International trade

International trade, economic transactions

that are made between countries.
 History of international trade
• Mercantilist analysis, which reached the peak
of its influence upon European thought in the
16th and 17th centuries, focused directly upon
the welfare of the nation.
• It insisted that the acquisition of wealth,
particularly wealth in the form of gold, was of
paramount importance for national policy. 
 Conts.
• The trade policy dictated by mercantilist
philosophy was accordingly simple:

Encourage exports, discourage imports, and

take the proceeds of the resulting export
surplus in gold
 Features of mercantilism
 1. The fundamental aim of Mercantilism was
to make a country strong.
 The country should have a favourable balance
of trade. 
 It should come forward to exploit the natural
resources of the country to increase its exports.
 Criticism
• (1) They gave too much importance to gold and silver
and neglected the importance of other commodities.
• (2) They exaggerated the importance of commerce
and undermined the usefulness of agriculture and
other branches of human history.
• (3) They were wrong in believing that a favourable
balance of trade was the only source of prosperity.
• (4) Their belief that the gain of one nation was
necessarily the loss of another was wrong.
 Internal and international trade
• Internal trade means the trade which is
conducted within the political and boundaries
of a country. It is also called Domestic or
Home trade.
•  External trade means the trade that takes
place between the two countries. It is also
called External or International trade.
 Difference between International Trade and Internal
Trade

Factor immobility
Difference in natural resources
Geographical and climatic differences
Different markets
Mobility of goods
Different currencies
Mobility of goods
 Conts…
 Different currencies
 Problem of balance of payment
 Different transport cost
 Different Economic environment
 Different political groups
 Different national policies
Need and purpose of international trade

 International division of labour and

specialization
 Optimum use of world resources
 Stabilization of prices
 Technological progress
 Easy flow of capital
 Promotion of competition
 Conts…

 Greater bilateral co-operation

 Growth of international economic institution
 Export-led growth
 Basis of Economic survival
 Arguments against international trade

 Exploitation of resources and markets

 Balance of payment deficit
 International debt problem
 Adverse terms of trade
 International transmission of fluctuations
 Lack of industrial diversification
 Shortage of development finance
 Conts…
 No advanced technical know-how
 No exchange stability
 Discriminatory trade policies
 No economic self sufficiency
 Political interference
 Cause of war
 Free trade Vs Protection
 The foreign trade policy is concerned with
whether a country should adopt the policy of
free trade or of protection.
 If the policy of protection of domestic
industries is adopted, the question which is
faced whether protection should be achieved
through imposing tariffs on imports or through
the fixation of quota or through licensing of
imports.
 Conts….

 Despite the classical arguments for free trade to

promote efficiency and well-being of the people,
various countries have been following the
protectionist policies which militate against free
trade.
 By imposing heavy tariff duties on imports of goods
or fixing quotas of imports they have prevented free
trade to take place between countries. Several
arguments have been given in favour of protection.
 Trade Policy: Tariffs and Quotas:

• Despite many benefits of free trade, the various

countries have put up barriers to trade to protect their
domestic industries.
• A number of instruments are used to protect the
domestic industries to free trade but most important are
tariffs and quotas.
• Both tariffs and quotas can be imposed either on
imports or exports but they are mostly imposed on
imports.
• Barriers to exports are quite uncommon.
 Tariff barriers:

• 1. Tariffs:
• Tariffs are excise duties imposed on imported
goods.
• The objective of imposing tariffs may be
either raising revenue for the Government or
providing protection to the domestic
industries.
• Therefore, two types of tariffs are
distinguished:
• (1) Revenue tariffs, and
• (2) Protective tariffs.
• Revenue tariffs are usually imposed on the
imports of those products which are not produced
domestically.
• Rates of revenue tariffs are generally small but
yields a good revenue for the Government.
 Conts…
• Protective tariff, on the other hand are imposed
to provide protection to the domestic producers
from foreign competition.
• The rates of these tariffs are not so high as to
completely prohibit their imports into a country.
• Rise in prices of their products as a result of
imposition of tariffs, foreign producers lose
their superior competitive power.
 Quotas

• Import quotas are another instrument used to check free trade.

