International trade is exchange of
capital,
goods, and
services across
international borders or territories.
In most countries, it represents a significant share of
gross domestic product (GDP). While
international
trade has been present
throughout much of history (see
Silk Road,
Amber Road), its economic, social, and
political importance has been on the rise in recent centuries.
Industrialization, advanced
transportation,
globalization,
multinational corporations, and
outsourcing are all having a major
impact on the international trade system. Increasing international
trade is crucial to the continuance of
globalization. International trade is a major
source of economic revenue for any nation that is considered a
world power. Without international trade, nations would be limited
to the goods and services produced within their own borders.
International trade is in principle not different from
domestic trade as the motivation and the
behavior of parties involved in a trade does not change
fundamentally depending on whether trade is across a border or not.
The main difference is that international trade is typically more
costly than domestic trade. The reason is that a border typically
imposes additional costs such as tariffs, time costs due to border
delays and costs associated with country differences such as
language, the legal system or a different culture.
Another difference between domestic and international trade is that
factors of production such as
capital and labor are typically more mobile within a country than
across countries. Thus international trade is mostly restricted to
trade in goods and services, and only to a lesser extent to trade
in capital, labor or other factors of production. Then trade in
goods and services can serve as a substitute for trade in factors
of production. Instead of importing the factor of production a
country can import goods that make intensive use of the factor of
production and are thus embodying the respective factor. An example
is the import of labor-intensive goods by the United States from
China. Instead of importing Chinese labor the United States is
importing goods from China that were produced with Chinese
labor.International trade is also a branch of
economics, which, together with
international finance, forms the
larger branch of
international
economics.
Models
Several different models have been proposed to predict patterns of
trade and to analyze the effects of trade policies such as tariffs.
Ricardian model
The Ricardian model focuses on
comparative advantage and is perhaps
the most important concept in international trade theory. In a
Ricardian model, countries specialize in producing what they
produce best. Unlike other models, the Ricardian framework predicts
that countries will fully specialize instead of producing a broad
array of goods. Also, the Ricardian model does not directly
consider
factor endowments, such as
the relative amounts of labor and capital within a country. The
main merit of Ricardin model is that it assumes technology
differences between countries. Technology gap is easily included in
the Ricardian and Ricardo-Sraffa model (See the
next
subsection).
The Ricardian model makes the following assumptions:
- Labor is the only primary input to production (labor is
considered to be the ultimate source of value).
- Constant Marginal Product of Labor (MPL) (Labor productivity is
constant, constant returns to scale, and simple technology.)
- Limited amount of labor in the economy
- Labor is perfectly mobile among sectors but not
internationally.
- Perfect competition (price-takers).
The Ricardian model measures in the short-run, therefore technology
differs internationally. This supports the fact that countries
follow their comparative advantage and allows for
specialization.
Modern development of the Ricardian model
The Ricardian trade model was studied by Graham, Jones, McKenzie
and others. All the theories excluded intermediate goods, or traded
input goods such as materials and capital goods. McKenzie(1954),
Jones(1961) and Samuelson(2001)emphasized that considerable gains
from trade would be lost once intermediate goods were excluded from
trade. In a famous comment McKenzie (1954, p.179) pointed that "A
moment's consideration will convince one that Lancashire would be
unlikely to produce cotton cloth if the cotton had to be grown in
England."
Recently, the theory was extended to the case that includes traded
intermediates. Thus the "labor only" assumption (#1 above) was
removed from the theory. Thus the new Ricardian theory, or the
Ricardo-Sraffa model, as it is sometimes named, theoretically
includes capital goods such as machines and materials, which are
traded across countries. In the time of global trade, this
assumption is much more realistic than the Heckscher-Ohlin model,
which assumes that capital is fixed inside the country and does not
move internationally.
Heckscher-Ohlin model
The Heckscher-Ohlin model was produced as an alternative to the
Ricardian model of basic comparative advantage. Despite its greater
complexity it did not prove much more accurate in its predictions.
However from a theoretical point of view it did provide an elegant
solution by incorporating the neoclassical price mechanism into
international trade theory.
The theory argues that the pattern of international trade is
determined by differences in
factor endowments. It predicts that countries
will
export those
goods that make intensive use of locally
abundant factors and will import goods that make intensive use of
factors that are locally scarce. Empirical problems with the H-O
model, known as the
Leontief
paradox, were exposed in empirical tests by
Wassily Leontief who found that the United
States tended to export labor intensive goods despite having a
capital abundance.
