Chapter 3: BASIC COMPONENT OF INTERNATIONAL TRADE

3.1 INTERNATIONAL TRADE DEFINED

International trade is the backbone of our modern commercial world, as producers in various
nations try to profit from an expanded market rather than be limited to selling within their own
borders. There are many reasons that trade across the national borders occurs, including lower
production costs in one region versus another, specialized industries, lack or surplus of national
resources and consumer tastes. International trade is quite wide. It involves not only
merchandising, importing or export but trade in services, licensing and franchising as well as
foreign investments.
International trade is a complex business system that operates independent of fixed spatial or
geographical boundaries. It is concerned mostly with information and technology transfer,
international trade in goods (e.g. Gas, petroleum product, raw materials, cement, columbite etc),
international trade of flow of labour and money/capital. The fundamental fact upon which
international trade rests is that goods and services are much more mobile internationally than the
resources used in their production. Each country will tend to export those goods and services for
which its resources base is most suited. The reasons for international trade is that it allows a country
to specialize in the goods and services that it can produce at a relatively low cost and export
those goods in return for import which domestic production is relatively costly. As a consequence,
international trade enables a country and the world to consume and produce more than would be
possible without trade.
No matter the proximity of one country to another, once there are differences in government
currency and cultural values, any form of trade dealing at this level are international.
Some countries benefit tremendously from trade as an important part of their GDP. For example,
Singapore is considered one of the world’s most open economies and has the highest trade-to-GDP
ratio in the world at 400 percent.

International trade and globalization have varying effects on other economic indicators. When a
national economy is strong, industries and businesses feel confident in expanding and spending,
which directly impacts the average citizen. However, because local demographics can affect
microeconomic indicators, a local economy can still succeed even while national and international
economies are facing difficulty.

When and if countries feel as though they are not benefiting from international trade, they can seek
to restrict it in order to boost local domestic production. To do so, these nations can impose either
tariffs or nontariff barriers—such as quotas—to limit the number of imports entering the country.
A complex regulatory environment can make it costlier for products and services to enter a market.

While international trade has been criticized for not providing uniform benefits to all countries,
experts agree that it has brought overall net gains to most countries and regions and contributed to
global prosperity. Countries heavily involved in the production of goods and services thrive
because their GDP is positively impacted by trade, while more consumption-oriented countries
benefit from the lower costs that come with a comparative advantage.

3.2 MAJOR COMPONENTS OF INTERNATIONAL TRADE

3.2.1 LOWER COSTS OF PRODUCTION OF DEVELOPING NATIONS.
One of the most controversial components of international trade is the lower costs
of production of developing nations.
There is currently a great deal of concern over jobs being taken away from the
united states, members countries of the European union and other developed nations as
countries such as China, Korea, India, Indonesia and others produce goods and services at
much lower costs. Both the United States and the European Union have imposed severe
restrictions on imports from Asia nations to try to stem this tide.
Clearly, a company that can pay its workers the equivalent of dollars a day, as
compared to dollars an hour, has a distinct selling advantage. Nevertheless, American and
European consumers are only too happy to lower their costs of living by taking advantage
of cheaper imported goods.

3.1.2 SPECIALIZED INDUSTRIES

Even though many consumers prefer to buy less expensive goods, some
international trade is fostered by a specialized industry that has developed due to national
talent and/or tradition. Swiss watches, for example, will never be price- competitive with
mass produced watches from Asia. Regardless, there is a strong market among certain
consumer groups for the quality, endurance and even “snob appeal” that owing a Rolex-
PatekPhilip or Audemars Piquet offers.
German Cutlery, English bone, China, Scottish wool, fine French silks such as
Hermes and other such products always find their way onto the international trade scene
because consumers in many parts of the world are willing to foster the importation of
these goods to satisfy their concept that certain countries are the best at making certain
goods.
3.1.3 VOLUME AND VALUE OF GOODS SAY OIL
Total net oil imports in 2010 are over 96 million barrels per day (U.S. Energy
Information Administration figures Imports crude oil, natural gas liquids and refined
products). At a recent average of $114 per barrel per day. The natural resources of a handful
of nations, most notably the nations of OPEC, the Organization of Petroleum Exporting
Countries, are swept onto the international trade scene in staggering numbers each day, and
consumer nations continue to absorb this flow. Other natural resources contribute to the
movement of international trade, but none to the extent of the oil trade.
 Despite complaints about trade imbalances, effects on domestic economics,
currency up heavals, and loss of jobs, the reality of goods and services continually
crossing borders will not go away.
The global economic system is thus characterized by a growing level of integrated
services, finance, retail, manufacturing and nonetheless distribution, which in turn is
mainly the outcome of improved transport and logistics, a more efficient exploitation
of regional comparative advantage and a transactional environment supportive of legal and
financial complexities of global trade.
The four major categories of the international trading environment:
 Geography (the climate, terrain, seaports, and natural resources of a country)
 Culture and Society (the accepted behaviors, customs, and values of a society to include
language, education, religion, values, customs, and social relationships)
 Politics and Law (the type of government, the stability of the government, and government
policies toward business; and anti-corruption and anti-bribery laws, import and export
regulations, labor laws, intellectual property protection and licensing, product safety, and
consumer protection)
 Economy (the types of industries and jobs in the country and the stability of the country’s
money supply)

