Unit 27 International Trade

References:
https://www.educba.com/advantages-and-disadvantages-of-international-trade/
https://www.thoughtco.com/free-trade-definition-theories-4571024
https://www.hellovaia.com/explanations/macroeconomics/international-economics/protectionism/
https://www.investopedia.com/terms/c/comparativeadvantage.asp
1. Foreign trade
The need for foreign trade
There is a need of foreign trade due to the following reasons:
- Uneven distribution of natural resources
- Division of labor and specialization
- Differences in economic growth rate
- Theory of comparative cost
The aim of foreign trade
- raise the standard of living of the people.
- Foreign trade helps citizens of one nation to consume and enjoy the possession of goods produced in some
other nation.
1.2. Characteristics and obstacles of foreign trade
Characteristics of foreign trade can be seen as follows:
- Separation of buyers and producers
- Foreign currency
- Restrictions
- Need for middlemen
- Risk element
- Law of comparative cost
- Governmental control
1.3 Obstacles in foreign trade
The following are the special obstacles of foreign trade:
- Distance
- Diversity of languages
- Transport and communications
- Risk and uncertainty
- Lack of information about international traders
- Import and export restrictions

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- Difficulties in payments
- Various documents to be used
- Knowledge of foreign markets
1.4. The advantages and disadvantages of international trade
(1) The advantages
- Increase in Revenue: International trade boosts revenue and business growth by increasing the number of
potential clients and opening opportunities for expansion into new markets.
- Better Availability of Goods and Services: International trade provides a country with access to goods and
services that it cannot produce locally, creating a wider choice for customers at competitive prices.
- Improved Relations: Foreign trade widens the scope of communication between the trading nations. It makes
sharing information and ideas easier, encourages goodwill, and leads to more cooperation and understanding.
Also, it gives a reason to improve transportation between the countries for a smooth trade.
- Improve Foreign Exchange Reserve: Some countries have ample resources, which promote production at
comparatively cheaper costs. They can make many things to sell in their own country and on the international
market to build up their foreign exchange reserves.
- Increased Efficiency: International competition allows producers to make better goods at the lowest possible
cost. It increases overall efficiency and provides benefits to consumers worldwide. It also strengthens the quality
and standard of products available for consumption.
- Relief at the Time of Emergency: Natural calamities like droughts, famines, earthquakes, or floods can
adversely affect a country’s production capacity by hitting available resources, resulting in a supply deficit.
Importing goods from other countries can help meet demand in such situations.
- Increase in Employment Opportunities: Expanding the market for goods through trade increases
employment opportunities. International trade generates employment by establishing industries to meet the
manifold demands of various nations, contributing to reducing the unemployment rates in different countries.
(2) The disadvantages
- Taxes, Customs, and Duties: Customs and duties, along with additional shipping fees, make international
products expensive and unaffordable, deterring potential customers.
- Language Barrier: Even though there are translators, language still needs to improve in international trade.
One can find poorly translated product descriptions that are prone to be misunderstood. In the same way, it’s
hard to figure out the mystery behind the unquoted expression of products.
- Poor Customer Service: Only some customers can be satisfied with the company’s products and services. In
such a case, the process of return and refund is quite complicated and costly. After selling a product, most
companies don’t care about customer complaints and think any flaws are the customer’s responsibility.

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- Risk of Uncertainty: International distribution of products can lead to illegal copying by competitors, making
it difficult for producers to prosecute. Political risks and changing policies add to the uncertainty, making it
challenging for producers to retain customers and sales globally.
- Shortage in Domestic Markets: Exporting goods allows producers to earn more foreign currency and gain a
cost advantage. Due to this reason, goods run short in domestic supply, causing inflation. It makes people angry
and could cause problems in both domestic and international trade.
- Economic Dependence: Most countries depend on imports and exports for their economic development. It
provokes political & socio-economic implications and exploitation of the dependent government. The standard
of living in such countries is comparatively low, further inducing poverty.
- Unwanted Restrictions: Imposing restrictions on trade can lead to the smuggling of harmful goods. Such
transactions can also lead to human trafficking by making the workers prone to manipulation and overwork with
the most negligible benefits.
2. Free trade
Free trade is the unrestricted importing and exporting of goods and services between countries. The opposite of
free trade is protectionism—a highly-restrictive trade policy intended to eliminate competition from other
countries. Today, most industrialized nations take part in hybrid free trade agreements (FTAs), negotiated
multinational pacts which allow for, but regulate tariffs, quotas, and other trade restrictions.
2.1 Advantages and disadvantages of free trade
It stimulates economic growth: Even when limited restrictions like tariffs are applied, all countries involved
tend to realize greater economic growth. For example, the Office of the US Trade Representative estimates that
being a signatory of NAFTA (the North American Free Trade Agreement) increased the United States’
economic growth by 5% annually.
It helps consumers: Trade restrictions like tariffs and quotas are implemented to protect local businesses and
industries. When trade restrictions are removed, consumers tend to see lower prices because more products
imported from countries with lower labor costs become available at the local level.
It increases foreign investment: When not faced with trade restrictions, foreign investors tend to pour money
into local businesses helping them expand and compete. In addition, many developing and isolated countries
benefit from an influx of money from U.S. investors.
It reduces government spending: Governments often subsidize local industries, like agriculture, for their loss
of income due to export quotas. Once the quotas are lifted, the government’s tax revenues can be used for other
purposes.
It encourages technology transfer: In addition to human expertise, domestic businesses gain access to the
latest technologies developed by their multinational partners.
2.2 Disadvantages of Free Trade

