Module 4

Foreign Trade

-Composition of Indian Foreign Trade

-Direction of Indian Foreign Trade

-Balance of Payments

-Foreign Direct Investment

Foreign Trade/International Trade

Introduction

“Make in India is also about Make for India. It’s Make in India, both for India
and for exports. India is the only major economy in the world which is
growing at over 7% annually. The Chinese are no longer that economical in
manufacturing because wage costs have gone up significantly there. In
general, their cost of production has risen and, therefore, some manufacturers
are said to be keen on getting out of China. So the fact that we can draw them
to India is definitely an issue which all of us are seized of.” - Nirmala
Sitharaman, India Commerce and Industry Minister

Today the entire world is a market for business. One of the distinctive
features of the modern world is the rapid expansion of economic, scientific,
technological and cultural ties among nations. The emergence of these
independent nations from the yoke of the imperialist powers has brought
funds-. mental changes in their economic relations. New they are free to trade
with any country in the world in order to accelerate the development of their
economies. The international trade accounts for a good part of a country’s
gross domestic product. Over the years, India's foreign trade has come to
occupy a pivotal position in the economic scenario and prosperity of the
country. Every country enters the field of foreign trade in order to fulfil its
need of foreign exchange. No country in the present day world desirous of
progress can remain isolated. However, there are other reasons also which
compel nation to carry on foreign trade. International trade allows countries
to expand their markets for both goods and services that otherwise may not
have been available domestically. As a result of international trade, the
market contains greater competition, and therefore more competitive prices,
which brings a cheaper product home to the consumer. International or
Foreign trade is recognized as the most significant determinants of economic
development of a country, all over the world. The importance of international
trade was recognized early on by political economists like Adam Smith and
David Ricardo.

The term ‘trade’ is commonly understood to means exchange of goods, wares

or merchandise among people.

Meaning of foreign trade

The buying and selling of goods and services across national borders is known
as international trade. Foreign trade is exchange of capital, goods, and services
across international borders or territories.

Definition of Foreign Trade

According to Wasserman and Haltman, “International trade consists of
transaction between residents of different countries”.

Emergence of the International trade:

Following factors are responsible for the emergence of the international trade.

(1) Differences in natural resources and geographical conditions

(2) increase in the demand for the commodities throughout the world.

(3) Non-availability of a particular of resource in an economy

(4)limitation of resources

(5) difference in the perfectness

(6) no country can claim self-sufficiency in all the goods

(7) a large number of new requirements, for example, technical know-how,

machines, etc

(8) difference in the cost of production

(9) comparative immobility of labour and capital

(10)differences in specializations.

NEED OF INTERNATIONAL TRADE

Foreign trade has an important place in the economy of a country. According

to Robertson, “foreign trade is an engine of economic growth”.Because of
foreign trade a country can make efficient use of its natural resources. It can
export its surplus production and much needed foreign capital, machines and
essential raw materials can be imported to facilitate

TERMS OF INTERNATIONAL TRADE:

International trade is a significant part of most International economies. The

theoretical tools of economics have been applied to answer such question as
why nations trade rather than pursue self-sufficiency, why a nation will
import specific types of goods and services and export others, and what are
the domestic effects of international trade. The following are the principal
terms of international trade.

i) A type of goods that exhibits significant differences in real or perceived

characteristics or features.

ii) Scale economies exist when per-unit production costs decline steadily as the
rate of production.
iii) Competition among producers of a type of product that is based on the
characteristics and features of the product.

iv) The cost of production of a goods that must be given up in order to increase
the production of other goods.

v) The cost of production of goods compared to the cost of production other of

goods.

VI) The price paid to purchase of a goods compared to the market prices of
other goods.

Vii) A type of goods with little or no variation in characteristics or features also

referred to as a homogeneous product.

viii) The quantity of exports exchanged for a given amount of imports

ROLE AND IMPORTANCE OF INTERNATIONAL TRADE

Haberler mentions four main ways in which trade helps the developing
countries in accelerating their rate of economic development.

First, it enables the developing countries to obtain capital goods, machinery,

essential raw materials etc,, required for executing the development
programmes.

Secondly, Trade enables the developing countries to import technical know-

how, skills, managerial talents and entrepreneurship; these are even more
important than the material means,’

Thirdly, trade serves as the vehicle for the international movement of the
capital. No doubt, capital movement can take place even in the absence of
trade, but it cannot be denied that trade facilitates international movements of
the capital, The larger the volume mf trade, the easier is likely to be the
transfer of the capital and the retransfer of the capital and the interest
thereupon.

Fourthly, free trade promotes healthy competition and checks inefficient

monopolies.

Haberler concludes that international trade has made a tremendous

contribution to the development of Less Developed Countries (LDCs) in the
nineteenth and twentieth century’s and can be expected to make an equally
big contribution in the future, if it is allowed to proceed freely. It does not
necessarily follow that a cent per cent free trade policy is always most
conducive to most rapid development. Marginal interferences with the free
flow of trade, properly selected may speed up development. According to him
substantially free trade with ·marginal insubstantial corrections and
deviations, is the best policy from the point of view of economic development.

