Module 1

The theory of international trade and commercial policy is one of the oldest branches of
economic thought. From the ancient Greeks to the present, government officials,
intellectuals, and economists have pondered the determinants of trade between
countries, have asked whether trade bring benefits or harms the nation, and, more
importantly, have tried to determine what trade policy is best for any particular country.
Since the time of the ancient Greek philosophers, there has been a dual view of trade: a
recognition of the benefits of international exchange combined with a concern that
certain domestic industries (or laborers, or culture) would be harmed by foreign
competition. Depending upon the weights put on the overall gains from trade or on the
losses of those harmed by imports, different analysts have arrived at different
conclusions about the desirability of having free trade. But economists have likened free
trade to technological progress: although some narrow interests may be harmed, the
overall benefits to society are substantial. Still, as evidenced by the intense debates
over trade today, the tensions inherent in this dual view of trade have never been
overcome.

The Contemporary World has become increasingly economically interconnected since

Adams Smith loud the division of labor. Adam Smith was the Father of Modern
Economics. He was also the 8th Century Scottish economist, philosopher and author
and he wrote the book “The Wealth of Nations” in the 1776.
David Ricardo an English economist highlighted the comparative advantage of
trading with other nations. International trade has grown in complexity as has the
number of trade and agreements. He gave the systematized classical form to the rising
sign of economics in 19th Century. His laissez-faire doctrines were exemplified in his
Iron Law of Wages. Which stated that all attempts to improve the real income of workers
were fruitless and that wages perform would remain near the subsistence level.
The fundamental reason for international trade is some nations are better at producing
certain things than the others. The logic of formal trade agreement is the outline on what
is agreed upon in the punishment for deviation from the rules set in the agreement.

Mercantilism

The first reasonably systematic body of thought devoted to international trade is called
“mercantilism” and emerged in seventeenth and eighteenth century Europe. An
outpouring of pamphlets on economic issues, particularly in England and especially
related to trade, began during this time. Although many different viewpoints are
expressed in this literature, several core beliefs are pervasive and tend to get restated
time and time again. For much of this period, mercantilist writers argued that a key
objective of trade should be to promote a favorable balance of trade. A “favorable”
balance of trade is one in which the value of domestic goods exported exceeds the
value of foreign goods imported. Trade with a given country or region was judged
profitable by the extent to which the value of exports exceeded the value of imports,
thereby resulting in a balance of trade surplus and adding precious metals and
treasure to the country’s stock. Scholars later disputed the degree to which mercantilists
confused the accumulation of precious metals with increases in national wealth. But
without a doubt, mercantilists tended to view exports favorably and imports unfavorably.

Even if the balance of trade was not a specific source of concern, the commodity
composition of trade was. Exports of manufactured goods were considered beneficial,
and exports of raw materials (for use by foreign manufacturers) were considered
harmful; imports of raw materials were viewed as advantageous and imports of
manufactured goods were viewed as damaging. This ranking of activities was based not
only on employment grounds, where processing and adding value to raw materials was
thought to generate better employment opportunities than just extraction or primary
production of basic goods, but also for building up industries that would strengthen the
economy and the national defense.

Mercantilists advocated that government policy be directed to arranging the flow of

commerce to conform to these beliefs. They sought a highly interventionist agenda,
using taxes on trade to manipulate the balance of trade or commodity composition of
trade in favor of the home country. But even if the logic of mercantilism was correct, this
strategy could never work if all nations tried to follow it simultaneously. Not every
country can have a balance of trade surplus, and not every country can export
manufactured goods and import raw materials.

One of the best example of the Mercantilist trade is policy during British Navigation Act
of 1651. Foreign ships were prohibited from taking part in coastal trade in England, and
all imports from continental Europe were required to be carried by either British ships or
ships that were registered in the country where the goods were produced.

1823- Reciprocity of Duties Act- helps the British carry commerce and enable
reciprocal abolition of import tariffs.

1846- Corn laws- which had levied restrictions on grain imports repelled.

