CHAPTER 1

EVOLUTION OF TRADE AND INTRODUCTORY TRADE ISSUES

INTRODUCTION

We live in a world that is highly interconnected by a bewildering array of complex

economic transactions, social and environmental problems, and international political
collaborations and conflicts. Examples from global economics are found in the news everyday. A
decision by American policymakers to subsidize the production of ethanol, a form of gasoline
containing an additive produced from corn, is seen by many as a key reason that grain prices are
high around the world. The spectacular emergence of China as a major exporter of manufactured
goods has affected wages in both rich and poor countries. As large corporations, such as
Microsoft, Intel, Toyota, General Electric, and Siemens have expanded their investments in
affiliates in many nations around the world, they have built global production networks that
share technological knowledge across locations to produce increasingly complex goods that
could be sold anywhere.

Today, a major cultural product, such as a Hollywood movie or a jazz band’s latest
compact disk, is likely to employ creative personnel from around the world, with various
components of the product recorded, mixed or edited in different locations. The importance of
international connections in trade, investment, and skilled services can be illustrated by
considering the apparently simple act of making and bringing to market an item of apparel, say a
fashionable woolen men’s suit. The initial task is to design the suit, a highly creative activity that
generally takes place in the headquarters of a major fashion label, such as Armani or Hugo Boss.
Beyond that, the firm must locate reliable suppliers of raw wool, which could be farmers in New
Zealand, Argentina, Scotland, or elsewhere. The wool needs to be spun into yarn and then woven
into finished fabrics, tasks that are likely to be done in low-wage economies with abundant labor,
such as Vietnam or Bangladesh, both major centers of fabric manufacture.

The fabrics then are shipped to locations where they are combined with such other
materials as buttons and zippers into high-quality sewn garments. These locations are most likely
to be in somewhat higher-productivity economies, such as China, Malaysia or Mexico and the
firms involved typically work as independent sub-contractors to many retailers rather than
affiliates of one. The garments are then shipped to brand-name apparel companies, who sell them
to high-end department stores and specialty retailers, and to generic trading companies that may
ultimately sell them in discount or outlet stores.
 Economics is a social science whose purpose is to understand the workings of the real-
world economy. An economy is something that no one person can observe in its entirety. We are
all a part of the economy, we all buys and sell things daily, but we cannot observe all parts and
aspects of an economy at any one time. For this reason, economists build mathematical models,
or theories, meant to describe different aspects of the real world. For some students, economics
seems to be all about these models and theories, these abstract equations and diagrams. However,
in actuality, economics is about the real world, the world we all live in. For this reason, it is
important in any economics course to describe the conditions in the real world before diving into
the theory intended to explain them. In this case, in a textbook about international trade, it is very
useful for a student to know some of the policy issues, the controversies, the discussions, and the
history of international trade. This first chapter provides an overview of the real world with
respect to international trade. It explains not only where we are now but also where we have been
and why things changed along the way. It describes current trade laws and institutions and
explains why they have been implemented. With this overview about international trade in the
real world in mind, a student can better understand why the theories and models in the later
chapters are being developed. This chapter lays the groundwork for everything else that follows.

1.1 The International Economy and International Economics

LEARNING OBJECTIVES

1. Learn past trends in international trade and foreign investment.

2. Learn the distinction between international trade and international finance.

International economics is growing in importance as a field of study because of the rapid

integration of international economic markets. Increasingly, businesses, consumers, and
governments realize that their lives are affected not only by what goes on in their own town,
state, or country but also by what is happening around the world. Consumers can walk into their
local shops today and buy goods and services from all over the world. Local businesses must
compete with these foreign products. However, many of these same businesses also have new
opportunities to expand their markets by selling to a multitude of consumers in other countries.
The advance of telecommunications is also rapidly reducing the cost of providing services
internationally, while the Internet will assuredly change the nature of many products and services
as it expands markets even further.
One simple way to see the rising importance of international economics is to look at the growth
of exports in the world during the past fifty or more years.