THE “FOUR TS” IN INTERNATIONAL TRADE

There are four major cost components in international trade, known as the “Four Ts”:

 Transaction costs. The costs related to the economic exchange behind trade. It can include the
gathering of information, negotiating, and enforcing contracts, letters of credit and transactions,
including monetary exchange rates if a transaction takes place in another currency. Transactions
taking place within a corporation are commonly lower than for transactions taking place between
corporations. Still, with e-commerce they have declined substantially.
 Tariff and non-tariff costs. Levies imposed by governments on a realized trade flow. They can
involve a direct monetary cost according to the product being traded (e.g. agricultural goods,
finished goods, petroleum, etc.) or standards to be abided to for a product to be allowed entry into
a foreign market. A variety of multilateral and bilateral arrangements have reduced tariffs and
internationally recognized standards (e.g. ISO) have marginalized non-tariffs barriers.
 Transport costs. The full costs of shipping goods from the point of production to the point of
consumption. Containerization, intermodal transportation and economies of scale have reduced
transport costs significantly.
 Time costs. The delays related to the lag between an order and the moment it is received by the
purchaser. Long distance international trade is often related with time delays that can be
compounded by custom inspection delays. Supply chain management strategies are able to
mitigate effectively time constraints, namely through the inventory in transit concept.
3.3 TERMS OF TRADE

Terms of trade is a quantitative measure of the rate at which a country’s export exchange for its
imports. It is a measure of the purchasing power of its exports expressed in its imports or,
alternatively, the price of its imports expressed in terms of its exports. It is the rate at which the
products of one country are exchanged for the products of the other. It is known to us that every
country has got its own money. The currency of one country is not legal tender in the other country.
So every country has to export commodities in order to import goods.

The terms of trade is said to be favourable if for some given imports a country pays with smaller
exports, or if for some given exports, it gets more imports. Though, the gains from international
trade brings about increase in output, except of course Portugal is able to trade some cloth for
wine, workers in Portugal will not get much work done, the same applies to England.

Without trade, workers in England will not get much done. But how much cloth must England
give in exchange for Portuguese wine is a question that is very much decided by countries terms
of trade. In other words, terms of trade is basically expressed as a relationship between a unit prices
of a country’s export to a unit price of the country’s import. In the case of England and Portugal;
terms of trade is how much of wine and vice versa.

Equation/Formula:

The terms of trade can be expressed in the form of equation as such:

Terms of Trade = Price of Imports and Volume of Imports

Price of Exports and Volume of Exports

The terms of trade are of economic significance to a country. If they are favorable to a country, it
will be gaining more from international trade and if they are unfavorable, the loss will be occurring
to it. When the country's goods are in high demand from abroad, i.e., when its terms of trade are
favorable, the level of money income increases. Conversely, when the terms of trade are
unfavorable, the level of money income falls.

3.3.1 ESSENTIAL FEATURES OF TERMS OF TRADE

An average: It should be carefully noted that when a country is trading in more
than one item a measure of its terms of trade represents an average with prices of individual
items of trade scattered around. This is because the measure is derived with the help of
price index numbers, which are themselves average of scattered values.

A Derivative: Being a derivative of price index numbers, a measure of terms of

trade is bound to suffer from all the limitations which are inherent in the compilation of
 price index numbers. E.g. choice of base period, the choice of weights, the method of
averaging, and so on.
3.3.2 MEASURES OF TERMS OF TRADE

Change in a country’s terms of trade has some direct and indirect effects on; economic
gains from trade, economic growth and potential, and its social welfare. If we take into
consideration these “spill-over” effects, several alternative concepts of terms of trade come up
for consideration. Hence there exists a plethora of measures of terms of trade going by different
names.

o Commodity terms of trade (TTC)

This is the most popular measure and it is also known as Net Barter Terms of trade or the unit
value index. It is the ratio of the price index number of exports to the price index of imports of the
country concerned.