International trade plays an important role in countries growth and

development. The area like 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. Without international trade,
nations would be limited to the goods and services produced within their own
borders. There are some important roles given below:

 Boost Economic Development: Trade can help boost development and

reduce poverty by generating growth through increased commercial
opportunities and investment, as well as broadening the productive
base through private sector development.
 Enhances Competitiveness: Trade enhances competitiveness by
helping developing countries reduce the cost of inputs, acquire finance
through investments, increase the value added of their products and
move up the global value chain.
 Make use of abundant raw materials: Some countries are naturally
abundant in raw materials – oil (Qatar), metals, fish (Iceland), Congo
(diamonds) Butter (New Zealand). Without trade, these countries would
not benefit from the natural endowments of raw materials.A theoretical
model for this was developed by Eli Heckscher and Bertil Ohlin. Known
as the Heckscher–Ohlin model (H–O model) it states countries will
specialise in producing and exports goods which use abundant local
factor endowments. Countries will import those goods, where resources
are scarce.
 Comparative advantage: The theory of comparative advantage states
that countries should specialise in those goods where they have a
relatively lower opportunity cost. Even if one country can produce two
goods at a lower absolute cost – doesn’t mean they should produce
everything. India, with lower labour costs, may have a comparative
advantage in labour-intensive production (e.g. call centres, clothing
manufacture). Therefore, it would be efficient for India to export these
services and goods. While an economy like the UK may have a
comparative advantage in education and video game production. Trade
allows countries to specialise. More details on how comparative
advantage can increase economic welfare. The theory of comparative
advantage has limitations, but it explains at least some aspects of
international trade.
 Trade as an enabler of inclusive and sustainable development:
International trade is a powerful enabler of economic development.
 Empirical literature supports this with strong evidence that increased
participation in international trade can spur economic growth, which
itself is a necessary condition for broader development outcomes to be
realized. By connecting global markets to developing-country producers
and consumers, trade – both through exports and imports – provides a
critical channel for the flow of finance, technology and services needed
to further improve productive capacity in agriculture, industry and
services. These are needed in turn for structural transformation of
economies. A case in point is the recent development path demonstrated
by developing countries in East Asia and South-East Asia. A fundamental
factor behind their rapid economic growth has been their ability to
strengthen competitive productive and export capacities, first in
traditional agricultural and textiles/clothing sectors and then in labour-
intensive manufactures which shifted at times swiftly into
hightechnology manufactures such as electronics. Their export-led
growth was a result of strategic trade opening, but also of policies that
were complementary to the enabling power of trade with its impacts on
economic and social development. Economic growth is a necessary
condition for poverty reduction, particularly in lowincome countries.
When a country’s gross domestic product (GDP) per capita is sufficiently
large, poverty reduction may be largely a question of redistribution of
income. In developing countries with low income levels, redistributive
transfers alone are not sufficient for, or may even become adversarial
to, poverty reduction. Poverty reduction in such cases requires
economic growth in terms of enlarging the share of gains received by
each member of the population, i.e. in terms of a higher output per
worker, which is usually approximated by GDP per capita.
 The impact of trade on national income can be called the “ income
channel” . Trade can raise the economy’s income-generating
opportunities via, inter alia, a “vent for surplus”.Through the income
channel, participation in international trade affects a wide range of
development outcomes by influencing relative prices in the domestic
economy. Income changes may affect the incentives facing particular
groups when deciding whether or not to enter the formal labour force,
which could generate significant impact on social inclusion, for
example, as regards gender equality. In addition to income channels,
there are non-income channels linking trade and development
outcomes. Trade can reduce the cost of goods and services that are not
domestically available at reasonable prices, and increase quality and
variety of such goods and services in the marketplace. A better and
greater variety of imported input factors (e.g. fuel and raw materials,
intermediate goods and machinery equipment) lowers production costs
and may enable production which otherwise would not be feasible in
 the country. Improved access to essential goods and services such as
medicines and vaccines, medical equipment, food, energy and
environment-related goods generates direct developmental gains for
consumers, as well as improves the cost-effectiveness of a given public
expenditure on, for example, health care.4 Also, as international trade
transmits the environmental preferences of firms and consumers in
world markets, trade can thus enhance the diffusion of environmental
goods, services, technologies and sustainable and socially equitable
methods of production across countries.

 Raises Standard of Living of the people – Imports can facilitate

standard of living of the people. This is because people can have a
choice of new and better varieties of goods and services. By consuming
new and better varieties of goods, people can improve their standard of
living.
 Generate employment opportunities – Foreign trade helps in
generating employment opportunities, by increasing the mobility of
labor and resources. It generates direct employment in import sector
and indirect employment in other sector of the economy. Such as
Industry, Service Sector (insurance, banking, transport,
communication), etc.
 Promotes World Peace – Foreign trade brings countries closer. It
facilitates transfer of technology and other assistance from developed
countries to developing countries. It brings different countries closer
due to economic relations arising out of trade agreements. Thus, foreign
trade creates a friendly atmosphere for avoiding wars and conflicts. It
promotes world peace as such countries try to maintain friendly
relations among themselves.
 Assistance during natural calamities – During natural calamities such
as earthquakes, floods, famines, etc., the affected countries face the
problem of shortage of essential goods. Foreign trade enables a country
to import food grains and medicines from other countries to help the
affected people.

DISADVANTAGES OF INTERNATIONAL TRADE

 OVER-DEPENDENCE
Countries or companies involved in the foreign trade are vulnerable to
global events. An unfavorable event may impact the demand of the
product, and could even lead to job losses. For instance, the recent US-
China trade war is adversely affecting the Chinese export industry.
 UNFAIR TO NEW COMPANIES
New companies or start-ups who don’t have much resources and
experience may find it difficult to compete against the big foreign firms.

 A THREAT TO NATIONAL SECURITY

If a country is over dependant on the imports for strategic industries, then
exporters may force it to take a decision that may not be in the national
interest.

 PRESSURE ON NATURAL RESOURCES

A country only has limited natural resources. But, if it opens its doors to the
foreign companies, it could drain those natural resources much
quicker.Even though international trade has its own advantage and
disadvantages, the advantages far outweigh the disadvantages. Nowadays,
international trade has become a necessity, but a country must maintain a
proper balance between imports and exports to ensure that the economy
stays on the growth track.