It refers to trade between different countries. It is a financial transaction that takes place across national political frontiers/boundaries. It is composed of import and export trade and involves movement of goods and services and finances between nations.
Benefits of International Trade
- It promotes growth of gross domestic product (GDP) thereby raising the standard of living.
- Helps the country to overcome its shortages especially during times of disaster.
- It expands market scope of a country’s products.
- It promotes international specialization / division of labour.
- It widens the range of commodities that a country can enjoy.
- It facilitates optimum resource exploitation through increased demand for output.
- Helps a country to dispose of its surplus products.
- It encourages competition leading to better quality services/goods and lower prices/output/products.
- It brings in revenue in form of foreign exchange earning to the country from exports and taxes on imports.
- It brings benefit of forward and backward linkage between home and foreign industries.
- It promotes political co operation (peace, unity).
Theories/Principles of International Trade
Comparative advantage theory
The theory explains the basis upon which countries specialize in the production of certain goods and services. It emphasizes that countries should concentrate on the production of goods and services in which they incur the least domestic opportunity cost in production and ignore the rest so that exchange may be enforced leading to international trade.
Absolute advantage theory
The absolute cost difference arises when a country produces a commodity at an absolute lower cost of production than the other, that is, when a country can produce more of a commodity than the other using the same quantity of given resources, it is said to have an absolute advantage in production of that commodity over the other country.
Terms of Trade
A term of trade is the relationship between the price index of exports and price index of imports.
It is a measure of the relative force of exports and imports.
It may also be referred to as the ratio of price index of exports to the price index of imports expressed as:
TOT = PX = Price index of Exports
PM Price index of Imports
TOT is therefore, the rate at which a country’s export exchange against its import to represent the unit of domestically produced goods that are forgone in order to acquire one unit of imported goods.
Description of TOT
This is when the export prices are higher than the prices of imports i.e. X >M.
It is when the import prices are higher than export prices i.e. M<X.
This is when the export prices are falling and import payments are rising.
This is when the import payment is falling and export prices are rising.
Balance of Payment
BOP is a record/a statement of a country’s monetary transactions it engages in which the rest of the world in a given period of time usually 1 year.
It is therefore a balanced sheet of a country’s economic/monetary transactions with the rest of the world plus changes in the country’s claims assets) and liabilities to the rest of the world for a given period.
Components of a BOP account
1. Current account
This section records all the transaction involving physical movement of goods and provision of services. It is further subdivided into the following subsections.
2. Visible trade account
The subsection keeps a record of all the receipts the export of tangible goods and all the expenditure abroad on import of goods. The different between these receipts from abroad and the expenditure abroad is referred to as balance of trade.
3. Invisible trade account
This subsection records all transactions arising from provision of services such as tourism, insurance, banking, transportation e.t.c. It records all expenditure on services rendered by non-national to the economy and receipts from of service by nationals abroad.
N/B: The different between all the expenditure abroad (both visible and non-visible) and all the receipt from abroad arising from both visible and invisible trade account is known as BOP current account.
4. Capital account
This section records all transactions arising from capital movement into and out of the country. It records capital inflows into the country and capital outflows from the country in a given period of time usually one year.
5. Capital inflows
They may include things like:-
- Investment by foreigners in a country
- Purchase of local currency by foreign residents.
Buying treasury bills, shares, real estates (physical investment e.g. buildings, stocks, equipment). These constitute credit entry on the Balance of Payment account.
6. Capital outflows
These include investments by nationals in other countries, purchase of shares, buying treasury bills by nationals in foreign countries. These constitute the debit entry in Balance of Payment.
7. Cash/Monetary account
This section records all the transactions related to changes in the country; foreign exchange reserves and it’s a summary of the net difference between the inflows and outflows from current and capital accounts. An increase in the foreign exchange reserve between the two accounts leads to a surplus in the monetary account and vice-versa.
