Introduction
International trade involves the exchange of goods and services beyond the borders of a country. In other words, trade between countries consists of an international trade (Carbaugh 7). The geographical differences between countries lead to different potentials in the production of the agricultural products, processed goods, services, and technology. Some countries are more endowed with one of the listed products than the others. There is, therefore, a high supply of one of the products in one country and a high demand for other goods. The forces of demand and supply make producers and consumers look for the means that help them exchange the commodities. The involvement of the cross-border trade leads to the international trade.
Sometimes the trade between the two or more countries may not be effective due to the distance involved. The producers’ final price may be higher when the goods reach the market. The trade becomes affected in such a way that the country of destination suffers a lot in terms of the balance of trade. The country with a higher demand may prefer to import the raw materials and process them into the finished commodities. The decision is affected by the number of factors that we will consider later in this topic. Other factors affecting the international trade include the bilateral and multilateral treaties that outline how the governments involved will carry out the trade. All these factors are meant to increase income as the nations seek to create a favorable balance of payment. In the later discussion, we are going to look in details the functions of various useful components of international economics. This report will indicate the various strategies that a government needs to undertake during the international trade so that it can come up with the crucial benefits of the international trade.
Literature Review
The study of international trade that is also called the international economics is important to students aspiring to work in a competent ground in trade. The students will benefit from the vast knowledge on that is covered in the topic. The study covers the elements of international trade. Students will benefit from this study as it will give them the knowledge of how the trade is carried out. They will be able to know the requirements that they need to have when undertaking the trade. Moreover, the government will benefit at large as the study involves the analysis of the balance of payment. The issue of the balance of payment is important for every state on the globe. The government involvement in international trade is based on the accounting result of this document. This document acts as a measure of how well the nation is performing in the global trade. In every exchange, traders usually seek to make a profit and not losses. The demonstrated ambitions of traders also exist in the international trade. It is the result of the balance of payment that gives directions to the nation as either making the profit or losses.
Alongside the knowledge of the balance of payment, there are also some theories that govern the open economy. An open economy is an economy that involves the exchange of commodities on the international basis. The study seeks to impart knowledge to the students on the available models that exist in this trade(Carbaugh 52). The study will be beneficial in strategic decision making of the firm that involves putting the model at work. The results of the research will reflect the importance of the international trade to the nation and the people living within the nation.
Importance of International Trade
As noted earlier, the international trade has various benefits to the countries involved. The benefits of the trade range from the availability of the goods and services to the population of the country to the availability of foreign income in the nation. The nations are also involved in forming a friendship that is extended to other relationship excepting trade. The following discussion gives a number of the benefits that are accrued from the international economy.
The international trade offers a country an opportunity of a competitive market. Some countries are blessed with natural resources unlike others, and they can do a mass production of goods or services (Krugman 71). For example, some countries are good in the production of rice due to the excellent weather conditions and the good soil. Let us take Pakistan as our nation that does a mass production of rice, the number of consumers of the product is less than the number of producers. The country, therefore, needs to look for potential market elsewhere, in another country.
The consumption of rice may be high in another country, let’s say Kenya. In Kenya, rice production is insufficient for the high demand from her population. The country major production in the international market is tea and coffee. The local consumption of the product may be low compared to the level of production. The country is forced to look for a potential buyer who will buy the tea and coffee outside Kenya. The money accrued from the sale of tea and coffee will then be transferred in the buying of rice that is in high demand. When these two countries meet on the international market, Pakistan will offer rice to Kenya at the price that the two countries will agree. On the other hand, Kenya will offer Pakistan tea and coffee at the agreed price. in such a way, the two countries will both benefit from the products that they have heavily invested in the production process.
Secondly, the international trade is essential to acquiring the essential raw material for the production (Krugman & Obstfield 23). Some countries are good in the production of raw materials while others have the technological capacity necessary in the production process. Most of the European nations and the countries in Asia have the technology necessary for the production process. Their capacity in the production of machineries is necessitated by the availability of iron and other metals that are used in the construction of the structure.
On the other hand, most of the countries in the south of the Sahara in Africa and the South America are good in the production of raw materials. In this case, the raw materials include the agricultural products that are necessary for the production process. The lack of adequate production units in the two continents makes them rely on the international market where they sell the raw materials (Reinert 314). The countries in Europe and Asia act as the source of demand where they buy the raw materials, process them and sell to potential consumers. Considering the role of the international market in connecting the source of the raw materials and the production units, it is essential to note the benefit of the international trade in this matter.