• Import quotas refer to the maximum quantities of goods
which may be permitted to be imported during any period of
time.
• They are also referred to as quantitative restrictions on
imports. Quotas are more effective method of reducing trade
than tariffs.
• A given commodity may be imported in a relatively large
quantity despite high tariffs but low quotas totally stop the
imports of a commodity beyond the fixed quota of the
commodity.
 Case for Free Trade:

1. Gains in Output and Well-being from Specialisation:

• The case for free trade is fundamentally based on the gain in output
and well-being a country obtains from specialising in the production
of those goods in which it is relatively more efficient and therefore
export a part of them and in exchange gets those goods from other
countries in production of which they are comparatively more
efficient.

• Specialisation and trading in this way would achieve a more efficient

allocation of resources and a higher level of output and well-being. 
 2. Gains from Economies of Scale:

• An important gain from trade is that it enables the

trading countries to benefit from the economies of
scale.
• If a country does not trade with others, its firms will
produce goods to meet the domestic demand for a
product.
• If domestic demand for a product is small, each of
them will produce at a higher cost since they would
not be able to enjoy the benefits of the economies of
large scale production.
 Conts…
• Thus trade expands the market for goods and
enables the producers to take advantage of the
economies of scale.
• Trade makes it possible for the producers to
move beyond domestic market into
international market and therefore makes it
worthwhile to specialise and produce on a
large scale and thereby to lower cost per unit.
 3. Long-Run Dynamic Gains:

• Free trade also leads to dynamic gains being obtained

from trade.
• Dynamic gains from trade refer to its stimulation of
economic growth.
• Dennis Robertson described foreign trade as ‘an
engine of growth’.
• The stimulation of growth through foreign trade are
apparent from the rapid growth of such economies
such as Japan, Taiwan, South Korea, Singapore, Hong
Kong and China.
Free trade promotes economic growth through:

(1)Raising the rate of saving and investment;

(2) Import of capital goods, and

(3) Transfer of technology.

• (i) Raising rate of saving and investment:
• Increase in national product or real national
income of a country obtained through trade
above the level that prevails in autarky leads to
a higher level of saving.
• The higher level of saving ensures a higher
rate of investment and capital formation which
stimulates growth.
• (ii) Import of capital goods:
• Besides trade permits a country to import capital goods
in exchange for exports of consumer goods or surplus
raw materials, and thereby accelerates industrial
growth.
• Imports of capital goods adds to the capital stock in a
country and raises its productive capacity more than it
would have been possible without trade.
• Free trade also often enables a country to borrow from
other countries to finance import of capital goods.
• (iii) Transfer of technology:
• If different countries worked in isolation the new
technology developed in one country would
remain confined locally.
• Through trade technological progress tends to
feed on each other.
• A technology discovered by one is improved by
another and so technology goes on being
improved successively.
• 4. Promotes Competition and Prevents Monopoly:
• The case for free trade also rests on the fact that it
promotes competition and prevents the emergence of
monopolies in the domestic economy.
• In the absence of trade and therefore without facing
any competition from foreign firms, domestic firms
tend to become inefficient which causes rise in cost
per unit of output and therefore higher prices of
goods.
• 5. Political Gains from Free Trade:
• Free trade increases well-being or standard of
living of the trading countries and this mutual
welfare gains from trade make different
nations economically dependent on each other.
• The economic interdependence raises the
likelihood of reduced hostility between
countries.
 Case for Protection:

• Case for Protection:

