Why Nations Trade

  Boosts economic growth by providing access to new

markets and needed resources
 • More efficient production systems
 • Less reliance on economies of home nations
 The factors of production are not evenly distributed
throughout the world
• Natural resources are more plentiful in some areas
(Oil & gas deposits, water, timber)
• Human capital is more skilled in nations with higher
literacy rates
• Physical capital is deeper in some nations
 Better machinery

 Better infrastructure allows for goods to be

transported easier on new roads, bridges, etc.

 The unequal distribution of resources
encourages nations to specialize
• The availability of resources differs
greatly from country to country
 Although some countries could be
self sufficient, it is to their advantage
to specialize in certain areas
• Ex: U.K. has double the airports as Peru
despite being much smaller in size
 MEASURING TRADE BETWEEN NATIONS
 • Balance of trade
Difference between a nation’s imports and exports
 • Balance of payments
Overall flow of money into or out of a country

 Exchange Rates
Value of one nation’s currency relative to the currencies of
other nations. Rates can quickly create or wipe out
competitive advantage.
Trade Barriers and
Agreements
 Free Trade?
 Many people argue that governments
should regulate trade in order to
protect industries and jobs from
foreign competition
• This is known as protectionism
 Many nations set up trade barriers in
order to provide protectionism
• Gov’ts want to protect their companies
from foreign competition
 Free Trade VS. Trade Barriers
 Free Trade: Nations can trade freely
with each other or there are trade
barriers. Nothing hinders or gets in the
way from two nations trading with each
other.
 Sometimes countries complain about
trade. They say that too much trade
cause workers to lose jobs. Therefore,
countries sometimes try to limit trade
by creating trade barriers.
 Trade Barriers
 Trade barriers...restrictions that prevent
foreign products or services from freely
entering a country
 However, barriers exist:
• Management (limited ambition, ignorance of
opportunities, lack of skills, fear, inertia)
• Distance (transport costs, and various fees,
resulting in transfer costs/transfer pricing
• Government (tariffs, nontariff barriers,
protectionism / infant-industry arguments
 The Impact of Tariff (Tax) Barriers

Tariff Barriers tend to Increase:

1. Inflationary pressures
2. Special interests’ privileges
3. Government control and political considerations in
economic matters

Tariff Barriers tend to Weaken:

1. Balance-of-payments positions
2. Supply-and-demand patterns
3. International relations (they can start trade wars)

Tariff Barriers tend to Restrict:

1. Manufacturer’ supply sources
2. Choices available to consumers
3. Competition
 Benefits of Trade Barriers
Trade barriers provide many benefits:
• They protect homeland industries from
competition.
• They protects jobs.
• They help provide extra income for the
government.
• They increase the number of goods people
can choose from.
• They decreases the costs of these goods
through increased competition.
 Costs of Trade Barriers
• Tariffs increase the price of imported
goods.
• The tax on imported goods is
passed along to the consumer so
the price of imported goods is
higher.
• Less competition from world
markets means there is an increase in
the price of goods.
 Physical Trade Barriers
• Natural barriers can slow down trade between
nations by making it harder and more expensive
to move goods from place to place.
• Example: The Swiss Alps make it difficult for
northern Italy to trade with Switzerland. The
countries are building tunnels through the
mountains to help make trade easier.
• Example: The Sahara Desert makes it
extremely hard for countries in Northern Africa
to trade with the rest of the continent.
 Monetary Barriers
 Three types of monetary barriers include:
1. Blocked currency: Blockage is accomplished by
refusing to allow importers to exchange its national
currency for the sellers’ currency.
2. Differential exchange rates: It encourages the
importation of goods the government deems desirable
and discourages importation of goods the government
does not want by adjusting the exchange rate. The
exchange rate for importation of a desirable product is
favorable and vice-versa
3. Government approval: In countries where there is a
severe shortage of foreign exchange, an exchange
permit to import foreign goods is required from the
government
 Economic Trade Barriers
 The most common types of trade barriers
are tariffs and quotas.
• A tariff is a tax on imports (imports are goods
purchased from other countries and exports
are goods sold to other countries).
• A quota is a specific limit placed on the
number of imports that may enter a country.
 Another type of trade barrier is an
Embargo.
• A complete trade block for a political purpose
 Tariffs
• Used to encourage purchasing of domestic products
• The effect of a tariff is to raise the price of the imported
product. It makes imported goods more expensive so that
people are more likely to purchase lower-priced items
produced domestically. In order to get a product from
another country, you have to pay extra for it. It is the same
concept as sales tax that is put on items your purchase at
the store.
• EXAMPLE: The European Union removes tariffs between
member nations, and imposes tariffs on nonmembers.
 Quota
 A quota is a limit on the amount of goods that can be
imported.
 Putting a quota on a good creates a shortage, which
causes the price of the good to rise and makes the
imported goods less attractive for buyers. Consumers
are less likely to buy this good because it’s now more
expensive than the good produced in the home country.
 This encourages people to buy domestic products,
rather than foreign goods.
 EXAMPLE: Brazil could put a quota on foreign made
shoes to 10,000,000 pairs a year. If Brazilians buy
200,000,000 pairs of shoes each year, this would leave
most of the market to Brazilian producers.
 Embargo
 Embargos are government orders which completely
prohibits trade with another country.
 The embargo is the harshest type of trade barrier and is
usually enacted for political purposes to hurt a country
economically.
 . This is usually done between two countries that are
disagreeing over political issues
 EXAMPLE: The United States placed an embargo
on Cuba after the Cuban Missile Crisis. We do not
refuse with Cuba—this is still in effect today.
REDUCING BARRIERS TO INTERNATIONAL
TRADE
 Organizations Promoting International Trade
• General Agreement on Tariffs and Trade (GATT)
 Sponsored negotiations to reduce worldwide barriers to trade
• World Trade Organization
Monitors GATT agreements
• World Bank
 Lends money to less-developed and developing countries
• International Monetary Fund
 Promotes trade through financial cooperation
 GATT – created in 1947 as a part of the Bretton
Woods agreements that also established the IMF and
the World Bank. Reduce tariffs & expand world trade
 The ITO—a precursor to today’s WTO was not ratified
by the U.S. Congress, but GATT served as a basis for
trade barrier reduction until 1986, when the WTO was
created as a successor (over the 1986-1994 time period
– the “Uruguay round”)
 Key recent issues: trade in services, limits on foreign
investment, establishing intellectual property rights,
and agricultural policies (EU)
International Trade Agreements
 Recent trends are encouraging free trade
• Raises living standards
• Encourages world peace
• Many free trade agreements have been established
• International Free Trade Agreements
 Cooperation of two or more countries to reduce

