination of exchange restrictions; and
• Assistance in time of emergencies affecting international trade and transactions.

FREE TRADE Vs PROTECTION
• If the trade between countries allowed without any restriction it is called as Free Trade. If
the government took any measures to control the free flow commodities between countries
in the form of exports and imports with a definite objective in view, it is not free trade.
Then the home industries are protected from other countries.
• The classical economists like Adam Smith, Ricardo and others were strongly in favour of
Free Trade Doctrine and this doctrine held sway for over 100 years from 1776. Even today
economists like Lionel Robbins, Haberler, support the policy of free trade.
• The policy of protection became popular from the end of the nineteenth century. The
object behind protection and regulation is to develop domestic industries and make the
country economically stronger. Let us discuss the arguments put forward in favour of free
trade and protection.

FREE TRADE Vs PROTECTION … …. …..
what will be the consequences?
• Arguments for Protection
• The mercantilist view, popular from the sixteenth to the middle of the eighteenth
century in such countries as Britain, Spain, France and the Netherlands, was that the
most important way for a nation to become rich and powerful was to export more
than it imported. The difference would be settled by an inflow of precious metals –
mostly gold. The more gold a nation had, the richer and more powerful it was.
Thus mercantilist advocated that the government should stimulate exports and
restrict imports. Since not all nations could have an export surplus simultaneously
and the amount of gold in existence was fixed at any one time, a nation could only
gain at the expense of other nations. Let us discuss the other arguments in the
following.

Arguments for Protection
• Infant industries Arguments: A country may enjoy very great national
advantages but may not be able to exploit them due to lack of skill,
experience and capitalistic enterprise or due to insufficient infrastructure
which are essential for modern industrial development. So, at the initial
stages of industrial development, there may be many technical troubles,
which have to be protected. Without properly protecting the young
industries, the countries, which are in the developing way, may not withstand
foreign competition, if a policy of free trade is adopted.

Arguments for Protection … …. …..
• The Employment Argument: Protection would curtail imports and encourage
local industries. This will offer large scope for creating employment. This argument
has special significance in a country like India where there is huge unemployment.
• Fiscal Argument: Protection is advocated on fiscal grounds. Protective duties
afford good revenue to the state at the expense of foreigners. To this, free traders
say that the incidence of protective duty is not always on the foreigner; some times
it is on the national consumer who has to pay high prices for a protected article.
Further, free traders argue that if large revenue is realized as a result of protective
duty, it is evident that foreign goods are successfully competing with the home made
products and to that extent protection has failed.

• Diversification of industry argument: The strength of a nation depends on its
economic independence that can be had only is having a broad industrial base.
According to free trade, countries having comparative advantage would develop
only those industries depending on other countries for the import of those
commodities, which are not produced.
• Defense Argument : The supporters of protection argue that a country should
develop at least key industries like iron, steel, munitions, ship-building, automobiles,
etc., to defend the country in times of war. Depending on foreign nations for
national defense would be a disastrous one. The interest of national safety certain
goods may have to be manufactured irrespective of the cost involved.

• Fiscal Argument: Protection is advocated on fiscal grounds. Protective duties
afford good revenue to the state at the expense of foreigners. To this, free traders
say that the incidence of protective duty is not always on the foreigner; some times
it is on the national consumer who has to pay high prices for a protected article.
Further, free traders argue that if large revenue is realized as a result of protective
duty, it is evident that foreign goods are successfully competing with the home made
products and to that extent protection has failed.
• Wages argument : Protection is also advocated on the ground that it keeps out
good made in low wage countries and eliminates injurious competition on that
score. If wages are high in a country, it is argues that industries need protection
against foreign competition.

• The Dumping Argument : Protection is necessary to prevent dumping of foreign
goods produced under monopolistic conditions or with the assistance of bounties.
This dumping will kill local industries.
• Conservation of National Resources: Unchecked trade may lead to the
exhaustion of the resources of the country. Countries producing raw materials may
be exporting those materials at a cheaper rate without getting much benefit for
themselves. Countries exporting raw materials are supposed to export ‘land’ itself.
• Correcting Adverse BOP: Protection also helps in correcting adverse balance of
payments. Protection reduces imports and the balance of payments situation would
be improved thereby although temporarily.

Arguments Against Protection
• The policy of protection should not be considered a remedy for
industrial development and national self-sufficiency.
• The policy of protection is a beggar–my-neighbour policy.
• The policy of restricted imports by every country that are
following protection in imports would ultimately curb foreign
trade.

Arguments Against Protection… …. ….
• Attitude of Domestic Manufacturer: The protection policy makes the domestic
manufacturers lethargic and lulls them to sleep without taking serious and sincere interest to
develop the industries. When once the industries get protection, they like to continue that
forever. Though protection is essential at the initial and infant stage, vested interests would
demand protection as a matter of right.
• Technological Development: Since the industries won’t have any competition, they won’t
take advantage of technological improvements. This is because fear of competition is
removed owing to assistance given by the state.
• Corruption: Protection promotes corruption. People connected with industries desiring
protection corrupt legislators,. Further, protection promotes monopolies. “Tariff is mother
of Trusts”. In the absence of foreign competition, national concerns engaged in a
particular industry combine and fix monopoly prices.

Arguments Against Protection… …. ….
• Negligence of Consumers Interest: The first victim under protection is the consumer
and his interest will not at all be considered. Under the guise of national development and
self-sufficiency, the consumer will have to pay the high prices for commodities produced in
such countries. In a poor country, by adhering to a policy of protection, the poor people will
be penalized by means of high prices to enrich the already rich manufacturers. The
inequalities of wealth will be aggravated.
• World Peace: This policy will retaliate by the other countries as well, and in the long run
the home industries will suffer. Further, this will cause friction, which will not promote
world peace.
• Utilisation of Factors of Production: Under free trade, there is a remunerative utilisation
of labour and other factors, while under protection there is the forced employment of
factors.

Conclusion
• In spite of these defects, protection has its own advantages.
• For developing countries, discriminating protection is the best solution for
development. But these days are gone. So the developing countries must
equip themselves to meet the forthcoming challenges in the free world
economic scenario.

Thank You
manimadhavan@gmail.com
+91-9865210146

International Trade

Recommended

Recommended

More Related Content

What's hot

What's hot (20)

Similar to International Trade

Similar to International Trade (20)

More from Dr. Mani Madhavan

More from Dr. Mani Madhavan (20)

Recently uploaded

Recently uploaded (20)

International Trade