Dr Zain Yusufzai International trade Chapter # 6 (page152-178).

Introduction

International trade:
The branch of economics concerned with the
exchange of goods and services with foreign
countries
 Trade deficit will not be reduced by political
measures
 International economic problems cannot be
solved in the short run
 Require long run economic measures that
reduce imports and increase exports
 All countries want favorable trade balance,
 Not possible since a nation with a deficit must
be matched b y a nation with a surplus
 Economies moving from state run to market
driven economies
 Inflation and unemployment severe problems
 Enhanced international trade is one way to
address a weak macroeconomic
 Economists have proven that free trade is
efficient and leads to maximum economic
prosperity

Intention trade theory

 Why do nations trade?

 Answer provided by mercantilism

Mercantilism: a trade theory, which holds that a

government can improve the economic well-being
of the country by encouraging exports and stifling
imports
 It results in positive balance of trade that
leads to wealth (gold) flowing into the
country

Theory of absolute advantage:

A trade theory, which holds that, by specializing in
the production of goods, which they can produce
more efficiently than any others, nations, can
increase their economic well-being

Theory of comparative advantage:

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A trade theory which holds that nations goods for

which they have the greatest relative advantage

Factor endowment theory

a trade theory that holds that nations will produce
and export products that use large amounts of
production factors that they have in abundance and
will import products requiring a large amount of
production factors that are scarce in their country
 First country has absolute advantage in
producing a product, there exists a potential
for gains from trade
 Second, the more a country is able to
specialize in the production of the goods it
produces most efficiently , the greater its
potential gains in national well being
 Third , within one country the competitive
market does not evenly distribute the grains
from trade
 The nation as a whole benefit from trade

Heckscher-Ohlin theory:
That extends the concept of comparative
advantage by bringing into consideration the
endowment and cost of factors of production
and helps to explain why nations with relatively
large labor forces will concentrate on producing

Labor-intensive goods,
Whereas countries with relatively mare capital than
labor will specialize in capital-intensive goods

Leontief paradox:
A finding by Wassily Leontief, a noble prize
economist, which shows that the US, surprisingly,
exports relatively more labor-intensive goods and
imports capital-intensive goods

International product life cycle theory (IPLC)

a theory of the stages of production of a product
with new know how it is fist produced by the parent
firm then by its foreign subsidiaries and finally
anywhere in the world where costs are the lowest it
helps to explain why a product that begins as a
nation’s export often ends up as an import

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Product stages: IPLC has three stages

1. new product
2. maturing product
3. standardized product
New product
 innovative or unique in some way
 initial consumption is in the home
country
 price inelastic, profits are high
 production increases and output runs
local consumption exporting begins
(maturity stage)
 competitors will be working to develop
substitute products so the original
product can be replaced with one of
their own
 introduction of substitutes and the
softening of demand for the original
product will eventually result in the
firm switching its strategy from
production to market protection,

Personal computers and the IPLC

 Change from desk top to laptop and notebooks
in five years

Other important considerations

 Government regulations
 Political reasons
 Monetary currency valuation
 Consumer tastes

Monetary currency valuation

Exchange rate the price of and currency stated in
terms of another currency

Consumer tastes
 Personal tastes dictate consumer decisions
 Price not the only decision factor
 Willing to pay more may be based on:
o Prestige, perceived quality
o Physical and psychological reasons

Barriers to trade

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 Trade barriers make less expensive foreign

product expensive

Reasons for trade barriers

 Encourage local production by making it
difficult for competition from foreign firms
 Help local firms export and build world wide
market share
 Protect local jobs
 Protect infant industries
 Promote export activity
 Promote political objectives such as refusing
to trade with counties that practice apartheid
or deny civil liberties to their citizens

Commonly used barriers (six barriers)

i. price based barriers
 imported goods and services
sometimes have a tariff added to their
price
 based on the value of the goods
Tariffs:
 raise revenues for the government,
 discourage imports
 make local goods more attractive

ii. Quantity limits

Also known as quota, restrict the number of units
that can be imported or the market share that is
permitted
Quota prices set at zero, it is called embargo