Another importance of the international transaction concerns the availability of goods and services in different forms, quality, and taste of the consumers. The international market provides competition at the global level that is to the best of the consumers. The market competition forces countries to the production of the same commodity to improve their quality and be innovative in making their goods appeal the consumers, in making products attractive and different from those produced by other countries. Therefore, they produce high-quality products and park them in beautiful sachets and boxes. The consumers from the international ground will have an option to pick the product that will be beneficial to their lives (Krugman & Obstfield 280). In addition to this benefit, the producers are very sensitive to the market when looking at how to attract the highest number of consumers. In this case, they will carry out innovative research that will lead to the creation of quality commodities at cheaper prices. The benefit of this strategy will be to beat their competitors on the market and retain the consumer’s faith in them. Thus, the consumers will benefit from the high-quality goods offered to them at a cheaper price.
The nation also benefits from the international market processes. When the country is involved in the sale of goods and services in this market, it gains money in the form of the foreign currency. The income from abroad is essential in the creation of a favorable balance of payment. When the balance of payment is favorable to the country, the home currency gains power over the foreign currencies. The demand for the home currency increases in the international fields, and it strengthens the economy of the country.
The international trade has also benefited the countries that focus on the production of a single commodity. Countries have concentrated in the production of the goods and services that will attract the best sale on the international market. The idea of specialized production has formed a major strategy to many nations. Therefore, a given country can produce the commodity in surplus and at the lowest cost. The benefit of specialization is that the commodity will always attract customers when presented in the international market. The fact that specialization in production leads to the manufacture of high-quality goods at a lower cost makes it the first choice for the customers.
The country does not only benefit from the income of the foreign currency, but also benefits in job creation to her population. It is the desire of every political group in all the nations to offer jobs to their population. In fact, the creation of jobs for the youths has become a core manifesto to the majority of developing countries when looking to ascend to power. The international economics offers a platform in fulfilling this promise to the population. The international trade will involve people to perform tasks in the production and the selling process. Nobody can do this task alone and therefore it will be necessary to employ from the population.
Secondly, the population engages buying of some products from abroad and selling them to the nation. This form of trade also includes buying goods from the local industries and selling them abroad (Carbaugh 114). The trader makes a profit at the end, and this is the best form of self-employment. In the end, when the process continues smoothly in favor of the country, it benefits from the increased portion of the population that is employed. An employed population is a healthy one as it can cater for various needs, hence, raise their standards of education.
Moreover, international trade is vital as countries become committed to other matters except trade. A country may sometimes be faced with a natural calamity or other issues that can be regarded as matters of national disasters. Civil war and terrorism may also affect the country at one moment or the other. When this matter arises, the friendly nations that are committed to the international trade usually come in and help in the recovery process. The countries may offer technical as well as the monetary support to the country in need, and this enhances their chances of coming out of the calamity. In case the country was not involved in the international trade, there could be a huge problem for the country in her efforts to recover.
The international trade involves the signing of treaties by the nations involved. The countries sometimes come up together with a union or communities tied by the treaties. When they come together, they usually discuss the issues of national importance concerning trade and their economic growth. The strategies are also formulated that ensures that countries that do not do well in the international scenes are equipped with knowledge on how they can improve their performance. The countries that did not previously do well can utilize the strategies and catch up with the rest of the nations. The strategies are important in ensuring a uniform economic growth to the nations belonging to the same region. A good example of a regional union that has adopted this strategy is the East African community. Having previously made a composition of three countries, more nations have joined the fastest growing community in the world. The exchange of views and strategies with the community has made it an extra mile in the development of international trade.
Heckscher-Ohlin Model
The difference in productivity between two or more nations can be explained by the utilization of the Heckscher-Ohlin Model that is popularly referred to as the H-O Model. The H-O Model is a theory that utilizes a mathematical approach in determining the production advantage between countries that are involved in the international trade. The production advantage of a country is determined by three factors, which are the capital, labor, and land. Land is the most crucial substance in the production process. It is in the land where we set the production unit popularly referred to as the industry. The price of land always appreciates and, therefore, becomes the only appreciating factor of production. Without land, no production can take place and, therefore, the country cannot benefit from the international trade. In highly congested nations, land is being utilized in the construction of skyscrapers that offers the room for industrial development in a vertical manner. The mode of building mainly serves a purpose of making a full utilization of land in the most suitable way possible.
The other factor of production that forms a central spot in the production process is capital. Capital is the money or the machineries that are used in the production process. The availability of capital determines whether the production process can take place or not. When the capital goods are available and easily accessible, a country can make production at a high rate. On the other hand, the O-H Model suggests that the hardship in acquiring the capital makes a country not to do well in the international market. The most important fact we need to note about capital is that this factor of production is transferable. A country in need of the capital can decide to buy the production machineries from another country and use it in the processing of her goods before selling them.