1850- Cobden – Chevalier Treaty most protectionist policies on British imports has
been dropped.

The Deterioration of Multilateral Trade

1873-1877 downturn

1878-1887 Italy enacted a mild set of tarrifs,

1879 iron and rye tariff

1892 Meline tariff

1890 McKinley Tarrif Act

Multilateral Regionalism

1944 Bretton Woods Agreement

International Monetary Fund (IMF)

World Bank

International Trade Organization (ITO)

 Gatt 1947

General Agrrement On Tariffs and Trade (GATT)

GATT from 1947-1955

Agreement to regulate trade among more than 120 countries.

Purpose: substantial reduction of tarrifs and other trade barriers and elimination of
preferences.

World Trade Organization 1995- took over as the global regulator of World trade
liberalization from the GATT in 1995 ,unlike the GATT focus exclusively on
products .WTO expanded to include regulation on services intellectual property and
investment.
Module 2

International Trade and Agreements

*Trade agreements regulate international trade between two or more nations.

An agreement may cover all imports and exports, certain categories of goods or a

single category.

*An export in international trade is a good or service produced in one country

that is sold into another country. The sellers of such goods and services is an

exporter, the foreign buyer is an importer.

*An import in the receiving country is an export from the sending country. An
import is a good or service bought in one country that was produced in another.
*Factors of Production
1. Land- natural resources----represents the gift of nature to our productive
processes.
2. Labor- consists of human time spent in production.
3. Capital- resources from durable goods of an economy, produced in order to
produce yet other goods.
4. Entrepreneur-the brain behind the business
*An import in the receiving country is an export from the sending country. An

import is a good or service bought in one country that was produced in another.

*Factors of Production

1. Land- natural resources----represents the gift of nature to our productive

processes.

2. Labor- consists of human time spent in production.

3. Capital- resources from durable goods of an economy, produced in order to

produce yet other goods.

4. Entrepreneur-the brain behind the business

*Production Possibility Frontier (PPF)- represents the maximum amounts of a

pair of goods or services that can both be produced with an economy’s given

resources assuming that all resources are fully employed.

*Opportunity cost of a decision arises because choosing one thing in a world of

scarcity means giving up something else.

- the loss of potential gain from other alternatives when one alternative is chosen.

- the idea of an opportunity cost was first begun by John Stuart Mill

*Specialization occurs when people concentrate their efforts on a particular set of

tasks.
*Comparative advantage arises for a nation when its opportunity cost of
producing a good is lower than that of another nation
*Specialization occurs when people concentrate their efforts on a particular set of

tasks.

*Comparative advantage arises for a nation when its opportunity cost of

producing a good is lower than that of another nation should export or import.

*The British economist David Ricardo developed the concept of comparative

advantage to answer the question, “Which nation should specialize in producing

which good?” He found that nation having a lower opportunity cost than other

nations in producing a product should specialize in that product, and called that

the principle of comparative advantage.

*The theory of comparative advantage helps to explain why protectionism has

been traditionally unsuccessful. If a country removes itself from an international

trade agreement, or if a government imposes tariffs, it may produce an immediate

local benefit in the form of new jobs and industry. However, this is often not a

long-term solution to a trade problem. Eventually, that country will grow to be at a

disadvantage relative to its neighbors: countries that were already better able to

produce these items at a lower opportunity cost.

*The Argument for Free Trade

Obviously, the example here is incredibly oversimplified. In the real world, there

are hundreds of nations producing thousands of products, most with different

cost structures and at different levels of efficiency. However, in this simple

example is the fundamental argument for free trade, which most economists

support both in theory and in practice.

Economists support free trade because in general they want an economy,

including the global economy, to deliver the greatest good to the greatest number

of people. A look back at the example of U.S. and Japanese food and computer

production will reveal the benefits of specialization and exchange.