"The rate at which given volume of exports is exchanged for a given quantity of imports is called
the commodity terms of trade".

The rate of exchange or the term of exchange depends upon the elasticities of the demand of each
country for the products of the other.
For instance, if Pakistan's demand for Indian's wheat is much more intense than Indian's demand
for Pakistan's cotton, the terms of trade will be more favorable to India than to Pakistan. This is
because Pakistan's demand for India's wheat is highly inelastic while India's demand for Pakistan's
cotton is highly elastic.

The country which is more eager to sell or purchase stands at disadvantage in the bargain. In the
words of Taussing:

"That country gains more from international trade whose exports are more in demand and which
itself has little demand for the things it imports, i.e., for the exports of the other countries, that
country gains least which has the most insistent demand for the products of the other country".

That terms of trade are measured by the ratio of import prices to export prices. The terms of trade
will be favorable to a country when the export prices are high relatively to import prices. This is
because the products of one unit of domestic resources will exchange against the product of more
than one unit of foreign exchange. If, on the other hand, the prices of its imports rise relatively to
the prices of its exports, the terms of trade will be unfavorable to the country. A certain year is
taken as base year and the average of the countries import and export prices of the base year is
called 100

Symbolically, this ratio may be written as: TTC = (Px/Pm) 100

Where,
TTC = Commodity terms of trade
Px = price index of exports
Pm = price index of imports
TTC is limited by the choice of base years, weight and average.
o Gross Barter terms of trade / Income terms of trade
This is a measure introduced by F.W. Taussig. It uses relative change in a country’s volume of
exports and imports as against the comparative changes in their prices.

It is the desire of every country that it should earn the maximum of income out of international
exchange by taking permanent favorable terms of trade. In order to secure maximum gain, the
country will try to increase the volume and value of exports and reduce the volume of imports and
buy it also from the cheapest market. If the country is having a monopoly in the supply of a
commodity and the demand for products is inelastic, then it can fetch more income. In case the
terms of trade move against the country, then there will be drain of national income, the commodity
terms of trade depend upon the following factors:
(i) Ratio of import prices to export prices.
(ii) The volume and value of exports and imports.
(iii) The condition attached to export and import such as insurance charges, supply of
machinery and shipping, etc.
If the terms of trade are favorable which may be due to monopolistic supply or inelastic demand
or cheap and better kind of exports, etc., the terms of trade will be favorable and the national
income will rise. In case of terms of trade are unfavorable over a period of time, the national
income will fall.
This is given as
TTg = (Qm/Qx) x 100
TTg = Gross barter terms of trade
Qm = Quantity index of imports
Qx = Quantity index of exports

The major limitation of this measure is the problems of compilation, No credit sales, unilateral
transfer etc

3.4 BALANCE OF TRADE

This is the difference between visible imports and visible exports. Simply, the balance of
trade is the difference between the value of a country's imports and exports for a given period. The balance
of trade is the largest component of a country's balance of payments. If visible imports is greater than
visible exports; balance of payments is said to be unfavourable. Where visible exports is greater
than visible imports, there is a favourable balance of trade. On the other hand, where visible
exports is equal to visible imports, there is a balance of trade. Economists use the BOT to measure
the relative strength of a country's economy. The balance of trade is also referred to as the trade balance or
the international trade balance.

Understanding Balance of Trade (BOT)

A country that imports more goods and services than it exports in terms of value has a trade
deficit. Conversely, a country that exports more goods and services than it imports has a trade
surplus. The formula for calculating the BOT can be simplified as the total value of imports minus
the total value of exports.

Calculating a Country's BOT

For example, if the United States imported $1.5 trillion in goods and services in 2017, but
exported only $1 trillion in goods and services to other countries, then the United States had a trade
balance of -$500 billion, or a $500 billion trade deficit.

$1.5 trillion in imports - $1 trillion in exports = $500 billion trade deficit

In effect, a country with a large trade deficit borrows money to pay for its goods and
services, while a country with a large trade surplus lends money to deficit countries. In some cases,
the trade balance may correlate to a country's political and economic stability because it
reflects the amount of foreign investment in that country.