Figure 1.1 "World Exports, 1948–2008 (in Billions of U.S. Dollars)" shows the overall annual
exports measured in billions of U.S. dollars from 1948 to 2008. Recognizing that

one country’s exports are another country’s imports, one can see the exponential growth in
outflows and inflows during the past fifty years.
Figure 1.1 World Exports, 1948–2008 (in Billions of U.S. Dollars)
Source: World Trade Organization, International trade and tariff

However, rapid growth in the value of exports does not necessarily indicate that trade is
becoming more important. A better method is to look at the share of traded goods in relation to
the size of the world economy. Figure 1.2 "World Exports, 1970–2008 (Percentage of World
GDP)" shows world exports as a percentage of the world gross domestic product (GDP) for the
years 1970 to 2008. It shows a steady increase in trade as a share of the size of the world
economy. World exports grew from just over 10 percent of the GDP in 1970 to over 30 percent
by 2008. Thus trade is not only rising rapidly in absolute terms; it is becoming relatively more
important too.

One other indicator of world interconnectedness can be seen in changes in the amount of foreign
direct investment (FDI). FDI is foreign ownership of productive activities and thus is another
way in which foreign economic influence can affect a country. Figure 1.3 "World Inward FDI
Stocks, 1980–2007 (Percentage of World GDP)" shows the stock, or the sum total value, of FDI
around the world taken as a percentage of the world GDP between 1980 and 2007. It gives an
indication of the importance of foreign ownership and influence around the world. As can be
seen, the share of FDI has grown dramatically from around 5 percent of the world GDP in 1980
to over 25 percent of the GDP just twenty-five years later.

The growth of international trade and investment has been stimulated partly by the steady decline
of trade barriers since the Great Depression of the 1930s. In the post–World War II era, the
General Agreement on Tariffs and Trade, or GATT, prompted regular negotiations among a
growing body of members to reciprocally reduce tariffs (import taxes) on imported goods.
During each of these regular negotiations (eight of these rounds were completed between 1948
and 1994), countries promised to reduce their tariffs on imports in exchange for concessions—
that means tariffs reductions—by other GATT members. When the Uruguay Round, the most
recently completed round, was finalized in 1994, the member countries succeeded in extending
the agreement to include liberalization promises in a much larger sphere of influence. Now
countries not only would lower tariffs on goods trade but also would begin to liberalize the
agriculture and services markets. They would eliminate the many quota systems—like the multi
fiber agreement in clothing—that had sprouted up in previous decades. And they would agree to
adhere to certain minimum standards to protect intellectual property rights such as patents,
trademarks, and copyrights. The World Trade Organization (WTO) was created to manage this
system of new agreements, to provide a forum for regular discussion of trade matters, and to
implement a well-defined process for settling trade disputes that might arise among countries.

As of 2009, 153 countries were members of the WTO “trade liberalization club,” and many more
countries were still negotiating entry. As the club grows to include more members—and if the
latest round of trade liberalization talks, called the Doha Round, concludes with an agreement—
world markets will become increasingly open to trade and investment. Another international
push for trade liberalization has come in the form of regional free trade agreements. Over two
hundred regional trade agreements around the world have been notified, or announced, to the
WTO. Many countries have negotiated these agreements with neighboring countries or major
trading partners to promote even faster trade liberalization. In part, these have arisen because of
the slow, plodding pace of liberalization under the GATT/WTO. In part, the regional trade
agreements have occurred because countries have wished to promote interdependence and
connectedness with important economic or strategic trade partners. In any case, the phenomenon
serves to open international markets even further than achieved in the WTO. These changes in
economic patterns and the trend toward ever increasing openness are an important aspect of the
more exhaustive phenomenon known as globalization. Globalization more formally refers to the
economic, social, cultural, or environmental changes that tend to interconnect peoples around the
world. Since the economic aspects of globalization are certainly the most pervasive of these
changes, it is increasingly important to understand the implications of a global marketplace on
consumers, businesses, and governments. That is where the study of international economics
begins.