*Arguments Against Free Trade

Today, most arguments against free international trade are mounted by special

interest groups. Both labor unions and management oppose free trade when they

believe—sometimes correctly, sometimes incorrectly—that it will make them

worse off. What they conveniently ignore is that free trade will make everyone

else better off.

It is true that if the U.S. auto industry loses 5,000 jobs to foreign competitors,

those 5,000 workers and their households are worse off. However, the millions of
other households that can purchase less expensive, more efficient vehicles from a

wider range of choices are better off. The pain endured by one of those 5,000

households may well be greater than the benefit enjoyed by any given car-buying

household. That is why labor unions fight so hard to keep their members' jobs. But

an economist would argue that if another nation can make cars more efficiently,

those autoworkers should move into another U.S. industry and let the whole

population enjoy the benefits of free trade with the more efficient auto industry

of another nation.

*The arguments most often heard are …

1. Keeping jobs in the United States is important, but it's more important to keep

jobs in industries in which we operate efficiently. Otherwise, we are subsidizing

inefficiency, which hurts national productivity as well as consumers. If, indeed,

another nation is more efficient—has a comparative advantage—in producing a

product, it's in our interests to buy it from them.

2. We don't want money leaving the country may sound like a sensible argument

when you look at the GDP formula. If we import more than we export, GDP is

lowered. Doesn't that mean we are worse off? In a way, yes, but in a way, no.

3. National security is at stake with regard to some industries. Defense is the best

example of an industry that requires protection on the basis of national security.

Steel may be another, but the steel industry has been only partly successful with

this argument. Oil is another industry on which national security can depend,

although U.S. consumption of and dependence on foreign oil has been virtually

encouraged by the phase out of fuel efficiency standards for passenger vehicles
and low gasoline taxes (relative to those in Europe).

4. Other nations' unfair treatment of their workers is a relatively new argument

against imports, and it can be a tough argument both to document and deflect.

It's hard to document because, as we've learned, everything is relative. The awful

truth is that jobs in sweatshops may enable people in poor nations to feed and

cloth themselves. Limiting imports from these nations may hurt the very people

we would be trying to help. These arguments are hard to deflect because the

truth is that low cost foreign production sites often don't meet reasonable health

and safety standards.

5. Other nations “dumping” goods in the United States and keeping our imports

out do give protectionists ammunition in their battle against free trade. Dumping

occurs when a nation sells its goods in a foreign market at a price that is lower

than its price in the domestic market or lower than it cost to produce. The

objective is to drive the domestic producer out of the market—and out of

business—and then to raise the price when the domestic competition has gone

out of business. Both dumping and protectionism by other nations can put the

United States at a disadvantage.

-Objectives of Dumping:

1. To find a place in the foreign market

2. To sell surplus commodity

3. Expansion of industry

4. New trade relations

*Barriers to International Trade

Free trade refers to the elimination of barriers to international trade. The most

common barriers to trade are tariffs, quotas, and nontariff barriers.

A tariff is a tax on imports, which is collected by the federal government and

which raises the price of the good to the consumer. Also known as duties or

import duties, tariffs usually aim first to limit imports and second to raise revenue.

A quota is a limit on the amount of a certain type of good that may be imported

into the country. A quota can be either voluntary or legally enforced.

Nontariff barriers include quotas, regulations regarding product content or

quality, and other conditions that hinder imports. One of the most commonly

used nontariff barriers are product standards, which may aim to serve as “barriers

to trade.” For instance, when the United States prohibits the importation of

unpasteurized cheese from France, is it protecting the health of the American

consumer or protecting the revenue of the American cheese producer?

Other nontariff barriers include packing and shipping regulations, harbor and

airport permits, and onerous customs procedures, all of which can have either

legitimate or purely anti-import agendas, or both.

*The most important general trade agreement is called, simply enough, the

General Agreement on Tariffs and Trade (GATT). GATT was signed in October

1947 to liberalize trade, to create an organization to administer more liberal trade

agreements, and to establish a mechanism for resolving trade disputes. The GATT

organization is small and located in Geneva. More than 110 nations have signed

the general agreement, which originally was signed by 24 nations, including the

United States. To a large degree, the role of GATT as an organization has been
superseded by the World Trade Organization, which I discuss later in this section.