Debit items include imports, foreign aid, domestic spending abroad and domestic investments
abroad. Credit items include exports, foreign spending in the domestic economy and foreign
investments in the domestic economy. By subtracting the credit items from the debit items,
economists arrive at a trade deficit or trade surplus for a given country over the period of a month,
quarter or year.

Examples of Balance of Trade

There are countries where it is almost certain that a trade deficit will occur. For example, the United
States has had a trade deficit since 1976 because of its dependency on oil imports and consumer
products. Conversely, China, a country that produces and exports many of the world's consumable
goods, has recorded a trade surplus since 1995.

A trade surplus or deficit is not always a viable indicator of an economy's health, and it must be
considered in the context of the business cycle and other economic indicators. For example, in a
recession, countries prefer to export more to create jobs and demand in the economy. In times of
economic expansion, countries prefer to import more to promote price competition, which limits
inflation.

In 2017, Germany, Japan, China and South Korea had the largest trade surpluses by current
account balance. The United States, the United Kingdom, Canada and Turkey had the largest trade
deficits.
3.5 TECHNIQUE AND ECONOMIC EFFECTS OF INTERNATIONAL TRADE
The theory of comparative advantage is based on free trade in which there are no trade inhibitions
among nations; but the government of a country may however decide to limit the amount of some
products coming into the country so as to discourage the import of these goods. This concept is
what is known as trade restrictions. (Bakare I.O., 2003) The following are the techniques and
economic effects of international trade restrictions.

Trade barriers are government-induced restrictions on international trade, which generally

decrease overall economic efficiency.

 Trade barriers cause a limited choice of products and, therefore, would force customers to
pay higher prices and accept inferior quality.
 Trade barriers generally favor rich countries because these countries tend to set international
trade policies and standards.
 Economists generally agree that trade barriers are detrimental and decrease overall economic
efficiency, which can be explained by the theory of comparative advantage.

Most trade barriers work on the same principle–the imposition of some sort of cost on trade that
raises the price of the traded products. If two or more nations repeatedly use trade barriers against
each other, then a trade war results.

A barrier to trade is a government-imposed restraint on the flow of international goods or services.

Those restraints are sometimes obvious, but are most often subtle and non-obvious.

Barriers to trade are often called “protection” because their stated purpose is to shield or advance
particular industries or segments of an economy. From an economic perspective, though, the costs
to the economy of reducing its opportunities to trade almost always outweigh the benefits enjoyed
by those who are protected.

They are designed to impose additional costs or limits on imports and/or exports in order to protect
local industries. These additional costs or increased scarcity result in a higher price of imported
products and thereby make local goods and services more competitive

3.5.1 TRADITIONAL TECHNIQUE

Usually in the past, countries have used traditional techniques such as imposition of tariffs and
quotas or both as a means of barrier to trade.
They are carefully examined as follows:

A. Tariff
Tariff is a tax imposed on imported goods. It is also called customs duty. Sometimes a customer
duty is levied as a percentage of the value of the product. The higher the tariff rate, the more
restrictive the tariff and vice versa. Obviously, if the tariff rate is set higher enough it may stop all
imports of that item. This price increase encourages consumers to pick the local option. The most
common barrier to trade is a tariff–a tax on imports. Tariffs raise the price of imported goods
relative to domestic goods (good produced at home).

Tariffs are taxes that are imposed by the government on imported goods or services. They are
sometimes also referred to as duties. Tariffs can be implemented to raise the cost of products to
consumers in order to make them as expensive or more expensive than local goods or services (i.e.
scientific tariffs). In many cases, tariffs are used to protect local industries that could otherwise not
compete with foreign producers (i.e. peril point tariffs). Of course, the countries affected by those
tariffs usually don’t like being economically disadvantaged, which often leads them to impose
their own tariffs to punish the other country (i.e. retaliatory tariffs).

For example, let’s assume there are only two countries in the world that produce candy bars. The
United States and Japan. In the US, local candy bars currently sell at a price of USD 2.50.
Meanwhile candy bars from Japan only cost USD 2.00. Hence, people in the US buy more
Japanese candy and local producers struggle. In response to this, the US government decides
to restrict imports of candy bars to promote local candy production. To do this, they impose a tariff
of USD 1.00 on every candy bar imported in the US. Because of this tariff, the price of Japanese
candy bars increases to USD 3.00, while US products still sell at USD 2.50. This makes local
candy relatively cheaper and more attractive for consumers.

Tariffs are paid to the customs authority of the country imposing the tariff. Tariffs on imports
coming into the United States, for example, are collected by Customs and Border Protection, acting
on behalf of the Commerce Department. In the U.K., it's HM Revenue & Customs (HMRC) that
collects the money.

