GLOBAL TRADE & THEORIES

Free trade vs. Fair Trade

Free Trade implies that the govt. of the land applies

minimal influence on the decisions relating to exports &
imports made by private individuals & businesses

Fair Trade or Managed Trade suggests that govt. of the

land should actively intervene & ensure that exports
from the country receive a fair share in the global trade
but the imports are controlled
Factors supporting Outward Trade Policies

• Free trade promotes world trade

• Economic interdependence leads to lesser conflicts
• Uneven distribution of Resources
• Efficient utilization of Global Resources
• Global competition forces efficiency & innovation
Factors supporting Inward Trade Policies

• Political Argument
• National Security
• Protection of Jobs
• Human Rights Protection
• Retaliation
• Economic Argument
• Infant Industry Argument
• Strategic Trade Policy
Barriers to Trade
• Tariff Barriers-tax imposed on goods involved in international
trade
• Import Duties

• Export Tariffs

• Transit Tariffs

• Non tariffs
• Quotas

• Subsidies

• Others
Trade barriers
• Quotas- Numerical limits on the quantity of goods that
may be imported into a country during a specified
period
• VER(Voluntary Export Restrain

• Subsidies- Govt. payments & concessions to domestic

producers, eg. Low interest loans, tax breaks
Non Tariff Barriers
• Others
• Embargoes
• Local Content requirement
• Administrative Delays
• Currency Controls
• Product Testing & Standards
TRADE THEORIES
Merchantilism
Absolute Advantage
Comparative Advantage
Factor Proportions Theory
Merchantilism

Emerged in England in mid-16th century

Gold & Silver are the mainstays of national wealth &
essential for commerce
Earning the same is the main motive
Emphasizes on maintaining trade surplus
Double exploitation
Believes in Zero sum game
Theory of Absolute Advantage
Propounded by Adam Smith – The Wealth of Nations in 1776
Countries differ in their ability to produce goods efficiently eg.
England – textiles, French- Wine
England has absolute advantage in production of textiles &
France in Wine
Countries should specialize in production of goods for which
they have an absolute advantage & then trade these goods
for the goods produced by other country
 Theory of Absolute Advantage
Country Olive Oil shoes

Spain 2 (hrs.) 4

Italy 4 2
Theory of Comparative Advantage
Propounded by Ricardo.
Country should specialize in the production of those goods that
it produces more efficiently and buy the goods that it
produces less efficiently from other countries.

Eg. England- cloth-100 men, wine-120 men

Portugal- cloth 90 men, wine-80 men
Theory of Comparative Advantage

Country Olive Oil Shoes

Spain 1 2

Italy 6 3
Theory of Comparative Advantage
Assumptions:
Countries are driven only by production and
consumption maximization.
Only two countries are engaged in the process.
There are no transportation costs for shipping.
Labor is the only factor of production.
Specialization and production of a particular good
does nor result in increased efficiency.
Factor Endowment Theory
 Propounded by Heckscher and Burtill Ohlin
 Comparative advantage arises from difference in national
factor endowment- land , labor capital.
 Different factor endowments explain differences in factor
costs.
 Countries will export those goods that make intensive use of
those factors that are locally abundant, while importing goods
that make intensive use of factors that are locally scarce
 capital abundancy will export capital- intensive goods while
the labor- abundant countries will export labor intensive
products.
FIRM SPECIFIC THEORIES
Product Life Cycle Theory
New Trade Theory
National Competitive Advantage
Product Life Cycle Theory

Propounded by Raymond Vernon in 1960

A company will begin by exporting its products and eventually
undertake FDI,as the product moves through its lifecycle i.e.
a country’s export eventually becomes its imports
The theory has identified three stages in the life of a product:
1. New Product Stage

2. Maturing Product Stage

3. Standardized Product Stage

Product Life Cycle Theory
New Product Stage
• Introduction of Innovative product
• Production in limited quantity, for domestic market
• Exports either non existent or minimal
Maturing Product Stage
• Rise in acceptance & Popularity
• Increased demand in domestic & foreign markets
• Manufacturing facilities set up abroad
• Near the end attempts made to produce the product in
developing countries
Product Life Cycle Theory