Since GATT was signed, several “rounds” of talks to liberalize trade have occurred.

The most significant of these were the Kennedy rounds, which eventually led to a

one-third reduction in tariffs and, more recently, the Uruguay rounds. The

Uruguay rounds dealt with general barriers to trade and the relatively new issues

of intellectual property rights, fishing practices, and environmental concerns.

A major trend of the past 25 years has been the creation and growth of free trade

zones among nations agreeing to form regional trade blocs. The agreements that

create free trade zones all share the same aims: to liberalize trade, promote

economic growth, and provide equal access to markets among the member

nations.

The most significant free trade zones are the European Union (EU), the North

American Free Trade Agreement (NAFTA), and the Association of Southeast Asian

Nations (ASEAN).

*From time to time you will hear about so-called fast track trade legislation, in

which Congress would give the president the authority to negotiate trade

agreements. This legislation has not been passed, and it remains controversial.

Supporters of the legislation believe that the present method of negotiating trade

agreements, which requires Congressional approval, is too slow and cumbersome

for today's world. Opponents point out that trade agreements are treaties with

other nations and that the Constitution invests Congress with the authority to

enter these agreements. They also point out that the fast track legislation would

limit public debate on trade policy. That debate, of course, is one of the reasons
that the present method is slow and cumbersome.

(The fast track authority for brokering trade agreements is the authority of the

President of the United States to negotiate international agreements that

Congress can approve or deny but cannot amend or filibuster.)

In addition, the World Trade Organization (WTO) is a global organization,

headquartered in Geneva, for dealing with trade between nations. Established in

January 1995 by the Uruguay round negotiations under GATT, the WTO included

144 nations as of January 2002. The WTO administers trade agreements, provides

a forum for trade negotiations and resolving trade disputes, monitors trade

policies, and provides technical assistance and training for developing countries.

*Other Possible Benefits of Trading Globally

International trade not only results in increased efficiency but also allows

countries to participate in a global economy, encouraging the opportunity for

foreign direct investment (FDI), which is the amount of money that individuals

invest into foreign companies and assets. In theory, economies can therefore grow

more efficiently and can more easily become competitive economic participants.

For the receiving government, FDI is a means by which foreign currency and

expertise can enter the country. It raises employment levels, and theoretically,

leads to a growth in gross domestic product (GDP). For the investor, FDI offers

company expansion and growth, which means higher revenues.

*Free Trade Vs. Protectionism

As with all theories, there are opposing views. International trade has two
contrasting views regarding the level of control placed on trade:

1. Free trade - the simpler of the two theories (a laissez-faire approach) with

no restrictions on trade. The main idea is that supply and demand factors,

operating on a global scale, will ensure that production happens efficiently.

Therefore, nothing needs to be done to protect or promote trade and growth,

because market forces will do so automatically.

2. Protectionism - holds that regulation of international trade is important to

ensure that markets function properly. Advocates of this theory believe that

market inefficiencies may hamper the benefits of international trade, and they

aim to guide the market accordingly. Protectionism exists in many different forms,

but the most common are tariffs, subsidies, and quotas. These strategies attempt

to correct any inefficiency in the international market.

As it opens up the opportunity for specialization, and therefore more efficient use

of resources, international trade has the potential to maximize a country's

capacity to produce and acquire goods. Opponents of global free trade have

argued, however, that international trade still allows for inefficiencies that leave

developing nations compromised. What is certain is that the global economy is in

a state of continual change, and, as it develops, so too must its participants.

*Advantages of International Trade:

1. Optimal use of natural resources:

International trade helps each country to make optimum use of its natural

resources. Each country can concentrate on production of those goods for which
its resources are best suited. Wastage of resources is avoided.

2. Availability of all types of goods:

It enables a country to obtain goods which it cannot produce or which it is not

producing due to higher costs, by importing from other countries at lower costs.