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It causes job loss through outsourcing: Tariffs tend to prevent job outsourcing by keeping product pricing at
competitive levels. Free of tariffs, products imported from foreign countries with lower wages cost less. While
this may be seemingly good for consumers, it makes it hard for local companies to compete, forcing them to
reduce their workforce. Indeed, one of the main objections to NAFTA was that it outsourced American jobs to
Mexico.
It encourages theft of intellectual property: Many foreign governments, especially those in developing
countries, often fail to take intellectual property rights seriously. Without the protection of patent laws,
companies often have their innovations and new technologies stolen, forcing them to compete with lower-priced
domestically-made fake products.
It allows for poor working conditions: Similarly, governments in developing countries rarely have laws to
regulate and ensure safe and fair working conditions. Because free trade is partially dependent on a lack of
government restrictions, women and children are often forced to work in factories doing heavy labor under
grueling working conditions.
It can harm the environment: Emerging countries have few, if any environmental protection laws. Since many
free trade opportunities involve the exporting of natural resources like lumber or iron ore, clear-cutting of
forests and un-reclaimed strip mining often decimate local environments.
It reduces revenues: Due to the high level of competition spurred by unrestricted free trade, the businesses
involved ultimately suffer reduced revenues. Smaller businesses in smaller countries are the most vulnerable to
this effect.
3. Protectionism
Protectionism refers to the policy of protecting domestic industries against foreign competition through tariffs,
import quotas and subsidies, or other restrictions placed on the imports of foreign competitors. Governments
may implement protectionist policies with a view to improving economic activity in the main, but policies may
also be the result of concerns by government or as a result of growing scepticism towards multilateral trade
arrangements.
Protectionist policies
(1) Tariffs
Tariffs are also known as customs duty or import tax. Imposing tariffs makes imports more expensive than the
domestic production of the same goods. Tariffs give domestic producers a chance to compete against foreign
goods and services. For the government, tariffs help raise tax revenue.
(2) Quotas
A quota is a physical limit set on the quantity of an imported good. The main difference between tariffs and
quotas is that with quotas imports are limited instead of more expensive.
(3) Embargoes

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They are a restriction or a ban imposed on certain goods. These goods are usually those that are consequential in
nature such as elephant ivory, drugs, weapons, etc. Embargoes are also typically politically motivated and less
about protecting domestic industries.
(4) Subsidies
They are a form of monetary assistance provided to either exporters, industries, or businesses. The assistance
helps such firms or businesses to reduce costs and capture a larger market share and consumers, both at home or
abroad. The subsidies paid to these businesses are paid from the tax revenues and while the taxpayers lose, the
consumers benefit from the subsidies in the short run as well. However, in the long run, more efficient foreign
firms could be rooted out and if the domestic producers raise prices, this would be a loss to the consumers.
Product standard regulations
These usually take the form of high safety standards or emission requirements. Foreign firms’ products that
don’t comply with the standards can’t be imported, and this gives the opportunity to the domestic firms who
comply with the standards to perform well.
Exchange control
This is when governments place a restriction on the amount of domestic currency that can be sold in the Forex
market for the purchase of foreign currency. This helps place a limit on imports, investments, or travel abroad.
Economic and administrative burdens
Also known as ‘red tape’. It can discourage importers or foreign firms from doing business in the domestic
market. Governments could do this deliberately to restrict foreign business activity. Product standards
regulations such as safety standards are also sometimes used deliberately for the same purpose.
Voluntary Export Restraints (VER)
This is an agreement made between the two countries to restrict imports they make to one another. Governments
can also manipulate exchange rates such as decreasing the exchange rate, to give domestic producers a
competitive edge over foreign competition.
4. Theory of comparative advantage (David Ricardo)
- Comparative advantage is an economy's ability to produce a particular good or service at a lower opportunity
cost than its trading partners.
- The theory of comparative advantage introduces opportunity cost as a factor for analysis in choosing between
different options for production.
- Comparative advantage suggests that countries will engage in trade with one another, exporting the goods that
they have a relative advantage in.
- There are downsides to focusing only on a country's comparative advantages, which can exploit the country's
labor and natural resources.
- Absolute advantage refers to the uncontested superiority of a country to produce a particular good better.