8. Balancing account
This section acts as the balancing item of the Balance of Payment account of the country. If the records of the Balance of Payment account are complete, both the credit and debit side of the Balance of Payment statement must be balanced i.e.be equal; incase of any disagreement/discrepancy between the ideal totals and what has been recorded on the cash account or difference between the credit and debit totals on the Balance of Payment account e.g. if the debit side is 10 and the credit side is 15 the then balancing item is 5 which is the difference between the two sides.
Role of International financial institutions in International Trade
There are two (2) main international financial institutions.
- World Bank
- International Monetary Fund (IMF) also known as the Briton Woods Institutions of 1944.
The World Bank formerly known as the International Bank for Reconstruction and Development provides loans for projects to member countries whereas the IMF provides loans for member countries with Balance of Payment deficit problem.
IMF (International Monetary Fund)
It requires countries to own membership i.e. to register. The members contribute to the institution according to each country’s economic position. The institution assists member countries facing a Balance of Payment deficit in their country.
The Role of IMF in economic growth and development
- It facilitates expansion and balanced growth of International trade by providing funds to member countries with Balance of Payment problems. This contributes to promotion and maintenance of high level of employment and real income leading to economic growth and development.
- It promotes international monetary co-operation through provision of machinery and collaboration on international monetary progress.
- It promotes foreign exchange stability by maintaining orderly exchange rates among member countries and this avoids competitive exchange rate causing fluctuations.
- It avails temporarily to member countries the general resources for production thus providing members with opportunity to correct mal-adjustment in their balance of payment without resorting to measures which are destructive to national and international prosperity.
- It assists in the establishment of multi-lateral system of payment in respect of current transaction and elimination of foreign exchange restrictions which hinder growth of international trade.
Roles of World Bank in economic growth and development
- It assists in reconstruction and development of territories of its member countries by facilitating of capital for productive purposes.
- It promotes foreign private investments through participation in loans and other investments or capital.
- Where private capital is not available in reasonable terms, the World Bank makes loans for productive purposes out of its own resources.
- It promotes long range growth in international trade and maintenance of equilibrium of Balance of Payment of members by encouraging international investment for development of productive resources.
The Balance of Payment Equilibrium and Disequilibrium
Disequilibrium in the Balance of Payment account arises in the form of either a deficit or surplus that is, when the credit and debit sides of Balance of Payment account fail to reconcile. On the other hand, Balance of Payment equilibrium is a situation when the credit and debit sides of the Balance of Payment accounts are equal.
Causes of BOP disequilibrium (BOP problem)
- Effect of domestic inflation: it makes the export of a country more expensive than the export of the other countries. This limits the export revenue and may result into BOP deficit.
- Political stability: this reduces the productive capacity of a country leading to less foreign exchange earning and increased military spending.
- Effect of imported inflation: this results into high prices of imports which means increased import expenditure that creates a BOP deficit.
- Deteriorating TOT: the continuous fall in the price of exports and appreciation in the prices of imports implies that the import expenditure is high while the export revenue is low creating a deficit.
- Lack of competitiveness of products in the world market: poor quality products which cannot compete effectively in the international market as well as low productivity results into less export revenue.
- Limited capital inflow: due to structural rigidities in the economy e.g. narrow markets, political instability, poor infrastructure, complicated administrative procedure e.t.c. may fail to attract foreign capital in the country through foreign investment.
- Excessive capital outflow: this may occur due to high rate of profit repatriation and capital flight by foreigners due to weak government policies.
- Protectionalism on trade: because of trade restrictions that developed countries impose on products from developing countries, the market for and the amount of product sold in the international market is always limited.
- Increased needs for capital goods: the LCDs have inelastic demands for capital goods as spare parts e.t.c. which led to increased foreign exchange expenditures.
- Excess expenditure by the government: the high expenditure by the government bureaucrats on foreign travels, diplomatic missions abroad, and importation e.t.c. leads to a deficit.