Also, a country can lure investors from other nations to invest their money in the country and sell them abroad. This idea is necessitated by offering the best infrastructure necessary for the production. The form of the infrastructures required by a nation to ease the effort of luring investors includes good transportation and communication network, cheap and reliable sources of energy, as well as security for the investment units. When a developing nation meets these requirements, it can easily enhance her competition in the international market by luring investors into the country.
The model also indicates the importance of labor in the production process. Labor is the effort that is invested directly or indirectly in the production unit during processing of commodities. Labor can be offered directly when people use their effort to change the form of the product to the desired one. The use of direct labor occurs where the use of machines is limited or when the country is unable to invest in capital goods. The use of labor directly in the production process is not desirable as only some few products will be produced. On the other hand, indirect labor is the use of human effort in controlling machineries that do a greater amount of work. The presence of skilled labor is regarded as useful as they will be able to give commands to machines that enhance productivity. A good example is the use of robots in the loading process. The robot may be connected to the computer with some useful software. The person involved in controlling it will be doing it just by the touch of the button.
The H-O Model is comparing two countries that are producing a common product suggest that it is labor and capital that determine the one who will have a greater market potential. The availability of land, in this case, is considered to be constant. The theory suggests that countries need to have an upper hand in the international market, must do a thorough investment in capital goods and in equipping their source of labor with the education necessary in the industrial sector. The government needs to encourage innovation in various sectors of production by availing the best platform for the industry.
Instruments of Trade Policy
Instruments of trade policy are the measures that a given nation that is participating in the international trade takes to ensure that it does not suffer a deficit in the balance of payment. Sometimes called the commercial policies, the trade policies are put into play to ensure that the local industries are protected from the internationally produced commodities. The trade policies control the incoming products via various means that include tariffs on imports, subsidies on locally produced goods, import quotas, voluntary export restraints, local content requirements, administration policy and anti-dumping duties. The responsibilities of these policies are to reduce the competition that might affect the local production of goods and services.
The tax is charged on commodities that are being sold in the country so that their prices may be higher or near equal to those that are produced within the nation. The government also benefits of the tariff as the tax levied on the imports is used to fund various government expenditures. Moreover, the tariff charged is useful in controlling the number of imports that could, otherwise, risk the growth of the local industries. When the imported commodities are cheaper and equal in terms of quality and size to those that are locally produced, the local consumers will opt to buy the imported products. The local industries will be deprived of a chance to sell their products in the local market since their prices are higher than that of the imported goods. The lack of market for the product will lead to the closure of the local industries. The implication of this will be transferred to the lack of employment of industry workers, and many families will languish in poverty. In order to control this effect, the government opts to issue the various types of tariffs which include specific and ad-valorem tariffs. Specific tariffs are issued for goods according to various sizes of imports. For example, when a person imports seven cars, each car will have a specific tariff issued on it. The ad-valorem tariff is issued to commodities as a whole. The beneficiaries of this process are the local industries and the government while the local consumers become the losers.
The second trade policy is that the government is to boost the local industries called subsidies. Subsidies are a form of a boost in terms of cash that is issued to local industries so that they can increase their production at a lower cost. When goods are finally produced at a cheaper cost, they can experience a good competition in the international market (Krugman 142). The commodities attract a lot of international consumers who enjoy the product. The subsidies are sometimes issued as grants to the local producers or loans at a cheaper cost. Cash that is non-refundable is also issued to the promising producers that will benefit the country in the future.
Moreover, subsidies may include tax relief and tax holidays to the local consumers. When the tax is issued to the local producers, they affect the final cost of the product as they are part of the expenditure. Therefore, when the firms are allowed to produce goods without being taxed, the cost in terms of tax does not exist. The final products, therefore, become cheaper compared to the ones that are produced by the international competitors. The international consumers and the local producers are viewed as the main gainers of the implication of subsidies. The local consumers, partly benefit from the cheaply produced goods, but also pay in other forms as the government needs to replace the funds used as subsidies. In other words, the local consumers are tax payers and, although they benefit from the lower price of the commodity, they also pay a huge tax that benefits the international consumers.
Import quotas are also put in place to regulate income. The government can totally ban the importation of commodities that seems to compete with locally produced products. In most cases, the government allows imports of these goods to a certain amount. The application of quotas benefits the local producers from a stiff competition from similar goods that are produced abroad.
Trade Policy in the Developing Countries
The developing countries mostly utilize the trade policies that have been discussed above. The developing countries are in need of growing their industries to the global level. They, therefore, implement the trade measures so that they can protect their infant industries. The production capacity in these countries is low, and the huge population offers a place for their homemade products.