Quota:
A quantity limit on imported goods

Embargo:
A quota set at zero, thus preventing the
importation of those products that are involved

iii. International price fixing

A host of international firms will fix prices or
quantities sold in an effort to control price this is
known as a cartel

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Cartel:
A group of firms that collectively agree to fix prices
or quantities sold in an effort to control price
(example: OPEC controls price of oil)

iv. Non-tariff barriers:

Rules, regulation, and bureaucratic red tape that
delay or preclude the purchase of foreign goods
(examples include)
• Slow processing of import permits
• establishment of quality standards that
exclude foreign producers,
• a “buy local” policy

v. Financial limits
i. Exchange controls that restrict the flow
of currency
ii. Allow exporters to exchange their
dollars for local currency
iii. Place restrictions on access to dollars
for purchasing imports
iv. Limit on currency taken out of the
country
v. Fixed exchange rates price of currency

V1. Foreign investment controls

Limits on foreign direct investment or the transfer
or remittance of funds
These controls take a number of different forms
• Requiring foreign investors to take minority
ownership position (49 % or less)
• Limiting profit remittance example 15% of
accumulated capita l per year
• Prohibiting royalty payments to parent
companies stopping the latter from taking
out capital

Tariffs:
A tax on goods shipped internationally
Import tariff:
A tax levied on goods shipped into a country
Export tariff:
A tax levied on goods sent out of a country
Transit tariff:
A tax levied on goods passing though a country
Specific duty:

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A tariff based on the number of items shipped into a

country
Ad valorem duty:
A tax, based on a percentage of the value of
imported goods
Compound duty:
A tariff consisting of both a specific and an ad
valorem duty
Dumping:
The selling of imported goods at a price below cost
or below that price in the home country

US Trade Policy
• US strives to lower tariffs and trade barriers
through the use of multilateral agreements
• Minimize the use of tariffs
• Supported the general agreement on tariff
and trade (GATT)
• Supported the world trade organization
(WTO) in 1994

Caribbean basin initiative:

A trade agreement that eliminates tariffs on many
imports to the US from the Caribbean and Central
American and Central American regions

Foreign sales:
Corporation ACT legislation designed to allow US
exporters to establish overseer’s affiliates and not
pay taxes on the affiliate’s income until the
earnings are remitted to the parent company

Trade adjustment assistance:

Assistance offered by the US government, to US
businesses and individuals harmed by competition
from imports

Non-tariff barriers to trade

• not imposed by countries to interfere with
trade
• a by product of domestic policy and
economic management
• example: tax break, to reduce regional
income disparities or regulations designed to
increase local purchasing or employment

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Buy national restrictions

• “buy National” regulations require national
governments to give preference to domestic
producers, sometimes to the complete
exclusion of foreign firms

Customs valuation
• value for duty is based on the invoice cost,
and the latitude of customers to reclassify
products has been reduced
Technical barriers
• product and process standards for health,
welfare, safety, quality, size and
measurements
• testing and certification procedures, such as
testing only in the importing country and on
site plant inspections
New code on technical barriers to trade requires:
• consultation between trading partners before
a standard that impedes trade is put in place
• it requires that testing and certification
procedures treat imports and domestic
goods equally
• importing country accepts certification
testing conducted in the exporting country

Antidumping legislation, subsides, and

countervailing duties
Governments protect local firms from foreign
companies, who practice,
Dumping goods at low prices to drive local
competition out of business

Agricultural products
• Trade in agricultural products highly
regulated by quotas and fixed and variable
tariffs
• Domestic product highly subsidized

Export restraints

Other economic developments (includes three

considerations:
i. Counter trade
Barter trade in which the exporting firm receives
payment in products from the importing country

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Trade in services
• High income countries move towards a
service economy
• Internationally traded services: banking,
investment income, insurance, media,
transportation, advertising accounting ,travel,
and technology licensing
• Subject to a host of national and international
regulations for economic, social, cultural and
political reasons

Free trade zones:

A designated area where importers can defer
payment of customs duty while further processing
of products takes place (same as foreign trade
zone)

Maquiladora industry:
a free trade zone that has sprung up along the US-
Mexican border for the purpose of producing goods
and them between the two countries

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