Standardized Product Stage

• Product stabilizes
• Markets become price sensitive

• Manufacturers search for low cost producing countries

• Product begins to be imported into innovative firm’s home

country
• E.g. electronic goods, television, calculators etc

Theory is illustrated by photocopiers- Xerox

New Trade Theory

• Gains to be made from specialization & economies of scale

• First movers create entry barriers
• Govt. may have a role to play in assisting its home based
firms
• Theory emphasizes on productivity rather than country’s
resources
 National Competitive Advantage
• Propounded by Michael Porter- studied 100 companies in 10
developed countries- to learn how a firm can become
competitive
• Identified 4 factors
• Factor conditions
• Demand conditions
• Strategy & Rivalry
• Related& Supporting Industries
National Competitive Advantage

 Factor condition
• Factors include land, labour & natural resources
• Competitive edge is provided by Specialized factors-Skilled
labour, capital & infrastructure
 Difficult to duplicate

 Demand condition
• Size & sophistication of market
National Competitive Advantage

 Related & supporting industries

• Enhance firm’s competitive advantage by joint research,
problem solving, sharing of knowledge & experience

 Strategy, Structure & Rivalry

• Competition- proactivity, innovation etc
BALANCE OF PAYMENT
 BALANCE OF TRADE – MOVEMENT OF GOODS (i.E., Visible
items only) between countreis.
 Balance of payment – includes visible as well as invisible items (viz.,
Charges for ship, banking, insurance, interest on investments, gifts
etc.
 Balance of payment has three components
1. Current account
2. Capital transactions
3. Overall surplus or deficit, and the method of using the surplus or
financing the deficit in the balance of payment
 CONTD…
 Current account – comprises of
1. Merchandise or import/export of goods (visible items)
2. Trade in services – tourist traffic, transportation, banking & insurance etc.
(Invisible items)
 Capital transactions – includes loans from or to foreigners, capital repayment
from ot to foreigners, borrowings from or to imf, purchase and sale of capital
assets etc.
 Distinction on current & capital account
 The current account deals with all receipt and payment for currently produced
goods & services, also includes interest earned or paid on claims and gifts and
donations while capital account deals with debts and claims of country
 The current of bop affects the national income directly while capital account
does’nt have direct influence as it only deals with the external assets and currency
reserves of the country
 CONTD…
 Overall deficit or surplus – method of settling deficit:
1. External assistance in the form of loans & grants from foreign countries &
financial institutions
2. Drawing from imf
3. Use of foreign exchange reserves and gold reserves
 If a country has deficit in a particular year, it is adjusted by one or more of the
above three methods
 If country suffers from persiitent & chronic deficit in bop year after year -
1. Country may not be able to borrow from other countries beyond certain limit
2. There is a limit to drawing from imf
3. Foreign exchange & gold reserves countries may be exhausted
DISEQUILIBRIUM IN THE BOP
 Disequilibrium means either the country has favourable or
unfavourable bop
 Types of disequilibrium
1. Cyclical –
 Favourable and adverse balances alternate
 Do not pose a problem to country so long as mechanism of adjustment
is automatic
2. Structural –
 Is the result of technology, tastes & attitude towards foreign
investment
 Such deficit is not permanent
3. Fundamental –
 Refers to the causes or size of disequilibrium or its persistence.
METHODS OF CORRECTING AN
ADVERSE BOP
 Five methods
1. Deflation & adverse balance –
 The fundamental cause is excessive demand for foreign goods
 To correct – curtail demands of foreign goods by restricting
consumptions
 Deflation (fall in prices & income) attempts to restrict demand for
foreign goods
 Deflation is diliked for two reasons
a. Reduction in money income implies reduction in wages which is
strongly opposed by trade unions
b. Deflation implies unemployment & suffering
 CONTD…
2. Exchange depreciation
 Decline in rate of exchange of one currency in terms of other
 It is automatic and correct the mild adverse bop
 If india is facing adverse bop in regard to us – the demand of dollar
will rise and price of dollar will go up
 This will raise the price of american goods & reduce india’s demands
for american goods
 India’s import will decline
 This will stimulate the export from india for 2 reasons
a. American will find indian commodities cheap
b. Indian export will export more because of larger earning than before
 CONTD..
 Exachnge depriciation is defective in many ways
a. Not suitable for countries which want to keep exchange rate fixed
b. Makes international trade risky and hence reduces volume of trade
c. The terms of trade will go against the country whose currency depreciates
in value
d. May result in inflationary situation by making goods more expensive
3. Devaluation
 Lowering the value of currency in terms of gold or in terms of other
currencies
 It is the proper method of correcting adverse bop which is due to
overvaluation of currency
 It may also resorted by countries if interested in getting competitive edge
by lowering cost in foreign market
CONTD..
 Conditions for success of devaluation
 Elasticity of demand
 Cost-price structure – it is possible for costs & prices within a
country to change for 2 reasons
 Rise in the price of goods whose imports are cut-off
 Imports which have become costly may be a part of
consumption, thus cost of ling will rise
 Co-operation of other countries
 Foreign countries will experience contraction in the demand
for their exports & while expansion in import
 May retaliate by keeping high tariffs to prevent imports or
grant of subsidies to push up export
 CONTD…
4. EXchange control
 Govt. Regulation of exchange rates as well as restriction on conversion of the local
currency against foreign currency
 Exchange control may be adopted by country under following circumstances –
a. Free exchange market may not be desirable/effective
b. May be necessary when there is a heavy run on a country’s foreign reserves either
due to heavy adverse bop or movement of capital out of country
c. To prevent the import’s of foreign goods in to the country
d. To secure an adequate amount of foreign currency to buy essential foreign goods
e. To freeze the assets of foreign national
f. To overvalue or undervalue its exchange rate or to avoid fluctuation in exchange
rate
g. Necessary in the planned economies
 CONTD…