THE EVOLUTION OF TRADE

Man, early in his age and development, learned that it was to his advantage and interest
that his wants and needs could be better satisfied by making use not only of the products of his
country but those of other lands and produced by other people as well. Thus, throughout history,
people have exchanged goods with people of distant land. In biblical times, long caravans were a
common sight which brought frankincense and myrrh from the East. During the Middle ages,
spices, condiments and silk from the orient were known to have contributed immeasurably
toward the enrichment of European manorial and monastic life. One my doubtless recall the
various expeditions which were sent out by the kings of Portugal and Spain in search of the
shortest route to the Moluccas group of islands in order to take advantages of the fabulous spice
trade, a circumstance that has been responsible for the discovery of the Philippines by Ferdinand
Magellan and the consequent colonization of our country by Spain.

Early traders have been credited of contributing to the spread of knowledge and ideas.
They have transplanted plants, animals, products, processes and ideas among the many countries
of the world from earliest times.

THE CARAVAN AND THE CARAVEL TRADE

Of the early stages in the growth and development of trade, the caravan and the caravel
trade are important and quite well known. With the dawn of the recorded history, merchants
whose donkey and camel caravans pioneered the first trade routes between the Eurphrates and
the Nile became quite common sights. (The mud flats of the Tigris-Eurphrates delta in
Mesopotomia, were the scene of the world’ s first trading civilization. During the ancient and as
well as middle times the hardly and enterprising merchants were regarded as foreigners
regardless of whether they came from near by towns or from a far distrust, if not with open
hostility by local traders. Such a circumstance made them pay dearly for protection by local
rulers just as they where under constant surveillance by members of the merchant guilds.
 As in caravel trade, there was no trade in bulky goods needed by the masses for the
reason that overly large caravan would be required for their transport. Such a circumstance
would indeed make the cost of transport become very prohibitive and burdensome. Thus,
caravan trade was also essentially trade in light and compact articles of high value.

The word “caravan” is of Persian origin, which was adopted into the later Arabic
vocabulary. As described in the dictionary, it refers to a “body of traders” travelling together for
greater security against bandits. Motivated by trade, merchants risked their lives and fortune by
transporting products across strange and isolated land where hidden dangers lurked among the
trading routes and waiting for their prey. As such, it was but logical for traders to travel not only
heavily armed but in big numbers for mutual protection and security.

Just as the highways of commerce were found infested by the presence of bandits so were
the high seas with the presence of pirates. Along with the absences of a navigating instrument
then, all these militated against mariners plying into the uncharted seas. Caravel trade – trade
across the seas- as it was known then, was confined along well known sea routes, generally from
one harbor to another. This trade in luxury appeared too tempting and more over fair game not
only for pirates who continued to infest the high seas but also to rules who were hungry for
revenue.

GROWTH AND DEVELOPMENT

“All roads lead to Rome” is, doubtless, a statement not without meaning and significance. It was,
in fact, a tribute to Rome not only for her political and military supremacy but equally so for her
high degree of civilization and its influence upon the other countries of the world.

Not to be overlooked in the Pax Romana, considered as her greatest contribution to the
development of trade, which helped weed out the presence of bandits and pirates across the land
and the seas thus making trade and travel safe. It need not be stated very strongly that not until
roads, highways and the seas become safe against all forms of danger that even improvements in
the means of communication and transportation will not be of much help in promoting
international exchange.

It might be interesting to note that because of such contribution, the busy medieval roads
where scholars, ministrels, pilgrims, crusaders, traders and merchants jostled with one another
were busy and important highways of ideas as well as of trade.