 Types of Tariffs

a. Specific Tariffs

A fixed fee levied on one unit of an imported good is referred to as a specific tariff.
This tariff can vary according to the type of good imported. For example, a country
could levy a $15 tariff on each pair of shoes imported, but levy a $300 tariff on each
computer imported.

b. Ad Valorem Tariffs

The phrase ad valorem is Latin for "according to value," and this type of tariff is levied
on a good based on a percentage of that good's value. An example of an ad valorem
tariff would be a 15% tariff levied by Japan on U.S. automobiles. The 15% is a price
 increase on the value of the automobile, so a $10,000 vehicle now costs $11,500 to
Japanese consumers. This price increase protects domestic producers from being
undercut but also keeps prices artificially high for Japanese car shoppers.

c. Licenses

A license is granted to a business by the government and allows the business to import
a certain type of good into the country. For example, there could be a restriction on
imported cheese, and licenses would be granted to certain companies allowing them to
act as importers. This creates a restriction on competition and increases prices faced by
consumers.

d. Voluntary Export Restraints

This type of trade barrier is "voluntary" in that it is created by the exporting country
rather than the importing one. A voluntary export restraint is usually levied at the behest
of the importing country and could be accompanied by a reciprocal VER. For example,
Brazil could place a VER on the exportation of sugar to Canada, based on a request by
Canada. Canada could then place a VER on the exportation of coal to Brazil. This
increases the price of both coal and sugar but protects the domestic industries.

They are agreements between an exporting and an importing country that limits the
quantity businesses can export during a period. Even though the term says the
agreement is voluntary, it is usually not. By reducing the quantity exported, the
exporting country can increase prices and total revenue.

e. Local content requirements

Instead of placing a quota on the number of goods that can be imported, the government
can require that a certain percentage of a good be made domestically. The restriction
can be a percentage of the good itself or a percentage of the value of the good. For
example, a restriction on the import of computers might say that 25% of the pieces used
to make the computer are made domestically, or can say that 15% of the value of the
good must come from domestically produced components

f. Import Quotas

An import quota is a restriction placed on the amount of a particular good that can be
imported. This sort of barrier is often associated with the issuance of licenses. For
example, a country may place a quota on the volume of imported citrus fruit that is
allowed.
B. Effect of Import Quota
Quota work the same way as tariff. In reality, there is indication that there is a major difference
being that while tariffs work through prices, quotas restrict quality.

However, while a tariff raises revenue for the government, a quota goes to protect domestic
producers and also benefit importers who manages to get some of this scarce import at low foreign
price and resell at the higher domestic price. And absolutely, assuming domestic demand increases,
with a tariff the quality of imports would increase, while a quota only price will increases.

Quotas are restrictions that limit the quantity or monetary value of specific goods or services that
can be imported over a certain period of time. The idea behind this is to reduce the quantity of
competitive products in local markets which increases demand for local goods and services. This
is usually done by handing out government issued licenses that allow companies or consumers to
import a certain quantity of a good or service. Although technically speaking, quotas are non-tariff
measures, they take quite a different approach than the other measures discussed above. Instead of
just making it more difficult or costly to import goods, quotas actually limit the amount of products
that can be traded. There is no way for foreign producers to circumvent such a quota. The most
restrictive type of quota is an embargo, i.e. an entire ban of trade and/or commercial activity
concerning a specified good or service.

NON-TARIFFS

Non-tariffs are barriers that restrict trade through measures other than the direct imposition of
tariffs. This may include measures such as quality and content requirements for imported goods
or subsidies to local producers. By establishing quality and content requirements the government
can restrict imports, because only products can be imported that meet certain criteria. More often
than not, these criteria are set to benefit local producers. In addition to that, the government can
grant subsidies, i.e. direct financial assistance to local producers in order to keep the price of their
goods and services competitive.

Let’s revisit our example from above. Apart from imposing a tariff on imported candy, the US
government could restrict trade by passing a law that requires all candy bars sold within the US to
contain at least 50% locally produced sugar. This prevents many Japanese producers from selling
their candy in the US and those who decide to comply with the new regulations will face higher
costs of production. As a result, the price of Japanese candy increases and US producers become
more competitive. Alternatively, the US government could directly support local companies by
paying them USD 0.50 for each candy bar they produce. This allows local producers to sell their
candy bars at USD 2.00 instead of USD 2.50 and match the price of Japanese candy.