• Despite gains from free trade, many arguments
have been given against free trade and in
favour of protection.
• By protection we mean in order to safeguard
the domestic industries from low-priced
imports some barriers against import of
foreign goods are imposed.
• Nationalism:
• First argument for protection has been that
nationalistic feeling or patriotism requires that
people of a country should buy products of their
domestic industries rather than foreign products.
• In the USA there has been a campaign ‘Be
American, buy American’ appealing people to
buy American goods instead of imported foreign
products.
• Employment Argument:
• An important argument for protection is that it
will lead to increase in domestic employment
or at least preserves present domestic
employment.
• It is often believed that imports of goods from
abroad reduce domestic employment.
• Infant Industry Argument:
• A powerful argument given in support of
protection, especially in the context of
developing countries is infant industries
should be provided protection from the
competition of low-priced imports of the
mature and well-established industries of the
developed industrialized countries.
• Anti-dumping Argument:
• The other important argument for protection is
that foreign producers compete unfairly by
dumping the goods in another country.
• Dumping is a form of price discrimination
when producers of a country sell goods in
another country at lower prices than those
charged at home.
• Of course, consumers in a country in which
foreign goods are dumped are beneficiaries,
the industries of that country suffer as they are
unable to compete with the ‘dumped goods’.

• Once the local industries are competed out,

they raise prices to obtain monopoly profits
• Correcting Balance of Payments Deficit:
• Correcting deficit in balance of payments is also
mentioned as justification for imposing tariffs to restrict
imports or fixing of quotas of imports.
• The solution for fundamental disequilibrium in the balance
of payments lies in the adoption of suitable adjustment in
exchange rate, appropriate fiscal and monetary policies to
lower domestic prices so as to encourage exports.
• The deficit in balance of pay­ments can be reduced by
ensuring rapid growth in exports of a country.
• Redistribution Income:
• Case for protection has also been built up on the ground that it
can be used for making desirable redistribution of income from
one section of society to another.
• Protection makes some people better off, while others worse off.
• By providing protection to domestic producers their profits can
be raised at the expense of consumers who suffer a loss in
consumer surplus as protection denies them consumption of
low-priced imported goods.
• That is, protection redistributes income in favour of domestic
producers
 Balance of Payment
• Introduction
• Balance of payments (BOP) accounts are an accounting record of all
monetary transactions between a country and the rest of the world.
• These transactions include payments for the country's exports and
imports of goods & services, financial capital, and financial transfers.
• A country has to deal with other countries in respect of 3 items
• Visible items which include all types of physical goods exported and
imported.
• Invisible items which include all those services whose export and
import are not visible. e.g. transport services, medical services etc.
• Capital transfers which are concerned with capital receipts and capital
payment.
 Balance of Payment
• Definition-
• According to Kindle Berger, "The balance of
payments of a country is a systematic record
of all economic transactions between the
residents of the reporting country and residents
of foreign countries during a given period of
time"
 Conts…