trade barriers (will reduce conflict)

 Free Trade Zones
 Areas established by countries to reduce or eliminate
trade barriers
 Two such Organizations
• European Union (EU) (1957)
 Set up to market & coordinate trade policies

 “Euro” is used in all 28 countries

• North American Free Trade Agreement (NAFTA)

 Eliminates trade barriers in Canada, Mexico &

USA
 European Union
 Regional trade organization made up of 28 member
nations
 Essentially developed a single market (EEC...European
Economic Community) in Europe (trades w/USA A
LOT!)
• EU has a parliament, a flag, a council, an anthem, and
currency (the euro)
 Goal is to create a single economy that rivals the US
• Currently the largest trading partner of the US
 Canada, Mexico, and Japan are next
 NAFTA
 Created to eliminate all tariffs and barriers in the
region (Canada, Mexico, US) – ratified in 1994
• Largest free trade zone in world
 Although there has been much controversy,
NAFTA has increased trade between the three
nations
• Today, NAFTA is working to expand to other
countries in Western Hemisphere
 General Agreement on Tariffs and
Trade (GATT)
1. GATT created as an agency to serve as watchdog over world
trade and provide a process to reduce tariffs
2. GATT also provided a mechanism to resolve trade disputes
bilaterally
GATT covers three basic areas:
1. trade shall be conducted on a nondiscriminatory basis;
2. protection shall be afforded domestic industries through
customs tariffs, not through such commercial measures
as import quotas; and
3. consultation shall be the primary method used to solve
global trade problems.

3. GATT now replaced by the World Trade Organization

 World Trade Organization
(WTO)

Unlike GATT, is an institution, not an agreement

1. It sets many rules governing trade between its 132

members
2. WTO provides a panel of experts to hear and rule on
trade disputes between members, and, unlike GATT,
issues binding decisions
 The International Monetary Fund (IMF)
1. IMF was created to assist nations in becoming and remaining
economically viable
2. It assists countries that seek capital for economic development
and restructuring
3. IMF loans come with stipulations that borrowing countries slash
spending and impose controls to curb inflation
4. It helps maintain stability in the world financial markets

Objectives of the IMF include:

1. stabilization of foreign exchange rates
2. Facilitate international trade
3. lend money to members in financial trouble
 Exchange Rates
 Value of a foreign nation’s currency in terms
of the home nation’s currency (allows us to
exchange $$)
 Exchange rates fluctuate on a daily basis with

the strength and weakness of a nation’s

currency
 http://www.xe.com/ucc/
 Strength of Currency
 Appreciation...increase in the value of currency: “a strong
dollar”
• When a currency appreciates, exports decline (US goods
are more expensive)
 Products are more expensive in other nations

 Depreciation...decrease in the value of currency: “weak

dollar”
• When a currency depreciates, exports rise and imports
decrease
 Other nations’ products are more expensive here in the

USA
 Exchange Rate Systems
 Fixed Exchange Rate System  governments try to keep
their currency constant with one another
• Requires countries to keep similar economic systems-
should be plus or minus 2% of center
• Ex: The euro for the EU
 Flexible Exchange Rate System  exchange rate is
determined by supply and demand and it fluctuates
• Used by most major currencies today
• Accounts for day to day changes in value
 Balance of Trade
 Trade surplus...export more than you import
 Trade deficit...import more than you export
 Balance of trade...relationship between exports and
imports
• Balancing trade will protect currency
• If imports are high – currency will fall
 Balancing trade requires international cooperation
Dumping - is the export of a commodity at below cost or at
least the sale of a commodity at a lower price abroad than
domestically.
 Dumping is the selling of a product abroad for less than
• The average cost of production in the exporting nation
• The market price in the exporting nation
• The price to third countries

 Result of
• Excess production
• Cyclical or seasonal factors
• Attempt to force domestic producers out of business
Dumping is classified as either:
1) Persistent Dumping (or international price discrimination): is the
continuous tendency of a domestic monopolist to maximize total
profits by selling the commodity at a higher price in the domestic
market than internationally (where it must meet the competition of
foreign producers).

2) Predatory Dumping: is the temporary sale of a commodity at

below cost or at a lower price abroad in order to drive foreign
producers out of business, after which prices are raised to take
advantage of the newly acquired monopoly power abroad.

3) Sporadic Dumping: is the occasional sale of a commodity at

below cost or at below price abroad than domestically in order to
unload an unforeseen and temporary surplus of the commodity
without having to reduce domestic prices.