Nations have been using other techniques set up to keep foreign goods from being imported. These
means are briefly the following:
1) Government Legislation: These are kind of government barriers in law. Some are domestic
preference laws which are preference to domestic suppliers in government purchases, others are
laws which were for domestic reasons which makes it more difficult for foreign supplies to
compete e.g. difference in safety standards and labeling requirements.

(2) Government commercial policy: This is sum total of actions that a country undertakes to
deliberately influence trade in goods and services. Any other commercial policy in any nation
other than the ones earlier explained fall under this category (Bakare I.O., 2003).

 Types of Non-tariffs

a. Subsidies

Government offer subsidies to help make firms more competitive by lowering their
cost. Another common barrier to trade is a government subsidy to a particular domestic
industry. Subsidies make those goods cheaper to produce than in foreign markets. This
results in a lower domestic price. Both tariffs and subsidies raise the price of foreign
goods relative to domestic goods, which reduces imports.

b. Quantity Restrictions, Quotas and Licensing Procedures

Under this system, the maximum quantity of different commodities which would be
allowed to be imported over a period of time from various countries is fixed in advance.
The quantity allowed to be imported or quota fixed normally depends upon the relations
of the two countries and the need of the importing country.

Quotas are very often combined with Licensing System to regulate the flow of imports
over the quota period as also to allocate them between various importers and supplying
countries. In this system a license or a permit has to be obtained from the Government
to import the goods mentioning the quantity and the country from which to import.

c. Foreign Exchange Restrictions

Under this system the importer must be sure that adequate foreign exchange would be
made available for the imports of goods by obtaining a clearance from the exchange
control authorities of the country before concluding the contract with the supplier.

d. Technical and Administrative Regulations

The imposition of technical production, technical specifications etc. to which an

importing commodity must conform. Such type of technical restrictions is imposed in
case of pharmaceutical products etc. Besides technical restrictions, administrative
 restrictions such as adherence to certain documentary procedure are adopted to regulate
imports. These measures impede the free flow of trade to a large extent.

e. Consular Formalities
Large number of countries demands that shipping documents must accompany the
consular documents such as:

(a) Certificate of origin,

(b) Certified invoices,
(c) Import certificates etc.

Sometimes, it is also insisted that such documents should be drawn in the language of
importing countries. In case the documentation is faculty and is not drawn in the
language of the importing country heavy penalties are imposed. Fees charged for such
documentation are quite heavy.

f. State Trading
In socialistic countries import and export transactions are handled by certain State
Agencies. These agencies carry international trade strictly according to Government
Policies. In India some articles decided by the government is imported only through
the State Trading Corporation (STC). Export of raw materials such as iron ore, mica
are handled by MMTC (Minerals and Metals Trading Corporation).