• Features
• It is a systematic record of all economic transactions between
one country and the rest of the world.
• It includes all transactions, visible as well as invisible.
• It relates to a period of time. Generally, it is an annual
statement.
• It adopts a double-entry book-keeping system. It has two
sides: credit side and debit side.
• Receipts are recorded on the credit side and payments on the
debit side.
 Conts…
• Components of BOP
• 1. Current Account Balance
• BOP on current account is a statement of actual receipts
and payments in short period.
• It includes the value of export and imports of both visible
and invisible goods.
• There can be either surplus or deficit in current account.
• The current account includes:- export & import of
services, interests, profits, dividends and unilateral
receipts/payments from/to abroad.
 Conts…
2.Capital Account Balance
• It is difference between the receipts and payments on
account of capital account. It refers to all financial
transactions.
• The capital account involves inflows and outflows relating to
investments, short term borrowings/lending, and medium
term to long term borrowing/lending.
• There can be surplus or deficit in capital account.
• It includes: - private foreign loan flow, movement in banking
capital, official capital transactions, reserves, gold movement
etc.
 Conts…
• Overall BOP -: Total of a country’s current and capital account
is reflected in overall Balance of payments.
• It includes errors and omissions and official reserve
transactions.
• The errors may be due to statistical discrepancies & omission
may be due to certain transactions may not be recorded.
• For e.g.: A remittance by an Indian working abroad to India
may not yet recorded, or a payment of dividend abroad by an
MNC operating in India may not yet recorded or so on.
• The errors and omissions amount equals to the amount
necessary to balance both the sides
 Conts…
• Causes of Disequilibrium
• 1. Natural causes – e.g. floods, earthquake etc.
• 2. Economic causes – e.g. Cyclical Fluctuations,
Inflation, Demonstration Effect etc.
• 3. Political causes – e.g. international relation,
political instability, etc.
• 4. Social factors – e.g. change in taste and
preferences etc. 
 Conts..
• How to correct the Balance of Payment?
• 1. Monetary measures – Deflation
• Exchange Depreciation - Devaluation
• 2. Non-Monetary Measures – Export
Promotion , Quotas , Tariffs
 Conts…
• How to correct the Balance of Payment?
• 1. Monetary measures –
• Deflation - Deflation means falling prices. Deflation has been used as a
measure to correct deficit disequilibrium. A country faces deficit when its
imports exceeds exports.
• Deflation is brought through monetary measures like bank rate policy, open
market operations, etc. or through fiscal measures like higher taxation,
reduction in public expenditure, etc.
• Deflation would make our items cheaper in foreign market resulting a rise in
our exports. At the same time the demands for imports fall due to higher
taxation and reduced income.
• This would build a favourable atmosphere in the balance of payment position.
However Deflation can be successful when the exchange rate remains fixed.
 Conts…
• Exchange Depreciation - Exchange depreciation means decline in
the rate of exchange of domestic currency in terms of foreign
currency.
• This device implies that a country has adopted a flexible exchange
rate policy.
• Suppose the rate of exchange between Indian rupee and US dolar
is $1 = Rs. 40. If India experiences an adverse balance of payments
with regard to U.S.A, the Indian demand for US dollar will rise.
• The price of dollar in terms of rupee will rise. Hence, dollar will
appreciate in external value and rupee will depreciate in external
value. The new rate of exchange may be say $1 = Rs. 50. This
means 25% exchange depreciation of the
 Conts…
• Devaluation –
• Devaluation refers to deliberate attempt made by monetary
authorities to bring down the value of home currency against
foreign currency.
• When devaluation is effected, the value of home currency goes
down against foreign currency, Let us suppose the exchange rate
remains $1 = Rs. 10 before devaluation.
• Let us suppose, devaluation takes place which reduces the value of
home currency and now the exchange rate becomes $1 = Rs. 20.
• After such a change our goods becomes cheap in foreign market.
This is because, after devaluation, dollar is exchanged for more
Indian currencies
 Conts…
• 2.Non-Monetary Measures –
• Export Promotion –
• The government can adopt export promotion measures to
correct disequilibrium in the balance of payments. This
includes substitutes, tax concessions to exporters,
marketing facilities, credit and incentives to exporters, etc.
• The government may also help to promote export through
exhibition, trade fairs; conducting marketing research &
by providing the required administrative and diplomatic
help to tap the potential markets
 Conts…
•  Quotas –
• Under the quota system, the government may fix and
permit the maximum quantity or value of a commodity
to be imported during a given period. By restricting
imports through the quota system, the deficit is reduced
and the balance of payments position is improved.
• Tariffs – Tariffs are duties (taxes) imposed on imports.
When tariffs are imposed, the prices of imports would
increase to the extent of tariff. The increased prices will
reduced the demand for
 Conts…
• Balance of Trade
• The difference between a country's imports and its exports.
Balance of trade is the largest component of a country's balance
of payments.
• 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.
• When exports are greater than imports than the BOT is
favourable and if imports are greater than exports then it is
unfavourable
Conts…