 Methods of exchange control

i. Interventions –
 Pegging operations – govt. Intervention in the foreign exchange
market take the form of ‘pegging up’ /‘pegging down’ the currency of
the country to a chosen rate of exchage.
ii. Restriction –
 A more powerful weapon – govt. Restricts the supply of currency
coming into exchange market. May be of three types:
 Centralize all trading in foreign exchange with one central authority
 Prevent the exchange of national currency against foreign currency
without the permission of govt.
 Make all foreign exchange transaction through the agency of govt.
CONTD..
iii. Exchange clearing arrangement
 Two countries engaged in trade pay their respective
central banks the amounts payable to their respective
foreign creditors
5. Import duties and quotas
 Most common devise to restrict foreign trade
 Import duties better than other method
International Financial institutions
International Monetary Fund
The World Bank
Asian Development Bank
International Monetary Fund

 Established on December,27th 1945

 Initial membership -29
 Present Members- 187
 Established as an outcome of the Bretton WoodsConference
IMF: Objectives

 To Promote international monetary cooperation

 To facilitate the expansion & balanced growth of
international trade
 To maintain exchange stability
 Establishing multilateral system of payment in respect of
current transaction between members
 Temporary financial assistance to members to help ease
balance of payment adjustments
 Shorten the duration and lessen the degree of disequilibria in
the international balances of payments of members
IMF: Basic Operations

 Financial Assistance
 Technical Assistance
 Surveillance
IMF: Financial Assistance

 Core responsibility of IMF  provide loans to countries

experiencing balance of payments problems
 Enabling countries to rebuild their international reserves, stabilise
their currencies, continue paying for imports, and restore
conditions for strong economic growth
 IMF does not lend for specific projects
 The nature and volume of IMF lending has changed overtime:
 1970s Oil shock
 1980s debt crisis
 1990s transition of central & eastern Europe and emerging market
economies like India
IMF: Financial Assistance