Early Fairs. The expansion of trade from ancient times to the present century has
brought about in its path the evolution and development of certain trading methods and
commercial techniques which have withstood the test of time through the intervening centuries.
Hence, some considered them no less as examples of trading institutions.
 The holding of fairs can be traced back to antiquity. The desire of the man of the early
century to gain indulgences that are necessary for the salvation for his soul made religious fairs
crowded with pilgrims for such purpose who moreover took advantage of doing business among
themselves. Thus, many of them traveled in the dual category of religious pilgrims and traders
who carried with them the products of their land for exchange. As time went on, the fair
functioned as a place for display and exhibit of goods of the commercial world.

In Europe, progressively minded rulers were known to have encouraged the

establishment of fairs in their territories, both in order to stimulate trade and largely because of
the direct profits which accrued to them resulting from the payment by merchants of tolls and
other duties, apart from the profits generated by special courts which were set up purposely to
deal with judicial business arising from the fairs. Such courts were known in England as Pie
powder courts. The older fair were no more than big markets and as such served as concourse of
trade. Within recent times, the commercial world is familiar with such industrial and commercial
expositions is the many leading centers of the world depicting the progress that has been attained
in the various fields of human endeavor but with particular emphasis on industry, science and
agriculture.

PLACE OF EXCHANGE. While the fairs served as places of exchange during ancient
times, it was no uncommon to designate certain places where transactions were to take place,
which today we call as markets. In fact, even much earlier as silent trade, wary tribesmen placed
their goods in a customary spot to be taken and replaced by fellow tribesmen with their products
which not long afterwards gave way to that method of exchange called BARTER.

In each Greek city, there was a specially designated market place called agora, which
served not only as a center for exchange but also for civic, political and religious activities. Each
group of sellers of services in a Greek agora, such as the bakers, butchers, cooks, carpenters, etc.,
was assigned a special circle in which its members were to stand with their corresponding tool or
symbol of their activities. Thus a market served not only for commodities but for labor or
services as well already existed then.

In Rome, markets during the early times were known as the forum, meaning a meeting
place. The concourse of people engaged in buying and selling was termed mercatus, derived
from mercari, which means “to buy” or “to traffic”. As in ancient Greece, the market place
served not only for exchange of goods but also for political, social and religious purposes. While
a single forum each week was sufficient for all exchanging activities in the smaller towns and
communities, in the larger cities, markets were open every day. The markets occurring every
ninth day were called nundinae from nundinus, signifying nine days. The occasional markets
held on national holidays were called mercatus.

The Romans limited the number of markets so that the local forces of supply and demand
would not operate ineffectively by being scattered in several markets. It was made unlawful for
any one to buy goods on their way to the market. Such an unlawful practice of buying goods was
designated in Germany as furkauf. In England, this practice is called forestalling, from the old
Saxon word “fore” meaning “before” and “stall” signifying “to hinder”. Thus, forestalling
means buying merchandise before it reaches the market. These practices were also considered
market offenses in other European countries.

In the Philippines, it will be recalled that the Royal Audencia in 1590 not only established
the official prices of chicken, pork, fish, and other commodities but also forbade any person “to
buy or contract the merchandise on its way to the market, with the intention of selling it again at
a higher price.”

Thus, the annual markets, which were originally chartered by churches and monasteries
in connection with the observance of religious festivities, soon became the great wholesale
markets for foreign traders from all over Europe and the East who travelled about from country
to country, buying the surplus goods and specialties of one region for sale elsewhere at a profit.

The Auction. The word auction is derived from the Latin term auctio meaning
“increase”, a process of trading carried on by succeeding offers of increasing sums from
potential bidders, oftentimes called bids, until at length the competition ceases and the sale of the
article is made to the highest bidder.