- Over reliance on expatriates’ manpower: due to low level of skills development especially in LDCs they import skilled labour from other countries at high cost.
- Heavy external debt servicing: this causes BOP deficit due to more money spent in paying bank loans plus interests accumulated.
Possible solutions to BOP disequilibrium
Measures that correct the BOP problems aimed at reducing the deficit by reducing the demand and increasing the supply of foreign exchange. These measures may include the following:
- Import restrictions: this can be done though tariffs, quota regulations, complete ban e.t.c. this reduces the balance of foreign exchange in the economy.
- Restrictive monetary policies: these are aimed at reducing the amount of money in circulation so as to reduce the balance of foreign exchange in the economy.
- Restrictive fiscal policy: this reduces the level of disposable income and discourages the expense on foreign goods. It also increases revenues through taxation while reducing government expenditure thereby conserving expenditure.
- Import substitution strategy: the government can encourage the production at home of formerly imported goods so as to reduce the volume of imports and conserve foreign exchange.
- Export promotion strategy: through this the government can encourage the production for exchange so as to earn more forex.
- The creation of peaceful, stable and conducive atmosphere reduces military expenditure. It also facilitates/enhances international trade.
- Through manpower development: the training of local skills reduces the need to import expatriates thereby reducing expenditure on expatriate manpower.
- Through devaluation of currencies: devaluation aims at making export cheaper and import expensive so as to encourage more exportation and discourage importation.
- Devaluation policies: it is a legal reduction in exchange rate (of a country’s currency in relation to the rate of the value of the other country’s currency).
- Debt manipulation: refers to the servicing through rescheduling or postponing payment, loan cancellation and debt conversion e.t.c.
Trade Restriction (trade protectionalism)
Refers to the restrictions imposed on freedom of trade among trading partners/between nations.
There are various forms of trade restrictions:-
These are the quantative restriction on the amount of imports and exports in a country in a given period and may either be imposed in physical quantities or in terms of the value of foreign currency that can be spent.
This is a tax duty imposed on imports and exports of a country, tariffs are used either to raise revenue of the government/to protect the home industries. The effect of a tariff (import duty) is to raise the prices of imported goods in relation to the domestically produced goods so that consumers are discouraged from buying foreign goods.
- Foreign exchange control
This involves the government restricting the amount of foreign exchange reserve that should be availed for the importation of certain commodities.
- Total Ban (embargo)
A country may impose a total ban on the importation/exportation of certain commodities. An embargo may also be endorsed on the importation of products from certain country/trade links with certain country.
- Special deposits on imports
Imports can be limited by requiring importers to make special advance deposits on their imports. This limits the ability to import.
- Administrative regulation
The government may stipulate a complicated and lengthy bureaucratic system which makes it hard to carry out trade.
Reasons for trade restrictions
- To protect the infant industries
Taxes may be imposed on imported products in order to enable the newly established local firms to gain competitive advantage over foreign firms and secure markets.
- To prevent dumping
It is justified and necessary for a country to protect its industries/firms from unfair competition from foreign markets that export their products at less than their domestic prices/production costs but simply for disposal.
- To reduce unemployment
The government may impose a ban on importation and encourage domestic production by enhancing development of industries so as to create employment opportunities at home.
- To protect declining industries
When products of an industry become outdated and the demand is declining the government can save such an industry by imposing restriction on importation of substitutes.
- To improve the BOP position
The government can correct BOP deficit through trade restrictions by restricting the amount of imports into the country.
- To improve the terms of trade (TOT)
A country can improve its terms of trade by increasing its prices of exports through restrictions on the supply of the commodities on the expense of importers.
- To discourage consumption of dangerous goods
It is sometimes undertaken to prevent the nationals from consuming certain goods e.g. bhang e.t.c. which are considered be harmful for human consumption.
- Revenue objective
Most activities especially the LDCs would impose restriction of tariffs in order to raise revenue for the government.