The process of IMF lending

 Provided under an “arrangement”, which stipulates the
specific policies and measures a country has agreed to
implement to resolve its balance of payments problems
 The economic program underlying an arrangement is
formulated by the country in consultation with the IMF
IMF Lending facilities
 Poverty Reduction & Growth Facility(PRGF) and
Exogenous Shocks Facility(ESF)
 Provided to Low Income countries
 Concessional rate of interest
 Rate of interest- 0.5% ,Repaid in -5 1/2-10 yrs.
 Stand by Arrangement (SBA)
 Provided to countries to address their short term balance
of Payment problem
 The length of SBA is 12-24 months
 Repayment period is 2 ¼ - 4 yrs.
IMF Lending facilities
 Extended Fund facility(EFF)
 Addresses longer term BOP problems
 Arrangements under EFF extend for 3 yrs.
 Repayment- 4 ½ - 7 yrs.
 Supplemental Reserve facility(SRF)
 Very Short-term financing on large scale
 Meant for emerging economies
 Repayment -2-2 ½ yrs.
IMF Lending facilities
 Emergency Assistance
 Assistance to countries that have experienced natural
disaster or have emerged from conflict
 Repayment- 3 ¼ - 5 yrs.
Technical Assistance
 To strengthen capacity in human & Institutional
resources
 Generally provided free of charge

 90% goes to low and lower middle income countries

 Post-conflict countries are major beneficiaries

Areas of technical assistance

Build capacity to design and implement poverty
reducing and growth programmes
Underatke debt sustainability analysis
Manage debt reduction programmes
Modes of Technical Assistance
 Through staff missions of limited durations
 Placement of experts or advisors
 Technical and diagnostic studies
 Training courses, seminars, workshops, online
advice
Regional approach to Technical Assistance
 Operates in six regional assistance centres- the pacific,
the carribean, east west and central Africa and Middle
east.
Surveillance
 Provides expert assessment of economic &
financial developments
 The economic & financial policies of one country
has spill over effect on the other countries
The World Bank Group
The bank came into existence on December,27, 1945
Family of five international organizations
• International Bank of Reconstruction & Development (IBRD)

• International Development Association (IDA)

• International Finance Corporation (IFC)

• Multilateral Investment Guarantee Agency (MIGA)

• International Centre for Settlement of Investment

Disputes(ICSID)
The World bank (IBRD & IDA)

• Activities focus on developing countries

• Human Development (education, health)

• Agriculture & Rural development (irrigation, rural services)

• Environmental Protection (pollution reduction,

establishing & enforcing regulations)
• Infrastructure( roads, electricity)

• Governance(anticorruption, legal institutions

development)
World Bank Assistance
 IBRD & IDA provide low or no interest
loans/grants to countries who have unfavorable or
no access to international credit markets
 Do not operate for profit
 Provides two kinds of Loans
 Investment Loans
 Development Policy Loans
World Bank Assistance
 Grants are designed to encourage innovation
between organizations and local stakeholders
participation, etc
 Grants are used to:
 Relive debt burden of heavily indebted poor countries
 Improve sanitation and water supplies
 Support vaccination and immunization programmes
 Combat the AIDS pandemic
 Create initiatives to counter global warming
Analytical & Advisory Services
Focuses on the following
 Poverty assessment

 Public expenditure reviews

 Social and structural reviews

 Sector reports

 Capacity building
Capacity Building
 To increase the capability of staff, partners, people
in developing countries
 Help them acquire knowledge, skills, provide
technical assistance, improve government
performance, promote economic growth, etc
 Knowledge sharing networks
Knowledge sharing networks
 Advisory services & ‘Ask Us’ help desk

 Global development learning network

 World Bank Institute Global and Regional

Programmes
 B-SPAN webcasting services
Surveillance
 When a country joins IMF, it agrees to subject its
economic and financial policies to the scrutiny of
the international community.
 It also makes commitment to pursue policies that are
conducive to orderly economic growth and
reasonable price stability, to avoid manipulating
exchange rates for unfair competitive advantage,
and to provide IMF with data about its economy
 The IMF’s regular monitoring of economies and
associated provision of policy advice to identify
weakness that are causing or could lead to financial
or economic instability
Surveillance
 Country Surveillance
 Regional Surveillance
 Global Survelliance