The trade partners usually come with the support of the developing countries in various ways. The countries usually work with overseas companies in their development agenda. Some multinational overseas owned companies are urged to set their production units in the country. When a firm is set in the country, the importation of a similar product will decline. Secondly, the firm will be able to export the produced goods to the overseas nations. The sale of the product will help in reducing the deficit in the balance of payment.
The trade policy that entails encouraging oversea countries to set up their firms within the nation also has an added advantage of the local population. The local population benefits from the industries as they are employed to offer labor to the firms. The labor offered is then compensated with a package of salaries. The local population working in the firm can, therefore, afford to feed their families and perform other activities with the cash that have been paid to them. Secondly, the local population can save a portion of the salary earned by the investment banks. After the savings had accumulated, the local population can use it as capital for the purchase of the production machineries. The production units can be used for further production of goods and services. After the initial production process , sometimes, the country will improve her industrial activity and reach the desired level of industrial development by improving the quality of the goods. The saving policy has worked in many developing countries, and most of these nations encourage their population to practice the saving habit.
Another importance of this policy is that it encourages the production of raw materials from the local farms. Most of the developing nations have been acting as the producers of the raw materials that are used in the overseas for manufacturing of goods and services. When the unprocessed raw materials are sold in the overseas markets, they usually fetch lower prices. The oversea companies then process the raw materials into finished products. The products are then sold back to the country by the oversea firms at a higher price. When this happens, the developing country suffers a loss. An unfavorable balance of payment is created and the country’s economy is about to decline. When an oversea production unit is set within the nation, the raw materials can easily be sold to the local industries. The issue of the high cost of transportation to the overseas producers will be cut. The local farmers’ level of income will increase and, therefore, their level of living standards will be enhanced.
Setting up of production units within the country is also beneficial to the local population status of health. In many cases, the imported goods that are meant for local consumption are not good for human consumption. The overseas nations usually dump them to the developing nations at very low prices. When the local population consumes the products, their health begins to deteriorate. When the country encourages these industries to run their activities from within the nation, the quality of goods produced can be checked and be controlled. The quality control measures that are put in place will lead to the production of high-quality goods and services. The dumping site that the overseas nations had within the nation will come to an end. The health of the local population will be positively transformed.
Another benefit that the local population will get from the setting of the overseas firms within the nation is that they will get improved services such as improved road network and proper security. When multinational firms set their production base within the nation, the government will be forced to improve the quality of security within the nation. In fact, security is the most determining factor that is used as bait to the international firms (Krugman 256). Other services that will be made available to the population include electricity, better roads, and other communications infrastructure. As the government puts an effort in providing these supporting services to the firm, it will also provide them to the local population. The local standards of living will be raised as a result of the provision of these services.
Lastly, the setting of the international production unit in the developing country acts as a platform for the skills transfer. The international producers from the developed nations are a step higher in terms of the important skills that can be utilized for efficient production. When the local workers offer their labor to the industries, they will learn about the best practices that are vital to efficient production. The skills will become vital when the nation establishes its production units. The country will not look for skilled workers from abroad, but will use the experienced local population.
National Income Accounting and the Balance of Payment
The development of the economy of the country is measured by the use of the data that are involved in the usual business. The national economy consists of the goods that are produced locally and sold abroad to get income. On the other hand, some goods that are produced abroad are also consumed locally leading to expenditure. For the economy to have a positive development, the price of commodities that are sold internationally should exceed the prices of the international produced goods that are consumed locally. The accounting of the national economic data and the position of the balance of payment determines how the economy of the country is faring.
The GDP that is closely related to the GNP accounts for all the locally produced goods. The total price of the goods that are produced within an economy forms part of the commodities that will be offered for sale in the international market. The price of the cost of production and the funds transfer does not account for in the favor of the GNP. The accounting concentrates purely on the value of the products and services that are produced for sale. In order to improve the GNP of a nation, the country needs to think about how it can increase the industrial growth. The increase in the number of industries that are producing goods and services will lead to the increase in the value of commodities produced for sale.
On the other hand, the national gross income is the total value of revenue that the country earns from the trade. When the domestic products are sold, the extra amount that is in terms of the profit is indicated as the national gross income. When the expenditure that was accrued during the accounting period is subtracted, the remaining amount is termed as the Net National Income (NNI). The NNI is, in other words, the profit the government earns from the international trade.
The income that the government earns from the international trade is also accounted for in the national accounting. The government uses a portion of it in investment. Another ratio is used by the government as transferred payments to various groups in the country and is indicated as consumption. In addition, the government uses a fraction of the earnings to pay salaries to the civil servants and for other expenditures. In summary, the national income is accounted for by the use of the following equation.
