UNIT 9

The Foreign Sector

THE FOREIGN SECTOR

Why do countries trade?

 TOP 10 GOODS SOUTH AFRICA IMPORTS
1] Machinery including computers: US$10.2 billion (13.7% of total imports
2] Mineral fuels including oil: $10 billion (13.4%)
3] Electrical machinery, equipment: $8.1 billion (10.8%)
4] Vehicles : $5.8 billion (7.7%)
5] Organic chemicals: $1.2 billion (1.6%)
6] Plastics, plastic articles: $2.2 billion (3%)
7] Optical, technical, medical apparatus: $2 billion (2.7%)
8] Pharmaceuticals: $1.9 billion (2.5%)
9] Cereals: $1.4 billion (1.8%)
10] Other chemical goods: $1.4 billion (1.8%)
 TOP 10 GOODS SOUTH AFRICA EXPORTS
1] Gems, precious metals: US$14.9 billion (16.7% of total exports)
2] Ores, slag, ash: $11.3 billion (12.6%)
3] Mineral fuels including oil: $10.6 billion (11.8%)
4] Vehicles: $9.8 billion (11%)
5] Iron, steel: $6.1 billion (6.8%)
6] Machinery including computers: $5.4 billion (6%)
7] Fruits, nuts: $3.4 billion (3.8%)
8] Electrical machinery, equipment: $1.8 billion (2%)
9] Aluminium: $1.8 billion (2%)
10] Beverages, spirits, vinegar: $1.4 billion (1.5%)
 WHY COUNTRIES PARTICIPATE IN THE GLOBAL ECONOMY

• Trade (Gains from trade)

• Apply political pressure
• Invest in other countries
• to increase profits for local companies and to gain access to cheaper labour
• move closer to sources of raw materials.
• To bring money, technology & skills that are not available locally
 WHY COUNTRIES PARTICIPATE IN THE GLOBAL ECONOMY

Why countries trade

• It is far better for an individual to specialize in the activities that he or she does
best, rather than attempt to do everything.

• This principle is equally important to countries.

• By trading, certain countries are able to obtain goods and services which their
own economy cannot produce or does not possess.
 WHY COUNTRIES PARTICIPATE IN THE GLOBAL ECONOMY

Why countries trade

• Many South African companies, such as Anglo-American and South African
Breweries, have invested in countries overseas.

• South Africa, together with other third world countries also try hard to encourage
foreign companies to invest locally.

• It is believed that foreign companies will bring money, technology and skills that
are not available locally.
 ABSOLUTE ADVANTAGE VERSUS COMPARATIVE ADVANTAGE

A country enjoys an absolute advantage over another country in the production of

a product when it uses fewer resources to produce that product than the other
country does.

Assume that South Africa and Botswana produce wool and DVD players. One
worker in South Africa can produce 100 kg wool and 4 DVD players whilst one
worker in Botswana can produce 200 kg wool and 2 DVD players. We say the South
Africa has an absolute advantage in production of DVD players and Botswana has
an absolute advantage in production of wool.
 ABSOLUTE ADVANTAGE VERSUS COMPARATIVE ADVANTAGE

A country enjoys a comparative advantage in the production of a good when that

good can be produced at a lower cost in terms of other goods (opportunity cost).

Comparative advantage is the fundamental force that generates trade between

nations.

Sources of comparative advantage are technology, resource endowments and

differences in trade/demand
 THE GAINS FROM INTERNATIONAL TRADE

Nations can increase the consumption of goods and services when they allocate
resources to the production of those goods and services for which they have a
comparative advantage.

When countries specialize in producing the goods in which they have a

comparative advantage, they maximize their combined output and allocate their
resources more efficiently.
 GAINS FROM COMPARATIVE ADVANTAGE

By means of glasses, hotbeds and hot walls, very good grapes can be raised in
Scotland, and very good wine, too, can be made of them at thirty times the
expense for which at least equally good wine can be bought from foreign countries.

The essence of comparative advantage is the idea that nations, like individuals can
carry out a particular economic activity (such as making a specific product) more
efficiently than another activity., and therefore should concentrate on what they
are best at producing.

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 GAINS FROM COMPARATIVE ADVANTAGE

If one person is an accomplished musician and the other a computer wizard, it is

more efficient to allow each person to specialize in one field rather than have each
of them produce their own music as well as their own computer programmes
individually.