g. Preferential Arrangement
The member countries of the group negotiate and arrive at a settlement of preferential
tariff rate to carry on trade amongst themselves. These rates are much lower than the
ordinary tariff rates and applicable only to the member nations of the small group. This
preferential arrangements made outside the purview of the GATT and EEC etc.
3.6 THE ILL EFFECTS OF INTERNATIONAL TRADE
For centuries, economic and policy makers assumed that every country gained from its
international trade. Their discussion focused on issues relating to the source, the mechanism, the
firms and the extent of these gains.
Doubts however, began to emerged after the second world war when issues relating to economic
development and welfare to gain ground.
Analysts found that while developed did gain from international trade this was not necessarily the
case with poor countries, rather, they could positively suffer on account of foreign trade. Such long
term ill- effects may include:
Inability of a developing country to pursue sustainable development.
Exhaustion of non-renewable productive resources and
 Environmental degradation and pollution.
Other Harmful Effects of International Trade
Effect # 1. Dual Economies:
International trade has resulted in creating ‘dual economies’ in underdeveloped countries as a
result of which the export sector became an island of development while the rest of the economy
remained backward.
The effects of foreign factor movements have been that of creating a highly unbalanced structure
of production of these countries. No doubt, the opening up of the export markets gave a fillip to
their export sector which led to the development of this sector while ignoring other sectors of the
economy. Although export increased but they did not contribute much to the development of the
rest of the economy. Moreover, excessive dependence on exports leads to cyclical fluctuations in
the advanced countries. During depression, terms of trade become adverse and their foreign
exchange earnings fall steeply. They are also not able to take advantage of world boom because
any improvement in their balance of payment does not lead to increased output and employment
due to market imperfections and non-availability of capital goods.
Effect # 2. Not Much Beneficial for Poor Countries:
The foreign trade has also not been entirely beneficial to poor countries because of the
adverse effects of foreign investments on their economy. It has been maintained that the inflow of
foreign capital and developed a country’s natural resources only for export purposes, to the neglect
of production in the domestic sector. In these countries the export sector remains an island of
development surrounded by a backward low-productivity sector. Thus, the inflow of foreign
capital in underdeveloped countries has not resulted either in the development of the domestic
sector or of the people in these countries. Despite huge foreign investments, the people have
remained backward in their countries.
Prof. H.W. Singer is also of the opinion that the benefits of technological progress have
gone disproportionately to the advanced countries. According to him, “Benefits of foreign trade
and investment have not been equally shared between the two groups of countries.
The capital exporting countries have received their repayment many times. Thus foreign
investment of the traditional type has formed part of a system of ‘economic imperialism’ and
‘exploitation.’
Effect # 3. Limited Possibility of Gain:
According to Prof. Nurkse the possibility of gain from foreign trade to underdeveloped countries
is restricted or limited. It is simply due to the reason that underdeveloped countries export mainly
primary goods. These exports suffer losses on account of:
(i) Fall n their demand due to the tendency on the part of developed countries to
establish heavy industries,
 (ii) Contribution of services in the aggregate production of developed countries has
been increasing,
(iii) Income elasticity of demand for agricultural production is less in developed
countries,
(iv) Many developed countries have been adopting policy of protection in respect
of agricultural products,
(v) Use of synthetic goods in place of agricultural products has been on the increase.
On account of these reasons, income of underdeveloped countries from the export of primary
products has been diminishing constantly. Under these circumstances, it is totally wrong to call
trade as ‘an Engine of Growth’.
Effect # 4. Adverse Effect on ‘Demonstration Effect’:
Another harmful effect is that the international operation of the ‘demonstration effect’ has been a
handicap for the poor countries. It has been responsible for reducing the capacity for capital
formation. The desire for luxury, show-off for higher standard of living and patterns of
consumption of advanced countries has been an important factor responsible for low level of
domestic savings in underdeveloped countries.
Higher income groups in these countries are trying to adopt the consumption standards of
advanced countries which have pushed up their propensity to consume and thereby limited capital
accumulation and economic growth. This leads to corruption and black marketing. Thus, these
evils have adverse effect on the economy.
Effect # 5. Secular Deterioration in the Terms of Trade:
Another important criticism of foreign trade has been that it has resulted in an international
transfer of income from the poor to the rich countries through a secular deterioration in the
commodity terms of trade of the poor countries. In the opinion of Prof. Raul Prebisch, there has
been a secular deterioration in the terms of trade of underdeveloped countries.
How maintains that underdeveloped countries have suffered with fatal effects of a continuous
weakening in their capacity to import. It has led to the weakening of the capacity of their existing
primary producing industries to support their growing population. It has resulted in a failure to
transmit to them the benefits of technical progress. This deterioration in terms of trade for
underdeveloped countries has been the result of differences in the distribution of gains from
increased productivity, diverse cyclical movements of primary product and industrial prices, and
disparities in the rates of increase in demand for imports between the industrial and primary
producing countries.
As a result, their secular terms of trade have deteriorated, unemployment increased and balance of
payments turned adverse.
 3.6.1 IMMISERISING GROWTH
The concept immiserising growth refers to the situation where an increase in a
country’s export commodity leads to such deterioration in it terms of trade that there is
a net decline in its export earnings and social welfare.
For immiserising growth to occur, the following conditions must hold:
The country’s growth should be characterized by a more than proportionate
increase in the production of its export commodity.
The supply of its exports commodity should be price inelastic so that it is willing
to export more even when price declines.
The share of its export commodity in the total supply in international (market
should be large enough to depress its international prices).

Immiserizing growth is a long-term phenomenon that occurs when the gain in a country's social
welfare arising from economic growth is more than offset by the loss in such welfare associated
with an adverse shift in the terms of trade. In one case explored many years ago by Jagdish
Bhagwati, immiserizing growth occurs in a developing nation that has started economic growth
but faces unfavorable international demand conditions as it increases its traditional exports. In
another case explored recently by Paul A. Samuelson, immiserizing growth occurs for the growing
industrialized country when its trade partner follows a policy of import substituting growth and,
as a result, shifts the terms of trade against the exporting country. Still others have specified a
variety of different cases of immiserizing growth. The author provides a simple graphical method
to analyze these situations and then presents data showing that immiserizing growth is a relatively
rare phenomenon.