Y=C+G+I+ (X-M),
Where:
- Y= the government income
- C= the national consumption
- G= the government expenditure
- I= the government investment
- X= the total exports
- M= the total imports
- (X-M) = the net export that is sometimes abbreviated as NX.
The balance of payment is a document that analyzes the proceedings of the international trade, including the monetary trends that do not form part of the trade. The transferred payments and other monetary gifts that are sent or received from other nations form a part of this document. The debit and the credit sides should always be balanced, meaning that their difference should be equal to zero. When the values of the items that are leaving the nation exceed the values that are entering the nation in terms of money leads to the balance of payment deficit (Sarooshi 97). On the other hand, when the total values of items in terms of money entering the nation exceed those that are leaving the country, a surplus in the balance of payment is achieved. Nations suffering a deficit in their balance of payment apply different strategies to reduce the deficit. They usually borrow loans and grants from the wealthy nations. They also put strategies on the means that would see them exporting more goods and services to the international market. The balance of payment is calculated every three months so that the government can keep on tracking and adjusting its involvement in the international trade. The document is an effective tracking device of how the nation is fairing in the international trade.
International Monetary Systems
During the international trade, countries usually exchange goods and services for money. There are some agreements that equate the money charged for the goods bought. Since the two or more countries do not have a common currency, they will have to agree on the rate at which they will exchange (Reinert 259). The procedures that are followed in the exchange of currency on the international basis constitute the international monetary system. There are some rules that need to be keenly followed during this process. The rules are essential in making sure that the process is smoothly undertaken.
The basic rule in the international monetary policy entails the exchange rates. The exchange rate is the agreed form of the currency’s value that is determined by the economic performance. The United States of America’s dollar is globally used to determine the value of other currencies globally (Krugman 307). The higher exchange rates are beneficial to the country’s exporters of the commodity since they will receive a lot of money from their exports. On the other hand, a high exchange rate is undesirable for people who are willing to import goods as they will be expensive. Industries that rely on raw materials are encouraged to purchase them when the exchange rate is low. On the other hand, those who export their finished products can do so when the exchange rates are high.
The European Union as a community has come up with a common currency that can be used in the purchase of goods and services within the country members (Wamboye, Adekola, & Bruno 218). The Euro is a currency that has come into play as the first of its type to unify the continent. Other international communities, like the East African community, are also planning on how they can come up with their common currency. The presence of a common currency is desirable as it eliminates barriers in international economics that are developed by the challenges of fluctuation and unstable currencies.
The international monetary policies are also influenced by the international monetary fund (IMF). The IMF is a set of funds that act as a central banking system to all the countries in the world. The World Bank acts as the central bank of the international economies (Krugman & Obstfield 218). The bank usually issues loans and grants to the developing nations in order to enhance development and growth
Conclusion and Implication of International Trade
The international trade is important to the all the global economies. The trade enables different countries to participate in the buying and selling of commodities internationally. Countries that do not have an opportunity to produce a certain type of the product are enabled to acquire them through their participation in the international trade. The standards of living of the people globally are enhanced by the engagement in this trade. The countries involved need to have the understanding of how this trade is undertaken. The rich countries should also help the developing countries to overcome the trade barriers that hinder them from participating effectively in the international trade. When this is enhanced, countries will develop as a unit and create a comfortable place for people to live. The study of international economics is important as it has allowed us to appreciate fully the participants who play a vital role in this trade.
Works Cited
Carbaugh, Robert. International Economics. New York: Cengage Learning, 2012. Print.
Krugman, R. Paul. Strategic Trade Policy and the New International Economics. New York: Pearson Addison-Wesley, 2013. Print.
Krugman, R. Paul, and Obstfield, Maurice. International Economics: Theory and Policy. New York: Pearson Addison-Wesley, 2009. Print.
Reinert A, Kenneth. An Introduction to International Economics: New Perspectives on the World Economy. New York: Cambridge University Press, 2011. Print.
Sarooshi, Dan. “Investment Treaty Arbitration And The World Trade Organization: What Role for Systemic Values in The Resolution Of International Economic Disputes?” Texas International Law Journal. 49.3 (2014): 445-467. Academic Search Premier. Web. 2015
Wamboye, Evelyn, Abel Adekola, and Bruno S. Sergi. “Foreign Aid, Legal Origin, Economic Growth and Africa’S Least Developed Countries.” Progress in Development Studies. 14.4 (2014): 335-357. Academic Search Premier. Web. 2015.