The auction as a trading method was used by the Dutch East Indies Company, more
particularly during the sixteenth century, for the disposal of colonial products such as pepper,
cinnamon, mace and other spices, tobacco, silk, cotton goods, and other merchandise which have
remained undisposed of at the end of selling season. Auctions were held twice a year. Remnants
of this trading device are still observed in our pawnshops today where sales of unredeemed
pledges consisting mostly of jewelry are disposed of through public auctions from time to time.
The same observation may be cited in the case of those goods which have been confiscated by
the Bureau of Customs for violation of our laws, rules, and regulations or articles which are
subject to a valid lien for customs duties, taxes, or other charges collected by the Bureau of
Customs. In the American military bases located in the Philippines, this method of disposal of
goods is common.

FACTORS THAT CONTRIBUTED TO THE ACCELERATION OF INTERNATIONAL

TRADE

A number of important factors and conditions may be noted briefly as having contributed
their share to the acceleration of international trade. Events which began at the end of 18 th
century were quite rapid and profound which produced effects of far-reaching significance. If not
to say helped transform primitive economy into a industrial one. Because of their profound
impact, not a few writers described the development as Industrial Revolution.
 Industrial Revolution. The introduction in the use of power machines in factories which
substituted for the use of hands and simple tools in production did not only lighten the physical
burdens of man but resulted in a number of advantages, which was the tremendous increase in
output in production.

That the setting of the Industrial Revolution was England may be explained if for no
other reason than the fact that the English people have favorable and stable political institutions,
internal free trade, advantages of climate, and geographical position, considerable experience
with foreign trading, special connections with the New World and an abundance of coal. With
coal becoming in time as the chief source of economic power, England started to enjoy a position
of tremendous importance both in production as well as in trade.

The great increase of commerce during the period of mercantilism was the result of wind-
driven ships, which were great improvements over the earlier vessels. Also, growth in commerce
had extended the use of water wheels. These improvements, however, were insignificant
compared to the results of the steam engine, to which were added electrical power, the internal
combustion engine, the jet engine and now, on the horizon, the likely harnessing of the atomic
power for good instead of for war efforts alone.

Thus, it could be said that it was only much later when the world became the beneficiary
of a number of inventions.

The constant improvement in transportation, land, water and air, has not only resulted in
increasing production in the industries but also facilitated the growth of agricultural production.

The historical sketch of important developments which help accelerate the tempo and
volume of international trade should however not be looked upon as a complete account. Far
from it. Rather, it seeks to portray how international trade grew and developed into what it is
now hand in hand with other important developments – through inventions, innovations and
changing technology. The expansion of international trade however would be far from possible
in spite of such dramatic developments where the world is thrown into continuous uproar and
upheavals.

Technological developments have resulted in new methods of production. With the new
demands resulting from rising standards of living and thus a better life than before have
accounted for increasing trade. Needless to mention, some of them could be found only in
relatively few areas of the world, and could be obtained only through importation.

Commercial Documents. Nobody needed documents more than those who were
engaged in trade. In fact, it appears quite logical to believe that the early traders had a hand in the
invention of writing, thereby making records and history possible. Writing was not invented all
at once just as alphabetical writing did not come about till after many centuries of
experimentation with crude pictographs.
 This early records were made of material that was abundant-clay. Thus, bills of exchange,
promissory notes and the like were engraved on clay tablets, baked hard under the scorching heat
of the sun, and stored in temple jars. With the invention of writing, documents came to be written
in the hand of the principal known as holographs, from a Greek word, “holography”, which
means “the whole message”.

Commercial Law. Much of the law by which we regulate the vast complexity of modern
production and trade, even the law of partnership and of corporate relationships, rests upon
concepts of fair practice applied to intricate and ever-changing situations according to the
experience of actual traders. Custom and precedent count far more than is often realized,
especially in the basic relations between men. Their roots go very deep in human consciousness.
Inevitably men have attached to them reverence and religious authority, or have sought to
identify them with the natural order of the universe.

The medieval “Law Merchant” or “Lex Mercatoria” (meaning law of trade) out of which
our modern commercial law developed has been described “as a particular application of the law
of contract.” As a body of rules laid down by merchants they were intended for regulating their
conduct with one another. Together with fellow merchants from all the trading regions, the
merchant had to devise both rules by which he could carry trade peacefully and equitably, and
the tribunals in which those rules could be interpreted and enforced.