3.6.2 THE DUTCH DISEASE

The term Dutch disease was coined by The Economist magazine in 1977 when the
publication analyzed a crisis that occurred in The Netherlands after the discovery of vast natural
gas deposits in the North Sea in 1959. The newfound wealth and massive exports of oil caused
the value of the Dutch guilder to rise sharply, making Dutch exports of all non-oil products less
competitive on the world market. Unemployment rose from 1.1% to 5.1%, and capital
investment in the country dropped.
Dutch disease became widely used in economic circles as a shorthand way of describing the
paradoxical situation in which seemingly good news, such as the discovery of large oil reserves,
negatively impacts a country's broader economy.
What is Dutch Disease?
Dutch disease is a concept that describes an economic phenomenon when the rapid development
of one sector of the economy (particularly natural resources) and the decline of other sectors lead
to the substantial appreciation of the domestic currency. Dutch disease is an economic paradox
when good news for the economy, such as the discovery of natural resources, results in a negative
impact on the country’s economy. This is an economic loss which a country suffers on account
of an increase in its factor endowment or a natural windfall (like the discovery of huge oil
resources or deposit of a mineral).
Dutch disease is an economic term for the negative consequences that can arise from a spike in
the value of a nation’s currency. It is primarily associated with the new discovery or exploitation
of a valuable natural resource and the unexpected repercussions that such a discovery can have
on the overall economy of a nation.
The concept describes a situation where an industrial country stats exploiting a natural product
which it was previously importing. In the process, its exchange rate appreciate so much that its
competitiveness in traditional industries weakness and even results in its de- industrialization to
some extent. Netherlands developed its natural gas fields from the North Sea and gave birth to
this term. Other countries that have suffered from the Dutch Disease are the United Kingdom,
Norway, Australia and Mexico
Dutch disease exhibits the following two chief economic effects:
 It decreases the price competitiveness of exports of the affected country's manufactured
goods.
 It increases imports.
 Both phenomena result from a higher local currency.
KEY TAKEAWAYS
Dutch disease is a shorthand way of describing the paradox which occurs when good news, such
as the discovery of large oil reserves, harms a country's broader economy.
It may begin with a large influx of foreign cash to exploit a newfound resource.
Symptoms include a rising currency value leading to a drop in exports and a loss of jobs to other
countries. In the long run, these factors can contribute to unemployment, as manufacturing jobs
move to lower-cost countries. Meanwhile, non-resource-based industries suffer due to the
increased wealth generated by resource-based industries.
Examples of Dutch Disease
In the 1970s, Dutch Disease hit Great Britain when the price of oil quadrupled, making it
economically viable to drill for North Sea Oil off the coast of Scotland. By the late 1970s,
Britain had become a net exporter of oil, though it had previously been a net importer. Although
the value of the pound skyrocketed, the country fell into recession as British workers demanded
higher wages and Britain's other exports became uncompetitive.
References:
http://www.cteresource.org/verso/courses/8135/opportunities-in-global-trade-tasklist/482952964
https://online.norwich.edu/academic-programs/resources/5-components-of-current-international-
economics
https://transportgeography.org/?page_id=4066
https://www.topperlearning.com/answer/define-the-term-trade-mention-the-two-components-of-
trade/jepe3scc
http://www.economicsdiscussion.net/international-trade/harmful-effects/5-harmful-effects-of-
international-trade-discussed/13173
https://www.econlib.org/library/Topics/College/barrierstotrade.html
http://www.yourarticlelibrary.com/trade-2/5-major-types-of-import-quotas-proactive-trade-
devices/26248
http://www.economicsdiscussion.net/tariffs/top-6-types-of-non-tariff-barriers-managerial-
economics/13967
https://www.investopedia.com/terms/d/dutchdisease.asp
https://corporatefinanceinstitute.com/resources/knowledge/economics/dutch-disease/
https://economicsconcepts.com/terms_of_trade.html
https://www.investopedia.com/terms/b/bot.asp
https://courses.lumenlearning.com/boundless-management/chapter/international-trade-barriers/
https://quickonomics.com/three-types-of-trade-barriers/
http://www.economicsdiscussion.net/economic-growth/theories-economic-growth/theory-of-
immiserising-growth-economics/30879
https://works.swarthmore.edu/fac-economics/174/

Submitted by: (BSA 2)

Cleo Faith C. Forio
Shiela N. Magbojos

2019, August 23.