By exporting each other’s services/skills to the other they will each benefit by
ending up with more goods/service than if they try making both goods/services
individually.

The same applies to nations.

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 RECAP: ABSOLUTE VERSUS COMPARATIVE ADVANTAGE

• Lets look at comparative advantage in more detail by way of an example!!

• ASSUME:
• Perfect competition prevails in all markets (perfect mobility of FOP, same product quality);
• There are constant returns to scale;
• There are zero transport costs; and
• There is only one factor of production – Labour.
 THE LAW OF COMPARATIVE ADVANTAGE

Each country will tend to specialize in and export those goods

for which it has a comparative advantage
 TRADE POLICY

The opening up of trade between countries leads to greater world production of

traded goods and, by implication, to an increase in economic welfare.

Not surprisingly, therefore, steps are taken from time to time to open up
economies to international trade and to reap the benefits of such trade.

Nevertheless, every government still takes steps to protect domestic firms against
foreign competition and to control the volume of imports entering the country.
 TRADE POLICY

The measures used include import tariffs, quotas, subsidies, other non-tariff
barriers, exchange controls and exchange rate policy.

• Import tariffs are duties or taxes imposed on products imported into a country. They are
generally used to protect domestic industries or sectors from foreign competition, but it
can be shown that they result in a net loss of welfare to the domestic society.

• import quotas seek to control the physical level of imports and are therefore a form of
direct intervention in the market mechanism. They have much the same economic
consequences as import tariffs.
 TRADE POLICY

The measures used include import tariffs, quotas, subsidies, other non-tariff
barriers, exchange controls and exchange rate policy.

• Subsidies granted to home producers also have essentially the same economic impact as
taxes on imported goods.

• Non-tariff barriers have become increasingly significant in recent years. They take the form
of, for example, discriminatory administrative practices, such as deliberately channelling
government contracts to domestic firms, insisting on certain technical standards or
specifications that may be difficult for foreign firms to meet, special licensing requirements
or, simply, unnecessary red tape.
 TRADE POLICY

The measures used include import tariffs, quotas, subsidies, other non-tariff
barriers, exchange controls and exchange rate policy.

• Exchange controls can also be used to restrict imports by limiting the amount of foreign
currency available for their purchase.

• Exchange rate policy: movements in exchange rates may have significant effects on exports
and imports and exchange rate policy may therefore be a much more effective instrument
for influencing international trade than the traditional instruments of trade policy such as
tariffs, quotas and subsidies
 THE EXCHANGE RATE

We get foreign currency and foreigners get Rands in the foreign exchange market
 the market in which the currency of one country is exchanged for the currency of
another.

The price at which one currency exchanges for another is called a foreign exchange
rate.
 THE EXCHANGE RATE

Exchange Rate Fluctuations

• Currency depreciation is the fall in the value of the currency in terms of another currency.
For example, if the rand falls from R1.40 to R1.26, the rand depreciates 10 per cent against
the euro.

• Currency appreciation is the rise in value of the currency in terms of another currency.
For example, if the rand rises from R1.30 to R1.95, the rand appreciates 50 per cent against
the US dollar. Exchange rate fluctuate because they depend on the demand and supply of a
particular currency
 THE EXCHANGE RATE

• Market Equilibrium

• Equilibrium in the market for rands depends on currency traders’ demand for rands and the
supply of Rands.

• The equilibrium also depends on whether SARB intervenes in the foreign exchange market.
 THE EXCHANGE RATE

Interventions in the Foreign Exchange Market

• The SARB cannot avoid influencing the exchange rate because it sets the SA interest rate,
which influences the demand and supply of rands in the foreign exchange market.

• When the South African interest rate rises, other things remaining the same, the rand
appreciates.

• When the South African interest rate falls, other things remaining the same, the rand
depreciates.
 THE EXCHANGE RATE

Floating exchange rate is a rate determined by the law of supply and

demand

A fixed exchange rate is a rate set and maintained by the government in

conjunction with its Central Bank (e.g. The SARB)
 THE EXCHANGE RATE

• Factors influencing relative DD and SS of the currency of a country

BOPs
Inflation
Business cycles
Real interest rates
Exchange controls
Politics