3. Specialisation:

Foreign trade leads to specialisation and encourages production of different goods

in different countries. Goods can be produced at a comparatively low cost due to

advantages of division of labour.

4. Advantages of large-scale production:

Due to international trade, goods are produced not only for home consumption

but for export to other countries also. Nations of the world can dispose of goods

which they have in surplus in the international markets. This leads to production

at large scale and the advantages of large scale production can be obtained by all

the countries of the world.

5. Stability in prices:

International trade irons out wild fluctuations in prices. It equalizes the prices of

goods throughout the world (ignoring cost of transportation, etc.)

6. Exchange of technical know-how and establishment of new industries:

Underdeveloped countries can establish and develop new industries with the

machinery, equipment and technical know-how imported from developed

countries. This helps in the development of these countries and the economy of

the world at large.

7. Increase in efficiency:

Due to international competition, the producers in a country attempt to produce

better quality goods and at the minimum possible cost. This increases the

efficiency and benefits to the consumers all over the world.

8. Development of the means of transport and communication:

International trade requires the best means of transport and communication. For

the advantages of international trade, development in the means of transport and

communication is also made possible.

ff. International co-operation and understanding:

The people of different countries come in contact with each other. Commercial

intercourse amongst nations of the world encourages exchange of ideas and

culture. It creates co-operation, understanding, cordial relations amongst various

nations.

10. Ability to face natural calamities:

Natural calamities such as drought, floods, famine, earthquake etc., affect the

production of a country adversely. Deficiency in the supply of goods at the time of

such natural calamities can be met by imports from other countries.

11. Other advantages:

International trade helps in many other ways such as benefits to consumers,

international peace and better standard of living.

*Disadvantages of International Trade:

Though foreign trade has many advantages, its dangers or disadvantages should

not be ignored.
1. Impediment in the Development of Home Industries:

International trade has an adverse effect on the development of home industries.

It poses a threat to the survival of infant industries at home. Due to foreign

competition and unrestricted imports, the upcoming industries in the country may

collapse.

2. Economic Dependence:

The underdeveloped countries have to depend upon the developed ones for

their economic development. Such reliance often leads to economic

exploitation. For instance, most of the underdeveloped countries in Africa and

Asia have been exploited by European countries.

3. Political Dependence:

International trade often encourages subjugation and slavery. It impairs

economic independence which endangers political dependence. For example,

the Britishers came to India as traders and ultimately ruled over India for a very

long time.

4. Mis-utilization of Natural Resources:

Excessive exports may exhaust the natural resources of a country in a shorter

span of time than it would have been otherwise. This will cause economic

downfall of the country in the long run.

5. Import of Harmful Goods:

Import of spurious drugs, luxury articles, etc. adversely affects the economy

and well-being of the people.

6. Storage of Goods:

Sometimes the essential commodities required in a country and in short supply

are also exported to earn foreign exchange. This results in shortage of these

goods at home and causes inflation. For example, India has been exporting

sugar to earn foreign trade exchange; hence the exalting prices of sugar in the

country.

7. Danger to International Peace:

International trade gives an opportunity to foreign agents to settle down in the

country which ultimately endangers its internal peace.

8. World Wars:

International trade breeds rivalries amongst nations due to competition in the

foreign markets. This may eventually lead to wars and disturb world peace.

9. Hardships in times of War:

International trade promotes lopsided development of a country as only those

goods which have comparative cost advantage are produced in a country.

During wars or when good relations do not prevail between nations, many

hardships may follow.

*Importance of trade:

1. Make use of abundant raw materials

2. Comparative advantage

3. Greater choice for consumers

4. Specialisation and economies of scale – greater efficiency

5. Service sector trade

6. Global growth and economic development

*The Reasons for Trade

1. Differences in Technology

2. Differences in Resource Endowments

3. Differences in Demand

4. Existence of Economies of Scale in Production

5. Existence of Government Policies