Reasons to Trade

There are five main reasons why countries may wish to engage in trade with other countries:

Differences in Technology

Countries may trade where there are differences in technology which affect the ability of firms to combine factors of production (labour capital and land) in order to turn resources into goods and services.

Resource Endowments

One country may have a greater supply of raw materials. Other countries will only be able to access these resources through trade. A classic example of this circumstance would be oil reserves held by middle-eastern countries. To access these resources western countries must engage in trade. The basis for trade in the Heckscher-Ohlin model is differences in resource endowments.

Differences in Demand

Demand varies between countries due to differences in tastes and preferences. This may result in excess demand in one market which cannot be met by the producers within that country. Imports from another country can help to satisfy that demand.

Economies of Scale in Production

Economies of scale in production may allow one country to produce goods more cheaply than another country.

Economies of scale arise when increasing production results in a fall in the unit cost of production as output increases. This phenomenon is known as “increasing returns to scale.”

Government Policies

Government tax and subsidies make the goods of one country less competitive than goods from another country

International trade is made up of exports and imports between countries. Exports and imports can be both visible and invisible. Countries may trade because they have an absolute advantage in a good or service or because they have a comparative advantage in a good or service. In the real world countries may trade in goods in which they have neither an absolute advantage nor a comparative advantage. They may trade in goods because they wish to earn foreign currency, even if they trade at a loss. This is called ‘dumping’. Dumping occurs when a country sells at below cost price.

The development of a comparative advantage in a good or service can results in an improvement in the living standards of a country’s population. It is possible to identify a long term correlation between the development of international trade and economic growth. The opportunity to buy cheap imported goods which are substitutes for more expensive domestically produced goods has the potential to increase the purchasing power of individuals. Inevitably some people may lose out as a consequence of increased trade as international competition may force domestic firms which are uncompetitive out of business. This in turn may lead to redundancies amongst the workforce. Countries may react to this lack of competitiveness by adopting protectionist policies. These are intended to provide obstacles to imported goods.
The United Kingdom’s trading activities are summarised in the Balance of Payments. The Balance of Payments are made up of a number of different sections and record the total value of the nation’s income from overseas trade and the total value of its imports (expenditure on overseas goods and services). It also records all international financial transactions.

The Balance of Payments is made up of the current account and the capital account. The current account includes a balance for visible trade and a balance for invisible trade.

The UK Balance of Payments

The capital account records transactions which involve the flow of money into and out of the UK as a result of investment. Capital outflows relate to the movement of funds overseas due to investment abroad. Capital inflows arise as a result of investment into the UK by foreign investors. In 2013, the financial account recorded a net inflow of £62.6 billion compared with a net inflow of £49.1 billion in 2012.

Why do countries have a Current Account deficit?

Lack of competitiveness – if wages costs or material costs are higher in one country than in another it will be harder to export. A lack of quality may also reduce competitiveness.

Lack of balance in the economy – an overemphasis on consumer spending rather than on investment and increasing exports may lead to an increasing current account deficit.

Increasing consumer spending – a rapid growth in consumer spending may lead to a rise in imports and the current account deteriorating.

An overvalued currency -may lead to a country’s goods becoming uncompetitive. Greece has struggled in the Eurozone because the currency makes its goods uncompetitive. Greek politicians have argued for an exit from the Eurozone because it would allow them to devalue their currency making exports more competitive

Barriers to Trade

A barrier to trade is a government-imposed restraint on the flow of international goods or services. There are a number of adverse consequences of trade barriers for consumers. One of the most obvious is that they result in a limited choice of products and force customers to pay higher prices and accept inferior quality.
The most common types of trade barrier are:

Tariffs which are a tax on imports or exports

Import licences are documents issued by a national government which authorise the importation of certain goods. Firms which do not have an import licence will not be able to export their goods to another country.

Export licences allow companies to export goods to another country. This type of restriction is often used to limit exports of weapons or materials which could be used to make weapons.

Import quotas limit the quantity of a good that can be produced abroad and sold domestically.

Subsidies provide financial support to an economic sector as a way of protecting that sector from cheaper imports and to make exports more competitive.

Voluntary export restraint (VER) is a government-imposed limit on the quantity of goods which can be exported to a specified country. This measure is often introduced in order to prevent a third party government placing greater restrictions on a country’s exports.

An embargo (trading ban) may be placed on one country’s exports. This measure is often used in an attempt to pressure another country when diplomatic relations are volatile. America has had an embargo on trade with Cuba since the 1950s.

Devaluation can be used to reduce the value of a country’s currency in order to make its exports more competitive.

Trade restrictions refer to red tape which can be used to limit imports. Japan has used trade restrictions to limit foreign car imports. Regulations make it difficult and more expensive for foreign car makers to sell their vehicles in Japan without significant modification.

Key Terms

Invisible trade: This is the import or export of services. Invisible trade consists of trade in financial services, insurance services, tourism and shipping. Invisibles are an important contributor to world trade and represent approximately one quarter of global trade. Historically the United Kingdom has enjoyed a surplus in its invisible trade. This surplus has helped to pay for the UK’s long standing deficit in visible trade.

Visible trade: This is concerned with the import and export of goods. The United Kingdom has experienced a recurring deficit in its visible trade since the Second World War.

Absolute advantage: This means being more productive or cost-efficient than another country whereas comparative advantage relates to how much productive or cost efficient one country is than another.

Comparative advantage: The ability of a firm or individual to produce goods and/or services at a lower opportunity cost than other countries. A comparative advantage company the ability to sell goods and services at a lower price than its competitors and realise stronger sales margins.

A barrier to trade: a government-imposed restraint on the flow of international goods or services.