The cosmopolitan body of rules and customs formed by the traders principally of the
Mediterranean designed to solve disputes between the traders attending the fairs gained public
acceptance neither in the name of Justinian (a Roman emperor who was famous as a legislator
and a codifier of law) nor of the Church, but for universal reason.

The Law Merchant covers not only commercial contracts but marine insurance as well.
The Law Merchant has been accumulating in English-speaking countries for more than four
hundred years. Reliable marine insurance brokers can be dependent upon to advise the foreign
trader on the proper coverage of risks and to represent his interests in the collection of claims and
in similar matters.

Following this, steps were at once taken to secure the adoption of the bill, thus approved,
in every state in the Union.

Banking Institutions. Observed from what have transpired in the centuries past, if trade
was responsible for the development of a system of finance through ambulatory bankers,
doubtless, it could also be equally said that banks in the course of their growth and development
have their own contributions to the rapid acceleration of international trade. In fact, it is because
of commercial banks that goods are able to move at a faster pace from one nation to another than
otherwise would be the case. This may be best appreciated when one takes into account the use
of what is known as commercial letters of credit as a means of financing foreign trade shipments.
 The bank, acting as a fiduciary agent for the buyer (importer) and the seller (exporter),
guarantees the exchange of documents giving title to the merchandise, in spite of the fact that the
sellers and the buyer are situated in different countries separated by thousands of miles. The form
of the bank’s undertaking Is known as a documentary credit, or letter of credit. The invaluable
function of banks in the commercial world will be discussed in a detailed treatment in a later
chapter of this book.

Briefly stated, documentary credits are used to finance shipments to and from almost
every country of the world. With so many different trade customs and countries involved, it is
understandable that certain terms may be interpreted differently, depending on the custom of the
trade of the country concerned.

Ports of Entry. What originally was introduced in England as the staple (literally
meaning a market or commercial emporium), that is, a system whereby the stream of commerce
is regulated and directed into definite channels, has come to be known in modern times as port
of entry.

A port of entry is simply a domestic port open to both foreign and coastwise trade. In the
case of the Philippines, all articles imported into this country, whether subject to duty or not,
shall be entered through a customhouse at a port of entry. Failure to do so shall subject the
merchandise to the treatment given to contraband or smuggled goods. Not only are imports
required to pass through a customhouse at the port of entry, exports of goods must go through the
same channel.

With the designation of ports of entry, as in the case of the system of the staple,
collection of custom duties, taxes and other charges is facilitated and rules and regulations
governing the country’s foreign trade could easily be implemented. For instance, where goods
for export are subject to proper standardization in order to maintain goodwill in the international
market, proper inspection could be easily made to find if there is proper compliance or not with
the regulations pertaining thereto.

Laissez Faire. The virtues and achievements of the age of laissez faire should not escape
our attention. For indeed, it was the faith in free competition in the nineteenth century which in
many respects has brought about immense social gains. For instance, it gave encouragement to
invention and meaning to the spirit of enterprise that transformed methods of production, trade
and transport.

Laissez faire is essentially a revolt against mercantilism – that doctrine – which sought to
attain its goals and objective through the institution of economic controls that negated the spirit
of enterprise and initiative and thus hindered international trade from its complete fruition and
development during its prime days.
 Laissez faire may be defined as the doctrine which demands the minimum interference
by the government in economic and political affairs. Under the doctrine of laissez faire, the ideal
society is characterized by the competition of individuals armed with equal rights who freely
search for their interests in the interaction of economic relationships. From its beginnings, laissez
faire is marked by an optimistic faith in the power of uncontrolled action to produce social good.
As a theory of exchange, laissez faire leads to such stabilization of prices as results, in a given
market, in the maximum possible satisfaction to all those participating therein.