The Basics of Foreign Trade
Free Trade Vs. Protectionism
All governments regulate foreign trade. The extent to which they do so is a matter of great controversy and debate. Although the amount of government involvement in trade varies from country to country and product to product, overall barriers to trade have been lowered since World War II.
Arguments for Protection
– Cheap labor: Less developed countries have a natural cost advantage as labor costs in those economies are low. They can produce goods less expensively than developed economies and their goods are more competitive in international markets.
– Infant industries: Protectionists argue that infant industries must be protected to give them time to grow and become strong enough to compete internationally, especially industries that may be a foundation for future growth, e.g. computers and telecommunications.
– National security concerns: Any industry crucial to national security, such as producers of military hardware, should be protected.
– Diversification of the economy: If a country channels all its resources into a few industries, no matter how internationally competitive those industries are, it runs the risk of becoming too dependent on them. Keeping weaker industries competitive through protection may help in diversifying the nation’s economy.
– Lowering environmental standards: In the rush to meet the world demand for their exports, some countries may compromise on environmental standards. This is particularly true for less developed countries that do not have well defined environmental protection laws in place.
Methods of Protection
– Tariffs: Tariffs are taxes on imports. Tariffs make the item more expensive for consumers, thereby reducing the demand. Ad valorem tariffs are usually levied as a percentage of the value of the import, although sometimes a flat rate may be charged.
– Import quotas: Governments sometimes restrict the sale of foreign goods by imposing quotas. They limit the quantity of foreign goods that can be imported and help domestic producers by limiting the share of the market that can be taken by foreigners.
– Voluntary restraints: Sometimes governments negotiate agreements whereby a country agrees to voluntarily limit its export of a certain product. Japan voluntarily limited its export of cars to the United States in 1992 to 1.65 million cars per year.
– Subsidies: Another way to achieve the goals of protectionism is to make the domestic industry more competitive through subsidies.
Subsidies can be:
–Direct – outright payments
–Indirect – special tax breaks or incentives, buying of surplus goods, providing low-interest loans or guaranteeing private loans. For example, the U.S. subsidizes the sugar and dairy industries, among others.
– Trade ban: Sometimes governments ban trade with certain countries for political reasons. Governments also ban import of certain products to protect domestic industries. For instance, Japan bans importation of rice.
– Imposing standards: Health, safety and environmental (HSE) standards often vary from country to country. These may act as a barrier to free trade and a tool of protectionism. For example, the EU has very stringent health and safety standards that goods have to meet in order to be imported.
– Others: Apart from the legal restrictions there may be other less formal obstacles that impede trade. Cultural factors are one such obstacle.
Arguments for Free Trade
U.S. free-trade advocates typically argue that consumers benefit from freer trade. Free trade and the resulting foreign competition forces U.S. companies to keep prices low. Consumers have a larger variety of goods and services to choose from in open markets. Domestic companies have to modernize equipment and technologies to keep themselves competitive.
Any kind of protectionist measures, like tariffs, often bring about retaliatory actions from foreign governments, which may restrict the sale of U.S. goods in their markets. This may result in inflation and unemployment in the U.S. as the export industries suffer and prices of imports rise.
Measures of Trade
Balance of trade and balance of payments are two of the statistics most widely used to measure a country’s international trade position. Balance of trade is the difference between a nation’s exports and imports of both goods and services.
A «favorable» balance of trade, or trade surplus, occurs when exports exceed imports. A «negative» balance, or trade deficit, occurs when the imports surpass exports. From the mid-1970s through 2001, the U.S. ran persistent trade deficits.
The balance of trade alone does not give the whole picture. The detailed record of all economic transactions between a country and the rest of the world is called the balance of payments. This includes trade in:
– Goods and services; and
– Financial and non-financial assets.
The BoP is separated into two main accounts:
–Current account – records export/import of goods and services and interest payments. The merchandise trade balance is contained in this account.
–Capital account – records purchase or sale of assets or investments, like companies, stocks, bonds, bank accounts, real estate and factories.
If you buy an automobile made by a factory in Germany, the transaction will be recorded in the current account. However, if you buy the automobile factory or stock in the automobile factory, the transaction will be a part of the capital account.
Every international transaction automatically enters the BoP twice, once as a credit and once as a debit, resulting in two equal and opposite entries. A transaction that involves money flowing into the country is recorded as a balance of payment credit and anything that draws money out of the country is a balance of payment debit.
This system of double-entry bookkeeping tries to ensure that the current and capital accounts are balanced. However, due to accounting conventions and differences in the recorded values of transactions, this does not always happen. Accounting for these differences, called statistical discrepancies, makes possible the following fundamental identity of the balance of payment accounts:
Current account + Capital account + Statistical discrepancy = 0