The H-O model makes the following core assumptions:
- Labor and capital flow freely between sectors
- The production of shoes is labor intensive and computers is
capital intensive
- The amount of labor and capital in two countries differ
(difference in endowments)
- free trade
- technology is the same across countries (long-term)
- Tastes are the same.
The problem with the H-O theory is that it excludes the trade of
capital goods (including materials and fuels).In the H-O theory,
labor and capital are fixed entities endowed to each country. In a
modern economy, capital goods are traded internationally. Gains
from trade of intermediate goods are considerable, as it was
emphasized by Samuelson (2001).In the early 1900s an international
trade theory called factor proportions theory emerged by two
Swedish economists, Eli Heckscher and Bertil Ohlin. This theory is
also called the Heckscher-Ohlin theory. The Heckscher-Ohlin theory
stresses that countries should produce and export goods that
require resources (factors) that are abundant and import goods that
require resources in short supply. This theory differs from the
theories of comparative advantage and absolute advantage since
these theory focuses on the productivity of the production process
for a particular good. On the contrary, the Heckscher-Ohlin theory
states that a country should specialise production and export using
the factors that are most abundant, and thus the cheapest. Not
produce, as earlier theories stated, the goods it produces most
efficiently.
Reality and Applicability of the Heckscher-Ohlin Model
The Heckscher-Ohlin theory is preferred to the Ricardo theory by
many economists, because it makes fewer simplifying assumptions. In
1953, Wassily Leontief published a study, where he tested the
validity of the Heckscher-Ohlin theory. The study showed that the
U.S was more abundant in capital compared to other countries,
therefore the U.S would export capital- intensive goods and import
labour-intensive goods. Leontief found out that the U.S's export
was less capital intensive than import.
After the appearance of Leontief's paradox, many researchers tried
to save the Heckscher-Ohlin theory, either by new methods of
measurement, or either by new interpretations. Leamer emphasized
that Leontief did not interpret HO theory properly and claimed that
with a right interpretation paradox did not occur. Brecher and
Choudri found that, if Leamer was right, the American workers
consumption per head should be lower than the workers world average
consumption.
Many other trials followed but most of them failed. Many of famous
textbook writers, including Krugman and Obstfeld and Bowen,
Hollander and Viane, are negative about the validity of H-O model..
After examining the long history of empirical research, Bowen,
Hollander and Viane concluded: "Recent tests of the factor
abundance theory [H-O theory and its developed form into
many-commodity and many-factor case] that directly examine the
H-O-V equations also indicate the rejection of the theory."
Heckscher-Ohlin theory is not well adapted to the analyze
South-North trade problems. The assumptions of HO are less
realistic with respect to N-S than N-N (or S-S) trade. Income
differences between North and South is the one that third world
cares most. The factor price equalization [a consequence of HO
theory] has not shown much sign of realization. HO model assumes
identical production functions between countries. This is highly
unrealistic. Technological gap between developed and developing
countries is the main concern of the poor countries.
Specific factors model
In this model, labor mobility between industries is possible while
capital is immobile between industries in the short-run. Thus, this
model can be interpreted as a 'short run' version of the
Heckscher-Ohlin model. The specific factors name refers to the
given that in the short-run, specific factors of production such as
physical capital are not easily transferable between industries.
The theory suggests that if there is an increase in the price of a
good, the owners of the factor of production specific to that good
will profit in real terms. Additionally, owners of opposing
specific factors of production (i.e. labor and capital) are likely
to have opposing agendas when lobbying for controls over
immigration of labor. Conversely, both owners of capital and labor
profit in real terms from an increase in the capital endowment.
This model is ideal for particular industries. This model is ideal
for understanding income distribution but awkward for discussing
the pattern of trade.
New Trade Theory
New Trade theory tries to explain several facts about trade, which
the two main models above have difficulty with. These include the
fact that most trade is between countries with similar factor
endowment and productivity levels, and the large amount of
multinational production(i.e.foreign direct investment) which
exists. In one example of this framework, the economy exhibits
monopolistic competition
and increasing returns to scale.
Gravity model
The Gravity model of trade presents a more empirical analysis of
trading patterns rather than the more theoretical models discussed
above. The gravity model, in its basic form, predicts trade based
on the distance between countries and the interaction of the
countries' economic sizes. The model mimics the Newtonian
law of gravity which also considers distance
and physical size between two objects. The model has been proven to
be empirically strong through
econometric analysis. Other factors such as
income level, diplomatic relationships between countries, and trade
policies are also included in expanded versions of the model.
Regulation of international trade
Traditionally trade was regulated through
bilateral treaties
between two nations. For centuries under the belief in
mercantilism most nations had high
tariffs and many restrictions on international trade.
In the
19th century, especially in the United Kingdom
, a belief in free trade
became paramount. This belief became the dominant thinking
among western nations since then. In the years since the
Second World War, controversial
multilateral treaties like the
General Agreement on
Tariffs and Trade (GATT) and
World Trade Organization have
attempted to create a globally regulated trade structure. These
trade agreements have often resulted in protest and discontent with
claims of unfair trade that is not mutually beneficial.
Free trade
is usually most strongly supported by the most economically
powerful nations, though they often engage in selective protectionism for those industries which are
strategically important such as the protective tariffs applied to
agriculture by the United
States
and Europe.
The
Netherlands
and the United Kingdom were both strong advocates
of free trade when they were economically dominant, today the
United States, the United Kingdom, Australia and Japan
are its
greatest proponents. However, many other countries (such as
India, China and Russia) are increasingly becoming advocates of
free trade as they become more economically powerful themselves. As
tariff levels fall there is also an increasing willingness to
negotiate non tariff measures, including foreign direct investment,
procurement and
trade
facilitation. The latter looks at the
transaction cost associated with meeting
trade and
customs procedures.
Traditionally agricultural interests are usually in favour of free
trade while manufacturing sectors often support protectionism. This
has changed somewhat in recent years, however. In fact,
agricultural lobbies, particularly in the United States, Europe and
Japan, are chiefly responsible for particular rules in the major
international trade treaties which allow for more protectionist
measures in agriculture than for most other goods and
services.
During
recessions there is often strong
domestic pressure to increase tariffs to protect domestic
industries. This occurred around the world during the
Great Depression. Many economists have
attempted to portray tariffs as the underlining reason behind the
collapse in world trade that many believe seriously deepened the
depression.
The regulation of international trade is done through the World
Trade Organization at the global level, and through several other
regional arrangements such as
MERCOSUR in
South America, the
North American Free Trade
Agreement (NAFTA) between the United States, Canada and Mexico,
and the
European Union between 27
independent states. The 2005 Buenos Aires talks on the planned
establishment of the
Free Trade Area of the
Americas (FTAA) failed largely because of opposition from the
populations of Latin American nations. Similar agreements such as
the
Multilateral
Agreement on Investment (MAI) have also failed in recent
years.
Risk in international trade
Companies doing business across international borders face many of
the same risks as would normally be evident in strictly domestic
transactions. For example,
- Buyer insolvency (purchaser cannot pay);
- Non-acceptance (buyer rejects goods as different from the
agreed upon specifications);
- Credit risk (allowing the buyer to take possession of goods
prior to payment);
- Regulatory risk (e.g., a change in rules that prevents the
transaction);
- Intervention (governmental action to prevent a transaction
being completed);
- Political risk (change in leadership interfering with
transactions or prices); and
- War and Acts of God.
In addition, international trade also faces the risk of unfavorable
exchange rate movements (and, the potential benefit of favorable
movements). .
(The paper analyzes the demand and supply of countertraded goods,
and defines and uses the Likelihood of Profitable Countertrade and
the Market Synergy concepts, directing the trader to those
industries that show the greatest benefit potential).
Gallery
Image:Dual
currency cash machines in Jersey.jpg|Dual-currency cash machines in Jersey
: as
international trade increases, the need to handle multiple
currencies is becoming more powerful.Image:1672 Gérard de
Lairesse - Allegory of the Freedom of Trade.jpg|A 1672 painting by
Gérard de Lairesse:
allegory of the freedom of
trade (see also:
free
market). International trade is commonly associated with
freedom of trade.
Image:Mall culture jakarta30.jpg|Globalisation: Peugeot
in Jakarta
, Indonesia
. International trade coincides with the
expansion of
multinational
corporations.Image:Dromader caravan.jpg|A
camel caravan, still used today for
international trade, especially in
Sahara.Image:Caravane hoggar1.jpg|A modern camel
caravan carrying
goods across villages and
international borders.
Image:Triangle trade.png|Triangle trade: Slaves
being sold from Africa to North America, sugar from
South America to New England
, and Rum and other goods from North America back to
Africa.Image:Jakarta WTO protest1.jpg|Some people do
not see international trade favourably: here a person protests
against the WTO in Jakarta.
See also
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